November 2023 IssueLong scroll reading

Fire-and-Forget Gone Wrong: First Foundation Total Return

By David Snowball

In the military realm, “fire and forget” designates a weapon that you don’t need to think about once it’s been launched. In investing, “fire and forget” could be used to describe several sorts of mistakes centering on our impulse to look away once we’ve made a decision. One of those mistakes is to buy a fund (presumably for a good reason), then sell it (presumably for a good reason), and then never re-examine your decision.

Managers – both corporate and fund – make mistakes. You can’t avoid it. They can’t. The best of them realize it, learn from it, correct it, and return to doing fine work. After inheriting Highland Total Return in 2015, the team at First Foundation seems to have diagnosed and corrected a fairly serious mistake they inherited.

First Foundation Total Return (FBBYX) was launched in November 1993. Sort of.

It is incredibly difficult to trace the actual history of this fund. It appears that it might have originated as a General Electric Asset Management fund, and it appears that GEAM might have sold its assets to Highland Capital after the financial crisis but continued to manage it, or most of it. For sure, Highland Total Return was managed by First Foundation after February 1, 2015, but the First Foundation team inherited a small fund with over 800 legacy holdings from the earlier teams.

The Highland Funds were somewhere between a mess and a dumpster fire. At MFO, they mostly appeared in articles about funds that were embarrassing and/or disappearing. One of those funds was Highland Total Return, of which we wrote:

On December 14, 2020, Highland Total Return Fund and Highland Fixed Income Fund morph into First Foundation Total Return Fund and First Foundation Fixed Income Fund. No substantial changes which, let’s be honest, is unfortunate. Total Return is a one-star fund with $67 million …

Since then, the fund has staged a remarkable turnaround. It is a five-star stock/bond hybrid that has substantially outperformed its peers since the change. Morningstar places it in the top 1% of its peer group for the past 1-, 3- and 5-year periods. As a result, flows have been steady, and the fund has $125 million invested today.

The fund has roughly tripled the returns of its peers over the past three years: 17.12% for FBBYX versus 5.84% for its peers (through 10/1/2023, per Morningstar). While the fund can be volatile, its returns and risk-adjusted returns are both purely first-rate.

Comparison of 3-Year Performance (Sept. 2020)

Return metrics APR #1 of 239
  Upside capture / S&P 500 #2
  Upside capture / 60/40 bm #2
Risk metrics Standard deviation #215
  Downside deviation #73
  Downmarket deviation #73
  Bear market deviation #50
  Maximum drawdown #6
  Downside capture / S&P 500 #29
  Downside capture / 60/40 bm #40
Risk-adjusted return metrics Sharpe ratio #1
  Sortino ratio #1
  Ulcer Index #2
  Capture ratio / S&P 500 #1
  Capture ratio / 60/40 bm #1

Source: MFO Premium fund screener and Lipper global data feed

How did that happen?

First Foundation Total Return’s strategy is to focus primarily, but not exclusively, on growth stocks at value prices. Their targets are mid- to large-cap companies with

  • strong earnings growth
  • favorable valuation
  • a presence in successful industries
  • high-quality management focused on generating shareholder value. The managers actually sit, without compensation, on the boards of some of their portfolio companies to help advance their investors’ interests. When board fees have been paid, it has been deposited directly into the mutual fund, akin to a dividend.

The “not exclusively” proviso reflects the managers’ conviction that there are times when investors’ enthusiasm has gotten far enough ahead of fundamentals that it’s prudent to increase exposure to “ballast” companies. Currently, for example, Morningstar locates the core of the fund’s equity holdings in the mid-cap value box (as of 6/30/2023). At the same time, half of the equity portfolio is in companies domiciled in France or Canada (again, as of 6/30/2023).

In terms of priorities on the equity side, you might imagine a funnel from the investable universe to the portfolio: they look first for securities selling for a fair price, then at companies with great alignment, and then finally at the quality of the business.

The most dramatic change in the transition from Highland to First Foundation was on the fixed-income side of the equation. When First Foundation took over that part of the portfolio, they found that “we then owned things like two mortgage back securities per issue and there were hundreds and hundreds of holdings, it was probably closer to a thousand,” some of which they were not able to sell. They held such issues to maturity and let them roll incrementally off the books, with just a few hundred thousand dollars tied up in such issues now.

The fixed-income portfolio is quite compact (under 40 issues), with the team looking for debt securities with characteristics such as:

  • attractive yields and prices
  • the potential for capital appreciation
  • reasonable credit quality, which means they typically buy investment-grade debt and frequently buy Treasuries.

The managers pursue what many readers might consider a T. Rowe Price model of investing, with the distinctive advantage that the funds are small enough to benefit substantially by aligning themselves with, and perhaps strengthening, “family-controlled companies whose managers act like principals rather than agents.”

This alignment of interest is something the managers have pursued firsthand as board members of some of their companies. Mr. Speron notes, “Capitalism works for owners when principals and agents are aligned. Low valuations and lower correlations mean small cap is important in a portfolio context, but mitigating agency risk has required real effort.” Those efforts have paid off for the fund’s investors. It’s an investment well worth remembering.

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About David Snowball

David Snowball, PhD (Massachusetts). Cofounder, lead writer. David is a Professor of Communication Studies at Augustana College, Rock Island, Illinois, a nationally-recognized college of the liberal arts and sciences, founded in 1860. For a quarter century, David competed in academic debate and coached college debate teams to over 1500 individual victories and 50 tournament championships. When he retired from that research-intensive endeavor, his interest turned to researching fund investing and fund communication strategies. He served as the closing moderator of Brill’s Mutual Funds Interactive (a Forbes “Best of the Web” site), was the Senior Fund Analyst at FundAlarm and author of over 120 fund profiles. David lives in Davenport, Iowa, and spends an amazing amount of time ferrying his son, Will, to baseball tryouts, baseball lessons, baseball practices, baseball games … and social gatherings with young ladies who seem unnervingly interested in him.