Dear friends,

They’re baaaaaack!

My students came rushing back to campus and, so far as I can tell, triggered some sort of stock market rout upon arrival. I’m not sure how they did it, but I’ve learned not to underestimate their energy and manic good spirits.

They’re a bright bunch, diverse in my ways. While private colleges are often seen as bastion of privilege, Augustana was founded to help the children of immigrants make their way in a new land. Really that mission hasn’t much changed in the past 150 years: lots of first-generation college students, lots of students of color, lots of kids who shared the same high school experience. They weren’t the class presidents so much as the ones who quietly worked to make sure that things got done.

It’s a challenge to teach them, not because they don’t want to learn but because the gulf between us is so wide. By the time they were born, I was already a senior administrator and a full-blown fuddy duddy. But we’re working, as always we do, to learn from each other. Humility is essential, both a sense of humor and cookies help.

Your first and best stop-loss order

The week’s events have convinced us that you all need to learn how to execute a stop-loss order to protect yourself in times like these. A stop-loss order is an automatic, pre-established command which kicks in when markets gyrate and which works to minimize your losses. Generally they’re placed through your broker (“if shares of X fall below $12/share, sell half my holdings. If it falls below $10, liquidate the position”) but an Observer Stop Loss doesn’t require one. Here’s how it works:

• On any day in which the market falls by enough to make you go “sweet Jee Zus!”
• Step Away from the Media
• Put Down your Phone
• Unhand that Mouse
• And Do Nothing for seven days.

Well, more precisely, “do nothing with your portfolio.” You’re more than welcome to, you know, have breakfast, go to the bathroom, wonder what it’s going to take for anyone to catch the Cardinals, figure out what you’re going to do with that ridiculous pile of tomatoes and all that.

My Irish grandfather told me that the worst time to fix a leaky roof is in a storm. “You’ll be miserable, you might break your neck and you’ll surely make a hames of it.” (I knew what Gramps meant and didn’t get around to looking up the “hames” bit until decades later when I was listening to the thunder and staring at a growing damp spot in the ceiling.)

The financial media loves financial cataclysm to the same extent, and for the same reason, that The Weather Channel loves superstorms. It’s a great marketing tool for them. It strokes their egos (we are important!). And it drives ratings.

Really, did you think this vogue for naming winter storms came from the National Weather Service? No, no, no.  “Winter Storm Juno” was straight from the marketing folks at TWC.

If CNBC’s ratings get any worse, I’m guessing that we’ll be subjected to Market Downturn Alan soon enough.

By and large, coverage of the market’s recent events has been relentlessly horrible. Let’s start with the obvious: if you invested $10,000 into a balanced portfolio on August 18, on Friday, August 28 you had $9,660.

That’s it. You dropped 3.4%.

(Don’t you feel silly now?)

The most frequently-invoked word in headlines? “Bloodbath.”

MarketWatch: What’s next after market’s biggest bloodbath of the year ? (Apparently they’re annual events.)

ZeroHedge: US Market Bouncing Back After Monday’s Bloodbath (hmm, maybe they’re weekly events?)

Business Insider: Six horrific stats about today’s market bloodbath. (“Oil hit its lowest level since March 2009.” The horror, the horror!)

ZeroHedge: Bloodbath: Emerging Market Assets Collapse. (Ummm … a $10,000 investment in an emerging markets balanced fund, FTEMX in this case, would have “collapsed” to $9872 over those two weeks.)

RussiaToday: It’s a Bloodbath. (Odd that this is the only context in which Russia Today is willing to apply that term.)

By Google’s count, rather more than 64,000 market bloodbaths in the media.

Those claims were complemented by a number of “yeah, it could get a lot worse” stories:

NewsMax: Yale’s Shiller, “Even bigger” plunge may follow.

Brett Arends: Dow 5,000? Yes, it could happen. (As might a civilization-ending asteroid strike or a Cubs’ World Series win.)

Those were bookended with celebratory but unsubstantiated claims (WSJ: U.S. stock swings don’t shake investors; Barry Ritholz: Mom and pop outsmart Wall Street pros) that “mom ‘n’ pop” stood firm.

Bottom line: nothing you read in the media over the past couple weeks improved either your short- or long-term prospects. To the contrary, it might well have encouraged you (or your clients) to do something emotionally satisfying and financially idiotic. The markers of panic and idiocy abound: Vanguard had to do the “all hands on deck” drill in which portfolio managers and others are pulled in to manage the phone banks, Morningstar’s site repeatedly froze, the TD Ameritrade and Scottrade sites couldn’t execute customer orders, and prices of thousands of ETFs became unmoored from the prices of the securities they held. We were particularly struck by trading volume for Vanguard’s Total Stock Market ETF (VTI).

That’s a 600% rise from its average volume.

Two points:

1. Winter is coming. Work on your roof now!

   Some argue that a secular bear market started last week. (Some always say that.) Some serious people argue that a sharp jolt this year might well be prelude to a far larger disruption later next year. Optimists believe that we are on a steadily ascending path, although the road will be far more pitted than in recent memory.

   Use the time you have now to plan for those developments. If you looked at your portfolio and thought “I didn’t know it could be this bad this fast,” it’s time to rethink.

