Dear friends,

As I begin this essay the thermostat registers an attention-grabbing minus 18 degrees Fahrenheit.  When I peer out of the window nearest my (windowless) office, I’m confronted with:

All of which are sure and certain signs that it’s what? Yes, Spring Break in the Midwest!

Which funds? “Not ours,” saith Fidelity!

If you had a mandate to assemble a portfolio of the stars and were given virtually unlimited resources with which to identify and select the country’s best funds and managers, who would you pick? And, more to the point, how cool would it be to look over the shoulders of those who actually had that mandate and those resources?

Welcome to the world of the Strategic Advisers funds, an arm of Fidelity Investments dedicated to providing personalized portfolios for affluent clients. The pitch is simple: “we can do a better job of finding and matching investment managers, some not accessible to regular people, than you possibly could.” The Strategic Advisers funds have broad mandates, with names like Core Fund (FCSAX) and Value Fund (FVSAX). Most are funds of funds, explicitly including Fidelity funds in their selection universe, or they’re hybrids between a fund-of-funds and a fund where other mutual fund managers contribute individual security names.

SA celebrates its manager research process in depth and in detail. The heart of it, though, is being able to see the future:

Yet all too often, yesterday’s star manager becomes tomorrow’s laggard. For this reason, Strategic Advisers’ investment selection process emphasizes looking forward rather than backward, and seeks consistency, not of performance per se, but of style and process.

They’re looking for transparent, disciplined, repeatable processes, stable management teams and substantial personal investment by the team members.

The Observer researched the top holdings of every Strategic Advisers fund, except for their target-date series since those funds just invest in the other SA funds. Here’s what we found:

A small handful of Fidelity funds found their way in. Only four of the eight domestic equity funds had any Fido fund in the sample and each of those featured just one fund. The net effect: Fidelity places something like 95-98% of their domestic equity money with managers other than their own. Fidelity funds dominate one international equity fund (FUSIX), while getting small slices of three others. Fidelity has little presence in core fixed-income funds but a larger presence in the two high-yield funds.

The Fidelity funds most preferred by the SA analysts are:

Blue Chip Growth (FBGRX), a five-star $19 billion fund whose manager arrived in 2009, just after the start of the current bull market. Not clear what happens in less hospitable climates.

Capital & Income (FAGIX), five star, $10 billion high yield hybrid fund It’s classified as high-yield bond but holds 17% of its portfolio in the stock of companies that have issued high-yield debt.

Emerging Markets (FEMKX), a $3 billion fund that improved dramatically with the arrival of manager Sammy Simnegar in October, 2012.

Growth Company (FDGRX), a $40 billion beast that Steven Wymer has led since 1997. Slightly elevated volatility, substantially elevated returns.

Advisor Stock Selector Mid Cap (FSSMX), which got new managers in 2011 and 2012, then recently moved from retail to Advisor class. The long term record is weak, the short term record is stronger.

Conservative Income Bond (FCONX), a purely pedestrian ultra-short bond fund.

Diversified International (FDIVX), a fund that had $60 billion in assets, hit a cold streak around the financial crisis, and is down to $26 billion despite strong returns again under its long-time manager.

International Capital Appreciation (FIVFX), a small fund by Fido standards at $1.3 billion, which has been both bold and successful in the current upmarket. It’s run by the Emerging Markets guy.

International Discovery (FIGRX), a $10 billion upmarket darling that’s stumbled badly in down markets and whose discipline seems to wander. Making it, well, not disciplined.

Low-Priced Stock (FLPSX), Mr. Tillinghast has led the fund since 1989 and is likely one of the five best managers in Fidelity’s history. Which, at $50 billion, isn’t quite a secret.

Short Term Bond (FSHBX), another perfectly pedestrian, low-risk, undistinguished return bond fund. Meh.

Fidelity favors managers that are household names. No “undiscovered gems” here. The portfolios are studded with large, safe bets from BlackRock, JPMorgan, MetWest, PIMCO and T. Rowe.

DFA and Vanguard are missing. Utterly, though whether that’s Fidelity’s decision or not is unknown.

JPMorgan appears to be their favorite outside manager. Five different SA funds have invested in JPMorgan products including Core Bond, Equity Spectrum, Short Duration, US Core Plus Large Cap Select and Value Advantage.

The word “Focus” is notably absent. Core hold 550 positions, including funds and individual securities while Core Multi-Manager holds 360. Core Income holds a thousand while Core Income Multi-Managers holds 240 plus nine mutual funds. International owns two dozen funds and 400 stocks.

Some distinguished small funds do appear further down the portfolios. Pear Tree Polaris Foreign Value (QFVOX) is a 1% position in International. Wasatch Frontier Emerging Small Countries (WAFMX) was awarded a freakish 0.02% of Emerging Markets Fund of Funds (FLILX), as well as 0.6% in Emerging Markets (FSAMX). By and large, though, timidity rules!

Bottom Line: the tyranny of career risk rules! Most professional investors know that it’s better to be wrong with the crowd than wrong by yourself. That’s a rational response to the prospect of being fired, either by your investors or by your supervisor. That same pattern plays out in fund selection committees, including the college committee on which I sit. It’s much more important to be “not wrong” than to be “right.” We prefer choices that we can’t be blamed for. The SA teams have made just such choices: dozens of funds, mostly harmless, and hundreds of stocks, mostly mainstream, in serried ranks.

If you’ve got a full-time staff that’s paid to do nothing else, that might be manageable if not brilliant. For the rest of us, private and professional investors alike, it’s not.

One of the Observers’ hardest tasks is trying to insulate ourselves, and you, from blind adherence to that maxim. One of the reasons we’ll highlight one- and two-star funds, and one of the reasons I’ve invested in several, is to help illustrate the point that you need to look beyond the easy answers and obvious choices. With the steady evolution of our Multi-Search screener, we’re hoping to help folks approach that task more systematically. Details soon!

The Death of “Buy the unloved”

You know what Morningstar would say about a mutual fund that claimed a spiffy 20 year record but has switched managers, dramatically changed its investment strategy, went out of business for several years, and is now run by managers who are warning people not to buy the fund. You can just see the analysts’ soured, disbelieving expression and hear the incredulous “what is this cr…?”

Welcome to the world of Buy the Unloved, which used to be my favorite annual feature. Begun in 1993, the strategy drew up the indisputable observation that investors tend to be terrible at timing: over and over again they sell at the bottom and buy at the top. So here was the strategy: encourage people to buy what everyone else was selling and sell what everyone else was buying. The implementation was simple:

Identify the three fund categories that saw the greatest outflows, measured by percentage of assets, then buy good funds in each of those categories and prepare to hold them for three years. At the same time identify the three fund categories with the greatest inrush and sell them.

I liked it, it worked, then Morningstar stopped publishing it. Investment advisor Neil Stoloff provided an interesting history of the strategy, detailed on pages 12-16 of a 2011 essay he wrote. When they resumed, the strategy had a far more conservative take: buy the three sectors that saw the greatest outflows measured in total dollar volume and hold them, while selling the most popular sectors.

The problem with, and perhaps strength of, the newer version is that it means that you’ll mostly be limited to playing with your core sectors rather than volatile smaller ones. By way of example, large cap blend holds about $1.6 trillion – a 1% outflow there ($16 billion) would be an amount greater than the total assets in any of the 50 smallest fund categories. Large cap growth at $1.2 trillion is close behind.

Oh, by the way, they haven’t traditionally allowed bond funds to play. They track bond flows but, in a private exchange, Mr. Kinnel allowed that “Generally they are too dull to provide much of a signal.”

Morningstar now faces two problems:

1. De facto, the system is rigged to provide “sell” signals on core fund groups.
2. Morningstar is not willing to recommend that you ever sell core fund groups.

Katie Reichart’s 2013 presentation of the strategy (annoying video ahead) warned that “It can be used just on the margin…perhaps for a small percentage of their portfolio.” In 2014, it was “Add some to the unloved pile and trim from the loved” and by 2015 there was a flat-out dismissal of it: “I’m sharing the information for those who want to follow the strategy to the letter–but I wouldn’t do it.”

The headline:	The bottom line:
	So, I’m sharing the information for those who want to follow the strategy to the letter–but I wouldn’t do it. R. Kinnel

So what’s happened? Kinnel’s analysis seems odd but might well be consistent with the data:

But since 2008, performance and flows have decoupled on the asset-class level even though they continue to be linked on a fund level.

Now flows are more linked to headlines. Since 2008, some people have taken a pessimistic (albeit incorrect) view of America’s economy and looked to China as a superior bet. It hasn’t worked that way the past five years, and it leaves us in the odd position of seeing the nature of fund flows change.

I don’t actually know what that means.

Morningstar has released complete 2014 fund flow data, by fund family and fund category. (Thanks, Dan!) It reveals that investors fled from:

• US Large Growth (-41 billion)
• Bank Loans (-20 billion)
• High Yield Bonds (-16 billion).

Since two of the three areas are bonds, you’re not supposed to use those as a signal. And since the other is a core category buffeted by headline risk, really there’s nothing there, either. Further down the list, categories such as commodities and natural resources saw outflows of 10% or so. But those aren’t signals, either.

Whither goest investors?

• US Large Blend (+105 billion)
• International Large Blend (+92 billion)
• Intermediate Bonds (+34 billion)
• Non-traditional Bonds (+23 billion)

Two untouchable core categories, two irrelevant bond ones. Meanwhile, the Multialternative category saw an inrush of about 33% of its assets in a year. Too small in absolute terms to matter.

Bottom Line: Get serious or get rid of it. The underlying logic of the strategy is psychological: investors are too cowardly to do the right thing. On face, that’s afflicting Morningstar’s approach to the feature. If the data says it works, they need to screw up their courage and announce the unpopular fact that it might be time to back away from core stock categories. If the data says it doesn’t work, they need to screw up their courage, explain the data and end the game.

The current version, “for amusement only,” version serves no real purpose and no one’s interest.

 

Whitebox Tactical Opportunities 4Q14 Conference Call 

Portfolio managers Andrew Redleaf and Dr. Jason Cross, along with Whitebox Funds’ President Bruce Nordin and Mike Coffey, Head of Mutual Fund Distribution, hosted the 4^th quarter conference call for their Tactical Opportunities Fund (WBMIX) on February 26. Robert Vogel and Paul Twitchell, the fund’s third and fourth portfolio managers, did not participate.

Prolific MFO board contributor Scott first made us aware of the fund in August 2012 with the post “Somewhat Interesting Tiny Fund.” David profiled its more market neutral and less tactical (less directionally oriented) sibling WBLFX in April 2013. I discussed WBMIX in the October 2013 commentary, calling the fund proper “increasingly hard to ignore.” Although the fund proper was young, it possessed the potential to be “on the short list … for those who simply want to hold one all-weather fund.”

WBMIX recently pasted its three year mark and at $865M AUM is no longer tiny. Today’s question is whether it remains an interesting and compelling option for those investors looking for alternatives to the traditional 60/40 balanced fund at a time of interest rate uncertainty and given the two significant equity drawdowns since 2000.

Mr. Redleaf launched the call by summarizing two major convictions:

• The US equity market is “expensive by just about any measure.” He noted examples like market cap to GDP or Shiller CAPE, comparing certain valuations to pre great recession and even pre great depression. At such valuations, expected returns are small and do not warrant the downside risk they bear, believing there is a “real chance of 20-30-40 even 50% retraction.” In short, “great risk in hope of small gain.”

• The global markets are fraught with risk, still recovering from the great recession. He explained that we were in the “fourth phase of government action.” He called the current phase competitive currency devaluation, which he believes “cannot work.” It provides temporary relief at best and longer term does more harm than good. He seems to support only the initial phase of government stimulus, which “helped markets avert Armageddon.” The last two phases, which included the zero interest rate policy (ZIRP), have done little to increase top-line growth.

Consequently, toward middle of last year, Tactical Opportunities (TO) moved away from its long bias to market neutral. Mr. Redleaf explained the portfolio now looks to be long “reasonably priced” (since cheap is hard to find) quality companies and be short over-priced storybook companies (some coined “Never, Nevers”) that would take many years, like 17, of uninterrupted growth to justify current prices.

The following table from its recent quarterly commentary illustrates the rationale:

Mr. Redleaf holds a deep contrarian view of efficient market theory. He works to exploit market irrationalities, inefficiencies, and so-called dislocations, like “mispriced securities that have a relationship to each other,” or so-called “value arbitrage.” Consistently guarding against extreme risk, the firm would never put on a naked short. Its annual report reads “…a hedge is itself an investment in which we believe and one that adds, not sacrifices returns.”

But that does not mean it will not have periods of underperformance and even drawdown. If the traditional 60/40 balanced fund performance represents the “Mr. Market Bus,” Whitebox chose to exit middle of last year. As can be seen in the graph of total return growth since WBMIX inception, Mr. Redleaf seems to be in good company.

Whether the “exit” was a because of deliberate tactical moves, like a market-neutral stance, or because particular trades, especially long/short trades went wrong, or both … many alternative funds missed-out on much of the market’s gains this past year, as evidenced in following chart:

But TO did not just miss much of the upside, it’s actually retracted 8% through February, based on month ending total returns, the greatest amount since its inception in December 2011; in fact, it has been retracting for ten consecutive months. Their explanation:

Our view of current opportunity has been about 180 degrees opposite Mr. Market’s. Currently, we love what we’d call “intelligent value” while Mr. Market apparently seems infatuated with what we’d call “unsustainable growth.”

Put bluntly, the stocks we disfavored most (and were short) were among the stocks investors remained enamored with.

A more conservative strategy would call for moving assets to cash. (Funds like ASTON RiverRoad Independent Value, which has about 75% cash. Pinnacle Value at 50%. And, FPA Crescent at 44%.) But TO is more aggressive, with attendant volatilities above 75% of SP500, as it strives to “produce competitive returns under multiple scenarios.” This aspect of the fund is more evident now than back in October 2013.

Comparing its performance since launch against other long-short peers and some notable alternatives, WBMIX now falls in the middle of the pack, after a strong start in 2012/13 but disappointing 2014:

From the beginning, Mr. Redleaf has hoped TO would be judged in comparison to top endowments. Below are a couple comparisons, first against Yale and Harvard, which report on fiscal basis, and second against a simple Ivy asset allocation (computed using Alpha Architect’s Allocation Tool) and Vanguard’s 60/40 Balanced Index. Again, a strong showing in 2012/13, but 2014 was a tough year for TO (and Ivy).

Looking beyond strategy and performance, the folks at Whitebox continue to distinguish themselves as leaders in shareholder friendliness – a much welcomed and refreshing attribute, particularly with former hedge fund shops now offering the mutual funds and ETFs. Since last report:

• They maintain a “culture of transparency and integrity,” like their name suggests providing timely and thoughtful quarterly commentaries, published on their public website, not just for advisors. (In stark contrast to other firms, like AQR Funds, which in the past have stopped publishing commentaries during periods of underperformance, no longer make commentaries available without an account, and cater to Accredited Investors and Qualified Eligible Persons.)
• They now benchmark against SP500 total return, not just SPX.
• They eliminated the loaded advisor share class.
• Their expense ratio is well below peer average. Institutional shares, available at some brokerages for accounts with $100K minimum, have been running between 1.25-1.35%. They impose a voluntary cap of 1.35%, which must be approved by its board annually, but they have no intention of ever raising … just the opposite as AUM grows, says Mr. Coffey. (The cap is 1.6% for investor shares, symbol WBMAX.)

These ratios exclude the mandatory reporting of dividend and interest expense on short sales and acquired fund fees, which make all long/short funds inherently more expensive than long only equity funds. The former has been running about 1%, while the latter is minimal with selective index ETFs.

• They do not charge a short-term redemption fee.

All that said, they could do even better going forward:

• While Mr. Redleaf has over $1M invested directly with the fund, the most recent SAI dated 15 January 2015, indicates that the other three portfolio managers have zero stake. A spokesman for the fund defends “…as a smaller company, the partners’ investment is implicit rather than explicit. They have ‘Skin in the game,’ as a successful Tac Ops increases Whitebox’s profitability and on the other side of the coin, they stand to lose.”

David, of course, would argue that there is an important difference: Direct shareholders of a fund gain or lose based on fund performance, whereas firm owners gain or lose based on AUM.

Ed, author of two articles on “Skin in the Game” (Part I & Part II), would warn: “If you want to get rich, it’s easier to do so by investing the wealth of others than investing your own money.”

• Similarly, the SAI shows only one of its four trustees with any direct stake in the fund.
• They continue to impose a 12b-1 fee on their investor share class. A simpler and more equitable approach would be to maintain a single share class eliminating this fee and continue to charge lowest expenses possible.
• They continue to practice a so-called “soft money” policy, which means the fund “may pay higher commission rates than the lowest available” on broker transactions in exchange for research services. Unfortunately, this practice is widespread in the industry and investors end-up paying an expense that should be paid for by the adviser.

In conclusion, does the fund’s strategy remain interesting? Absolutely. Thoughtfulness, logic, and “arithmetic” are evident in each trade, in each hedge. Those trades can include broad asset classes, wherever Mr. Redleaf and team deem there are mispriced opportunities at acceptable risk.

Another example mentioned on the call is their longstanding large versus small theme. They believe that small caps are systematically overpriced, so they have been long on large caps while short on small caps. They have seen few opportunities in the credit markets, but given the recent fall in the energy sector, that may be changing. And, finally, first mentioned as a potential opportunity in 2013, a recent theme is their so-called “E-Trade … a three‐legged position in which we are short Italian and French sovereign debt, short the euro (currency) via put options, and long US debt.”

Does the fund’s strategy remain compelling enough to be a candidate for your one all-weather fund? If you share a macro-“market” view similar to the one articulated above by Mr. Redleaf, the answer to that may be yes, particularly if your risk temperament is aggressive and your timeline is say 7-10 years. But such contrarianism comes with a price, shorter-term at least.

During the call, Dr. Cross addressed the current drawdown, stating that “the fund would rather be down 8% than down 30% … so that it can be positioned to take advantage.” This “positioning” may turn out to be the right move, but when he said it, I could not help but think of a recent post by MFO board member Tampa Bay:

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch 

Mr. Redleaf is no ordinary investor, of course. His bet against mortgages in 2008 is legendary. Whitebox Advisers, LLC, which he founded in 1999 in Minneapolis, now manages more than $4B.

He concluded the call by stating the “path to victory” for the fund’s current “intelligent value” strategy is one of two ways: 1) a significant correction from current valuations, or 2) a fully recovered economy with genuine top-line growth.

Whitebox Tactical Opportunities is facing its first real test as a mutual fund. While investors may forgive not making money during an upward market, they are notoriously unforgiving losing money (eg., Fairholme 2011), perhaps unfairly and perhaps to their own detriment, but even over relatively short spans and even if done in pursuit of “efficient management of risk.”

We’ve Seen This Movie Before

By Edward Studzinski

“We do not have to visit a madhouse to find disordered minds; our planet is the mental institution of the universe.”          Goethe

For students of the stock market, one of the better reads is John Brooks’, The Go-Go Years.   It did a wonderful job of describing the rather manic era of the 60’s and 70’s (pre-1973). One of the arguments made then was that the older generation of money managers was out of touch with both technology and new investment ideas. This resulted in a youth movement on Wall Street, especially in the investment management firms. You needed to have a “kid” as a portfolio manager, which was taken to its logical conclusion in a cartoon which showed an approximately ten-year old sitting behind a desk, looking at a Quotron machine. Around 2000, a similar youth movement came along during the dot.com craze, where once again investment managers, especially value managers, were told that their era was over, that they didn’t understand the new way and new wave of investing. Each of those two eras ended badly for those who had entrusted their assets to what was in vogue at the time.

In 2008, we had a period of over-valuation in the markets that was pretty clear in terms of equities. We also had what appears in retrospect to have been the deliberate misrepresentation and marketing of certain categories of fixed income investments to those who should have known better and did not. This resulted in a market meltdown that caused substantial drawdowns in value for many equity mutual funds, in a range of forty to sixty per cent, causing many small investors to panic and suffer a permanent loss of capital which many of them could not afford nor replace. The argument of many fund managers who had invested in their own funds (and as David has often written about, many do not), was that they too had skin in the game, and suffered the losses alongside of their investors.

Let’s run some simple math. Assume a fund management firm that at 2/27/2015 has $100 billion in assets under management. Assets are equities, a mix of international and domestic, the international with fees and expenses of 1.30% and the domestic with fees and expenses of 0.90%. Let’s assume a 50/50 international/domestic split of assets, so $50 billion at 0.90% and $50 billion at 1.30%. This results in $1.1billion in fees and expenses to the management company. Assuming $300 million goes in expenses to non-investment personnel, overhead, and the other expenses that you read about in the prospectus, you could have $800 million to be divided amongst the equity owners of the management firm. In a world of Marxian simplicity, each partner is getting $40 million dollars a year. But, things are often not simple if we take the PIMCO example. Allianz as owners of the firm, having funded through their acquisitions the buy-out of the founders, may take 50% of profits or revenues off the top. So, each equal-weighted equity owner may only be getting paid $20 million a year. Assets under management may go down with the market sell-off so that fees going forward go down. But it should be obvious that average mutual fund investors are not at parity with the fund managers in risk exposure or tolerance.

Why am I beating this horse into the ground again? U.S. economic growth for the final quarter was revised down from the first reported estimate of 2.6% to 2.2%. More than 440 of the companies in the S&P 500 index had reported Q4 numbers by the end of last week showed revenue growth of 1.5% versus 4.1% in the previous quarter. Earnings increased at an annual rate that had slowed to 5.9% from 10.4% in the previous quarter. Earnings downgrades have become more frequent. 

Why then has the market been rising – faith in the Federal Reserve’s QE policy of bond repurchases (now ended) and their policy of keeping rates low. Things on the economic front are not as good as we are being told. But my real concern is that we have become detached from thinking about the value of individual investments, the margin of safety or lack thereof, and our respective time horizons and risk tolerances. And I will not go into at this time, how much deflation and slowing economies are of concern in the rest of the world.

Look at the energy sector, where the price of oil has come down more than 50% since the 2014 high. Each time we see a movement in the price of oil, as well as in the futures, we see swings in the equity prices of energy companies. Should the valuations of those companies be moving in sync with energy prices, and are the balance sheets of each of those companies equal? No, what you are seeing is the algorithmic trading programs kicking in, with large institutional investors and hedge funds trying to grind out profits from the increased volatility. Most of the readers of this publication are not playing the same game. Indeed they are unable to play that game. 

So I say again, focus upon your time horizons and risk tolerance. If your investment pool represents the accumulation of your life’s work and retirement savings, your focus should be not on how much you can make but rather how much you can afford to lose. As the U.S. equity market has continued to hit one record high after another,  recognize that it is getting close to trading at nearly thirty times long-term, inflation-adjusted earnings. In 2014, the S&P 500 did not fall for more than three consecutive days.

We are in la-la land, and there is little margin for error in most investment opportunities. On January 15, 2015, when the Swiss National Bank eliminated its currency’s Euro-peg, the value of that currency moved 30% in minutes, wiping out many currency traders in what were thought to be low-risk arbitrage-like investments. 

What should this mean for readers of this publication? We at MFO have been looking for absolute value investors. I can tell you that they are in short supply. Charlie Munger had some good advice recently, which others have quoted and I will paraphrase. Focus on doing the easy things. Investment decisions or choices that are complex, and by that I mean things that include shorting stocks, futures, and the like – leave that to others. One of the more brilliant value investors and a contemporary of Benjamin Graham, Irving Kahn, passed away last week. He did very well with 50% of his assets in cash and 50% of his assets in equities. For most of us, the cash serves as a buffer and as a reserve for when the real, once in a lifetime, opportunities arise. I will close now, as is my wont, with a quote from a book, The Last Supper, by one of the great, under-appreciated American authors, Charles McCarry. “Do you know what makes a man a genius? The ability to see the obvious. Practically nobody can do that.”

Top developments in fund industry litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before. For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

New Lawsuits

The Calamos Growth Fund is the subject of a new section 36(b) lawsuit that alleges excessive advisory and 12b-1 fees. The complaint alleges that Calamos extracted higher investment advisory fees from the Growth Fund than from “third-party, arm’s length institutional clients,” even though advisory services were “similar” and “in some cases effectively identical.” (Chill v. Calamos Advisors LLC.)

A new lawsuit accuses T. Rowe Price of infringing several patents relating to management of its target-date funds. (GRQ Inv. Mgmt., LLC v. T. Rowe Price Group, Inc.)

New Appeal

Plaintiffs have appealed a district court’s dismissal of state-law claims against Vanguard regarding fund holdings of gambling-related securities. The district court held that the claims were time barred and, alternatively, that the fund board’s refusal to pursue plaintiffs’ litigation demand was protected by the business judgment rule. Defendants include independent directors. (Hartsel v. Vanguard Group, Inc.)

Settlements

ERISA class action plaintiffs filed an unopposed motion to settle their claims against Northern Trust for $36 million. The lawsuit alleged mismanagement of the securities lending program in which collective trust funds participated. (Diebold v. N. Trust Invs., N.A.)

In an interrelated class action against Northern Trust that asserts non-ERISA claims, plaintiffs filed an unopposed motion to partially settle the lawsuit for $24 million. The settlement covers plaintiffs who participated in the securities lending program indirectly (i.e., through investments in commingled investment funds); the litigation will continue with respect to plaintiffs who participated directly (i.e., through a securities lending agreement with Northern Trust). (La. Firefighters’ Ret. Sys. v. N. Trust Invs., N.A.)

The Alt Perspective: Commentary and news from DailyAlts.

By Brian Haskin, editor of DailyAlts.com

February is in the books, and fortunately it ended with a significant decline in volatility, and a nice rally in the equity market. Bonds took it on the chin as rates rose over the month, but commodities rallied on the back of rising oil prices over the month. In the alternative mutual fund are, all of the major categories put up positive returns over the month, with long/short equity leading the way with a category return of 1.88%, according to Morningstar. Multi-alternative funds posted a category return of 0.98%, while non-traditional bonds ended the month 0.88% higher and managed futures funds added 0.47%.

Industry Evolution

The liquid alternatives industry continues to evolve in many ways, the most obvious of which is the continuous launch of new funds. However, we are now beginning to see more activity and consolidation of players at the company level. In December of 2014, we ended the year with New York Life’s MainStay arm purchasing IndexIQ, an alternative ETF provider. This acquisition gave MainStay immediate access to two of the hottest segments of the investment field, all in one package: active ETFs and liquid alternatives.

In February, we saw two more firms combine forces with Salient Partner’s purchase of Forward Management. Both firms have strong footholds in the liquid alternatives market, and the combination of the two firms will expend both their product platforms and distribution capabilities. Scale becomes more important as competition continues to grow. Expect more mergers over the year as firms jockey for position.

Waking Giants

Aside from merger activity, some firms just finally wake up and realize there is an opportunity passing them by. Columbia Management is one of them. The firm has been making some moves over the past few months with new hires and product filings, and finally put the pedal to the metal this month and launched a new alternative mutual fund in partnership with Blackstone. At the same time, Columbia rationalized some of their existing offerings and announced the termination terminated three alternative mutual funds that were launched more than three years ago.

In addition to Columbia, American Century has decided to formalize their liquid alternatives business with new branding (AC Alternatives) and three new alternative mutual funds. These new funds join a stable of two equity market neutral funds and two long/short “130-30” funds (these funds remain beta 1 funds but increase their long exposure to 130% of the portfolio’s value and offset that with 30% shorting, bringing the fund to a net long position of 100%). With at least five alternative mutual funds (the 130-30 funds are technically not liquid alternatives since they are beta 1 funds), American Century will have a solid stable of products to roll under their new AC Alternatives brand that has been created just for their liquid alternatives business.

Featured New Funds

February new fund activity picked up over January with a few notable new funds that hit the market. One theme that has emerged is the growth of globally focused long/short equity funds. Up until last year, a large majority of long/short equity funds were focused on US equities, however last year, firms began introducing funds that could invest in globally developed and emerging markets. The Boston Partners Global Long/Short Fund was one of note, and was launched after the firm had closed its first two long/short equity funds.

This increased diversity of funds is good for both asset managers and investors. Asset managers have a larger global pond in which to fish, thus creating more opportunities, while investors can diversify across both domestic and globally focused funds. Four new funds of note are as follows:

Meeder Spectrum Fund – This is the firm’s first alternative mutual fund, but not their first unconstrained fund. The fund will use a quantitative process to create a globally allocated long/short equity fund, and will use both stocks and other mutual funds or ETFs to implement its strategy. The fund’s management fee is a reasonable 0.75%.

Stone Toro Market Neutral Fund – While described as market neutral, the fund can move between -10% net short to +60% net long. This means that the fund will likely have some beta exposure, but it does allocate globally to both developed and emerging market stocks using an arbitrage approach that looks for structural imperfections related to investor behavior and corporate actions. This is different from the traditional valuation driven approach and could prove to add some value in ways other funds will not.

PIMCO Multi-Strategy Alternative Fund – This fund will allocate to a range of PIMCO alternative mutual funds, including alternative asset classes such as commodities and real assets. Research Affiliates will also sub-advise on the fund and assist in the allocation to funds advised by Research Affiliates.

Columbia Adaptive Alternatives Fund – launched in partnership with Blackstone, this fund invests across three different sleeves (one of which is managed by Blackstone), and allocates to twelve different investment strategies. Lots of complexity here – give it time to see what it can deliver.

While there is plenty more news and fund activity to discuss, let’s call it a wrap there. If you would like to receive daily or weekly updates on liquid alternatives, feel free to sign up for our free newsletter: http://dailyalts.com/mailinglist.php.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Northern Global Tactical Asset Allocation (BBALX): This fund is many things: broadly diversified, well designed, disciplined, low priced and successful. It is not, however, a typical “moderate allocation” fund. As such, it’s imperative to get past the misleading star rating (which has ranged from two to five) to understand the fund’s distinctive and considerable strengths.

Pinnacle Value (PVFIX): If they (accurately) rebranded this as Pinnacle Hedged Microcap Value, the liquid alts crowd would be pounding on the door (and Mr. Deysher would likely be bolting it). While it doesn’t bear the name, the effect is the same: hedged exposure to a volatile asset class with a risk-return profile that’s distinctly asymmetrical to the upside.

Elevator Talk: Waldemar Mozes, ASTON/TAMRO International Small Cap (AROWX/ATRWX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

Waldemar Mozes manages AROWX which launched at the end of December 2014. The underlying strategy, however, has a record that’s either a bit longer or a lot longer, depending on whether you’re looking at the launch of separately managed accounts in this style (from April 2013) or the launch of TAMRO’s investment strategy (2000), of which this is just a special application. Mr. Mozes joined TAMRO in 2008 after stints with Artisan Partners and The Capital Group, adviser to the American Funds.

TAMRO uses the same strategy in their private accounts and all three of the funds they sub-advise for Aston:

… we identify undervalued companies with a competitive advantage. We attempt to mitigate our investment risk by purchasing stocks where, by our calculation, the potential gain is at least three times the potential loss (an Upside reward-to-Downside risk ratio of 3:1 or greater). While our investments fall into three different categories – Leaders, Laggards and Innovators – all share the key characteristics of success:

• Differentiated product or service offering

• Capable and motivated leadership

• Financial flexibility

As a business development matter, Mr. Mozes proposed extending the strategy to the international small cap arena. There are at least three reasons why that made sense:

• The ISC universe is huge. Depending on who’s doing the calculation, there are 10,000 – 25,000 stocks.
• It is the one area demonstrably ripe for active managers to add value. The average ISC stock is covered by fewer than five analysts and it’s the only area where the data shows the majority of active managers consistently outperforming passive products. Across standard trailing time periods, international small caps outperform international large caps with higher Sharpe and Sortino ratios.
• Most investors are underexposed to it. International index funds (e.g, BlackRock International Index MDIIX, Schwab International IndexSWISX, Rowe Price International Index PIEQX or Vanguard Total International Stock Index VGTSX) typically commit somewhere between none of their portfolio (BlackRock, Price, Schwab) to up a tiny slice (Vanguard) to small caps. Of the 10 largest actively managed international funds, only one has more than 2% in small caps.

There are very few true international small cap funds worth examining since most that claim to be small cap actually invest more in mid- and large-cap stocks than in actual small caps. Here are Waldemar’s 268 words on why you should add AROWX to your due-diligence list:

At TAMRO, our objective is to invest in high-quality companies trading below their intrinsic value due to market misperceptions. This philosophy has enabled our domestic small cap strategy to beat its benchmark, 10 of the past 14 calendar years. We’re confident, after 3+ years of rigorous testing and nearly a two-year composite performance track record, that it will work for international small cap too. 

Here’s why:

Bigger Universe = Bigger Opportunity. The international equity universe is three times larger than the domestic universe and probably contains both three times as many high-quality and three times as many poorly-run companies. We exploit this weakness by focusing on quality: businesses that generate high and consistent ROIC/ROE, are run by skilled capital allocators, and produce enough free cash flow to self-fund growth without excessive leverage or dilution. But we also care deeply about downside risk, which is why our valuation mantra is: the price you pay dictates your return.

GDP Always Growing Somewhere. Smaller companies tend to be the engines of local economic growth and GDP is always growing somewhere. We use a proprietary screening tool that provides a timely list of potential research ideas based on fundamental and valuation characteristics. It’s not a black box, but it does flag companies, industries, or countries that might otherwise be overlooked.

Something Different. One reason international small-cap as an asset class has such great appeal is lower correlation. We strive to build on this advantage with a concentrated (40-60 positions), quality-biased portfolio. Ultimately, we care little about growth/value styles and focus on market-beating returns with high active share, low tracking error, and low turnover.

ASTON/TAMRO International Small Cap has a $2500 minimum initial investment which is reduced to $500 for IRAs and other types of tax-advantaged accounts. Expenses are capped at 1.50% on the investor shares and 1.25% for institutional shares, with a 2.0% redemption fee on shares sold within 90 days. The fund has about gathered about $1.3 million in assets since its December 2014 launch. Here’s the fund’s homepage. It’s understandably thin on content yet but there’s some fairly rich analysis on the TAMRO Capital page devoted to the underlying strategy.

Conference Call Highlights: Guinness Atkinson Global Innovators

Every month through the winter, the Observer conspires to give folks the opportunity to do something rare and valuable: to hear directly from managers, to put questions to them in-person and to listen to the quality of the unfiltered answers. A lot of funds sponsor quarterly conference calls, generally web-based. Of necessity, those are cautious affairs, with carefully screened questions and an acute awareness that the compliance folks are sitting there. Most of the ones I’ve attended are also plagued by something called a “slide deck,” which generally turns out to be a numbing array of superfluous PowerPoint slides. We try to do something simpler and more useful: find really interesting folks, let them talk for just a little while and then ask them intelligent questions – yours and mine – that they don’t get to rehearse the answers to. Why? Because the better you understand how a manager thinks and acts, the more likely you are to make a good decision about one.

In February with spoke with Matthew Page and Ian Mortimer of the Guinness Atkinson funds. Both of their funds have remarkable track records, we’ve profiled both and I’ve had good conversations with the team on several occasions. Here’s what we heard on the call.

The guys run two strategies for US investors. The older one, Global Innovators, is a growth strategy that Guinness has been pursuing for 15 years. The newer one, Dividend Builder, is a value strategy that the managers propounded on their own in response to a challenge from founder Tim Guinness. These strategies are manifested in “mirror funds” open to European investors. Curiously, American investors seem taken by the growth strategy ($180M in the US, $30M in the Euro version) while European investors are prone to value ($6M in the US, $120M in the Euro). Both managers have an ownership stake in Guinness Atkinson and hope to work there for 30 years, neither is legally permitted to invest in the US version of the strategy, both intend – following some paperwork – to invest their pensions in the Dublin-based version. The paperwork hang up seems to affect, primarily, the newer Dividend Builder (in Europe, “Global Equity Income”) strategy and I failed to ask directly about personal investment in the older strategy.

The growth strategy, Global Innovators IWIRX, starts by looking for firms “doing something smarter than the average company in their industry. Being smarter translates, over time, to higher return on capital, which is the key to all we do.” They then buy those companies when they’re underpriced. The fund holds 30 equally-weighted positions.

Innovators come in two flavors: disruptors – early stage growth companies, perhaps with recent IPOs, that have everyone excited and continuous improvers – firms with a long history of using innovation to maintain consistently high ROC. In general, the guys prefer the latter because the former tend to be wildly overpriced and haven’t proven their ability to translate excitement into growth.

The example they pointed to was the IPO market. Last year they looked at 180 IPOs. Only 60 of those were profitable firms and only 6 or 7 of the stocks were reasonably priced (p/e under 20). Of those six, exactly one had a good ROC profile but its debt/equity ratio was greater than 300%. So none of them ended up in the portfolio. Matthew observes that their portfolio is “not pure disruptors. Though those can make you look extremely clever when they go right, they also make you look extremely stupid when they go wrong. We would prefer to avoid that outcome.”

This also means that they are not looking for a portfolio of “the most innovative companies in the world.” A commitment to innovation provides a prism or lens through which to identify excellent growth companies. That’s illustrated in the separate paths into the portfolio taken by disruptors and continuous improvers. With early stage disruptors, the managers begin by looking for evidence that a firm is truly innovative (for example, by looking at industry coverage in Fast Company or MIT’s Technology Review) and then look at the prospect that innovation will produce consistent, affordable growth. For the established firms, the team starts with their quantitative screen that finds firms with top 25% return on capital scores in every one of the past ten years, then they pursue a “very subjective qualitative assessment of whether they’re innovative, how they might be and how those innovations drive growth.”

In both cases, they have a “watch list” of about 200-250 companies but their discipline tends to keep many of the disruptors out because of concerns about sustainability and price. Currently there might be one early stage firm in the portfolio and lots of Boeing, Intel, and Cisco.

They sell when price appreciates (they sold Shire pharmaceuticals after eight months because of an 80% share-price rise), fundamentals deteriorate (fairly rare – of the firms that pass the 10 year ROC screen, 80% will continue passing the screen for each of the subsequent five years) or the firm seems to have lost its way (shifting, for example, from organic growth to growth-through-acquisition).

The value strategy, Dividend Builder GAINX is a permutation of the growth strategy’s approach to well-established firms. The value strategy looks only at dividend-paying companies that have provided an inflation-adjusted cash flow return on investment of at least 10% in each of the last 10 years. The secondary screens require at least a moderate dividend yield, a history of rising dividends, low levels of debt and a low payout ratio. In general, they found a high dividend strategy to be a loser and a dividend growth one to be a winner.

In general, the guys are “keen to avoid getting sucked into exciting stories or areas of great media interest. We’re physicists, and we quite like numbers rather than stories.” They believe that’s a competitive advantage, in part because listening to the numbers rather than the stories and maintaining a compact, equal-weight portfolio both tends to distance them from the herd. The growth strategy’s active share, for instance, is 94. That’s extraordinarily high for a strategy with a de facto large cap emphasis.

Bottom line: I’m intrigued by the fact that this fund has consistently outperformed both as a passive product and as an active one and with three different sets of managers. The gain is likely a product of what their discipline consciously and uniquely excludes, firms that don’t invest in their futures, as what it includes. The managers’ training as physicists, guys avowedly wary of “compelling narratives” and charismatic CEOs, adds another layer of distinction.

We’ve gathered all of the information available on the two Guinness Atkinson funds, including an .mp3 of the conference call, into its new Featured Fund page. Feel free to visit!

Conference Call Upcoming: RiverPark Focused Value

We’d be delighted if you’d join us on Tuesday, March 17^th, from 7:00 – 8:00 Eastern, for a conversation with David Berkowitz and Morty Schaja of the RiverPark Funds. Mr. Berkowitz has been appointed as RiverPark’s co-chief investment officer and is set to manage the newly-christened RiverPark Focused Value Fund (RFVIX/RFVFX) which will launch on March 31.

It’s unprecedented for us to devote a conference call to a manager whose fund has not launched, much less one who also has no public performance record. So why did we?

Mr. Berkowitz seems to have had an eventful career. Morty describes it this way:

David’s investment career began in 1992, when, with a classmate from business school, he founded Gotham Partners, a value-oriented investment partnership. David co-managed Gotham from inception through 2002. In 2003, he joined the Jack Parker Corporation, a New York family office, as Chief Investment Officer; in 2006, he launched Festina Lente, a value-oriented investment partnership; and in 2009 joined Ziff Brothers Investments where he was a Partner and Chief Risk and Strategy Officer.

It will be interesting to talk about why a public fund for the merely affluent is a logical next step in his career and how he imagines the structural differences might translate to differences in his portfolio.

RiverPark’s record on identifying first-tier talent is really good. Pretty much all of the RiverPark funds have met or exceeded any reasonable expectation. In addition, they tend to be distinctive funds that don’t fit neatly into style boxes or fund categories. In general they represent thoughtful, distinctive strategies that have been well executed.

Good value investors are in increasingly short supply. When you reach the point that everyone’s a value investor, then no one is. It becomes just a sort of rhetorical flourish, devoid of substance. As the market ascends year after year, fewer managers take the career risk of holding out for deeply-discounted stocks. Mr. Berkowitz professes a commitment to a compact, high commitment portfolio aiming for “substantial discounts to conservative assessments of value.” As a corollary to a “high commitment” mindset, Mr. Berkowitz is committing $10 million of his own money to seed the fund, an amount supplemented by $2 million from the other RiverPark folk. It’s a promising gesture.

Andrew Foster of Seafarer Overseas Growth & Income (SFGIX) has agreed to join us on April 16. We’ll share details in our April issue.

HOW CAN YOU JOIN IN? 

If you’d like to join in the RiverPark call, just click on register and you’ll be taken to the Chorus Call site. In exchange for your name and email, you’ll receive a toll-free number, a PIN and instructions on joining the call. If you register, I’ll send you a reminder email on the morning of the call.

Remember: registering for one call does not automatically register you for another. You need to click each separately. Likewise, registering for the conference call mailing list doesn’t register you for a call; it just lets you know when an opportunity comes up. 

WOULD AN ADDITIONAL HEADS UP HELP?

Over four hundred readers have signed up for a conference call mailing list. About a week ahead of each call, I write to everyone on the list to remind them of what might make the call special and how to register. If you’d like to be added to the conference call list, just drop me a line.

Launch Alert

At the end of January, T. Rowe Price launched their first two global bond funds. The more interesting of the two might be T. Rowe Price Global High Income Bond Fund (RPIHX). The fund will seek high income, with the prospect of some capital appreciation. The plan is to invest in a global portfolio of corporate and government high yield bonds and in floating rate bank loans.  The portfolio sports a 5.86% dividend yield.

It’s interesting, primarily, because of the strength of its lead managers.  It will be managed by Michael Della Vedova and Mark Vaselkiv. Mr. Della Vedova runs Price’s European high-yield fund, which Morningstar UK rates as a four-star fund with above average returns and just average risk.  Before joining Price in 2009, he was a cofounder and partner of Four Quarter Capital, a credit hedge fund focusing on high-yield European corporate debt.  There’s a video interview with Mr. Della Vedova on Morningstar’s UK site. (Warning: the video begins playing automatically and somewhat loudly.) Mr. Vaselkiv manages Price’s first-rate high yield bond fund which is closed to new investors. He’s been running the fund since 1996 and has beaten 80% of his peers by doing what Price is famous for: consistent, disciplined performance, lots of singles and no attempts to goose returns by swinging for the fences. His caution might be especially helpful now if he’s right that we’re “in the late innings of an amazing cycle.” With European beginning to experiment with negative interest rates on its investment grade debt, carefully casting a wider net might well be in order.

The opening expense ratio is 0.85%. The minimum initial investment is $2,500, reduced to $1,000 for IRAs.

Funds in Registration

After months of decline, the number of new no-load funds in the pipeline, those in registration with the SEC for April launch, has rebounded a bit. There are at least 16 new funds on the way.  A couple make me just shake my head, though they certainly will have appeal to fans of Rube Goldberg’s work. There are also a couple niche funds – a luxury brands fund and an Asian sustainability one – that might have merit beyond their marketing value, though I’m dubious. That said, there are also a handful of intriguing possibilities:

American Century is launching a series of multi-manager alternative strategies funds.

Brown Advisory is launching a global leaders fund run by a former be head of Asian equities for HSBC.

Brown Capital Management is planning an international small cap fund run by the same team that manages their international large growth fund.

They’re all detailed on the Funds in Registration page.

Manager Changes

February was a month that saw a number of remarkable souls passing from this vale of tears. Irving Kahn, Benjamin Graham’s teaching assistant and Warren Buffett’s teacher, passed away at 109. All of his siblings also lived over 100 years. Jason Zweig published a nice remembrance of him, “Investor Irving Kahn, Disciple of Benjamin Graham, Dies at 109,” which you can read if you Google the title but which I can’t directly link to.  Leonard Nimoy, whose first autobiography was entitled I Am Not Spock (1975), died of chronic obstructive pulmonary disease at age 83. He had a global following, not least among mixed-race youth who found solace in the character Spock’s mixed heritage. Of immediate relevance to this column, Don Hodges, founder of the Hodges Funds, passed away in late January at age 80. He’d been a professional investor for 50 years and was actively managing several of the Hodges Funds until a few weeks before his death.

You can see all of the comings and goings on our Manager Changes page.

Updates

Bretton Fund (BRTNX) is a small, concentrated portfolio managed by Stephen Dodson. The fund launched in 2010 in an attempt to bring a Buffett-like approach to the world of funds. In thinking about his new firm and its discipline, he was struck by a paradox: almost all investment professionals worshipped Warren Buffett, but almost none attempted to invest like him. Stephen’s estimate is that there are “a ton” of concentrated long-term value hedge funds, but fewer than 20 mutual funds (Pinnacle Value PVFIX and The Cook and Bynum Fund COBYX, for example) that follow Buffett’s discipline: he invests in “a small number of good business he believes that he understands and that are trading at a significant discount to what they believe they’re worth.” Stephen seemed particularly struck by his interviews of managers who run successful, conventional equity funds: 50-100 stocks and a portfolio sensitive to the sector-weightings in some index.

I asked each of them, “How would you invest if it was only your money and you never had to report to outside shareholders but you needed to sort of protect and grow this capital at an attractive rate for the rest of your life, how would you invest. Would you invest in the same approach, 50-100 stocks across all sectors.” And they said, “absolutely not. I’d only invest in my 10-20 best ideas.” 

One element of Stephen’s discipline is that he only invests in companies and industries that he understands; that is, he invests within a self-defined “circle of competence.”

In February he moved to dramatically expand that circle by adding Raphael de Balmann as co-principal of the adviser and co-manager of BRTNX. Messrs. Dodson and de Balmann have known each other for a long time and talk regularly and he seems to have strengths complementary to Mr. Dodson’s. De Balmann has primarily been a private equity investor, where Dodson has been public equity. De Balmann is passionate about understanding the sources and sustainability of cash flows, Dodson is stronger on analyzing earnings. De Balmann understands a variety of industries, including industrials, which are beyond Dodson’s circle of competence.

Stephen anticipates a slight expansion of the number of portfolio holdings from the high teens to the low twenties, a fresh set of eyes finding value in places that he couldn’t and likely a broader set of industries. The underlying discipline remains unchanged.

We wish them both well.

Star gazing

Seafarer Overseas Growth & Income (SFGIX) celebrated its third anniversary on February 5^th. By mid-March it should receive its first star rating from Morningstar. With a risk conscious strategy and three year returns in the top 3% of its emerging markets peer group, we’re hopeful that the fund will gain some well-earned recognition from investors.

Guinness Atkinson Dividend Builder (GAINX) will pass its three-year mark at the end of March, with a star rating to follow by about five. The fund has returned 49% since inception, against 38% for its world-stock peers.

A resource for readers

Our colleague Charles Boccadoro is in lively and continuing conversation with a bunch of folks whose investing disciplines have a strongly quantitative bent. He offers the following alert about a new book from one of his favorite correspodents.

Official publication date is tomorrow, March 2.

Like his last two books, Shareholder Yield and Global Value, reviewed in last year’s May commentary, Meb Faber’s new book “Global Asset Allocation: A Survey of the World’s Top Asset Allocation Strategies” is a self-published ebook, available on Amazon for just $2.99.

On his blog, Mr. Faber states “my goal was to keep it short enough to read in one sitting, evidence-based with a basic summary that is practical and easily implementable.”

That description is true of all Meb’s books, including his first published by Wiley in 2009, The Ivy Portfolio. To celebrate he’s making downloads of Shareholder Yield and Global Value available for free.

We will review his new book next time we check-in on Cambria’s ETF performance.

 

Here appears to be its Table of Contents:

INTRODUCTION

CHAPTER 1 – A History of Stocks, Bonds, and Bills

CHAPTER 2 – The Benchmark Portfolio: 60/40

CHAPTER 3 – Asset Class Building Blocks

CHAPTER 4 – The Risk Parity and All Seasons Portfolios

CHAPTER 5 – The Permanent Portfolio

CHAPTER 6 – The Global Market Portfolio

CHAPTER 7 – The Rob Arnott Portfolio

CHAPTER 8 – The Marc Faber Portfolio

CHAPTER 9 – The Endowment Portfolio: Swensen, El-Erian, and Ivy

CHAPTER 10 – The Warren Buffett Portfolio

CHAPTER 11 – Comparison of the Strategies

CHAPTER 12 – Implementation (ETFs, Fees, Taxes, Advisors)

CHAPTER 13 – Summary

APPENDIX A – FAQs

Briefly Noted . . .

Vanguard, probably to Jack Bogle’s utter disgust, is making a pretty dramatic reduction in their exposure to US stocks and bonds. According an SEC filing, the firm’s retirement-date products and Life Strategy Funds will maintain their stock/bond balance but, over “the coming months,” the domestic/international balance with the stock and bond portfolios will swing.

For long-dated funds, those with target dates of 2040 or later, the US stock allocation will drop from 63% to 54% while international equities will rise from 27% to 36%. In shorter-date funds, there’s a 500 – 600 basis point reallocation from domestic to international. There’s a complementary hike in international body exposure, from 2% of long-dated portfolios up to 3% and uneven but substantial increases in all of the shorter-date funds as well.

SMALL WINS FOR INVESTORS

Okay, it might be stretching to call this a “win,” but you can now get into two one-star funds for a lot less money than before. Effective February 27, 2015, the minimum investment amount in the Class I Shares of both the CM Advisors Fund (CMAFX) and the CM Advisors Small Cap Value (CMOVX) was reduced from $250,000 to $2,500.

CLOSINGS (and related inconveniences)

None that we noticed.

OLD WINE, NEW BOTTLES

Around May 1, the $6 billion ClearBridge Equity Income Fund (SOPAX) becomes ClearBridge Dividend Strategy Fund. The strategy will be to invest in stocks and “other investments with similar economic characteristics that pay dividends or are expected to initiate their dividends over time.”

Effective May 1, 2015, European Equity Fund (VEEEX/VEECX) escapes Europe and equities. It gets renamed at the Global Strategic Income Fund and adds high-yield bonds to its list of investment options.

On April 30, Goldman Sachs U.S. Equity Fund (GAGVX) becomes Goldman Sachs Dynamic U.S. Equity Fund. The “dynamic” part is that the team that guided it to mediocre large cap performance will now guide it to … uh, dynamic all-cap performance.

Goldman Sachs Absolute Return Tracker Fund (GARTX) attempts to replicate the returns of a hedge fund index without, of course, investing in hedge funds. It’s not clear why you’d want to do that and the fund has been returning 1-3% annually. Effective April 30, the fund’s investment strategies will be broadened to allow them to invest in an even wider array of derivatives (e.g. master limited partnership indexes) in pursuit of their dubious goal.

Effective March 31, 2015, MFS Research Bond Fund will change to MFS® Total Return Bond Fund and MFS Bond Fund will change to MFS® Corporate Bond Fund.

OFF TO THE DUSTBIN OF HISTORY

Aberdeen Global Select Opportunities Fund was swallowed up by Aberdeen Global Equity Fund (GLLAX) on Friday, February 25, 2015. GLLAX is … performance-challenged.

As we predicted a couple months ago when the fund suddenly closed to new investors, Aegis High Yield Fund (AHYAX/AHYFX) is going the way of the wild goose. Its end will come on or before April 30, 2015.

Frontier RobecoSAM Global Equity Fund (FSGLX), a tiny institutional fund that was rarely worse than mediocre and occasionally a bit better, will be closed and liquidated on March 23, 2015.

Bad news for Chuck Jaffe. He won’t have the Giant 5 to kick around anymore. Giant 5 Total Investment System Fund received one of Jaffe’s “Lump of Coal” awards in 2014 for wasting time and money changing their ticker symbol from FIVEX to CASHX. Glancing at their returns, Jaffe suggested SUCKX as a better move. From here it starts to get a bit weird. The funds’ adviser changed its name from Willis Group to Index Asset Management, which somehow convinced them to spend more time and money changed the ticker on their other fund, Giant 5 Total Index System Fund, from INDEX to WILLX. So they decided to surrender a cool ticker that reflected their current name for a ticker that reminds them of the abandoned name of their firm. Uh-huh. At this point, cynics might suggest changing their URL from weareindex.com to the more descriptively accurate wearecharging2.21%andchurningtheportfolio.com. Doubtless sensing Chuck beginning to stock up on the slings and arrows of outrageous fortune, the adviser sprang into action on February 27 … and announced the liquidation of the funds, effective March 30^th.

The $24 million Hatteras PE Intelligence Fund (HPEIX) will liquidate on March 13, 2015. The plan was to produce the returns of a Private Equity index without investing in private equity. The fund launched in November 2013, has neither made nor lost any meaningful money, so the adviser pulled the plug after 15 months.

JPMorgan Alternative Strategies Fund (JASAX), a fund mostly comprised of other Morgan funds, will liquidate on March 23, 2015.

Martin Focused Value Fund (MFVRX), a dogged little fund that held nine stocks and 70% cash, has decided that it’s not economically viable and that’s unlikely to change. As a result, it will cease operations by the end of March.

Old Westbury Real Return Fund (OWRRX), which has about a half billion in assets, is being liquidated in mid-March 2015. It was perfectly respectable as commodity funds go. Sadly, the fund’s performance charts had a lot of segments that looked like

and like

In consequence of which it finished down 9% since inception and down 24% over the past five years.

Parnassus Small Cap Fund (PARSX) is being merged into the smaller but far stronger Parnassus Mid Cap (PARMX) at the end of April, 2015. PARMX’s prospectus will be tweaked to make it SMID-ier.

The Board of Trustees of PIMCO approved a plan of liquidation for the PIMCO Convertible Fund (PACNX) which will occur on May 1, 2015. The fund has nearly a quarter billion in assets, so presumably the Board was discouraged by the fund’s relatively week three year record: 11% annually, which trailed about two-thirds of the funds in the tiny “convertibles” group.

The Board of Rainier Balanced Fund (RIMBX/RAIBX) has approved, the liquidation and termination of the fund. The liquidation is expected to occur as of the close of business on March 27, 2015. It’s been around, unobjectionable and unremarkable, since the mid-90s but has under $20 million in assets.

S1 (SONEX/SONRX), the Simple Alternatives fund, will liquidate in mid-March. We were never actually clear about what was “simple” about the fund: it was a high expense, high turnover, high manager turnover operation.

Salient Alternative Strategies Master Fund liquidated in mid-February, around the time they bought Forward Funds to get access to more alternative strategies.

In examples of an increasingly common move, Touchstone decided to liquidated both Touchstone Institutional Money Market Fund and Touchstone Money Market Fund, proceeds of the move will be rolled over into a Dreyfus money market.

In a sort of “snatching Victory from the jaws of defeat, then chucking some other Victory into the jaws” development, shareholders have learned that Victory Special Value (SSVSX) is not going to be merged out of existence into Victory Dividend Growth. Instead, Special Value has reopened to new investment while Dividend Growth has closed and replaced it on Death Row. Liquidation of Dividend Growth is slated for April 24, 2015. In the meantime, Victory Special Value got a whole new management team. The new managers don’t have a great record, but it does beat their predecessors’, so that’s a small win.

Wasatch Heritage Growth Fund (WAHGX) has closed to new investors and will be liquidated at the end of April, 2015. The initial plan was to invest in firms that had grown too large to remain in Wasatch’s many small cap portfolios; those “graduates” were the sort of the “heritage” of the title. The strategy generated neither compelling results nor investor interest.

In Closing . . .

The Observer celebrates its fourth anniversary on April 1^st. We’re delighted (and slightly surprised) at being here four years later; the average lifespan of a new website is generally measured in weeks. We’re delighted and humbled by the realization that nearly 30,000 folks peek in each month to see what we’re up to. We’re grateful, especially to the folks who continue to support the Observer, both financially and with an ongoing stream of suggestions, leads, questions and corrections. I’m always anxious about thanking folks for their contributions because I’m paranoid about forgetting anyone (if so, many apologies) and equally concerned about botching your names (a monthly goof). To the folks who use our Paypal link (Lee – I like the fact that your firm lists its professionals alphabetically rather than by hierarchy, Jeffrey who seems to have gotten entirely past Twitter and William, most recently), remember that you’ve got the option to say “hi”, too. It’s always good to hear from you. One project for us in the month ahead will be to systematize access for subscribers to our steadily-evolved premium site.

We’d been planning a party with party hats, festive noisemakers, a round of pin-the-tail-on-the-overrated-manager and a cake. Chip and Charles were way into it. 

Hmmm … apparently we might end up with something a bit more dignified instead. At the very least we’ll all be around the Morningstar conference in June and open to the prospect of a celebratory drink.

Spring impends. Keep a good thought and we’ll see you in a month!

Dear friends,

Investing by aphorism is a tricky business.

“Buy on the sound of cannons, sell on the sound of trumpets.” It’s widely attributed to “Baron Nathan Rothschild (1810).” Of course, he wasn’t a baron in 1810. There’s no evidence he ever said it. 1810 wouldn’t have been a sensible year for the statement even if he had said it. And the earliest attributions are in anti-Semitic French newspapers advancing the claim that some Rothschild or another triggered a financial panic for family gain.

And then there’s weiji. It’s one of the few things that Condoleeza Rice and Al Gore agree upon. Here’s Rice after a trip to the Middle East:

I don’t read Chinese but I’m told that the Chinese character for crisis is “weiji”, which means both danger and opportunity. And I think that states it very well.

And Gore, accepting the Nobel Prize:

In the Kanji characters used in both Chinese and Japanese, “crisis” is written with two symbols, the first meaning “danger,” the second “opportunity.”

John Kennedy, Richard Nixon, business school deans, the authors of The Encyclopedia of Public Relations, Flood Planning: The Politics of Water Security, On Philosophy: Notes on A Crisis, Foundations of Interpersonal Practice in Social Work, Strategy: A Step by Step Approach to the Development and Presentation of World Class Business Strategy (apparently one unencumbered by careful fact-checking), Leading at the Edge (the author even asked “a Chinese student” about it, the student smiled and nodded so he knows it’s true). One sage went so far as to opine “the danger in crisis situations is that we’ll lose the opportunity in it.”

Except, of course, that it’s not true. Chinese philologists keep pointing out that “ji” is being misinterpreted. At base, “ji” can mean a lot of things. Since at least the third century CE, “weiji” meant something like “latent danger.” In the early 20^th century it was applied to economic crises but without the optimistic “hey, let’s buy the dips!” sense now given it. As Victor Mair, a professor of Chinese language and literature at the University of Pennsylvania put it:

Those who purvey the doctrine that the Chinese word for “crisis” is composed of elements meaning “danger” and “opportunity” are engaging in a type of muddled thinking that is a danger to society, for it lulls people into welcoming crises as unstable situations from which they can benefit. Adopting a feel-good attitude toward adversity may not be the most rational, realistic approach to its solution.

Maybe in our March issue, I’ll expound on the origin of the phrase “furniture polish.” Did you know that it’s an Olde English term that comes from the French. It reflects the fact that the best furniture in the world was made around the city of Krakow, Poland so if you had furniture Polish, you had the most beautiful anywhere.

The good folks at Leuthold foresee a market decline of 30%, likely some time in 2015 or 2016 and likely sooner rather than later. Professor Studzinski suspects that they’re starry-eyed optimists. Yale’s Crash Confidence Index is drifting down, suggesting that investors think there will be a crash, a perception that moves contrary to the actual likelihood of a crash, except when it doesn’t. AAII’s Investor Confidence Index rose right along with market volatility. American and Chinese investors became more confident, Europeans became less confident and US portfolios became more risk-averse.

Meanwhile oil prices are falling, Russia is invading, countries are unraveling, storms are raging, Mitt’s withdrawing … egad! What, you might ask, am I doing about it? Glad you asked.

Snowball and the power of positive stupidity

My portfolio is designed to allow me to be stupid. It’s not that I try to be stupid but, being human, the temptation is almost irresistible at times. If you’re really smart, you can achieve your goals by taking a modest amount and investing it brilliantly. My family suggested that I ought not be banking on that route, so I took the road less traveled. Twenty years ago, I used free software available from Fidelity, Price and Vanguard, my college’s retirement plan providers, to determine how much I needed to invest in order to fund my retirement. I used conservative assumptions (long-term inflation near 4% and expected portfolio returns below 8% nominal), averaged the three recommendations and ended up socking away a lot each month. 

Downside (?): I needed to be careful with our money – my car tends to be a fuel-efficient used Honda or Toyota that I drive for a quarter million miles or so, I tend to spend less on new clothes each year than on good coffee (if you’re from Pittsburgh, you know Mr. Prestogeorge’s coffee; if you’re not, the Steeler Nation is sad on your behalf), our home is solid and well-insulated but modest and our vacations often involve driving to see family or other natural wonders. 

Upside: well, I’ve never become obsessed about the importance of owning stuff. And the more sophisticated software now available suggests that, given my current rate of investment, I only need to earn portfolio returns well under 6% (nominal) in order to reach my long-term goals. 

And I’m fairly confident that I’ll be able to maintain that pace, even if I am repeatedly stupid along the way. 

It’s a nice feeling. 

A quick review of my fund portfolio’s 2015 performance would lead you to believe that I managed to be extra stupid last year with a portfolio return of just over 3%. If my portfolio’s goal was to maximize one-year returns, you’d be exactly right. But it isn’t, so you aren’t. Here’s a quick review of what I was thinking when I constructed my portfolio, what’s in it and what might be next.

The Plan: Follow the evidence. My non-retirement portfolio is about half equity and half income because the research says that more equity simply doesn’t pay off in a portfolio with an intermediate time horizon. The equity portion is about half US and half international and is overweighted toward small, value, dividend and quality. The income portion combines some low-cost “normal” stuff with an awful lot of abnormal investments in emerging markets, convertibles, and called high-yield bonds. On whole the funds have high active share, long-tenured managers, are risk conscious, lower turnover and relatively low expense. In most instances, I’ve chosen funds that give the managers some freedom to move assets around.

Pure equity:

Artisan Small Cap Value (ARTVX, closed). This is, by far, my oldest holding. I originally bought Artisan Small Cap (ARTSX) in late 1995 and, being a value kinda guy, traded those shares in 1997 for shares in the newly-launched ARTVX. It made a lot of money for me in the succeeding decade but over the past five years, its performance has sucked. Lipper has it ranked as 203 out of 203 small value funds over the past five years, though it has returned about 7% annually in the period. Not entirely sure what’s up. A focus on steady-eddy companies hasn’t helped, especially since it led them into a bunch of energy stocks. A couple positions, held too long, have blown up. The fact that they’re in a leadership transition, with Scott Satterwhite retiring in October 2016, adds to the noise. I’ll continue to watch and try to learn more, but this is getting a bit troubling.

