November 2020 IssueLong scroll reading

The End of Many Eras

By Edward A. Studzinski

“A genius is the man who can do the average thing when everyone else around him is losing his mind.”

            Napoleon Bonaparte

For those who missed my comments last month, there were not any. I felt I had nothing new to say. And while the same may be true this month, I thought I would give it a shot.

The other day I was joking with David Snowball about the fact that, although this publication is called The Mutual Fund Observer, it was perhaps time to admit that the day of the 1940’s Act mutual fund was over. David responded by indicating that more new funds had been started recently than had been seen in a long time. Many of those newly formed funds were shutting down almost as quickly as they had been started.

Some of that is a function of the increasing presence of exchange-traded funds, with their low fees and daily investor liquidity. At the same time, a generational shift continues in the portfolio managers of established active-managed funds, along with shrinkage in terms of assets under management.

When I left Harris Associates in January of 2012, the Oakmark Equity and Income Fund had, on 12/31/2011, $18.9B in assets. Performance over the long-term had been above the relevant benchmarks. As of 10/31/2020, per Morningstar, the fund’s assets are at $7.2B, and performance has been lagging benchmarks for the last 1, 3, and 5 years. 

What is the problem? Has my former colleague Clyde McGregor lost his touch? No, certainly not that I can see. The equity portion of the portfolio is a classic Harris Associates’ value portfolio, and it looks very interesting to me looking forward over a three to five-year time horizon. 

There are two areas of issue. Please recognize that I am speaking about balanced funds, which is the class of investment I am most familiar with, having managed the same for more than twenty-five years at a national bank trust department as well as at Harris Associates. The first competitive issue is fees. When Fidelity’s Balanced Fund shows a 53-basis point expense ratio and Vanguard’s Wellington Fund shows a 25-basis point expense ratio (and the Vanguard Admiral share class drops that fee to 17 basis points). A 25 to 35 basis point fee disadvantage is a lot of baggage to overcome consistently in terms of its detrimental impact upon performance. If the fee disparity is larger, making up the differential becomes nigh on impossible. I will leave it to others to address the issue of the fee disadvantages relative to exchange traded funds.

The other area of disadvantage currently is fixed income as an asset class for a balanced portfolio. With rates where they are and where they are likely to be for the foreseeable future, it is almost impossible to add any value in the fixed income area without taking on extreme amounts of risk. Money market rates, when not negative, are running from zero to perhaps eight basis points. Maturities beyond two years are not compensating you for the risk you are taking on (if you are lucky, you can find 1% on a credit union’s three-year insured certificate of deposit). 

I will leave aside the issue of value being out of favor as opposed to growth. Those of us who are value investors are prepared to wait through those periods of underperformance. That said, the goalposts for various asset classes have shifted. Small cap was equities with a market capitalization of $500M to $1B. Now, the range is extended up to $2.5B. And one must consider the extent to which other asset classes impinge on your allocation decisions. An article on the “Seeking Alpha” website was making an argument not too long ago that the better way to achieve portfolio diversification going forward was to pair an S&P 500 Index Fund with one of the publicly-traded C-Corporation private equity firms. It is an interesting question to think about.

The final wildcard here is the election. What does a different administration mean for fiscal policy? Instead of Steve Mnuchin at Treasury, what does Lael Brainerd mean as Treasury Secretary mean to policy going forward? 

Oldies but Goodies

One of the old favorite value-investor approaches has been to have passbook savings accounts at mutual savings banks throughout the country, waiting for them to convert to publicly-traded stock corporations. When the conversion occurred, as a longer-term depositor, you were given the first crack at subscribing for shares, which were usually priced at a 20–30 percent discount to book value. Depending on the capitalization of the thrift involved, you would then wait three to five years (three years being the minimum period imposed by the regulators before the publicly-traded bank could sell/merge with another institution). Those transactions usually happened at 1.5–1.6X book value. I had the good fortune over my career to be tutored in that form of investment by one of the grandmasters of the art, Mr. Stanley Wells, who was a Senior Vice President with the Hartford, CT office of Keefe, Bruyette and Woods and is now retired and working on his golf game in Florida. 

I bring this up because after a multi-year drought of conversions, this past summer Eastern Bank of Massachusetts, one of the largest mutual savings banks in the country at $11B in assets, converted and offered shares to its depositors as Eastern Bankshares, Inc. Besides great results, Eastern had the distinction of a large branch network, a low-cost deposit base, and is the largest SBA lender in Massachusetts. The senior management team is highly regarded in banking circles. We shall see whether lightning can strike again, going forward. 

The End of Brands

A question I will leave you with is this – during the disruption and shut-in period, which has caused shortages in various consumer goods, has the American consumer finally discovered and accepted that high-end store private label is a better buy than the old standard brands? Anecdotally, I have the sense that is the case, based on my discussion with managers in Ace Hardware Stores and Kroger. And of course, there is Costco’s Kirkland brand, which has blazed new trails in traditional branded areas such as beer, spirits, and wine. One of the only areas that I see brand strength continuing in is in cigarettes – the Marlboro brand still dominates globally. If this plays out as I think it will, the implications going forward have not yet been priced into the germane equities—something to think about for the future.  

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About Edward A. Studzinski

Ed Studzinski has more than 30 years of institutional investment experience. He was a partner at Harris Associates in Chicago, Illinois. Harris is known for its value-oriented, bottom-up investment approach that frames the investment process as owning a piece of the business relative to the business value of the whole, ideally forever. At Harris, Ed was co-manager of the Oakmark Equity & Income Fund (OAKBX). During the nearly twelve years that he was in that role, the fund in 2006 won the Lipper Award in the balanced category for "Best Fund Over Five Years." Additionally, in 2011 the fund won the Lipper Award in the mixed-asset allocation moderate funds category as "Best Fund Over Ten Years. Concurrently Ed was also an equity research analyst, providing many of the ideas that contributed to the fund’s success. He has specialist knowledge in the defense, property-casualty insurance, and real estate industries, having followed and owned companies as diverse as Catellus Development, General Dynamics, Legacy Hotels, L-3, PartnerRe, Progressive Insurance, Renaissance Reinsurance, Rockwell Collins, SAFECO, St. Joe Corporation, Teledyne, and Textron. Before joining Harris Associates, over a period of more than 10 years, Ed was the Chief Investment Officer at the Mercantile National Bank of Indiana, and also served on their Executive and Asset-Liability Committees. Prior to Mercantile, Ed practiced law. A native of Peabody, Massachusetts, he received his A.B. in history (magna cum laude) from Boston College, where he was a Scholar of the College. He has a J.D. from Duke University and an M.B.A. in marketing and finance, as well as a Professional Accounting Program Certificate, from Northwestern University. Ed has earned the Chartered Financial Analyst credential. Ed belongs to the Investment Analyst Societies of Boston, Chicago, and New York City. He is admitted to the Bar in the District of Columbia, Illinois, and North Carolina.