Objective and strategy
The fund is trying to grow capital, with the particular goal of beating the MSCI All Country World Index over the long term while maintaining an emphasis on capital preservation. The fund allocates assets between stocks (10-90%), fixed-income securities (10-90%), and cash depending on market conditions. The equity portion of the portfolio is invested in stocks of firms that they designate as “knowledge leaders.” Knowledge Leaders are a group of the world’s leading innovators with deep reservoirs of intangible capital. These companies often possess competitive advantages such as strong brand, proprietary knowledge, or a unique distribution mechanism. Knowledge Leaders are largely service-based and advanced manufacturing businesses, often operating globally. Their investable universe is mid- and large-cap stocks in 24 developed markets. They buy those stocks directly, in local currencies, and do not hedge their currency exposure.
Knowledge Leaders Capital, LLC, of Denver, Colorado. KL started as a US money management affiliate of GaveKal Research Ltd., a Hong Kong-based independent research boutique. Founder Steven Vannelli had partnered with GaveKal for about a decade (2006-17) but had a long-term plan to become an independent shop. They manage over $300 million in the Knowledge Leaders Allocation Fund, an ETF that embodies the equity-only portion of the strategy and a series of separately managed accounts that replicate both the allocation and equity-only strategies.
Steven Vannelli and Bruce Coward. Mr. Vannelli is managing director of Knowledge Leaders Capital, manager of the fund, and lead author of the firm’s strategy for how to account for intangible capital. Before joining GaveKal, he served for 10 years at Denver-based money management firm Alexander Capital, most recently as Head of Equities.
Bryce Coward, the Deputy CIO, joined Knowledge Leaders in 2009 after a two-year stint as an analyst at Level 3 Communications. He shares responsibility for the selection of developed world equities, fixed income, cash and commodities.
Strategy capacity and closure
With a large-cap, global focus, they believe they might easily manage something like $3 billion across tactical allocation manifestations of the strategy, this fund, and some separate accounts. The equity-only version, the Knowledge Leaders Developed World ETF (KLDW), has probably three times that capacity.
97. “Active share” measures the degree to which a fund’s portfolio differs from the holdings of its benchmark portfolio. High active share indicates management which is providing a portfolio that is substantially different from, and independent of, the index. An active share of zero indicates perfect overlap with the index, 100 indicates perfect independence. The active share for the Knowledge Leaders Fund is 97, which reflects a very high level of independence from its benchmark MSCI All Country World Index.
Management’s stake in the fund
Mr. Vannelli seeded the fund with $250,000 of his own money. His current stake is in the range of $100,000 – 500,000. There is no corporate policy encouraging or requiring employee investment in the fund and none of the fund’s directors have invested in it.
September 30, 2010. Two caveats. First, Mr. Vannelli began managing a version for European investors in 2006. Second, the fund’s strategy changed on March 31, 2015, when it went from an all-equity portfolio to one relying on a tactical allocation strategy.
$2500 for Advisor shares, $500,000 for Institutional ones.
1.49% on the Advisor share class and1.24% on Institutional share class, on assets of $157 million.
The stock investors have three nemeses:
- Low long-term returns
- High short-term volatility
- A tendency to overpay for equities
Many managers specialize in addressing one or two of these three faults. Knowledge Leaders think they’ve got a formula for addressing three of three.
Low long-term returns: Knowledge Leaders believes that large stocks of “intangible capital” are key drivers of long-term returns and has developed a database of historic intangible-adjusted financial data, which it believes gives it a unique perspective. Intangible capital represents investments in a firm’s future profitability. It includes research and development investments but also expenditures to upgrade the abilities of their employees. There’s unequivocal evidence that such investments drive a firm’s long-term success. Sadly, current accounting practices punish firms that make these investments by characterizing them as “expenses,” the presence of which makes the firm look less attractive to short-term investors. Mr. Vannelli’s specialty has been in tracking down and accurately characterizing such investments in order to assess a firm’s longer-term prospects.
High short-term volatility: there’s unequivocal empirical and academic research that shows that investors are far more cowardly than they know. While we might pretend to be gunslingers, we’re actually likely to duck under the table at the first sign of trouble. Knowing that, the manager works to minimize both security and market risk for his investors. His first tool is the structure of the equity portfolio. In addition to the inherent resilience of Knowledge Leaders, they also limit the size of any individual position to 5% of the portfolio. They entirely screen out a number of high leverage sectors, especially those where a firm’s fate might be controlled by government policies or other macro factors. The excluded sectors include financials, commodities, utilities, and energy. Conversely, many of the sectors with high concentrations of knowledge leaders, health care, for example, are defensive.
The second tool is the fixed-income and cash buffer. The extent of equity exposure is controlled by their view of the macro environment. Finally, they have the option to reduce market exposure when some combination of four correlation and volatility triggers are pulled. They monitor the correlation between stocks and bonds, the correlation between stocks within a broad equity index, the correlation between their benchmark index and the VIX and the absolute level of the VIX. In high-risk markets, they increase the buffer. Equities, as a percentage of the portfolio, have ranged over the past five years from 45 – 70% with a substantial fraction invested overseas.
That cautious flexibility has paid remarkable dividends: the fund has outperformed its benchmark in every one of the 17 drawdowns of 5% or more since its launch and even made money during two of the three major drawdowns between May 2019 and May 2020.
A tendency to overpay: “expensive” is always relative to the quality of goods that you’re buying. Knowledge Leaders assigns two grades to every stock, a valuation grade based on factors such as price to free cash flow relative both to a firm’s own history and to its industry’s and a quality grade based on an analysis of the firm’s balance sheet, cash flow, and income statement. Importantly, Knowledge Leaders use their proprietary intangible-adjusted metrics in the analysis of value and quality.
In the end, you get a very solid, mildly-mannered portfolio. Here are the standard measures of the fund against its benchmark. Since the fund added its allocation strategy about five years ago, we’ll look at the five-year metrics.
|GAVAX||MSCI All Country World Index|
Compared against its Lipper Flexible Portfolio peer group, which is home to funds such as FPA Crescent, Bruce, First Eagle Global and IVA Worldwide, GAVAX places in the top 10% of all funds in every meaningful measure: total returns, Sharpe ratio, downside deviation, bear market deviation, down market deviation, capture ratio for the S&P 500, capture ratio for 60/40 hybrid benchmark and so on.
And, by each of those same measures, KL Allocation has outperformed all of those famous titans over the past five years.
This is not a fund for investors seeking unwaveringly high exposure to the global equities market. The fund has quietly made a strong case for consideration by investors anxious that the markets of the next five years will be rockier and less rewarding than the five years just past. It has earned serious consideration for investors and advisors crafting a sustainable, long-term conservative equity portfolio.
KL Allocation Fund. As befits folks who take knowledge seriously, the site is ridiculously rich in content, some appropriate to all of us and some sensible mostly to trained professionals. A really good intro to their thinking – from why they were increasing equity during the meltdown in the first quarter to why gold is becoming a better hedge than bonds – is in the Quarterly Commentary for the first quarter of 2020.
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