Artisan International Value (ARTKX, closed). I acquired this the same way I acquired ARTVX, in trade. I bought Artisan International (ARTIX) shortly after its launch, then moved my investment here because of its value focus. Good move, by the way. It’s performed brilliantly with a compact, benchmark-free portfolio of high quality stocks. I’m a bit concerned about the fund’s size, north of $11 billion, and the fact that it’s now dominated by large cap names. That said, no one has been doing a better job.

Grandeur Peak Global Reach (GPROX, closed). When it comes to global small and microcap investing, I’m not sure that there’s anyone better or more disciplined than Grandeur Peak. This is intended to be their flagship fund, with all of the other Grandeur Peak funds representing just specific slices of its portfolio. Performance across the group, extending back to the days when the managers ran Wasatch’s international funds, has been spectacular. All of the existing funds are closed though three more are in the pipeline: US Opportunities, Global Value, and Global Microcap.

Pure income

RiverPark Short Term High Yield (RPHYX, closed). The best and most misunderstood fund in the Morningstar universe. Merely noting that it has the highest Sharpe ratio of any fund doesn’t go far enough. Its Sharpe ratio, a measure of risk-adjusted returns where higher is better, since inception is 6.81. The second-best fund is 2.4. Morningstar insists on comparing it to its high yield bond group, with which it shares neither strategy nor portfolio. It’s a conservative cash management account that has performed brilliantly. The chart is RPHYX against the HY bond peer group.

RiverPark Strategic Income (RSIVX). At base, this is the next step out from RPHYX on the risk-return spectrum. Manager David Sherman thinks he can about double the returns posted by RPHYX without a significant risk of permanent loss of capital. He was well ahead of that pace until mid-2014 when he encountered a sort of rocky plateau. In the second half of 2014, the fund dropped 0.45% which is far less than any plausible peer group. Mr. Sherman loathes the prospect of “permanent impairment of capital” but “as long as the business model remains acceptable and is being pursued consistently and successfully, we will tolerate mark-to-market losses.” He’s quite willing to hold bonds to maturity or to call, which reduces market volatility to annoying noise in the background. Here’s the chart of Strategic Income (blue) against its older sibling.

Matthews Strategic Income (MAINX). I think this is a really good fund. Can’t quite be sure since it’s essentially the only Asian income fund on the market. There’s one Asian bond fund and a couple ETFs, but they’re not quite comparable and don’t perform nearly as well. The manager’s argument struck me as persuasive: Asian fixed-income offers some interesting attributes, it’s systematically underrepresented in indexes and underfollowed by investors (the fund has only $67 million in assets despite a strong record). Matthews has the industry’s deepest core of Asia analysts, Ms. Kong struck me as exceptionally bright and talented, and the opportunity set seemed worth pursuing.

Impure funds

FPA Crescent (FPACX). I worry, sometimes, that the investing world’s largest “free-range chicken” (his term) might be getting fat. Steve Romick has one of the longest and most successful records of any manager but he’s currently toting a $20 billion portfolio which is 40% cash. The cash stash is consistent with FPA’s “absolute value” orientation and reflects their ongoing concerns about market valuations which have grown detached from fundamentals. It’s my largest fund holding and is likely to remain so.

T. Rowe Price Spectrum Income (RPSIX). This is a fund of TRP funds, including one equity fund. It’s been my core fixed income holding since it’s broadly diversified, low cost and sensible. Over time, it tends to make about 6% a year with noticeably less volatility than its peers. It’s had two down years in a quarter century, losing about 2% in 1994 and 9% in 2008. I’m happy.

Seafarer Overseas Growth & Income (SFGIX). I believe that Andrew Foster is an exceptional manager and I was excited when he moved from a large fund with a narrow focus to launch a new fund with a broader one. Seafarer is a risk-conscious emerging markets fund with a strong presence in Asia. It’s my second largest holding and I’ve resolved to move my account from Scottrade to invest directly with Seafarer, to take advantage of their offer of allowing $100 purchase minimums on accounts with an automatic investing plan. Given the volatility of the emerging markets, the discipline to invest automatically rather than when I’m feeling brave seems especially important.

Matthews Asian Growth & Income (MACSX). I first purchased MACSX when Andrew Foster was managing this fund to the best risk-adjusted returns in its universe. It mixes common stock with preferred shares and convertibles. It had strong absolute returns, though poor relative ones, in rising markets and was the best in class in falling markets. It’s done well in the years since Andrew’s departure and is about the most sensible option around for broad Asia exposure.

Northern Global Tactical Asset Allocation (BBALX). Formerly a simple 60/40 balanced fund, BBALX uses low-cost ETFs and Northern funds to execute their investment planning committee’s firm-wide recommendations. On whole, Northern’s mission is to help very rich people stay very rich so their strategies tend to be fairly conservative and tilted toward quality, dividends, value and so on. They’ve got a lot less in the US and a lot more emerging markets exposure than their peers, a lot smaller market cap, higher dividends, lower p/e. It all makes sense. Should I be worried that they underperform a peer group that’s substantially overweighted in US, large cap and growth? Not yet.

Aston River Road Long/Short (ARLSX). Probably my most controversial holding since its performance in the past year has sucked. That being said, I’m not all that anxious about it. By the managers’ report, their short positions – about a third of the portfolio – are working. It’s their long book that’s tripping them up. Their long portfolio is quite different from their peers: they’ve got much larger small- and mid-cap positions, their median market cap is less than half of their peers’ and they’ve got rather more direct international exposure (10%, mostly Europe, versus 4%). In 2014, none of those were richly rewarding places to be. Small caps made about 3% and Europe lost nearly 8%. Here’s Mr. Moran’s take on the former:

Small-cap stocks significantly under-performed this quarter and have year-to-date as well. If the market is headed for a correction or something worse, these stocks will likely continue to lead the way. We, however, added substantially to the portfolio’s small-cap long positions during the quarter, more than doubling their weight as we are comfortable taking this risk, looking different, and are prepared to acknowledge when we are wrong. We have historically had success in this segment of the market, and we think small-cap valuations in the Fund’s investable universe are as attractive as they have been in more than two years.

It’s certainly possible that the fund is a good idea gone bad. I don’t really know yet.

Since my average holding period is something like “forever” – I first invested in eight of my 12 funds shortly after their launch – it’s unlikely that I’ll be selling anyone unless I need cash. I might eventually move the Northern GTAA money, though I have no target in mind. I suspect Charles would push for me to consider making my first ETF investment into ValueShares US Quantitative Value (QVAL). And if I conclude that there’s been some structural impairment to Artisan Small Cap Value, I might exit around the time that Mr. Satterwhite does. Finally, if the markets continue to become unhinged, I might consider a position in RiverPark Structural Alpha (RSAFX), a tiny fund with a strong pedigree that’s designed to eat volatility.

My retirement portfolio, in contrast, is a bit of a mess. I helped redesign my college’s retirement plan to simplify and automate it. That’s been a major boost for most employees (participation has grown from 23% to 93%) but it’s played hob with my own portfolio since we eliminated the Fidelity and T. Rowe funds in favor of a greater emphasis on index funds, funds of index funds and a select few active ones. My allocation there is more aggressive (80/20 stocks) but has the same tilt toward small, value, and international. I need to find time to figure out how best to manage the two frozen allocations in light of the more limited options in the new plan. Nuts.

For now: continue to do the automatic investment thing, undertake a modest bit of rebalancing out of international equities, and renew my focus on really big questions like whether to paint the ugly “I’m so ‘70s” brick fireplace in my living room.

Strange doings, currency wars, and unintended consequences

By Edward A. Studzinski

Imagine the Creator as a low comedian, and at once the world becomes explicable.     H.L. Mencken

January 2015 has perhaps not begun in the fashion for which most investors would have hoped. Instead of continuing on from last year where things seemed to be in their proper order, we have started with recurrent volatility, political incompetence, an increase in terrorist incidents around the world, currency instability in both the developed and developing markets, and more than a faint scent of deflation creeping into the nostrils and minds of central bankers. Through the end of January, the Dow, the S&P 500, and the NASDAQ are all in negative territory. Consumers, rather than following the lead of the mass market media who were telling them that the fall in energy prices presented a tax cut for them to spend, have elected to save for a rainy day. Perhaps the most unappreciated or underappreciated set of changed circumstances for most investors to deal with is the rising specter of currency wars.

So, what is a currency war? With thanks to author Adam Chan, who has written thoughtfully on this subject in the January 29, 2015 issue of The Institutional Strategist, a currency war is usually thought of as an effort by a country’s central bank to deliberately devalue their currency in an effort to stimulate exports. The most recent example of this is the announcement a few weeks ago by the European Central Bank that they would be undertaking another quantitative easing or QE in shorthand. More than a trillion Euros will be spent over the next eighteen months repurchasing government bonds. This has had the immediate effect of producing negative yields on the market prices of most European government bonds in the stronger economies there such as Germany. Add to this the compound effect of another sixty billion Yen a month of QE by the Bank of Japan going forward. Against the U.S. dollar, those two currencies have depreciated respectively 20% and 15% over the last year.

We have started to see the effects of this in earnings season this quarter, where multinational U.S. companies that report in dollars but earn various streams of revenues overseas, have started to miss estimates and guide towards lower numbers going forward. The strong dollar makes their goods and services less competitive around the world. But it ignores another dynamic going on, seen in the collapse of energy and other commodity prices, as well as loss of competitiveness in manufacturing.

Countries such as the BRIC emerging market countries (Brazil, Russia, India, China) but especially China and Russia, resent a situation where the developed countries of the world print money to sustain their economies (and keep the politicians in office) by purchasing hard assets such as oil, minerals, and manufactured goods for essentially nothing. For them, it makes no sense to allow this to continue.

The end result is the presence in the room of another six hundred pound gorilla, gold. I am not talking about gold as a commodity, but rather gold as a currency. Note that over the last year, the price of gold has stayed fairly flat while a well-known commodity index, the CRB, is down more than 25% in value. Reportedly, former Federal Reserve Chairman Alan Greenspan supported this view last November when he said, “Gold is still a currency.” He went on to refer to it as the “premier currency.” In that vein, for a multitude of reasons, we are seeing some rather interesting actions taking place around the world recently by central banks, most of which have not attracted a great deal of notice in this country.

In January of this year, the Bundesbank announced that in 2014 it repatriated 120 tons of its gold reserves back to Germany, 85 tons from New York and the balance from Paris. Of more interest, IN TOTAL SECRECY, the central bank of the Netherlands repatriated 122 tons of its gold from the New York Federal Reserve, which it announced in November of 2014. The Dutch rationale was explained as part of a currency “Plan B” in the event the Netherlands left the Euro. But it still begs the question as to why two of the strongest economies in Europe would no longer want to leave some of their gold reserves on deposit/storage in New York. And why are Austria and Belgium now considering a similar repatriation of their gold assets from New York?

At the same time, we have seen Russia, with its currency under attack and not by its own doing or desire as a result of economic sanctions. Putin apparently believes this is a deliberate effort to stimulate unrest in Russia and force him from power (just because you are paranoid, it doesn’t mean you are wrong). As a counter to that, you see the Russian central bank being the largest central bank purchaser of gold, 55 tons, in Q314. Why? He is interested in breaking the petrodollar standard in which the U.S. currency is used as the currency to denominate energy purchases and trade. Russia converts its proceeds from the sale of oil into gold. They end up holding gold rather than U.S. Treasuries. If he is successful, there will be considerably less incentive for countries to own U.S. government securities and for the dollar to be the currency of global trade. Note that Russia has a positive balance of trade with most of its neighbors and trading partners.

Now, my point in writing about this is not to engender a discussion about the wisdom or lack thereof in investing in gold, in one fashion or another. The students of history among you will remember that at various points in time it has been illegal for U.S. citizens to own gold, and that on occasion a fixed price has been set when the U.S. government has called it in. My purpose is to point out that there have been some very strange doings in asset class prices this year and last. For most readers of this publication, since their liabilities are denominated in U.S. dollars, they should focus on trying to pay those liabilities without exposing themselves to the vagaries of currency fluctuations, which even professionals have trouble getting right. This is the announced reason, and a good one, as to why the Tweedy, Browne Value Fund and Global Value Fund hedge their investments in foreign securities back into U.S. dollars. It is also why the Wisdom Tree ETF’s which are hedged products have been so successful in attracting assets. What it means is you are going to have to pay considerably more attention this year to a fund’s prospectus and its discussion of hedging policies, especially if you invest in international and/or emerging market mutual funds, both equity and fixed income.

My final thoughts have to do with unintended consequences, diversification, and investment goals and objectives. The last one is most important, but especially this year. Know yourself as an investor! Look at the maximum drawdown numbers my colleague Charles puts out in his quantitative work on fund performance. Know what you can tolerate emotionally in terms of seeing a market value decline in the value of your investment, and what your time horizon is for needing to sell those assets. Warren Buffett used to speak about evaluating investments with the thought as to whether you would still be comfortable with the investment, reflecting ownership in a business, if the stock market were to close for a couple of years. I would argue that fund investments should be evaluated in similar fashion. Christopher Browne of Tweedy, Browne suggested that you should pay attention to the portfolio manager’s investment style and his or her record in the context of that style. Focus on whose record it is that you are looking at in a fund. Looking at Fidelity Magellan’s record after Peter Lynch left the fund was irrelevant, as the successor manager (or managers as is often the case) had a different investment management style. THERE IS A REASON WHY MORNINGSTAR HAS CHANGED THEIR METHODOLOGY FROM FOLLOWING AND EVALUATING FUNDS TO FOLLOWING AND EVALUATING MANAGERS.

Diversification is another key issue to consider. Outstanding Investor Digest, in Volume XV, Number 7, published a lecture and Q&A with Philip Fisher that he gave at Stanford Business School. If you don’t know who Philip Fisher was, you owe it to yourself to read some of his work. Fisher believed strongly that you had achieved most of the benefits of risk reduction from diversification with a portfolio of from seven to ten stocks. After that, the benefits became marginal. The quote worth remembering, “The last thing I want is a lot of good stocks. I want a very few outstanding ones.” I think the same discipline should apply to mutual fund portfolios. You are not building an investment ark, where you need two of everything.

Finally, I do expect this to be a year of unintended consequences, both for institutional and individual investors. It is a year (but the same applies every year) when predominant in your mind should not be, “How much money can I make with this investment?” which is often tied to bragging rights at having done better than your brother-in-law. The focus should be, “How much money could I lose?” And my friend Bruce would ask if you could stand the real loss, and what impact it might have on your standard of living? In 2007 and 2008, many people found that they had to change their standard of living and not for the better because their investments were too “risky” for them and they had inadequate cash reserves to carry them through several years rather than liquidate things in a depressed market.

Finally, I make two suggestions. One, the 2010 documentary on the financial crisis by Charles Ferguson entitled “Inside Job” is worth seeing and if you can’t find it, the interview of Mr. Ferguson by Charlie Rose, which is to be found on line, is quite good. As an aside, there are those who think many of the most important and least watched interviews in our society today are conducted by Mr. Rose, which I agree with and think says something about the state of our society. And for those who think history does not repeat itself, I would suggest reading volume I, With Fire and Sword of the great trilogy of Henryk Sienkiewicz about the Cossack wars of the Sixteenth Century set in present day Ukraine. I think of Sienkiewicz as the Walter Scott of Poland, and you have it all in these novels – revolution and uprising in Ukraine, conflict between the Polish-Lithuanian Commonwealth and Moscow – it’s all there, but many, many years ago. And much of what is happening today, has happened before.

I will leave you with a few sentences from the beginning pages of that novel.

It took an experienced ear to tell the difference between the ordinary baying of the wolves and the howl of vampires. Sometimes entire regiments of tormented souls were seen to drift across the moonlit Steppe so that sentries sounded the alarm and garrisons stood to arms. But such ghostly armies were seen only before a great war.

Genius, succession and transition at Third Avenue

The mutual fund industry is in the midst of a painful transition. As long ago as the 1970s, Charles Ellis recognized that the traditional formula could no longer work. That formula was simple:

1. Read Dodd and Graham
2. Apply Dodd and Graham
3. Crush the competition
4. Watch the billions flow in.

Ellis’s argument is that Step 3 worked only if you were talented and your competitors were not. While that might have described the investing world in the 1930s or even the 1950s, by the 1970s the investment industry was populated by smart, well-trained, highly motivated investors and the prospect of beating them consistently became as illusory as the prospect of winning four Super Bowls in six years now is. (With all due respect to the wannabees in Dallas and New England, each of which registered three wins in a four year period.)

The day of reckoning was delayed by two decades of a roaring stock market. From 1980 – 1999, the S&P 500 posted exactly two losing years and each down year was followed by eight or nine winning ones. Investors, giddy at the prospect of 100% and 150% and 250% annual reports, catapulted money in the direction of folks like Alberto Vilar and Garrett Van Wagoner. As the acerbic hedge fund manager Jim Rogers said, “It is remarkable how many people mistake a bull market for brains.”

That doesn’t deny the existence of folks with brains. They exist in droves. And a handful – Charles Royce and Marty Whitman among them – had “brains” to the point of “brilliance” and had staying power.

For better and worse, Step 4 became difficult 15 years ago and almost a joke in the past decade. While a handful of funds – from Michael C. Aronstein’s Mainstay Marketfield (MFLDX) and The Jeffrey’s DoubleLine complex – managed to sop up tens of billions, flows into actively-managed fund have slowed to a trickle. In 2014, for example, Morningstar reports that actively-managed funds saw $90 billion in outflows and passive funds had $156 billion in inflows.

The past five years have not been easy ones for the folks at Third Avenue funds. It’s a firm with that earned an almost-legendary reputation for independence and success. Our image of them and their image of themselves might be summarized by the performance of the flagship Third Avenue Value Fund (TAVFX) through 2007.

The Value Fund (blue) not only returned more than twice what their global equity peers made, but also essential brushed aside the market collapse at the end of the 1990s bubble and the stagnation of “the lost decade.” Investors rewarded the fund by entrusting it with billions of dollars in assets; the fund held over $11 billion at its peak.

But it’s also a firm that struggled since the onset of the market crisis in late 2007. Four of the firm’s funds have posted mediocre returns – not awful, but generally below-average – during the market cycle that began in early October 2007 and continues to play out. The funds’ five- and ten-year records, which capture parts of two distinct market cycles but the full span of neither, make them look distinctly worse. That’s been accompanied by the departure of both investment professionals and investor assets:

Third Avenue Value (TAVFX) saw the departure of Marty Whitman as the fund’s manager (2012) and of his heir presumptive Ian Lapey (2014), along with 80% of its assets. The fund trails about 80% of its global equity peers over the past five and ten years, which helps explain the decline. Performance has rallied in the past three years with the fund modestly outperforming the MSCI World index through the end of 2014, though investors have been slow to return.

Third Avenue Small Cap Value (TASCX) bid adieu to manager Curtis Jensen (2014) and analyst Charles Page, along with 80% of its assets. The fund trails 85% of its peers over the past five years and ten years.

Third Avenue International Value (TAVIX) lost founding manager Amit Wadhwaney (2014), his co-manager and two analysts. Trailing 96% of its peers for the past five and ten years, the fund’s AUM declined by 86% from its peak assets.

Third Avenue Focused Credit (TFCIX) saw its founding manager, Jeffrey Gary, depart (2010) to found a competing fund, Avenue Credit Strategies (ACSAX) though assets tripled from around the time of his departure to now. The fund’s returns over the past five years are almost dead-center in the high yield bond pack.

Only Third Avenue Real Estate Value (TAREX) has provided an island of stability. Lead manager Michael Winer has been with the fund since its founding, he’s got his co-managers Jason Wolfe (2004) and Ryan Dobratz (2006), a growing team, and a great (top 5% for the past 3, 5, 10 and 15 year periods) long-term record. Sadly, that wasn’t enough to shield the fund from a 67% drop in assets from 2006 to 2008. Happily, assets have tripled since then to about $3 billion.

In sum, the firm’s five mutual funds are down by $11 billion from their peak asset levels and nearly 50% of the investment professionals on staff five years ago, including the managers of four funds, are gone. At the same time, only one of the five funds has had performance that meets the firm’s long-held standards of excellence.

Many outsiders noted not just the departure of long-tenured members of the Third Avenue community, but also the tendency to replace some those folks with outsiders, including Robert Rewey, Tim Bui and Victor Cunningham. The most prominent change was the arrival, in 2014, of Robert Rewey, the new head of the “value equity team.” Mr. Rewey formerly was a portfolio manager at Cramer Rosenthal McGlynn, LLC, where his funds’ performance trailed their benchmark (CRM Mid Cap Value CRMMX, CRM All Cap Value CRMEX and CRM Large Cap Opportunity CRMGX) or exceeded it modestly (CRM Small/Mid Cap Value CRMAX). Industry professionals we talked with spoke of “a rolling coup,” the intentional marginalization of Mr. Whitman within the firm he created and the influx of outsiders. Understandably, the folks at Third Avenue reject that characterization, noting that Mr. Whitman is still at TAM, that he attends every research meeting and was involved in every hiring decision.

Change in the industry is constant; the Observer reports on 500 or 600 management changes – some occasioned by a manager’s voluntary change of direction, others not – each year. The question for investors isn’t “had Third Avenue changed?” (It has, duh). The questions are “how has that change been handled and what might it mean for the future?” For answers, we turned to David Barse. Mr. Barse has served with Mr. Whitman for about a quarter century. He’s been president of Third Avenue, of MJ Whitman LLC and of its predecessor firm. He’s been with the operation continuously since the days that Mr. Whitman managed the Equity Strategies Fund in the 1980s.

From that talk and from the external record, I’ve reached three tentative conclusions:

1. Third Avenue Value Fund’s portfolio went beyond independent to become deeply, perhaps troublingly, idiosyncratic during the current cycle. Mr. Whitman saw Asia’s growth as a powerful driver to real estate values there and the onset of the SARS/avian flu panics as a driver of incredible discounts in the stocks’ prices. As a result, he bought a lot of exposure to Asian real estate and, as the markets there declined, bought more. At its peak, 65% of the fund’s portfolio was exposed to the Asian real estate market. Judging by their portfolios, neither the very successful Real Estate Value Fund nor the International Value Fund, the logical home of such investments, believed that it was prudent to maintain such exposure. Mr. Winer got his fund entirely out of the Asia real estate market and Mr. Wadhwaney’s portfolio contained none of the stocks held in TAVFX. Reportedly members of Mr. Whitman’s own team had substantial reservations about the extent of their investment and many shareholders, including large institutional investors, concluded that this was not at all what they’d signed up for. Third Avenue has now largely unwound those positions, and the Value Fund had 8.5% of its 2014 year-end portfolio in Hong Kong.
2. “Succession planning” always works better on paper than in the messy precinct of real life. Mr. Whitman and Mr. Barse knew, on the day that TAVFX launched, that they needed to think about life after Marty. Mr. Whitman was 67 when the fund launched and was setting out for a new adventure around the time that most professionals begin winding down. In consequence, Mr. Barse reports, “Succession planning was intrinsic to our business plans from the very beginning. This was a fantastic business to be in during the ‘90s and early ‘00s. We pursued a thoughtful expansion around our core discipline and Marty looked for talented people who shared his discipline and passion.” Mr. Whitman seems to have been more talented in investment management than in business management and none of this protégés, save Mr. Winer, showed evidence of the sort of genius that drove Mr. Whitman’s success. Finally, in his 89^th year of life, Mr. Whitman agreed to relinquish management of TAVFX with the understanding that Ian Lapey be given a fair chance as his successor. Mr. Lapey’s tenure as manager, both the five years which included time as co-manager with Mr. Whitman and the 18 months as lead manager, was not notably successful.
3. Third Avenue is trying to reorient its process from “the mercurial genius” model to “the healthy team” one. When Third Avenue was acquired in 2002 by the Affiliated Managed Group (AMG), the key investment professionals signed a ten year commitment to stay with the firm – symbolically important if legally non-binding – with a limited non-compete period thereafter. 2012 saw the expiration of those commitments and the conclusion, possibly mutual, that it was time for long-time managers like Curtis Jensen and Amit Wadhwaney to move on. The firm promoted co-managers with the expectation that they’d become eventual successors. Eventually they began a search for Mr. Whitman’s successor. After interviewing more than 50 candidates, they selected Mr. Rewey based on three factors: he understood the nature of a small, independent, performance-driven firm, he understood the importance of healthy management teams and he shared Mr. Whitman’s passion for value investing. “We did not,” Mr. Barse notes, “make this decision lightly.” The firm gave him a “team leader” designation with the expectation that he’d consciously pursue a more affirmative approach to cultivating and empowering his research and management associates.

It’s way too early to draw any conclusions about the effects of their changes on fund performance. Mr. Barse notes that they’ve been unwinding some of the Value Fund’s extreme concentration and have been working to reduce the exposure of illiquid positions in the International Value Fund. In the third quarter, Small Cap Value eliminated 16 positions while starting only three. At the same time, Mr. Barse reports growing internal optimism and comity. As with PIMCO, the folks at Third Avenue feel they’re emerging from a necessary but painful transition. I get a sense that folks at both institutions are looking forward to going to work and to the working together on the challenges they, along with all active managers and especially active boutique managers, face.

The questions remain: why should you care? What should you do? The process they’re pursuing makes sense; that is, team-managed funds have distinct advantages over star-managed ones. Academic research shows that returns are modestly lower (50 bps or so) but risk is significantly lower, turnover is lower and performance is more persistent. And Third Avenue remains fiercely independent: the active share for the Value Fund is 98.2% against the MSCI World index, Small Cap Value is 95% against the Russell 2000 Value index, and International Value is 97.6% against MSCI World ex US. Their portfolios are compact (38, 64 and 32 names, respectively) and turnover is low (20-40%).

For now, we’d counsel patience. Not all teams (half of all funds claim them) thrive. Not all good plans pan out. But Third Avenue has a lot to draw on and a lot to prove, we wish them well and will keep a hopeful eye on their evolution.

Where are they now?

We were curious about the current activities of Third Avenue’s former managers. We found them at the library, mostly. Ian Lapey’s LinkedIn profile now lists him as a “director, Stanley Furniture Company” but we were struck by the current activities of a number of his former co-workers:

Apparently time at Third Avenue instills a love of books, but might leave folks short of time to pursue them.

Would you give somebody $5.8 million a year to manage your money?

And would you be steamed if he lost $6.9 million for you in your first three months with him?

If so, you can sympathize with Bill Gross of Janus Funds. Mr. Gross has reportedly invested $700 million in Janus Global Unconstrained Bond (JUCIX), whose institutional shares carry a 0.83% expense ratio. So … (mumble, mumble, scribble) 0.0083 x 700,000,000 is … ummmm … he’s charging himself $5,810,000 for managing his personal fortune.

Oh, wait! That overstates the expenses a bit. The fund is down rather more than a percent (1.06% over three months, to be exact) so that means he’s no longer paying expenses on the $7,420,000 that’s no longer there. That’d be a $61,000 savings over the course of a year.

It calls to mind a universally misquoted passage from F. Scott Fitzgerald’s short story, “The Rich Boy” (1926)

Let me tell you about the very rich. They are different from you and me. They possess and enjoy early, and it does something to them, makes them soft, where we are hard, cynical where we are trustful, in a way that, unless you were born rich, it is very difficult to understand. 

Hemingway started the butchery by inventing a conversation between himself and Fitzgerald, in which Fitzgerald opines “the rich are different from you and me” and Hemingway sharply quips, “yes, they have more money.” It appears that Mary Collum, an Irish literary critic, in a different context, made the comment and Hemingway pasted it seamlessly into a version that made him seem the master.

P.S. please don’t tell the chairman of Janus. He’s the guy who didn’t know that all those millions flowing from a single brokerage office near Gross’s home into Gross’s fund was Gross’s money. I suspect it’s just better if we don’t burden him with unnecessary details.

Top developments in fund industry litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before. For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

Decision

• The court granted Vanguard‘s motion to dismiss shareholder litigation regarding two international funds’ holdings of gambling-related securities: “the court concludes that plaintiffs’ claims are time barred and alternatively that plaintiff has not established that the Board’s refusal to pursue plaintiffs’ demand for litigation violated Delaware’s business judgment rule.” Defendants included independent directors. (Hartsel v. Vanguard Group Inc.)

Settlement

• Morgan Keegan defendants settled long-running securities litigation, regarding bond funds’ investments in collateralized debt obligations, for $125 million. Defendants included independent directors. (In re Regions Morgan Keegan Open-End Mut. Fund Litig.; Landers v. Morgan Asset Mgmt., Inc.)

Briefs

• AXA Equitable filed a motion for summary judgment in fee litigation regarding twelve subadvised funds: “The combined investment management and administrative fees . . . for the funds were in all cases less than 1% of fund assets, and in some cases less than one half of 1%. These fees are in line with industry medians.” (Sanford v. AXA Equitable Funds Mgmt. Group, LLC; Sivolella v. AXA Equitable Life Ins. Co.)
• Plaintiffs filed their opposition to Genworth‘s motion for summary judgment in a fraud case regarding an investment expert’s purported role in the management of the BJ Group Services portfolios. (Goodman v. Genworth Fin. Wealth Mgmt., Inc.)
• Plaintiffs filed their opposition to SEI defendants’ motion to dismiss fee litigation regarding five subadvised funds: By delegating “nearly all of its investment management responsibilities to its army of sub-advisers” and “retaining substantial portions of the proceeds for itself,” SEI charges “excessive fees that violate section 36(b) of the Investment Company Act.” (Curd v. SEI Invs. Mgmt. Corp.)

Answer

• Having previously lost its motion to dismiss, Harbor filed an answer to excessive-fee litigation regarding its subadvised International and High-Yield Bond Funds. (Zehrer v. Harbor Capital Advisors, Inc.)

The Alt Perspective: Commentary and news from DailyAlts.

By Brian Haskin, editor of DailyAlts.com

Last month, I took a look at a few of the trends that took shape over the course of 2014 and noted how those trends might unfold in 2015. Now that the full year numbers are in, I thought I would do a 2014 recap of those numbers and see what they tell us.

Overall, assets in the Liquid Alternatives category, including both mutual funds and ETFs, were up 10.9% based on Morningstar’s classification, and 9.8% by DailyAlts classification. For ease of use, let’s call it 10%. Not too bad, but quite a bit short of the growth rates seen earlier in the year that hovered around 40%. But, compared to other major asset classes, alternative funds actually grew about 3 times faster. That’s quite good. The table below summarizes Morningstar’s asset flow data for mutual funds and ETFs combined:

The macro shifts in investor’s allocations were quite subtle, but nonetheless, distinct. Assets growth increased at about an equal rate for both stocks and bonds at a 3.4% and 3.7%, respectively, while commodities fell out of favor and lost 3.4% of their assets. However, with most investors underinvested in alternatives, the category grew at 10.9% and ended the year with $199 billion in assets, or 1.4% of the total pie. This is a far cry from institutional allocations of 15-20%, but many experts expect to see that 1.4% number increase to the likes of 10-15% over the coming decade.

Now, let’s take a look a more detailed look at the winning and loosing categories within the alternatives bucket. Here is a recap of 2014 flows, beginning assets, ending assets and growth rates for the various alternative strategies and alternative asset classes that we review:

The dominant category over the year was what Morningstar calls non-traditional bonds, which took in $22.8 billion. Going into 2014, investors held the view that interest rates would rise and, thus, they looked to reduce interest rate risk with the more flexible non-traditional bond funds. This all came to a halt as interest rates actually declined and flows to the category nearly dried up in the second half.

On a growth rate perspective, multi-alternative funds grew at a nearly 34% rate in 2014. These funds allocate to a wide range of alternative investment strategies, all in one fund. As a result, they serve as a one-stop shop for allocations to alternative investments. In fact, they serve the same purpose as fund-of-hedge funds serve for institutional investors but for a much lower cost! That’s great news for retail investors.

Finally, what is most striking is that the asset flows to alternatives all came in the first half of the year – $36.2 billion in the first half and only $622 million in the second half. Much of the second half slowdown can be attributed to two factors: A complete halt in flows to non-traditional bonds in reaction to falling rates, and billions in outflows from the MainStay Marketfield Fund (MFLDX), which had an abysmal 2014. The good news is that multi-alternative funds held steady from the first half to the second – a good sign that advisors and investors are maintaining a steady allocation to broad based alternative funds.

For 2015, expect to see multi-alternative funds continue to gather assets at a steady clip. The managed futures category, which grew at a healthy 19.5% in 2014 on the back of multiple difficult years, should see continued action as global markets and economies continue to diverge, thus creating a more favorable environment for these funds. Market neutral funds should also see more interest as they are designed to be immune to most of the market’s ups and downs.

Next month we will get back to looking at a few of the intriguing fund launches for early 2015. Until then, hold on for the ride and stay diversified!

Observer Fund Profiles

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past two or three years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Osterweis Strategic Investment (OSTVX). I’m always intrigued by funds that Morningstar disapproves of. When you combine disapproval with misunderstanding, then add brilliant investment performance, it becomes irresistible for us to address the question “what’s going on here?” Short answer: good stuff.

Pear Tree Polaris Foreign Value Small Cap (QUSOX). There are three, and only three, great international small cap funds: Wasatch International Opportunities (WAIOX), Grandeur Peak International Opportunities (GPIOX) and Pear Tree Polaris Foreign Value Small Cap. Why have you only heard of the first two?

TrimTabs Float Shrink ETF (TTFS). This young ETF is off to an impressive start by following what it believes are the “best informed market participants.” This is a profile by our colleague Charles Boccadoro, which means it will be data-rich!

Touchstone Sands Capital Emerging Markets Growth (TSEMX). Sands Capital has a long, strong record in tracking down exceptional businesses and holding them close. TSEMX represents the latest extension of the strategy from domestic core to global and now to the emerging markets.

Conference Call Highlights: Bernie Horn, Polaris Global Value

About 40 of us gathered in mid-January to talk with Bernie Horn. It was an interesting talk, one which covered some of the same ground that he went over in private with Mr. Studzinski and me but one which also highlighted a couple new points.

Highlights:

• The genesis of the fund was in his days as a student at the Sloan School of Management at MIT at the end of the 1970s. It was a terrible decade for stocks in the US but he was struck by the number of foreign markets that had done just fine. One of his professors, Fischer Black, an economist whose work with Myron Scholes on options led to a Nobel Prize, generally preached the virtues of the efficient market theory but carries “a handy list of exceptions to EMT.” The most prominent exception was value investing. The emerging research on the investment effects of international diversification and on value as a loophole to EMT led him to launch his first global portfolios.
• His goal is, over the long-term, to generate 2% greater returns than the market with lower volatility.
• He began running separately-managed accounts but those became an administrative headache and so he talked his investors into joining a limited partnership which later morphed into Polaris Global Value Fund (PGVFX).
• The central discipline is calculating the “Polaris global cost of equity” (which he thinks separates him from most of his peers) and the desire to add stocks which have low correlations to his existing portfolio.
• The Polaris global cost of capital starts with the market’s likely rate of return, about 6% real. He believes that the top tier of managers can add about 2% or 200 bps of alpha. So far that implies an 8% cost of capital. He argues that fixed income markets are really pretty good at arbitraging currency risks, so he looks at the difference between the interest rates on a country’s bonds and its inflation rate to find the last component of his cost of capital. The example was Argentina: 24% interest rate minus a 10% inflation rate means that bond investors are demanding a 14% real return on their investments. The 14% reflects the bond market’s judgment of the cost of currency; that is, the bond market is pricing-in a really high risk of a peso devaluation. In order for an Argentine company to be attractive to him, he has to believe that it can overcome a 22% cost of capital (6 + 2 + 14). The hurdle rate for the same company domiciled elsewhere might be substantially lower.
• He does not hedge his currency exposure because the value calculation above implicitly accounts for currency risk. Currency fluctuations accounted for most of the fund’s negative returns last year, about 2/3s as of the third quarter. To be clear: the fund made money in 2014 and finished in the top third of its peer group. Two-thirds of the drag on the portfolio came from currency and one-third from stock selections.
• He tries to target new investments which are not correlated with his existing ones; that is, ones that do not all expose his investors to a single, potentially catastrophic risk factor. It might well be that the 100 more attractively priced stocks in the world are all financials but he would not overload the portfolio with them because that overexposes his investors to interest rate risks. Heightened vigilance here is one of the lessons of the 2007-08 crash.
• An interesting analogy on the correlation and portfolio construction piece: he tries to imagine what would happen if all of the companies in his portfolio merged to form a single conglomerate. In the conglomerate, he’d want different divisions whose cash generation was complementary: if interest rates rose, some divisions would generate less cash but some divisions would generate more and the net result would be that rising interest rates would not impair the conglomerates overall free cash flow. By way of example, he owns energy exploration and production companies whose earnings are down because of low oil prices but also refineries whose earnings are up.
• He instituted more vigorous stress tests for portfolio companies in the wake of the 2007-09 debacle. Twenty-five of 70 companies were “cyclically exposed”. Some of those firms had high fixed costs of operations which would not allow them to reduce costs as revenues fell. Five companies got “bumped off” as a result of that stress-testing.

A couple caller questions struck me as particularly helpful:

Ken Norman: are you the lead manager on both the foreign funds? BH: Yes, but … Here Bernie made a particularly interesting point, that he gives his associates a lot of leeway on the foreign funds both in stock selection and portfolio construction. That has two effects. (1) It represents a form of transition planning. His younger associates are learning how to operate the Polaris system using real money and making decisions that carry real consequences. He thinks that will make them much better stewards of Polaris Global Value when it becomes their turn to lead the fund. (2) It represents a recruitment and retention strategy. It lets bright young analysts know that they have a real role to play and a real future with the firm.

Shostakovich, a member of the Observer’s discussion board community and investor in PGVFX: you’ve used options to manage volatility. Is that still part of the plan? BH: Yes, but rarely now. Three reasons. (1) There are no options on many of the portfolio firms. (2) Post-08, options positions are becoming much more expensive, hence less rewarding. (3) Options trade away “excess” upside in exchange for limiting downside; he’s reluctant to surrender much alpha since some of the firms in the portfolio have really substantial potential.

Bottom line: You need to listen to the discussion of ways in which Polaris modified their risk management in the wake of 2008. Their performance in the market crash was bad. They know it. They were surprised by it. And they reacted thoughtfully and vigorously to it. In the absence of that one period, PGVFX has been about as good as it gets. If you believe that their responses were appropriate and sufficient, as I suspect they were, then this strikes me as a really strong offering.

We’ve gathered all of the information available on Polaris Global Value Fund, including an .mp3 of the conference call, into its new Featured Fund page. Feel free to visit!

Conference Call Upcoming: Matthew Page and Ian Mortimer, Guinness Atkinson Funds

We’d be delighted if you’d join us on Monday, February 9th, from noon to 1:00 p.m. Eastern, for a conversation with Matthew Page and Ian Mortimer, managers of Guinness Atkinson Global Innovators (IWIRX) and Guinness Atkinson Dividend Builder (GAINX). These are both small, concentrated, distinctive, disciplined funds with top-tier performance. IWIRX, with three distinctive strategies (starting as an index fund and transitioning to an active one), is particularly interesting. Most folks, upon hearing “global innovators” immediately think “high tech, info tech, biotech.” As it turns out, that’s not what the fund’s about. They’ve found a far steadier, broader and more successful understanding of the nature and role of innovation. Guinness reports:

Guinness Atkinson Global Innovators is the #1 Global Multi-Cap Growth Fund across all time periods (1,3,5,& 10 years) this quarter ending 12/31/14 based on Fund total returns.

They are ranked 1 of 500 for 1 year, 1 of 466 for 3 years, 1 of 399 for 5 years and 1 of 278 for 10 years in the Lipper category Global Multi-Cap Growth.

Goodness. And it still has under $200 million in assets.

Matt volunteered the following plan for their slice of the call:

I think we would like to address some of the following points in our soliloquy.

• Why are innovative companies an interesting investment opportunity?
• How do we define an innovative company?
• Aren’t innovative companies just expensive?
• Are the most innovative companies the best investments?

I suppose you could sum all this up in the phrase: Why Innovation Matters.

In deference to the fact that Matt and Ian are based in London, we have moved our call to noon Eastern. While they were willing to hang around the office until midnight, asking them to do it struck me as both rude and unproductive (how much would you really get from talking to two severely sleep-deprived Brits?).

Over the past several years, the Observer has hosted a series of hour-long conference calls between remarkable investors and, well, you. The format’s always the same: you register to join the call. We share an 800-number with you and send you an emailed reminder on the day of the call. We divide our hour together roughly in thirds: in the first third, our guest talks with us, generally about his or her fund’s genesis and strategy. In the middle third I pose a series of questions, often those raised by readers. Here’s the cool part, in the final third you get to ask questions directly to our guest; none of this wimpy-wompy “you submit a written question in advance, which a fund rep rewords and reads blankly.” Nay nay. It’s your question, you ask it. The reception has been uniformly positive.

HOW CAN YOU JOIN IN?

If you’d like to join in, just click on register and you’ll be taken to the Chorus Call site. In exchange for your name and email, you’ll receive a toll-free number, a PIN and instructions on joining the call. If you register, I’ll send you a reminder email on the morning of the call.

Remember: registering for one call does not automatically register you for another. You need to click each separately. Likewise, registering for the conference call mailing list doesn’t register you for a call; it just lets you know when an opportunity comes up. 

WOULD AN ADDITIONAL HEADS UP HELP?

Over two hundred readers have signed up for a conference call mailing list. About a week ahead of each call, I write to everyone on the list to remind them of what might make the call special and how to register. If you’d like to be added to the conference call list, just drop me a line.

Funds in Registration

There continued to be remarkably few funds in registration with the SEC this month and I’m beginning to wonder if there’s been a fundamental change in the entrepreneurial dynamic in the industry. There are nine new no-load retail funds in the pipeline, and they’ll launch by the end of April. The most interesting development might be DoubleLine’s move into commodities. (It’s certainly not Vanguard’s decision to launch a muni-bond index.) They’re all detailed on the Funds in Registration page.

Manager Changes

About 50 funds changed part or all of their management teams in the past month. An exceptional number of them were part of the continuing realignment at PIMCO. A curious and disappointing development was the departure of founding manager Michael Carne from the helm of Nuveen NWQ Flexible Income Fund (NWQAX). He built a very good, conservative allocation fund that holds stocks, bonds and convertibles. We wrote about the fund a while ago: three years after launch it received a five-star rating from Morningstar, celebration followed until a couple weeks later Morningstar reclassified it as a “convertibles” fund (it ain’t) and it plunged to one-star, appealed the ruling, was reclassified and regained its stars. It has been solid, disciplined and distinctive, which makes it odd that Nuveen chose to switch managers.

You can see all of the comings and goings on our Manager Changes  page.

Briefly Noted . . .

On December 1, 2014, Janus Capital Group announced the acquisition of VS Holdings, parent of VelocityShares, LLC. VelocityShares provides both index calculation and a suite of (creepy) leveraged, reverse leveraged, double leveraged and triple leveraged ETNs.

Fidelity Strategic Income (FSICX) is changing the shape of the barbell. They’ve long described their portfolio as a barbell with high yield and EM bonds on the one end and high quality US Treasuries and corporates on the other. They’re now shifting their “neutral allocation” to inch up high yield exposure (from 40 to 45%) and drop investment grade (from 30 to 25%).

GaveKal Knowledge Leaders Fund (GAVAX/GAVIX) is changing its name to GaveKal Knowledge Leaders Allocation Fund. The fund has always had an absolute value discipline which leads to it high cash allocations (currently 25%), exceedingly low risk … and Morningstar’s open disdain (it’s currently a one-star large growth fund). The changes will recognize the fact that it’s not designed to be a fully-invested equity fund. Their objective changes from “long-term capital appreciation” to “long-term capital appreciation with an emphasis on capital preservation” and “fixed income” gets added as a principal investment strategy.

SMALL WINS FOR INVESTORS

Palmer Square Absolute Return Fund (PSQAX/PSQIX) has agreed to a lower management fee and has reduced the cap on operating expenses by 46 basis points to 1.39% and 1.64% on its institutional and “A” shares.

Likewise, State Street/Ramius Managed Futures Strategy Fund (RTSRX) dropped its expense cap by 20 basis points, to 1.90% and 1.65% on its “A” and institutional shares.

CLOSINGS (and related inconveniences)

Effective as of the close of business on February 27, 2015, BNY Mellon Municipal Opportunities Fund (MOTIX) will be closed to new and existing investors. It’s a five-star fund with $1.1 billion in assets and five-year returns in the top 1% of its peer group.

Franklin Small Cap Growth Fund (FSGRX) closes to new investors on February 12, 2015. It’s a very solid fund that had a very ugly 2014, when it captured 240% of the market’s downside.

OLD WINE, NEW BOTTLES

Stand back! AllianceBernstein is making its move: all AllianceBernstein funds are being rebranded as AB funds.

OFF TO THE DUSTBIN OF HISTORY

Ascendant Natural Resources Fund (NRGAX) becomes only a fond memory as of February 27, 2015.

AdvisorShares International Gold and AdvisorShares Gartman Gold/British Pound ETFs liquidated at the end of January.

Cloumbia is cleaning out a bunch of funds at the beginning of March: Columbia Masters International Equity Portfolio, Absolute Return Emerging Markets Macro Fund,Absolute Return Enhanced Multi-Strategy Fund and Absolute Return Multi-Strategy Fund. Apparently having 10-11 share classes each wasn’t enough to save them. The Absolute Return funds shared the same management team and were generally mild-mannered under-performers with few investors.

Direxion/Wilshire Dynamic Fund (DXDWX) will be dynamically spinning in its grave come February 20^th.

Dynamic Total Return Fund (DYNAX/DYNIX) will totally return to the dust whence it came, effective February 20^th. Uhhh … if I’m reading the record correctly, the “A” shares never launched, the “I” shares launched in September 2014 and management pulled the plug after three months.

Loeb King Alternative Strategies (LKASX) and Loeb King Asia Fund (LKPAX) are being liquidated at the end of February because, well, Loeb King doesn’t want to run mutual funds anymore and they’re getting entirely out of the business. Both were pricey long/short funds with minimal assets and similar success.

New Path Tactical Allocation Fund became liquid on January 13, 2015.

In “consideration of the Fund’s asset size, strategic importance, current expenses and historical performance,” Turner’s board of directors has pulled the plug on Turner Titan Fund (TTLFX). It wasn’t a particularly bad fund, it’s just that Turner couldn’t get anyone (including one of the two managers and three of the four trustees) to invest in it. Graveside ceremonies will take place on March 13, 2015 in the family burial plot.

In Closing . . .

I try, each month, to conclude this essay with thanks to the folks who’ve supported us, by reading, by shopping through our Amazon link and by making direct, voluntary contributions. Part of the discipline of thanking folks is, oh, getting their names right. It’s not a long list, so you’d think I could manage it.

Not so much. So let me take a special moment to thank the good folks at Evergreen Asset Management in Washington for their ongoing support over the years. I misidentified them last month. And I’d also like to express intense jealousy over what appears to be the view out their front window since the current view out my front window is

With extra careful spelling, thanks go out to the guys at Gardey Financial of Saginaw (MI), who’ve been supporting us for quite a while but who don’t seem to have a particularly good view from their office, Callahan Capital Management out of Steamboat Springs (hi, Dan!), Mary Rose, our friends Dan S. and Andrew K. (I know it’s odd, but just knowing that there are folks who’ve stuck with us for years makes me feel good), Rick Forno (who wrote an embarrassingly nice letter to which we reply, “gee, oh garsh”), Ned L. (who, like me, has professed for a living), David F., the surprising and formidable Dan Wiener and the Hastingses. And, as always, to our two stalwart subscribers, Greg and Deb. If we had MFO coffee mugs, I’d sent them to you all!

Do consider joining us for the talk with Matt and Ian. We’ve got a raft of new fund profiles in the works, a recommendation to Morningstar to euthanize one of their long-running features, and some original research on fund trustees to share. In celebration of our fourth birthday this spring, we’ve got surprises a-brewin’ for you.

Until then, be safe!

Dear friends,

Welcome to the New Year!

And to an odd question: why is it a New Year?  That is, why January 1?  Most calendrical events correspond to something: cycles of the moon and stars, movement of the seasons, conclusions of wars or deaths of Great Men.

But why January 1?  It corresponds with nothing.

Here’s the short answer: your recent hangover and binge of bowl watching were occasioned by the scheming of some ancient Roman high priest, named a pontifex, and the political backlash to his overreach. Millennia ago, the Romans had a year that started sensibly enough, at the beginning of spring when new life began appearing. But the year also ended with the winter solstice and a year-end party that could stretch on for weeks.  December, remember? Translates as “the tenth month” out of ten.

So what happened in between the party and the planting? The usual stuff, I suppose: sex, lies, lies about sex, dinner and work.  What didn’t happen was politics: new governments, elected in the preceding year, weren’t in power until the new year began. And who decided exactly when the new year began? The pontifex. And how did the pontifex decide? Oracles, goat entrails and auguries, mostly. And also a keen sense of whether he liked the incoming government more than the outgoing one.  If the incoming government promised to be a pain in the butt, the new year might start a bit later.  If the new government was full of friends, the new year might start dramatically earlier. And if the existing government promised to be an annoyance in the meanwhile, the pontifex could declare an extended religious holiday during which time the government could not convene.

Eventually Julius Caesar and the astronomer Sosigenes got together to create a twelve month calendar whose new year commenced just after the hangover from the year-end parties faded. Oddly, the post-Roman Christian world didn’t adopt January 1 (pagan!) as the standard start date for another 1600 years.  Pope Gregory tried to fiat the new start day. Protestant countries flipped him off. In England and the early US, New Year’s Day was March 25^th, for example. Eventually the Brits standardized it in their domains in 1750.

Pagan priest examining the gall bladder of a goat. Ancient politics and hefty campaign contributions.

So, why exactly does it make sense for you to worry about how your portfolio did in 2014?  The end date of the year is arbitrary. It corresponds neither to the market’s annual flux nor to the longer seven(ish) year cycles in which the market rises and falls, much less your own financial needs and resources.

I got no clue. You?

I’d hoped to start the year by sharing My Profound Insights into the year ahead, so I wandered over to the Drawer of Clues. Empty. Nuts. The Change Jar of Market Changes? Nothing except some candy wrappers that my son stuffed in there. The white board listing The Four Funds You Must Own for 2015? Carried off by some red-suited vagrant who snuck in on Christmas Eve. (Also snagged my sugar cookies and my bottle of Drambuie. Hope he got pulled over for impaired flying.)

Oddly, I seem to be the only person who doesn’t know where things are going. The Financial Times reports that “the ‘divergence’ between the economies of the US and the rest of the world … features in almost every 2015 outlook from Wall Street strategists.” Yves Kuhn, an investment strategist from Luxembourg, notes the “the biggest consensus by any margin is to be long dollar, short euro … I have never seen such a consensus in the market.” Barron’s December survey of economists and strategists: “the consensus is ‘stick with the bull.’” James Paulsen, allowed that “There’s some really, really strong Wall Street consensus themes right now” in favor of US stocks, the dollar and low interest rates.  

Of course, the equally universal consensus in January 2014 was for rising interest rates, soaring energy prices and a crash in the bond market.

Me? I got no clue. Here’s the best I got:

• Check to see if you’ve got a plan. If not, get one. Fund an emergency account. Start investing in a conservative fund for medium time horizon needs. Work through a sensible asset allocation plan for the long-term. It’s not as hard as you want to imagine it is.
• Pursue it with some discipline. Find a sustainable monthly contribution. Set your investments on auto-pilot. Move any windfalls – whether it’s a bonus or a birthday check – into your savings. If you get a raise (I’m cheering for you!), increase your savings to match.
• Try not to screw yourself. Again. Don’t second guess yourself. Don’t obsess about your portfolio. Don’t buy because it’s been going up and you’re feeling left out. Don’t sell because your manager is being patient and you aren’t.
• Try not to let other people screw you. Really, if your fund has a letter after its name, figure out why. It means you’re paying extra. Be sure you know what exactly you’re paying and why.
• Make yourself useful, ‘cause then you’ll also make yourself happy. Get in the habit of reading again. Books. You know: the dead tree things. There’s pretty good research suggesting that the e-versions disrupt sleep and addle your mind. Try just 30 minutes in the evening with the electronics shut down, perusing Sarah Bakewell’s How to Live: A Life of Montaigne in One Question and Twenty Attempts at an Answer (2011) or Sherry Turkle’s Alone Together: Why We Expect More from Technology and Less from Each Other (2012). Read it with someone you enjoy hugging. Upgrade your news consumption: listen to the Marketplace podcasts or programs. Swear you’ll never again watch a “news program” that has a ticker constantly distracting you with unexplained 10 word snippets that pretend to explain global events. Set up a recurring contribution to your local food bank (I’ll give you the link to mine if you can’t find your own), shelter (animal or otherwise), or cause. They need you and you need to get outside yourself, to reconnect to something more important than YouTube, your portfolio or your gripes.

For those irked by sermonettes, my senior colleague has been reflecting on the question of what lessons we might draw from the markets of 2014 and offers a far more nuanced take in …

Reflections – 2014

By Edward Studzinski

The Mountains are High, and the Emperor is Far, Far Away

Chinese Aphorism

Year-end 2014 presents investors with a number of interesting conundrums. For a U.S. dollar investor, the domestic market, as represented by the S&P 500, provided a total return of 13.6%, at least for those invested in it by the proxy of Vanguard’s S&P 500 Index Fund Admiral Shares. Just before Christmas, John Authers of the Financial Times, in a piece entitled “Investment: Loser’s Game” argued that this year, with more than 90% of active managers on track to underperform their benchmarks, a tipping point may have finally been reached. The exodus of money from actively managed funds has accelerated. Vanguard is on track to take in close to $200B (yes, billion) into its passive funds this year.

And yet, I have to ask if it really matters. As I watch the postings on the Mutual Fund Observer’s discussion board, I suspect that achieving better than average investment performance is not what motivates many of our readers. Rather, there is a Walter Mittyesque desire to live vicariously through their portfolios. And every bon mot that Bill (take your pick, there are a multitude of them) or Steve or Michael or Bob drops in a print or televised interview is latched on to as a reaffirmation the genius and insight to invest early on with one of The Anointed. The disease exists in a related form at the Berkshire Hathaway Annual Circus in Omaha. Sooner or later, in an elevator or restaurant, you will hear a discussion of when that person started investing with Warren and how much money they have made. The reality is usually less that we would like to know or admit, as my friend Charles has pointed out in his recent piece about the long-term performance of his investments.

Rather than continuing to curse the darkness, let me light a few candles.

1. When are index funds appropriate for an investment program? For most of middle America, I am hard pressed to think of when they are not. They are particularly important for those individuals who are not immortal. You may have constructed a wonderful portfolio of actively-managed funds. Unfortunately, if you pass away suddenly, your spouse or family may find that they have neither the time nor the interest to devote to those investments that you did. And that assumes a static environment (no personnel changes) in the funds you are invested in, and that the advisors you have selected, if any, will follow your lead. But surprise – if you are dead, often not at the time of your choice, you cannot control things from the hereafter. Sit in trust investment committee meetings as I did for many years, and what you will most likely hear is – “I don’t care what old George wanted – that fund is not on our approved list and to protect ourselves, we should sell it, regardless of its performance or the tax consequences.”
2. How many mutual funds should one own? The interplay here is diversification and taxes. I suspect this year will prove a watershed event as investors find that their actively-managed fund has generated a huge tax bill for them while not beating its respective benchmark, or perhaps even losing money. The goal should probably be to own fewer than ten in a family unit, including individual and retirement investments. The right question to ask is why you invested in a particular fund to begin with. If you can’t remember, or the reason no longer applies, move on. In particular, retirement and 401(k) assets should be consolidated down to a smaller number of funds as you get older. Ideally they should be low cost, low expense funds. This can be done relatively easily by use of trustee to trustee transfers. And forget target date funds – they are a marketing gimmick, predicated on life expectancies not changing.
3. Don’t actively managed funds make sense in some circumstances? Yes, but you really have to do a lot of due diligence, probably more than most investment firms will let you do. Just reading the Morningstar write-ups will not cut it. I think there will be a time when actively-managed value funds will be the place to be, but we need a massive flush-out of the industry to occur first, followed by fear overcoming greed in the investing public. At that point we will probably get more regulation (oh for the days of Franklin Roosevelt putting Joe Kennedy in charge of the SEC, figuring that sometimes it makes sense to have the fox guarding the hen house).
4. Passive funds are attractive because of low expenses, and the fact that you don’t need to worry about managers departing or becoming ill. What should one look for in actively-managed funds? The simple answer is redundancy. Dodge and Cox is an ideal example, with all of their funds managed by reasonably-sized committees of very experienced investment personnel. And while smaller shops can argue that they have back-up and succession planning, often that is marketing hype and illusion rather than reality. I still remember a fund manager more than ten years ago telling me of a situation where a co-manager had been named to a fund in his organization. The CIO told him that it was to make the Trustees happy, giving the appearance of succession planning. But the CIO went on to say that if something ever happened to lead manager X, co-manager Y would be off the fund by sundown since Y had no portfolio management experience. Since learning such things is difficult from the outside, stick to the organizations where process and redundancy are obvious. Tweedy, Browne strikes me as another organization that fits the bill. Those are not meant as recommendations but rather are intended to give you some idea of what to look for in kicking tires and asking questions.

A few final thoughts – a lot of hedge funds folded in 2014, mainly for reasons of performance. I expect that trend to spread to mutual funds in 2015, especially those that are at best marginally profitable. Some of this is a function of having the usual acquiring firms (or stooges, as one investment banker friend calls them) – the Europeans – absent from the merger and acquisition trail. Given the present relationship of the dollar and the Euro, I don’t expect that trend to change soon. But I also expect funds to close just because the difficulty of outperforming in a world where events, to paraphrase Senator Warren, are increasingly rigged, is almost impossible. In a world of instant gratification, that successful active management is as much an art as a science should be self-evident. There is something in the process of human interaction which I used to refer to as complementary organizational dysfunction that produces extraordinary results, not easily replicable. And it involves more than just investment selection on the basis of reversion to the mean.

One example of genius would be Thomas Jefferson, dining alone, or Warren Buffet, sitting in his office, reading annual reports.  A different example would be the 1927 Yankees or the Fidelity organization of the 1980’s. In retrospect what made them great is easy to see. My advice to people looking for great active management today – look for organizations without self-promotion, where individuals do not seek out to be the new “It Girl” and where the organizations focus on attracting curious people with inquiring but disciplined minds, so that there ends up being a creative, dynamic tension. Avoid organizations that emphasize collegiality and consensus. In closing, let me remind you of that wonderful scene where Orson Welles, playing Harry Lime in The Third Man says,

… in Italy for 30 years under the Borgias they had warfare, terror, murder, and bloodshed, but they produced Michelangelo, Leonardo da Vinci, and the Renaissance. In Switzerland they had brotherly love – they had 500 years of democracy and peace, and what did they produce? The cuckoo clock.

Where In The World Is Your Fund Adviser?

When our esteemed colleague Ed Studzinski shares his views on an adviser or fund house, he invariably mentions location.

I’ve started to take notice.

Any place but Wall Street
Some fund advisers seem to identify themselves with their location. Smead Capital Management, Inc., which manages Smead Value Fund (SMVLX), states: ”Our compass bearings are slightly Northwest of Wall Street…” The firm is headquartered in Seattle.

SMVLX is a 5-year Great Owl sporting top quintile performance over the past 5-, 3-, and even 1-year periods (ref. Ratings Definitions):

Bill Smead believes the separation from Wall Street gives his firm an edge.

Legendary value investor Bruce Berkowitz, founder of Fairholme Capital Management, LLC seems to agree. Fortune reported that he moved the firm from New Jersey to Florida in 2006 in order to … ”put some space between himself and Wall Street … no matter where he went in town, he was in danger of running into know-it-all investors who might pollute his thinking. ’I had to get away,’ he says.”

In 2002, Charles Akre of Akre Capital Management, LLC, located his firm in Middleburg, Virginia. At that time, he was sub-advising Friedman, Billings, Ramsey & Co.’s FBR Focus Fund, an enormously successful fund. The picturesque town is in horse country. Since 2009, the firm’s Akre Focus Fund (AKREX/AKRIX) is a top-quintile performer and another 5-year Great Owl:

Perhaps location does matter?

Tales of intrigue and woe
Unfortunately, determining an adviser’s actual work location is not always so apparent. Sometimes it appears downright labyrinthine, if not Byzantine.

Take Advisors Preferred, LLC. Below is a snapshot of the firm’s contact page. There is no physical address. No discernable area code. Yet, it is the named adviser for several funds with assets under management (AUM) totaling half a billion dollars, including Hundredfold Select Alternative (SFHYX) and OnTrack Core Fund (OTRFX).

Advisors Preferred turns out to be a legal entity that provides services for sub-advisers who actually manage client money without having to hassle with administrative stuff … an “adviser” if you will by name only … an “Adviser for Hire.” To find addresses of the sub-advisers to these funds you must look to the SEC required fund documents, the prospectus or the statement of additional information (SAI).

Hunderfold Funds is sub-advised by Hunderfold Funds, LLC, which gives its sub-advisory fees to the Simply Distribute Charitable Foundation. Actually, the charity appears to own the sub-adviser. Who controls the charity? The people that control Spectrum Financial Inc., which is located, alas, in Virginia.

The SAI also reveals that the fund’s statutory trust is not administered by the adviser, Advisors Preferred, but by Gemini Funds Services, LLC. The trust itself is a so-called shared or “series trust” comprised of independent funds. Its name is Northern Lights Fund Trust II. (Ref. SEC summary.) The trust is incorporated in Delaware, like many statutory trusts, while Gemini is headquartered in New York.

Why use a series trust? According to Gemini, it’s cheaper. “Rising business costs along with the increased level of regulatory compliance … have magnified the benefits of joining a shared trust in contrast to the expenses associated with registering a standalone trust.”

How does Hundredfold pass this cost savings on to investors? SFHYX’s latest fact sheet shows a 3.80% expense ratio. This fee is not a one-time load or performance based; it is an annual expense.

OnTrack Funds is sub-advised by Price Capital Management, Inc, which is located in Florida. Per the SEC Filing, it actually is run out of a residence. Its latest fact sheet has the expense ratio for OTRFX at 2.95%, annually. With $130M AUM, this expense translates to $3.85M per year paid by investors the people at Price Capital (sub adviser), Gemini Funds (administrator), Advisors Preferred (adviser), Ceros Financial (distributer), and others.

What about the adviser itself, Advisors Preferred? It’s actually controlled by Ceros Financial Services, LLC, which is headquartered in Maryland. Ceros is wholly-owned by Ceros Holding AG, which is 95% owned by Copiaholding AG, which is wholly-owned by Franz Winklbauer.  Mr. Winklbauer is deemed to indirectly control the adviser. In 2012, Franz Winklbauer resigned as vice president of the administrative board from Ceros Holding AG. Copiaholding AG was formed in Switzerland.

Which is to say … who are all these people?

Where do they really work?

And, what do they really do?

Maybe these are related questions.

If it’s hard to figure out where advisers work, it’s probably hard to figure out what they actually do for the investors that pay them.

Guilty by affiliation
Further obfuscating adviser physical location is industry trend toward affiliation, if not outright consolidation. Take Affiliated Managers Group, or more specifically AMG Funds LLC, whose main office location is Connecticut, as registered with the SEC. It currently is the named adviser to more than 40 mutual funds with assets under management (AUM) totaling $42B, including:

• Managers Intermediate Duration Govt (MGIDX), sub advised by Amundi Smith Breeden LLC, located in North Carolina,
• Yacktman Service (YACKX), sub advised by Yacktman Asset Management, L.P. of Texas, and
• Brandywine Blue (BLUEX), sub advised by Friess Associates of Delaware, LLC, located in Delaware (fortunately) and Friess Associates LLC, located in Wyoming.

All of these funds are in process of being rebranded with the AMG name. No good deed goes unpunished?

AMG, Inc., the corporation that controls AMG Funds and is headquartered in Massachusetts, has minority or majority ownership in many other asset managers, both in the US and aboard. Below is a snapshot of US firms now “affiliated” with AMG. Note that some are themselves named advisers with multiple sub-advisers, like Aston.

AMG describes its operation as follows: “While providing our Affiliates with continued operational autonomy, we also help them to leverage the benefits of AMG’s scale in U.S. retail and global product distribution, operations and technology to enhance their growth and capabilities.”

Collectively, AMG boasts more than $600B in AUM. Time will tell whether its affiliates become controlled outright and re-branded, and more importantly, whether such affiliation ultimately benefits investors. It currently showcases full contact information of its affiliates, and affiliates like Aston showcase contact information of its sub-advisers.

Bottom line
Is Bill Smead correct when he claims separation from Wall Street gives his firm an edge? Does location matter to performance? Whether location influences fund performance remains an interesting question, but as part of your due diligence, there should be no confusion about knowing where your fund adviser (and sub-adviser) works.

Closing the capital gains season and thinking ahead

This fall Mark Wilson has launched Cap Gains Valet to help investors track and understand capital gains distributions. In addition to being Chief Valet, Mark is chief investment officer for The Tarbox Group in Newport Beach, CA. He is, they report, “one of only four people in the nation that has both the Certified Financial Planner® and Accredited Pension Administrator (APA) designations.” As the capital gains season winds down, we asked Mark if he’d put on his CIO hat for a minute and tell us what sense an investor should make of it all. Yeah, lots of folks got hammered in 2014 but that’s past. What, we asked, about 2015 and how we act in the year ahead? Here are Mark’s valedictory comments:

As 2014 comes to a close, so does capital gains season. After two straight months thinking about capital gains distributions for CapGainsValet.com, it is a great time for me to reflect on the website’s inaugural year.

At The Tarbox Group (my real job), our firm has been formally gathering capital gains estimates for the mutual funds and ETFs we use in client accounts for over 20 years. Strategizing around these distributions has been part of our year-end activities for so long I did not expect to learn much from gathering and making this information available. I was wrong. Here are some of the things I learned (or learned again) from this project:

• Checking capital gains estimates more than once is a good idea. I’m sure this has happened before, but this year we saw a number of funds “up” their estimates a more than once before their actual distribution date. Given that a handful of distributions doubled from their initial estimates, it is possible that having this more up-to-date information might necessitate a different strategy.
• Many mutual fund websites are terrible. Given the dollars managed and fees fund companies are collecting, there is no reason to have a website that looks like a bad elementary school project. Not having easily accessible capital gains estimates is excusable, but not having timely commentary, performance information, or contact information is not.
• Be wary of funds that have a shrinking asset base. This year I counted over 50 funds that distributed more than 20% of their NAV. The most common reason for the large distributions… funds that have fallen out of favor and have had huge redemptions. Unfortunately, shareholders that stick around often get stuck with the tax bill.
• Asset location is important. We found ourselves saying “good thing we own that in an IRA!” more than once this year. Owning actively managed funds in tax deferred accounts reduces stress, extra work and tax bills. Deciding which account to hold your fund can be as important a decision as which fund to hold.

CapGainsValet is “going dark” this week. Be on the lookout for our return in October or November. In the meantime, have a profitable 2015!

Fund companies explain their massive taxable distributions to us

Well, actually, most of them don’t.

I had the opportunity to chat with Jason Zweig as he prepared his year end story on how to make sense out of the recent state of huge capital gains distributions. In preparing in advance of my talk with Jason, I spent a little time gettin’ granular. I used Mark Wilson’s site to track down the funds with the most extraordinary distributions.

Cap Gains Valet identified a sort of “dirty dozen” of funds that paid out 30% or more of their NAV as taxable distributions. “Why on earth,” we innocently asked ourselves, “would they do that?” So we started calling and asking. In general, we discovered that fund advisers reacted to the question about the same way that you react to the discovery of curdled half-and-half in your coffee: with a wrinkled nose and irritated expression.

For those of you who haven’t been following the action, here’s our cap gains primer:

Capital gains are profits that result from the sales of appreciated securities in a portfolio. They come in two flavors: long-term capital gains, which result from the sale of stocks the fund has held for a while, and short-term gain gains, which usually result for the bad practice of churning the portfolio.

Even funds which have lost a lot of money can hit you with a capital gains tax bill. A fund might be down 40% year-to-date and if the only shares it sold were the Google shares it wangled at Google’s 2004 IPO, you could be hit with a tax bill for a large gain.

Two things trigger large taxable distributions: a new portfolio manager or portfolio strategy which requires cleaning out the old portfolio or forced redemptions because shareholders are bolting and the manager needs to sell stuff – often his best and most liquid stuff – to meet redemptions.

So, how did this Dirty Dozen make the list?

Neuberger Berman Large Cap Disciplined Growth (NBCIX, 53% distribution). I had a nice conversation with Neil Groom for Neuberger Berman. He was pretty clear about the problem: “we’ve struggled with performance,” and over 75% of the fund shares have been redeemed. The manager liquidates shares pro rata – that is, he sells them all down evenly – and “there are just no losses to offset those sales.” Neuberger is now underwriting the fund’s expenses to the tune of $300,000/year but remains committed to it for a couple reasons. One is that they see it as a core investment product. And the other is that the fund has had long winning streaks and long losing streaks in the past, both of which they view as a product of their discipline rather than as a failing by their manager.

We reached out to the folks at Russell LifePoints 2040 Strategy (RXLAX, 35% distribution) and Russell LifePoints 2050 Strategy (RYLRX, 33% distribution): after getting past the “what does it matter? These funds are held in tax-deferred retirement accounts” response – why is true but still doesn’t answer the question “why did this happen to you and not all target-date funds?” Russell’s Kate Stouffer reported that the funds “realized capital gains in 2014 predominantly as a result of the underlying fund reallocation that took place in August 2014.” The accompanying link showed Russell punting two weak Russell funds for two newly-launched Russell funds overseen by the same managers.

Turner Emerging Growth (TMCGX, 48% distribution), Midcap Growth (TMGFX, 42% distribution) and Small Cap Growth (TSCEX, 54% distribution): I called Turner directly and bounced around a bit before being told that “we don’t speak to the media. You’ll need to contact our media relations firm.” Suh-weet! I did. They promised to make some inquiries. Two weeks later, still no word. Two of the three funds have changed managers in the past year and Turner has seen a fair amount of asset outflows, which together might explain the problem.

Janus Forty (JDCAX, 33% distribution): about a half billion in outflows, a net loss in assets of about 75% from its peak plus a new manager in mid-2013 who might be reshaping the portfolio.

Eaton Vance Large-Cap Value (EHSTX, 29% distribution): new lead manager in mid-2014 plus an 80% decline in assets since 2010 led to it.

Nationwide HighMark Large Cap Growth (NWGLX, 42% distribution): another tale of mass redemption. The fund had $73 million in assets as of July 2013 when a new co-manager was added. The fund rose since then, but a lot less than its peers or its benchmark, investors decamped and the fund ended up with $40 million in December 2014.

Nuveen NWQ Large-Cap Value (NQCAX, 47% distribution) has been suffering mass redemptions – assets were $1.3 billion in mid-2013, $700 million in mid-2014, and $275 million at year’s end. The fund also had weak and inconsistent returns: bottom 10% of its peer group for the past 1, 3 and 5 years and far below average – about a 20% return over the current market cycle as compared to 38% for its large cap value peers – despite a couple good years.

Wells Fargo Small Cap Opportunities (NVSOX, 41% distribution) has a splendid record, low volatility, a track record for reasonably low payouts, a stable management team … and crashing assets. The fund held $700 million in October 2013, $470 million in March 2014 and $330 million in December 2014. With investment minimums of $1 million (Administrative share class) and $5 million (Institutional), the best we can say is that it’s nice to see rich people being stupid, too.

A couple of these funds are, frankly, bad. Most are mediocre. And a couple are really good but, seemingly, really unlucky. For investors in taxable accounts, their fate highlights an ugly reality: your success can be undermined by the behavior of your funds’ other investors. You really don’t want to be the last one out the door, which means you need to understand when others are heading out.

Hear “it’s a stock-pickers market”? Run quick … away

Not from the market necessarily, but from any dim bulb whose insight is limited not only by the need to repeat what others have said, but to repeat the dumbest things that others have said.

“Active management is oversold.” Run!

“Passive investing makes no sense to us or to our investors.” Run faster!

Ted, the discussion board’s indefatigable Linkster, pointed us at Henry Blodget’s recent essay “14 Meaningless Phrases That Will Make You Sound Like A Stock-Market Wizard” at his Business Insider site.  Yes, that Henry Blodget: the poster child for duplicitous stock “analysis” who was banned for life from the securities industry. He also had to “disgorge” $2 million in profits, a process that might or might not have involved a large bucket. In any case, he knows whereof he speaks.)  He pokes fun at “the trend is your friend” (phrased differently it would be “follow the herd, that’s always a wise course”) and “it’s a stockpicker’s market,” among other canards.

Chip, the Observer’s tech-crazed tech director, appreciated Blodget’s attempt but recommends an earlier essay: “Stupid Things Finance People Say” by Morgan Housel of Motley Fool. Why? “They cover the same ground. The difference is the he’s actually funny.”

Hmmm …

Blodget: “It’s not a stock market. It’s a market of stocks.” It sounds deeply profound — the sort of wisdom that can be achieved only through decades of hard work and experience. It suggests the speaker understands the market in a way that the average schmo doesn’t. It suggests that the speaker, who gets that the stock market is a “market of stocks,” will coin money while the average schmo loses his or her shirt.

Housel: “Earnings were positive before one-time charges.” This is Wall Street’s equivalent of, “Other than that, Mrs. Lincoln, how was the play?”

Blodget: “I’m cautiously optimistic.” A classic. Can be used in almost all circumstances and market conditions … It implies wise, prudent caution, but also a sunny outlook, which most people like.

Housel: “We’re cautiously optimistic.” You’re also an oxymoron.

Blodget: “Stocks are down on ‘profit taking.” …It sounds like you know what professional traders are doing, which makes you sound smart and plugged in. It doesn’t commit you to a specific recommendation or prediction. If the stock or market goes down again tomorrow, you can still have been right about the “profit taking.” If the stock or market goes up tomorrow, you can explain that traders are now “bargain hunting” (the corollary). Whether the seller is “taking a profit” — and you have no way of knowing — the buyer is at the same time placing a new bet on the stock. So collectively describing market activity as “profit taking” is ridiculous.

Housel: “The Dow is down 50 points as investors react to news of [X].” Stop it, you’re just making stuff up. “Stocks are down and no one knows why” is the only honest headline in this category.

Your pick.  Or try both for the same price!

Alternately, if you’re looking to pick up hot chicks as well as hot picks at your next Wall Street soiree, The Financial Times helpfully offered up “Strategist’s icebreakers serve up the season’s party from hell” (12/27/2014). They recommend chucking out the occasional “What’s all the fuss about the central banks?” Or you might try the cryptic, “Inflation isn’t keeping me up at night — for now.”

Top developments in fund industry litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before. For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

New Lawsuit

• The plaintiff in existing fee litigation regarding ten Russell funds filed a new complaint, covering a different damages period, that additionally adds a new section 36(b) claim for excessive administrative fees. (McClure v. Russell Inv. Mgmt. Co.)

Orders

• The court consolidated ERISA lawsuits regarding “stable value funds” offered by J.P. Morgan to 401(k) plan participants. (In re J.P. Morgan Stable Value Fund ERISA Litig.)
• The court preliminarily approved a $9.475 million settlement of an ERISA class action that challenged MassMutual‘s receipt of revenue-sharing payments from unaffiliated mutual funds. (Golden Star, Inc. v. Mass Mut. Life Ins. Co.)
• The court gave its final approval to the $22.5 million settlement of Regions Morgan Keegan ERISA litigation. Plaintiffs had alleged that defendants imprudently caused and permitted retirement plans to invest in (1) Regions common stock (“despite the dire financial problems facing the Company”), (2) certain bond funds (“heavily and imprudently concentrated and invested in high-risk structured finance products”), and (3) the RMK Select Funds (“despite the fact that they incurred unreasonably expensive fees and were selected . . . solely to benefit Regions”). (In re Regions Morgan Keegan ERISA Litig.)

Briefs

• The plaintiff filed a reply brief in her appeal to the Eighth Circuit regarding gambling-related securities held by the American Century Ultra Fund. Defendants include independent directors. (Seidl v. Am. Century Cos.)
• In the ERISA class action alleging that TIAA-CREF failed to honor redemption and transfer requests in a timely fashion, the plaintiff filed her opposition to TIAA-CREF’s motion to dismiss. (Cummings v. TIAA-CREF.)

Amended Complaints

• Plaintiffs filed an amended complaint in the consolidated fee litigation regarding the Davis N.Y. Venture Fund: “The investment advisory fee rate charged to the Fund is as much as 96% higher than the rates negotiated at arm’s length by Davis with other clients for the same or substantially the same investment advisory services.” (In re Davis N.Y. Venture Fund Fee Litig.)
• Plaintiffs filed an amended complaint in the consolidated fee litigation regarding the Harbor International and and High-Yield Bond Funds: “Defendant charges investment advisory fees to each of the Funds that include a mark-up of more than 80% over the fees paid by Defendant to the Subadvisers who provide substantially all of the investment advisory services required by the Funds.” (Zehrer v. Harbor Capital Advisors, Inc.)

The Alt Perspective: Commentary and news from DailyAlts.

By Brian Haskins, editor of DailyAlts.com

As they say out here in Hollywood, that’s a wrap. Now we can close the books on 2014 and take a look at some of the trends that emerged over the year, and make a few projections about what might be in store for 2015. So let’s jump in.

Early in 2014, it was clear that assets were flowing strongly into liquid alternatives, with twelve-month growth rates hovering around 40% for most of the first half of the year. While the growth rates declined as the year went on, it was clear that 2014 was a real turning point in both asset growth and new fund launches. In total, more than $26 billion of net new assets flowed into the category over the past twelve months.

Three of the categories that garnered the most new asset flows were non-traditional bonds, long/short equity and multi-alternative strategies. Each of these makes sense, as follows:

• Non-traditional bonds provide a hedge against a rise in interest rates, so investors naturally were looking for a way to avoid what was initially thought to be a sure thing in 2014 – rising rates. As we know, that turned not to be the case, and instead we saw a fairly steady decline in rates over the year. Nonetheless, investors who flowed into these funds should be well positioned should rates rise in 2015.
• On the equity side, long/short equity provides a hedge against a decline in the equity markets, and here again investors looked to position their portfolios more conservatively given the long bull run. As a result, long/short equity funds saw strong inflows for most of the year with the exception of the $11.9 billion MainStay Marketfield Fund (MFLDX) which experienced more than $5 billion of outflows over eight straight months on the back of a difficult performance period. As my old boss would say, they have gone from the penthouse to the doghouse. But with nearly $12 billion remaining in the fund and a 1.39% management fee, their doghouse probably isn’t too bad.
• Finally, investors favored multi-alternative funds steadily during the year. These funds provide an easy one-stop-shop for making an allocation to alternatives, and for many investors and financial advisors, these funds are a solid solution since they package multiple alternative investment strategies into one fund. I would expect to see multi-alternative funds continue to play a dominant role in portfolios over the next few years while the industry becomes more comfortable with evaluating and allocating to single strategy funds.

Now that the year has come to a close, we can take a step back and look at 2014 from a big picture perspective. Here are five key trends that I saw emerge over the year:

1. The conversion of hedge funds into mutual funds – This is an interesting trend that will likely continue, and gain even more momentum in 2015. There are a few reasons why this is likely. First, raising assets in hedge funds has become more difficult over the past five years. Institutional investors allocate a bulk of their assets to well-known hedge fund managers, and performance isn’t the top criteria for making the allocations. Second, investing in hedge funds involves the review of a lot of non-standard paperwork, including fee agreements and other terms. This creates a high barrier to entry for smaller investors. Thus, the mutual fund vehicle is a much easier product to use for gathering assets with smaller investors in both the retail and institutional channels. As a result, we will see many more hedge fund conversions in the coming years. Third, the track record and the assets of a hedge fund are portable over to a mutual fund. This gives new mutual funds that convert from a hedge fund a head start over all other new funds.
2. The re-emergence of managed futures funds – A divergence in global economic policies among central banks created more opportunities for managers that look for asset prices that move in opposite directions. Managed futures managers do just that, and 2014 proved to be the first year in many where they were able to put positive, double digit returns on the board. It is likely that 2015 will be another solid year for these strategies as strong price trends will likely continue with global interest rates, currencies, commodity prices and other assets over the year.
3. More well-known hedge fund managers are getting into the liquid alternatives business – It’s hard to resist strong asset flows if you are an asset manager, and as discussed above, the asset flows into liquid alternatives have been strong. And expectations are that they will continue to be strong. So why wouldn’t a decent hedge fund manager want to get in the game and diversify their business away from institutional and high net worth assets. Some of the top hedge fund managers are recognizing this and getting into the space, and as more do, it will become even more acceptable for those who haven’t.
4. A continued increase in the use of alternative beta strategies, and the introduction of more complex alternative beta funds – Alternative beta (or smart beta) strategies give investors exposure to specific “factors” that have otherwise not been easy to obtain historically. With the introduction of alternative beta funds, investors can now fine tune their portfolio with specific allocations to low or high volatility stocks, high yielding stocks, high momentum stocks, high or low quality stocks, etc. A little known secret is that factor exposures have historically explained more of an active manager’s excess returns (returns above a benchmark) than individual stock selection. With the advent of alternative beta funds in both the mutual fund and ETF format, investors have the ability to build more risk efficient portfolios or turn the knobs in ways they haven’t been able to in the past.
5. An increase in the number of alternative ETFs – While mutual funds have a lower barrier to entry for investors than hedge funds, ETFs are even more ubiquitous. Nearly every ETF can be purchased in nearly every brokerage account. Not so for mutual funds. The biggest barrier to seeing more alternative ETFs has historically been the fact that most alternative strategies are actively managed. This is slowly changing as more systematic “hedge fund” approaches are being developed, along with alternative ETFs that invest in other ETFs to gain their underlying long and short market exposures. Expect to see this trend continue in 2015.

There is no doubt that 2015 will bring some surprises, but by definition we don’t know what those are today. We will keep you posted as the year progresses, and in the meantime, Happy New Year and all the best for a prosperous 2015!

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

RiverPark Large Growth (RPXFX/RPXIX): it’s a discipline that works. Find the forces that will consistently drive growth in the years ahead.  Do intense research to identify great firms that are best positioned to reap enduring gains from them. Wait. Wait. Wait. Then buy them when they’re cheap. It’s worked well, except for that pesky “get investors to notice” piece.

River Park Large Growth Conference Call Highlights

On December 17th we spoke for an hour with Mitch Rubin, manager of RiverPark Large Growth (RPXFX/RPXIX), Conrad van Tienhoven, his long-time associate, and Morty Schaja, CEO of RiverPark Funds. About 20 readers joined us on the call.

Here’s a brief recap of the highlights:

• The managers have 20 years’ experience running growth portfolios, originally with Baron Asset Management and now with RiverPark. That includes eight mutual funds and a couple hedge funds.
• Across their portfolios, the strategy has been the same: identify long-term secular trends that are likely to be enduring growth drivers, do really extensive fundamental research on the firm and its environment, and be patient before buying (the target is paying less than 15-times earnings for companies growing by 20% or more) or selling (which is mostly just rebalancing within the portfolio rather than eliminating names from the portfolio).
• In the long term, the strategy works well. In the short term, sometimes less so. They argue for time arbitrage. Investors tend to underreact to changes which are strengthening firms. They’ll discount several quarters of improved performance before putting a stock on their radar screen, then may hesitate for a while longer before convincing themselves to act. By then, the stock may already have priced-in much of the potential gains. Rubin & co. try to track firms and industries long enough that they can identify the long-term winners and buy during their lulls in performance.

In the long term, the system works. The fund has returned 20% annually over the past three years. It’s four years old and had top decile performance in the large cap growth category after the first three years.

Then we spent rather a lot of time on the ugly part.

In relative terms, 2014 was wretched for the fund. The fund returned about 5.5% for the year, which meant it trailed 93% of its peers. It started the year with a spiffy five-star rating and ended with three. So, the question was, what happened?

Mitch’s answer was presented with, hmmm … great energy and conviction. There was a long stretch in there where I suspect he didn’t take a breath and I got the sense that he might have heard this question before. Still, his answer struck me as solid and well-grounded. In the short term, the time arbitrage discipline can leave them in the dust. In 2014, the fund was overweight in a number of underperforming arenas: energy E&P companies, gaming companies and interest rate victims.

• Energy firms: 13% of the portfolio, about a 2:1 overweight. Four high-quality names with underlevered balance sheets and exposure to the Marcellus shale deposits. Fortunately for consumers and unfortunately for producers, rising production, difficulties in selling US natural gas on the world market and weakening demand linked to a spillover from Russia’s travails have caused prices to crater.
  
  The fundamental story of rising demand for natural gas, abetted by better US access to the world energy market, is unchanged. In the interim, the portfolio companies are using their strong balance sheets to acquire assets on the cheap.

• Gaming firms: gaming in the US, with regards to Ol’ Blue Eyes and The Rat Pack, is the past. Gaming in Asia, they argue, is the future. The Chinese central government has committed to spending nearly a half trillion dollars on infrastructure projects, including $100 billion/year on access, in and around the gambling enclave of Macau. Chinese gaming (like hedge fund investing here) has traditionally been dominated by the ultra-rich, but gambling is culturally entrenched and the government is working to make it available to the mass affluent in China (much like liquid alt investing here). About 200 million Chinese travel abroad on vacation each year. On average, Chinese tourists spend a lot more in the casinos and a lot more in attendant high-end retail than do Western tourists. In the short term, President Xi’s anti-corruption campaign has precipitated “a vast purge” among his political opponents and other suspiciously-wealthy individuals. Until “the urge to purge” passes, high-rolling gamblers will be few and discreet. Middle class gamblers, not subject to such concerns, will eventually dominate. Just not yet.
• Interest rate victims: everyone knew, in January 2014, that interest rates were going to rise. Oops. Those continuingly low rates punish firms that hold vast cash stakes (think “Google” with its $50 billion bank account or Schwab with its huge network of money market accounts). While Visa and MasterCard’s stock is in the black for 2014, gains are muted by the lower rates they can charge on accounts and the lower returns on their cash flow.

Three questions came up:

• Dan Schein asked about the apparent tension between the managers’ commitment to a low turnover discipline and the reported 33-40% turnover rate. Morty noted that you need to distinguish between “name turnover” (that is, firms getting chucked out of the portfolio) and rebalancing. The majority of the fund’s turnover is simple internal rebalancing as the managers trim richly appreciated positions and add to underperforming ones. Name turnover is limited to two or three positions a year, with 70% of the names in the current portfolio having been there since inception.
• I asked about the extent of international exposure in the portfolio, which Morningstar reports at under 2%. Mitch noted that they far preferred to invest in firms operating under US accounting requirements (Generally Accepted Accounting Principles) and U.S. securities regulations, which made them far more reliable and transparent. On the other hand, the secular themes which the managers pursue (e.g., the rise of mobile computing) are global and so they favor U.S.-based firms with strong global presence. By their estimate, two thirds of the portfolio firms derive at least half of their earnings growth from outside the US and most of their firms derived 40-50% of earnings internationally; Priceline is about 75%, Google and eBay around 60%. Direct exposure to the emerging markets comes mainly from Visa and MasterCard, plus Schlumberger’s energy holdings.
• Finally I asked what concern they had about volatility in the portfolio. Their answer was that they couldn’t predict and didn’t worry about stock price volatility. They were concerned about what they referred to as “business case volatility,” which came down to the extent to which a firm could consistently generate free cash from recurring revenue streams (e.g., the fee MasterCard assesses on every point-of-sale transaction) without resorting to debt or leverage.

For folks interested but unable to join us, here’s the complete audio of the hour-long conversation.

The RPXFX Conference Call

As with all of these funds, we’ve created a new Featured Funds page for RiverPark Large Growth Fund, pulling together all of the best resources we have for the fund.

Conference Calls Upcoming

We anticipate three conference calls in the next three months and we would be delighted by your company on each of them. We’re still negotiating dates with the managers, so for now we’ll limit ourselves to a brief overview and a window of time.

At base, we only do conference calls when we think we’ve found really interesting people for you to talk with. That’s one of the reasons we do only a few a year.

Here’s the prospective line-up for winter.

Bernard Horn is manager of Polaris Global Value (PGVFX) and sub-adviser to a half dozen larger funds. Mr. Horn is president of Polaris Capital Management, LLC, a Boston-based global and international value equity firm. Mr. Horn founded Polaris in 1995 and launched the Global Value Fund in 1998. Today, Polaris manages more than $5 billion for 30 clients include rich folks, institutions and mutual and hedge funds. There’s a nice bio of Mr. Horn at the Polaris Capital site.

Why talk with Mr. Horn? Three things led us to it. First, Polaris Global is really good and really small. After 16 years, it’s a four- to five-star fund with just $280 million in assets. He seems just a bit abashed by that (“we’re kind of bad at marketing”) but also intent on doing right for his shareholders rather than getting rich. Second, his small cap international fund (Pear Tree Polaris Foreign Value Small Cap QUSOX) is, if anything, better and it trawls the waters where active management actually has the greatest success. Finally, Ed and I have a great conversation with him in November. Ed and I are reasonably judgmental, reasonably well-educated and reasonably cranky. And still we came away from the conversation deeply impressed, as much by Mr. Horn’s reflections on his failures as much as by his successes. There’s a motto often misattributed to the 87 year old Michelangelo: Ancora imparo, “I am still learning.” We came away from the conversation with a sense that you might say the same about Mr. Horn.

Matthew Page and Ian Mortimer are co-managers of Guinness Atkinson Global Innovators (IWIRX) and Guinness Atkinson Dividend Builder (GAINX), both of which we’ve profiled in the past year. Dr. Mortimer is trained as a physicist, with a doctorate from Oxford. He began at Guinness as an analyst in 2006 and became a portfolio manager in 2011. Mr. Page (the friendly looking one over there->) earned a master’s degree in physics from Oxford and somehow convinced the faculty to let him do his thesis on finance: “Financial Markets as Complex Dynamical Systems.” Nice trick! He spent a year with Goldman Sachs, joined Guinness in 2005 and became a portfolio co-manager in 2006.

Why might you want to hear from the guys? At one level, they’re really successful. Five star rating on IWIRX, great performance in 2014 (also 2012 and 2013), laughably low downside capture over those three years (almost all of their volatility is to the upside), and a solid, articulated portfolio discipline. In 2014, Lipper recognized IWIRX has the best global equity fund of the preceding 15 years and they still can’t attract investors. It’s sort of maddening. Part of the problem might be the fact that they’re based in London, which makes relationship-building with US investors a bit tough. At another level, like Mr. Horn, I’ve had great conversations with the guys. They’re good listeners, sharp and sometimes witty. I enjoyed the talks and learned from them.

David Berkowitz will manage the new RiverPark Focused Value Fund once it launches at the end of March. Mr. Berkowitz earned both a bachelor’s and master’s degree in chemical engineering at MIT before getting an MBA at that other school in Cambridge. In 1992, Mr. Berkowitz and his Harvard classmate William Ackman set up the Gotham Partners hedge fund, which drew investments from legendary investors such as Seth Klarman, Michael Steinhardt and Whitney Tilson. Berkowitz helped manage the fund until 2002, when they decided to close the fund, and subsequently managed money for a New York family office, the Festina Lente hedge fund (hmmm … “Make haste slowly,” the family motto of the Medicis among others) and for Ziff Brother Investments, where he was a Partner as well as the Chief Risk and Strategy Officer. He’s had an interesting, diverse career and Mr. Schaja speaks glowingly of him. We’re hopeful of speaking with Mr. Berkowitz in March.

Would you like to join in?

It’s very simple. In February we’ll post exact details about the time and date plus a registration link for each call. The calls cost you nothing, last exactly one hour and will give you the chance to ask the managers a question if you’re so moved. It’s a simple phone call with no need to have access to a tablet, wifi or anything.

Alternately, you can join the conference call notification list. One week ahead of each call we’ll email you a reminder and a registration link.

Launch Alert: Cambria Global Momentum & Global Asset Allocation

Cambria Funds recently launched two ETFs, as promised by its CIO Mebane Faber, who wants to “disrupt the traditional high fee mutual fund and hedge fund business, mostly through launching ETFs.” The line-up is now five funds with assets under management totaling more than $350M:

• Cambria Shareholder Yield ETF (SYLD)
• Cambria Foreign Shareholder Yield ETF (FYLD)
• Cambria Global Value ETF (GVAL)
• Cambria Global Momentum ETF (GMOM)
• Cambria Global Asset Allocation ETF (GAA)

We wrote about the first three in “The Existential Pleasures of Engineering Beta” this past May. SYLD is now the largest actively managed ETF among the nine categories in Morningstar’s equity fund style box (small value to large growth). It’s up 12% this year and 32% since its inception May 2013.

GMOM and GAA are the two newest ETFs. Both are fund of funds.

GMOM is based on Mebane’s definitive paper “A Quantitative Approach To Tactical Asset Allocation” and popular book “The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets.” It appears to be an in-house version of AdvisorShares Cambria Global Tactical ETF (GTAA), which Cambria stopped sub-advising this past June. Scott, a frequent and often profound contributor to our discussion board, describes GTAA in one word: “underwhelming.” (You can find follow some of the debate here.) The new version GMOM sports a much lower expense ratio, which can only help. Here is link to fact sheet.

GAA is something pretty cool. It is an all-weather strategic asset allocation fund constructed for global exposure across diverse asset classes, but with lower volatility than your typical long term target allocation fund. It is a “one fund for a lifetime” offering. (See DailyAlts “Meb Faber on the Genesis of Cambria’s Global Tactical ETF.”) It is the first ETF to have a permanent 0% management fee. Its annual expense ratio is 0.29%. From its prospectus:

Here’s is link to fact sheet, and below is snapshot of current holdings:

In keeping with the theme that no good deed goes unpunished. Chuck Jaffe referenced GAA in his annual “Lump of Coal Awards” series. Mr. Jaffe warned “investors should pay attention to the total expense ratio, because that’s what they actually pay to own a fund or ETF.” Apparently, he was irked that the media focused on the zero management fee. We agree that it was pretty silly of reporters, members of Mr. Jaffe’s brotherhood, to focus so narrowly on a single feature of the fund and at the same time celebrate the fact that Mr. Faber’s move lowers the expenses that investors would otherwise bear.

Launch Alert: ValueShares International Quantitative Value

Wesley Gray announced the launch of ValueShares International Quantitative Value ETF (IVAL) on 19 December, his firm’s second active ETF. IVAL is the international sister to ValueShares Quantitative Value ETF (QVAL), which MFO profiled in December. Like QVAL, IVAL seeks the cheapest, highest quality value stocks … within the International domain. These stocks are selected in quant fashion based on value and quality criteria grounded in investing principles first outlined by Ben Graham and validated empirically through academic research.

The concentrated portfolio currently invests in 50 companies across 14 countries. Here’s breakout:

As with QVAL, there is no sector diversification constraint or, in this case, country constraint. Japan dominates current portfolio. Once candidate stocks pass the capitalization, liquidity, and quality screens, value is king.

Notice too no Russia or Brazil.

Wesley explains: “We only trade in liquid tradeable names where front-running issues are minimized. We also look at the custodian costs. Russia and Brazil are insane on both the custodial costs and the frontrunning risks so we don’t trade ’em. In the end, we’re trading in developed/developing markets. Frontier/emerging don’t meet our criteria.”

Here is link to IVAL overview. Dr. Gray informs us that the new fund’s expense ratio has just been reduced by 20bps to 0.79%.

Launch Alert: Pear Tree Polaris Small Cap Fund (USBNX/QBNAX)

On January 1, a team from Polaris Capital assumed control of the former Pear Tree Columbia Small Cap Fund, which has now been rechristened. For the foreseeable future, the fund’s performance record will bear the imprint of the departed Columbia team.  The Columbia team had been in place since the middle 1990s and the fund has, for years, been a study in mediocrity.  We mean that in the best possible way: it rarely cratered, it rarely soared and it mostly trailed the pack by a bit. By Morningstar’s calculation, the compounding effect of almost always losing by a little ended up being monumental: the fund trailed more than 90% of its peers for the past 1, 3, 5, and 10 year periods while trailing two-thirds over them over the past 15 years.

Which is to say, your statistical screens are not going to capture the fund’s potential going forward.

We think you should look at the fund, and hope to ask Mr. Horn about it on a conference call with him.  Here are the three things you need to know about USNBX if you’re in the market for a small cap fund:

• The management team here also runs Pear Tree Polaris Foreign Value Small Cap Fund (QUSOX / QUSIX) which has earned both five stars from Morningstar and a Great Owl designation from the Observer.
• The new subadvisory agreement pays Polaris 20 basis points less than Columbia received, which will translate into lower expenses that investors pay.
• The portfolio will be mostly small cap ($100 million – $5 billion) US stocks but they’ve got a global watch-list of 500 names which are candidates for inclusion and they have the ability to hedge the portfolio. The foreign version of the fund has been remarkable in its ability to manage risk: they typically capture one-third as much downside risk as their peers while capturing virtually all of the upside.

The projected expense ratio is 1.44%. The minimum initial investment is $2500, reduced to $1000 for tax-advantaged accounts and for those set up with an automatic investing plan. Pear Tree has not, as of January 1, updated the fund’s webpage is reflect the change but you should consider visiting Pear Tree’s homepage next week to see what they have to say about the upgrade.  We’ll plan profiles of both funds in the months ahead.

Funds in Registration

Yikes. We’ve never before had a month like this: there’s only one new, no-load retail fund on file with the SEC. Even if we expand the search to loaded funds, we only get to four or five.  Hmmm …

The one fund is RiverPark Focused Value Fund. It will be primarily a large cap domestic equity fund whose manager has a particular interest in “special situations” such as spin-offs or reorganizations and on firms whose share prices might have cratered. They’ll buy if it’s a high quality firm and if the stock trades at a substantial discount to intrinsic value. It will be managed by a well-known member of the hedge fund community, David Berkowitz.

Manager Changes

This month also saw an uptick in manager turnover; 73 funds reported changes, about 50% more than the month before. The most immediately noticeable of which was Bill Frels’ departure from Mairs & Power Growth (MPGFX) and Mairs & Power Balanced (MAPOX) after 15 and 20 years, respectively. They’re both remarkable funds: Balanced has earned five stars from Morningstar for the past 3, 5, 10 and since inception periods while Growth has either four or five stars for all those periods. Both invest primarily in firms located in the upper Midwest and both have negligible turnover.

Mr. Frels’ appointment occasioned considerable anxiety years ago because he was an unknown guy replacing an investing legend, George Mairs. At the time, we counseled calm because Mairs & Power had themselves calmly and deliberately planned for the handout.  I suppose we’ll do the same today, though we might use this as an excuse for calling M&P to update our 2011 profile of the fund. That profile, written just as M&P appointed a co-manager in what we said was evidence of succession planning, concluded “If you’re looking for a core holding, especially for a smaller portfolio where the reduced minimum will help, this has to be on the short-list of the most attractive balanced funds in existence.”  We were right and we don’t see any reason to alter that conclusion now.

Updates

Andrew Foster and the folks at Seafarer Partners really are consistently better communicators than almost any of their peers.  In addition to a richly informative website and portfolio metrics that almost no one else thinks to share, they have just published a semi-annual report with substantial content.

Two arguments struck me.  First, the fund’s performance was hampered by their decision to avoid bad companies:

the Fund’s lack of exposure to small and mid-size technology companies – mostly located in Taiwan – caused it to lag the benchmark during the market’s run-up. While interesting investments occasionally surface among the sea of smaller technology firms located in and around Taipei, this group of companies in general is not distinguished by sustainable growth. Most companies make components for consumer electronics or computers, and while some grow quickly for a while, often their good fortune is not sustainable, as their products are rapidly commoditized, or as technological evolution renders their products obsolete. Their share prices can jump rapidly higher for a time when their products are in vogue. Nevertheless, I rarely find much that is worthwhile or sustainable in this segment of the market, though there are sometimes exceptions.

As a shareholder in the fund, I really do applaud a discipline that avoids those iffy but easy short-term bets.

The second argument is more interesting and a lot more important for the investing community. Andrew argues that “value investing” might finally be coming to the emerging markets.

Yet even as the near-term is murky, I believe the longer-term outlook has recently come into sharper focus. A very important structural change – one that I think has been a long time in coming – has just begun to reshape the investment landscape within the developing world. I think the consequence of this change will play out over the next decade, at a minimum.

For the past sixteen years, I have subscribed to an investment philosophy that stresses “growth” over “value.” By “value,” I mean an investment approach that places its primary emphasis on the inherent cheapness of a company’s balance sheet, and which places secondary weight on the growth prospect of the company’s income statement..

In the past, I have had substantial doubts as to whether a classic “value” strategy could be effectively implemented within the developing world – “value” seemed destined to become a “value trap.”  … In order to realize the value embedded in a cheap balance sheet, a minority investor must often invest patiently for an extended period, awaiting the catalyst that will ultimately unlock the value.

The problem with waiting in the developing world is that most countries lack sufficient legal, financial, accounting and regulatory standards to protect minority investors from abuse by “control parties.” A control party is the dominant owner of a given company. Without appropriate safeguards, minorities have little hope of avoiding exploitation while they wait; nor do they have sufficient legal clout to exert pressure on the control party to accelerate the realization of value. Thus in the past, a prospective “value” investment was more likely to be a “trap” than a source of long-term return.

Andrew’s letter outlines a series of legal and structural changes which seem to be changing that parlous state and he talks about the implications for his portfolio and, by extension, for yours. You should go read the letter.

Seafarer Growth & Income (SFGIX) is closing in on its third anniversary (February 15, 2015) with $122 million in assets and a splendid record, both in terms of returns and risk-management. The fund finished 2014 with a tiny loss but a record better than 75% of its peers.  We’re hopeful of speaking with Andrew and his team as they celebrate that third anniversary.

Speaking of third anniversaries, Grandeur Peak funds have just celebrated theirs. Their success has been amazing, at least to the folks who weren’t paying attention to their record in their preceding decade.  Eric Heufner, the firm’s president, shared some of the highlights in a December email:

… our initial Funds have reached the three-year milestone.  Both Funds ranked in the Top 1% of their respective Morningstar peer groups for the 3 years ending 10/31/14, and each delivered an annualized return of more than 20% over the period. The Grandeur Peak Global Opportunities Fund was the #1 fund in the Morningstar World Stock category and the Grandeur Peak International Opportunities Fund was the #2 fund in the Morningstar Foreign Small/Mid Growth category.  We also added two new strategies over the past year 18 months.  [He shared a performance table which comes down to this: all of the funds are top 10% or better for the available measurement periods.] 

Our original team of 7 has now grown to a team of 30 (16 full-time & 14 part-time).  Our assets under management have grown to $2.4 billion, and all four of our strategies are closed to additional investment—we remain totally committed to keeping our portfolios nimble.  We still plan to launch other Funds, but nothing is imminent.

And, too, their discipline strikes me as entirely admirable: all four of their funds have now been hard-closed in accordance with plans that they announced early and clearly. 2015 should see the launch of their last three funds, each of which was also built-in early to the firm’s planning and capacity calculations.

Finally, Matthews Asia Strategic Income (MAINX) celebrated its third anniversary and first Morningstar rating in December, 2014. The fund received a four-star rating against a “world bond” peer group. For what interest it holds, that rating is mostly meaningless since the fund’s mandate (Asia! Mostly emerging) and portfolio (just 70% bonds plus income-producing equities and convertibles) are utterly distant from what you see in the average world bond fund. The fund has crushed the one or two legitimate competitors in the space, its returns have been strong and its manager, Teresa Kong, comes across a particularly smart and articulate.

Briefly Noted . . .

Investors have, as predicted, chucked rather more than a billion dollars into Bill Gross’s new charge, Janus Unconstrained Bond (JUCAX) fund. Despite holding 75% of that in cash, Gross has managed both to lose money and underperform his peers in these opening months.  Both are silly observations, of course, though not nearly so silly as the desperate desire to rush a billion into Gross’s hands.

SMALL WINS FOR INVESTORS

Effective January 1, 2015, Perkins Small Cap Value Fund (JDSAX) reopened to new investors. I’m a bit ambivalent here. The fund looks sluggish when measured by the usual trailing periods (it has trailed about 90% of its peers over the past 3 and 5 year periods) but I continue to think that those stats mislead as often as they inform since they capture a fund’s behavior in a very limited set of market conditions. If you look at the fund’s performance over the current market cycle – from October 1 2007 to now – it has returned 78% which handily leads its peers’ 61% gain. Nonetheless the team is making adjustments which include spending down their cash (from 15% to 5%), which is a durned odd for a value discipline focused on high quality firms to do. They’re also dropping the number of names and adding staff. It has been a very fine fund over the long term but this feels just a bit twitchy.

CLOSINGS (and related inconveniences)

A couple unusual cases here.

Aegis High Yield Fund (AHYAX/AHYFX) closed to new investors in mid-December and has “assumed a temporary defensive position.” (The imagery is disturbing.) As we note below, this might well signal an end to the fund.

The more striking closure is GL Beyond Income Fund (GLBFX). While the fund is tiny, the mess is huge. It appears that Beyond Income’s manager, Daniel Thibeault (pronounced “tee-bow”), has been inventing non-existent securities then investing in them. Such invented securities might constitute a third of the fund’s portfolio. In addition, he’s been investing in illiquid securities – that is, stuff that might exist but whose value cannot be objectively determined and which cannot be easily sold. In response to the fraud, the manager has been arrested and charged with one count of fraud.  More counts are certainly pending but conviction just on the one original charge could carry a 20-year prison sentence. Since the board has no earthly idea of what the fund’s portfolio is worth, they’ve suspended all redemptions in the fund as well as all purchased. 

GL Beyond Income (it’s certainly sounding awfully ironic right now, isn’t it?) was one of two funds that Mr. Thibeault ran. The first fund, GL Macro Performance Fund (GLMPX), liquidated in July after booking a loss of nearly 50%. Like Beyond Income, it invested in a potpourri of “alternative investments” including private placements and loans to other organizations controlled by the manager.

There have been two pieces of really thoughtful writing on the crime. Investment News dug up a lot of the relevant information and background in a very solid story by Mason Braswell on December 30^th.  Chuck Jaffe approached the story as an illustration of the unrecognized risks that retail investors take as they move toward “liquid alts” funds which combine unusual corporate structures (the GL funds were interval funds, meaning that you could not freely redeem your shares) and opaque investments.

Morningstar, meanwhile, remains thoughtfully silent.  They seem to have reprinted Jaffe’s story but their own coverage of the fraud and its implications has been limited to two one-sentence notes on their Advisor site.

OLD WINE, NEW BOTTLES

Effective January 1, 2015, the name of the AIT Global Emerging Markets Opportunities Fund (VTGIX) changed to the Vontobel Global Emerging Markets Equity Institutional Fund.

American Century One Choice 2015 Portfolio has reached the end of its glidepath and is combining with One Choice In Retirement. That’s not really a liquidation, more like a long-planned transition.

Effective January 30, 2015, the name of the Brandes Emerging Markets Fund (BEMAX) will be changed to the Brandes Emerging Markets Value Fund.

At the same time that Brandes gains value, Calamos loses it. Effective March 1, Calamos Opportunistic Value Fund (CVAAX) becomes plain ol’ Calamos Opportunistic Fund and its benchmark will change from Russell 1000 Value to the S&P 500. Given that the fund is consistently inept, one could imagine calling for new managers … except for the fact that the fund is managed by the firm’s founder and The Gary Black.

Columbia Global Equity Fund (IGLGX) becomes Columbia Select Global Equity Fund on or about January 15, 2015. At that point Threadneedle International Advisers LLC takes over and it becomes a focused fund (though no one is saying how focused or focused on what?).

Effective January 1, 2015, Ivy International Growth Fund (IVINX) has changed to Ivy Global Growth Fund. Even before the change, over 20% of the portfolio was invested in the US.

PIMCO EqS^® Dividend Fund (PQDAX) became PIMCO Global Dividend Fund on December 31, 2014.

Effective February 28, 2015, Stone Ridge U.S. Variance Risk Premium Fund (VRLIX) will change its name to Stone Ridge U.S. Large Cap Variance Risk Premium Fund.

Effective December 29, 2014, the T. Rowe Price Retirement Income Fund has changed its name to the T. Rowe Price Retirement Balanced Fund.

The two week old Vertical Capital Innovations MLP Energy Fund (VMLPX) has changed its name to the Vertical Capital MLP & Energy Infrastructure Fund.

Voya Strategic Income Fund has become Voya Strategic Income Opportunities Fund. I’m so glad. I was worried that they were missing opportunities, so this reassures me. Apparently their newest opportunities lie in being just a bit more aggressive than a money market fund, since they’ve adopted the Bank of America Merrill Lynch U.S. Dollar Three-Month LIBOR Constant Maturity Index as their new benchmark. Not to say this is an awfully low threshold, but that index has returned 0.34% annually from inception in 2010 through the end of 2014.

OFF TO THE DUSTBIN OF HISTORY

Aberdeen Core Fixed Income Fund (PCDFX) will be liquidated on February 12, 2015.

Aegis High Yield Fund (AHYAX/AHYFX) hard-closed in mid-December. Given the fund’s size ($36 million) and track record, we’re thinking it’s been placed in a hospice though that hasn’t been announced. Here’s the 2014 picture:

AllianzGI Opportunity (POPAX) is getting axed. The plan is to merge the $90 million small cap fund into its $7 million sibling, AllianzGI Small-Cap Blend Fund (AZBAX). AZBAX has a short track record, mostly of hugging its index, but that’s a lot better than hauling around the one-star rating and dismal 10 year record that the larger fund’s managers inherited in 2013. They also didn’t improve upon the record. The closing date of the Reorganization is expected to be on or about March 9, 2015, although the Reorganization may be delayed.

Alpine Global Consumer Growth Fund (AWCAX) has closed and will, pending shareholder approval, be terminated in early 2015. Given that the vast majority of the fund’s shares (70% of the retail and 95% of the institutional shares) are owned by the family of Alpine’s founder, Sam Leiber, I’ve got a feeling that the shareholder vote is a done deal.

The dizzingly bad Birmiwal Oasis Fund (BIRMX) is being put out of manager Kailash Birmiwal’s misery. From 2003 – 07, the fund turned $10,000 into $67,000 and from 2007 – present it turned that $67,000 back into $21,000. All the while turning the portfolio at 2000% a year. Out of curiosity, I went back and reviewed the board of trustee’s decision to renew Mr. Birmiwal’s management contract in light of the fund’s performance. The trustees soberly noted that the fund had underperformed its benchmark and peers for the past 1-, 5-, 10-year and since inception periods but that “performance compared to its benchmark was competitive since the Fund’s inception which was reflective of the quality of the advisory services, including research, trade execution, portfolio management and compliance, provided by the Adviser.” I’m not even sure what that sentence means. In the end, they shrugged and noted that since Mr. B. owned more than 75% of the fund’s shares, he was probably managing it “to the best of his ability.”

I’m mentioning that not to pick on the decedent fund. Rather, I wanted to offer an example of the mental gymnastics that “independent” trustees frequently go through in order to reach a preordained conclusion.

The $75 million Columbia International Bond fund (CNBAX) has closed and will disappear at the being of February, 2015.

DSM Small-Mid Cap Growth Fund (DSMQZ/DSMMX) was liquidated and terminated on short notice at the beginning of December, 2014.

EP Strategic US Equity (EPUSX) and EuroPac Hard Asset (EPHAX) are two more lost lambs subject to “termination, liquidation and dissolution,” both on January 8^th, 2015.

Fidelity trustees unanimously approved the merge of Fidelity Fifty (FFTYX) into Fidelity Focused Stock (FTGQX). Not to point out the obvious but they have the same manager and near-identical 53 stock portfolios already. Shareholders will vote in spring and after baaa-ing appropriately, the reorganization will take place on June 5, 2015.

The Frost Small Cap Equity Fund was liquidated on December 15, 2014.

It is anticipated that the $500,000 HAGIN Keystone Market Neutral Fund (HKMNX) will liquidate on or about December 30, 2014 based on the Adviser’s “inability to market the Fund and that it does not desire to continue to support the Fund.”

Goldman Sachs World Bond Fund (GWRAX) will be liquidated on January 16, 2014. No reason was given. One wonders if word of the potential execution might have leaked out and reached the managers, say around June?

The $300 million INTECH U.S. Managed Volatility Fund II (JDRAX) is merging into the $100 million INTECH U.S. Managed Volatility Fund (JRSAX, formerly named INTECH U.S. Value Fund). Want to guess which of them had more Morningstar stars at the time of the merger? Janus will “streamline” (their word) their fund lineup on April 10, 2015.

ISI Strategy Fund (STRTX), a four star fund with $100 million in assets, will soon merge into Centre American Select Equity Fund (DHAMX). Both are oriented toward large caps and both substantially trail the S&P 500.

Market Vectors Colombia ETF, Latin America Small-Cap Index ETF, Germany Small-Cap ETF and Market Vectors Bank and Brokerage ETF disappeared, on quite short notice, just before Christmas.

New Path Tactical Allocation Fund (GTAAX), an $8 million fund which charges a 5% sales load and charges 1.64% in expenses – while investing in two ETFs at a time, though with a 600% turnover we can’t know for how long – has closed and will be vaporized on January 23, 2015.

The $2 million Perimeter Small Cap Opportunities Fund (PSCVX) will undergo “termination, liquidation and dissolution” on or about January 9, 2015.

ProShares is closing dozens of ETFs on January 9^th and liquidating them on January 22^nd. The roster includes:

Short 30 Year TIPS/TSY Spread (FINF) UltraPro 10 Year TIPS/TSY Spread (UINF) UltraPro Short 10 Year TIPS/TSY Spread (SINF) UltraShort Russell3000 (TWQ) UltraShort Russell1000 Value (SJF) UltraShort Russell1000 Growth (SFK) UltraShort Russell MidCap Value (SJL) UltraShort Russell MidCap Growth (SDK)

UltraShort Russell2000 Value (SJH) UltraShort Russell2000 Growth (SKK) Ultra Russell3000 (UWC) Ultra Russell1000 Value (UVG) Ultra Russell1000 Growth (UKF) Ultra Russell MidCap Value (UVU) Ultra Russell MidCap Growth (UKW) Ultra Russell2000 Value (UVT) Ultra Russell2000 Growth (UKK)

SSgA IAM Shares Fund (SIAMX) has been closed in preparation for liquidation cover January 23, 2015. That’s just a mystifying decision: four-star rating, low expenses, quarter billion in assets … Odder still is the fund’s investment mandate: to invest in the equity securities of firms that have entered into collective bargaining agreements with the International Association of Machinists (that’s the “IAM” in the name) or related unions.

UBS Emerging Markets Debt Fund (EMFAX) will experience “certain actions to liquidate and dissolve the Fund” on or about February 24, 2015. The Board’s rationale was that “low asset levels and limited future prospects for growth” made the fund unviable. They were oddly silent on the question of the fund’s investment performance, which might somehow be implicated in the other two factors:

In Closing . . .

Jeez, so many interesting things are happening. There’s so much to share with you. Stuff on our to-do list:

• Active share is a powerful tool for weeding dead wood out of your portfolio. Lots and lots of fund firms have published articles extolling it. Morningstar declares you need to “get active or get out.” And yet neither Morningstar nor most of the “have our cake and eat it, too” crowd release the data. We’ll wave in the direction of the hypocrites and give you a heads up as the folks at Alpha Architect release the calculations for everyone.
• Talking about the role of independent trustees in the survival of the fund industry. We’ve just completed our analysis of the responsibilities, compensation and fund investments made by the independent trustees in 100 randomly-selected funds (excluding only muni bond funds). Frankly, our first reactions are (1) a few firms get it very right and (2) most of them have rigged the system in a way that screws themselves. You can afford to line your board with a collection of bobble-head dolls when times are good but, when times are tough, it reads like a recipe for failure.
• Not to call the ETF industry “scammy, self-congratulatory and venal” but there is some research pointing in that direction. We’re hopeful of getting you to think about it.
• Conference calls with amazing managers, maybe even tricking Andrew Foster into a reprise of his earlier visits with us.
• We’ve been talking with the folks at Third Avenue funds about the dramatic changes that this iconic firm has undergone. I think we understand them but we still need to confirm things (I hate making errors of fact) before we share. We’re hopeful that’s February.
• There are a couple new services that seem intent on challenging the way the fund industry operates. One is Motif Investing, which allows you to be your own fund manager. There are some drawbacks to the service but it would allow all of the folks who think they’re smarter than the professionals to test that hypothesis. The service that, if successful, will make a powerful social contribution is Liftoff. It’s being championed by Josh Brown, a/k/a The Reformed Broker, and the folks at Ritholtz Wealth Management. We mentioned the importance of automatic investing plans in December and Josh followed with a note about the role of Liftoff in extending such plans: “We created a solution for this segment of the public – the young, the underinvested and the people who’ve never been taught anything about how it all works. It’s called Liftoff … We custom-built portfolios that correspond to a matrix of answers the clients give us online. This helps them build a plan and automatically selects the right fund mix. The bank account link ensures continual allocation over time.” This whole “young and underinvested” thing does worry me. We’ll try to learn more.
• And we haven’t forgotten the study of mutual funds’ attempts to use YouTube to reach that same young ‘n’ muddled demographic. It’s coming!

Finally, thanks to you all. A quarter million readers came by in 2014, something on the order of 25,000 unique visitors each month.  The vast majority of you have returned month after month, which makes us a bit proud and a lot humbled.  Hundreds of you have used our Amazon link (if you haven’t bookmarked it, please do) and dozens have made direct contributions (regards especially to the good folks at Emerald Asset Management and to David Force, who are repeat offenders in the ‘help out MFO’ category, and to our ever-faithful subscribers). We’ll try to keep being worth the time you spend with us.

We’ll look for you closer to Valentine’s Day!

Dear friends,

The Christmas of the early American republic – of the half century following the Revolution – would be barely recognizable to us. It was a holiday so minor as to be virtually invisible to the average person. You’ll remember the famous Christmas of 1776 when George Washington crossed the Delaware on Christmas and surprised the Hessian troops who, one historian tells us, were “in blissful ignorance of local custom” and had supposed that there would be celebration rather than fighting on Christmas. Between the founding of the Republic and 1820, New England’s premier newspaper – The Hartford Courant – had neither a single mention of Christmas-keeping nor a single ad for holiday gifts. In Pennsylvania, the Harrisburg Chronicle – the newspaper of the state’s capital – ran only nine holiday advertisements in a quarter century, and those were for New Year’s gifts. The great Presbyterian minister and abolitionist orator Henry Ward Beecher, born in 1813, admitted that he knew virtually nothing about Christmas until he was 30: “To me,” he writes, “Christmas was a foreign day.” In 1819, Washington Irving, author of The Legend of Sleepy Hollow and Rip van Winkle, mourned the passing of Christmas. And, in 1821, the anonymous author of Christmas-keeping lamented that “In London, as in all great cities … the observances of Christmas must soon be lost.” Though, he notes, “Christmas is still a festival in some parts of America.”

Why? At base, Christmas was suppressed by the actions and beliefs of just two groups: the rich people . . . and the poor people.

The rich — the Protestant descendants of the founding Puritans, concentrated in the booming commercial and cultural centers of the Northeast – reviled Christmas as pagan and unpatriotic. About which they were at least half right: pagan certainly, unpatriotic . . . ehhh, debatable.

Here we seem to have a contradiction in terms: a pagan Christmas. To resolve the contradiction, we need to separate a religious celebration of Christ’s birth from a celebration of Christ’s birth on December 25^th. Why December 25^th? The most important piece of the puzzle is obscured by the fact that we use a different calendar system – the Gregorian – than the early Christians did. Under their calendar, December 25^th was the night of the winter solstice – the darkest day of the year but also the day on which light began to reassert itself against the darkness. It is an event so important that every ancient culture placed it as the centerpiece of their year. We have record of at least 40 holidays taking place on, or next to, the winter solstice. Our forebears rightly noted that the choice of December 25^th with a calculated marketing decision meant to draw pagans away from one celebration and into another.

So the Puritans were correct when they pointed out – and they pointed this out a lot – that Christmas was simply a pagan feast in Christian garb. Increase Mather found it nothing but “mad mirth…highly dishonorable to the name of Christ.” Cromwell’s Puritan parliament banned Christmas-keeping in the 1640s and the Massachusetts Puritans did so in the 1650s.

And while the legal bans on Christmas could not be sustained, the social ones largely were.

The rich, who didn’t party, were a problem. The poor, who did, were a far bigger one.

There was, by long European tradition, a period of wild festivity to celebrate New Year’s. Society’s lowest classes – slaves or serfs or peasants or blue collar toilers – temporarily slipped their yokes and engaged in a period of wild revelry and misrule.

In America, the parties were quite wild. Really quite wild.

Think: Young guys.

Lots of them.

With guns.

Drunk.

Ohhh . . . way drunk, lots of alcohol, to . . . uh, drive the cold winter away.

And a sense of entitlement – a sense that their social betters owed them good food, small bribes and more alcohol.

Then add lots more alcohol.

Roving gangs, called “callithumpian bands,” roamed night after night – by a contemporary account “shouting, singing, blowing trumpets and tin horns, beating on kettles, firing crackers … hurling missiles” and demanding some figgy pudding. Remember?

Oh, bring us a figgy pudding and a cup of good cheer

We won’t go until we get some;

We won’t go until we get some;

We won’t go until we get some, so bring some out here

Back then, that wasn’t a song. It was a set of non-negotiable demands.

In a perverse way, what saved Christmas was its commercialization. Beginning in New York around 1810 or 1820, merchants and civic groups began “discovering” old Dutch Christmas traditions (remember New York started as New Amsterdam) that surrounded family gatherings, communal meals and presents. Lots of presents. The commercial Christmas was a triumph of the middle class. Slowly, over a generation, they pushed aside old traditions of revelry and half-disguised violence. By creating a civic holiday which helped to bridge a centuries’ old divide between Christian denominations – the Christmas-keepers and the others – and gave people at least an opportunity to offer a fumbling apology, perhaps in the form of a Chia pet, for their idiocy in the year past and a pledge to try better in the year ahead.

I might even give it a try, minus regifting my Chia thing.

Harness the incomparable power of lethargy!

We are lazy, inconstant, wavering and inattentive. It’s time to start using it to our advantage. It’s time to set up a low minimum/low pain account with an automatic investment plan.

About a third of us have saved nothing. The reasons vary. Some of us simply can’t; about 60 million of us – the bottom 20% of the American population – are getting by (or not) on $21,000/year. Over the past 40 years, that group has actually seen their incomes decline by 1%. Folks with just high school diplomas have lost about 20% in purchasing power over that same period. NPR’s Planet Money team did a really good report on how the distribution of wealth in the US has changed over the past 40 years.

A rather larger group of us could save, or could save more, but we’re thwarted by the magnitude of the challenge. Picking funds is hard, filling out forms is scary and thinking about how far behind we are is numbing. So we sort of panic and freeze. That reaction is only so-so in possums; it pretty much reeks in financial planning.

Fortunately, you’ve got an out: low minimum accounts with automatic investment plans. That’s not the same as a low minimum mutual fund account. The difference is that low minimum accounts are a bad idea and an economic drain to all involved; when I started maintaining a list of funds for small investors in the 1990s, there were over 600 no-load options. Most of those are gone now because fund advisers discovered an ugly truth: small accounts stay small. Full of good intentions people would invest the required $250 or $500 or whatever, then bravely add $100 in the next month but find that cash was a bit tight in the next month and that the cat needed braces shortly thereafter. Fund companies ended up with thousands of accounts containing just a few hundred dollars each; those accounts might generate just $3 or 4 a year in fees, far below what it cost to keep them open. Left to its own a $250 account would take 20 years to reach $1,000, a nice amount but not a meaningful one.

But what if you could start small then determinedly add a pittance – say $50 – each month? Over that same 20 year period, your $250 account with a $50 monthly addition would grow to $29,000. Which, for most of us, is really meaningful.

Would you like to start moving in that direction? Here’s how.

If you do not have an emergency fund or if you mostly want to sleep well at night, make your first fund one that invests mostly in cash and bonds with just a dash of stocks. As we noted last month, such a stock-light portfolio has, over the past 65 years, captured 60% of the stock market’s gains with only 25% of its risks. Roughly 7% annual returns with a minimal risk of loss. That’s not world-beating but you don’t want world-beating. For a first fund or for the core of your emergency fund, you want steady, predictable and inflation-beating.

Consider one of these two:

TIAA-CREF Lifestyle Income Fund (TSILX). TIAA-CREF is primarily a retirement services provider to the non-profit world. This is a fund of other TIAA-CREF funds. About 20% of the fund is invested in dividend-paying stocks, 40% in short-term bonds and 40% in other fixed-income investments. It charges 0.83% per year in expenses. You can get started for just $100 as long as you set up an automatic investment of at least $100/month from your bank account. Here’s the link to the account application form. You’ll have to print off the pdf and mail it. Sorry that they’re being so mid-90s about it.

Manning & Napier Strategic Income, Conservative Series (MSCBX). Manning & Napier is a well-respected, cautious investment firm headquartered in Fairport, NY. Their funds are all managed by the same large team of people. Like TSILX, it’s a fund-of-funds and invests in just five of M&N’s other funds. About 30% of the fund is invested in stocks and 70% in bonds. The bond portfolio is a bit more aggressive than TSILX’s and the stock portfolio is larger, so this is a slightly more-aggressive choice. It charges 0.88% per year in expenses. You can get started for just $25 (jeez!) as long as you set up a $25 AIP. Do yourself a favor a set a noticeably higher bar than that, please. Here’s the direct link to the fund application form. Admittedly it’s a poorly designed one, where they stretch two pages of information they need over about eight pages of noise. Be patient with them and with yourself, it’s just not that hard to complete and you do get to fill it out online.

Where do you build from there? The number of advisers offering low or waived minimums continues to shrink, though once you’re through the door you’re usually safe even if the firm ups their requirement for newcomers.

Here’s a quick warning: Almost all of the online lists of funds with waived or reduced minimum contain a lot of mistakes. Morningstar, for instance, misreports the results for Artisan (which does waive its minimum) as well as for DoubleLine, Driehaus, TCW and Vanguard (which don’t). Others are a lot worse, so you really want to follow the “trust but verify” dictum.

Here are some of your best options for adding funds to your monthly investing portfolio:

Family	AIP minimum	Notes
Amana	$250	The Amana minimum does not require an automatic investment plan; a one-time $250 investment gets you in. Very solid, very risk-conscious.
Ariel	50	Six value-oriented, low turnover equity funds.
Artisan	50	Artisan has four Great Owl funds (Global Equity, Global Opportunities, Global Value, and International Value) but the whole collection is risk-conscious and disciplined.
Azzad	300	Two socially-responsible funds, one midcap and one focused on short-term fixed-income investments.
Buffalo	100	Ten funds across a range of equity and stock styles. Consistently above average with reasonable expenses. Look at Buffalo Flexible Income (BUFBX) which would qualify as a Great Owl except for a rocky stretch well more than a decade ago under different managers.
FPA Funds	100	These guys are first-rate, absolute return value investors. Translation: if nothing is worth buying, they’ll buy nothing. The funds have great long term records but lag in frothy markets. All are now no-load for the first time.
Gabelli	0	On AAA shares, anyway. Gabelli’s famous, he knows it and he overcharges. That said, he has a few solid funds including their one Great Owl, Gabelli ABC. It’s a market neutral fund with badly goofed up performance reporting from Morningstar.
Guinness Atkinson	100	Guinness offers nine funds, all of which fit into unique niches – Renminbi Yuan & Bond Fund (a Great Owl) or Inflation-Managed Dividend Fund, for instances
Heartland	0	Four value-oriented small to mid-cap funds, from a scandal-touched firm. Solid to really good.
Hennessy	100	Hennesy has a surprisingly large collection of Great Owls: Equity & Income, Focus, Gas Utility Index, Japan and Japan Small Cap.
Homestead	0	Seven funds (stock, bond, international), solid to really good performance (including the Great Owls: Short Term Bond and Small Company Stock), very fair expenses.
Icon	100	17 funds whose “I” or “S” class shares are no-load. These are sector or sector-rotation funds, a sort of odd bunch.
James	50	Four very solid funds, the most notable of which is James Balanced: Golden Rainbow (GLRBX), a quant-driven fund that keeps a smallish slice in stocks
Laudus Mondrian	100	An “institutional managers brought to the masses” bunch with links to Schwab.
Manning & Napier	25	The best fund company that you’ve never heard of. Thirty four diverse funds, including many mixed-asset funds, all managed by the same team. Their sole Great Owl is Target Income.
Northern Trust	250	One of the world’s largest advisers for the ultra-wealthy, Northern offers an outstanding array of low expense, low minimum funds – stock and bond, active and passive, individual and funds of funds. Their conservatism holds back performance but Equity Income is a Great Owl.
Oberweis	100	International Opportunities is both a Great Owl and was profiled by the Observer.
Permanent Portfolio	100	A spectacularly quirky bunch, the Permanent Portfolio family draws inspiration from the writings of libertarian Harry Browne who was looking to create a portfolio that even government ineptitude couldn’t screw up.
Scout	100	By far the most compelling options here are the fixed-income funds run by Reams Asset Management, a finalist for Morningstar’s fixed-income manager of the year award (2012).
Steward Capital	100	A small firm with a couple splendid funds, including Steward Capital Mid Cap, which we’ve profiled.
TETON Westwood	0	Formerly called GAMCO (for Gabelli Asset Management Co) Westwood, these are rebranded in 2013 but are the same funds that have been around for years.
TIAA-CREF	100	Their whole Lifecycle Index lineup of target-date funds has earned Great Owl designation.
Tributary	100	Four solid little funds, including Tributary Balanced (FOBAX) which we’ve profiled several times.
USAA	500	USAA primarily provides financial services for members of the U.S. military and their families. Their funds are available to anyone but you need to join USAA (it’s free) in order to learn anything about them. That said, 26 funds, some quite good. Ultra-Short Term Bond is a Great Owl.

Do you have a fund family that really should be on this list but we missed? Sorry ‘bout that! But we’ll fix it if only you’ll let us know!

Correcting our misreport of FPA Paramount’s (FPRAX) expense ratio

In our November profile of FPRAX, we substantially misreported FPRAX’s expense ratio. The fund charges 1.26%, not 0.92% as we reported. . Morningstar, which had been reporting the 0.92% charge until late November, now reports a new figure. The annual report is the source for the 1.06% number, the prospectus gives 1.26%.  The difference is that one is backward-looking, the other forward looking.

Where did the error originate? Before the fall of 2013, Paramount operated as a domestic small- to mid-cap fund which focused on high quality stocks. At that point the expense ratio was 0.92%. That fall FPA changed its mandate so that it now focuses on a global, absolute value portfolio.  Attendant to that change, FPA raised the fund’s expense ratio from 0.92 to 1.26%. We didn’t catch it. Apologies for the error.

The next question: why did FPA decide to charge Paramount’s shareholders an extra 37%? I’ve had the opportunity to chat at some length with folks from FPA, including Greg Herr, who serves as one of the managers for Paramount. The shortest version of the explanation came in an email:

… the main reasons we sought a change in fees was because [of] the increased scope of the mandate and comparable fees charged by other world stocks funds.

FPA notes that the fund’s shareholders voted overwhelmingly to raise their fees. The proxy statement adds a bit of further detail:

FPA believes that the proposed fee would be competitive with other global funds, consistent with fees charged by FPA to other FPA Funds (and thus designed to create a proper alignment of internal incentives for the portfolio management team), and would allow FPA to attract and retain high quality investment and trading personnel to successfully manage the Fund into the future.

Based on our conversations and the proxy text, here’s my best summary of the arguments in favor of a higher expense ratio:

• It’s competitive with what other companies charge
• The fund has higher costs now
• The fund may have higher costs in the future, for example higher salaries and larger analyst teams
• FPA wants to charge the same fee to all of our shareholders

Given the fund’s current size ($304 million), the additional 34 bps translates to an additional $1.03 million/year transferred from shareholders to the adviser.

Let’s start with the easy part. Even after the repricing, Paramount remains competitively priced. We screened for all retail, no-load global funds with between $100-500 million in their portfolios, and then made sure to add the few other global funds that the Observer already profiled. There are 35 such funds. Twelve are cheaper than Paramount, 21 are more expensive. Great Owls appear in highlighted blue rows, while profiled funds have links to their MFO profiles.

		Expense ratio	Size (million)
Vanguard Global Minimum Volatility	VMVFX	0.30	475
Guinness Atkinson Inflation Managed Dividend	GAINX	0.68	5
T. Rowe Price Global Stock	PRGSX	0.91	488
Polaris Global Value	PGVFX	0.99	289
Dreyfus Global Equity Income I	DQEIX	1.06	299
Deutsche World Dividend S	SCGEX	1.09	362
Voya Global Equity Dividend W	IGEWX	1.11	108
Invesco Global Growth Y	AGGYX	1.18	359
PIMCO EqS® Dividend D	PQDDX	1.19	166
Deutsche CROCI Sector Opps S	DSOSX	1.20	152
Hartford Global Equity Income	HLEJX	1.20	288
Deutsche Global Small Cap S	SGSCX	1.25	499
FPA Paramount	FPRAX	1.26	276
First Investors Global	FIITX	1.27	430
Invesco Global Low Volatility	GTNYX	1.29	206
Perkins Global Value S	JPPSX	1.29	285
Cambiar Aggressive Value	CAMAX	1.35	165
Motley Fool Independence	FOOLX	1.36	427
Artisan Global Value	ARTGX	1.37	1800
Portfolio 21 Global Equity R	PORTX	1.42	494
Columbia Global Equity W	CGEWX	1.45	391
Guinness Atkinson Global Innovators	IWIRX	1.46	147
Artisan Global Equity	ARTHX	1.50	247
Artisan Global Small Cap	ARTWX	1.50	169
BBH Global Core Select	BBGRX	1.50	130
William Blair Global Leaders N	WGGNX	1.50	162
Grandeur Peak Global Reach	GPROX	1.60	324
AllianzGI Global Small-Cap D	DGSNX	1.61	209
Evermore Global Value A	EVGBX	1.62	249
Grandeur Peak Global Opportunities	GPGOX	1.68	709
Royce Global Value	RIVFX	1.69	154
Wasatch World Innovators	WAGTX	1.77	237
Wasatch Global Opportunities	WAGOX	1.80	195
	average	1.32%	$325M

Unfortunately other people’s expenses are a pretty poor explanation for FPA’s prices.

There are two ways of reading FPA’s decision:

1. We’re going to charge what the market will bear. Welcome to capitalism. The cynical reading starts with the suspicion that the fund’s expenses haven’t risen by a million dollars. While FPA cites research, trading, settlement and compliance expenses that are higher in a global fund than in a domestic fund, the fact that every international stock in Paramount’s portfolio was already in International Value’s means that the change required no additional analysts, no additional research trips, no additional registrations, certifications or subscriptions. While Paramount’s shareholders might need to share the cost of those reports with International Value’s (which lowers the cost of running International Value), at best it’s a wash: International Value’s expenses should fall as Paramount’s rise.
2. We need to raise fees a lot in the short term to be sure we can do right by our shareholders in the long term. There are increased expenses, they were fully disclosed to the fund’s board, and that the board acted thoughtfully and in good faith in deciding to propose a higher expense ratio. They also argue that it makes sense that Paramount and International Value’s shareholders should pay the same rate for their manager’s services, the so-called management fee, since they’ve got the same managers and objectives. Before the change, FPIVX shareholders paid 1% and FPRAX shareholders paid 0.65%. The complete list of FPA management fees:
   

   FPA New Income	Non-traditional bond	0.50
   FPA Capital	Mid-cap value	0.65
   FPA Perennial	Mid-cap growth	0.65
   FPA Crescent	Free-range chicken	1.00
   FPA International Value	International all-cap	1.00
   FPA Paramount	Global	1.00

   Finally, the new expenses create a sort of war-chest or contingency fund which will give the adviser the resources to address opportunities that are not yet manifest.

So what do we make of all this? I don’t know. I respect and admire FPA but this decision is disquieting and opaque. I’m short on evidence, which is frustrating.

That, sadly, is where we need to leave it.

Whitney George and the Royce Funds part ways

We report each month on manager changes, primarily at equity and balanced funds. All told, nearly 700 funds have reported changes so far in 2014. Most of those changes have a pretty marginal effect. Of the 68 manager changes we reported in our November issue, only 12 represented house cleanings. The remainder were simply adding a new member to an existing team (20 instances) or replacing part of an existing team (36 funds).

Occasionally, though, manager departures are legitimate news and serious business, both for a fund’s shareholders and the larger investing community.

And so it is with the departure of Whitney George from Royce Funds.

Mr. George has been with Royce Funds for 23 years, both as portfolio manager and with founder Charles Royce, co-Chief Investment Officer. He manages the $65 million Royce Privet hedge fund (‘cause “privet” is a kind of hedge, you see) and the $170 million Royce Focus Trust (FUND), an all-cap, closed-end fund. On November 10, Royce announced that Mr. George was leaving to join Toronto-based Sprott Asset Management and that, pending shareholder approval, Privet and Focus were going with him. At the same time he stepped aside from the management (sole, co- or assistant) of five open-end funds: Royce Global Value (RIVFX), Low-Priced Stock (RYLPX), Premier (RPFFX), SMid-Cap Value (RMVSX) and Value (RYVFX). They are all, by Morningstar’s reckoning, one- or two-star funds. As of May 2014, Mr. George was connected with the management of more than $15 billion in assets.

Why? The firm’s leadership was contemplating long term succession planning for Chuck and decided on an executive transition that did not include Whitney. The position of president went to Chris Clark. Sometime thereafter, he concluded that his greatest contributions and greatest natural strengths lay in managing investments for Canadians and began negotiating a separation. He’ll remain with Royce through the end of the first quarter of 2015, and will remain domiciled in New York City rather than moving to Toronto and feigning an interest in the Maple Leafs, Blue Jays, Rock, Raptors or round bacon.

What’s worth knowing?

• The media got it wrong. In 2009, Mr. George was named co-chief investment officer along with Chuck Royce. At the time Royce was clear that this was not succession planning (this was “not in preparation for Mr. Royce retiring at some point”); which is to say, Mr. George was not being named heir apparent. Outsiders knew better: “The succession plan has become clearer recently: Whitney George was promoted to co-chief investment officer in 2009, and for now he serves alongside Chuck Royce” Karen Anderson, Morningstar, 12/01/10.
• Succession is clearer now. Royce’s David Gruber allowed that the 2009 move was contingency planning, not succession planning. There now are succession plans: the firm has created a management committee to help Mr. Royce, who is 75, run the firm. While Mr. Royce has no plans on retiring, they “would rather make these decisions now than when Chuck is 85” and imagine that “Chris Clark will become CEO in the next several years.” Mr. Clark has been with Royce for over seven years, has been a manager for them and used to be a hedge fund manager. He’s now their co-CIO.
• The change will make a difference in the funds. David Nadel, an international equity specialist for them, will take over the international sleeve of Global Value. Mr. Royce assumes the lead on Premier, his 13^th Most significantly, James Stoeffel intends to reorient the Low-Priced Stock portfolio toward, well, low-priced stocks. The argument is that low-priced stocks are inefficiently priced stocks. They have limited interest to institutions for some reason, especially those priced below $10. Stocks priced below $5 cannot be purchased on margin, which further limits their market. Mr. Stoeffel intends to look more closely now at stocks priced near $10 rather than those in the upper end of the allowable range ($25). Up until the last three years, RLPSX has stayed step-for-step with Joel Tillinghast and the remarkable Fidelity Low-Priced Stock Fund (FLPSX). If they can regain that traction, it would be a powerful addition to Royce’s lagging lineup.
• Royce is making interesting decisions. Messrs. George and Royce served as co-CIOs from 2009 to the end of 2013. At that point, the firm appointed Chris Clark and Francis Gannon to the role. The argument strikes me as interesting: Royce does not want their senior portfolio managers serving as CIOs (or, for that matter, as CEO). They believe that the CIO should complement the portfolio managers, rather than just being managers. The vision is that Clark and Gannon function as the firm’s lead risk managers, trying to understand the bigger picture of threats and challenges and working with a new risk management committee to find ways around them. And the CEO should have demonstrated business management skills, rather than demonstrated investment management ones. That’s rather at odds with the prevailing “great man” ideology. And, frankly, being at odds with the prevailing ideology strikes me as fundamentally healthy.

Succession is an iffy business, especially when a firm’s founder was a titanic personality. We learned that in the barely civil transition from Jack Bogle to John Brennan and some fear that we’re seeing it as Marty Whitman becomes marginalized at Third Avenue. We’ll follow-up on the Third Avenue transition in our January issue and, for now, continue to watch Royce Funds to see if they’re able to regain their footing in the year ahead.

Top developments in fund industry litigation – November 2014

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before.

“We built Fundfox from the ground up for mutual fund insiders,” says attorney-founder David M. Smith. “Directors and advisory personnel now have easier and more affordable access to industry-specific litigation intelligence than even most law firms had before.”

The core offering is a database of case information and primary court documents for hundreds of industry cases filed in federal courts from 2005 through the present. A Premium Subscription also includes robust database searching—by fund family, subject matter, claim, and more.

Orders

• In a win for Fidelity, the U.S. Supreme Court denied a certiorari petition in an ERISA class action regarding the float income generated by transactions in plan accounts. (Tussey v. ABB Inc.)
• Extending the fund industry’s losing streak, the court denied Harbor’s motion to dismiss excessive fee litigation regarding the subadvised International Fund: “Although it is far from clear that Zehrer [the plaintiff-shareholder] will be able to meet the high standard for liability under § 36(b), he has alleged sufficient facts specific to the fees paid to Harbor Capital to survive a motion to dismiss.” (Zehrer v. Harbor Capital Advisors, Inc.)
• The court dismissed Nuveen from an ERISA class action regarding services rendered by FAF Advisors, holding that the contract for Nuveen’s purchase of FAF “unambiguously indicates that Nuveen did not assume any liability that FAF may have had” with respect to the plan at issue. (Adedipe v. U.S. Bank, N.A.)

Briefs

• Genworth filed a motion for summary judgment in the class action alleging that defendants misrepresented the role that Robert Brinker played in the management of the BJ Group Services portfolio. (Goodman v. Genworth Fin. Wealth Mgmt., Inc.)
• SEI Investments filed a motion to dismiss an amended complaint challenging advisory and transfer agent fees for five funds. (Curd v. SEI Invs. Mgmt. Corp.)
• In the ERISA class action regarding TIAA-CREF’s account closing procedures, defendants filed a motion seeking dismissal of interrelated state-law claims as preempted by ERISA. (Cummings v. TIAA-CREF.)

Amended Complaint

• Plaintiffs filed an amended complaint in a consolidated class action regarding an alleged Ponzi scheme related to “TelexFree Memberships.” Defendants include a number of investment service providers, including Waddell & Reed. (Abdelgadir v. TelexElectric, LLLP.)

Supplemental Complaint

• In the class action regarding Northern Trust’s securities lending program, a pension fund’s board of trustees filed a supplemental complaint asserting individual non-class claims. (La. Firefighters’ Ret. Sys. v. N. Trust Invs., N.A.)

The Alt Perspective: Commentary and news from DailyAlts.

Brian Haskin publishes and edits the DailyAlts site, which is devoted to the fastest-growing segment of the fund universe, liquid alternative investments. Here’s his quick take on the DailyAlts mission:

Our aim is to provide our readers (investment advisors, family offices, institutional investors, investment consultants and other industry professionals) with a centralized source for high quality news, research and other information on one of the most dynamic and fastest growing segments of the investment industry: liquid alternative investments.

Brian offers this as his take on the month just past.

NO PLACE TO HIDE

Asset flows into and out of mutual funds and ETFs provide the market with insights about investor behavior, and in this past month it was clear that investors were not happy about active management and underperformance. While the data is lagged a month (October flow data becomes available in November, for instance), asset flows out of alternative mutual funds and ETFs exceeded inflows for the first time in…. well quite a while.

As noted in the table below, alternatives suffered $2.8 billion in outflows across both active and passive strategies. This is a stark change from previous months whereby the category generated consistent positive inflows. Of the $2.8 billion in outflows however, the MainStay Marketfield Fund, a long/short equity fund, contributed $2.2 billion. Market neutral funds also suffered outflows, while managed futures, multi-alternative and commodity funds all saw reasonable inflows.

However, alternatives were not the only category hit in October. Actively managed funds were hit to the tune of $31 billion in outflows, while passive funds recorded $54 billion in inflows. Definitely a shift in investor preferences as active funds in general struggle to keep up with their passive counterparts.

NEW FUND LAUNCHES IN NOVEMBER

Year to date, we have seen 80 new alternative funds hit the market, and six of those were launched in November (this may be revised upward in the next few days; see List of New Funds for more information). Both the global macro and managed futures categories had two new entrants, while other new funds fell into the long/short equity and mutli-alternative categories. Two notable new funds are as follows:

• Neuberger Berman Global Long Short Fund – There are not many pure global long/short funds, yet a larger opportunity set creates more potential for value added. The portfolio manager is new to Neuberger Berman, but not new to global investing. With its global mandate, this fund has the potential to work well alongside a US focused long/short fund.
• Eaton Vance Global Macro Capital Opportunities Fund – This fund is also global but looks for opportunities across multiple asset classes including equity and fixed income securities. The fund carries a moderate fee relative to other multi-alternative funds, and Eaton Vance has had longer-term success with other global macro funds.

FUND REGISTRATIONS IN NOVEMBER

October was the final month to register a fund and still get it launched in 2014, and as a result, November only saw eight new alternative funds enter the registration process, all of which fall into the alternative fixed income or multi-alternative categories. Two of these that look promising are:

• Franklin Mutual Recovery Fund – If you like distressed fixed income, then keep an eye out for the launch of this fund. This fund goes beyond junk and looks for bonds and other fixed income securities of distressed or bankrupt companies.
• Collins Long/Short Credit Fund – If interest rates ever rise, long/short credit funds can help get out of the way of volatile fixed income markets. The sub-advisor of this new fund has a record of delivering fairly steady returns over past several years while beating the Barclays Aggregate Bond Index.

NOVEMBER’S TOP RESEARCH / EDUCATIONAL ARTICLES

Education is critical when it comes to newer and more complex investment approaches, and liquid alternatives fit that description. The good news is that asset managers, investment consultants and other thought leaders in the industry publish a wide range of research papers that are available to the public. At DailyAlts, we provide summaries of these papers, along with links to the full versions. The top three research related articles in November were:

• The Sharpe Ratio is Not the Best Metric for Maximizing Portfolio Efficiency
• MLP Investment Guide for Taxable and Non-Taxable Investors
• The Free Lunch Effect: The Value of Decoupling Diversification and Risk

OTHER NEWS

Probably the most interesting news during the month was the SEC’s approval of Eaton Vance’s proposal to launch Exchange Traded Managed Funds, which essentially combines the intra-day trading, brokerage account availability and lower operating costs of exchange traded funds (ETFs) with the less frequent transparency (at least quarterly disclosure of holdings) of mutual funds. Think of actively managed mutual funds in an ETF wrapper.

Why is this significant? The ETF market is growing at a much faster rate than the mutual fund market, and so far most of the flows into ETFs have been into indexed ETFs. Now the door is open for actively managed ETFs with less transparency than a typical ETF, so expect to see over the next few years a long line of active fund management companies shift gears away from mutual funds and prepping new ETMF structures on the heels of Eaton Vance’s approval from the SEC. Many active fund managers that have wanted to tap the growth of the ETF market now have a mechanism to do so, assuming they can either create their own structure without violating patents held by Eaton Vance, or license the technology directly from Eaton Vance.

Visit us at DailyAlts.com for ongoing news and information about liquid alternatives.

Dodging the tax bullet

We’re entering capital gains season, a time when funds make the distributions that will come back to bite you around April 15^th. Because funds operate as pass-through vehicles for tax purposes, investors can end up paying taxes in two annoying circumstances: when they haven’t sold a single share of a fund and when the fund is losing money. The sooner you know about a potential hit, the better you’re able to work on offsetting strategies. We’re offering two short-term resources to help you sort through.

Our colleague The Shadow, one of our discussion board’s most vigilant members, has assembled links to the announced distributions for over 160 fund families. If you want to go directly there, let your mouse hover over the Resources tab at the top of this page and the link will appear.

Beyond that, Mark Wilson has launched Cap Gains Valet to help you. In addition to being Chief Valet, Mark is chief investment officer for The Tarbox Group in Newport Beach, CA. He is, they report, “one of only four people in the nation that has both the Certified Financial Planner® and Accredited Pension Administrator (APA) designations.” Mark’s site, which is also free and public, offers a nice search engine, interpretive articles and a list of funds with the most horrifyingly large distributions. Here’s a friendly suggestion to any of you invested in the Turner Funds: go now! There’s a good chance that you’re going to say something that rhymes with “oh spit.”

We asked Mark what advice he could offer to avoid taking another hit next year. Here’s his year-end planning list for you:

Keeping More of What You Make

Between holiday shopping, decorating and goodie eating there is more than enough going on this time of year without worrying about the tax consequences from mutual fund capital gain distributions.

I have already counted over 450 funds that will distribute more than 10% of their net asset value (NAV) this year, and 50 of these are expected to distribute in excess of 20%! Mutual fund information providers, fund marketers, and most fund managers focus on total investment returns, so they do not care much about taxable distributions. Of course, total returns are very important, but it is not what you make, it is what you keep! After-tax returns are what are most important for the taxable investor.

You can keep more of what you make by considering these factors before you make your investment:

• Use funds with embedded losses or low potential capital gains exposures. Are there really quality funds that have little/no gains? Yes, and Mutual Fund Observer (MFO) is a great site to find these opportunities. The most likely situations are when an experienced manager opens his/her own shop or when one takes over a failing fund and makes it their own.
• Use funds with low turnover and with a long-term investment philosophy. Paying taxes on annual long-term capital gains is not pleasant; however, it is the short-term gains that are the real killer. Short-term gains are taxed at your ordinary income tax rates. Worse yet, short-term capital gains distributions are not offset by other types of capital losses, as these are reported on a completely different tax schedule. Fund managers who trade frequently might have attractive returns, but their returns have to be substantially higher than tax-efficient managers to offset the higher tax bite they are generating.
• Think about asset location. Putting your most tax-inefficient holdings in your tax-deferred accounts will help you avoid these issues. Funds that typically have significant taxable income, high turnover, or mostly short-term gains should be placed in your IRA, Roth IRA, etc. High yield funds, REIT funds and many alternative strategies are usually ideal funds to place in tax-deferred accounts.
• Use index funds or broad based indexed ETFs. I know MFO is not an index fund site, but it is clear that it is not easy to choose funds that beat comparable broad based, low cost index funds or ETFs. When taxes are added to the equation, the hurdle gets even higher. Using index-based holdings in taxable accounts and active fund managers in tax-deferred accounts can make for a great compromise.

I hope considering these strategies will leave you with a little more to spend on the holidays in 2015. Mark.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Polaris Global Value (PGVFX) Polaris sports one of the longer records among global stock funds, low expenses, excellent tax efficiency, dogged independence and excellent long term returns. Well, no wonder they have such a small fund!

RiverPark Structural Alpha (RSAFX) Structural Alpha starts with a simple premise: people are consistently willing to overpay in order to hedge their risks. That makes the business of selling insurance to them consistently profitable if you know what you’re doing and don’t get greedy. Justin and Jeremy have proven over the course of years that (1) they do and (2) they don’t, much to their investors’ gain. For folks disgusted with bonds and overexposed to stocks, it’s an interesting alternative.

ValueShares US Quantitative Value (QVAL) We don’t typically profile ETFs, but our colleague Charles Boccadoro has been in an extended conversation with Wesley Gray, chief architect of Alpha Architect, and he offers an extended profile with a wealth of unusual detail for this quant’s take on buying “the cheapest, highest quality value stocks.”

Conference call with Mitch Rubin, CIO and PM, RiverPark Large Growth Fund, December 17th, 7:00 Eastern

We’d be delighted if you’d join us on Wednesday, December 17^th, for a conversation with Mitch Rubin, chief investment officer for the RiverPark Funds. Over the past several years, the Observer has hosted a series of hour-long conference calls between remarkable investors and, well, you. The format’s always the same: you register to join the call. We share an 800-number with you and send you an emailed reminder on the day of the call. We divide our hour together roughly in thirds: in the first third, our guest talks with us, generally about his or her fund’s genesis and strategy. In the middle third I pose a series of questions, often those raised by readers. Here’s the cool part, in the final third you get to ask questions directly to our guest; none of this wimpy-wompy “you submit a written question in advance, which a fund rep rewords and reads blankly.” Nay nay. It’s your question, you ask it.

The stability of the Chinese economy has been on a lot of minds lately. Between the perennial risks of the unregulated shadow banking sector and speculation fueled by central bank policies to the prospect of a sudden crackdown on whatever the bureaucrats designate as “corruption,” the world’s second largest stock market – and second largest economy – has been excessively interesting.

Mr. Rubin and his fund have a fair amount of exposure to China. In the second week of December, he and his team will embark on a research trip to the region. They’ve agreed to speak with us about the trip and the positioning of his fund almost immediately after the jet lag has passed.

RiverPark’s president Morty Schaja is coordinating the call and offers this explanation from why you might want to join it.

Given the planned openings of new casinos and the expected completion of the bridge from Hong Kong to Macau, Mitch and his team believe that the current stock weakness presents an unusual opportunity for investors.

Generally speaking Mitch is excited about the opportunity for the Fund post a period of relative underperformance. This year many of the fund’s positions – relative to both the market and, more importantly, to their expected growth – are now as inexpensive as they have been in some time. The Fund is trading at a weighted average price-earnings ratio (PE) of about 13x 2016 earnings, a discount to the market as a whole. This valuation is, in Mitch’s view, especially compelling given that their holdings have demonstrated substantially faster earnings growth of 15-20% or more as compared with the 7% historical earnings growth for the market. Given these valuations and the team’s continued confidence in the long-term earnings growth of the companies, they believe the Fund is especially well positioned going into year end.

It will be an interesting opportunity to talk with Mitch about how he thinks about the vicissitudes of “relative performance” (three excellent years are being followed by one poor one) and shareholder twitchiness.

HOW CAN YOU JOIN IN?

If you’d like to join in, just click on register and you’ll be taken to the Chorus Call site. In exchange for your name and email, you’ll receive a toll-free number, a PIN and instructions on joining the call. If you register, I’ll send you a reminder email on the morning of the call.

Remember: registering for one call does not automatically register you for another. You need to click each separately. Likewise, registering for the conference call mailing list doesn’t register you for a call; it just lets you know when an opportunity comes up. 

WOULD AN ADDITIONAL HEADS UP HELP?

Over two hundred readers have signed up for a conference call mailing list. About a week ahead of each call, I write to everyone on the list to remind them of what might make the call special and how to register. If you’d like to be added to the conference call list, just drop me a line.

Funds in registration

There were remarkably few funds in registration with the SEC this month, just four and a half. That reflects, in part, the fact that advisers wanted to get new funds launched by December 30^th and the funds in registration now won’t be available until February. It might also reflect a loss of confidence within the fund industry, since it’s the lowest total we’ve recorded in nine years. That said, several of the new registrations will end up being solid and useful offerings: T. Rowe Price is launching a global high income bond fund and a global unconstrained bond fund while Vanguard will offer an ultra-short bond fund for the ultra-nervous. They’re all detailed on the Funds in Registration page.

Manager changes

This month also saw a modest level of manager turnover; 53 funds reported changes, the most immediately noticeable of which was Mr. George’s departure from various Royce funds. More-intriguing changes include the appointment of former Janus manager and founding partner of Arrowpoint Minyoung Sohn to manage Meridian Equity Income (MEIFX). At about the same time, Bernard Horn and Polaris Capital were appointed to manage Pear Tree Columbia Small Cap Fund (USBNX) which I assume will become Pear Tree Polaris Small Cap Fund on January 1. Polaris already subadvises Pear Tree Polaris Foreign Value Small Cap Fund (QUSOX / QUSIX) which has earned both five stars from Morningstar and a Great Owl designation from the Observer.

We know you’re communicating in new ways …

But why don’t you communicate in simple ones? It turns out that fund firms are, with varying degrees of conviction, invading the world of cat videos. A group called Corporate Insights maintains a series of Mutual Fund Monitor reports, the most recent of which is “Fund Films Go Viral: The Diverse Strategies of Fund Firms on YouTube.” They were kind enough to share a copy and a quick reading suggests that firms have a long way to go if they intend to use sites like YouTube to reach younger prospective investors. We’ll talk with the report’s authors in December and pass along what we learn.

In the meanwhile: all fund firms have immediate access to a simple technology that could dramatically increase the number of people noticing what you’ve written and published. And you’re not using it. Why is that?

Chip, our technical director and founding partner, has been looking at the possibility of aggregating interesting content from fund advisers and making it widely available.  The technology to acquire that content is called Real Simple Syndication, or RSS for short. At base the technology simply pushes your new content out to folks who’ve already expressed an interest in it; the Observer, for example, subscribes to the New York Times RSS feed for mutual funds. When they write it there, it pops up here.

Journalists, analysts, investors and advisers could all receive your analyses automatically, without needing to remember to visit your site, in their inboxes. And yet, Chip discovered, almost no one uses the feed (or, in at least one case, made a simple coding mistake that made their feed ineffective).

If you work with or for a fund company, would you let us know why? And if you don’t know, would you ask someone in web services?  In either case, drop Chip a note to let her know what’s up. We’d be happy to foster the common good by getting more people to notice high-quality independent shops, but we’d need your help. Thanks!

Briefly noted . . .

If you ever wondered I look like, you’re in luck. The Wall Street Journal ran a nice interview with me, entitled, “Mutual Funds’ Professor Can Flunk Them.” Embarrassed that the only professional pictures of me were from my high school graduation, I duped a very talented colleague into taking a new set, one of which appears in the Journal article. Pieces of the article, though not the radiant portrait, were picked up by Ben Carlson, at A Wealth of Common Sense; Cullen Roche, at Pragmatic Capitalism; and Joshua Brown, at The Reformed Broker.

A reader has requested that we share word of Seafarer‘s upcoming conference call. Here it is:

SMALL WINS FOR INVESTORS

DuPont Capital Emerging Markets Fund (DCMEX) reopened to new investors on December 1, 2014. It sports a $1 million minimum, $348 million portfolio and record that trails 96% of its peers over the past three years. On the upside, the fund appointed two additional managers in mid-October.

Guggenheim Alpha Opportunity Fund (SAOAX) reopens to new and existing investors on January 28^th. At the same time they’ll get a new long/short strategy and management team. Okay, I’m baffled. Here’s the fund’s performance under its current strategy and managers (blue line) versus long/short benchmark (orange line):

If you’d invested $10,000 in the average long/short fund on the day the SAOAX team came on board, your account would have grown by 25%. If you’d given your money to the SAOAX team, it would have grown by 122%. That’s rarely grounds for kicking the scoundrels out. Admittedly the fund has a minuscule asset base ($11 million after 11 years) but that seems like a reason to change the marketing team, doesn’t it?

As a guy who likes redemption fees since they benefit long-term fund holders at the expense of traders, I’m never sure of whether their elimination qualifies as a “small win” or a “small loss.” In the holiday spirit, we’ll classify the elimination of those fees from four Guinness Atkinson funds (Inflation-Managed Dividend, Global Innovators, Alternative Energy, Global Energy and Alternative Energy) as “wins.” After the New Year, though, we’re back to calling them losses.

Invesco European Small Company Fund (ESMAX) has reopened to existing investors though it remains closed to new ones. It’s the best open-end fund in its space, but then it’s almost the only open-end mutual fund in its space. Its two competitors are Royce European Smaller-Companies (RESNX) and DFA Continental Small Company (DFCSX). ESMAX handily outperforms either. There are a couple ETF alternatives to it, the best being WisdomTree Europe SmallCap Dividend ETF (DFE). DFE’s a bit more volatile but a lot cheaper (58 bps versus 146), available and has posted near-identical returns over the past five years.

Loomis Sayles gives new meaning to “grandfathered-in.” While several Loomis Sayles funds (notably Small Cap Growth and Small Cap Value) remain closed to new investors, as of November 19, 2014 they became available to Natixis employees … and to their grandparents. Also grandkids. Had I mentioned mothers-in-law? The institutional share classes of a half dozen funds are available to family members without a minimum investment requirement. Yes, indeed, if your wretched son-in-law (really, none of us have any idea of what your daughter saw in that ne’er do well) works for Natixis you can at least comfort yourself with your newly gained access to first-rate investment management.

Market Vectors lowered the expense cap on Market Vectors Investment Grade Floating Rate ETF (NYSE Arca: FLTR) from 0.19% to 0.14%. As the release discusses, FLTR is an interesting option for income investors looking to decrease interest rate sensitivity in their portfolios. The fund was recently recognized by Morningstar at the end of September with a 5-star overall rating. 

CLOSINGS (and related inconveniences)

None that I could find. I’m not sure what to make of the fact that the Dow has had 29 record closes through late November, and still advisers aren’t finding cause to close any funds. It might be that stock market records aren’t translating to fund flows, or it might be that advisers are seeing flows but are loathe to close the doors.

OLD WINE, NEW BOTTLES

Effective January 28, 2015, AQR is renaming … well, pretty much everything.

Current Name	New Name
AQR Core Equity	AQR Large Cap Multi-Style
AQR Small Cap Core Equity	AQR Small Cap Multi-Style
AQR International Core Equity	AQR International Multi-Style
AQR Emerging Core Equity	AQR Emerging Multi-Style
AQR Momentum	AQR Large Cap Momentum Style
AQR Small Cap Momentum	AQR Small Cap Momentum Style
AQR International Momentum	AQR International Momentum Style
AQR Emerging Momentum	AQR Emerging Momentum Style
AQR Tax-Managed Momentum	AQR TM Large Cap Momentum Style
AQR Tax-Managed Small Cap Momentum	AQR TM Small Cap Momentum Style
AQR Tax-Managed International Momentum	AQR TM International Momentum Style
AQR U.S. Defensive Equity	AQR Large Cap Defensive Style
AQR International Defensive Equity	AQR International Defensive Style
AQR Emerging Defensive Equity	AQR Emerging Defensive Style

The ticker symbols remain the same.

Effective December 19, 2014, a handful of BMO funds add the trendy “allocation” moniker to their names:

Current Name	Revised Name
BMO Diversified Income Fund	BMO Conservative Allocation Fund
BMO Moderate Balanced Fund	BMO Moderate Allocation Fund
BMO Growth Balanced Fund	BMO Balanced Allocation Fund
BMO Aggressive Allocation Fund	BMO Growth Allocation Fund

On January 14, 2015, Cloud Capital Strategic Large Cap Fund (CCILX) is becoming Cloud Capital Strategic All Cap Fund. It will be as strategic as ever, but now will be able to ply that strategy on firms with capitalizations down to $169 million.

Effective December 30, 2014, the name of the CMG Managed High Yield Fund (CHYOX) will be changed to CMG Tactical Bond Fund. And “high yield bond” will disappear from the mandate. Additionally, effective January 28, 2015, the Fund will no longer have a non-fundamental policy of investing at least 80% of its assets in fixed income securities.

Crystal Strategy Leveraged Alternative Fund has become the Crystal Strategy Absolute Return Plus Fund (CSLFX). That change occurred less than a year after launch but that fund has attracted only $5 million, which might be linked to high expenses (2.3%), a high sales load and losing money while their multi-alternative peers were making it. It’s another instance where “change the name” doesn’t seem to be the greatest imperative.

Deutsche International Fund (SUIAX) has changed its name to Deutsche CROCI® International Fund and Deutsche Equity Dividend (KDHAX) has become Deutsche CROCI® Equity Dividend Fund. Oddly the name change does not appear to be accompanied by any explanation of what’s up with the CROCI (cash return on capital invested??) thing. CROCI was part of Deutsche Bank’s research operation until late 2013.

Effective December 8, 2014, Guinness Atkinson Asia Pacific Dividend Fund (GAADX) will be renamed Guinness Atkinson Asia Pacific Dividend Builder Fund with this strategy clarification:

The Advisor uses fundamental analysis to assess a company’s ability to maintain consistent, real (after inflation) dividend growth. The Advisor seeks to invest in companies that have returned a real cash flow return on investment of at least 8% for each of the last eight years, and, in the opinion of the Advisor, are likely to grow their dividend over time.

At the same time, Guinness Atkinson Inflation Managed Dividend Fund (GAINX) becomes Guinness Atkinson Inflation Managed Dividend Builder Fund.

RESQ Absolute Income Fund has become the RESQ Strategic Income Fund (RQIAX). It now “seeks income with an emphasis on total return and capital preservation as a secondary objective.” “Capital appreciation” is out; “total return” is in. And again, the fund has been around for less than a year so changing the name and strategy doesn’t seem like evidence of patience and planning. Oh, too, RESQ Absolute Equity Fund is now RESQ Dynamic Allocation Fund (RQEAX). It appears to be heightening the visibility of international equities in the investment plan and adding popular words to the name.

Orion/Monetta Intermediate Bond Fund is now Varsity/Monetta Intermediate Bond Fund (MIBFX). Sorry, Orion, you’ve been chopped!

Effective November 12, 2014, Virtus Mid-Cap Value Fund became Virtus Contrarian Value Fund (FMIVX). By the end of January 2015, the principle investment strategy be tweaked but in reading the old and new text side-by-side, I couldn’t quite figure out what was changing. A performance chart of the fund suggests that it’s pretty much a mid-cap value index fund with slightly elevated volatility and noticeably elevated expenses.

OFF TO THE DUSTBIN OF HISTORY

Aberdeen Global Select Opportunities Fund (BJGQX), formerly Artio Select Opportunities, formerly Artio Global Equity, formerly Julius Baer Global Equity Fund, is disappearing. Either shareholders will approve a merger with Aberdeen Global Equity Fund or the trustees will liquidate it. Note from the Observer: vote for the merger. Global Equity has been a dramatically better fund.

AIS Tactical Asset Allocation Portfolio (TAPAX) has closed and will liquidate by December 15, 2014.

AllianceBernstein Global Value Fund (ABAGX) will liquidate and dissolve around January 16, 2015. Not to be picking on the decedent, but don’t “liquidate” and “dissolve” conjure the exact same image, sort of what happened to the witch in The Wizard of Oz?

In distinction to most such actions, the Board of Trustees of the ALPS ETF Trust ordered “an orderly liquidation” of the VelocityShares Emerging Markets DR ETF, VelocityShares Russia Select DR ETF and VelocityShares Emerging Asia DR ETF. All are now “former options.”

BMO Pyrford Global Strategic Return Fund (BPGAX) and BMO Global Natural Resources Fund (BAGNX) are both scheduled to be liquidated on December 23, 2014, perhaps part of an early Christmas present to their investors. BAGNX has, in six short months of existence, parlayed a $1,000 investment into an $820 portfolio, rather more dismal than even its average peer.

BTS Bond Asset Allocation Fund (BTSAX) will be merging into the BTS Tactical Fixed Income Fund (BTFAX) on December 12, 2014.

DSM Small-Mid Cap Growth Fund (DSMQX) will liquidate on December 2, 2014.

Eaton Vance Asian Small Companies Fund (EVASX) bites the dust on or about January 23, 2015. Despite the addition of How Teng Chiou as a co-manager in March (I’m fascinated by that name), the fund has drawn neither assets nor kudos.

Huntington Income Generation Fund (HIGAX) is another victim of poor planning, impatience and the redundant “dissolve and liquidate” fate. The fund launched in January 2014, performed miserably, for which reason the D&L is scheduled for December 19, 2014.

MassMutual Premier Focused International Fund was dissolved, liquidated and terminated, all on November 14^th. We’re not sure of the order of occurrence.

The 20 year old, $150 million Victory Special Value Fund (SSVSX) has merged into the two year old, $8 million Victory Dividend Growth Fund (VDGAX). Cynics would suggest an attempt to bury Special Value’s record of trailing 85% of its peers by merging into a tiny fund run by the same manager. We wouldn’t, of course. Only cynics would say that.

Virginia Equity Fund decided to liquidate before it launched. Here’s the official word: “the Fund’s investment adviser, recommended to the Board to approve the Plan based on the inability to raise sufficient capital necessary to commence operations. As a result, the Board of Trustees has concluded that it is in the best interest of the sole shareholder to liquidate the Fund.”

Wright Total Return Bond Fund (WTRBX) disappears at the same moment that 2014 does.

In Closing . . .

In November we picked up about 1500 new registrants for our monthly email notification. Greetings to you all and, especially, to the nice folks at Smart Chicken. Love your work! Welcome to one and all.

A number of readers deserve thanks for their support in the month just passed. And so to the amazing Madame Nadler: “thanks! We’re not going anywhere.” To the folks at Gaia Capital: cool logo, though I’m still not sure that “proactive” is a word. To Jason, Matt and Tyler: “thanks” are in the mail! (Soon, anyway.) For Jason and our other British readers, by the way, we are trying to extend the Amazon partnership to Amazon UK. Finally thanks, as always, to our two stalwart subscribers, Deb and Greg. Do let us know how we can make the beta version of the premium site better.

November also saw us pass the 30,000 “unique visitors” threshold for the first time. Thanks to you all, but dropping by and imagining possibilities smarter and better than behemoth funds and treacherous, trendy trading products.

Finally, I promise I won’t mention this again (in 2014): Frankly it would help a lot if folks who haven’t already done so would take a moment to bookmark our Amazon link. Our traffic has grown by almost 80% in the past 12 months and that extra traffic increases our operating expenses by a fair bit. At the same time our Amazon revenue for November grew by (get ready!) $1.48 from last year, a full one-third of one percent. While we’re grateful for the extra $1.48, it doesn’t quite cover the added hosting and mail expenses.

The Amazon thing is remarkably quick, painless and helpful. The short story is that Amazon will rebate to us an amount equivalent to about 6% of whatever you purchase through our Associates link. It costs you nothing, since it’s built into Amazon’s marketing budget. It adds no steps to your shopping. And it doesn’t require that you come to the Observer to use it. Just set it as a bookmark, use it as your homepage or use it as one of the opening tabs in your browser. Okay, here’s our link. Click on it then click on the star on the address bar of your browser – they all use the same symbol now to signal “make a bookmark!” If you want to Amazon as your homepage or use it as one of your opening tabs but don’t know how, just drop me a note with your browser’s name and we’ll send off a paragraph.

There are, in addition, way cool smaller retailers that we’ve come across but that you might not have heard of. The Observer has no financial stake in any of this stuff but I like sharing word of things that strike me as really first-rate.

Some guys wear ties rarely enough that they need to keep that little “how to tie a tie” diagram taped to their bathroom mirrors. Other guys really wish that they had a job where they wore ties rarely enough that they needed to keep that little “how to tie a tie” diagram taped up.

Duluth sells clothes, and accessories, for them. I own rather a lot of it. Their stuff is remarkably well-made and, more importantly, thoughtfully made. Their clothes are designed, for example, to allow a great deal of freedom of motion; they accomplish that by adding panels where other folks just have seams. Admittedly they cost more than department store stuff. Their sweatshirts, by way of example, are $45-50 when they’re not on sale. JCPenney claims that their sweatshirts are $55 but on perma-sale for $20 or so. The difference is that Duluth’s are substantially better: thicker fabric, longer cut, with thoughtful touches like expandable/stretchy side panels.

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QuoteArts.com is a small shop that consistently offers a bunch of the most attractive, best written greeting cards (and refrigerator magnets) that I’ve seen. Steve Metivier, who runs the site, shared one of his favorites:

The text reads “’tis not too late to seek a newer world.” The original cards are, of course, sharper and don’t have the copyright watermark. Steve writes that “we’ve found that a number of advisors and other professionals buy our cards to keep in touch with their clients throughout the year. So, we offer a volume discount of 100 or more cards. The details can be found on our specials page.”

We hope it’s a joyful holiday season for you all, and we look forward to seeing you in the New Year.

 

Dear friends,

It’s been that kind of month. Oh so very much that kind of month. In addition to teaching four classes and cheering Will on through 11 baseball games, I’ve spent much of the past six weeks buying a new (smaller, older but immaculate) house and beginning to set up a new household. It was a surprisingly draining experience, physically, psychologically and mentally. Happily I had the guidance and support of family and friends throughout, and I celebrated the end of April with 26 signatures, eight sets of initials, two attorneys, one large and one moderately-large check, and the arrival of a new set of keys and a new garage door clicker. All of which slightly derailed my focus on the world of funds. Fortunately the indefatigable Charles came to the rescue with …

The Existential Pleasures of Engineering Beta

Mebane Faber is a quant.

He is a student of financial markets, investor behavior, trend-following, and market bubbles. He pursues absolute return, value, and momentum strategies. And, he likes companies that deliver cash to shareholders.

He recognizes alpha is elusive, so instead focuses on engineering beta, which promises a more pragmatic and enduring reward.

In a field full of business majors and MBAs, he holds degrees in engineering and biology.

He distills a wealth of financial literature, research, and conditions into concise and actionable investing advice, shared through books, his blog, and lectures.

Given low-cost ETFs and mutual funds available today, he thinks people generally should no longer need to hire advisors, or “brokers back in the day,” at 1-2% fees to tell them how to allocate buy-and-hold portfolios. “It kind of borderlines on criminal,” he tells Michael Covel in a recent interview, since such advisors “do not do enough to justify their fees.”

He is a portfolio manager and CIO of Cambria Investment Management, L.P., which he co-founded along with Eric Richardson in 2006. It is located in El Segundo, CA.

His down-to-earth demeanor is at once confident and refreshingly approachable. He cites philosopher Henry David Thoreau: “There is no more fatal blunderer than he who consumes the greater part of his life getting his living.”

The Paper. Mebane (pronounced “meb-inn”) started his career as biotech equity analyst during the genome revolution and internet bubble. While at University of Virginia, he attended an advanced seminar in security analysis taught by the renowned hedge fund manager John Griffin of Blue Ridge Capital. In fulfillment of the Chartered Market Technician program, Mebane drafted a paper that became the basis for “A Quantitative Approach To Tactical Asset Allocation,” published in the Journal of Wealth Management in 2007.

The paper originally included the words “market timing,” but he soon discovered that to a lot of people, the phrase comes with “enormous emotional baggage” and “can immediately shut-down all synapses in their brains.” Similar to Ed Thorp’s experience with his first academic paper on winning at blackjack, Mebane had to change the title to get it published. (It continues to stimulate synapses, as discussed in David’s July 2013 commentary, “Timing Method Performance Over Ten Decades” and periodically on the MFO discussion board.)

He attributes the paper’s ultimate popularity to 1) its simple presentation and explanation of the compelling results, and 2) the fortuitous timing of the publication itself – just before the financial meltdown of 2008/9. Practitioners of the method during that period were rewarded with a maximum drawdown of only -2% through versus -51% for the S&P 500.

The Books. There are three. All insightful, concise, and well-received:

• The first published by Wiley in 2009, entitled “The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets.”
• The second, self-published in 2013, entitled “Shareholder Yield: A Better Approach to Dividend Investing.”
• The third, also self-published and just released, “Global Value: How to Spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock Market.”

As summarized above, each contains straight-forward strategies that investors can follow on their own using publically available information. That said, each also forms the basis of ETFs launched by Cambria Investment Management.

The First Fund. Last December, Mebane tweeted “Diversification was deworseification in 2013.” To understand what he meant, just compare US stock return against just about all other asset classes – it trounced them. Several all-asset strategies have underperformed during the current bull market, as seen in the comparison below, including AdvisorShares Cambria Global Tactical ETF Fund (GTAA). GTAA was Cambria’s first ETF, launched in November 2010, as a sub-advisor through ETF house AdvisorShares, and based on the strategy outlined in “The Ivy Portfolio.”

If it helps, Mebane is in good company. Rob Arnott’s all asset and John Hussman’s total return strategies have not received much love lately either. In fact, since GTAA’s inception, the “generic” all-asset allocation of US stocks, foreign stocks, bonds, REITs, and broad commodities has underperformed US equity index by 40% and traditional 60/40 balanced index by 15%.

GTAA’s actual portfolio currently shows more than 50 holdings, virtually all ETFs. Looking back, the fund has held substantial cash at times, approaching 40% in mid-2013…”assuming a defensive posture and utilizing cash as an alternative to its long positions.”

Market volatility has likely hurt GTAA as well. Its timing strategy, shown to thrive in trending markets, can struggle with short-term gyrations, which have been present in commodity, foreign equity, and real estate markets during this time. Finally, AdvisorShares’ high expense ratio, even after waivers, only adds to the headwind. At the 3.5-year mark, GTAA remains at $36M assets under management (AUM).

The New Funds. Cambria has since launched three other ETFs, based on the strategies outlined in Mebane’s two new books, but this time the funds were kept in-house to have “control over the process and charge reasonable fees.” Each fund invests in some 100 companies with capitalizations over $200M. And, each has quickly attracted AUM, rather remarkably given the proliferation of ETFs today. They are:

GVAL is the newest and actually tracks to a Cambria-developed index, maintained daily. It focuses on companies that trade 1) below their assessed intrinsic value, and 2) in countries with the most undervalued markets determined by parameters like CAPE, as depicted in earlier figure. These days, Mebane believes that means outside the US. “We certainly don’t think the [US] market is in a bubble, rather, valuations will be a headwind. There are much better opportunities abroad.”

SYLD is actively managed and focuses primarily on US companies that exhibit strong characteristics of returning free cash flow to their shareholders; specifically, “shareholder yield,” which comprises dividend payments, share buybacks, and debt pay-down. FYLD seeks the same types of companies, but in developed foreign countries and it passively tracks to Cambria’s FYLD index.

Mebane believes that these are the first ETFs to incorporate the shareholder yield strategy. And, based on their reception in the crowded ETF market, he seems pretty pleased: “I certainly think alpha is possible…lots of jargon across smart beta, alpha, etc., but beating a market cap index is a great first step.” Morningstar’s Samuel Lee noted them among best new ETFs of 2013. Approaching its first year, SYLD is certainly off to a strong start:

Interestingly, none of these three ETFs employ explicit draw-down control or trend-following, like GTAA, although GVAL does “start moving to cash if markets don’t pass an absolute valuation filter … no sense in buying what is cheapest when everything is expensive,” Mebane explains. SYLD too has the discretion to take the entire portfolio to “Temporary Defensive Positions.”

When asked if his approach to risk management is changing, given the incorporation of more traditional strategies, he asserts that he’s “still a firm believer in trend-following and future funds will have trend components.” (Other funds in pipeline at Cambria include Global Momentum ETF and Value and Momentum ETF).

Mebane remains one of the largest shareholders on record among the portfolio managers at AdvisorShares. His overall skin-in-the-game? “100% of my investable net worth is in our funds and strategies.”

The Blog. mebfaber.com (aka “World Beta”) started in November 2006. It is a pleasant blend of perspective, opinion, results from his and other’s research – quantitative and factual, images, and references. He shares generously on both personal and professional levels, like in the recent posts “My Investing Mentor” and “How to Start an ETF.”

There is a great reading list and blogroll. There are sources for data, references, and research papers. It’s free, with occasional plugs, but no annoying pop-ups. For the more serious investors, fund managers, and institutions, he offers a premium subscription to “The Idea Farm.”

He once wrote actively for SeekingAlpha, but stopped in 2010, explaining: “I find the quality control of the site is poor, and the respect for authors to be low. Also, [it] becomes a compliance risk and headache.”

He strikes me as having the enviable ability to absorb enormous about of information, from past lessons to today’s water-hose of publications, blogs, tweets, and op-eds, then distill it all down to chart a way forward. Asked whether this comes naturally or does he use a process, he laughs: “I would say it comes unnaturally and painfully!”

29Apr14/Charles

It Costs How Much?

by Edward Studzinski

A democracy is a government in the hands of men of low birth, no property, and vulgar entitlements.

Aristotle

One of the responses I received to last month’s diatribe about mutual fund fees was that the average mutual fund investor did not object to them because they were unseen. They painlessly and invisibly disappeared every quarter. The person who pointed this out noted that lawyers charged a bill for services rendered, as did accountants. Why then, should not a quarterly mutual fund statement show the gross amount invested at the beginning of the period, the investment appreciation or depreciation, and then the deduction of fees to arrive at a net amount invested at the end of the period ? Not a bad idea. But one that has been resisted (or gutted) at every turn by the industry and one that the regulators have never felt strongly enough to move forward on.

But do clients truly understand what they are giving up or what they are actually paying? Charlie Ellis, in an article in the current issue of the Financial Analysts Journal would argue that they do not. He goes on to make the case that the enormity of the fees as a percentage makes the 2% and 20% that many hedge funds charge seem reasonable in comparison. His rationale is thus. Assume an S&P 500 Index Fund achieves in a year a total return of 36% and charges investment management fees of 5 basis points (0.05%). Assume your other investment is Mick the Bookie’s Select Investment Fund which had a total return of 41% over the same period and charges 85 basis points (0.85%). Your incremental return is 500 basis points (5%) for which you paid an extra 80 basis points (0.80%). Ellis would argue, and I believe correctly so, that your incremental fee for achieving that excess return was SIXTEEN PER CENT. And don’t forget that the money that went into the account to begin with was already your money that you had earned.

So, one question that I hear coming is – the outside trustees or directors have to approve fees annually and they wouldn’t do it if it was not fair and reasonable, especially given the returns. Answer #1 – eighty per cent of the time the active manager does not beat the benchmark and achieve an excess return. Answer #2 – the 20% of the time when the active manager beats the return, it is not on a sustainable basis, but rather almost random. Answer #3 – rarely does the investor actually get a benchmark beating return because he or she moves their investments too frequently to even achieve the performance numbers advertised by the investment management firm. Answer #4 – all too rarely do the outside trustees or directors have an aligned vested interest in the fee question (a) because in most instances they have at best a de minimis investment in the fund or funds that they are overseeing and (b) oddly enough the outside trustees or directors often have more of a vested interest in the success of the investment management company. Growth and profitability there will lead to increases in their fees.

So you say, I must be getting something of value for the incremental fees at those times when the investment returns don’t justify the added expense? Well, sadly, if recent history is any guide, the kinds of things you have gotten for such excess incremental fees include things like vicarious interests in yachts and sports cars; race horses in Lexington, Kentucky; and multiple homes and pent houses on the lake front in the greater Chicago area. I could go on and on in a similar vein. Rather than outperforming benchmarks or making money for investors, the primary goal has morphed to the creation and accumulation of substantial personal wealth, often to the tune of hundreds of millions of dollars.

To paraphrase Don Corleone in that scene in New York City where he says to the heads of the Five Families, “How did we let things go so far?” I don’t have a good answer for that. I suspect that the painlessness of fee extraction explains part of it. Having had the present administration in Washington serving in the role of defender of Middle Class America, one has to wonder why they have allowed the savings and investments of the Middle Class to effectively be clipped by dollars and cents every month. What has happened is one of the great hidden wealth transfers in our society, similar to what happens when hackers get into a bank computer and start skimming fractions of cents from millions of transactions. It is not solely the administration’s fault however, as neither the regulators nor the courts have wanted to clean up the fee mess. Everyone really wants to believe that there is a Santa Claus, or more appropriately, a Horatio Alger ending to the story.

One might hope that financial publications such as Morningstar, would through their media outlets as well as their conferences, address the subject of fees and their excessive nature. Certainly when they first started with their primary conference at the Grand Hyatt at Illinois Center in Chicago, there was a decided tilt to the content and substance that favored and indeed championed the small investor. However, since then in terms of content the current big Morningstar conference here has taken on more of an industry tilt or bias.

Why do I keep harping on this subject? For this reason – mutual fund investors cannot negotiate their own fees. Institutional investors can, and corporate and endowment investors do just that, every day. And often, their fee agreements with the investment manager will have a “most favored nation” clause, which means if someone else in the institutional world with a similar amount of assets negotiates a lower fee agreement with that investment firm the existing clients get the benefit of it. If you sit in enough presentations from fund managers, it becomes obvious that, public industry statements notwithstanding, in many instances the mutual fund business (and the small investor) is being used as the cash cow that subsidizes the institutional business.

Remember, expenses matter as they lessen the compounding ability of your investment. That in turn keeps the investment from growing as much as it should have over a period of time. With interest rates and tax rates where they are, it is hard enough to compound at a required rate to meet future accumulation targets without having even further degradation occur from the impact of high fees. Rule Number One of investing is “Don’t lose money” and Rule Number Two is “Don’t forget Rule Number One.” However, Rule Number Three is “Keep the expenses low to maximize the compounding effect.”

From Russia, with Love

While journalist Brett Arends bravely offered to explain “Why I’m going to invest in the Russian stock market” – roughly, Russian stocks are cheap and Putin couldn’t be that crazy, right? – a whole series of Russia-oriented funds have amended their statements of principal risks to include potential financial warfare:

SSgA Emerging Markets (SSEMX)

In response to recent political and military actions undertaken by Russia, the United States and European Union have instituted numerous sanctions against certain Russian officials and Bank Rossiya. These sanctions, and other intergovernmental actions that may be undertaken against Russia in the future, may result in the devaluation of Russian currency, a downgrade in the country’s credit rating, and a decline in the value and liquidity of Russian stocks. These sanctions could result in the immediate freeze of Russian securities, impairing the ability of the Fund to buy, sell, receive or deliver those securities. Retaliatory action by the Russian government could involve the seizure of U.S. and/or European residents’ assets and any such actions are likely to impair the value and liquidity of such assets. Any or all of these potential results could push Russia’s economy into a recession. These sanctions, and the continued disruption of the Russian economy, could have a negative effect on the performance of funds that have significant exposure to Russia, including the Fund.

SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF (EMCD) uses the same language, apparently someone was sharing drafts.

iShares MSCI Russia Capped ETF (ERUS) posits similar concerns:

The United States and the European Union have imposed economic sanctions on certain Russian individuals and a financial institution. The United States or the European Union could also institute broader sanctions on Russia. These sanctions, or even the threat of further sanctions, may result in the decline of the value and liquidity of Russian securities, a weakening of the ruble or other adverse consequences to the Russian economy. These sanctions could also result in the immediate freeze of Russian securities, impairing the ability of the Fund to buy, sell, receive or deliver those securities. Sanctions could also result in Russia taking counter measures or retaliatory actions which may further impair the value and liquidity of Russian securities.

ING Russia Fund (LETRX) adds the prospect that they might not be able to honor redemption requests:

… the sanctions may require the Fund to freeze its existing investments in Russian companies, prohibiting the Fund from selling or otherwise transacting in these investments. This could impact the Fund’s ability to sell securities or other financial instruments as needed to meet shareholder redemptions. The Fund could seek to suspend redemptions in the event that an emergency exists in which it is not reasonably practicable for the Fund to dispose of its securities or to determine the value of its net assets.

I’ve continued my regular investments in two diversified emerging markets funds whose managers have earned my trust: Andrew Foster at Seafarer Overseas Growth & Income (SFGIX) and Robert Gardiner at Grandeur Peak Emerging Markets Opportunities (GPEOX). I don’t think I have nearly the expertise needed to run toward that particular fire, nor to know when it’s gotten too hot. I wish Mr. Arends well, but would advise others to consider finding a manager whose experience and judgment is tested and true.

Here’s my rule of thumb: Avoid rules of thumb at all costs

The folks on our discussion board have posted links to two “rule of thumb” articles about investing. Just a quick word on why they’re horrifying.

Rule One: You need to invest $82.28 a day! 

The story comes from USA Today, by way of Lifehacker. “Want to live well in old age? You’d better get cracking: $82.28 a day to be exact.”

That’s $29,000 a year. Cool! That’s just $1000 more than the average per capita income in the US! In fairness, though, it’s just 54% of the median family income: $53,046. So here’s the advice: if you’re living paycheck-to-paycheck, remember to set aside 54% of your income. BankRate.com, by the way, advises you to invest 10%. Why 10%? Presumably because it’s a nice round number.

Rule Two: Your age should be your bond allocation!

More of the same: where to put it? Your bond allocation should be equal to your age, which Lifehacker shares from Bankrate.com. But why is this a good rule of thumb? Like “remember to drink eight glasses of water each day,” it’s catchy and memorable but I’ve seen no research that validates it.

Forbes magazine places it #1 on its list of “10 Terrible Pieces of Investment Advice.” Fund companies flatly reject it in their own retirement planning products. The target-date 2030 funds are designed for folks about 50; that is, people who might retire in 15 years or so. If this advice were sound, some or all of those funds would have 50% in bonds. They don’t. T. Rowe Price Retirement 2030 is 16% bonds, American Funds is 10%, Fidelity is 12%, TIAA-CREF is 21% and Vanguard 20%. JPMorgan (23%) and BlackRock (30-33%) seem to represent the high end.

Especially at the end of a three decade bull market in bonds, we owe it to ourselves and our readers to be particularly thoughtful about quick ‘n’ easy advice.

I’m sorry, they paid Gabelli what?

The folks are MFWire did a nice, nearly snarky story on The Mario’s most recent payday. (I’m Sorry, They Paid Gabelli What?). I’ll share the intro and suggest that you read one of the two linked stories:

Mario Gabelli made $85 million in salary in 2013.

That’s one eighth the global domestic product of Somoa.

According to USA Today, the GAMCO founder, chief executive and investment officer was paid not only $85 million last year, but his three-year total compensation came to over $215 million.

No wonder he looks like that.

Morningstar Goes on Autopilot

On April 23^rd, Morningstar’s Five-Star Investor feature trumpeted “9 Core Funds That Beat the Market,” which they might reasonably have subtitled “Small funds need not apply.”

Morningstar highlights nine funds in the article, with assets up to $101 billion. Those are drawn from a list of 28 that made the cut. Of those 28, one has under a billion in assets.

The key to making the cut: Morningstar must designate it a “core” fund, a category for which there are no hard-and-fast rules. They’re generally large cap and generally diversified, but also fairly large. There’s only one free-standing fund with under $250 million in assets that they think of as “core.”

There are a lot of “core” funds under $250 million but that occurs only when they’re part of a target-date suite: Fidelity Retirement 2090 might have only $12 in it but it becomes “core” because the whole Fido series is core.

Morningstar’s implied judgments (“we don’t trust anyone over 30 or with under a billion in assets”) might be fair, but would be fairer if more explicit.

They followed that up with a list of 4 Medalist Ideas for Long-Short Strategies.”Some of the funds we like in this area are Robeco Boston Partners Long/Short Equity, Robeco Boston Partners Research Fund, MainStay Marketfield, and Wasatch Long/Short.”

I’d describe those as Long-Closed, Recently-Closed, Bloated (they had $1 billion three years ago and $21 billion today; trailing 12 month performance is exactly mediocre which might be a blip or might be the effects of the $11 billion they picked up last year) and Very Solid, respectively.

Russel Kinnel finished the month by asking “How Bloated is your Fund?” He calculates a “bloat ratio” which “tries to find out how much a fund trades and how liquid its holdings are. It multiplies turnover by the average day’s trading volume of a fund’s holdings (asset-weighted).” At base, Russel’s assumption is that the only cost of bloat is a loss of the ability to trade quickly in and out of stocks.

With due respect, that seems silly. As assets grow, fund managers necessarily target the sorts of stocks that they can trade and begin avoiding the ones that they can’t. If your fund’s size constrains you to invest mostly in stocks worth $10 billion or more (the upper end of the mid-cap range), your investable universe is just 420 stocks. You may trade those 420 effectively, but you’re not longer capable of benefiting from the 6360 stocks at below $10 billion.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Martin Focused Value (MFVRX): it’s easy for us to get stodgy as we age; to become sure that whatever we did back then is quite exactly what we should be doing today. Frank Martin, who has been doing this stuff for 40 years, could certainly be excused if he did stick with the tried and true. But he hasn’t. There’s clear evidence that this absolute value equity investor has been grappling with new ideas and new evidence, and they’ve led him to construct his portfolio around the notion of “an antifragile dumbbell” (with insights credited to Nassim Talib). His argument, as much as his fund, are worth your attention.

Conference Call Upcoming

We’re toying with the possibility of talking with Dr. Ian Mortimer (Oxford, no less) and Matt Page of Guinness Atkinson Global Innovators (IWIRX), which targets investments in firms that are demonstrably engaged in creative thinking and are demonstrably beginning from it. They appear to be the single best performer in Lipper’s global growth category and we know from our work on Guinness Atkinson Inflation-Managed Dividend (GAINX) that they’re awfully bright and articulate. Both of their funds have small asset bases, distinctive and rigorous disciplines and splendid performance. The hang-up is the time difference between here and London; our normal nighttime slot (7:00 Eastern) would be midnight for them. Hmmm … we’ll work on it.

Launch Alert

It says something regrettable about the industry that Morningstar reports 156 new funds since mid-March, of which 153 are new share classes of older funds, one is Artisan Global High Income (ARTFX) and two aren’t terribly interesting. We’ll keep looking… Found another worth noting, just launched 4/28: Whitebox Tactical Income (WBIVX/WBINX).

Funds in Registration

Funds currently in registration with the SEC will generally be available for purchase around the end of June, 2014. Our dauntless research associate David Welsch tracked down 17 new no-load funds in registration this month. There are several intriguing possibilities:

Catalyst added substantially to their collection of quirky funds (uhhh … Small Cap Insider Buying (CTVAX) might be a decent example) with the registration of five more funds, of which three (Catalyst Absolute Total Return, Catalyst/Stone Beach Income Opportunity and Catalyst/Groesbeck Aggressive Growth Funds) will be sub-advised by folks with strong documented performance records.

LSV GLOBAL Managed Volatility Fund will follow the recent vogue for investing in low-volatility stocks. The fund gains credibility from the pedigree of its managers (“L” is a particularly renowned academic who was one of the path-breaking researchers in behavioral finance) and by the strength of the other four LSV funds (all three of the rated funds have earned four stars, though tend toward high volatility).

North Star Bond Fund will invest primarily in the bonds, convertible securities and (potentially) equities issued by small cap companies. I’m not sure that I know of any other fund with that specialization. The management team includes North Star’s microcap and opportunistic equity managers. Their equity funds have had very solid performance in not-quite three years of operation (though I’m a bit puzzled by Morningstar’s assignment of the North Star Opportunity fund to the “aggressive allocation” category given its high stock exposure). In any case, this strikes me as an interesting idea and we’re apt to follow up in the months after launch.

All of the new registrants are available on the May Funds in Registration page.

Manager Changes

On a related note, we also tracked down 52 sets of fund manager changes. The most intriguing of those include the exit of Stephen and Samuel Lieber, Alpine Woods founders and Alpine Small Cap’s founding managers, from Alpine Small Cap (ADIAX) and Chuck McQuaid’s long-anticipated departure from Columbia Acorn (ACRNX).

Active share updates

“Active share” is a measure of the degree to which a fund’s portfolio differs from what’s in its benchmark index. Researchers have found that active share is an important predictor of a fund’s future performance. Highly active fund are more like to outperform their benchmarks than are index funds (which should never outperform the index itself) or “closet index” funds which charge for active management but really only play around the edges of an indexed portfolio.

In March, we began publishing a list of active share data for as many funds as we could. And the same time, we asked folks to share data for any funds that we’d missed. We’re maintaining a master list of all funds, which you can get to by clicking on our Resources tab:

Each month we try to update our list with new funds submitted by our readers. This month folks shared seven more data reports:

Fund	Ticker	Active share	Benchmark	Stocks
LG Masters International	MSILX	89.9	MSCI EAFE	90
LG Masters Smaller Companies	MSSFX	98.2	Russell 2000	52
LG Masters Equity	MSEFX	84.2%	Russell 3000	85
Third Avenue Value	TAVFX	98.1	MSCI World	37
Third Avenue International Value	TAVIX	97.0	MSCI World ex US	34
Third Avenue Small Cap Value	TASCX	94.3	Russell 2000 Value	37
Third Avenue Real Estate	TAREX	91.1	FTSE EPRA/NAREIT Developed	31

Thanks to jlev, one of the members of the Observer’s discussion community and Mike P from Litman Gregory for sharing these leads with us. Couldn’t do it without you!

The return of Jonathan Clements

Jonathan Clements had an interesting valedictory column when he left The Wall Street Journal. He said he had about three messages for his readers and he’d repackaged them into 1008 columns: “Forget spending more money at the mall — and instead spend more time with friends. Your bank account may still be skimpy, but your life will be far, far richer.”

Apparently he’s found either a fourth message to share, or renewed passion for the first three, because he returned to the Journal in April. Oddly, his work appears only on Sundays and only online; he doesn’t even use a Dow Jones email address. When I asked him about the plan, he noted:

I didn’t want a fulltime position with the WSJ again, at least not at this juncture. The column gives a little variety to my week. But most of my time is currently devoted to a new personal-finance book. The book is a huge undertaking, and it wouldn’t be possible if I was fulltime at the WSJ.

He’s written several really solid columns (on the importance of saving even in a zero-interest environment and on the role of dividend funds in a retirement portfolio) and has a useful website that shares personal finance resources and works to dispel the rumor that he’s an accomplished writer of erotica. (Really.)

On whole, I’m glad he’s back.

MFO in the news!

Indeed

The English-language version of the article by Javier Espinosa, “Travel Guide: Do Acronyms Aid ‘Emerging’ Investing?” ran on April 7^th but lacked the panache of the Malay version.

MFO on the road

For those of you interested in dropping by and saying “hi,” we’ll be present at a couple conferences this summer.

 

I’ve been asked to provide the keynote address at the Cohen Client Conference, August 20 – 21, 2014. The conference, in Milwaukee, is run by Cohen Fund Audit Services. This will be Cohen’s third annual client conference. Last year’s version, in Cleveland OH, drew about 100 clients from 23 states.

Cohen offers the conference as a way of helping fund professionals – directors, compliance officers, tax and accounting guys, operating officers and the occasional curious hedge fund manager –develop both professional competence and connections within the fund community. Which is to say, the Cohen folks promised that there would be both serious engagement – staff presentations, panels by industry experts, audience interaction – and opportunities for fellowshipping. (My first, unworthy impulse is to drive a bunch of compliance officers over to Horny Goat Brewing, buy a round or two, then get them to admit that they’re making stuff up as they go.)

The good and serious folks at Cohen want to offer fund professionals help with fund operations, accounting, governance, tax, legal and compliance updates, and sales, marketing and distribution best practices.

And they want me to say something interesting and useful for 45 minutes or so. Hmmm … so here’s a request for assistance. Many of you folks work in the industry (I don’t) and all of you know the sorts of stuff I talk about. What do you think I could say that would most help someone trying to be a good fund trustee or operations professional? Drop me a line through this link, please!

For more information about the conference itself, you can contact

Chris Bellamy, 216-649-1701 or [email protected] or

Megan Howell, 216-774-1145 or [email protected].

They’d love to hear from you. So would I.

We’ll also spend three full days in and around the Morningstar Investment Conference, June 18 – 20, in Chicago. We try to divide our time there into thirds: interviewing fund managers and talking to fund reps, listening to presentations by famous guys, and building our network of connections by spending time with readers, friends and colleagues. If you’d like to connect with us somewhere in the bowels of McCormick Place, just let me know.

Briefly Noted . . .

Interesting developments in the neighborhood of Gator Focus Fund and Gator Opportunities Fund. At the end of February, Brad W. Olecki and Michael Parks resigned from their positions as Trustees of the Trust. No new Trustees have been appointed. On the same date Andres Sandate resigned from his position as President, Secretary and Treasurer of the Trust.

Do recall that, for reasons that continue to elude me, ING Funds have been rebranded as Voya Funds.

LS Opportunity Fund (LSOFX) just reclassified itself from “diversified” to “non-diversified.” It’s not clear why or what effect that will have on its 100 stock portfolio.

SMALL WINS FOR INVESTORS

IMS Capital Management is reorganizing three of its funds (IMS Capital Value,Strategic Income Fund, and Dividend Growth funds) into a new series of the 360 funds. I’m guessing they’ll be rebranded and the advisor is guessing that the reorganization will result in lower administration, fund accounting and transfer agency costs.” With luck, those savings will be passed along to investors.

Effective immediately, the Leader Total Return Fund (LCTRX) has discontinued the redemption fee.

Vanguard has decreased, generally by one basis point, the expense ratios on seven of its ETFs include Vanguard Total Bond Market ETF (BND), Vanguard FTSE Developed Markets ETF (VEA), Vanguard Value ETF (VTV), Vanguard Growth ETF (VUG), Vanguard Small-Cap ETF (VB) and a couple others

CLOSINGS (and related inconveniences)

First Eagle Overseas Fund (SGOVX) will close to new investors on May 9, 2014. Good fund but with $15 billion in AUM, its best days might be in the past.

Grandeur Peak Global Reach (GPROX) closed on April 30^th. That closure was the subject of our first mid-month alert to readers, which we sent to 4800 of you about 10 days before the closure was effective. We heard back from four readers who said that the information was useful to them. My hope is that we didn’t overly annoy the other 99.9% of recipients.

On May 9, 2014, the Wasatch Frontier Emerging Small Countries Fund (WAFMX) will close to new investors. Wasatch avers that it “takes fund capacity very seriously. We monitor assets in each of our funds carefully and commit to shareholders to close funds before asset levels rise to a point that would alter our intended investment strategy.” At $1.2 billion with investments in Nigeria, Kuwait and Kenya, it seems like a prudent move for a fund with top decile returns. (Thanks to JimJ on the Observer’s discussion board for timely notice of the closing.)

OLD WINE, NEW BOTTLES

Bridgehampton Value Strategies Fund (BVSFX) is being rebranded as the Tocqueville Alternative Strategies Fund. Same management and a “substantially similar” strategy but lower expenses for investors. The change becomes effective on June 27, 2014. Looks like a pretty decent fund.

The Board of John Hancock Rainier Growth Fund decided to axe Rainier and hire Baillie Gifford to manage it. As of mid-April, it was rechristened as JHancock Select Growth Fund (RGROX).

 Neuberger Berman Dynamic Real Return Fund (NDRAX) becomes Neuberger Berman Inflation Navigator Fund on June 2.

Hansberger International Growth Fund is being reorganized into the Madison Fund.

On June 2, 2014, Neuberger Berman International Select Fund changed its name from Neuberger Berman International Large Cap Fund. Two year record, slightly below-average returns and absolutely no investor interest.

Neuberger Berman Emerging Markets Income Fund’s name has changed to Neuberger Berman Emerging Markets Debt Fund.

Effective on May 1, 2014, Parnassus Equity Income Fund (PRBLX) became Parnassus Core Equity Fund while Parnassus Workplace Fund (PARWX) became Parnassus Endeavor. There were no changes to management, strategy or fees.

Effective December 29, 2014, the T. Rowe Price Retirement Income Fund (TRRIX) will change its name to the T. Rowe Price Retirement Balanced Fund. It’s a really solid fund but with 40% of its portfolio in equities, it’s probably not what most folks think of as a “retirement income” fund.

OFF TO THE DUSTBIN OF HISTORY

Ever wonder why it’s “The Dustbin of History”? It’s Leon Trotsky’s dismissal of the Menshevik revolutionaries, who he saw as failed agents: “You are pitiful, isolated individuals. You are bankrupts; your role is played out. Go where you belong from now on – in the dustbin of history!” It was in Russian, of course, so translations vary (occasional “the trash heap of history”) but the spirit is there.

CMG SR Tactical Bond Fund (CMGTX/CMGOX) liquidated on April 29, 2014. Nope, I’d never heard of it either.

The Board of Directors of Nomura Partners Funds approved the merger of The Japan Fund (NPJAX) into Matthews Japan (MJFOX), effective in late July, 2014. Japan Fund has sort of bounced from adviser to adviser over the years and is more the victim of Nomura’s decision to get out of the U.S. fund business than of crippling incompetence. The investors are getting a stronger fund with lower expenses, with the merger boosting MJFOX’s size by about 30%.

Morgan Stanley Institutional Total Emerging Markets Portfolio (MTEPX) will liquidate on May 30, 2014.

Principal intends to merge Principal Large Cap Value Fund I (PVUAX) into the Large Cap Value Fund III (PESAX). Shareholders are scheduled to rubbersta vote on the proposal at the end of May. Neither fund is particularly attractive, but the dying fund actually has the stronger record of the two.

On April 17, 2014, Turner’s Board of Trustees decided ed to close and liquidate the Turner Market Neutral Fund (TMNFX) on or about June 1, 2014. Three stars but also $3 million in assets. Sadly the performance was decent and steadily improving.

Vanguard continues with its surprising shakeup. It has decided to merge Vanguard Tax-Managed Growth and Income Fund (VTMIX) into Vanguard 500 Index Fund (VFISX) on about May 16, 2014. Why surprising? VTMIX has over $3 billion in assets, 0.08% expenses, a “Gold” analyst rating and four stars, which are not usually characteristics associated with descendent funds. Vanguard is looking to lower investor expenses (by about three basis points in this case) and simplify their line-up. On an after-tax basis, it looks like investors will gain two basis points in returns.

World Commodity Fund (WCOMX) has closed and will liquidate on May 26, 2014. It’s got rather less than a million in the portfolio and has, over the course of its seven-and-a-half year life, managed to turn a $10,000 initial investment into $10,120 which averages out to rather less than 0.10% per year. That saddest part? That’s not nearly the worst record, at least over the past five years, in either the “natural resources equity” or “broad commodities” groups.

 

In Closing . . .

Thanks to folks who’ve been supporting MFO financially, with a special tip of the cap to Capt. Neel (thank you, sir) and the Right Reverend Rick (I’m guided here by Luke: “In every way and everywhere we accept this with all gratitude”).

Especially for the benefit of the 6000 first-time readers we see each month, if you’re inclined to support the Observer, the easiest way is to use the Observer’s Amazon link. The system is simple, automatic, and painless. We receive an amount equivalent to about 7% of the value of almost anything you purchase through our Amazon link (used books, Kindle downloads, groceries, sunscreen, power tools, pool toys …). You might choose to set it as a bookmark or, in my case, you might choose to have one of your tabs open in Amazon whenever you launch your browser. Some purchases generate a dime, some generate $10-12 and all help keep the lights on!

June: the month for income. With the return of summer turbulence and Janet Yellen’s insistent dovishness about rates, we thought we’d take some time to look at four new funds that promise high income and managed volatility:

Artisan High Income (ARTFX) run by former Ivy High Income manager Bryan Krug. The fund has drawn $76 million in its first six weeks.

Dodge & Cox Global Bond, which went live on May 1.

RiverNorth Oaktree High Income (RNOTX), which combines RiverNorth’s distinctive CEF strategy with Oaktree’s first-rate institutional income one.

(maybe) West Shore Real Asset Income (AWSFX) which combines an equity-oriented income strategy with substantial exposure to alternative investments. We’ve had a couple readers ask, and we’ve been trying to learn enough to earn an opinion but it’s a bit challenging.

We’ve also scheduled a conversation with the folks at Arrowpoint, adviser to the new Meridian Small Cap Growth Fund (MSGAX) which is run by former Janus Triton managers Brian Schaub and Chad Meade.

As ever.

Dear friends,

It’s not a question of whether it’s coming.  It’s just a question of whether you’ve been preparing intelligently.

There’s an old joke about the farmer with the leaky roof that never gets fixed.  When the sun’s out, he never thinks about the leak and when it’s raining, he can’t get up there to fix it anyway.  And so the leak continues.

Our investments likewise: people who are kicking themselves for not having 100% equity exposure in March 2009 and 200% exposure in January 2013 have been pulling money steadily from boring investments and adding them to stocks.  The domestic stock market has seen its 13^th consecutive month of inflows and the S&P 500 closed February at its highest nominal level ever.

I mention this now because the sun has been shining so brightly.  March 9, 2014 marches the five-year anniversary of the current bull market.  In those five years, a $10,000 investment in the S&P500 would have grown to $30,400.  The same amount invested in the NASDAQ on March 9 would have grown to $35,900. The last remnants of the ferocious bear markets of 2000-02 and 2007-09 have faded from the ratings.  And investors really want a do-over.  All the folks hiding under their beds in 2009 and still peering out from under the blankies in 2011 feel cheated and they want in on the action, and they want it now.

Hence inflows into an overpriced market.

Our general suggestion is to learn from the past, but not to live there.  Nothing we do today can capture the returns of the past five years for us.  Sadly, we still can damage the next five.  To help build a strong prospects for our future, we’re spending a bit of time this month talking about hedging strategies – ways to get into a pricey market without quite so much heartache – and cool funds that might be better positioned for the next five than you’d otherwise find.

And, too, we get to celebrate the onset of spring!

The search for active share

It’s much easier to lose in investing than to win.  Sometimes we lose because we’re offered poor choices and sometimes we lose because we make poor ones.  Frankly, it doesn’t take many poor choices to trash the best laid plans.

Winning requires doing a lot of things right.  One of those things is deciding whether – or to what extent – your portfolio should rely on actively and passively managed funds.  A lot of actively managed funds are dismal but so too are a lot of passive products: poorly constructed indexes, trendy themes, disciplines driven by marketing, and high fees plague the index and EFT crowd.

If you are going to opt for active management, you need to be sure that it’s active in more than name alone.  As we’ve shown before, many active managers – especially those trying to deploy billions in capital – offer no advantage over a broad market index, and a lot of disadvantages. 

One tool for measuring the degree to which your manager is active is called, appropriately enough, “active share.”  Active share measures the degree to which your fund’s holdings differ from its benchmark’s.  The logic is simple: you can’t beat an index by replicating it and if you can’t beat it, you should simply buy it.

The study “How Active Is Your Manager” (2009) by Cremers and Petajitso concluded that “Funds with high active share actually do outperform their benchmarks.” The researchers originally looked at an ocean of data covering the period from 1990 to 2003, then updated it through 2009.  They found that funds with active share of at least 90% outperformed their benchmarks by 1.13% (113 basis points per year) after fees. Funds with active share below 60% consistently underperformed by 1.42 percentage points a year, after accounting for fees.

Some researchers have suggested that the threshold for active share needs to be adjusted to account for differences in the fund’s investment universe: a fund that invests in large to mega-cap names should have an active share north of 70%, midcaps should be above 80% and small caps above 90%. 

So far, we’ve only seen research validating the 60% and 90% thresholds though the logic of the step system is appealing; of the 5008 publicly-traded US stocks, there are just a few hundred large caps but several thousand small and micro-caps.

There are three problems with the active share data.  We’d like to begin addressing one of them and warn you of the other two.

Problem One: It’s not available.  Morningstar has the data but does not release it, except in occasional essays. Fund companies may or may not have it, but almost none of them share it with investors. And journalists occasionally publish pieces that include an active share chart but those tend to be an idiosyncratic, one-time shot of a few funds. Nuts.

Problem Two: Active share is only as valid as the benchmark used. The calculation of active share is simply a comparison between a fund’s portfolio and the holdings in some index. Pick a bad index and you get a bad answer. By way of simple illustration, the S&P500 stock index has an active share of 100 (woo hoo!) if you benchmark it against the MSCI Emerging Markets Index.

Fund companies might have the same incentive and the same leverage with active share providers that the buyers of bond ratings did: bond issuers could approach three ratings agencies and say “tell me how you’ll rate my bond and I’ll tell you whether we’re paying for your rating.” A fund company looking for a higher active share might simply try several indexes until they find the one that makes them look good. Here’s the warning: make sure you know what benchmark was used and make sure it makes sense.

Problem Three: You can compare active share between two funds only if they’ve chosen to use the same benchmark. One large cap might have an active share of 70 against the Mergent Dividend Achievers Index while another has a 75 against the Russell 1000 Value Index. There’s no way, from that data, to know whether one fund is actually more active than the other. So, look for comparables.

To help you make better decisions, we’ve begun gathering publicly-available active share data released by fund companies.  Because we know that compact portfolios are also correlated to higher degrees of independence, we’ve included that information too for all of the funds we could identify.  A number of managers and advisors have provided active share data since our March 1^st launch.  Thanks!  Those newly added funds appear in italics.

Fund	Ticker	Active share	Benchmark	Stocks
Artisan Emerging Markets (Adv)	ARTZX	79.0	MSCI Emerging Markets	90
Artisan Global Equity	ARTHX	94.6	MSCI All Country World	57
Artisan Global Opportunities	ARTRX	95.3	MSCI All Country World	41
Artisan Global Value	ARTGX	90.5	MSCI All Country World	46
Artisan International	ARTIX	82.6	MSCI EAFE	68
Artisan International Small Cap	ARTJX	97.8	MSCI EAFE Small Cap	45
Artisan International Value	ARTKX	92.0	MSCI EAFE	50
Artisan Mid Cap	ARTMX	86.3	Russell Midcap Growth	65
Artisan Mid Cap Value	ARTQX	90.2	Russell Value	57
Artisan Small Cap	ARTSX	94.2	Russell 2000 Growth	68
Artisan Small Cap Value	ARTVX	91.6	Russell 2000 Value	103
Artisan Value	ARTLX	87.9	Russell 1000 Value	32
Barrow All-Cap Core Investor	BALAX	92.7	S&P 500	182
Diamond Hill Select	DHLTX	89	Russell 3000 Index	35
Diamond Hill Large Cap	DHLRX	80	Russell 1000 Index	49
Diamond Hill Small Cap	DHSIX	97	Russell 2000 Index	68
Diamond Hill Small-Mid Cap	DHMIX	97	Russell 2500 Index	62
DoubleLine Equities Growth	DLEGX	88.9	S&P 500	38
DoubleLine Equities Small Cap Growth	DLESX	92.7	Russell 2000 Growth	65
Driehaus EM Small Cap Growth	DRESX	96.4	MSCI EM Small Cap	102
FPA Capital	FPPTX	97.7	Russell 2500	28
FPA Crescent	FPACX	90.3	Barclays 60/40 Aggregate	50
FPA International Value	FPIVX	97.8	MSCI All Country World ex-US	23
FPA Perennial	FPPFX	98.9	Russell 2500	30
Guinness Atkinson Global Innovators	IWIRX	99	MSCI World	28
Guinness Atkinson Inflation Managed Dividend	GAINX	93	MSCI World	35
Linde Hansen Contrarian Value	LHVAX	87.1 *	Russell Midcap Value	23
Parnassus Equity Income	PRBLX	86.9	S&P 500	41
Parnassus Fund	PARNX	92.6	S&P 500	42
Parnassus Mid Cap	PARMX	94.9	Russell Midcap	40
Parnassus Small Cap	PARSX	98.8	Russell 2000	31
Parnassus Workplace	PARWX	88.9	S&P 500	37
Pinnacle Value	PVFIX	98.5	Russell 2000 TR	37
Touchstone Capital Growth	TSCGX	77	Russell 1000 Growth	58
Touchstone Emerging Markets Eq	TEMAX	80	MSCI Emerging Markets	68
Touchstone Focused	TFOAX	90	Russell 3000	37
Touchstone Growth Opportunities	TGVFX	78	Russell 3000 Growth	60
Touchstone Int’l Small Cap	TNSAX	97	S&P Developed ex-US Small Cap	97
Touchstone Int’l Value	FSIEX	87	MSCI EAFE	54
Touchstone Large Cap Growth	TEQAX	92	Russell 1000 Growth	42
Touchstone Mid Cap	TMAPX	96	Russell Midcap	33
Touchstone Mid Cap Growth	TEGAX	87	Russell Midcap Growth	74
Touchstone Mid Cap Value	TCVAX	87	Russell Midcap Value	80
Touchstone Midcap Value Opps	TMOAX	87	Russell Midcap Value	65
Touchstone Sands Capital Select	TSNAX	88	Russell 1000 Growth	29
Touchstone Sands Growth	CISGX	88	Russell 1000 Growth	29
Touchstone Small Cap Core	TSFAX	99	Russell 2000	35
Touchstone Small Cap Growth	MXCAX	90	Russell 2000 Growth	81
Touchstone Small Cap Value	FTVAX	94	Russell 2000 Value	75
Touchstone Small Cap Value Opps	TSOAX	94	Russell 2000 Value	87
William Blair Growth	WBGSX	83	Russell 3000 Growth	53

*        Linde Hansen notes that their active share is 98 if you count stocks and cash, 87 if you look only at the stock portion of their portfolio.  To the extent that cash is a conscious choice (i.e., “no stock in our investable universe meets our purchase standards, so we’ll buy cash”), count both makes a world of sense.  I just need to find out how other investors have handled the matter.

Who’s not on the list? 

A lot of firms, some of whose absences are in the ironic-to-hypocritical range. Firms not choosing to disclose active share include:

BlackRock – which employs Anniti Petajisto, the guy who invented active share, as a researcher and portfolio manager in their Multi-Asset Strategies group. (They do make passing reference to an “active share buyback” on the part on one of their holdings, so I guess that’s partial credit, right?)

Fidelity – whose 5 Tips to Pick a Winning Fund tells you to look for “stronger performers [which are likely to] have a high ‘active share’”.  (They do reprint a Reuters article ridiculing a competitor with a measly 56% active share, but somehow skip the 48% for Fidelity Blue Chip Growth, 47% for Growth & Income, the 37% for MegaCap Stock or the under 50% for six of their Strategic Advisers funds). (per the Wall Street Journal, Is Your Fund a Closet Index Fund, January 14, 2014).

Oakmark – which preens about “Harris Associates and Active Share” without revealing any.

Are you active?  Would you like someone to notice?

We’ve been scanning fund company sites for the past month, looking for active share reports. If we’ve missed you, we’re sorry. Help us correct the oversight  by sending us the link to where you report your active share stats. We’d be more than happy to offer a permanent home for the web’s largest open collection of active share data.

Does Size Matter?

By Edward Studzinski

“Convictions are more dangerous enemies of truth than lies.”

                    Nietzsche

One of the more interesting consequences of the performance of equities in 2013 is the ramp-up of the active investment management marketing machines to explain why their performance in many instances lagged that of inexpensive index funds. This has resulted in a manure storm media blitz with terms and phrases such as “stock picker’s market” or “active share” or “concentrated portfolios.” 

“Stock picker’s market” is generally a euphemism for active management. That is, why you should pay me 100 basis points for investing in a subset of the S&P 500, rather than pay Vanguard or some other index fund provider 5 basis points for their product. One of the rationales I used to regularly hear to justify active management fees was that the active manager will know when to get out of the market and when to get back in, whereas the small investor will always go in and out at the wrong time. The period of 2008-2009 puts paid to that argument when one looks at maximum drawdown numbers.  The question it raises however is whether the time horizon most investment managers and investors use is far too short. I think it clearly is and that rather than three years or three to five years, we should be thinking of ten years at a minimum.  Unfortunately, given personnel turnover in many investment organizations, it is difficult for the investing public to know or understand that the people who gave a fund its long-term performance, looking in the rear-view mirror, are not the ones doing the analysis or selecting the investments going forward. And if they are, often their time and attention is pulled in many other directions.  This is why I now, sitting on an endowment investment committee, appreciate why an integral part of the investment consultant’s report covers stability of personnel and succession planning at current firms invested in as well as firms proposed for consideration. Of course, if you are the average retail investor, you are far better off to focus on your risk tolerance, true time horizon, and asset allocation, again making use of low cost index products if you are not going to spend the time and effort to replicate the work of the consultants used by endowments and pension funds.

I am going to leave it to others to discuss “active share.”  I do think the question of “concentrated portfolios” is worth a few thoughts.  I once asked a friend of mine, at a large East Coast fund complex, how he managed to keep track of the two hundred or so stocks in his fund portfolio. His answer was illuminating.  He said that his firm had a very large research department and prided itself on its selection and training of analysts.  Politically then, over time he had to use an idea or two from everyone or every area. His preference would have been to have a much more concentrated portfolio.  I will refer to that then as the “ark” approach to investment management. Other firms, such as Longleaf, have tended from the get-go to have truly concentrated portfolios, say somewhere between twenty to twenty five stocks, given that the benefits of diversification run-out at a certain number of securities. Their rationale has been that rarely, when you are building a portfolio from the bottom up based on what are the most undervalued ideas, do ideas number thirty to forty have the same expected return potential as ideas number one to ten. (That is even more the case with the S&P 500 hitting new all time highs now).

There is another way to look at this which I think makes it more understandable for the average person.  In 2006, Huber Capital Managed LLC performed a study, looking at value-oriented investors, entitled “Limited Assets Under Management is a Competitive Advantage.”   The study assumed an equal weighted portfolio of 2.5% positions (forty stocks) to show how the investable universe of securities shrank at certain asset levels. It looked at the Russell 1000 Value Index and the Russell 2000 Value Index. The conclusion of the study was that as assets under management grew, portfolio managers faced increasingly unpleasant choices. One choice of course was to shrink the investment universe, what I have referred to in the past as the rule limiting investments to securities that can be bought or sold in five days average trading volume.

Another alternative was to increase the number of stocks held in the portfolio. You can see whether your manager has done this by going back five or ten years and looking at annual reports.  When the fund was $5B in asset size, did it own thirty stocks? Do you really believe that with the fund at $10B or $15B in asset size, that it has found another twenty or thirty undervalued stocks?  Look also to see if the number of research analysts has increased materially. Are roughly the same number of analysts covering more names? 

The third choice was to make the fund very concentrated or even non-diversified by SEC standards, with individual positions greater than five per cent. That can work, but it entails taking on career risk for the analysts and fund managers, and enterprise risk for the management company. A fund with $10B in assets under management has available only 50% of the investable set of stocks to invest in, assuming it is going to continue to focus on liquidity of the investment as an implicit criteria. That is why you see more and more pension funds, endowments, and family office managers shifting to low-cost index or ETF vehicles for their large cap investments. The incremental return is not justified by the incremental fee over the low-cost vehicle. And with a long-term time horizon, the compounding effect of that fee differential becomes truly important to returns.

My thanks to Huber Capital Manangement LLC for doing this study, and to Long Short Advisors for making me aware of it in one of their recent reports. Both firms are to be commended for their integrity and honesty. They are truly investment managers rather than asset gatherers. 

On the impact of fund categorization: Morningstar’s rejoinder

Morningstar’s esteemed John Rekenthaler replied to MFO’s February commentary on categorization, although officially “his views are his own.” His February 5 column is entitled How Morningstar Categorizes Funds.

Snowball’s gloss: John starts with a semantic quibble (Charles: “Morningstar says OSTFX is a mid-cap blend fund,” John: “Morningstar does not say what a fund is,” just what category it’s been assigned to), mischaracterizes Charles’s article as “a letter to MFO” (which I mention only because he started the quibble-business) and goes on to argue that the assignment of OSTFX to its category is about as reasonable a choice as could be made. Back to Charles:

Mr. R. uses BobC’s post to frame an explanation of what Morningstar does and does not do with respect to fund categorization. In his usual thoughtful and self-effacing manner, he defends the methodology, while admitting some difficulty in communicating. Fact is, he remains one of Morningstar’s best communicators and Rekenthaler Report is always a must read.

I actually agree with his position on Osterweis. Ditto for his position on not having an All Cap category (though I suspect I’m in the minority here and he actually admits he may be too). He did not address the (mis-)categorization of River Park Short Term High Yield Fund (RPHYX/RPHIX, closed). Perhaps because he is no longer in charge of categorization at Morningstar.

The debate on categorization is never-ending, of course, as evidenced by the responses to his report and the many threads on our own board. For the most part, the debate remains a healthy one. Important for investors to understand the context, the peer group, in which prospective funds are being rated.

In any case and as always, we very much appreciate Mr. Rekenthaler taking notice and sharing his views.

Snowball’s other gloss: geez, Charles is a lot nicer than I am. I respect John’s work but frankly I don’t really tingle at the thought that he “takes notice.” Well, except maybe for that time at the Morningstar conference when he swerved at the last minute to avoid crashing into me. I guess there was a tingle then.

Snowball’s snipe: at the sound of Morningstar’s disdain, MFWire did what MFWire does. They raised high the red-and-white banner, trumpeting John’s argument and concluding with a sharp “grow up, already!” I would have been much more impressed with them if they’d read Charles’s article beforehand. They certainly might have, but there’s no evidence in the article that they felt that need.

One of the joys of writing for the Observer is the huge range of backgrounds and perspectives that our readers bring to the discussion. A second job is the huge range of backgrounds and perspectives that my colleagues bring. Charles, in particular, can hear statistics sing. (He just spent a joyful week in conference studying discounted cash-flow models.) From time to time he tries, gently, to lift the veil of innumeracy from my eyes. The following essay flows from our extended e-mail exchanges in which I struggled to understand the vastly different judgments of particular funds implied by different ways of presenting their risk-adjusted statistics. 

We thought some of you might like to overhear that conversation.  

Morningstar’s Risk Adjusted Return Measure

Central to any fund rating system is the performance measure used to determine percentile rank order. MFO uses Martin ratio, as described Rating System Definitions. Morningstar developed its own risk adjusted return (MRAR), which Nobel Laureate William Sharpe once described as a measure that “…differs significantly from more traditional ones such as various forms of the Sharpe ratio.” While the professor referred to an earlier version of MRAR, the same holds true today.

Here is how Morningstar describes MRAR on its Data FAQ page: Morningstar adjusts for risk by calculating a risk penalty for each fund based on “expected utility theory,” a commonly used method of economic analysis. Although the math is complex, the basic concept is relatively straightforward. It assumes that investors are more concerned about a possible poor outcome than an unexpectedly good outcome and that those investors are willing to give up a small portion of an investment’s expected return in exchange for greater certainty. A “risk penalty” is subtracted from each fund’s total return, based on the variation in its month-to-month return during the rating period, with an emphasis on downward variation. The greater the variation, the larger the penalty. If two funds have the exact same return, the one with more variation in its return is given the larger risk penalty.

For the curious and mathematically inclined, the detailed equations are well documented in The Morningstar Rating Methodology. The following figure illustrates how MRAR behaves for three hypothetical funds over a 3 year period ending Dec 2013:

Each fund in the illustration delivers the same total return, but with varying levels of volatility. The higher the volatility, the lower the risk adjusted return. Fund 0 delivers consistent returns every month with zero volatility; consequently, it receives the highest MRAR, which in this case is the fund’s annualized total return minus the risk-free T-Bill (i.e., it’s the annualized “excess” return).

Morningstar computes MRAR for all funds over equivalent periods, and then percentile ranks them within their respective categories to assign appropriate levels, 1 star for those funds in the lowest group and the coveted 5 star rating for the highest.

It also computes a risk measure MRisk and performs a similar ranking to designate “low” to “high” risk funds within each category. MRisk is simply the difference between the annualized excess return of the fund and its MRAR.

The following figure provides further insight into how MRAR behaves for funds of varying volatility. This time, fund total returns have been scaled to match their category averages, again for the 3 year period ending Dec 2013. The figure includes results from several categories showing MRAR versus the tradition volatility measure, annualized standard deviation.

Once again we see that funds with higher volatility generally receive lower MRARs and that the highest possible MRAR is equal to a fund’s annualized excess return, which occurs at zero standard deviation.

A consequence of Morningstar’s methodology is that low volatility funds with below average returns can quite possibly be out-ranked by average volatility funds with average returns. Put another way, the methodology generally penalizes funds with high volatility more so than it rewards funds with low volatility, since with the latter the benefit is “capped.”

This behavior is different from other risk adjusted return measures based on say Sharpe ratio, as can be seen in the figure below. Here the same funds from above are plotted against Sharpe, but now funds with low volatility are rewarded handsomely, even if they have below average total returns.

Revisiting the Morningstar risk measure MRisk, one finds another observation: it appears to correlate rather satisfactorily against a simple function based on standard deviation (up to about 30% for funds of positive total return without load):

Which means that Morningstar’s risk adjusted return can be estimated from the following:

This simple approximation may come in handy, like when David wonders: “Why do RPHIX and ICMYX, which have superior 3 year Sharpe ratios, rate a very inferior 1 star by Morningstar?” He can use the above calculation to better understand, as illustrated here:

While both do indeed have great 3 year Sharpe ratios – RPHIX is highest of any US fund – they both have below average total returns relative to their current peer group, as represented by say VWEHX, a moderate risk and average returning high yield bond “reference” fund.

Their low volatilities simply get no love from Morningstar’s risk adjusted return measure.

27Feb2014/Charles

Celebrating one-starness

I was having a nice back-channel conversation with a substantially frustrated fund manager this week. He read Charles’s piece on fund categorization and wrote to express his own dismay with the process. He’s running a small fund. It hit its three-year mark and earned five stars. People noticed. Then Morningstar decided to recategorize the fund (into something he thinks he isn’t). And it promptly became one star. And, again, people – potential investors – noticed, but not in a good way.

Five to one, with the stroke of a pen? It happens, but tends not to get trumpeted. After all, it rather implies negligence on Morningstar’s part if they’ve been labeling something as, say, a really good conservative allocation fund for years but then, on further reflection, conclude that it’s actually a sucky high-yield bond or preferred stock fund.

Here’s what Morningstar’s explanation for such a change looks like in practice:

Morningstar Alert

Osterweis Strategic Income Fund OSTIX

12-03-13 01:00 PM

Change in Morningstar Fund Star Rating: The Morningstar Star Rating for this fund has changed from 4 stars to 2 stars. For details, go to http://quicktake.morningstar.com/Fund/RatingsAndRisk.asp?Symbol=OSTIX.

Sadly, when you go to that page there are no details that would explain an overnight drop of that magnitude. On the “performance” page, you will find the clue:

I don’t have an opinion on the appropriateness of the category assignment but it would be an awfully nice touch, given the real financial consequences of such a redesignation, if Morningstar would take three sentences to explain their rationale at the point that they make the change.

Which got me to thinking about my own favorite one-star fund (RiverPark Short Term High Yield RPHYX and RPHIX, which is closed) and Charles’s favorite one-shot stat on a fund’s risk-adjusted returns (its Sharpe ratio).

And so, here’s the question: how many funds have a higher (i.e., better) Sharpe ratio than does RPHYX?

And, as a follow-up, how many have a Sharpe ratio even half as high as RiverPark’s?

That would be “zero” and “seven,” respectively, out of 6500 funds.

Taking up Rekenthaler’s offer

In concluding his response to Charles’s essay, John writes:

A sufficient critique is one that comes from a fund that truly does not behave like others in its category, that contains a proposal for a modification to the existing category system, that does not lead to rampant category proliferation, and that results in a significantly closer performance comparison between the fund and its new category. In such cases, Morningstar will consider the request carefully–and sometimes make the suggested change.

Ummm … short-term high-yield? In general, those are funds that are much more conservative than the high-yield group. The manager at RiverPark Short-Term High Yield (RPHYX) positions the fund as a “cash management” account. The managers at Intrepid Income (ICMYX) claim to be “absolute return” investors. Wells Fargo Advantage Short-Term High-Yield Bond (STHBX) seems similarly positioned. All are one-star funds (as of February 2014) when judged against the high-yield universe.

“Does not behave like others in its category” but “results in a significantly closer performance comparison [within] its new category.” The orange line is the high-yield category. That little cluster of parallel, often overlapping lines below it are the three funds.

“Does not lead to rampant category proliferation.” You mean, like creating a “preferred stock” category with seven funds? That sort of proliferation? If so, we’re okay – there are about twice as many short-term high-yield candidates as preferred stock ones.

I’m not sure this is a great idea. I am pretty sure that dumping a bunch of useful, creative funds into this particular box is a pretty bad one.

Next month’s unsought advice will highlight emerging markets balanced (or multi-asset) funds. We’re up to a dozen of them now and the same logic that pulled US balanced funds out of the equity category and global balanced funds out of the international equity category, seems to be operating here.

Two things you really should read

In general, most writing about funds has the same problem as most funds do: it’s shallow, unoriginal, unreflective. It contributes little except to fill space and get somebody paid (both honorable goals, by the way). Occasionally, though, there are pieces that are really worth some of our time, thought and reflection. Here are two.

I’m not a great fan of ETFs. They’ve always struck me as trading vehicles, tools for allowing hedge funds and others to “make bets” rather than to invest. Chuck Jaffe had a really solid piece entitled “The growing case against ETFs” (Feb. 23, 2014) that makes the argument that ETFs are bad for you. Why? Because the great advantage of ETFs are that you can trade them all day long. And, as it turns out, if you give someone a portfolio filled with ETFs that’s precisely – and disastrously – what they do.

The Observer was founded on the premise that small, independent, active funds are the only viable alternative to a low-cost indexed portfolio. As funds swell, two bad things happen: their investable universe shrinks and the cost of making a mistake skyrockets, both of which lead to bad investment choices. There’s a vibrant line of academic research on the issue. John Rekenthaler began dissecting some of that research – in particular, a recent study endorsing younger managers and funds – in a four-part series of The Rekenthaler Report. At this writing, John had posted two essays: “Are Young Managers All That?” (Feb. 27, 2014) and “Has Your Fund Become Too Large, Or Is Industry Size the Problem?” (Feb. 28, 2014).  The first essay walks carefully through the reasons why older, larger funds – even those with very talented managers – regress. To my mind, he’s making a very strong case for finding capacity-constrained strategies and managers who will close their funds tight and early. The second picks up an old argument made by Charles Ellis in his 1974 “The Loser’s Game” essay; that the growth and professionalization of the investment industry is so great that no one – certainly not someone dragging a load – can noticeably outrun the crowd. The problem is less, John argues, the bloat of a single fund as the effect of “$3 trillion in smart money chasing the same ideas.”  

Regardless of whether you disdain or adore ETFs, or find the industry’s difficulties located at the level of undisciplined funds or an unwieldy industry, you’ll come away from these essays with much to think about.

RiverPark Strategic Income: Another set of ears

I’m always amazed by the number of bright and engaging folks who’ve been drawn to the Observer, and humbled by their willingness to freely share some of their time, insights and experience with the rest of us. One of those folks is an investor and advisor named “Mark” who is responsible for extended family money, a “multi-family office” if you will. He had an opportunity to spend some time chatting with David Sherman in mid-January as he contemplated a rather sizeable investment in RiverPark Strategic Income (RSIVX) for some family members who would benefit from such a strategy. Herewith are some of the reflections he shared over the course of a series of emails with me.

Where he’s coming from

Mark wrote that to him it’s important to understand the “context” of RSIVX. Mr. Sherman manages private strategies and hedge fund monies at Cohanzick Management, LLC. He cut his teeth at Leucadia National (whose principal Ian Cumming is sometimes referred to as Canada’s Warren Buffett) and is running some sophisticated and high entry strategies that have big risks and big rewards. His shop is not as large as some, sure, but Mr. Sherman seems to prefer it that way.

Some of what Mr. Sherman does all day “informs” RSIVX. He comes across an instrument or an idea that doesn’t fit in one strategy but may in another. It has the risk/reward characteristics that he wants for a particular strategy and so he and his team perform their due diligence on it. More on that later.

Where he is

RSIVX only exists, according to Mr. Sherman, because it fills a need. The need is for an annuity like stream of income at a rate that “his mother could live off” and he did not see such a thing in the marketplace. (In 2007 you could park money at American Express Bank in a jumbo CD at 5.5%. No such luck today.) He saw many other total return products out there in the high yield space where an investor can get a bit higher returns than what he envisions. But some of those returns will be from capital appreciation, i.e., returns from in essence trading. Mr. Sherman did not want to rely on that. He wants a lower duration portfolio (3-4 years) that he can possibly but not necessarily hold to get nice, safe, relatively high coupons from. As long as his investor has that timeframe, Mr. Sherman believes he can compound the money at 6-8% annually, and the investor gets his money back plus his return.

Shorter timeframes, because of impatience or poor timing choices, carry no such assurances. It’s not a CD, it’s not a guaranteed annuity from an insurer, but it’s what is available and what he is able to get for an investor.

How? Well, one inefficiency he hopes to exploit is in the composition of SPDR Barclays High Yield Bond (JNK) and iShares High Yield Corporate Bond (HYG). He doesn’t believe they reflect the composition of high yield space accurately with their necessary emphasis on the most liquid names. He will play in a different sandbox with different toys. And he believes it’s no more risky and thinks it is less so. In addition, when the high yield market moves, especially down, those names move fast.

Mark wrote that he asked David whether the smoothness of his returns exhibited in RPHYX and presumably in RSIVX in the future was due or would be due to a laddering strategy that he employed. He said that it was not – RSIVX’s portfolio was more of a barbell presently- and he did not want to be pigeonholed into a certain formula or strategy. He would do whatever it took to produce the necessary safe returns and that may change from time to time depending upon the market.

What changing interest rates might mean

What if rates fall? If rates fall then, sure, the portfolio will have some capital appreciation. What if rates rise? Well, every day and every month, David said, the investor will grind toward the payday on the shorter duration instruments he is holding. Mark-to-market they will be “worth” less. The market will be demanding higher interest rates and what hasn’t rolled off yet will not be as competitive as the day he bought them. The investor will still be getting a relatively high 6-8% return and as opportunities present themselves and with cash from matured securities and new monies the portfolio will be repopulated over time in the new interest rate environment. Best he can do. He does not intend to play the game of hedging. 

Where he might be going

Mark said he also asked about a higher-risk follow-on to RSIVX. He said that David told him that if he doesn’t have something unique to bring that meets a need, he doesn’t want to do it. He believes RPHYX and RSIVX to be unique. He “knew” he could pull off RPHYX, that he could demonstrate its value, and then have the credibility to introduce another idea. That idea is the Strategic Income Fund.

He doesn’t see a need for him to step out on the spectrum right now. There are a hundred competitors out there and a lot of overlap. People can go get a total return fund with more risk of loss. Returns from them will vary a lot from year to year unless conditions are remarkably stable. This [strategy] almost requires a smaller, more nimble fund and manager. Here he is. Here it is. So the next step out isn’t something he is thinking [immediately] about, but he continually brings ideas to Morty.

Mark concludes: “We discussed a few of his strategies that had more risk. They are fascinating but definitely not vanilla or oatmeal and a few I had to write out by hand the mechanics afterward so I could “see” what he was doing. One of them took me about an hour to work through where the return came from and where it could go possibly wrong.

But he described it to me because working on it gave him the inspiration for a totally different situation that, if it came to pass, would be appropriate for RSIVX. It did, is much more vanilla and is in the portfolio. Very interesting and shows how he thinks. Would love to have a beer with this guy.”

Mark’s bottom line(s)

Mark wanted me to be sure to disclose that he and his family have a rather large position in RiverPark Strategic Income now, and will be holding it for an extended period assuming all goes well (years) so, yeah, he may be biased with his remarks. He says “the strategy is not to everyone’s taste or risk tolerance”. He holds it because it exactly fills a need that his family has.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Driehaus Emerging Markets Small Cap Growth (DRESX): There’s a lot to be said for EM small caps. They provide powerful diversification and performance benefits for a portfolio. The knock of them is that they’re too hot to handle. Driehaus’s carefully constructed, hedged portfolio seems to have cooled the handle by a lot.

Guinness Atkinson Inflation Managed Dividend (GAINX): It’s easy to agree that owning the world’s best companies, especially if you buy them on the cheap, is a really good strategy. GAINX approaches the challenge of constructing a very compact, high quality, low cost portfolio with quantitative discipline and considerable thought.

Intrepid Income (ICMUX): What’s not to like about this conservative little short-term, high-yield fund. It’s got it all: solid returns, excellent risk management and that coveted one-star rating! Intrepid, like almost all absolute value investors, is offering an object lesson on the important of fortitude in the face of frothy markets and serial market records.

RiverPark Gargoyle Hedged Value (RGHVX): The short story is this. Gargoyle’s combination of a compact, high quality portfolio and options-based hedging strategy has, over time, beaten just about every reasonable comparison group. Unless you anticipate a series of 20 or 30% gains in the stock market over the rest of the decade, it might be time to think about protecting some of what you’ve already made.

Elevator Talk: Ted Gardner, Salient MLP & Energy Infrastructure II (SMLPX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

Master limited partnerships (MLPs) are an intriguing asset class which was, until very recently, virtually absent from both open-end fund and ETF portfolios.

MLPs are a form of business organization, in the same way corporations are a form of organization. Their shares trade on US exchanges (NYSE and NASDAQ) and they meet the same SEC security registration requirements as corporations do. They were created in the 1980s primarily as a tool to encourage increased energy production in the country and the vast majority of MLPs (75% or so) are in the energy sector.

MLPs are distinct from corporations in a number of ways:

• They’re organized around two groups: the limited partners (i.e., investors) and the general partners (i.e., managers). The limited partners provide capital and receive quarterly distributions.
• MLPs are required, by contract, to pay minimum quarterly distributions to their limited partners. That means that they produce very consistent streams of income for the limited partners.
• MLPs are required, by law, to generate at least 90% of their income from “qualified sources.” Mostly that means energy production and distribution.

The coolest thing about MLPs is the way they generate their income: they operate hugely profitable, economically-insensitive monopolies whose profits are guaranteed by law. A typical midstream MLP might own a gas or oil pipeline. The MLP receives a fee for every gallon of oil or cubic foot of gas moving through the pipe. That rate is set by a federal agency and that rate rises every year by the rate of inflation plus 1.3%. It doesn’t matter whether the price of oil soars or craters; the MLP gets its toll regardless. And it doesn’t really matter whether the economy soars or craters: people still need warm homes and gas to get to work. At worst, bad recessions eliminate a year’s demand rise but haven’t yet caused a net demand decrease. As the population grows and energy consumption rises, the amount moving through the pipelines rise and so does the MLPs income.

Those profits are protected by enormously high entry barriers: building new pipelines cost billions, require endless hearings and permits, and takes years. As a result, the existing pipelines function as de facto a regional monopoly, which means that the amount of material traveling through the pipeline won’t be driven down by competition for other pipelines.

Quick highlights of the benchmark Alerian MLP index:

• From inception through early 2013, the index returned 16% annually, on average.
• For that same period, it had a 7.1% yield which grew 7% annually.
• There is a low correlation – 50 – between the stock market and the index. REITs say at around 70 and utility stocks at 25, but with dramatically lower yield and returns.

Only seven of the 17 funds with “MLP” in their names have been around long enough to quality for a Morningstar rating; all seven are four- or five-star funds, measured against an “energy equity” peer group. Here’s a quick snapshot of Salient (the blue line) against the two five-star funds (Advisory Research MLP & Energy Income INFIX and MLP & Energy Infrastructure MLPPX) and the first open-end fund to target MLPs (Oppenheimer SteelPath MLP Alpha MLPAX):

The quick conclusion is that Salient was one of the best MLP funds until autumn 2013, at which point it became the best one. I did not include the Alerian MLP index or any of the ETFs which track it because they lag so far behind the actively-managed funds. Over the past year, for example, Salient has outperformed the Alerian MLP Index – delivering 20% versus 15.5%.

High returns and substantial diversification. Sounds perfect. It isn’t, of course. Nothing is. MLP took a tremendous pounding in the 2007-09 meltdown when credit markets froze and dropped again in August 2013 during a short-lived panic over changes in MLP’s favorable tax treatment. And it’s certainly possible for individual MLPs to get bid up to fundamentally unattractive valuations.

Ted Gardner is the co‐portfolio manager for Salient’s MLP Complex, one manifestation of which is SMLPX. He oversees and coordinates all investment modeling, due diligence, company visits, and management conferences. Before joining Salient he was both Director of Research and a portfolio manager for RDG Capital and a research analyst with Raymond James. Here are his 200 words on why you should consider getting into the erl bidness:

Our portfolio management team has many years of experience with MLP investing, as managers and analysts, in private funds, CEFs and separate accounts. We considered both the state of the investment marketplace and our own experiences and thought it might translate well into an open-end product.

As far as what we saw in the marketplace, most of the funds out there exist inside a corporate wrapper. Unfortunately C-Corp funds are subject to double taxation and that can create a real draw on returns. We felt like going the traditional mutual fund, registered investment company route made a lot of sense.

We are very research-intensive, our four analysts and I all have a sell side background. We take cash flow modeling very seriously. It’s a fundamental modeling approach, modeling down to the segment levels to understand cash flows. And, historically, our analysts have done a pretty good job at it.

We think we do things a bit differently than many investors. What we like to see is visible growth, which means we’re less yield-oriented than others might be. We typically like partnerships that have a strategic asset footprint with a lot of organic growth opportunities or those with a dropdown story, where a parent company drops more assets into a partnership over time. We tend to avoid firms dependent on third-party acquisitions for growth. And we’ve liked investing in General Partners which have historically grown their dividends at approximately twice the rate of the underlying MLPs.

The fund has both institutional and retail share classes. The retail classes (SMAPX, SMPFX) nominally carry sales loads, but they’re available no-load/NTF at Schwab. The minimum for the load-waived “A” shares is $2,500. Expenses are 1.60% on about $630 million in assets. Here’s the fund’s homepage, but I’d recommend that you click through to the Literature tab to grab some of the printed documentation.

River Park/Gargoyle Hedged Value Conference Call Highlights

On February 12th we spoke for an hour with Alan Salzbank and Josh Parker, both of the Gargoyle Group, and Morty Schaja, CEO of RiverPark Funds. Here’s a brief recap of the highlights:

Alan handles the long portfolio. Josh, a securities lawyer by training, handles the options portfolio. He’s also an internationally competitive bridge player (Gates, Buffett, Parker…) and there’s some reason to believe that the habits of mind that make for successful bridge play also makes for successful options trading. They have 35 and 25 years of experience, respectively, and all of the investment folks who support them at Gargoyle have at least 20 years of experience in the industry. Morty has been investigating buy-write strategies since the mid-1980s and he described the Gargoyle guys as “the team I’ve been looking for for 25 years.”

The fund combines an unleveraged long portfolio and a 50% short portfolio, for a steady market exposure of 50%. The portfolio rebalances between those strategies monthly, but monitors and trades its options portfolio “in real time” throughout the month.

The long portfolio is 80-120 stocks, and stock selection is algorithmic. They screen the 1000 largest US stocks on four valuation criteria (P/B, P/E, P/CF, P/S) and then assign a “J score” to each stock based on how its current valuation compares with (1) its historic valuation and (2) its industry peers’ valuation. They then buy the 100 more undervalued stocks, but maintain sector weightings that are close to the S&P 500’s.

The options portfolio is a collection of index call options. At base, they’re selling insurance policies to nervous investors. Those policies pay an average premium of 2% per month and rise in value as the market falls. That 2% is a long-term average, during the market panic in the fall of 2008, their options were generating 8% per month in premiums.

Why index calls? Two reasons: (1) they are systematically mispriced, and so they always generate more profit than they theoretically should. In particular, they are overpriced by about 35 basis points/month 88% of the time. For sellers, that means something like a 35 bps free lunch. And (2) selling calls on their individual stocks – that is, betting that the stocks in their long portfolio will fall – would reduce returns. They believe that their long portfolio is a collection of stocks superior to any index and so they don’t want to hedge away any of their upside.

And it works. Their long portfolio has outperformed the S&P 500 by an average of 5% per year for 15 years. The entire strategy has outperformed the S&P in the long-term and has matched its returns, with less volatility, in the shorter term. Throughout, it has sort of clubbed its actively-managed long-short peers. It also anticipates clubbing the emerging bevy of buy-write ETFs.

The guys identify two structural advantages they have over an ETF: (1) they buy stocks superior to those in broad indexes and (2) they manage their options portfolio moment by moment, while the ETF just sits and takes hits for 29 out of 30 days each month.

There’s evidence that they’re right. The ETFs are largely based on the CBOE S&P Buy-Write Index (BXM). Between 2000-12, the S&P 500 returned 24% and the BXM returned 52%; the options portion of the Gargoyle portfolio returned 110% while the long portfolio crushed the S&P.

Except not so much in 2008. The fund’s maximum drawdown was 48%, between 10/07 and 03/08. The guys attributed that loss to the nature of the fund’s long portfolio: it buys stocks in badly dented companies when the price of the stock is even lower than the company’s dents would warrant. Unfortunately in the meltdown, those were the stocks people least wanted to own so they got killed. The fund’s discipline kept them from wavering: they stayed 100% invested and rebalanced monthly to buy more of the stocks that were cratering. The payback comes in 2009 when they posted a 42% return against the S&P’s 26% and again in 2010 when they made 18% to the index’s 15%.

The managers believe that ’08 was exceptional, and note that the strategy actually made money from 2000-02 when the market suffered from the bursting of the dot-com bubble.

In general, the strategy fares poorest when the market has wild swings. It fares best in gently rising markets, since both the long and options portfolios can make money if the market rises but less than the strike price of the options – they can earn 2% a month on an option that’s triggered if the market rises by more than 1%. If the market rises but by less than 1%, they pay out nothing, pocket the 2% and pocket the capital appreciation from their long portfolio.

What’s the role of the fund in a portfolio? They view it as a substitute for a large-cap value investment; so if your asset allocation plan is 20% LCV, then you could profitably invest up to 20% of your portfolio in Gargoyle. For the guys, it’s 100% of their US equity exposure.

Morty Speaks!  The rationale for hedging a long-term portfolio.

The Gargoyle call sparked – here’s a surprise – considerable commentary on our discussion board. Some were impressed with Josh and Alan’s fortitude in maintaining their market exposure during the 2007-09 meltdown but others had a more quizzical response. “Expatsp” captured it this way: “Though this seems the best of the long/short bunch, I just don’t see the appeal of long/short funds for anyone who has a long-term horizon.”

There’s a great scene in Big Bang Theory where the brilliant but socially-inept Sheldon clears up a misunderstanding surrounding a comment he made about his roommate: “Ah, I understand the confusion. Uh, I have never said that you are not good at what you do. It’s just that what you do is not worth doing.” Same theme.

Morty Schaja, RiverPark’s president, is in an interesting position to comment on the question. His firm not only advises a pure long/short fund (RiverPark Long/Short Opportunity RLSFX) and a long hedged with options fund (RiverPark Gargoyle), but it also runs a very successful long-only fund (RiverPark Large Cap Growth RPXFX, which he describes as “our five-star secret weapon”).

With the obvious disclaimer that Morty has a stake in the success of all of the RiverPark funds (and the less-obvious note that he has invested deeply in each), we asked him the obvious question: Is it worth doing?

 

Since RiverPark is one of the very few investment advisors to offer the whole range of hedged funds, I asked Morty to share a quick snapshot of each to illustrate how the different strategies are likely to play out in various sets of market conditions.

Let’s start with the RiverPark Long/Short Opportunity Fund.

 

How does this compare with the RiverPark/Gargoyle Hedged Value Fund?

 

And finally, tell us about the new Structural Alpha Fund.

 

Is the Structural Alpha Fund an absolute return strategy?

Conference Call Upcoming

We haven’t scheduled a call for March. We only schedule calls when we can offer you the opportunity to speak with someone really interesting and articulate.  No one has reached that threshold this month, but we’ll keep looking on your behalf.

Conference call junkies might want to listen in on the next RiverNorth call, which focuses on the RiverNorth Managed Volatility Fund (RNBWX). Managed Volatility started life as RiverNorth Dynamic Buy-Write Fund. Long/short funds comes in three very distinct flavors, but are all lumped in the same performance category. For now, that works to the detriment of funds like Managed Volatility that rely on an options-based hedging strategy. The fund trails the long/short peer group since inception but has performed slightly better than the $8 billion Gateway Fund (GATEX). If you’re interested in the potential of an options-hedged portfolio, you’ll find the sign-up link on RiverNorth’s Events page.  The webcast takes place March 13, 2014 at 3:15 Central.

Launch Alert: Conestoga SMid Cap (CCSMX)

On February 28, 2014, Conestoga Mid Cap (CCMGX) ceased to be. Its liquidation was occasioned by negative assessments of its “asset size, strategic importance, current expenses and historical performance.” It trailed its peers in all seven calendar quarters since inception, in both rising and falling periods. With under $2 million in assets, its disappearance is not surprising.

Two things are surprising, however. First, its poor relative performance is surprising given the success of its sibling, Conestoga Small Cap (CCASX). CCASX is a four-star fund that received a “Silver” designation from Morningstar’s analysts. Morningstar lauds the stable management team, top-tier long-term returns, low volatility (its less volatile than 90% of its peers) and disciplined focus on high quality firms. And, in general, small cap teams have had little problem in applying their discipline successfully to slightly-larger firms.

Second, Conestoga’s decision to launch (on January 21, 2014) a new fund – SMid Cap – in virtually the same space is surprising, given their ability simply to tweak the existing fund. It smacks of an attempt to bury a bad record.

My conclusion after speaking with Mark Clewett, one of the Managing Directors at Conestoga: yeah, pretty much. But honorably.

Mark made two arguments.

1. Conestoga fundamentally mis-fit its comparison group. Conestoga targeted stocks in the $2 – 10 billion market cap range. Both its Morningstar peers and its Russell Midcap Growth benchmark have substantial investments in stocks up to $20 billion. The substantial exposure to those large cap names in a mid-cap wrapper drove its peer’s performance.

   The evidence is consistent with that explanation. It’s clear from the portfolio data that Conestoga was a much purer mid-cap play that either its benchmark or its peer group.

   Portfolio	Conestoga Mid Cap	Russell Mid-cap Growth	Mid-cap Growth Peers
   % large to mega cap	0	35	23
   % mid cap	86	63	63
   % small to micro cap	14	2	14
   Average market cap	5.1M	10.4M	8.4M

    By 2013, over 48% of the Russell index was stocks with market caps above $10 billion.

   Mark was able to pull the attribution data for Conestoga’s mid-cap composite, which this fund reflects. The performance picture is mixed: the composite outperformed its benchmark in 2010 and 2011, then trailed in 2013 and 2013. The fund’s holdings in the $2-5 billion and $5–10 billion bands sometimes outperformed their peers and sometimes trailed badly.

2. Tweaking the old fund would not be in the shareholders’ best interest.  The changes would be expensive and time-consuming. They would, at the same time, leave the new fund with the old fund’s record; that would inevitably cause some hesitance on the part of prospective investors, which meant it would be longer before the fund reached an economically viable size.

The hope is that with a new and more appropriate benchmark, a stable management team, sensible discipline and clean slate, the fund will achieve some of the success that Small Cap’s enjoyed.  I’m hopeful but, for now, we’ll maintain a watchful, sympathetic silence.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details.

Funds in registration this month are eligible to launch in late April or early May 2014 and some of the prospectuses do highlight that date.

This month David Welsch battled through wicked viruses and wicked snowstorms to track down eight funds in registration, one of the lowest totals since we launched three years ago.

The clear standout in the group is Dodge & Cox Global Bond, which the Dodge & Cox folks ran as “a private fund” since the end of December 2012.  It did really well in its one full year of operation – it gained 2.6% while its benchmark lost the same amount – and it comes with D&C’s signature low minimum, low expenses, low drama, team management.

Three other income funds are at least mildly interesting: Lazard Emerging Markets Income, Payden Strategic Income and Whitebox Unconstrained Income.

Manager Changes

On a related note, we also tracked down 50 sets of fund manager changes. The most intriguing of those include fallout from the pissing match at Pimco as Marc Seidner, an El-Erian ally, leaves to become GMO’s head of fixed-income operations.

Updates: The Observer here and there

I had a long conversation with a WSJ reporter which led to a short quotation in “Infrastructure funds are intriguing, but ….” The Wall Street Journal, Feb. 4 2014.  My bottom line was “infrastructure funds appear to be an incoherent mish-mash, with no two funds even agreeing on what sectors are worth including much less what stocks.  I don’t see any evidence of them adding value to a portfolio,” an observation prompted in part by T. Rowe Price’s decision to close their own Global Infrastructure fund. The writer, Lisa Ward, delicately quotes me as saying “you probably already own these same stocks in your other funds.” 

I was quoted as endorsing Artisan Global Small Cap (ARTWX) in Six promising new funds (though the subtitle might have been: “five of which I wouldn’t go near”), Kiplinger’s, Feb. 12 2014.  ARTWX draws on one of the most storied international management teams around, led by Mark Yockey.  The other funds profiled include three mutual funds and two ETFs.  The funds are Miller Income Opportunity (I’ve written elsewhere that “The whole enterprise leaves me feeling a little queasy since it looks either like Miller’s late-career attempt to prove that he’s not a dinosaur or Legg’s post-divorce sop to him”), Fidelity Event-Driven (FARNX: no record that Fido can actually execute with new funds anymore, much less with niche funds and untested managers), and Vanguard Global Minimum Volatility (VMVFX: meh – they work backward from a target risk level to see what returns they can generate).  The ETFs are two of the “smart beta” sorts of products, iShares MSCI USA Quality Factor (QUAL) and Schwab Fundamental U.S. Broad Market (FNDB). 

Finally, there was a very short piece entitled “Actively managed funds with low volatility,” in Bottom Line, Feb. 15 2014.  The publication is not online, at least not in an accessible form.  The editors were looking for funds with fairly well-established track records that have a tradition of low volatility.  I offered up Cook & Bynum Fund (COBYX, I’ve linked to our 2013 profile of them), FPA Crescent (FPACX, in which I’m invested) and Osterweis Fund (OSTWX).

Updates: Forbes discovers Beck, Mack & Oliver Partners (BMPEX)

Forbes rank a nice article on BMPEX, “Swinging at Strikes,” in their February 10, 2014 issue. Despite the lunacy of describing a $175 million fund as “puny” and “tiny,” the author turns up some fun facts to know and tell (the manager, Zac Wydra, was a premed student until he discovered that the sight of blood made him queasy) and gets the fund’s basic discipline right. Zac offers some fairly lively commentary in his Q4 shareholder letter, including a nice swipe at British haughtiness and a reflection on the fact that the S&P 500 is at an all-time high at the same time that the number of S&P 500 firms issuing negative guidance is near an all-time high.

Briefly Noted . . .

BlackRock has added the BlackRock Emerging Markets Long/Short Equity Fund (BLSAX) and the BlackRock Global Long/Short Equity Fund (BDMAX) as part of the constituent fund lineup in its Aggressive Growth, Conservative , Growth and Moderate Prepared Portfolios, and its Lifepath Active-Date series. Global has actually made some money for its investors, which EM has pretty much flatlined while the emerging markets have risen over its lifetime.  No word on a target allocation for either.

Effective May 1, Chou Income (CHOIX) will add preferred stocks to the list of their principal investments: “fixed-income securities, financial instruments that provide exposure to fixed-income securities, and preferred stocks.” Morningstar categorizes CHOIX as a World Bond fund despite the fact that bonds are less than 20% of its current portfolio and non-U.S. bonds are less than 3% of it.

Rydex executed reverse share splits on 13 of its funds in February. Investors received one new share for between three and seven old shares, depending on the fund.

Direxion will follow the same path on March 14, 2014 with five of their funds. They’re executing reverse splits on three bear funds and splits on two bulls.  They are: 

 

 SMALL WINS FOR INVESTORS

Auxier Focus (AUXIX) is reducing the minimum initial investment for their Institutional shares from $250,000 to $100,000. Investor and “A” shares remain at $5,000. The institutional shares cost 25 basis points less than the others.

TFS Market Neutral Fund (TFSMX) reopened to new investors on March 1, 2014.

At the end of January, Whitebox eliminated its Advisor share class and dropped the sales load on Whitebox Tactical. Their explanation: “The elimination of the Advisor share class was basically to streamline share classes … eliminating the front load was in the best interest of our clients.” The first makes sense; the second is a bit disingenuous. I’m doubtful that Whitebox imposed a sales load because it was “in the best interest of our clients” and I likewise doubt that’s the reason for its elimination.

CLOSINGS (and related inconveniences)

Artisan Global Value (ARTGX) closed on Valentine’s Day.

Grandeur Peak will soft close the Emerging Markets Opportunities (GPEOX) and hard close the Global Opportunities (GPGOX) and International Opportunities (GPIOX) strategies on March 5, 2014.

 Effective March 5, 2014, Invesco Select Companies Fund (ATIAX) will close to all investors.

Vanguard Admiral Treasury Money Market Fund (VUSSX) is really, really closed.  It will “no longer accept additional investments from any financial advisor, intermediary, or institutional accounts, including those of defined contribution plans. Furthermore, the Fund is no longer available as an investment option for defined contribution plans. The Fund is closed to new accounts and will remain closed until further notice.”  So there.

OLD WINE, NEW BOTTLES

Effective as of March 21, 2014, Brown Advisory Emerging Markets Fund (BIAQX) is being changed to the Brown Advisory – Somerset Emerging Markets Fund. The investment objective and the investment strategies of the Fund are not being changed in connection with the name change for the Fund and the current portfolio managers will continue. At the same time, Brown Advisory Strategic European Equity Fund (BIAHX) becomes Brown Advisory -WMC Strategic European Equity Fund.

Burnham Financial Industries Fund has been renamed Burnham Financial Long/Short Fund (BURFX).  It’s a tiny fund (with a sales load and high expenses) that’s been around for a decade.  It’s hard to know what to make of it since “long/short financial” is a pretty small niche with few other players.

Caritas All-Cap Growth Fund has become Goodwood SMID Cap Discovery Fund (GAMAX), a name that my 13-year-old keeps snickering at.  It’s been a pretty mediocre fund which gained new managers in October.

Compass EMP Commodity Long/Short Strategies Fund (CCNAX) is slated to become Compass EMP Commodity Strategies Enhanced Volatility Weighted Fund in May. Its objective will change to “match the performance of the CEMP Commodity Long/Cash Volatility Weighted Index.”  It’s not easily searchable by name at Morningstar because they’ve changed the name in their index but not on the fund’s profile.

Eaton Vance Institutional Emerging Markets Local Debt Fund (EELDX) has been renamed Eaton Vance Institutional Emerging Markets Debt Fund and is now a bit less local.

Frost Diversified Strategies and Strategic Balanced are hitting the “reset” button in a major way. On March 31, 2014, they change name, objective and strategy. Frost Diversified Strategies (FDSFX) becomes Frost Conservative Allocation while Strategic Balanced (FASTX) becomes Moderate Allocation. Both become funds-of-funds and discover a newfound delight in “total return consistent with their allocation strategy.” Diversified currently is a sort of long/short, ETFs, funds and stocks, options mess … $4 million in assets, high expense, high turnover, indifferent returns, limited protection. Strategic Balanced, with a relatively high downside capture, is a bit bigger and a bit calmer but ….

Effective on or about May 30, 2014, Hartford Balanced Allocation Fund (HBAAX) will be changed to Hartford Moderate Allocation Fund.

At the same time, Hartford Global Research Fund (HLEAX) becomes Hartford Global Equity Income Fund, with a so far unexplained “change to the Fund’s investment goal.” 

Effective March 31, 2014, MFS High Yield Opportunities Fund (MHOAX) will change its name to MFS Global High Yield Fund.

In mid-February, Northern Enhanced Large Cap Fund (NOLCX) became Northern Large Cap Core Fund though, at last check, Morningstar hadn’t noticed. Nice little fund, by the way.

Speaking of not noticing, the folks at Whitebox have accused of us ignoring “one of the most important changes we made, which is Whitebox Long Short Equity Fund is now the Whitebox Market Neutral Equity Fund.” We look alternately chastened by our negligence and excited to report such consequential news.

OFF TO THE DUSTBIN OF HISTORY

BCM Decathlon Conservative Portfolio, BCM Decathlon Moderate Portfolio and BCM Decathlon Aggressive Portfolio have decided that they can best serve their shareholders by liquidating.  The event is scheduled for April 14, 2014.

BlackRock International Bond Portfolio (BIIAX) has closed and will liquidate on March 14, 2014.  A good move given the fund’s dismal record, though you’d imagine that a firm with BlackRock’s footprint would want a fund of this name.

Pending shareholder approval, City National Rochdale Diversified Equity Fund (AHDEX) will merge into City National Rochdale U.S. Core Equity Fund (CNRVX) of the Trust. I rather like the honesty of their explanation to shareholders:

This reorganization is being proposed, among other reasons, to reduce the annual operating expenses borne by shareholders of the Diversified Fund. CNR does not expect significant future in-flows to the Diversified Fund and anticipates the assets of the Diversified Fund may continue to decrease in the future. The Core Fund has significantly more assets [and] … a significantly lower annual expense ratio.

Goldman Sachs Income Strategies Portfolio merged “with and into” the Goldman Sachs Satellite Strategies Portfolio (GXSAX) and Goldman Sachs China Equity Fund with and into the Goldman Sachs Asia Equity Fund (GSAGX) in mid-February.

Huntington Rotating Markets Fund (HRIAX) has closed and will liquidate by March 28, 2014.

Shareholders of Ivy Asset Strategy New Opportunities Fund (INOAX) have been urged to approve the merger of their fund into Ivy Emerging Markets Equity Fund (IPOAX).  The disappearing fund is badly awful but the merger is curious because INOAX is not primarily an emerging markets fund; its current portfolio is split between developed and developing.

The Board of Trustees of the JPMorgan Ex-G4 Currency Strategies Fund (EXGAX) has approved the liquidation and dissolution of the Fund on or about March 10, 2014.  The “strategies” in question appear to involve thrashing around without appreciable gain.

After an entire year of operation (!), the KKR Board of Trustees of the Fund approved a Plan of Liquidation with respect to KKR Alternative Corporate Opportunities Fund (XKCPX) and KKR Alternative High Yield Fund (KHYZX). Accordingly, the Fund will be liquidated in accordance with the Plan on or about March 31, 2014 or as soon as practicable thereafter. 

Loomis Sayles Mid Cap Growth Fund (LAGRX) will be liquidated on March 14^th, a surprisingly fast execution given that the Board approved the action just the month before.

On February 13, 2014, the shareholders of the Quaker Small Cap Growth Tactical Allocation Fund (QGASX) approved the liquidation and dissolution of the Fund. 

In Closing . . .

We asked you folks, in January, what made the Observer worthwhile.  That is, what did we offer that brought you back each month?  We poured your answers into a Wordle in hopes of capturing the spirit of the 300 or so responses.

Three themes recurred:  (1) the Observer is independent. We’re not trying to sell you anything.  We’re not trying to please advertisers. We’re not desperate to write inflated drivel in order to maximize clicks. We don’t have a hidden agenda. 

(2) We talk about things that other folks do not. There’s a lot of appreciation for our willingness to ferret out smaller, emerging managers and to bring them to you in a variety of formats. There’s also some appreciate of our willingness to step back from the fray and try to talk about important long-term issues rather than sexy short-term ones.

(3) We’re funny. Or weird. Perhaps snarky, opinionated, cranky and, on a good day, curmudgeonly.

And that helps us a lot.  As we plan for the future of the Observer, we’re thinking through two big questions: where should we be going and how can we get there? We’ll write a bit next time about your answer to the final question: what should we be doing that we aren’t (yet)?

We’ve made a couple changes under the hood to make the Observer stronger and more reliable.  We’ve completed our migration to a new virtual private server at Green Geeks, which should help with reliability and allow us to handle a lot more traffic.  (We hit records again in January and February.)  We also upgraded the software that runs our discussion board.  It gives the board better security and a fresher look.  If you’ve got a bookmarked link to the discussion board, we need you to reset your link to http://www.mutualfundobserver.com/discuss/discussions.  If you use your old bookmark you’ll just end up on a redirect page.  

In April we celebrate our third anniversary. Old, for a website nowadays, and so we thought we’d solicit the insights of some of the Grand Old Men of the industry: well-seasoned, sometimes storied managers who struck out on their own after long careers in large firms. We’re trying hard to wheedle our colleague Ed, who left Oakmark full of years and honors, to lead the effort. While he’s at that, we’re planning to look again at the emerging markets and the almost laughable frenzy of commentary on “the bloodbath in the emerging markets.”  (Uhh … Vanguard’s Emerging Market Index has dropped 8% in a year. That’s not a bloodbath. It’s not even a correction. It’s a damned annoyance. And, too, talking about “the emerging markets” makes about as much analytic sense as talking about “the white people.”  It’s not one big undifferentiated mass).  We’ve been looking at fund flow data and Morningstar’s “buy the unloved” strategy.  Mr. Studzinski has become curious, a bit, about Martin Focused Value (MFVRX) and the arguments that have led them to a 90% cash stake. We’ll look into it.

Please do bookmark our Amazon link.  Every bit helps! 

 As ever,

Dear friends,

Welcome to the New Year.  At least as we calculate it.  The Year of the Horse begins January 31, a date the Vietnamese share.  The Iranians, like the ancient Romans, sensibly celebrate the New Year at the beginning of spring.  A bunch of cultures in South Asia pick mid-April. Rosh Hashanah (“head of the year”) rolls around in September.  My Celtic ancestors (and a bunch of modern Druidic wannabees) preferred Samhain, at the start of November.

Whatever your culture, the New Year is bittersweet.  We seem obsessed with looking back in regret at all the stuff we didn’t do, as much as we look forward to all of the stuff we might yet do.

My suggestion: can the regrets, get off yer butt, and do the stuff now that you know you need to do.  One small start: get rid of that mutual fund.  You know the one.  You’ve been regretting it for years.  You keep thinking “maybe I’ll wait to let it come back a bit.”  The one that you tend to forget to mention whenever you talk about investments.

Good gravy.  Dump it!  It takes about 30 seconds on the phone and no one is going to hassle you about it; it’s not like the manager is going to grab the line and begin pleading for a bit more time.  Pick up a lower cost replacement.  Maybe look into a nice ETF or index fund. Track down a really good fund whose manager is willing to put his own fortune and honor at risk along with yours.

You’ll feel a lot better once you do.

We can talk about your gym membership later.

Voices from the bottom of the well

THESE are the times that try men’s souls. The summer soldier and the sunshine patriot will, in this crisis, shrink from the service of their country; but he that stands by it now, deserves the love and thanks of man and woman. Tyranny, like hell, is not easily conquered; yet we have this consolation with us, that the harder the conflict, the more glorious the triumph. What we obtain too cheap, we esteem too lightly: it is dearness only that gives every thing its value. Heaven knows how to put a proper price upon its goods; and it would be strange indeed if so celestial an article as FREEDOM should not be highly rated.

Thos. Paine, The Crisis, 23 December 1776

Investors highly value managers who are principled, decisive, independent, active and contrarian.  Right up to the moment that they have one. 

Then they’re appalled.

There are two honorable approaches to investing: relative value and absolute value.  Relative value investors tend to buy the best-priced securities available, even if the price quoted isn’t very good.  They tend to remain fully invested even when the market is pricey and have, as their mantra, “there’s always a bull market in something.”  They’re optimistic by nature, enjoy fruity wines and rarely wear bowties.

Absolute value investors tend to buy equities only when they’re selling for cheap.  Schooled in the works of Graham and Dodd, they’re adamant about having “a margin of safety” when investing in an inherently risk asset class like stocks.  They tend to calculate the fair value of a company and they tend to use cautious assumptions in making those calculations.  They tend to look for investments selling at a 30% discount to fair value, or to firms likely to produce 10% internal returns of return even if things turn ugly.  They’re often found sniffing around the piles that trendier investors have fled.  And when they find no compelling values, they raise cash.  Sometimes lots of cash, sometimes for quite a while.  Their mantra is, “it’s not ‘different this time’.”  They’re slightly-mournful by nature, contemplate Scotch, and rather enjoyed Andy Rooney’s commentaries on “60 Minutes.”

If you’re looking for a shortcut to finding absolute value investors today, it’s a safe bet you’ll find them atop the “%age portfolio cash” list.  And at the bottom of the “YTD relative return” list.  They are, in short, the guys you’re now railing against.

But should you be?

I spent a chunk of December talking with guys who’ve managed five-star funds and who were loved by the crowds but who are now suspected of having doubled-up on their intake of Stupid Pills.  They are, on whole, stoic. 

Take-aways from those conversations:

1. They hate cash.  As a matter of fact, it’s second on their most-hated list behind only “risking permanent impairment of capital”.
2. They’re not perma-bears. They love owning stocks. These are, by and large, guys who sat around reading The Intelligent Investor during recess and get tingly at the thought of visiting Omaha. But they love them for the prospect of the substantial, compounded returns they might generate.  The price of those outsized returns, though, is waiting for one of the market’s periodic mad sales.
3. They bought stocks like mad in early 2009, around the time that the rest of us were becoming nauseated at the thought of opening our 401(k) statements. Richard Cook and Dowe Bynum, for example, were at 2% cash in March 2009.  Eric Cinnamond was, likewise, fully invested then.
4. They’ve been through this before though, as Mr. Cinnamond notes, “it isn’t very fun.”  The market moves in multi-year cycles, generally five years long more or less. While each cycle is different in composition, they all have similar features: the macro environment turns accommodative, stocks rise, the fearful finally rush in, stocks overshoot fair value by a lot, there’s an “oops” and a mass exit for the door.  Typically, the folks who arrived late inherit the bulk of the pain.
5. And they know you’re disgusted with them. Mr. Cinnamond, whose fund has compounded at 12% annually for the past 15 years, allows “we get those long-term returns by looking very stupid.”  Richard Cook agrees, “we’re going to look silly, sometimes for three to five years at a stretch.”  Zac Wydra admits that he sometimes looks at himself in the mirror and asks “how can you be so stupid?”

And to those investors who declare, “but the market is reasonably priced,” they reply: “we don’t buy ‘the market.’  We buy stocks.  Find the individual stocks that meet the criteria that you hired us to apply, and we’ll buy them.”

What do they think you should do now?  In general, be patient.  Mr. Cook points to Charlie Munger’s observation:

I think the [Berkshire Hathaway’s] record shows the advantage of a peculiar mind-set – not seeking action for its own sake, but instead combining extreme patience with extreme decisiveness. It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.

Which is hard.  Several of the guys pointed to Seth Klarman’s decision to return $4 billion in capital to his hedge fund investors this month. Klarman made the decision in principle back in September, arguing that if there were no compelling investment opportunities, he’d start mailing out checks.  Two things are worth noting about Klarman: (1) his hedge funds have posted returns in the high teens for over 30 years and (2) he’s willing to sit at 33-50% cash for a long time if that’s what it takes to generate big long-term returns.

Few managers have Klarman’s record or ability to wait out markets.  Mr. Cinnamond noted, “there aren’t many fund managers with a long track record doing this because you’re so apt to get fired.”  Jeremy Grantham of GMO nods, declaring that “career risk” is often a greater driver of a manager’s decisions than market risk is.

In general, the absolute value guys suggest you think differently about their funds than you think about fully-invested relative value ones.  Cook and Bynum’s institutional partners think of them as “alternative asset managers,” rather than equity guys and they regard value-leaning hedge funds as their natural peer group.  John Deysher, manager of Pinnacle Value (PVFIX), recommends considering “cash-adjusted returns” as a viable measure, though Mr. Cinnamond disagrees since a manager investing in unpopular, undervalued sectors in a momentum driven market is still going to look inept.

Our bottom line: investors need to take a lot more responsibility if they’re going to thrive.  That means we’ve got to look beyond simple return numbers and ask, instead, about what decisions led to those returns.  That means actually reading your managers’ commentaries, contacting the fund reps with specific questions (if your questions are thoughtful rather more than knee-jerk, you’d be surprised at the quality of answers you receive) and asking the all-important question, “is my manager doing precisely what I hired him to do: to be stubbornly independent, fearful when others are greedy and greedy when others are fearful?” 

Alternately: buy a suite of broadly diversified, low-cost index funds.  There are several really solid funds-of-index-funds that give you broad exposure to market risk with no exposure to manager risk.  The only thing that you need to avoid at all costs is the herd: do not pay active management prices for the services of managers whose only goal is to be no different than every other timid soul out there.

The Absolute Value Guys

	Cash	Absolute 2013 return	Relative 2013 return
ASTON River Road Independent Value ARIVX	67%	7%	bottom 1%
Beck, Mack & Oliver Partners BMPEX	18	20	bottom 3%
Cook & Bynum COBYX	44	11	bottom 1%
FPA Crescent FPACX *	35	22	top 5%
FPA International Value FPIVX	40	18	bottom 20%
Longleaf Partners Small-Cap LLSCX	45	30	bottom 23%
Oakseed SEEDX	21	24	bottom 8%
Pinnacle Value PVFIX	44	17	bottom 2%
Yacktman YACKX	22	28	bottom 17%

* FPACX’s “moderate allocation” competitors were caught holding bonds this year, dumber even than holding cash.

Don’t worry, relative value guys.  Morningstar’s got your back.

Earnings at S&P500 companies grew by 11% in 2013, through late December, and they paid out a couple percent in dividends.  Arguably, then, stocks are worth about 13% more than they were in January.  Unfortunately, the prices paid for those stocks rose by more than twice that amount.  Stocks rose by 32.4% in 2013, with the Dow setting 50 all-time record highs in the process. One might imagine that if prices started at around fair value and then rose 2.5 times as much as earnings did, valuations would be getting stretched.  Perhaps overvalued by 19% (simple subtraction of the earnings + dividend rise from the price + dividend rise)?

Not to worry, Morningstar’s got you covered.  By their estimation, valuations are up only 5% on the year – from fully valued in January to 5% high at year’s end.  They concluded that it’s certainly not time to reconsider your mad rush into US equities.  (Our outlook for the stock market, 12/27/2013.) While the author, Matthew Coffina, did approvingly quote Warren Buffett on market timing:

Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.

He didn’t, however, invoke what Warren Buffett terms “the three most important words in all of investing,” margin of safety.  Because you can’t be sure of a firm’s exact value, you always need to pay less than you think it’s worth – ideally 30 or 40% less – in order to protect your investors against your own fallible judgment. 

Quo Vadis Japan

I go out of the darkness

Onto a road of darkness

Lit only by the far off

Moon on the edge of the mountains.

Izumi

One of the benefits of having had multiple careers and a plethora of interests is that friends and associates always stand ready with suggestions for you to occupy your time. In January of 2012, a former colleague and good friend from my days with the Navy’s long-range strategic planning group suggested that I might find it interesting to attend the Second China Defense and Security Conference at the Jamestown Foundation. That is how I found myself seated in a conference room in February with roughly a hundred other people. My fellow attendees were primarily from the various alphabet soup governmental agencies and mid-level military officers. 

The morning’s presentations might best be summed up as grudging praise about the transformation of the Chinese military, especially their navy, from a regional force to one increasingly able to project power throughout Asia and beyond to carry out China’s national interests. When I finally could not stand it any longer, after a presentation during Q&A, I stuck my hand up and asked why there was absolutely no mention of the 600 pound gorilla in the corner of the room, namely Japan and the Japanese Maritime Self-Defense Force. The JMSDF was and is either the second or third largest navy in the world. It is considered by many professional observers to be extraordinarily capable. The silence that greeted my question was akin to what one would observe if I had brought in a dog that had peed on the floor. The moderator muttered a few comments about the JMSDF having fine capabilities. We then went on with no mention of Japan again. At that point I realized I had just learned the most important thing that I was going to take from the conference, that Japan (and its military) had become the invisible country of Asia. 

The New Year is when as an investor you reflect back on successes and mistakes. And if one is especially introspective, one can ponder why. For most of 2013, I was banging the drum on two investment themes that made sense to me:  (a) the Japanese equity market and (b) the Japanese currency – the yen – hedged back into U.S. dollars. The broad Japanese market touched highs this month not seen before this century. The dollar – yen exchange rate moved from 89.5 at the beginning of the year to 105.5. In tandem, the themes have proven to be quite profitable. Had an investment been made solely in the Wisdom Tree: Japan Hedged Equity ETF, a total return of 41.8% would have been achieved by the U.S. dollar investor. So, is this another false start for both the Japanese stock market and economy? Or is Japan on the cusp of an economic and political transformation?   

When I mention to institutional investors that I think the change in Japan is real, the most common response I get is a concern about “Abenomics.” This is usually expressed as “They are printing an awful lot of money.”  Give me a break.  Ben Bernanke and his little band of merry Fed governors have effectively been printing money with their various QE efforts. Who thinks that money will be repaid or the devaluation of the U.S. dollar will be reversed?  The same can be said of the EU central bankers.  If anything, the U.S. has been pursuing a policy of beggar thy creditor, since much of our debt is owed to others.  At least in Japan, they owe the money to themselves. They have also gone through years of deflation without the social order and fabric of society breaking down. One wonders how the U.S. would fare in a similar long-term deflationary environment. 

I think the more important distinction is to emphasize what “Abenomics” is not.  It is not a one-off program of purchasing government bonds with a view towards going from a multi-year deflationary spiral to generating a few points of inflation.  It is a comprehensive program aimed at reversing Japan’s economic, political, and strategic slide of the past twenty years. Subsumed under the rubric of “Abenomics” are efforts to increase and widen the acceptance of child care facilities to enable more of Japan’s female talent pool to actively participate in the workforce, a shift in policy for the investments permitted in pension funds to dramatically increase domestic equity exposure, and incentives to transform the Japanese universities into research and resource engines. Similarly, the Japanese economy is beginning to open from a closed economy to one of free trade, especially in agriculture, as Japan has joined the Trans Pacific Partnership. Finally, public opinion has shifted dramatically to a willingness to contemplate revision of Japan’s American-drafted post-war Constitution. This would permit a standing military and a more active military posture. It would normalize Japan as a global nation, and restore a balance of interests and power in East Asia. The ultimate goal then is to restore the self-confidence of the Japanese nation.  So, what awakened Japan and the Japanese?

Strangely enough, the Chinese did it. I have been in Japan four times in the last twenty-two months, which does not make me an expert on anything. But it has allowed me to discern a shift in the mood of the country. Long-time Japan hands had told me that when public opinion in Japan shifts, it shifts all at once and moves together in the same direction. Several months ago, I asked a friend and investment manager who is a long-time resident of Tokyo what had caused that shift in opinion. His response was that most individuals, he as well, traced it to the arrest and detention by the Japanese Coast Guard, of a Chinese fishing vessel and its captain who had strayed into Japanese waters. China responded aggressively, embargoing rare earth materials that the Japanese electronics and automobile industries needed, and made other public bellicose noises. Riots and torching of Japanese plants in China followed, with what seemed to be the tacit approval of the Chinese government. Japan released the ship and its captain, and in Asian parlance, lost face. As my friend explained it, the Japanese public came to the conclusion that the Chinese government was composed of bad people whose behavior was unacceptable. Concurrently, Japan Inc. began to relocate its overseas investment away from China and into countries such as Vietnam, Indonesia, Thailand, and Singapore.

From an investment point of view, what does it all mean? First, one should not look at Prime Minister Abe, Act II (remember that he was briefly in office for 12 months in 2006-2007) in a vacuum. Like Reagan and Churchill, he used his time in the “wilderness years” to rethink what he wanted to achieve for Japan and how he would set about doing it. Second, one of the things one learns about Japan and the Japanese is that they believe in their country and generally trust their government, and are prepared to invest in Japan. This is in stark contrast to China, where if the rumors of capital flows are to be believed, vast sums of money are flowing out of the country through Hong Kong and Singapore. So, after the above events involving China, Abe’s timing in return to office was timely. 

While Japanese equities have surged this year, that surge has been primarily in the large cap liquid issues that are easily studied and invested in by global firms. Most U.S. firms follow the fly-by approach. Go to Tokyo for a week of company meetings, and invest accordingly. Few firms make the commitment of having resources on the ground. That is why if you look at most U.S.-based Japan specialist mutual funds, they all own pretty much the same large cap liquid names, with only the percentages and sector weightings varying. There are tiers of small and mid-cap companies that are under-researched and under-invested in.  If this is the beginning of a secular bull market, as we saw start in the U.S. in 1982, Japan will just be at the beginnings of eliminating the value gap between intrinsic value and the market price of securities, especially in the more inefficiently-traded and under-researched companies. 

So, as Lenin once famously asked, “What is to be done?”  For most individuals, individual stock investments are out of the question, given the currency, custody, language, trading, and tax issues. For exposure to the asset class, there is a lot to be said for a passive approach through an index fund or exchange-traded fund, of which there are a number with relatively low expense ratios. Finally, there are the fifteen or so Japan-only mutual funds. I am only aware of three that are small-cap vehicles – DFA, Fidelity, and Hennessy. There are also two actively-managed closed end funds. I will look to others to put together performance numbers and information that will allow you to research the area and draw your own conclusions.  

Finally, it should be obvious that Japan does not lend itself to simple explanations. As Americans, we are often in a time-warp, thinking that with the atomic bombs, American Occupation and force-fed Constitution, we successfully transformed Japan into a pacifist democratically-styled Asian theme park.  My conclusion is rather that what you see in Japan is not reality (whatever that is) but what they are comfortable with you seeing. I think for instance of the cultural differences with China in a business sense.  With the Chinese businessman, a signed contract is in effect the beginning of the negotiation.  For the Japanese businessman, a signed contract is a commitment to be honored to the letter.

I will leave you with one thing to ponder shared with me by a Japanese friend. She told me that the samurai have been gone for a long time in Japan. But, everyone in Japan still knows who the samurai families are and everyone knows who is of those families and who is not. And she said, everyone from those families still tends to marry into other samurai families.  So I thought, perhaps they are not gone after all.  

Edward Studzinski

From Day One …

… the Observer’s readers were anxious to have us publish lists of Great Funds, as FundAlarm did with its Honor Roll funds.  For a long time I demurred because I was afraid folks would take such a list too seriously.  That is, rather than viewing it as a collection of historical observations, they’d see it as a shopping list. 

After two years and unrelenting inquires, I prevailed upon my colleague Charles to look at whether we could produce a list of funds that had great track records but, at the same time, highlight the often-hidden data concerning those funds’ risks.  With that request and Charles’s initiative, the Great Owl Funds were launched.

And now Charles returns to that troubling original question: what can we actually learn about the future from a fund’s past?

In Search of Persistence

It outperformed nearly 3/4ths of the time, while it under-performed only 5%. NAINX essentially equaled or beat its peers 194 out of 205 periods. Encouraged, the investor purchases the fund making a long-term commitment to buy-and-hold.

It’s now 2013, twenty years later. How has NAINX performed? To the investor’s horror, Virtus Tactical Allocation underperformed 3/4ths of the time since purchased! And the fund that outperformed most persistently? Mairs & Power Balanced (MAPOX), of course.

Back to 1993. This time a more aggressive investor applies the same methodology to the large growth category and finds an extraordinary fund, named Fidelity Magellan (FMAGX).  This fund outperformed nearly 100% of the time across 205 rolling 3-year periods over 20 years versus 31 other long-time peers. But during the next 20 years…? Not well, unfortunately. This investor would have done better choosing Fidelity Contrafund (FCNTX). How can this be? Most industry experts would attribute the colossal shift in FMAGX performance to the resignation of legendary fund manager Peter Lynch in 1990.

MJG, one of the heavy contributors to MFO’s discussion board, posts regularly about the difficulty of staying on top of one’s peer group, often citing results from Standard & Poor’s Index Versus Active Indexing (SPIVA) reports. Here is the top lesson-learned from ten years of these reports:

“Over a five-year horizon…a majority of active funds in most categories fail to outperform indexes. If an investing horizon is five years or longer, a passive approach may be preferable.”

The December 2013 SPIVA “Persistence Scorecard” has just been published, which Joshua Brown writes insightfully about in “Persistence is a Killer.” The scorecard once again shows that only a small fraction of top performing domestic equity mutual funds remain on top across any 2, 3, or 5 year period.

What does mutual fund non-persistence look like across 40 years? Here’s one depiction:

The image (or “mural”) represents monthly rank by color-coded quintiles of risk-adjusted returns, specifically Martin Ratio, for 101 funds across five categories. The funds have existed for 40 years through September 2013. The calculations use total monthly returns of oldest share class only, ignoring any load, survivor bias, and category drift.  Within each category, the funds are listed alphabetically.

There are no long blue/green horizontal streaks. If anything, there seem to be more extended orange/red streaks, suggesting that if mutual fund persistence does exist, it’s in the wrong quintiles! (SPIVA actually finds similar result and such bottom funds tend to end-up merged or liquated.)

Looking across the 40 years of 3-year rolling risk-adjusted returns, some observations:

• 98% of funds spent some periods in every rank level…top, bottom, and all in-between
• 35% landed in the bottom two quintiles most of the time…that’s more than 1/3^rd of all funds
• 13% were in the top two bottom quintiles…apparently harder to be persistently good than bad
• Sequoia (SEQUX) was the most persistent top performer…one of greatest mutual funds ever
• Wall Street (WALLX) was the most persistent cellar dweller…how can it still exist?

The difference in overall return between the most persistent winner and loser is breathtaking: SEQUX delivered 5.5 times more than SP500 and 16 times more than WALLX. Put another way, $10K invested in SEQUX in October 1973 is worth nearly $3M today. Here’s how the comparison looks:

So, while attaining persistence may be elusive, the motivation to achieve it is clear and present.

The implication of a lack of persistence strikes at the core of all fund rating methodologies that investors try to use to predict future returns, at least those based only on historical returns. It is, of course, why Kiplinger, Money, and Morningstar all try to incorporate additional factors, like shareholder friendliness, experience, and strategy, when compiling their Best Funds lists. An attempt, as Morningstar well states, to identify “funds with the highest potential of success.”

The MFO rating system was introduced in June 2013. The current 20-year Great Owls, shown below for moderate allocation and large growth categories, include funds that have achieved top performance rank over the past 20, 10, 5, and 3 year evaluation periods. (See Rating Definitions.)

But will they be Great Owls next year? The system is strictly quantitative based on past returns, which means, alas, a gentle and all too ubiquitous reminder that past performance is not a guarantee of future results. (More qualitative assessments of fund strategy, stewardship, and promise are provided monthly in David’s fund profiles.) In any case and in the spirit of SPIVA, we will plan to publish periodically a Great Owl “Persistence Scorecard.”

31Dec2013/Charles

It’s not exciting just because the marketers say it is

Most mutual funds don’t really have any investment reason to exist: they’re mostly asset gathering tools that some advisor created in support of its business model. Even the funds that do have a compelling case to make often have trouble receiving a fair hearing, so I’m sympathetic to the need to find new angles and new pitches to try to get journalists’ and investors’ attention.

But the fact that a marketer announces it doesn’t mean that journalists need to validate it through repetition. And it doesn’t mean that you should just take in what we’ve written.

Case in point: BlackRock Emerging Markets Long/Short Fund (BLSAX).  Here’s the combination of reasonable and silly statements offered in a BlackRock article justifying long/short investing:

For example, our access to information relies on cutting edge infrastructure to compile vast amounts of obvious and less-obvious sources of publicly available information. In fact, we consume a massive amount of data from more than 25 countries, with a storage capacity 4 times the Library of Congress and 8 times the size of Wikipedia. We take that vast quantity of publicly available information and filter and identify relevant pieces.

Reasonable statement: we do lots of research.  Silly statement: we have a really big hard drive on our computer (“a storage capacity of…”).  Why on earth would we care?  And what on earth does it mean?  “4 times the Library of Congress”?  The LoC digital collection – a small fraction of its total collection – holds three petabytes of data, a statement that folks immediately recognize as nonsensical.  3,000,000 gigabytes.  So the BlackRock team has a 12 petabyte hard drive?  12 petabytes of data?  How’s it used?  How much is reliable, consistent, contradictory or outdated?  How much value do you get from data so vast that you’ll never comprehend it?

NSA’s biggest “data farm” consumes 65 megawatts of power, has melted down 10 times, and – by the fed’s own reckoning – still hasn’t produced demonstrable security gains.  Data ≠ knowledge.

The Google, by the way, processes 20 petabytes of user-generated content per day.

Nonetheless, Investment News promptly and uncritically gloms onto the factoid, and then gets it twice wrong:

The Scientific Active Equity team takes quantitative investing to a whole new level. In fact, the team has amassed so much data on publicly traded companies that its database is now four times the size of Wikipedia and eight times the size of the Library of Congress (Jason Kephart, Beyond black box investing: Fund uses database four times the size of Wikipedia, 12/26/13).

Error 1: reversing the LoC and the Wikipedia.  Error 2: conflating “storage capacity” with “data.” (And, of course, confusing “pile o’ data” with “something meaningful.”)

MFWire promptly grabs the bullhorn to share the errors and the credulity:

This Fund Uses the Data of Eight Libraries of Congress (12/26/13, Boxing Day for our British friends)

The team managing the fund uses gigantic amounts of data — four times the size of Wikipedia and eight times the size of the Library of Congress — on public company earnings, analyst calls, news releases, what have you, to gain on insights into different stocks, according to Kephart.

Our second, perhaps larger, point of disagreement with Jason (who, in fairness, generally does exceptionally solid work) comes in his enthusiasm for one particular statistic:

That brings us to perhaps the fund’s most impressive stat, and the one advisers really need to keep their eyes on: its correlation to global equities.

Based on weekly returns through the third quarter, the most recent data available, the fund has a correlation of just 0.38 to the MSCI World Index and a correlation of 0.36 to the S&P 500. Correlations lower than 0.5 lead to better diversification and can lead to better risk-adjusted returns for the entire portfolio.

Uhhh.  No?

Why, exactly, is correlation The Golden Number?  And why is BlackRock’s correlation enough to make you tingle?  The BlackRock fund has been around just one year, so we don’t know its long-term correlation.  In December, it had a net market exposure of just 9% which actually makes a .36 correlation seem oddly high. BlackRock’s correlation is not distinctively low (Whitebox Long/Short WBLSX has a three-year correlation of 0.33, for instance). 

Nor is low correlation the hallmark of the best long-term funds in the group.  By almost any measure, the best long/short fund in existence is the closed Robeco Boston Partners L/S Equity Fund (BPLEX).  BPLEX is a five-star fund, a Lipper Leader, a Great Owl fund, with returns in the top 4% of its peer group over the past decade. And its long term correlation to the market: 75.  Wasatch Long/Short (FMLSX), another great fund with a long track record: 90. Marketfield (MFLDX), four-star, Great Owl: 67.

The case for BlackRock EM L/S is it’s open. It’s got a good record, though a short one.  In comparison to other, more-established funds, it substantially trails Long-Short Opportunity (LSOFX) since inception, is comparable to ASTON River Road (ARLSX) and Wasatch Long Short (FMLSX), while it leads Whitebox Long-Short (WBLSX), Robeco Boston Partners (BPLEX) and RiverPark Long/Short Opportunity (RLSFX). The fund has nearly $400 million in assets after one year and charges 2% expenses plus a 5.25% front load.  That’s more than ARLSX, WBLSX or FMLSX, though cheaper than LSOFX. 

Bottom Line: as writers, we need to guard against the pressures created by deadlines and the desire for “clicks.”  As readers, you need to realize we have good days and bad and you need to keep asking the questions we should be asking: what’s the context of this number?  What does it mean?  Why am I being given it? How does it compare?  And, as investors, we all need to remember that magic is more common in the world of Harry Potter than in the world we’re stuck with.

Wells Fargo and the Roll Call of the Wretched

Our Annual Roll Call of the Wretched highlights those funds which consistently, over a period of many years, trail their benchmark.  We noted that inclusion on the list signaled one of two problems:

• Bad fund or
• Bad benchmark.

The former problem is obvious.  The latter takes a word of explanation.  There are 7055 distinct mutual funds, each claiming – more or less legitimately – to be different from all of the others.   For the purpose of comparison, Morningstar and Lipper assign them to one of 108 categories.  Some funds fit easily and well, others are laughably misfit.  One example is RiverPark Short-Term High Yield Fund (RPHYX), which is a splendid cash management fund whose performance is being compared to the High-Yield group which is dominated by longer-duration bonds that carry equity-like risks and returns.

You get a sense of the mismatch – and of the reason that RPHYX was assigned one-star – when you compare the movements of the fund to the high-yield group.

That same problem afflicts Wells Fargo Advantage Short-Term High Yield Bond (SSTHX), an entirely admirable fund that returns around 4% per year over the long term in a category that delivers 50% greater returns with 150% greater volatility.  In Morningstar’s eyes, one star.

Joel Talish, one of the managing directors at Wells Fargo Advisors, raised the entirely reasonable objection that SSTHX isn’t wretched – it’s misclassified – and it shouldn’t be in the Roll Call at all. He might well be right. Our strategy has been to report all of the funds that pass the statistical screen, then to highlight those whose performance is better than the peer data suggest.  We don’t tend to remove funds from the list just because we believe that the ratings agencies are wrong. We’ve made that decision consciously: investors need to read these ubiquitous statistical screens more closely and more skeptically.  A pattern of results arises from a series of actions, and they’re meaningful only if you take the time to understand what’s going on. By highlighting solid funds that look bad because of a rater’s unexplained assignments, we’re trying to help folks learn how to look past the stars.

It might well be the case that highlighting and explaining SSTHX’s consistently one-star performance did a substantial disservice to the management team. It was a judgment call on our part and we’ll revisit it as we prepare future features.  For now, we’re hopeful that the point we highlighted at the start of the list: 

Use lists like the Roll Call of the Wretched or the Three Alarm Funds as a first step, not a final answer.  If you see a fund of yours on either list, find out why.  Call the adviser, read the prospectus, try the manager’s letter, post a question on our board.  There might be a perfectly good reason for their performance, there might be a perfectly awful one.  In either case, you need to know.

Observer Fund Profile

Each month the Observer provides in-depth profiles of notable funds that you’d otherwise not hear of.  Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds.  “Stars in the Shadows” are older funds that have attracted far less attention than they deserve. 

RiverPark Strategic Income (RSIVX): RSIVX sits at the core of Cohanzick’s competence, a conservative yet opportunistic strategy that they’ve pursued for two decades and that offers the prospect of doubling the returns of its very fine Short-Term High Yield Fund.

Elevator Talk: Oliver Pursche, GMG Defensive Beta Fund (MPDAX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more. 

The traditional approach to buffering the stock market’s volatility without entirely surrendering the prospect of adequate returns was to divide the portfolio between (domestic, large cap) stocks and (domestic, investment grade) bonds, at a ratio of roughly 60/40.  That strategy worked passably well as long as stocks could be counted on to produce robust returns and bonds could be counted on to post solid though smaller gains without fail.  As the wheels began falling off that strategy, advisors began casting about for alternative strategies. 

Some, like the folks at Montebello Partners, began drawing lessons from the experience of hedge funds and institutional alternatives managers.  Their conclusion was that each asset class had one or two vital contributions to make to the health of the portfolio, but that exposure to those assets had to be actively managed if they were going to have a chance of producing equity-like (perhaps “equity-lite”) returns with substantial downside protection.

Their strategy is manifested in GMG Defensive Beta, which launched in the summer of 2009.  Its returns have generally overwhelmed those of its multi-alternative peers (top 3% over the past three years, substantially higher returns since inception) though at the cost of substantially higher volatility.  Morningstar rates it as a five-star fund, while Lipper gives it four stars for both Total Return and Consistency of Return and five stars for Capital Preservation.

Oliver Pursche is the president of Gary M Goldberg Financial Services (hence GMG) one of the four founding co-managers of MPDAX.  Here are his 218 words (on whole, durn close to target) on why you should consider a multi alternative strategy:

Markets are up, and as a result, so are the risks of a correction. I don’t think that a 2008-like crash is in the cards, but we could certainly see a 20% correction at some point. If you agree with me, protecting your hard fought gains makes all the sense in the world, which is why I believe low-volatility and multi-alternative funds like our GMG Defensive Beta Fund will continue to gain favor with investors. The problem is that most of these new funds have no, or only a short track-record, so it’s difficult to know how they will actually perform in a prolonged downturn. One thing is certain, in the absence of a longer-term track record, low fees and low turnover tend to be advantageous to investors. This is why our fund is a no-load fund and we cap our fees at 1.49%, well below most of our peers, and our cap gain distributions have been minimal.

From my perspective, if you’re looking to continue to have market exposure, but don’t want all of the risks associated with investing in the S&P 500, our fund is ideally suited. We’re strategic and tactical at the same time and have demonstrated our ability to remain disciplined, which is (I think) why Morningstar has awarded us a 5 Star ranking.

MPDAX is a no-load fund with a single share class.  The minimum initial investment is $1,000.   Expenses are 1.49% on about $27 million in assets.

The fund’s website is functional but spare.  You get the essential information, but there’s no particular wealth of insight or commentary on this strategy.  There’s a Morningstar reprint available but you should be aware that the file contains one page of data reporting and five pages of definitions and disclaimers.

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures.  We’re saddened to report that Tom chose to liquidate the fund.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.
10. November 2013: Jeffrey Ringdahl of American Beacon Flexible Bond (AFXAX) gives teams from Brandywine Global, GAM and PIMCO incredible leeway wth which to pursue “positive total return regardless of market conditions.” Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

Conference Call Highlights

On December 9^th, about 50 of us spent a rollicking hour with David Sherman of Cohanzick Asset Management, discussing his new fund: RiverPark Strategic Income Fund (RSIVX).  I’m always amazed at how excited folks can get about short-term bonds and dented credits.  It’s sort of contagious.

David’s first fund with RiverPark, the now-closed Short Term High Yield (RPHYX), was built around Cohanzick’s strategy for managing its excess cash.  Strategic Income represents their seminal, and core, strategy to fixed-income investing.  Before launching Cohanzick in 1996, David was a Vice President of Leucadia National Corporation, a holding company that might be thought of as a mini-Berkshire Hathaway. His responsibilities there included helping to manage a $3 billion investment portfolio which had an opportunistic distressed securities flair.  When he founded Cohanzick, Leucadia was his first client.  They entrusted him with $150 million, this was the strategy he used to invest it.

Rather than review the fund’s portfolio, which we cover in this month’s profile of it (below), we’ll highlight strategy and his response to listener questions.

The fund focuses on “money good” securities.  Those are securities where, if held to maturity, he’s confident that he’ll get his entire principal and all of the interest due to him.  They’re the sorts of securities where, if the issuer files for bankruptcy, he still anticipates eventually receiving his principal and interest plus interest on his interest.  Because he expects to be able to hold securities to maturity, he doesn’t care about “the taper” and its effects – he’ll simply hold on through any kerfuffle and benefit from regular payments that flow in much like an annuity stream.  These are, he says, bonds that he’d have his mother hold.

Given that David’s mother was one of the early investors in the fund, these are bonds his mother holds.  He joked that he serves as a sort of financial guarantor for her standard of living (if her portfolio doesn’t produce sufficient returns to cover her expenses, he has to reach for his checkbook), he’s very motivated to get this right.

While the fund might hold a variety of securities, they hold little international exposure and no emerging markets debt. They’re primarily invested in North American (77%) and European(14%)  corporate debt, in firms where the accounting is clear and nations where the laws are. The fund’s investment mandate is very flexible, so they can actively hedge portfolio positions (and might) and they can buy income-producing equities (but won’t).

The portfolio focuses on non-investment grade securities, mostly in the B – BB range, but that’s consistent with his intention not to lose his investors’ money. He values liquidity in his investments; that is to say, he doesn’t get into investments that he can’t quickly get out of.  The fund has been letting cash build, and it’s now about 30% of the portfolio.  David’s general preference is to get out too early and lose some potential returns, rather than linger too long and suffer the risk of permanent impairment.

There were rather more questions from callers than we had time to field.  Some of the points we did get to talk about:

David is not impressed with the values available in one- to three-year bonds, they’ve been subject to too much buying by the anxious herd.  He’s currently finding better values in three- to five-year bonds, especially those which are not included in the major bond indexes.  There is, he says, “a lot of high yield value outside of indexed issues.”

About 50% of the corporate bond market qualifies as “high yield,” which gives him lots of opportunities.

This could function as one’s core bond portfolio.  While there will be more NAV volatility because of mark-to-market rules (that is, you have to ask “what would I get if I stupidly decided to sell my entire portfolio in the midst of a particular day’s market panic”), the risk of permanent impairment of capital occurs only if he’s made a mistake.

Munis are a possibility, but they’re not currently cheap enough to be attractive.

If there’s a limited supply of a security that would be appropriate for both Short-Term and here, Short-Term gets dibs.

Cohanzick is really good at pricing their portfolio securities.  At one level, they use an independent pricing service.  At another, getting the price right has been a central discipline since the firm’s founding and he’s comfortable with his ability to do so even with relatively illiquid names.

At base, David believes the fund can generate returns in the 7-8% range with minimal risk of capital loss.  Given his record with Cohanzick and RPHYX, we are confident that he’s capable of delivering on that promise.  By way of full disclosure: In aligning our mouths and our money, both Chip and I added RSIVX to our personal portfolios this fall.  Once we work out all of the Observer’s year-end finances, we also intend to transfer a portion of the money now in MFO’s credit union savings account into an investment in this fund.

For folks interested but unable to join us, here’s the complete audio of the hour-long conversation.

The RSIVX conference call

As with all of these funds, we’ve created a new featured funds page for the RiverPark Strategic Income Fund, pulling together all of the best resources we have for the fund.

January Conference Call: Matt Moran, ASTON River Road Long/Short

Last winter we spent time talking with the managers of really promising hedged funds, including a couple who joined us on conference calls.  The fund that best matched my own predilections was ASTON River Road Long/Short (ARLSX), extensive details on which appear on our ARLSX Featured Fund Page.   In our December 2012 call, manager Matt Moran argued that:

1. The fund might outperform the stock market by 200 bps/year over a full, 3-5 year market cycle.
2. The fund can maintain a beta at 0.3 to 0.5, in part because of their systematic Drawdown Plan.
3. Risk management is more important than return management, so all three of their disciplines are risk-tuned.

I was sufficiently impressed that I chose to invest in the fund.  That does not say that we believe this is “the best” long/short fund (an entirely pointless designation), just that it’s the fund that best matched my own concerns and interests.  The fund returned 18% in 2013, placing it in the top third of all long/short funds.

Matt and co-manager Dan Johnson have agreed to join us for a second conversation.  That call is scheduled for Wednesday, January 15, from 7:00 – 8:00 Eastern.  Please note that this is one day later than our original announcement. Matt has been kicking around ideas for what he’d like to talk about.  His short-list includes:

• How we think about our performance in 2013 and, in particular, why we’re satisfied with it given our three mandates (equity-like returns, reduced volatility, capital preservation)
• Where we are finding value on the long side.  It’s a struggle…
• How we’re surviving on the short side.  It’s a huge challenge.  Really, how many marginal businesses can keep hanging on because of the Fed’s historic generosity?  Stocks must ultimately earn what underlying business earns and a slug of these firms are earning …
• But, too, our desire not to be carried out in body bags on short side.
• The fact that we sleep better at night with Drawdown Plan in place.  

HOW CAN YOU JOIN IN?

If you’d like to join in, just click on register and you’ll be taken to the Chorus Call site. In exchange for your name and email, you’ll receive a toll-free number, a PIN and instructions on joining the call. If you register, I’ll send you a reminder email on the morning of the call.

Remember: registering for one call does not automatically register you for another. You need to click each separately. Likewise, registering for the conference call mailing list doesn’t register you for a call; it just lets you know when an opportunity comes up. 

For those of you new to our conference calls, here’s the short version: we set up an audio-only phone conversation, you register and receive an 800-number and a PIN, our guest talks for about 20 minutes on his fund’s genesis and strategy, I ask questions for about 20, and then our listeners get to chime in with questions of their own.  A couple days later we post an .mp3 of the call and highlights of the conversation. 

WOULD AN ADDITIONAL HEADS UP HELP?

Over two hundred readers have signed up for a conference call mailing list. About a week ahead of each call, I write to everyone on the list to remind them of what might make the call special and how to register. If you’d like to be added to the conference call list, just drop me a line.

February Conference Call: Joshua B. Parker and Alan Salzbank, RiverPark / Gargoyle Hedged Value

We extend our conversation with hedged fund managers in a conversation with Messrs. Parker and Salzbank, whose RiverPark / Gargoyle Hedged Value (RGHVX) we profiled last June, but with whom we’ve never spoken. 

Gargoyle is a converted hedge fund.  The hedge fund launched in 1999 and the strategy was converted to a mutual fund on April 30, 2012.  Rather than shorting stocks, the strategy is to hold a diversified portfolio mid- to large-cap value stocks, mostly domestic, and to hedge part of the stock market risk by selling a blend of index call options. That value focus is both distinctive and sensible; the strategy’s stock portfolio has outperformed the S&P500 by 4.5% per year over the past 23 years. The options overlay generates 1.5 – 2% in premium income per month. The fund ended 2013 with a 29% gain, which beat 88% of its long/short peers.

That call is scheduled for Wednesday, February 12, from 7:00 – 8:00 Eastern.  We’ll provide additional details in our February issue.  

HOW CAN YOU JOIN IN?

If you’d like to join in, just click on register and you’ll be taken to the Chorus Call site. In exchange for your name and email, you’ll receive a toll-free number, a PIN and instructions on joining the call. If you register, I’ll send you a reminder email on the morning of the call.

Launch Alert: Vanguard Global Minimum Volatility Fund (VMVFX)

Vanguard Global Minimum Volatility Fund (VMVFX) launched on December 12, 2013.  It’s Vanguard’s answer to the craze for “smart beta,” a strategy that seemingly promises both higher returns and lower risk over time.  Vanguard dismisses the possibility with terms like “new-age investment alchemy,” and promise instead to provide reasonable returns with lower risk than an equity investor would otherwise be subject to.  They are, they say, “trying to deliver broadly diversified exposure to the equity asset class, with lower average volatility over time than the market. We will use quantitative models to assess the expected volatility of stocks and correlation to one another.”  They also intend to hedge currency risk in order to further dampen volatility. 

Most portfolios are constructed with an eye to maximizing returns within a set of secondary constraints (for example, market cap).  Volatility is then a sort of fallout from the system.  Vanguard reverses the process here by working to minimize the volatility of an all-equity portfolio within a set of secondary constraints dealing with diversification and liquidity.  Returns are then a sort of fallout from the design.  Vanguard recently explained the fund’s distinctiveness in Our new fund offering: What it is and what it isn’t.

The fund will be managed by James D. Troyer, James P. Stetler, and Michael R. Roach.  They are members of the management teams for about a dozen other Vanguard funds.

The Investor share class has a $3,000 minimum initial investment.  The opening expense ratio is 0.30%.

MFS made its first foray into low-volatility investing this month, launching MFS Low Volatility Equity (MLVAX) and MFS Low Volatility Global Equity (MVGAX) just one week before Vanguard. The former will target a volatility level that is 20% lower than that of the S&P 500 Index over a full market cycle, while the latter will target 30% less volatility than the MSCI All Country World Index.  The MFS funds charge about four times what Vanguard does.

Launch Alert II: Meridian Small Cap Growth Advisor (MSGAX)

Meridian Small Cap Growth Fund launched on December 16^th.  The prospectus says very little about what the managers will be doing: “The portfolio managers apply a ‘bottom up’ fundamental research process in selecting investments. In other words, the portfolio managers analyze individual companies to determine if a company presents an attractive investment opportunity and if it is consistent with the Fund’s investment strategies and policies.”

Nevertheless, the fund warrants – and will receive – considerable attention because of the pedigree of its managers.  Chad Meade and Brian Schaub managed Janus Triton (JATTX) together from 2006 – May 2013.  During their tenure, they managed to turn an initial $10,000 investment into $21,400 by the time they departed; their peers would have parlayed $10,000 into just over $14,000.  The more remarkable fact is that the managed it with a low turnover (39%, half the group average), relatively low risk (beta = .80, S.D. about 3 points below their peers) strategy.  Understandably, the fund’s assets soared to $6 billion and it morphed from focused on small caps to slightly larger names.  Regrettably, Janus decided that wasn’t grounds for closing the fund.

Messrs Meade and Schaub joined Arrowpoint Partners in May 2013.  Arrowpoint famously is the home of a cadre of Janus alumni (or escapees, depending):  David Corkins, Karen Reidy, Tony Yao, Minyoung Sohn and Rick Grove.  Together they managed over $2 billion.  In June, they purchased Aster Investment Management, advisor to the Meridian funds, adding nearly $3 billion more in assets.  We’ll reach out to the Arrowpoint folks early in the new year.

The Advisor share class is available no-load and NTF through brokerages like Scottrade, with a $2,500 minimum initial investment.  The opening expense ratio is 1.60%.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details.

Funds in registration this month are eligible to launch in March, 2014 and some of the prospectuses do highlight that date.

And there were a lot of funds targeting a year-end launch. Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves. This month he tracked down 15 no-load retail funds in registration, which represents our core interest. That number is down from what we’d normally see because these funds won’t launch until February 2014; whenever possible, firms prefer to launch by December 30^th and so force a lot of funds into the pipeline in October.

Interesting entries this month include:

Artisan High Income Fund will invest in high yield corporate bonds and debt.  There are two major distinctions here.  First, it is Artisan’s first fixed-income fund.  Second, Artisan has always claimed that they’re only willing to hire managers who will be “category-killers.”  If you look at Artisan’s returns, you’ll get a sense of how very good they are at that task.  Their new high-yield manager, and eventual head of a new, autonomous high-yield team, is Bryan C. Krug who ran the $10 billion, five star Ivy High Income Fund (WHIYX) for the past seven years.  The minimum initial investment will be $1000 for Investor shares and $250,000 for Advisor shares.  The initial expense ratio will be 1.25% for both Investor and Advisor shares.

Brown Advisory Japan Alpha Opportunities Fund will pursue total return by investing principally in Japanese stocks.  The fund will be constructed around a series of distinct “sleeves,” each with its own distinct risk profile but they don’t explain what they might be. They may invest in common and preferred stock, futures, convertibles, options, ADRs and GDR, REITs and ETFs.  While they advertise an all-cap portfolio, they do flag small cap and EM risks.  The fund will be managed by a team from Wellington Management.  The minimum initial investment will be $5000.  The initial expense ratio will be 1.36%. 

Perritt Low Priced Stock Fund will pursue long-term capital appreciation by investing in small cap stocks priced at $15 or less.  I’m a bit ambivalent but could be talked into liking it.  The lead manager also runs Perritt Microcap (PRCGX) and Ultra MicroCap (PREOX), both of which are very solid funds with good risk profiles.  Doubtless he can do it here.  That said, the whole “under $15” thing strikes me as a marketing ploy and a modestly regrettable one. What benefit does that stipulation really offer the investors?  The minimum initial investment will be $1000, reduced to $250 for all sorts of good reasons, and the initial expense ratio will be 1.5%. 

Manager Changes

On a related note, we also tracked down 40 fund manager changes.  The most intriguing of those include what appears to be the abrupt dismissal of Ken Feinberg, one of the longest-serving managers in the Davis/Selected Funds, and PIMCO’s decision to add to Bill Gross’s workload by having him fill in for a manager on sabbatical.

Updates

There are really very few emerging markets investors which whom I’d trust my money.  Robert Gardiner and Andrew Foster are at the top of the list.  There are notable updates on both this month.

Grandeur Peak Emerging Opportunities (GPEOX) launched two weeks ago, hasn’t released a word about its portfolio, has earned one half of one percent for its investors . . . and has drawn nearly $100 million in assets.  Mr. Gardiner and company have a long-established plan to close the fund at $200 million.  I’d encourage interested parties to (quickly!) read our review of Grandeur Peak’s flagship Global Reach fund.  If you’re interested in a reasonably assertive, small- to mid-cap fund, you may have just a few weeks to establish your account before the fund closes.  The advisor does not intend to market the fund to the general public until February 1, by which time it might well be at capacity.

Investors understandably assume that an e.m. small cap fund is necessarily, and probably substantially, riskier than a more-diversified e.m. fund. That assumption might be faulty. By most measures (standard deviation and beta, for example) it’s about 15% more volatile than the average e.m. fund, but part of that volatility is on the upside. In the past five years, emerging markets equities have fallen in six of 20 quarters.   We can look at the performance of DFA’s semi-passive Emerging Markets Small Cap Fund (DEMSX) to gauge the downside of these funds. 

DFA E.M. Small Cap …	No. of quarters
Falls more	2
Fall equally (+/- 25 bps)	1
Falls less	2
Rises	1

The same pattern is demonstrated by Templeton E.M. Small Cap (TEMMX): higher beta but surprising resilience in declining quarters.  For aggressive investors, a $2,000 foot-in-the-door position might well represent a rational balance between the need for more information and the desire to maintain their options.

Happily, there’s an entirely-excellent alternative to GPEOX and it’s not (yet) near closing to new investors.

Seafarer Overseas Growth & Income (SFGIX and SIGIX) is beginning to draw well-earned attention. Seafarer offers a particularly risk-conscious approach to emerging markets investing.  It offers a compact (40 names), all-cap portfolio (20% in small- and microcap names and 28% in mid-caps, both vastly higher than its peers) that includes both firms domiciled in the emerging markets (about 70%) and those headquartered in the developing world but profiting from the emerging one (30%). It finished 2013 up 5.5%, which puts it in the top tier of all emerging markets funds. 

That’s consistent with both manager Andrew Foster’s record at his former charge (Matthews Asian Growth & Income MACSX which was one of the two top Asian funds in existence through his time there) and Seafarer’s record since launch (it has returned 20% since February 2012 while its average peer made less than 4%). Assets had been growing briskly through the fund’s first full year, plateaued for much of 2013 then popped in December: the fund moved from about $40 million in AUM to $55 million in a very short period. That presumably signals a rising recognition of Seafarer’s strength among larger investors, which strikes me as a very good thing for both Seafarer and the investors.

On an unrelated note, Oakseed Opportunity (SEEDX) has added master limited partnerships to its list of investable securities. The guys continue negotiating distribution arrangements; the fund became available on the Fidelity platform in the second week of December, 2013. They were already available through Schwab, Scottrade, TDAmeritrade and Vanguard.

Briefly Noted . . .

The Gold Bullion Strategy Fund (QGLDX) has added a redemption fee of 2.00% for shares sold within seven days of purchase because, really, how could you consider yourself a long-term investor if you’re not willing to hold for at least eight days?

Legg Mason Capital Management Special Investment Trust (LMSAX) will transition from being a small- and mid-cap fund to a small cap and special situations fund. The advisor warns that this will involve an abnormal turnover in the portfolio and higher-than-usual capital gains distributions. The fund has beaten its peers precisely twice in the past decade, cratered in 2007-09, got a new manager in 2011 and has ascended to … uh, mediocrity since then. Apparently “unstable” and “mediocre” is sufficient to justify someone’s decision to keep $750 million in the fund. 

PIMCO’s RealRetirement funds just got a bit more aggressive. In an SEC filing on December 30, PIMCO shifted the target asset allocations to increase equity exposure and decrease real estate, commodities and fixed income.  Here’s the allocation for an individual with 40 years until retirement

	New allocation	Old allocation
Stocks	62.5%, with a range of 40-70%	55%, same range
Commodities & real estate	20, range 10-40%	25, same range
Fixed income	17.5, range 10-60%	20, same range

Real estate and commodities are an inflation hedge (that’s the “real” part of RealRetirement) and PIMCO’s commitment to them has been (1) unusually high and (2) unusually detrimental to performance.

SMALL WINS FOR INVESTORS

Effective January 2, 2014, BlackRock U.S. Opportunities Portfolio (BMEAX) reopened to new investors. Skeptics might note that the fund is large ($1.6 billion), overpriced (1.47%) and under-performing (having trailed its peers in four of the past five years), which makes its renewed availability a distinctly small win.

Speaking of “small wins,” the Board of Trustees of Buffalo Funds has approved a series of management fees breakpoints for the very solid Buffalo Small Cap Fund (BUFSX).  The fund, with remains open to new investors despite having nearly $4 billion in assets, currently pays a 1.0% management fee to its advisor.  Under the new arrangement, the fee drops by five basis points for assets from $6 to $7 billion, another five for assets from $7-8 and $8-9 then it levels out at 80 bps for assets over $9 billion.  Those gains are fairly minor (the net fee on the fund at $7 billion is $69.5 million under the new arrangement versus $70 million under the old) and the implication that the fund might remain open as it swells is worrisome.

Effective January 1, 2014, Polaris Global Value Fund (PGVFX) has agreed to cap operating expenses at 0.99%.  Polaris, a four-star fund with a quarter billion in assets, currently charges 1.39% so the drop will be substantial. 

The investment minimum for Institutional Class shares of Yacktman Focused Fund (YAFFX) has dropped from $1,000,000 to $100,000.

Vanguard High-Yield Corporate Fund (VWEHX) has reopened to new investors.  Wellington Management, the fund’s advisor, reports that  “Cash flow to the fund has subsided, which, along with a change in market conditions, has enabled us to reopen the fund.”

CLOSINGS (and related inconveniences)

Driehaus Select Credit Fund (DRSLX) will close to most new investors on January 31, 2014. The strategy capacity is about $1.5 billion and the fund already holds $1 billion, with more flowing in, so they decided to close it just as they closed its sibling, Driehaus Active Income (LCMAX). You might think of it as a high-conviction, high-volatility fixed income hedge fund.

Hotchkis & Wiley Mid-Cap Value (HWMIX) is slated to close to new investors on March 1, 2014. Ted, our board’s most senior member, opines “Top notch MCV fund, 2.8 Billion in assets, and superior returns.”  I nod.

Sequoia (SEQUX) closed to new investors on December 10^th. Their last closure lasted 25 years.

Vanguard Capital Opportunity Fund (VHCOX), managed by PRIMECAP Management Company, has closed again. It closed in 2004, opened the door a crack in 2007 and fully reopened in 2009.  Apparently the $2 billion in new assets generated a sense of concern, prompting the reclosure.

OLD WINE, NEW BOTTLES

Aberdeen Diversified Income Fund (GMAAX), a tiny fund distinguished more for volatility than for great returns, can now invest in closed-end funds.  Two other Aberdeen funds, Dynamic Allocation (GMMAX) and Diversified Alternatives (GASAX), are also now permitted  to invest, to a limited extent, in “certain direct investments” and so if you’ve always wanted exposure to certain direct investments (as opposed to uncertain ones), they’ve got the funds for you.

American Independence Core Plus Fund (IBFSX) has changed its name to the American Independence Boyd Watterson Core Plus Fund, presumably in the hope that the Boyd Watterson name will work marketing magic.  Not entirely sure why that would be the case, but there it is.

Effective December 31, 2013, FAMCO MLP & Energy Income Fund became Advisory Research MLP & Energy Income Fund. Oddly, the announcement lists two separate “A” shares with two separate ticker symbols (INFIX and INFRX).

In February Compass EMP Long/Short Fixed Income Fund (CBHAX) gets rechristened Compass EMP Market Neutral Income Fund and it will no longer be required to invest at least 80% in fixed income securities.  The change likely reflects the fact that the fund is underwater since its November 2013 inception (its late December NAV was $9.67) and no one cares (AUM is $28 million).

In yet another test of my assertion that giving yourself an obscure and nonsensical name is a bad way to build a following (think “Artio”), ING reiterated its plan to rebrand itself as Voya Financial.  The name change will roll out over the first half of 2014.

As of early December, Gabelli Value Fund became Gabelli Value 25 Fund (GABVX). And no, it does not hold 25 stocks (the portfolio has nearly 200 names).  Here’s their explanation: “The name change highlights the Fund’s overweighting of its core 25 equity positions and underscores the upcoming 25^th anniversary of the Fund’s inception.” And yes, that does strike me as something that The Mario came up with and no one dared contradict.

GMO, as part of a far larger fund shakeup (see below), has renamed and repurposed four of its institutional funds.  GMO International Core Equity Fund becomes GMO International Large/Mid Cap Equity Fund, GMO International Intrinsic Value Fund becomes GMO International Equity Fund, GMO International Opportunities Equity Allocation Fund becomes GMO International Developed Equity Allocation Fund, and GMO World Opportunities Equity Allocation Fund morphs (slightly) into GMO Global Developed Equity Allocation Fund, all on February 12, 2014. Most of the funds tweaked their investment strategy statements to comply with the SEC’s naming rules which say that if you have a distinct asset class in your name (large/midcap equity), you need to have at least 80% of your portfolio in that class. 

Effective February 28, MainStay Intermediate Term Bond Fund (MTMAX) becomes MainStay Total Return Bond Fund.

Nuveen NWQ Flexible Income Fund (NWQIX), formerly Nuveen NWQ Equity Income Fund has been rechristened as Nuveen NWQ Global Equity Income Fund, with James Stephenson serving as its sole manager.  If you’d like to get a sense of what “survivorship bias” looks like, you might check out Nuveen’s SEC distributions filing and count the number of funds with lines through their names.

Old Westbury Global Small & Mid Cap Fund (OWSMX) has been rechristened as Old Westbury Small & Mid Cap Fund. It’s no longer required to have a global portfolio, but might.  It’s been very solid, with about 20% of its portfolio in ETFs and the rest in individual securities.

At the meeting on December 3, 2013, the Board approved a change in Old Westbury Global Opportunities Fund’s (OWGOX) name to Old Westbury Strategic Opportunities Fund.  Let’s see: 13 managers, $6 billion in assets, and a long-term record that trails 70% of its peers.  Yep, a name change is just what’s needed!

OFF TO THE DUSTBIN OF HISTORY

Jeez, The Shadow is just a wild man here.

On December 6, 2013, the Board of the Conestoga Funds decided to close and liquidate the Conestoga Mid Cap Fund (CCMGX), effective February 28, 2014.  At the same time, they’re launched a SMid cap fund with the same management team.  I wrote the advisor to ask why this isn’t just a scam to bury a bad track record and get a re-do; they could, more easily, just have amended Mid Cap’s principal investment strategy to encompass small caps and called it SMid Cap.  They volunteered to talk then reconsidered, suggesting that they’d be freer to walk me through their decision once the new fund is up and running. I’m looking forward to the opportunity.

Dynamic Energy Income Fund (DWEIS), one of the suite of former DundeeWealth funds, was liquidated on December 31, 2013.

Fidelity has finalized plans for the merger of Fidelity Europe Capital Appreciation Fund (FECAX) into Fidelity Europe Fund (FIEUX), which occurs on March 21.

The institutional firm Grantham, Mayo, van Otterloo (GMO) is not known for precipitous action, so their December announcement of a dozen fund closures is striking.  One set of funds is simply slated to disappear:

In addition, the Board has approved the termination of GMO Asset Allocation International Small Companies Fund and GMO International Large/Mid Cap Value Fund, neither of which had commenced operations.

They then added two sets of fund mergers: GMO Debt Opportunities Fund into GMO Short-Duration Collateral Fund (with the freakish coda that “GMO Short-Duration Collateral Fund is not pursuing an active investment program and is gradually liquidating its portfolio” but absorbing Debt Opportunities gives it reason to live) and GMO U.S. Flexible Equities Fund into GMO U.S. Core Equity Fund, which is expected to occur on or about January 24, 2014.

Not to be outdone, The Hartford Mutual Funds announced ten fund mergers and closures themselves.  Hartford Growth Fund (HGWAX) is merging with Hartford Growth Opportunities Fund (HGOAX), Hartford Global Growth (HALAX) merges with Hartford Capital Appreciation II (HCTAX) and Hartford Value (HVFAX) goes into Hartford Value Opportunities (HV)AX), all effective April 7, 2014. None of which, they note, requires shareholder approval. I have real trouble seeing any upside for the funds’ investors, since most going from one sub-par fund into another and will see expenses drop by just a few basis points. The exceptions are the value funds, both of which are solid and economically viable on their own. In addition, Hartford is pulling the plug on its entire target-date retirement line-up. The funds slated for liquidation are Hartford Target Retirement 2010 through 2050. That dirty deed will be done on June 30, 2014. 

Highbridge Dynamic Commodities Strategy Fund (HDSAX) is slated to be liquidated and dissolved (an interesting visual image) on February 7, 2014. In the interim, it’s going to cash.

John Hancock Sovereign Investors Fund (SOVIX) will merge into John Hancock Large Cap Equity Fund (TAGRX), on or about April 30, 2014.

Principal SmallCap Growth Fund II (PPMIX) will be absorbed by SmallCap Growth Fund I (PGRTX) on or about April 25, 2014.

It’s with some sadness that we bid adieu to Tom Kerr and his Rocky Peak Small Cap Value Fund (RPCSX), which liquidated on December 30.  The fund sagged from “tiny” to “microscopic” by the end of its run, with under a million in assets.  Its performance in 2013 was pretty much calamitous, which was both curious and fatal.  Tom was an experienced manager and sensible guy who will, we hope, find a satisfying path forward. 

In a sort of three-for-one swap, Pax World International Fund (PXIRX) and Pax MSCI EAFE ESG Index ETF (EAPS) are merging to form the Pax World International ESG Index Fund.

On October 21, 2013, the Board of Directors of the T. Rowe Price Summit GNMA Fund (PRSUX) approved a proposed merger with, and into, T. Rowe Price GNMA Fund (PRGMX).

The Vanguard Managed Payout Growth Focus Fund (VPGFX) and Vanguard Managed Payout Distribution Focus Fund (VPDFX) are each to be reorganized into the Vanguard Managed Payout Growth and Distribution Fund (VPGDX) on or about January 17, 2014.

W.P. Stewart & Co. Growth Fund (WPSGX) is merging into the AllianceBernstein Concentrated Growth Fund (WPCSX), which has the same manager, investment discipline and expenses of the WPS fund.  Alliance acquired WPS in December, so the merger was a sort of foregone conclusion.

Wegener Adaptive Growth Fund (WAGFX) decided, on about three days’ notice, to close and liquidate at the end of December, 2013.  It had a couple very solid years (2008 and 2009) then went into the dumper, ending with a portfolio smaller than my retirement account.

A small change

Our navigation menu is growing. If you look along the top of our page, you’ll likely notice that “Featured Funds” is no longer a top-level menu item. Instead the “Featured Funds” category can now be found under the “Fund” or “The Best” menus. Replacing it as a new top-level menu is “Search Tools”, which is the easiest way to directly access new search functionality that Accipiter, Charles, and Chip have been working on for the past few months.

Under Search Tools, you’ll find:

1. Risk Profile – designed to help you understand the different measures of a fund’s risk profile. No one measure of risk captures the full picture and most measures of risk are not self-explanatory. Our Risk Profile reporter allows you to enter a single ticker symbol for any fund and it will generate a short, clear report, in simple, conversational English, that walks you through the various means of risk and returns and will provide you with the profiles for a whole range of possible benchmarks. Alternatively, entering multiple ticker symbols will return a tabular results page, making side-by-side comparisons more convenient.
2. Great Owls – allows you to screen our Great Owl Funds – those which have top tier performance in every trailing period of three years or more – by category or profile. We know that past performance should never be the primary driver of your decision-making, but working from a pool of consistently superior performers and learning more about their risk-return profile strikes us as a sensible place to start.
3. Fund Dashboard – a snapshot of all of the funds we’ve profiled, is updated monthly and is available both as a .pdf and as a searchable and sortable search.
4. Miraculous Multi-Search – Accipiter’s newest screening tool helps us search Charles’ database of risk elements. Searches are available by fund name, category, risk group and age group. There’s even an option to restrict the results to GreatOwl funds. Better yet, you can search on multiple criteria and further refine your results list by choosing to hide certain results.

In Closing . . .

Thank you, dear friends.  It’s been a remarkable year.  In December of 2012, we served 9000 readers.  A year later, 24,500 readers made 57,000 visits to the Observer in December – a gain of 150%.  The amount of time readers spend on site is up, too, by about 50% over last year.  The percentage of new visitors is up 57%.  But almost 70% of visits are by returning readers.

It’s all the more striking because we’re the antithesis of a modern news site: our pieces tend to be long, appear once a month and try to be reflective and intelligent.  NPR had a nice piece that lamented the pressure to be “first, loud and sensational” (This is (not) the most important story of the year, 12/29/2013).  The “reflective and intelligent” part sort of reflects our mental image of who you are. 

We’ve often reminded folks of their ability to help the Observer financially, either through our partnership with Amazon (they rebate us about 7% of the value of items purchased through our link) or direct contributions.  Those are both essential and we’re deeply grateful to the dozens of folks who’ve acted on our behalf.  This month we’d like to ask for a different sort of support, one which might help us make the Observer better in the months ahead.

Would you tell us a bit about who you are and why you’re here?  We do not collect any information about you when you visit. The cosmically-talented Chip found a way to embed an anonymous survey directly in this essay, so that you could answer a few questions without ever leaving the comfort of your chair.  What follows are six quick questions.  We’re setting aside questions about our discussion board for now, since it’s been pretty easy to keep in touch with the folks there.  Complete as many as you’re comfortable with.

We’ll share as soon as we hear back from you.

Thanks to Deb (the first person ever to set up an automatic monthly contribution to the site, which was really startling when we found out), to David and the other contributors scattered (mostly) in warm states (and Indianapolis), and to friends who’ve shared books, cookies, well-wishes and holiday cheer.

Finally, thanks to the folks whose constant presence makes the Observer happen: the folks who’ve spent this entire century supporting the discussion board (BobC, glampig, rono, Slick, the indefatigable Ted, and Whakamole among them) and the hundred or so folks regularly on the board; The Shadow, who can sense the presence of interesting SEC filings from a mile away; Accipiter, whose programming skills – generally self-taught – lie behind our fund searches; Ed, who puzzles and grumbles; Charles, who makes data sing; and the irreplaceable Chip, friend, partner and magician.  I’m grateful to you all and look forward to the adventures of the year ahead.

As ever,

Dear friends,

Welcome.  Do you think it a coincidence that the holiday season occurs at the least promising time of the year?  The days are getting shorter and, for our none-too-distant ancestors, winter represented a period of virtual house arrest.  Night was a time of brigands and beasts.  Even in the largest cities, respectable folks traveled abroad after dark only with armed guard.  In villages and on farms, travel on a clouded night risked disappearance and death.  The homes of all but the richest citizens were, contrary to your mental fantasy of roaring hearths and plentiful candles, often a single room that could boast a single flickering rushlight.  The hungry months of late winter were ahead.

And so they did what any sensible group would do.  They partied.  One day’s worth of oil became eight nights’ worth of light; Jewish friends gathered, ate and gifted.  Bacchus reigned from our Thanksgiving to the Winter Solstice, and the Romans drank straight through it.  The Kalash people of Pakistan sang, danced, lit bonfires and feasted on goat tripe “and other delicacies” (oh, yum!).  Chinese and Korean families gathered and celebrated with balls of glutinous rice (more yum!).  Welsh friends dressed up like wrens (yuh), and marched from home to home, singing and snacking.  Romans in the third century CE celebrated Dies Natalis Solis Invicti (festival of the birth of the Unconquered Sun) on December 25^th, a date later borrowed by Christians for their own mid-winter celebration.  Some enterprising soul, having consumed most of the brandy, inexplicably mashed together figs, stale bread and the rest of the brandy.  Figgy pudding was born and revelers refused to go until they got some (along with a glass of good cheer).

Few of these celebrations recognized a single day, they brought instead Seasons Greetings.  Fewer still celebrated individual success or personal enrichment, they instead brought to the surface the simple truth that we often bury through the rest of the year: we are infinitely poorer alone in our palaces than we are together in our villages.

Season’s greetings, dear friends.

But curb yer enthusiasm

Small investors and great institutions alike are partaking in one of the market’s perennial ceremonies: placing your investments atop an ever-taller pile of dried kindling and split logs.  All of the folks who hated stocks when they were cheap are desperate to buy them now that they’re expensive.

We have one word for you: Don’t.

Or, at the very least, don’t buy them until you’re clear why they weren’t attractive to you five years ago but are calling so loudly to you now.  We’re not financial planners, much like market visionaries, but some very careful folks forecast disappointment for starry-eyed stock investors in the years ahead.

Sam Lee, editor of Morningstar ETFInvestor, warned investors to “Expect Below-Average Stock Returns Ahead” based on his reading of the market’s cyclically-adjusted price/earnings ratio.  He wrote, on November 21, that:

The Shiller P/E recently hit 25. When you invert that you get is another measure that I like: the cyclically adjusted earnings yield. The inverse of the Shiller P/E, 1 divided by 25 is about 0.04, or 4%. And this is the smooth earnings yield of the market. This is actually, I think, a reasonable forecast for what the market can be expected to return during the next 10, 20 years. And a 4% real expected return is well below the historical average of 6.5%. 

The Shiller P/E is saying that the market is overvalued relative to history, that you can expect about 2 percentage points less per year over a long period of time. .. if you believe that the market is mean reverting to its historical Shiller P/E, and that the past is a reasonable guide to the future, then you can expect lower returns than the naive 4% forecast return that I provided.

The institutional investors at Grantham, Mayo, van Otterloo (GMO) believe in the same tendency of markets to revert to their mean valuations and profits to revert to their mean levels (that is, firms can’t achieve record profit levels forever – some combination of worker demands to share the wealth and predatory competitors drawn by the prospect of huge profits, will drive them back down).  After three years of research on their market projection models, GMO added some factors that slightly increased their estimate of the market’s fair value and still came away from the projection that US stocks are poised to trail inflation for the rest of this decade.  Ben Inker writes:

In a number of ways it is a “clean sheet of paper” look at forecasting equities, and we have broadened our valuation approach from looking at valuations through the lens of sales to incorporating several other methods. It results in about a 0.7%/year increase in our forecast for the S&P 500 relative to the old model. On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation.

On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. For those interested in the broader U.S. stock market, our forecast for the Wilshire 5000 is a bit worse, at -2.0%, due to the fact that small cap valuations are even more elevated than those for large caps.

In 2013, the average equity investor made inflation plus about 28%.  Through the remainder of the decade, optimists might give you inflation plus 2, 3 or 4%.  Bearish realists are thinking inflation minus 1 or 2%.

The Leuthold Group, looking at the market’s current valuation, is at most masochistically optimistic: they project that a “normal” bear market, starting now, would probably not trim much more than 25% off your portfolio.

What to do?  Diversify, keep expenses aligned with the value added by your managers, seek some income from equities and take time now – before you forget and before some market event makes you want to look away forever – to review your portfolio for balance and performance.  As an essential first step, remember the motto:

Off with their heads!

As the Thanksgiving holiday passes and you begin year-end financial planning, we say it’s time to toss out the turkeys.  There are some funds that we’re not impressed with but which have the sole virtue that they’re not rolling disasters. You know: the overpriced, bloated index-huggers that seemed like the “safe” choice long ago. And now, like mold or lichen, they’ve sort of grown on you.

Fine. Keep ‘em if you must. But at least get rid of the rolling disasters you’ve inherited. There are a bunch of funds whose occasional flashes of adequacy and earnest talk of new paradigms, great rotations, sea changes, and contrarian independence simply can’t mask the fact that they suck. A lot. For a long time.

It’s time to work through your portfolio, fund by fund, and answer the simple question: “if I didn’t already own this fund, is there any chance on earth I’d buy it?” If the answer is “no,” sell.

Mutual Fund Observer is an outgrowth of FundAlarm, whose iconic Three Alarm Funds list continually identified the worst of the worst in the fund industry. For the last several years we’ve published our own Roll Call of the Wretched, an elite list of funds whose ineptitude stretches over a decade or more. In response to requests that arrive every month, we’re happy to announce the re-introduction of the Three Alarm Funds list which will remain an ongoing service of the Observer. So here we go!

The Observer’s Annual “Roll Call of the Wretched”

If you’re resident in one of the two dozen states served by Amazon’s wine delivery service, you might want to buck up your courage with a nice 2007 Domaine Gerard Charvin Chateauneuf du Pape Rhône Valley Red before you settle in to enjoy the Observer’s annual review of the industry’s Most Regrettable funds. Just as last year, we looked at funds that have finished in the bottom one-fourth of their peer groups for the year so far. And for the preceding 12 months, three years, five years and ten years. These aren’t merely “below average.” They’re so far below average they can hardly see “mediocre” from where they are.

When we ran the screen in 2011, there were 151 consistently awful funds, the median size for which is $70 million. In 2012 there were . . . 151 consistently awful funds, the median size for which is $77 million. And now? 152 consistently awful funds (I love consistency), the median size of which is $91 million.

Since managers love to brag about the consistency of their performance, here are the most consistently awful funds that have over a billion in assets. Funds repeating from last year are flagged in red.

Some funds did manage to escape this year’s Largest Wretched Funds list, though the strategies vary: some went extinct, some took on new names, one simply shrank below our threshold and a few rose all the way to mediocrity. Let’s look:

While most Roll Call funds are small enough that they’re unlikely to trouble you, there are 50 more funds with assets between $100 million and a billion. Check to see if any of these wee beasties are lurking around your portfolio:

Morningstar maintains a favorable analyst opinion on three Wretched funds, is Neutral on three (Brandywine BRWIX, Fidelity Freedom 2000 FFFMX and Pioneer PIODX) and Negative on just four (Hussman Strategic Growth HSGFX, Oppenheimer Flexible Strategies QVOPX and two State Farm LifePath funds). The medalist trio are:

And now (drum roll, please), it’s the return of a much-loved classic …

Three Alarm Funds Redux

Roy Weitz first published the legacy Three Alarm fund list in 1996. He wanted to help investors decide when to sell mutual funds. Being on the list was not an automatic sell, but a warning signal to look further and see why.

“I liken the list to the tired old analogy of the smoke detector. If it goes off, your house could be on fire. But it could also be cobwebs in the smoke detector, in which case you just change the batteries and go back to sleep,” he explained in a 2002 interview.

Funds made the list if they trailed their benchmarks for the past 1, 3, and 5 year periods. At the time, he grouped funds into only five equity (large-cap, mid-cap, small-cap, balanced, and international) and six specialty “benchmark categories.” Instead of pure indices, he used actual funds, like Vanguard 500 Index Fund VFINX, as benchmarks. Occasionally, the list would catch some heat because “mis-categorization” resulted in an “unfair” rating. Some things never change.

At the end of the day, however, Mr. Weitz wanted “to highlight the most serious underperformers.” In that spirit, MFO will resurrect the Three Alarm fund list, which will be updated quarterly along with the Great Owl ratings. Like the original methodology, inclusion on the list will be based entirely on absolute, not risk-adjusted, returns over the past 1, 3, and 5 year periods.

Since 1996, many more fund categories exist. Today Morningstar assigns over 90 categories across more than 7500 unique funds, excluding money market, bear, trading, volatility, and specialized commodity. MFO will rate the new Three Alarm funds using the Morningstar categories. We acknowledge that “mis-categorization” may occasionally skew the ratings, but probably much less than if we tried to distill all rated funds into just 11 or so categories.

For more than two-thirds of the categories, one can easily identify a reasonable “benchmark” or reference fund, thanks in part to the proliferation of ETFs. Below is a sample of these funds, sorted first by broad investment Type (FI – Fixed Income, AA – Asset Allocation, EQ – Equity), then Category:

Values in the table include the 3-year annualized standard deviation percentage (STDEV), as well as annualized return percentages (APR) for the past 1, 3, and 5 year periods.

A Return Rating is assigned based how well a fund performs against other funds in the same category during the same time periods. Following the original Three Alarm nomenclature, best performing funds rate a “2” (highlighted in blue) and the worst rate a “-2” (red).

As expected, most of the reference funds rate mid range “0” or slightly better. None produce top or bottom tier returns across all evaluation periods. The same is true for all 60 plus category reference funds. Selecting reference funds in the other 30 categories remains difficult because of their diversity.

To “keep it simple” MFO will include funds on the Three Alarm list if they have the worst returns in their categories across all three evaluation periods. More precisely, Three Alarm Funds have absolute returns in the bottom quintile of their categories during the past 1, 3, and 5 years. Most likely, these funds have also under-performed their “benchmarks” over the same three periods.

There are currently 316 funds on the list, or fewer than 6% of all funds rated. Here are the Three Alarm Funds in the balanced category, sorted by 3 year annualized return:

Like in the original Three Alarm list, a fund’s Risk Rating is assigned based a “potential bad year” relative to other funds in the same category. A Risk Rating of “2” (highlighted in red) goes to the highest risk funds, while “-2” (blue) goes to the lowest risk funds. (Caution: This rating measures a fund’s risk relative to other funds in same category, so a fund in a high volatility category like energy can have high absolute risk relative to market, even if it has a low risk rating in its category.)

“Risk” in this case is based on the 3 year standard deviation and return values. Specifically, two standard deviations are subtracted from the return value. The result is then compared with other funds in the category to assign a rating. The rating is a little more sensitive to downside than the original measure as investors have experienced two 50% drawdowns since the Three Alarm system was first published.

While never quite as popular as the Three Alarm list, Mr. Weitz also published an Honor Roll list. In the redux system, Honor Roll funds have returns in the top quintile of their categories in the past 1, 3, and 5 years. There are currently 339 such funds.

The Three Alarm, Honor Roll, and Reference funds can all be found in a down-loadable *.pdf version.

06Nov2013/Charles

Funds that are hard to love

Not all regrettable funds are defined by incompetent management. Far from it. Some have records good enough that we really, really wish that they weren’t so hard to love (or easy to despise). High on our list:

Oceanstone Fund (OSFDX)

Why would we like to love it? Five-star rating from Morningstar. Small asset base. Flexible mandate. Same manager since launch. Top 1% returns over the past five years.

What makes it hard to love? The fund is entirely opaque and the manager entirely autocratic. Take, for example, this sentence from the Statement of Additional Information:

Ownership of Securities: As of June 30, 2013, the dollar range of shares in the Fund beneficially owned by James J. Wang and Yajun Zheng is $500,001-$1,000,000.

Mr. Wang manages the fund. Ms. Zheng does not. Nor is she a director or board member; she is listed nowhere else in the prospectus or the SAI as having a role in the fund. Except this: she’s married to Mr. Wang. Which is grand. But why is she appearing in the section of the manager’s share ownership?

Mr. Wang was the only manager to refuse to show up to receive a Lipper mutual fund award. He’s also refused all media attempts to arrange an interview and even the chairman of his board of trustees sounds modestly intimidated by him. His explanation of his investment strategy is nonsense. He keeps repeating the magic formula: IV = IV divided by E, times E. No more than a high school grasp of algebra tells you that this formula tells you nothing. I shared it with two professors of mathematics, who both gave it the technical term “vacuous.” It works for any two numbers (4 = 4 divided by 2, times 2) but it doesn’t allow you to derive one value from the other.

The fund’s portfolio turns over at triple the average rate, consists of just five stocks and a 70% cash stake.

Value Line Asset Allocation Fund (VLAAX)

Why would we like to love it? Five-star rating from Morningstar. Consistency below-average to low risk. Small asset base. Same manager for 20 years. Top tier returns over the past decade.

What makes it hard to love? Putting aside the fact that the advisory firm’s name is “value” spelled backward (“Eulav”? Really guys?), it’s this sentence:

Ownership of Securities. None of the portfolio managers of the Value Line Asset Allocation Fund own shares of the Fund. The portfolio manager of the Value Line Small Cap Opportunities Fund similarly does not own shares of that Fund.

It’s also the fact that I’ve tried, on three occasions, to reach out to the fund’s advisor to ask why no manager ever puts a penny alongside his shareholders but they’ve never responded to any of the queries.

But wait! There’s 

Four things strike us as quite good:

1. You probably aren’t invested in any of the really rotten funds!
2. Even if you are, you know they’re rotten and you can easily get out.
3. There are better funds – ones more appropriate to your needs and personality – available.
4. We can help you find them!

Accipiter, Charles and Chip have been working hard to make it easier for you to find funds you’ll be comfortable with. We’d like to share two and have a third almost ready, but we need to be sure that our server can handle the load (we might a tiny bit have precipitated a server crash in November and so we’re being cautious until we can arrange a server upgrade).

The Risk Profile Search is designed to help you understand the different measures of a fund’s risk profile. Most fund profiles reduce a fund’s risks to a single label (“above average”) or a single stat (standard deviation = 17.63). Unfortunately, no one measure of risk captures the full picture and most measures of risk are not self-explanatory (how would you do on a pop quiz over the Martin Ratio?). Our Risk Profile Reporter allows you to enter a single ticker symbol for any fund and it will generate a short, clear report, in simple, conversational English, that walks you through the various means of risk and returns and will provide you with the profiles for a whole range of possible benchmarks. Alternatively, entering multiple ticker symbols will return a tabular results page, making side-by-side comparisons more convenient.

The Great Owl Search Engine allows you to screen our Great Owl Funds – those which have top tier performance in every trailing period of three years or more – by category or profile. We know that past performance should never be the primary driver of your decision-making, but working from a pool of consistently superior performers and learning more about their risk-return profile strikes us as a sensible place to start.

Our Fund Dashboard. a snapshot of all of the funds we’ve profiled, is updated quarterly and is available both as a .pdf and searchable, sortable search.

Accipiter’s Miraculous Multi-Search will, God and server willing, launch by mid-December and we’ll highlight its functions for you in our New Year’s edition.

Touchstone Funds: Setting a high standard on analysis

On November 13, Morningstar published an essay entitled “A Measure of Active Management.” Authored by Touchstone Investments, it’s entirely worth your consideration as one of the most readable walk-throughs available of the literature on active management and portfolio outperformance.

We all know that most actively managed funds underperform their benchmarks, often by more than the amount of their expense ratios. That is, even accounting for an index fund’s low-expense advantage, the average manager seems to actively detract value. Literally, many investors would be better off if their managers were turned to stone (“calling Madam Medusa, fund manager in Aisle Four”), the portfolio frozen and the manager never replaced.

Some managers, however, do consistently earn their keep. While they might or might not produce raw returns greater than those in an index fund, they can fine-tune strategies, moderate risks and keep investors calm and focused.

Touchstone’s essay at Morningstar makes two powerful contributions. First, the Touchstone folks make the criteria for success – small funds, active and focused portfolios, aligned interests – really accessible. Second, they document the horrifying reality of the fund industry: that a greater and greater fraction of all investments are going into funds that profess active management but are barely distinguishable from their benchmarks.

Here’s a piece of their essay:

A surprising take away from the Active Share studies was the clear trend away from higher Active Share (Exhibit 5). The percentage of assets in U.S. equity funds with Active Share less than 60% went from 1.5% in 1980 to 50.2% in 2009. Clearly indexing has had an impact on these results.

Yet mutual funds with assets under management with an Active Share between 20% and 60% (the closet indexers) saw their assets grow from 1.1% in 1980 to 31% in 2009, meaning that closet index funds have seen the greatest proportion of asset growth. Assets in funds managed with a high Active Share, (over 80%), have dropped precipitously from 60% in 1980 to just 19% in 2009.

While the 2009 data is likely exaggerated — as Active Share tends to come down in periods of high market volatility —the longer term trend is away from high Active Share.

 

Cremers and Petajisto speculate that asset growth of many funds may be one of the reasons for the trend toward lower Active Share. They note that the data reveals an inverse relationship between assets in a fund and Active Share. As assets grow, managers may have a tougher time maintaining high Active Share. As the saying goes “nothing fails like success,” and quite often asset growth can lead to a more narrow opportunity set due to liquidity constraints that prevent managers from allocating new assets to their best ideas, they then add more liquid benchmark holdings. Cremers states in his study: “What I say is, if you have skill, why not apply that skill to your whole portfolio? And if your fund is too large to do that, why not close your portfolio?”

In an essentially unprecedented disclosure, Touchstone then published the concentration and Active Share statistics for their entire lineup of funds:

While it’s clear that Touchstone has some great funds and some modest ones, they really deserve attention and praise for sharing important, rarely-disclosed information with all of their investors and with the public at large. We’d be much better served if other fund companies had the same degree of confidence and transparency.

Touchstone is also consolidating four funds into two, effective March 2014. Steve Owen, one of their Managing Directors and head of International Business Development, explains:

With regard to small value, we are consolidating two funds, both subadvised by the same subadvisor, DePrince, Race & Zollo. Touchstone Small Cap Value Fund (TVOAX) was a legacy fund and that will be the receiving fund. Touchstone Small Company Value Fund (FTVAX), the one that is going away, is a fund that was adopted last year when we bought the Fifth Third Fund Family and we replaced the subadvisor at that time with DePrince Race & Zollo. Same investment mandate, same subadvisor, so it was time to consolidate the two funds.

The Mid Value Opportunities Fund (TMOAX)was adopted last year from the Old Mutual Fund Family and will be merged into Touchstone Mid Cap Value Fund (TCVAX). Consolidating the lineup, eliminating the adopted fund in favor of our incumbent from four years ago.

In preparation for the merger, Lee Munder Capital Group has been given manager responsibilities for both mid-cap funds. Neither of the surviving funds is a stand-out performer but bear watching.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Aegis Value (AVALX): There are a few funds that promise to pursue the most inefficient, potentially most profitable corner of the domestic equity mark, ultra-small deep value stocks. Of the handful that pursue it, only one other microcap value fund even comes close to Aegis’s long-term record.

T. Rowe Price Global Allocation (RPGAX): T. Rowe is getting bold, cautiously. Their newest and most innovative fund offers a changing mix of global assets, including structural exposure to a single hedge fund, is also broadly diversified, low-cost and run by the team responsible for their Spectrum and Personal Strategy Funds. So far, so good!

Elevator Talk

Elevator Talks are a short feature which offer the opportunity for the managers of interesting funds which we are not yet ready to profile, to speak directly to you. The basic strategy is for the Observer to lay out three paragraphs of introduction and then to give the manager 200 unedited words – about what he’d have time for in an elevator ride with a prospective investors – to lay out his case for the fund.

Our planned Elevator Talk for December didn’t come to fruition, but we’ll keep working with the managers to see if we can get things lined up for January.

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.
10. November 2013: Jeffrey Ringdahl of American Beacon Flexible Bond (AFXAX) gives teams from Brandywine Global, GAM and PIMCO incredible leeway wth which to pursue “positive total return regardless of market conditions.” Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

Conference Call Highlights: John Park and Greg Jackson, Oakseed Opportunity

If I had to suggest what characteristics gave an investor the greater prospects for success, I suggest looking for demonstrably successful managers who viscerally disliked the prospect of careless risk and whose interests were visibly, substantially and consistently aligned with yours.

The evidence increasingly suggests that Oakseed Opportunity matches those criteria. On November 18^th, Messrs Jackson and Park joined me and three dozen Observer readers for an hour-long conversation about the fund and their approach to it.

I was struck, particularly, that their singular focus in talking about the fund is “complete alignment of interests.” A few claims particularly stood out:

1. their every investable penny in is in the fund.
2. they intend their personal gains to be driven by the fund’s performance and not by the acquisition of assets and fees
3. they’ll never manage separate accounts or a second fund
4. they created an “Institutional” class as a way of giving shareholders a choice between buying the fund NTF with a marketing fee or paying a transaction fee but not having the ongoing expense; originally they had a $1 million institutional minimum because they thought institutional shares had to be that pricey. Having discovered that there’s no logical requirement for that, they dropped the institutional minimum by 99%.
5. they’ll close on the day they come across an idea they love but can’t invest in
6. they’ll close if the fund becomes big enough that they have to hire somebody to help with it (no analysts, no marketers, no administrators – just the two of them)

Highlights on the investing front were two-fold:

first, they don’t intend to be “active investors” in the sense of buying into companies with defective managements and then trying to force management to act responsibly. Their time in the private equity/venture capital world taught them that that’s neither their particular strength nor their passion.

second, they have the ability to short stocks but they’ll only do so for offensive – rather than defensive – purposes. They imagine shorting as an alpha-generating tool, rather than a beta-managing one. But it sounds a lot like they’ll not short, given the magnitude of the losses that a mistaken short might trigger, unless there’s evidence of near-criminal negligence (or near-Congressional idiocy) on the part of a firm’s management. They do maintain a small short position on the Russell 2000 because the Russell is trading at an unprecedented high relative to the S&P and attempts to justify its valuations require what is, to their minds, laughable contortions (e.g., that the growth rate of Russell stocks will rise 33% in 2014 relative to where they are now.

Their reflections of 2013 performance were both wry and relevant. The fund is up 21% YTD, which trails the S&P500 by about 6.5%. Greg started by imagining what John’s reaction might have been if Greg said, a year ago, “hey, JP, our fund will finish its first year up more than 20%.” His guess was “gleeful” because neither of them could imagine the S&P500 up 27%. While trailing their benchmark is substantially annoying, they made these points about performance:

• beating an index during a sharp market rally is not their goal, outperforming across a complete cycle is.
• the fund’s cash stake – about 16% – and the small short position on the Russell 2000 doubtless hurt returns.
• nonetheless, they’re very satisfied with the portfolio and its positioning – they believe they offer “substantial downside protection,” that they’ve crafted a “sleep well at night” portfolio, and that they’ve especially cognizant of the fact that they’ve put their friends’, families’ and former investors’ money at risk – and they want to be sure that they’re being well-rewarded for the risks they’re taking.

John described their approach as “inherently conservative” and Greg invoked advice given to him by a former employer and brilliant manager, Don Yacktman: “always practice defense, Greg.”

When, at the close, I asked them what one thing they thought a potential investor in the fund most needed to understand in order to know whether they were a good “fit” for the fund, Greg Jackson volunteered the observation “we’re the most competitive people alive, we want great returns but we want them in the most risk-responsible way we can generate them.” John Park allowed “we’re not easy to categorize, we don’t adhere to stylebox purity and so we’re not going to fit into the plans of investors who invest by type.”

They announced that they should be NTF at Fidelity within a week. Their contracts with distributors such as Schwab give those platforms latitude to set the minimums, and so some platforms reflect the $10,000 institutional minimum, some picked $100,000 and others maintain the original $1M. It’s beyond the guys’ control.

Finally, they anticipate a small distribution this year, perhaps $0.04-0.05/share. That reflects two factors. They manage their positions to minimize tax burdens whenever that’s possible and the steadily growing number of investors in the fund diminishes the taxable gain attributed to any of them.

If you’re interested in the fund, you might benefit from reviewing the vigorous debate on the discussion board that followed the call. Our colleague Charles, who joined in on the call, looked at the managers’ previous funds. He writes: “OK, quick look back at LTFAX and OAKGX from circa 2000 through 2004. Ted, even you should be impressed…mitigated drawdown, superior absolute returns, and high risk adjusted returns.”

For folks interested but unable to join us, here’s the complete audio of the hour-long conversation.

The SEEDX Conference Call

As with all of these funds, we’ve created a new featured funds page for Oakseed Opportunity Fund, pulling together all of the best resources we have for the fund.

December Conference Call: David Sherman, RiverPark Strategic Income

We’d be delighted if you’d join us on Monday, December 9^th, for a conversation with David Sherman of Cohanzick Asset Management and Morty Schaja, president of the RiverPark funds. On September 30, 2013, Cohanzick and Riverpark collaborated on the launch of their second fund together, RiverPark Strategic Income (RSIVX). Two months later, the fund has drawn nearly $90 million into a limited capacity strategy that sort of straddles the short- to intermediate-term border.

David describes this as a conservatively managed fund that focuses on reasonable returns with maximum downside protection. With both this fund and RiverPark Short-Term High-Yield (RPHYX, closed to new investors), David was comfortable having his mom invest in the fund and is also comfortable that if he gets, say, abducted by aliens, the fund could simply and profitably hold all of its bonds to redemption without putting her security as risk. Indeed, one hallmark of his strategy is its willingness to buy and hold to redemption rather than trading on the secondary market.

President Schaja writes, “In terms of a teaser….

• Sherman and his team are hoping for returns in the 6-8% range while managing a portfolio of “Money Good” securities with an average duration of less than 5 years.  Thereby, getting paid handsomely for the risk of rising rates.
• By being small and nimble Sherman and his team believe they can purchase “Money Good” securities with above average market yields with limited risk if held to maturity.
• The fund will be able to take advantage of some of the same securities in the 1-3 year maturity range that are in the short term high yield fund.
• There are “dented Credits” where credit stress is likely, however because of the seniority of the security the Fund will purchase, capital loss is deemed unlikely.

David has the fund positioned as the next step out from RPHYX on the risk-return spectrum and he thinks the new fund will about double the returns on its sibling. So far, so good:

Since I’m not a fan of wild rivers in a fixed-income portfolio, I really appreciate the total return line for the two RiverPark funds. Here’s Strategic Income against its multisector bond peer group:

Well, yes, I know that’s just two months. By way of context, here’s the three year comparison of RPHYX with its wildly-inappropriate Morningstar peer group (high yield bonds, orange), its plausible peer group (short-term bonds, green) and its functional peer, Vanguard’s Prime Money Market (VMMXX, hmmm…goldenrod?):

Our conference call will be Monday, December 9, from 7:00 – 8:00 Eastern. It’s free. It’s a phone call.

How can you join in?

If you’d like to join in, just click on register and you’ll be taken to the Chorus Call site. In exchange for your name and email, you’ll receive a toll-free number, a PIN and instructions on joining the call. If you register, I’ll send you a reminder email on the morning of the call.

Remember: registering for one call does not automatically register you for another. You need to click each separately. Likewise, registering for the conference call mailing list doesn’t register you for a call; it just lets you know when an opportunity comes up. 

WOULD AN ADDITIONAL HEADS UP HELP?

Over two hundred readers have signed up for a conference call mailing list. About a week ahead of each call, I write to everyone on the list to remind them of what might make the call special and how to register. If you’d like to be added to the conference call list, just drop me a line.

Launch Alert: Kopernik Global All-Cap Fund (KGGAX and KGGIX)

It’s rare that the departure of a manager triggers that collapse of an empire, but that’s pretty much what happened when David Iben left his Nuveen Tradewinds Global All-Cap Fund (NWGAX) in June 2012. From inception through his departure, a $10,000 investment in NWGAX would have grown by $3750. An investment made in his average peer would have grown by $90.

Iben was hired away from Tradewinds by Jeff Vinik, the former Fidelity Magellan manager who’d left that fund in 1996 to establish his hedge fund firm, Vinik Asset Management. Iben moved with four analysts to Vinik and became head of a 20-person value investing team.

In the six months following his announced intention to depart, Tradewinds lost nearly 75% of its total assets under management. Not 75% of his funds’ assets. 75% of the entire firm’s assets, about $28 billion between investor exits and market declines.

In May 2013, Vinik announced the closure of his firm “citing poor performance over a 10-month period” (Tampa Bay Business Journal, May 3 2013). You’ll have to give me a second to let my eyes return to normal; the thought of closing a firm because of a ten month bad stretch made them roll.  Mr. Iben promptly launched his own firm, backed by a $20 million investment (a/k/a pocket change) by Mr. Vinik.

On November 1, 2013, Kopernik Global Investors launched launched Kopernik Global All-Cap Fund (Class A: KGGAX; Class I: KGGIX) which they hope will become their flagship. By month’s end, the fund had nearly $120 million in assets.

If we base an estimate of Kopernik Global on the biases evident in Nuveen Tradewinds Global, you might expect:

A frequently out-of-step portfolio, which reflects Mr. Iben’s value orientation, disdain for most investors’ moves and affinity for market volatility. They describe the outcome this way:

This investment philosophy implies ongoing contrarian asset positioning, which in turn implies that the performance of Kopernik holdings are less reliant on the prevailing sentiment of market investors. As one would expect with such asset positioning, the performance of Kopernik strategies tend to have little correlation to common benchmarks.

A substantial overweight in energy and basic materials, which Mr. Iben overweighted almost 2:1 relative to his peers. He had a particular affinity for gold-miners.

The potential for a substantial overweight in emerging markets, which Mr. Iben overweighted almost 2:1 relative to his peers.

A slight overweight in international stocks, which were 60% of the Tradewinds’ portfolio but a bit more than 50% of its peers.

The themes of independence, lack of correlation with other investments, and the exploitation of market anomalies recur throughout Kopernik’s website. If you’re even vaguely interested in exploring this fund, you’d better take those disclosures very seriously. Mr. Iben had brilliant performance in his first four years at Tradewinds, and then badly trailed his peers in five of his last six quarters. While we do not know how his strategy performed at Vinik, we do know that 10 months after his arrival, the firm closed for poor performance.

Extended periods of poor performance are one of the hallmarks of independent, contrarian, visionary investors. It’s also one of the hallmarks of self-prepossessed monomaniacs.  Sometimes the latter look like the former. Often enough, the former are the latter.

The first month of Kopernik’s performance (in blue) looks like this:

Mr. Iben is clearly not following the pack. You’d want to be comfortable with where he is leading the caravan before joining.

“A” shares carry a 5.75% load, capped 1.35% expenses and $3000 minimum. Institutional shares are no-load with expenses of 1.10% and a $1 million minimum. The fund is not (yet) available for sale at Schwab or the other major platforms and a Schwab rep says he does not see any evidence of active negotiation with Kopernik but recommends that interested parties check in occasionally at the Kopernik Global All-Cap page at Schwab. The “availability” tab will let you know if it has become available.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Any fund that wanted to launch before the end of the year needed to be in registration by mid- to late October.

And there were a lot of funds targeting a year-end launch. Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves. This month he tracked down 15 no-load retail funds in registration, which represents our core interest. That number is down from what we’d normally see because these funds won’t launch until February 2014; whenever possible, firms prefer to launch by December 30^th and so force a lot of funds into the pipeline in October.

Interesting entries this month include:

American Beacon Global Evolution Frontier Markets Income Fund will be the first frontier market bond fund, focusing on sovereign debt. It will be managed by a team from Global Evolution USA, LLC, a subsidiary of Global Evolution Fondsmæglerselskab A/S. But you already knew that, right?

PIMCO Balanced Income Fund primarily pursues income and will invest globally, both very much unlike the average balanced fund. They’ll invest globally in dividend-paying common and preferred stocks and all flavors of fixed- and floating-rate instruments. The prospectus is still in the early stages of development, so there’s no named manager or expense ratio. This might be good news for Sextant Global High Income (SGHIX), which tries to pursue the same distinctive strategy but has had trouble explaining itself to investors.

SPDR Floating Rate Treasury ETF and WisdomTree Floating Rate Treasury Fund will track index of the as-yet unissued floating rate Treasury notes, the first small auction of which will occur January 29, 2014.

Manager Changes

On a related note, we also tracked down 58 fund manager changes.

Updates: the reorganization of Aegis Value, take two

Last month we noted, with unwarranted snarkiness, the reorganization of Aegis Value Fund (AVALX).  We have now had a chance to further review the preliminary prospectus and a 73-page proxy filing. The reorganization had two aspects, one of which would be immediately visible to investors and the other of which may be significant behind the scenes.

The visible change: before reorganization AVALX operates as a no-load retail fund with one share class and a $10,000 investment minimum.  According to the filings, after reorganization, Aegis is expected to have two share classes.  In the reorganization, a new, front-loaded, retail A-share class would be introduced with a maximum 3.75% sales load but also a series of breakpoint reductions.  There would also be a two-year, 1% redemption fee on some A-share purchases with value in excess of $1 million. There would also be a no-load institutional share class with a published $1,000,000 minimum.  However, current AVALX shareholders would become holders of grandfathered institutional shares not subject to the $1 million investment minimum.

Does this mean that new retail investors get stuck paying a sales load?  No, not necessarily. While the institutional class of Aegis High Yield has the same nominal million dollar minimum as Aegis Value will, it’s currently available through many fund supermarkets with the same $10,000 minimum investment as the retail shares of Aegis Value now have. We suspect that Aegis Value shareholders may benefit from the same sort of arrangement.

Does this mean that retail investors get stuck paying a 1% redemption fee on shares sold early? Again, not necessarily. As best I understand it, the redemption fee applies only to broker-sold A-shares sold in denominations greater than $1 million where the advisor pays a commission to the broker if the shares are then redeemed within two years of purchase.  So folks buying no-load institutional shares or buying “A” shares and actually paying the sales load are expected to be exempt.

The visible changes appear designed to make the fund more attractive in the market and especially to the advisor market, though it remains an open question whether “A” shares are the package most attractive to such folks.  Despite competitive returns over the past five years, the fund’s AUM remains far below its peak so we believe there’s room and management ability for substantially more assets.

The invisible change: two existing legal structures interfere with the advisor’s smooth and efficient organization.  They have two funds (Aegis High Yield AHYAX/AHYFX is the other) with different legal structures (one Delaware Trust, one Maryland Corporation) and different fiscal year ends. That means two sets of bookkeeping and two sets of reports; the reorganization is expected to consolidate the two and streamline the process.  We estimate the clean-up might save the advisor a little bit in administrative expenses.  In the reorganization, AVALX is also eliminating some legacy investment restrictions.  For example, AVALX is currently restricted from holding more than 10% of the publicly-available shares of any company.  The reorganization would lift these restrictions.  While the Fund has in the past only rarely held positions approaching the 10 percent ownership threshold, lifting these kinds of restrictions may provide management with more investment flexibility in the future.

Briefly Noted . . .

In a surprising announcement, Forward Funds removed a four-person team from Cedar Ridge Partners as the sub-advisers responsible for Forward Credit Analysis Long/Short Fund (FLSLX).  The fund was built around Cedar Ridge’s expertise in muni bond investing and the team had managed the fund from inception.  Considered as a “non-traditional bond” fund by Morningstar, FLSLX absolutely clubbed their peers in 2009, 2011, and 2012 while trailing a bit in 2010.  Then this in 2013:

Over the past six months, FLSLX dropped about 14% in value while its peers drifted down less than 2%.

We spoke with CEO Alan Reid in mid-November about the change.  While he praised the Cedar Ridge team for their work, he noted that their strategy seemed to work best when credit spreads were compressed and poorly when they widened.  Bernanke’s May 22 Congressional testimony concerning “tapering” roiled the credit markets, but appears to have gobsmacked the Cedar Ridge team: that’s the cliff you see them falling off.  Forward asked them to “de-risk” the portfolio and shortly afterward asked them to do it again.  As he monitored the fund’s evolution, Mr. Reid faced the question “would I put my money in this fund for the next three to five years?”   When he realized the answer was “no,” he moved to change management.

The new management team, Joseph Deane and David Hammer, comes from PIMCO.  Both are muni bond managers, though neither has run a fund or – so far as I can tell – a long/short portfolio.  Nonetheless they’re back by an enormous analyst corps.  That means they’re likely to have access to stronger research which would lead to better security selection.  Mr. Reid points to three other distinctions:

There is likely to be less exposure to low-quality issues, but more exposure to other parts of the fixed-income market.  The revised prospectus points to “municipal bonds, corporate bonds, notes and other debentures, U.S. Treasury and Agency securities, sovereign debt, emerging markets debt, variable rate demand notes, floating rate or zero coupon securities and nonconvertible preferred securities.”

There is likely to be a more conservative hedging strategy, focused on the use of credit default swaps and futures rather than shorting Treasury bonds.

The fund’s expenses have been materially reduced.  Cedar Ridge’s management fee had already been cut from 1.5% to 1.2% and the new PIMCO team is under contract for 1.0%.

It would be wise to approach with care, since the team is promising but untested and the strategy is new.  That said, Forward has been acting quickly and decisively in their shareholders’ interests and they have arranged an awfully attractive partnership with PIMCO.

Wow.  In mid-November T. Rowe Price’s board decided to merge the T. Rowe Price Global Infrastructure Fund (TRGFX) into T. Rowe Price Real Assets Fund (PRAFX).  Equity CIO John Linehan talked with us in late November about the move.  The short version is this: Global Infrastructure found very little market appeal because the vogue for infrastructure investing is in private equity rather than stocks.  That is, investors would rather own the lease on a toll road than own stock in a company which owns, among other things, the lease on a toll road. Since the fund’s investment rationale – providing a hedge against inflation – can be addressed well in the Real Assets funds, it made business sense to merge Infrastructure away.

Taken as a global stock fund, Infrastructure was small and mediocre. (We warned that “[t]he case for a dedicated infrastructure fund, and this fund in particular, is still unproven.”) Taken as a global stock fund, Real Assets is large and rotten. The key is that “real assets” funds are largely an inflation-hedge, investing in firms that control “stuff in the ground.”  With inflation dauntingly low, all funds with this focus (AllianceBernstein, Cohen & Steers, Cornerstone, Harford, Principal and others offer them) has looked somewhere between “punky” and “putrid.”  In the interim, Price has replaced Infrastructure’s manager (Kes Visuvalingam has replaced Susanta Mazumdar) and suspended its redemption fee, for the convenience of those who would like out early. 

Our Real Assets profile highlights the fact that this portfolio might be used as a small hedge in a diversified portfolio; perhaps 3-5%, which reflects its weight in Price’s asset allocation portfolios.  Mr. Lee warns that the fund, with its huge sector bets on energy and real estate, will underperform in a low-inflation environment and would have no structural advantage even in a moderate rate one. Investors should probably celebrate PRAFX’s underperformance as a sign that the chief scourge of their savings and investments – inflation – is so thoroughly suppressed.

FundX Tactical Total Return Fund (TOTLX) Effective January 31, 2014, the investment objective of the FundX Tactical Total Return Fund is revised to read:  “The Fund seeks long term capital appreciation with less volatility than the broad equity market; capital preservation is a secondary consideration.”

SMALL WINS FOR INVESTORS

CAN SLIM® Select Growth Fund (CANGX) On Monday, November 11, 2013, the Board of Trustees of Professionally Managed Portfolios approved the following change to the Fund’s Summary Prospectus, Prospectus and Statement of Additional Information: The Fund’s Expense Cap has been reduced from 1.70% to 1.39%.

The expense ratio on nine of Guggenheim’s S&P500 Equal Weight sector ETFS (Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Materials, Technology and Utilities) have dropped from 0.50% to 0.40%.

Effective November 15^th, REMS Real Estate Income 50/50 (RREFX) eliminated its sales load and reduced its 12(b)1 fee from 0.35% to 0.25%.  The new investment minimum is $2,500, up from its previous $1,000.  The 50/50 refers to the fund’s target allocation: 50% in the common stock of REITs, 50% in their preferred securities.

Effective mid-November, the Meridian Funds activated Advisor and Institutional share classes.

CLOSINGS (and related inconveniences)

Effective November 18, 2013, the Buffalo Emerging Opportunities Fund (BUFOX), a series of Buffalo Funds, will be closed to all new accounts, including new employer sponsored retirement plans (“ESRPs”).  The Fund will remain open to additional investments by all existing accounts

Invesco European Small Company Fund (ESMAX) will close to all investors effective the open of business on December 4, 2013. The fund has $560 million in AUM, a low turnover style and a splendid record. The long-time lead manager, Jason Holzer, manages 13 other funds, most for Invesco and most in the European and international small cap realms. That means he’s responsible for over $16 billion in assets.  He has over a million invested both here and in his International Small Company Fund (IEGAX).

Effective December 31, 2013, T. Rowe Price New Horizons Fund (PRHNX) will be closed to new investors.  This used to be one of Price’s best small cap growth funds until the weight of $14 billion in assets moved it up the scale.  Morningstar still categorizes it as “small growth” and it still has a fair chunk of its assets in small cap names, but a majority of its holdings are now mid- to large-cap stocks.

Also on December 31, 2013, the T. Rowe Price Small-Cap Stock Fund (OTCFX) will be closed to new investors.  Small Cap is smaller than New Horizons – $9 billion versus $14 billion – and maintains a far higher exposure to small cap stocks (about 70% of the portfolio).  Nonetheless it faces serious headwinds from the inevitable pressure of a rising asset base – up by $2 billion in 12 months.  There’s an interesting hint buried in the fund’s ticker symbol: it was once the Over the Counter Securities Fund.

Too late: Vulcan Value Partners Small Cap Fund (VVPSX), which we profiled as “a solid, sensible, profitable vehicle” shortly after launch, vindicated our judgment when it closed to new investors at the end of November.  The closure came with about one week’s notice, which strikes me as a responsible decision if you’re actually looking to close off new flows rather than trigger a last minute rush for the door.  The fund’s current AUM, $750 million, still gives it plenty of room to maneuver in the small cap realm. 

Effective December 31, 2013, Wells Fargo Advantage Emerging Markets Equity Fund (EMGAX) will be closed to most new investors.  Curious timing: four years in a row (2009-2012) of top decile returns, and it stayed open.  Utterly mediocre returns in 2013 (50^th percentile, slightly underwater) and it closes.

OLD WINE, NEW BOTTLES

BlackRock Emerging Market Local Debt Portfolio (BAEDX) is changing its name and oh so much more.  On New Year’s 2014, shareholders will find themselves invested in BlackRock Emerging Markets Flexible Dynamic Bond Portfolio which certainly sounds a lot more … uhh, flexible.  And dynamic!  I sometimes wonder if fund marketers have an app on their iPhones, rather like UrbanSpoon, where you hit “shake” and slot machine-like wheels start spinning.  When they stop you get some combination of Flexible, Strategic, Multi-, Asset, Manager, Strategy, Dynamic, Flexible and Tactical.

Oh, right.  Back to the fund.  The Flexible Dynamic fund will flexibly and dynamically invest in what it invests in now except they are no longer bound to keep 65% or more in local-currency bonds.

Effective March 1, 2014, BMO Government Income Fund (MRGIX) beomes BMO Mortgage Income Fund. There will be no change in strategy reflecting the fact that the government gets its income from . . . uh, mortgages?

Effective December 11, 2013 Columbia Large Cap Core Fund (NSGAX) will change to Columbia Select Large Cap Equity Fund.  The prospectus for the new version of the fund warns that it might concentrate on a single sector (they name technology) and will likely hold 45-65 stocks, which is about where they already are.  At that same time, Columbia Active Portfolios® – Diversified Equity Income Fund (INDZX) becomes Active Portfolios® Multi-Manager Value Fund and Columbia Recovery and Infrastructure (RRIAX) becomes Columbia Global Infrastructure Fund.  Morningstar rates it as a one-star fund despite high relative returns since inception, which suggests that the fund’s volatility is higher still.

Dreyfus will ask shareholders to approve a set of as-yet undescribed strategy changes which, if approved, will cause them to change the Dreyfus/Standish Intermediate Tax Exempt Bond Fund to Dreyfus Tax Sensitive Total Return Bond Fund

On February 21, 20414, Dreyfus/The Boston Company Emerging Markets Core Equity Fund will change its name to Dreyfus Diversified Emerging Markets Fund.

Effective December 23, 2013, Forward Select Income Opportunity Fund (FSONX) becomes Forward Select Opportunity Fund.  The fact that neither the fund’s webpage nor its fact sheet report any income (i.e., there’s not even a spot for 30-day SEC yield or anything like it) might be telling us why “income” is leaving the name.

Ivy Pacific Opportunities Fund (IPOAX) seems to have become Ivy Emerging Markets Equity Fund. The new fund’s prospectus shifts it from a mid-to-large cap fund to an all-cap portfolio, adds the proviso that up to 20% of the portfolio might be invested in precious metals. There’s an unclear provision about investing in a Cayman Islands subsidiary to gain commodities exposure but it’s not clear whether that’s in addition to the gold.  And, finally, Ivy Asset Strategy New Opportunities Fund (INOAX) will merge into the new fund in early 2014.  That might come as a surprise to INOAX shareholders, since their current fund is not primarily an emerging markets vehicle.

OFF TO THE DUSTBIN OF HISTORY

Corporate America CU Short Duration Fund (CASDX) liquidated at the end of November.  That’s apparently more evidence of Corporate America’s shortened time horizon.  The fund was open a bit more than a year and pulled in a bit more than $60 million in assets before the advisor thought … what?  “Oh, we’re not very good at this”?  “Oh, we’re not apt to get very good at this”?  “Oh, look!  There’s a butterfly”?

Delaware International Bond Fund (DPIFX) will be liquidated and dissolved on New Year’s Eve.  I knew several grad students who suffered a similar fate that evening.

The Equinox funds plan a wholesale liquidation: Equinox Abraham Strategy Fund (EABIX), Absolute Return Plus Strategy (EMEIX), Eclipse Strategy (EECIX), John Locke Strategy (EJILX), QCM Strategy (EQQCX) and Tiverton Strategy (EQTVX) all meet their maker on December 9^th.  The smallest of these funds has about $8500 in AUM.  Right: not enough to buy a used 2010 Toyota Corolla.  The largest has about $600,000 and, in total, they don’t reach $750,000.  All are classified as “managed futures” funds and no, I have no earthly idea why Equinox has seven such funds: the six dead funds walking and the surviving Equinox Crabel Strategy (EQCRX) which has about $15,000 in AUM.

Given that these funds have $25,000 minimums and half of them have under $25,000 in assets, the clear implications is that several of these funds have one shareholder. In no instance, however, is that one shareholder a manager of the fund since none of the five managers was silly enough to invest.

FundX ETF Upgrader Fund (REMIX) is merging into the FundX Upgrader Fund (FUNDX) and the FundX ETF Aggressive Upgrader Fund (UNBOX) goes into the FundX Aggressive Upgrader Fund (HOTFX), effective January 24, 2014.   My colleague Charles’s thoughtful and extensive analysis of their flagship FundX Upgrader Fund offers them as “a cautionary tale” for folks whose strategy is to churn their portfolios, always seeking hot funds.

An ING fund disappears: ING has designated ING Bond Portfolio (IABPX) as a “disappearing portfolio.”  They craftily plan to ask shareholders in late February to authorize the disappearance.  The largely-inoffensive ING Intermediate Bond Portfolio (IIABX) has been designated as “the Surviving Portfolio.”

But nothing will survive of ING American Funds International Growth and Income Portfolio (IAIPX) or ING American Funds Global Growth and Income Portfolio (IAGPX), both of which will be liquidated on February 7, 2014.

ING PIMCO High Yield Portfolio (IPHYX) disappears on February 14 and is replaced by ING High Yield Portfolio.  See ING decided to replace the world’s most renowned fixed income shop, which was running a four-star $900 million portfolio for them, with themselves with Rick Cumberledge and team, nice people who haven’t previously managed a mutual fund.  The investors get to celebrate a two (count ‘em: 2!) basis point fee reduction as a result.

The Board of Trustees of the JPMorgan India Fund (JIDAX) has approved the liquidation and dissolution of the Fund on or about January 10, 2014.  The fund has a six-year record that’s a bit above average but that comes out as a 17% loss since inception.  The $9.5 million there would have been, and would still be, better used in Matthews India (MINDX).  

We’d already announced the closure and impending liquidation of BlackRock India Fund (BAINX).  The closure occurred October 28 and the liquidation occurs on December 10, 2013.  BAINX – the bane of your portfolio?  due to be bain-ished from it? – is down 14% since launch, its peers are down 21% from the same date. 

The Board of Trustees of the JPMorgan U.S. Real Estate Fund (SUSIX) has approved the liquidation and dissolution of the Fund on or about December 20, 2013.  Color me clueless: it’s an unimpressive fund, but it’s not wretched and it does have $380 million dollars.

Litman Gregory Masters Focused Opportunities Fund (MSFOX) is merging into Litman Gregory Masters Equity Fund (MSENX) because, they explain, MSFOX

… has had net shareholder redemptions over the past five years, causing the asset level of the Focused Opportunities Fund to decline almost 50% over that time period.  The decline in assets has resulted in a corresponding increase in the Focused Opportunities Fund’s expense ratio, and … it is unlikely that the Focused Opportunities Fund will increase in size significantly in the foreseeable future.

The first part of that statement is a bit disingenuous.  MSFOX has $67 million at the moment.  The only time it exceeded that level was in 2007 when, at year end, it had $118 million.  It lost 60% between October 2007 and March 2009 (much more than its peers) and has never regained its place in the market. The Observer has a favorable opinion of the fund, which has earned four stars from Morningstar and five for Returns, Consistency and Preservation from Lipper but its fall does point to the fragility of survival once investors have been burned. This is the second fund to merge into MSENX, Litman Gregory Masters Value was the first, in May 2013.

The Lord hath left the building: the shareholders of Lord Abbett Classic Stock Fund (LRLCX) convened on November 7^th to ponder the future of their fund.  Fifteen days later it was gone, absorbed by Lord Abbett Calibrated Dividend Growth Fund (LAMAX).  Not to suggest that Lord Abbett was going through the motions, but they did put the LAMAX managers in charge of LRLCX back on June 11^th. 

Mercer Investment Management decided to liquidate the Mercer US Short Maturity Fixed Income Fund (MUSMX) on or about December 16, 2013

Monetta has decided to liquidate Monetta Mid-Cap Equity Fund (MMCEX), effective as of the close of business on December 20, 2013.  Robert Baccarella has been running the fund for 20 years, the last four with his son, Robert.  Despite a couple good years, the fund has resided in the 98^th or 99^th percentiles for performance for long ago.

Effective December 9, 2013, the name of the MutualHedge Frontier Legends Fund (MHFAX) changes to Equinox MutualHedge Futures Strategy Fund.  Morningstar has a Neutral rating on the fund and describes it as “good but not great yet” because of some management instability and high expenses.

Paladin Long Short Fund (PALFX) will discontinue operations on December 20, 2013.  Given the fund’s wild churning, this closure might well threaten the profitability of three or four systemically important institutions:

Why, yes, the liquidation is a taxable event for you.  Not so much for the fund’s manager, who has under $50,000 invested.  Given that the fund has, from inception in 2011 to mid-November 2013 lost money for its investors, taxes generated by churn will be particularly galling.

As noted above, T. Rowe Price Global Infrastructure Fund (TRGFX) is slated to merge into T. Rowe Price Real Assets Fund (PRAFX) in the spring of 2014.

Quaker Funds closed Quaker Akros Absolute Return Fund (AARFX) and the Quaker Small-Cap Growth Tactical Allocation Fund (QGASX) on November 5^th in anticipation of liquidating them (an action which requires shareholder approval).  I have no idea of why they’re ditching AARFX.  The fund promises “absolute returns.”  $10,000 invested at inception in 2005 would be worth $10,040 today.  Mission accomplished!

Roosevelt Strategic Income Fund (RSTIX) was liquidated on November 27, 2013.  That’s presumably a low-assets/bad marketing sort of call since the fund had top tier returns compared to its global bond peers over the two-plus years of its existence.  The manager, Arthur Sheer, continues managing Roosevelt Multi-Cap (BULLX).

The Royce Fund’s Board of Trustees approved a plan of liquidation for Royce Global Select Long/Short Fund (RSTFX), to be effective on December 2, 2013. The Fund is being liquidated primarily because it has not attracted and maintained assets at a sufficient level for it to be viable.  The decision elicited several disgusted comments on the board, directed at Royce Funds.  The tenor of the comments was this: “Royce, a Legg Mason subsidiary, has morphed from an investment manager to an asset gatherer.  It’s the Legg Mason mantra: “assets (hence revenues) über alles.”  It’s indisputably the case that Royce rolled out a bunch of funds once it became part of Mason; they ran 11 funds when they were independent, 29 today plus some Legg Mason branded funds (such as Legg Mason Royce Smaller Companies Premier, £ denominated “A” shares in Ireland) and some sub-advised ones.  And the senior Royce managers presume to oversee more funds than almost any serious peer: Charles Royce – 13 funds, Whitney George – 10 funds, David Nadel – 10 funds.

Then, too, it’s not very good. At least over the past three years, it’s badly trailed a whole variety of benchmarks.

Symetra funds has decided, for no immediately evident reason, to liquidate several successful funds (Symetra DoubleLine Total Return, Symetra DoubleLine Emerging Markets Income and Symetra Yacktman Focused).

TEAM Asset Strategy Fund (TEAMX) is liquidating, but it’s doing so with refreshing honesty: it’s “because of a decline in assets due to continued poor performance and significant redemptions.” 

Yep.  You’re reading it right: $10,000 becomes $1904.  75% YTD loss.  To which I can only response: “Go, TEAM, go!  Quickly!  Go now!”

The Board of Directors of Tributary Funds has approved liquidation of Tributary Large Cap Growth Fund (FOLCX) on or about January 29, 2014.  Since David Jordan, manager of the five-star Tributary Balanced (FOBAX) and flagship four-star Growth Opportunities (FOGRX) funds, took over in 2011, the fund has had very competitive returns but not enough to draw serious assets and move the fund toward economic viability.

Vanguard Tax-Managed International Fund (VTMGX) merges into the Vanguard Developed Markets Index Fund, which is expected to occur on or about April 4, 2014.  Finally, a $20 billion closet index fund (the r-squared against the MSCI EAFE Index was nearly 99) that just surrenders to being an index!  In a final dose of irony, VTMGX tracked its index better than does the index fund into which it’s merging.  Indeed, there are seven international large-blend index funds which track their indexes less faithfully than the supposedly-active VTMGX did. 

In Closing . . .

Thanks to all of the folks who join us each month, and thanks especially to those who support the Observer by joining our remarkably thoughtful discussion board, by sharing tips and leads with me by email, and by contributing through PayPal or via our Amazon partnership.  Your interest and engagements helps make up for a lot of late nights and the occasional withering glare as we duck away from family gatherings to write a bit more.

Our partnership with Amazon provides our steadiest income stream: if you buy a $14 book, we get about a buck. If you buy a Cuisinart Brew Central coffeemaker at $78, we get five or six.  Buy an iPad and we get bumpkus (Apple refuses to play along), but that’s okay, they’re cool anyway. There are, nonetheless, way cool smaller retailers that we’ve come across but that you might not have heard of. The Observer has no financial stake in any of this stuff but I like sharing word of things that strike me as really first-rate.

Some guys wear ties rarely enough that they need to keep that little “how to tie a tie” diagram taped to their bathroom mirrors.  Other guys really wish that they had a job where they wore ties rarely enough that they needed to keep that little “how to tie a tie” diagram taped up.

Duluth sells clothes, and accessories, for them.  I own rather a lot of it.  Their stuff is remarkably well-made if moderately pricey.  Their sweatshirts, by way of example, are $45-50 when they’re not on sale.  JCPenney claims that their sweatshirts are $48 but on perma-sale for $20 or so.  The difference is that Duluth’s are substantially better: thicker fabric, longer cut, with thoughtful touches like expandable/stretchy side panels.

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VoiceBase offers cools, affordable transcription services.  We’re working with the folks at Beck, Mack & Oliver to generate a FINRA-compliant transcript of our October conference call with Zac Wydra.  Step One was to generate a raw transcript with which the compliance folks at Beck, Mack might work. Chip, our estimable technical director, sorted through a variety of sites before settling on VoiceBase.

It strikes us that their service is cool, reliable and affordable.  Here’s the process.  Set up a free account.  Upload an audio file to their site.  About 24 hours later, they’ve generate a free machine-based transcription for you.  If you need greater accuracy than the machine produces – having multiple speakers and variable audio quality wreaks havoc with the poor beastie’s circuits – they provide human transcription within two or three days.

The cool part is that they host the audio on their website in a searchable format.  Go to the audio, type “emerging markets” and the system automatically flags any uses of that phrase and allows you to listen directly to them. If you’d like to play, here is the MFO Conference Call with Zac Wydra.

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QuoteArts.com is a small shop that consistently offers a bunch of the most attractive, best written greeting cards (and refrigerator magnets) that I’ve seen.  Steve Metivier, who runs the site, gave us permission to reproduce one of their images (normally the online version is watermarked):

The text reads “A time to quiet our hearts… (inside) to soften our edges, clear our minds, enjoy our world, and to share best wishes for the season. May these days and all the new year be joyful and peaceful.”  It strikes me as an entirely-worthy aspiration.

We hope it’s a joyful holiday season for you all, and we look forward to seeing you in the New Year.

Dear friends,

Occasionally Facebook produces finds that I’m at a loss to explain.  Ecce:

(Thanks to Nina K., a really first-rate writer and first-rate property/insurance lawyer in the Bay State for sharing Mr. Takei’s post with us. Now if I could just get her to restrain the impulse to blurt out, incredulous, “you really find this stuff interesting?”)

Let’s see.  Should I be more curious about the fact that Mr. Takei (iconically Ensign Sulu on Star Trek) manages just a basso profundo “oh myyy” on his post or the fact that he was recently lounging in a waiting room at the University of Iowa Hospitals, a bit west of here?  Perhaps it would be better to let his friends weigh in?

Chip’s vote was to simply swipe her favorite image from the thread, one labeled “a real hedge fund.”

Which is to say, a market that tacks on 29% in a year makes it easy to think of investing as fun and funny again. 

Now if only that popular sentiment could be reconciled with the fact that a bunch of very disciplined, very successful managers are quietly selling down their stocks and building their cash reserves again.

Here’s today’s “know your Morningstar!” quiz.  

Here are the total return charts for two short-term bond funds.  One is the sole Morningstar Gold Medalist in the group, representing “one of the industry’s best managers, and one of the category’s best funds.”  The other is a lowly one-star fund unworthy of Morningstar’s notice 

 

Question: do you …know your Morningstar!?  Which is the golden child?  Is it blue or orange?

Would it help to know that one of these funds is managed by a multi-trillion dollar titan and the other by a small, distinctive boutique?  Or that one of the funds invests quite conventionally and fits neatly into a style-box while the other is one-of-a-kind?

If you know your Morningstar, you’ll know that “small, distinctive and hard to pigeonhole” is pretty much the kiss of death.  The orange (or gold) line represents PIMCO Low Duration, “D” shares (PLDDX).  It’s a $24 billion “juggernaut” (Morningstar’s term) that’s earned four stars and a Gold designation.  It tends to be in the top quarter of the short-term bond group, though not at its top, and is a bit riskier than average.

The blue line represents RiverPark Short Term High Yield (RPHYX), an absolutely first-rate cash management fund about which we’ve written a lot. And which Morningstar just designated as a one-star fund. Why so?  Because Morningstar classifies it as a “high yield bond” fund and benchmarks it against an investment class that has outperformed the stock market over the past 15 years but with the highest volatility in the fixed-income universe. To be clear: there is essentially no overlap between RiverPark’s portfolio and the average high-yield bond funds and they have entirely different strategies, objectives and risk profiles. Which is to say, Morningstar has managed a classic “walnuts to lug nuts” comparison.

Here’s the defense Morningstar might reasonably make: “we had to put it somewhere.  It says ‘high yield.’  We put it there.”

Here’s our response: “that’s a sad and self-damning answer.  Yes, you had to put it somewhere.  But having put it in a place that you know is wildly inappropriate, you also need to accept the responsibility – to your readers, to RiverPark’s investors and to yourselves – to address your decision.  You’ve got the world’s biggest and best supported corps of analysts in the world. Use them! Don’t ignore the funds that do well outside of the comfortable framework of style boxes, categories and corporate investing! If the algorithms produce palpably misleading ratings, speak up.”

But, of course, they didn’t.

The problem is straightforward: Morningstar’s ratings are most reliable when you least need them. For funds with conventional, straightforward, style-pure disciplines – index funds and closet index funds – the star ratings probably produce a fair snapshot across the funds. But really, how hard is it – even absent Morningstar’s imprimatur – to find the most solid offering among a gaggle of long-only, domestic large cap, growth-at-a-reasonable price funds? You’ll get 90% of the way there with three numbers: five year returns, five year volatility and expense ratio. Look for ones where the first is higher and the second two are lower.

When funds try not to follow the herd, when the manager appears to have a brain and to be using it to pursue different possibilities, is when the ratings system is most prone to misleading readers. That’s when you need to hear an expert’s analysis. 

So why, then, deploy your analysts to write endless prose about domestic large cap funds? Because that’s where the money is.

Morningstar ETF Invest: Rather less useful content than I’d imagined

Morningstar hosted their ETF-focused conference in Chicago at the beginning of October.  The folks report that the gathering has tripled in size over the last couple years, turned away potential registrants and will soon need to move to a new space.  After three days there, though, I came away with few strong reactions.  I was struck by the decision of one keynote speaker to refer to active fixed-income managers as “the enemy” (no, dude, check the mirror) and the apparent anxiety around Fidelity’s decision to enter the ETF market (“Fidelity is coming.  We know they’re coming.  It’s only a matter of time,” warned one).

My greatest bewilderment was at the industry’s apparent insistence on damaging themselves as quickly and thoroughly as possible.  ETFs really have, at most, three advantages: they’re cheap, transparent and liquid.  The vogue seems to be for frittering that away.  More and more advisors are being persuaded to purchase the services of managed portfolio advisors who, for a fee, promise to custom-package (and trade) dozens of ETFs.  I spoke with representatives of a couple index providers, including FTSE, who corroborated Morningstar’s assertion that there are likely two million separate security indexes in operation with more being created daily. And many of the exchange-traded products rely in derivatives to try to capture the movements of those 2,000,000.  On whole, it feels like a systematic attempt to capture the most troubling features of the mutual fund industry – all while preening about your Olympian superiority to the mutual fund industry.

Odd.

The most interesting presentation at the conference was made by Austan Goolsbee, a University of Chicago economist and former chief of the President’s Council of Economic Advisers, who addressed a luncheon crowd. It was a thoroughly unexpected performance: there’s a strong overtone of Jon Stewart from The Daily Show, an almost antic energy. The presentation was one-third Goolsbee family anecdotes (“when I’d complain about a problem, gramma would say ‘80% of us don’t care. . . and the other 20% are glad about it'”), one-third White House anecdotes and one-third economic arguments.

The short version:

• The next 12-18 months will be tough because the old drivers of recovery aren’t available this time. Over the last century, house prices appreciated by 40 basis points annually for the first 90 years. From 2000-08, it appreciated 1350 bps annually. In the future, 40 bps is likely about right which means that a recovery in the housing industry won’t be lifting all boats any time soon.
• We’ll know the economy is recovering when 25 year olds start moving out of their parents’ basements, renting little apartments, buying futons and cheap pots and pans. (Technically, an uptick in household formation. Since the beginning of the recession, the US population has grown by 10 million but the number of households has remained flat.) One optimistic measure that Goolsbee did not mention but which seems comparable: the number of Americans choosing to quit their jobs (presumably for something better) is rising.
• The shutdown is probably a good thing, since it will derail efforts to create an unnecessary crisis around the debt ceiling.
• In the longer term, the US will recover and grow at 3.5% annually, driven by a population that’s growing (we’ll likely peak around 400 million while Japan, Western Europe and Russia contract), the world’s most productive workforce and relatively light taxation. While Social Security faces challenges, they’re manageable. Given the slow rolling crisis in higher education and the near collapse of new business launches over the past decade, I’m actually somewhere between skeptical and queasy on this one.
• The Chinese economic numbers can’t be trusted at all. The US reports quarterly economic data after a 30 day lag and frequently revises the numbers 30 days after that. China reports their quarterly numbers one day after the end of the quarter and has never revised any of the numbers. A better measure of Chinese activity is derivable from FedEx volume (it’s way down) since China is so export driven.

One highlight was his report of a headline from The Onion: “recession-plagued nation demands a new bubble to invest in … so we can get the economy going again. We need a concrete way to create illusory wealth in the near future.”

One of the great things about having Messrs Studzinski and Boccadoro contributing to the Observer is that they’re keen, experienced observers and very good writers.  The other great thing about it is that I no longer have to bear the label, “the cranky one.” In the following essay, Ed Studzinkski takes on one of the beloved touchstones of shareholder-friendly management: “skin in the game.”  Further down, Charles Boccadoro casts a skeptical eye, in a data-rich piece, on the likelihood that an investor’s going to avoid permanent loss of capital.

 

Skin in the Game, Part Two

The trouble with our times is that the future is not what it used to be.

Paul Valery

Nassim Nicholas Taleb, the author of The Black Swan as well as Antifragile: Things That Gain from Disorder, has recently been giving a series of interviews in which he argues that current investment industry compensation practices lead to subtle conflicts of interest, that end up inuring to the disadvantage of individual investors. Nowhere is this more apparent than when one looks at the mutual fund complexes that have become asset gatherers rather than investment managers.

By way of full disclosure I have to tell you that I am an admirer of Mr. Taleb’s. I was not always the most popular boy in the classroom as I was always worrying about the need to consider the potential for “Black Swan” or outlier events. Unfortunately all one has to have is one investment massacre like the 2008-2009 period. This gave investors a lost decade of investment returns and a potentially permanent loss of capital if they panicked and liquidated their investments. To have a more in-depth appreciation of the concept and its implications, I commend those of you with the time to a careful study of the data that the Mutual Fund Observer has compiled and begun releasing regularly. You should pay particular attention to a number called the “Maximum Drawdown.” There you will see that as a result of that dark period, looking back five years it is a rarity to find a domestic fund manager who did not lose 35-50% of his or her investors’ money. The same is to be said for global and international fund managers who likewise did not distinguish themselves, losing 50-65% of investors’ capital, assuming the investors panicked and liquidated their investments, and many did.

A number of investment managers that I know are not fans of Mr. Taleb’s work, primarily because he has a habit of bringing attention to inconvenient truths. In Fooled by Randomness, he made the case that given the large number of people who had come into the investment management business in recent years, there were a number who had to have generated good records randomly. They were what he calls “spurious winners.” I would argue that the maximum drawdown numbers referred to above confirm that thesis.

How then to avoid the spurious winner? Taleb argues that the hedge fund industry serves as a model, by truly having managers with “skin in the game.” In his experience a hedge fund manager typically has twenty to fifty times the exposure of his next biggest client. That of necessity makes them both more careful and as well as aware of the consequences if they have underinvested in the necessary talent to remain competitive. Taleb quite definitively states, “You don’t get that with fund managers.”

I suspect the counterargument I am going to hear is that fund managers are now required to disclose, by means of reporting within various ranges, the amount of money they have invested in the fund they are managing. Just go to the Statement of Additional Information, which is usually found on a fund website. And if the SAI shows that the manager has more than $1 million invested in his or her fund, then that is supposed to be a good sign concerning alignment of interests. Like the old Hertz commercial, the real rather than apparent answer is “not exactly.”

The gold standard in this regard has been set by Longleaf Partners with their funds. Their employees are required to limit their publicly offered equity investments to funds advised by Southeastern Asset Management, Longleaf’s advisor, unless granted a compliance exception. Their trustees also must obtain permission before making a publicly offered equity investment. That is rather unique in the fund industry, since what you usually see in the marketing brochures or periodic fund reports is something like “the employees and families of blah-blah have more than $X million invested in our funds.” If you are lucky this may work out to be one percent of assets under management in the firm, hardly hedge-fund like metrics. At the same time, you often find trustees of the fund with de minimis investments.

The comparison becomes worse when you look at a fund with $9 billion in assets and the “normal” one percent investment management fee, which generates $90 million in revenue. The fund manager may tell you that his largest equity investment is in the fund and is more than $1 million. But if his annual compensation runs somewhere between $1million and $10 million, and this is Taleb’s strongest point, the fund manager does not have a true disincentive for losing money. The situation becomes even more blurred where compliance policy allows investment in ETF’s or open-ended mutual funds, which in today’s world will often allow a fund manager to construct his own personal market neutral or hedged portfolio, to offset his investment in the fund he is managing.

Is there a solution? Yes, a fairly easy one – adopt as an industry standard through government regulation the requirement that all employees in the investment firm are required to limit their publicly offered equity investments to the funds in the complex. To give credit where credit is due, just as we have a Volcker rule, we can call it the “Southeastern Asset Management” rule. If that should prove too restrictive, I would suggest as an alternative that the SEC add another band of investment ranges above the current $1 million limit, at perhaps $5 million. That at least would give a truer picture for the investor, especially given the money flows now gushing into a number of firms, which often make a $1 million investment not material to the fund manager. Such disclosure will do a better job of attuning investment professionals to what should be their real concern – managing risk with a view towards the potential downside, rather than ignoring risk with other people’s money.

Postscript:

What does it say when such well known value managers as Tweedy, Browne and First Pacific Advisors are letting cash positions rise in their portfolios as they sell and don’t replace securities that have reached their target valuations? Probably the same thing as when one of the people I consider to be one of the outstanding money managers of our time, Seth Klarman at Baupost Partners, announces that he will be returning some capital to his partnership investors at year end. Stay tuned.

So, if it’s “the best,” why can’t people just agree on what it is?

Last month David pointed out how little overlap he found between three popular mutual fund lists: Kiplinger 25, Money 70, and Morningstar’s Fantastic 51. David mused: “You’d think that if all of these publications shared the same sensible goal – good risk-adjusted returns and shareholder-friendly practices – they’d also be stumbling across the same funds. You’d be wrong.”

He found only one fund, Dodge & Cox International Fund DODFX, on all three lists. Just one! Although just one is a statistically better outcome than randomly picking three such lists from the 6600 or so mutual funds and 1000 ETFs, it does seem surprisingly small. 

Opening up the field a little, by replacing the Fantastic 51 with a list of 232 funds formed from Morningstar’s current “Gold-Rated Funds” and “Favorite ETFs,” the overlap does not improve much. Just two funds appear in all three publications: DODFX and Habor Bond Institutional HABDX. Just two!

While perhaps not directly comparable, the table below provides a quick summary of the criteria used by each publication. Money 70 criteria actually include Morningstar’s so-called stewardship grade, which must be one of the least maintained measures. For example, Morningstar awarded Bruce Berkowitz Fund Manager of the Decade, but it never published a stewardship grade for Fairholme.

Overall, however, the criteria seem quite similar, or as David described “good risk-adjusted returns and shareholder-friendly practices.”  Add in experienced managers for good measure and one would expect the lists to overlap pretty well. But again, they don’t.

How do the “forward-looking” recommendations in each of these lists fare against Morningstar’s purely quantitative “backward-looking” performance rating system? Not as well as you might think. There are just seven 5-star funds on Money’s list, or 1-in-10. Kiplinger does the best with six, from a percentage perspective, or almost 1-in-4. (They must have peeked.) Morningstar’s own list includes 44 5-star funds, or about 1-in-5. So, as well intentioned and “forward looking” as these analysts certainly try to be, only a small minority of their “best funds” have delivered top-tier returns.

On the other hand, they each do better than picking funds arbitrarily, if not unwittingly, since Morningstar assigns 5 stars to only about 1-in-17 funds. Neither of the two over-lapping funds that appear on all three lists, DODFX and HABDX, have 5 stars. But both have a commendable 4 stars, and certainly, that’s good enough.

Lowering expectations a bit, how many funds appear on at least two of these lists? The answer: 38, excluding the two trifectas. Vanguard dominates with 14. T. Rowe Price and American Funds each have 4. Fidelity has just one. Most have 4 stars, a few have 3, like SLASX, probably the scariest.

But there is no Artisan. There is no Tweedy. There is no Matthews. There is no TCW or Doubleline. There are no PIMCO bond funds. (Can you believe?) There is no Yacktman. Or Arke. Or Sequoia. There are no funds less than five years old. In short, there’s a lot missing.

There are, however, nine 5-star funds among the 38, or just about 1-in-4. That’s not bad. Interestingly, not one is a fixed income fund, which is probably a sign of the times. Here’s how they stack-up in MFO’s own “backward looking” ratings system, updated through September:

Four are moderate allocation funds: FPACX, PRWCX, VWELX, and TRRBX. Three are Vanguard funds: VWELX, VDIGX, and VASVX. One FMI fund FMIHX and one Oakmark fund OAKIX. Hard to argue with any of these funds, especially the three Great Owls: PRWCX, VWELX, and OAKIX.

These lists of “best funds” are probably not a bad place to start, especially for those new to mutual funds. They tend to expose investors to many perfectly acceptable, if more mainstream, funds with desirable characteristics: lower fees, experienced teams, defensible, if not superior, past performance.

They probably do not stress downside potential enough, so any selection needs to also take risk tolerance and investment time-frame into account. And, incredulously, Morningstar continues to give Gold ratings to loaded funds, about 1-in-7 actually.

The lists produce surprisingly little overlap, perhaps simply because there are a lot of funds available that satisfy the broad screening criteria. But within the little bit of overlap, one can find some very satisfying funds.

Money 70 and Kiplinger 25 are free and online. Morningstar’s rated funds are available for a premium subscription. (Cheapest path may be to subscribe for just one month each year at $22 while performing an annual portfolio review.)

As for a list of smaller, less well known mutual funds with great managers and intriguing strategies? Well, of course, that’s the niche MFO aspires to cover.

23Oct2013/Charles

The Great Owl search engine has arrived

Great Owls are the designation that my colleague Charles Boccadoro gives to those funds which are first in the top 20% of their peer group for every trailing period of three years or more. Because we know that “risk” is often more durable and a better predictor of investor actions than “return” is, we’ve compiled a wide variety of risk measures for each of the Great Owl funds.

Up until now, we’ve been limited to publishing the Great Owls as a .pdf while working on a search engine for them. We’re pleased to announce the launch of the Great Owl Search, 1.0. We expect in the months ahead to widen the engine’s function and to better integrate it into the site. We hope you like it.

For JJ and other fans of FundAlarm’s Three-Alarm and Most Alarming fund lists, we’re working to create a predefined search that will allow you to quickly and reliable identify the most gruesome investments in the fund world. More soon!

Who do you trust for fund information?

The short answer is: not fund companies.  On October 22, the WSJ’s Karen Damato hosted an online poll entitled Poll: The Best Source of Mutual-Fund Information? 

Representing, as I do, Column Three, I should be cheered.  Teaching, as I do, Journalism 215: News Literacy, I felt compelled to admit that the results were somewhere between empty (the margin of error is 10.89, so it’s “somewhere between 16% and 38% think it’s the fund company’s website and marketing materials”) and discouraging (the country’s leading financial newspaper managed to engage the interest of precisely 81 of its readers on this question).

Nina Eisenman, President of Eisenman Associates which oversees strategic communications for corporations, and sometime contributor to the Observer

Asking which of the 3 choices individual investors find “most useful” generates data that creates an impression that they don’t use the other two at all when, in fact, they may use all 3 to varying degrees. It’s also a broad question. Are investors responding based on what’s most useful to them in conducting their initial research or due diligence? For example, I may read about a fund in the Mutual Fund Observer (“other website”) and decide to check it out but I would (hopefully) look at the fund’s website, read the manager’s letters and the fund prospectus before I actually put money in.

When I surveyed financial advisors and RIAs on the same topic, but gave them an option to rate the importance of various sources of information they use, the vast majority used mutual funds’ own websites to some extent as part of their due diligence research. [especially for] fund-specific information (including the fund prospectus which is generally available on the website) that can help investors make educated investment decisions.

Both Nina’s own research and the results of a comparable Advisor Perspectives poll can be found at FundSites, her portal for addressing the challenges and practices of small- to medium sizes fund company websites.

The difference between “departures” and “succession planning”

Three firms this month announced the decisions of superb managers to move on. Happily for their investors, the departures are long-dated and seem to be surrounded by a careful succession planning process.

Mitch Milias will be retiring at the end of 2013

Primecap Management was founded by three American Funds veterans. That generation is passing. Howard Schow has passed away at age 84 in April 2012. Vanguard observer Dan Weiner wrote at the time that “To say that he was one of the best, and least-known investors would be a vast understatement.”  The second of the triumvirate, Mitch Milias, retires in two months at 71.  That leaves Theo Kolokotrones who, at 68, is likely in the latter half of his investing career.  Milias has served as comanager of four Gold-rated funds: Vanguard Primecap  (VPMCX) Vanguard Primecap Core (VPCCX), Primecap Odyssey Growth (POGRX), and  Primecap Odyssey Stock (POSKX).

Neil Woodford will depart Invesco in April, 2014

British fund manager Neil Woodford is leaving after 25 years of managing Invesco Perpetual High Income Fund and the Invesco Perpetual Income Fund. Mr. Woodford apparently is the best known manager in England and described as a “hero” in the media for his resolute style.  He’s decided to set up his own English fund company.  In making the move he reports:

My decision to leave is a personal one based on my views about where I see long-term opportunities in the fund management industry.  My intention is to establish a new fund management business serving institutional and retail clients as soon as possible after 29th April 2014.

His investors seem somehow less sanguine: they pulled over £1 billion in the two weeks after his announcement.  Invesco’s British president describes that reaction as “calm.”

Given Mr. Woodford’s reputation and the global nature of the securities market, I would surely flag 1 May 2014 as a day to peer across the Atlantic to see what “long-term opportunities” he’s pursuing.

Scott Satterwhite will be retiring at the end of September, 2016

Scott Satterwhite joined Artisan from Wachovia Securities in 1997 and was the sole manager of Artisan Small Cap Value (ARTVX) from its launch. ARTVX is also the longest-tenured fund in my non-retirement portfolio; I moved my Artisan Small Cap (ARTSX) investment into Satterwhite’s fund almost as soon as it launched and I’ve never had reason to question that decision.  Mr. Satterwhite then extended his discipline into Artisan Mid Cap Value (ARTQX) and the large cap Artisan Value (ARTLX).  All are, as is typical of Artisan, superb.

Artisan has a really strong internal culture and focus on creating coherent, self-sustaining investment teams.  Three years after launch, Satterwhite’s long-time analyst Jim Kieffer became a co-manager.  George Sertl was added six years after that and Dan Kane six years later.  Mr. Kane is now described as “the informal lead manager” with Satterwhite on ARTVX.  This is probably one of the two most significant manager changes in Artisan’s history (the retirement of its founder was the other) but the firm seems exceptionally well-positioned both to attract additional talent and to manage the required three year transition.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds.  Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds.  “Stars in the Shadows” are older funds that have attracted far less attention than they deserve. 

T. Rowe Price Global Allocation (RPGAX): T. Rowe is getting bold, cautiously.  Their newest and most innovative fund offers a changing mix of global assets, including structural exposure to a single hedge fund, is also broadly diversified, low-cost and run by the team responsible for their Spectrum and Personal Strategy Funds.  So far, so good!

Oops! The fund profile is slightly delayed. Please check back tomorrow.

Elevator Talk: Jeffrey K. Ringdahl of American Beacon Flexible Bond (AFXAX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

In a fundamentally hostile environment, investors need to have a flexible approach to income investing. Some funds express that flexibility by investing in emerging market bonds, financial derivatives such as options, or illiquid securities (think: “lease payments from the apartment complex we just bought”).

American Beacon’s decision was to target “positive total return regardless of market conditions” in their version.  Beacon, like Harbor, positions itself as “a manager of managers” and assembles teams of institutional sub-advisors to manage the actual portfolio.  In this case, they’ve paired Brandywine Global, GAM and PIMCO and have given the managers extraordinarily leeway in pursuing the fund’s objective.  One measure of that flexibility is the fund’s duration, a measure of interest rate sensitivity.  They project a duration of anything from negative five years (effectively shorting the market) to plus eight years (generally the preferred spot for long-term owners of bond funds).  Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

Jeff Ringdahl is American Beacon’s Chief Operating Officer and one of the primary architects of the Flexible Bond Strategy. He’s worked with a bunch of “A” tier management firms including Touchstone Investments, Fidelity and State Street Global Advisors.   Here are his 245 words (I know, he overshot) on why you should consider a flexible bond strategy:

In building an alternative to a traditional bond fund, our goal was to stay true to what we consider the three tenets of traditional bond investing: current income, principal preservation and equity diversification.  However, we also sought to protect against unstable interest rates and credit spreads.

The word “unconstrained” is often used to describe similar strategies, but we believe “flexible” is a better descriptor for our approach. Many investors associate the word “unconstrained” with higher risk.  We implemented important risk constraints which help to create a lower risk profile. Our multi-manager structure is a key distinguishing characteristic because of its built-in risk management. Unconstrained or flexible bond funds feature a great degree of investment flexibility. While investment managers may deliver compelling risk-adjusted performance by using this enhanced flexibility, there may be an increased possibility of underperformance because there are fewer risk controls imposed by many of our peer funds. In our opinion, if you would ever want to diversify your managers you would do so where the manager had the greatest latitude. We think that this product style is uniquely designed for multi-manager diversification.

Flexible bond investing allows asset managers the ability to invest long and short across the global bond and currency markets to capitalize on opportunities in the broad areas of credit, currencies and yield curve strategies. We think focusing on the three Cs: Credit, Currency and Curve gives us an advantage in seeking to deliver positive returns over a complete market cycle.

The fund has five share classes. The minimum initial investment for the no-load Investor class is $2,500.   Expenses are 1.27% on about $300 million in assets.

The fund’s website is functional but spare.  You get the essential information, but there’s no particular wealth of insight or commentary on this strategy (and there is one odd picture of a bunch of sailboats barely able to get out of one another’s way).

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.

Conference Call Highlights: Zac Wydra of Beck, Mack & Oliver Partners

In mid-October we spoke for about an hour with Zac Wydra of Beck, Mack & Oliver Partners Fund (BMPEX). There were about 30 other participants on the call. I’ve elsewhere analogized Beck, Mack to Dodge & Cox: an old money, white shoe firm whose core business is helping the rich stay rich. In general, you need a $3 million minimum investment to engage with them. Partners was created in 1991 as a limited partnership to accommodate the grandkids or staff of their clients, folks who might only have a few hundred thousand to commit. (Insert about here: “Snowball gulps”) The “limited” in limited partnership signals a maximum number of investors, 100. The partnership filled up and prospered. When the managing partner retired, Zac made a pitch to convert the partnership to a ’40 fund and make it more widely available. He argued that he thought there was a wider audience for a disciplined, concentrated fund.

He was made the fund’s inaugural manager. He’s 41 and anticipates running BMPEX for about the next quarter century, at which point he’ll be required – as all partners are – to move into retirement and undertake a phased five year divestment of his economic stake in the firm. His then-former ownership stake will be available to help attract and retain the best cadre of younger professionals that they can find. Between now and retirement he will (1) not run any other pooled investment vehicle, (2) not allow BMPEX to get noticeably bigger than $1.5 billion – he’ll return capital to investors first – and (3) will, over a period of years, train and oversee a potential successor.

In the interim, the discipline is simple:

1. never hold more than 30 securities – he can hold bonds but hasn’t found any that offer a better risk/return profile than the stocks he’s found.
2. only invest in firms with great management teams, a criterion that’s met when the team demonstrates superior capital allocation decisions over a period of years
3. invest only in firms whose cash flows are consistent and predictable. Some fine firms come with high variable flows and some are in industries whose drivers are particularly hard to decipher; he avoids those altogether.
4. only buy when stocks sell at a sufficient discount to fair value that you’ve got a margin of safety, a patience that was illustrated by his decision to watch Bed, Bath & Beyond for over two and a half years before a short-term stumble triggered a panicky price drop and he could move in. In general, he is targeting stocks which have the prospect of gaining at least 50% over the next three years and which will not lose value over that time.
5. ignore the question of whether it’s a “high turnover” or “low turnover” strategy. His argument is that the market determines the turnover rate. If his holdings become overpriced, he’ll sell them quickly. If the market collapses, he’ll look for stocks with even better risk/return profiles than those currently in the portfolio. In general, it would be common for him to turn over three to five names in the portfolio each year, though occasionally that’s just recycling: he’ll sell a good firm whose stock becomes overvalued then buy it back again once it becomes undervalued.

Two listener questions, in particular, stood out:

Kevin asked what Zac’s “edge” was. A focus on cash, rather than earnings, seemed to be the core of it. Businesses exist to generate cash, not earnings, and so BM&O’s valuations were driven by discounted cash flow models. Those models were meaningful only if it were possible to calculate the durability of cash flows over 5 years. In industries where cash flows have volatile, it’s hard to assign a meaningful multiple and so he avoids them.

Seth asked what mistakes have you made and what did you learn from them? Zac hearkened back to the days when the fund was still a private partnership. They’d invested in AIG which subsequently turned into a bloody mess. Ummm, “not an enjoyable experience” was his phrase. He learned from that that “independent” was not always the same as “contrary.” AIG was selling at what appeared to be a lunatic discount, so BM&O bought in a contrarian move. Out of the resulting debacle, Zac learned a bit more respect for the market’s occasionally unexplainable pricings of an asset. At base, if the market says a stock is worth twenty cents a share, you’d better than remarkably strong evidence in order to act on an internal valuation of twenty dollars a share.

Bottom Line: On whole, it strikes me as a remarkable strategy: simple, high return, low excitement, repeatable, sustained for near a quarter century and sustainable for another.

For folks interested but unable to join us, here’s the complete audio of the hour-long conversation.

The BMPEX Conference Call

As with all of these funds, we’ve created a new featured funds page for Beck, Mack & Oliver Partners Fund, pulling together all of the best resources we have for the fund, including a brand new audio profile in .mp3 format.

When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded. If the file downloads, instead, you may have to double-click to play it.

As promised, my colleague Charles Boccadoro weighs in on your almost-magical ability to turn a temporary loss of principal into a …

Permanent Loss of Capital

The father of value investing, Benjamin Graham, employed the concept of “Margin of Safety” to minimize risk of permanent loss. His great student, Warren Buffett, puts it like this: “Rule No. 1: never lose money; rule No. 2: don’t forget rule No. 1.”

Zachary Wydra, portfolio manager of the 5-star Beck Mack & Oliver Partners (BMPEX) fund, actually cited Mr. Buffett’s quote during the recent MFO conference call.

But a look at Berkshire Hathaway, one of the great stocks of all time, shows it dropped 46% between December 2007 and February of 2009. And, further back, it dropped about the same between June 1998 and February 2002. So, is Mr. Buffett not following his own rule? Similarly, a look at BMPEX shows an even steeper decline in 2009 at -54%, slightly worse than the SP500.

The distinction, of course, is that drawdown does not necessarily mean loss, unless one sells at what is only a temporary loss in valuation – as opposed to an unrecoverable loss, like experienced by Enron shareholders. Since its 2009 drawdown, BMPEX is in fact up an enviable 161%, beating the SP500 by 9%.

Robert Arnott, founder of Research Associates, summarizes as follows: “Temporary losses of value are frequent; at times they can become so frightening that they become permanent—for those that sell.” Distinguishing between temporary drawdown and permanent loss of capital (aka “the ultimate risk”) is singularly the most important, if unnerving, aspect of successful value investing.

Mr. Wydra explains his strategy is to target stocks that have an upside potential over the next three years of at least 50% and will not lose value over that time. Translation: “loss,” as far as BMPEX is concerned, equates to no drawdown over a three year period. A very practical goal indeed, since any longer period would likely not be tolerated by risk averse investors.

And yet, it is very, very hard to do, perhaps even impossible for any fund that is primarily long equities.

Here is downside SP500 total return performance looking back about 52 years:

It says that 3-year returns fall below zero over nearly 30% of the time and the SP500 shows a loss of 20% or more in 15% of 3-year returns. If we compare returns against consumer price index (CPI), the result is even worse. But for simplicity (and Pete’s) sake, we will not. Fact is, over this time frame, one would need to have invested in the SP500 for nearly 12 years continuously to guarantee a positive return. 12 years!

How many equity or asset allocation funds have not experienced a drawdown over any three year period? Very few. In the last 20 years, only four, or about 1-in-1000. Gabelli ABC (GABCX) and Merger (MERFX), both in the market neutral category and both focused on merger arbitrage strategies. Along with Permanent Portfolio (PRPFX) and Midas Perpetual Portfolio (MPREX), both in the conservative allocation category and both with large a percentage of their portfolios in gold. None of these four beat the SP500. (Although three beat bonds and GABCX did so with especially low volatility.)

So, while delivering equity-like returns without incurring a “loss” over a three year period may simply prove too high a goal to come true, it is what we wish was true.

29Oct2013/Charles

Conference Call Upcoming: John Park and Greg Jackson, Oakseed Opportunity, November 18, 7:00 – 8:00 Eastern

On November 18, Observer readers will have the opportunity to hear from, and speak to John Park and Greg Jackson, co-managers of Oakseed Opportunity Fund (SEEDX and SEDEX). John managed Columbia Acorn Select for five and a half years and, at his 2004 departure, Morningstar announced “we are troubled by his departure: Park had run this fund since its inception and was a big driver behind its great long-term record. He was also the firm’s primary health-care analyst.” Greg co-managed Oakmark Global (OAKGX) for over four years and his departure in 2003 prompted an Eeyore-ish, “It’s never good news when a talented manager leaves.”

The guys moved to Blum Capital, a venture capital firm.  They did well, made money but had less fun than they’d like so they decided to return to managing a distinctly low-profile mutual fund.

Oakseed is designed to be an opportunistic equity fund.  Its managers are expected to be able to look broadly and go boldly, wherever the greatest opportunities present themselves.  It’s limited by neither geography, market cap nor stylebox.   John Park laid out its mission succinctly: “we pursue the maximum returns in the safest way possible.”

I asked John where he thought they’d focus their opening comments.  Here’s his reply:

We would like to talk about the structure of our firm and how it relates to the fund at the outset of the call.  I think people should know we’re not the usual fund management company most people think of when investing in a fund. We discussed this in our first letter to shareholders, but I think it’s worthwhile for our prospective and current investors to know that Oakseed is the only client we have, primarily because we want complete alignment with our clients from not only a mutual investment perspective (“skin in the game”), but also that all of our time is spent on this one entity. In addition, being founders of our firm and this fund, with no intentions of ever starting and managing a new fund, there is much less risk to our investors that one or both of us would ever leave. I think having that assurance is important.

Our conference call will be Monday, November 18, from 7:00 – 8:00 Eastern.  It’s free.  It’s a phone call.

How can you join in?

If you’d like to join in, just click on register and you’ll be taken to the Chorus Call site.  In exchange for your name and email, you’ll receive a toll-free number, a PIN and instructions on joining the call.  If you register, I’ll send you a reminder email on the morning of the call.

Remember: registering for one call does not automatically register you for another.  You need to click each separately.  Likewise, registering for the conference call mailing list doesn’t register you for a call; it just lets you know when an opportunity comes up. 

WOULD AN ADDITIONAL HEADS UP HELP?

Nearly two hundred readers have signed up for a conference call mailing list.  About a week ahead of each call, I write to everyone on the list to remind them of what might make the call special and how to register.  If you’d like to be added to the conference call list, just drop me a line.

Conference Call Queue: David Sherman, RiverPark Strategic Income, December 9, 7:00 – 8:00 Eastern

On Monday, December 9, from 7:00 – 8:00 Eastern, you’ll have a chance to meet David Sherman, manager of RiverPark Short Term High Yield (RPHYX) and the newly-launched RiverPark Strategic Income Fund (RSIVX). David positions RSIVX as the next step out on the risk-return ladder from RPHYX: capable of doubling its sibling’s returns with entirely manageable risk.  If you’d like to get ahead of the curve, you can register for the call with David though I will highlight his call in next month’s issue.

Launch Alert: DoubleLine Shiller Enhanced CAPE

On October 29, DoubleLine Shiller Enhanced CAPE (DSEEX and DSENX) launched. The fund will use derivatives to try to outperform the Shiller Barclays CAPE US Sector Total Return Index.  CAPE is an acronym for “cyclically-adjusted price/earnings.”  The measure was propounded by Nobel Prize winning economist Robert Shiller as a way of taking some of the hocus-pocus out of the calculation of price/earnings ratios.  At base, it divides today’s stock price by the average, inflation-adjusted earnings from the past decade.  Shiller argues that current earnings are often deceptive since profit margins tend over time to regress to the mean and many firms earnings run on three to five year cycles.  As a result, the market might look dirt cheap (high profit margins plus high cyclical earnings = low conventional P/E) when it’s actually poised for a fall.  Looking at prices relative to longer-term earnings gives you a better chance of getting sucked into a value trap.

The fund will be managed by The Gundlach and Jeffrey Sherman. Messrs Gundlach and Sherman also work together on the distinctly disappointing Multi-Asset Growth fund (DMLAX), so the combination of these guys and an interesting idea doesn’t translate immediately into a desirable product.  The fact that it, like many PIMCO funds, is complicated and derivatives-driven counsels for due caution in one’s due diligence. The “N” share class has a $2000 minimum initial investment and 0.91% expense ratio.  The institutional shares are about one-third cheaper.

Those interested in a nice introduction to the CAPE research might look at Samuel Lee’s 2012 CAPE Crusader essay at Morningstar. There’s a fact sheet and a little other information on the fund’s homepage.

Funds in Registration (The New Year’s Edition)

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Any fund that wanted to launch before the end of the year needed to be in registration by mid- to late October.

And there were a lot of funds targeting a year-end launch. Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves.  This month he tracked down 24 no-load retail funds in registration, which represents our core interest.  But if you expand that to include ETFs, institutional funds, reorganized funds and load-bearing funds, you find nearly 120 new vehicles scheduled for Christmas delivery.

Close readers might find the answers to four funds in reg quiz questions:

1. Which manager of a newly-registered fund had the schmanciest high society wedding this year?
2. Which fund in registration gave Snowball, by far, the biggest headache as he tried to translate their prose to English?
3. Which hedge fund manager decided that the perfect time to launch a mutual fund was after getting bludgeoned on returns for two consecutive years?
4. Which managers seem most attuned to young investors, skippering craft that might be described as Clifford the Big Red Mutual Fund and the Spongebob Fund?

Manager Changes

On a related note, we also tracked down 51 fund manager changes.

Updates

One of the characteristics of good managers is their ability to think clearly and one of the best clues to the existence of clear thinking is clear writing. Here’s a decent rule: if they can’t write a grocery list without babbling, you should avoid them. Contrarily, clear, graceful writing often reflects clear thinking.

Many managers update their commentaries and fund materials quarterly and we want to guide you to the most recent discussions and data possible for the funds we’ve written about. The indefatigable Mr. Welsch has checked (and updated) every link and linked document for every fund we’ve profiled in 2013 and for most of 2012. Here’s David’s summary table, which will allow you to click through to a variety of updated documents.

Advisory Research Strategic Income	Q3 Report Manager Commentary Fact Sheet
Artisan Global Equity Fund	Q3 Report
Artisan Global Value Fund	Q3 Report
Beck, Mack & Oliver Partners Fund	Fact Sheet
Bretton Fund	Q3 Report Fund Fact Page
Bridgeway Managed Volatility	Q3 Report Fact Sheet
FPA International Value	Q3 Report and Commentary Fact Sheet
FPA Paramount	Q3 Report and Commentary Fact Sheet
Frank Value	Fact Sheet Q3 Report and Commentary
FundX Upgrader Fund	Fact Sheet
Grandeur Peak Global Opportunities	Q3 Report Commentary
Grandeur Peak Global Reach	Q3 Report Commentary
LS Opportunity Fund	Q3 Report
Matthews Asia Strategic Income	Commentary Q3 Report
Oakseed Opportunity Fund	Fact Sheet
Oberweis International Opportunities	Q3 Report
Payden Global Low Duration Fund	Q3 Report Commentary
PIMCO Short Asset Investment Fund “D” shares	Q3 Report
RiverPark/Gargoyle Hedge Value	Q3 Report
Scout Low Duration Bond Fund	Q3 Report Commentary
Sextant Global High Income	Q3 Report
Smead Value Fund	Q3 Report Fact Sheet
The Cook and Bynum Fund	Fact Sheet
Tributary Balanced	Q3 Report Fact Sheet
Whitebox Long Short Equity Investor Class	Fact Sheet

Briefly Noted 

A big ol’ “uhhh” to Advisory Research Emerging Markets All Cap Value Fund (the “Fund”) which has changed both manager (“Effective immediately, Brien M. O’Brien is no longer a portfolio manager of the Fund”) and name (it will be Advisory Research Emerging Markets Opportunities Fund), both before the fund even launched.  A few days after that announcement, AR also decided that Matthew Dougherty would be removed as a manager of the still-unlaunched fund.  On the bright side, it didn’t close to new investors before launch, so that’s good.  Launch date is November 1, 2013.

In a singularly dark day, Mr. O’Brien was also removed as manager of Advisory Research Small Micro Cap Value Fund, which has also not launched and has changed its name: Advisory Research Small Company Opportunities Fund.”

A Centaur arises!  The Tilson funds used to be a two-fund family: the one that Mr. Tilson ran and the one that was really good. After years of returns that never quite matched the hype, Mr. Tilson liquidated his Tilson Focus (TILFX) fund in June 2013.  That left behind the Tilson-less Tilson Dividend Fund (TILDX) which we described as “an awfully compelling little fund.”

Effective November 1, Tilson Dividend became Centaur Total Return Fund (TILDX), named after its long-time sub-adviser, Centaur Capital Partners.  Rick Schumacher, the operations guy at the Centaur funds, elaborates:

Since Tilson is no longer involved in the mutual fund whatsoever, and since the Dividend Fund has historically generated as much (if not more) income from covered call premiums rather than pure dividends, we felt that it was a good time to rebrand the fund.  So, effective today, our fund is now named the Centaur Total Return Fund.  We have kept the ticker (TILDX), as nothing’s really changed as far as the investment objective or strategy of the fund, and besides, we like our track record.  But, we’re very excited about our new Centaur Mutual Funds brand, as it will provide us with potential opportunities to launch other strategies under this platform in the future.

They’ve just launched a clean and appropriate dignified website that both represents the new fund and archives the analytic materials relevant to its old designation.  The fund sits at $65 million in assets with cash occupying about a quarter of its portfolio.  All cap, four stars, low risk. It’s worth considering, which we’ll do again in our December issue.

Laudus Growth Investors U.S. Large Cap Growth Fund is having almost as much fun.  On September 24, its Board booted UBS Global Asset Management as the managers of the fund in favor of BlackRock.  They then changed the name (to Laudus U.S. Large Cap Growth Fund) and, generously, slashed the fund’s expense ratio by an entire basis point from 0.78% to 0.77%.

But no joy in Mudville: the shareholder meeting being held to vote on the merger of  Lord Abbett Classic Stock Fund (LRLCX) into Lord Abbett Calibrated Dividend Growth Fund (LAMAX) has been adjourned until November 7, 2013 for lack of a quorum.

Scout Funds are sporting a redesigned website. Despite the fact that our profiles of Scout Unconstrained Bond and Scout Low Duration don’t qualify as “news” for the purposes of their media list (sniffles), I agree with reader Dennis Green’s celebration of the fact the new site is “thoughtful, with a classy layout, and—are you sitting down?— their data are no longer stale and are readily accessible!”  Thanks to Dennis for the heads-up.

Snowball’s portfolio: in September, I noted that two funds were on the watchlist for my own, non-retirement portfolio.  They were Aston River Road Long Short (ARLSX) and RiverPark Strategic Income (RSIVX). I’ve now opened a small exploratory position in Aston (I pay much more attention to a fund when I have actual money at risk) as I continue to explore the possibility of transferring my Northern Global Tactical Asset Allocation (BBALX) investment there.  The Strategic Income position is small but permanent and linked to a monthly automatic investment plan.

For those interested, John Waggoner of USA Today talked with me for a long while about the industry and interesting new funds.  Part of that conversation contributed to his October 17 article, “New Funds Worth Mentioning.”

SMALL WINS FOR INVESTORS

Eaton Vance Asian Small Companies Fund (EVASX) will eliminate its danged annoying “B” share class on November 4, 2013. It’s still trying to catch up from having lost 70% in the 2007-09 meltdown. 

Green Owl Intrinsic Value Fund (GOWLX) substantially reduced its expense cap from 1.40% to 1.10%. It’s been a very solid little large cap fund since its launch in early 2012.

Invesco Balanced-Risk Commodity Strategy Fund (BRCAX) will reopen to new investors on November 8, 2013. The fund has three quarters of a billion in assets despite trailing its peers and losing money in two of its first three years of existence.

As of December, Vanguard Dividend Appreciation Index (VDAIX) will have new Admiral shares with a 0.10% expense ratio and a $10,000 minimum investment. That’s a welcome savings on a fund currently charging 0.20% for the Investor share class.

At eight funds, Vanguard will rename Signal shares as Admiral shares and will lower the minimum investment to $10,000 from $100,000.

Zeo Strategic Income Fund (ZEOIX) dropped its “institutional” minimum to $5,000.  I will say this for Zeo: it’s very steady.

CLOSINGS (and related inconveniences)

The Brown Capital Management Small Company Fund (BCSIX) closed to new investors on October 18, 2013.

Buffalo Emerging Opportunities Fund (BUFOX) formally announced its intention to close to new investors when the fund’s assets under management reach $475 million. At last check, they’re at $420 million.  Five star fund with consistently top 1% returns.  If you’re curious, check quick!

GW&K Small Cap Equity Fund (GWETX) is slated to close to new investors on November 1, 2013.

Matthews Pacific Tiger Fund (MAPTX) closed to new investors on October 25, 2013.

Oakmark International (OAKIX) closed to most new investors as of the close of business on October 4, 2013

Templeton Foreign Smaller Companies (FINEX) will close to new investors on December 10^th.  I have no idea of why: it’s a small fund with an undistinguished but not awful record. Liquidation seems unlikely but I can’t imagine that much hot money has been burning a hole in the managers’ pockets.

Touchstone Merger Arbitrage Fund (TMGAX), already mostly closed, will limit access a bit more on November 11, 2013.  That means closing the fund to new financial advisors.

OLD WINE, NEW BOTTLES

Advisory Research Emerging Markets All Cap Value Fund has renamed itself, before launch, as Advisory Research Emerging Markets Opportunities Fund.

Aegis Value Fund (AVALX) has been reorganized as … Aegis Value Fund (AVALX), except with a sales load (see story above).

DundeeWealth US, LP (the “Adviser”) has also changed its name to “Scotia Institutional Investments US, LP” effective November 1, 2013.

The Hatteras suite of alternative strategy funds (Hatteras Alpha Hedged Strategies, Hedged Strategies Fund, Long/Short Debt Fund, Long/Short Equity Fund and Managed Futures Strategies Fund) have been sold to RCS Capital Corporation and Scotland Acquisition, LLC.  We know this because the SEC filing avers the “Purchaser will purchase from the Sellers and the Sellers will sell to the Purchaser, substantially all the assets related to the business and operations of the Sellers and … the “Hatteras Funds Group.” Morningstar has a “negative” analyst rating on the group but I cannot find a discussion of that judgment.

Ladenburg Thalmann Alternative Strategies Fund (LTAFX) have been boldly renamed (wait for it) Alternative Strategies Fund.  It appears to be another in the expanding array of “interval” funds, whose shares are illiquid and partially redeemable just once a quarter. Its performance since October 2010 launch has been substantially better than its open-ended peers.

Effective October 7, 2013, the WisdomTree Global ex-US Growth Fund (DNL) became WisdomTree Global ex-US Dividend Growth Fund.

U.S. Global Investors MegaTrends Fund (MEGAX) will, on December 20, become Holmes Growth Fund

OFF TO THE DUSTBIN OF HISTORY

On-going thanks to The Shadow for help in tracking the consequences of “the perennial gale of creative destruction” blowing through the industry.  Shadow, a member of the Observer’s discussion community, has an uncanny talent for identifying and posting fund liquidations (and occasionally) launches to our discussion board about, oh, 30 seconds after the SEC first learns of the change.  Rather more than three dozen of the changes noted here and elsewhere in Briefly Noted were flagged by The Shadow.  While my daily reading of SEC 497 filings identified most of the them, his work really does contribute a lot. 

And so, thanks, big guy!

On October 16, 2013, the Board of Trustees of the Trust approved a Plan of Liquidation, which authorizes the termination, liquidation and dissolution of the 361 Absolute Alpha Fund. In order to effect such liquidation, the Fund is closed to all new investment. Shareholders may redeem their shares until the date of liquidation. The Fund will be liquidated on or about October 30, 2013.

City National Rochdale Diversified Equity Fund (the “Diversified Fund”) has merged into City National Rochdale U.S. Core Equity Fund while City National Rochdale Full Maturity Fixed Income Fund was absorbed by City National Rochdale Intermediate Fixed Income Fund

Great-West Ariel Small Cap Value Fund (MXSCX) will merge into Great-West Ariel Mid Cap Value Fund (MXMCX) around Christmas, 2013.  That’s probably a win for shareholders, since SCV has been mired in the muck while MCV has posted top 1% returns over the past five years.

As we suspected, Fidelity Europe Capital Appreciation Fund (FECAX) is merging into Fidelity Europe Fund (FIEUX). FECAX was supposed to be the aggressive growth version of FIEUX but the funds have operated as virtually clones for the past five years.  And neither has particularly justified its existence: average risk, average return, high r-squared despite the advantages of low expenses and a large analyst pool.

The Board of the Hansberger funds seems concerned that you don’t quite understand the implications of having a fund liquidated.  And so, in the announcement of the October 18 liquidation of Hansberger International Fund they helpfully explain: “The Fund no longer exists, and as a result, shares of the Fund are no longer available for purchase.”

Highland Alpha Trend Strategies Fund (HATAX), formerly Pyxis Alpha Trend Strategies Fund, will close on November 20, 2013.  With assets not much greater than my retirement account (and performance vastly below it), I’m not sure that even the manager will notice the disappearance.

Huntington Income Equity (HUINX) will merge into Huntington Dividend Capture Fund (HDCAX) at the end of the first week of December.  It’s never a good sign when the winning fund – the more attractive of the two – trails 80% of its peers.

The JPMorgan Global Opportunities Fund was liquidated and dissolved on or about October 25, 2013. Given that they’re speaking in the past tense, don’t you think that they’d know whether it was “on” or “about”?

Update on the JPMorgan Value Opportunities Fund: an attempt to merge the fund out of existence in September failed because the Board couldn’t get enough shareholders to vote one way or the other.  On October 10, though, they reached a critical mass and folded the fund into JPMorgan Large Cap Value Fund (OLVAX) on October 18^th.

So long to LONGX! Longview Tactical Allocation Fund (LONGX) has closed and will liquidate on November 15, 2013.  700% turnover which might well have led to a joke about their ability to take the long view except for the fact that they’ve joined the zombie legion of walking dead funds.

In a determinedly “WTF?” move, the Mitchell Capital’s Board of Trustees has determined to liquidate the Mitchell Capital All-Cap Growth Fund (MCAEX) “due to the adviser’s business decision that it no longer is economically viable to continue managing the Fund because of the Fund’s small size, the increasing costs associated with managing the Fund, and the difficulty encountered in distributing the Fund’s shares.”  Huh?  “No longer economically viable”?  They only launched this sucker on March 1, 2013.  Seven months, guys?  You hung on seven months and that’s it?  What sort of analytic abilities are on display here, do you suppose?

On October 15, Nomura Partners Funds closed all of its remaining five mutual funds to purchases and exchanges.  They are The Japan Fund (NPJAX), Nomura Partners High Yield (NPHAX), Nomura Partners Asia Pacific Ex Japan (NPAAX), Nomura Partners Global Equity Income (NPWAX), and Nomura Partners Global Emerging Markets (NPEAX).  Here’s a sentence you should take seriously: “The Board will consider the best interests of the investors in each of the Funds and may decide to liquidate, merge, assign the advisory contract or to take another course of action for one or more of the Funds.”  The NPJAX board has acted boldly in the past.  In 2002, it fired the fund’s long-standing adviser, Scudder,Stevens, and turned the fund over to Fidelity to manage.  Then, in 2008, they moved it again from Fidelity to Nomura.  No telling what they might do next.

The firm also announced that it, like DundeeWealth, is planning to get out of the US retail fund business.

The liquidations of Nuveen Tradewinds Global Resources Fund and Nuveen Tradewinds Small-Cap Opportunities Fund are complete.  It’s an ill wind that blows …

Oppenheimer SteelPath MLP and Infrastructure Debt Fund went the way of the wild goose on October 4.

Transamerica is bumping off two sub-advised funds in mid-December: Transamerica International Bond (TABAX), subadvised by J.P. Morgan, and Transamerica International Value Opportunities Fund, subadvised by Thornburg but only available to other Transamerica fund managers.

UBS Global Frontier Fund became UBS Asset Growth Fund (BGFAX) on October 28.  Uhhh … doesn’t “Asset Growth” strike you as pretty much “Asset Gathering”?  Under the assumption that “incredibly complicated” is the magic strategy, the fund will adopt a managed volatility objective that tries to capture all of the upside of the MSCI World Free Index with a standard deviation of no more than 15.  On the portfolio’s horizon: indirect real estate securities, index funds, options and derivatives with leverage of up to 75%. They lose a couple managers and gain a couple in the process.

U.S. Global Investors Global Emerging Markets Fund closed on October 1 and liquidated on Halloween.  If you were an investor in the fund, I’m hopeful that you’d already noticed.  And considered Seafarer as an alternative.

Vanguard plans to merge two of its tax-managed funds into very similar index funds.  Vanguard Tax-Managed International (VTMNX) is merging into Vanguard Developed Markets Index (VDMIX) and Vanguard Tax-Managed Growth & Income (VTMIX) will merge into Vanguard 500 Index (VFINX). Since these were closet index funds to begin with – they have R-squared values of 98.5 and 100(!) – the merger mostly serves to raise the expenses borne by VTMNX investors from 10 basis points to 20 for the index fund.

Vanguard Growth Equity (VGEQX) is being absorbed by Vanguard US Growth (VWUSX). Baillie Gifford, managers of Growth Equity, will be added as another team for US Growth.

Vanguard Managed Payout Distribution Focus (VPDFX) and Vanguard Managed Payout Growth Focus (VPGFX) are slated to merge to create a new fund, Vanguard Managed Payout Fund. At that time, the payout in question will decrease to 4% from 5%.

WHV Emerging Markets Equity Fund (WHEAX) is suffering “final liquidation”  on or about December 20, 2013.  Okay returns, $5 million in assets.

In Closing . . .

As Chip reviewed how folks use our email notification (do they open it?  Do they click through to MFO?), she discovered 33 clicks from folks in Toyko (youkoso!), 21 in the U.K. (uhhh … pip pip?), 13 in the United Arab Emirates (keep cool, guys!) and 10 scattered about India (Namaste!).  Welcome to all.

Thanks to the kind folks who contributed to the Observer this month.  I never second guess folks’ decision to contribute, directly or through PayPal, but I am sometimes humbled by their generosity and years of support.  And so thanks, especially, to the Right Reverend Rick – a friend of many years – and to Andrew, Bradford, Matt, James (uhh… Jimmy?) and you all.  You make it all possible.

Thanks to all of the folks who bookmarked or clicked on our Amazon link.   Here’s the reminder of the easiest way to support the Observer: just use our Amazon link whenever you’d normally be doing your shopping, holiday or other, on Amazon anyway.  They contribute an amount equal to about 7% of the value of all stuff purchased through the link.  It costs you nothing (the cost is already built into their marketing budget) and is invisible.  If you’re interested in the details, feel free to look at the Amazon section under “Support.”  

Remember to join us, if you can, for our upcoming conversations with John, Greg and David.  Regardless, enjoy the quiet descent of fall and its seasonal reminder to slow down a bit and remember all the things you have to be grateful for rather than fretting about the ones you don’t have (and, really, likely don’t need and wouldn’t enjoy).

Cheers!