   Questions worth considering:

   • Are you ready to give up Magical Thinking yet? Here’s the essence of Magical Thinking: “Eureka! I’ve found it! The fund that makes over 10% in the long-term and sidesteps turbulence in the short-term! And it’s mine. Mine! My Preciousssss!” Such a fund does not exist in the lands of Middle-Earth. Stop expecting your funds to act as if they do.
   • Do you have more funds in your portfolio than you can explain? Did you look at your portfolio Monday and think, honestly puzzled, “what is that fund again?”
   • Do you know whether traditional hybrid funds, liquid alt funds or a slug of low-volatility assets is working better as your risk damper? Folks with either a mordant sense of humor or stunted perspective declared last week that liquid alts funds “passed their first test with flying colors.” Often that translated to: “held up for one day while charging 2.75% for one year.”
   • Have you allocated more to risky assets than you can comfortably handle? We’re written before about the tradeoffs embedded in a stock-light strategy where 70% of the upside for 50% of the downside begins to sound less like cowardice and more like an awfully sweet deal.
   • Are you willing to believe that the structure of the fixed income market will allow your bond funds to deliver predictable total returns (current income plus appreciation) over the next five to seven years? If critics are right, a combination of structural changes in the fixed-income markets brought on by financial reforms and rising interest rates might make traditional investment-grade bond funds a surprisingly volatile option.

   If your answer is something like “I dunno,” then your answer is also something like “I’m setting myself up to fail.” We’ll try to help, but you really do need to set aside some time to plan (goals –> resources –> strategies –>tactics) with another grown-up. Bring black coffee if you’re Lutheran, Scotch if you aren’t.

2. If you place your ear tightly against the side of any ETF, you’re likely to hear ticking.

   My prejudices are clear and I’ll repeat them here. I think ETFs are the worst financial innovation since the Ponzi scheme. They are trading vehicles, not investment vehicles. The Vanguard Total Stock Market ETF has no advantage over the Vanguard Total Stock Market Index fund (the tiny expense gap is consumed in trading costs) except that it can be easily and frequently traded. The little empirical research available documents the inevitable: when given a trading vehicle, investors trade. And (the vast majority of) traders lose.

   Beyond that, ETFs cause markets to move in lockstep: all securities in an ETF – the rock solid and the failing, the undervalued and the overpriced – are rewarded equally when investors purchase the fund. If people like small cap Japanese stocks, they bid up the price of good stocks and bad, cheap and dear, which distorts the ability of vigilantes to enforce some sort of discipline.

   And, as Monday demonstrates, ETFs can fail spectacularly in a crisis because the need for instant pricing is inconsistent with the demands of rational pricing. Many ETFs, CEFs and some stocks opened Monday with 20-30% losses, couldn’t coordinate buyers and sellers fast enough and that caused a computer-spawned downward price spiral. Josh Brown makes the argument passionately in his essay “Computers are the new dumb money” and followed it up with the perhaps jubilant report that some of the “quants I know told me the link was hitting their inboxes all day from friends and colleagues around the industry. A few desk traders I talk to had some anecdotes backing my assumptions up. One guy, a ‘data scientist’, was furiously angry, meaning he probably blew himself up this week.”

   As Chris Dietrich concludes in his August 29 Barron’s article, “Market Plunge Provides Harsh Lessons for ETF Investors”

   For long-term investors unsure of their trading chops, or if uncertainty reigns, mutual funds might be better options. Mutual fund investors hand over their money and let the fund company do the trading. The difference is that you get the end-of-day price; the price of an ETF depends on when you sold or bought it during the trading day. “There are benefits of ETFs, including transparency and tax efficiency, but those come at a cost, which is that is you must be willing to trade,” says Dave Nadig, director of ETFs at FactSet Research Systems. “If you don’t want to be trading, you should not be using ETFs.”

The week’s best

Jack Bogle, Buddhist. Jack Bogle: “I’ve seen turbulence in the market. This is not real turbulence. Don’t do something. Just stand there.” (Thanks for johnN for the link.) Vanguard subsequently announced, “The Inaction Plan.”

All sound and fury, signifying nothing. Jason Zweig: “The louder and more forcefully a market pundit voices his certainty about what is going to happen next, the more likely it is that he will turn out to be wrong.”

Profiting from others’ insanity

Anyone looking at the Monday, 8/24, opening price for, say, General Electric – down 30% within the first few seconds – had to think (a) that’s insanity and (b) hmmm, wonder if there’s a way to profit from it? It turns out that the price of a number of vehicles – stocks, a thousand ETFs and many closed-end funds – became temporarily unmoored from reality. The owners of many ETFs, for example, were willing to sell $10 worth of stock for $7, just to get rid of it.

The folks at RiverNorth are experts at arbitraging such insanity. They track the historical discounts of closed-end funds; if a fund becomes temporarily unmoored, they’ll consider buying shares of it. Why? Because when the panic subsides, that 30% discount might contract by two-thirds. RiverNorth’s shareholders have the opportunity to gain from that arbitrage, whether or not the general direction of the stock market is up or down.

I spoke with Steve O’Neill, one of RiverNorth’s portfolio managers, about the extent of the market panic. Contrary to the popular stories about cool-headed investors, Steve described them as “vomiting up assets” at a level he hadn’t seen since the depth of the financial meltdown when the stability of the entire banking sector was in question.

In 2014, RiverNorth reopened their flagship RiverNorth Core Opportunity (RNCOX) fund after a three-year closure. We’ll renew our profile of this one-of-a-kind product in our October issue. In the meanwhile, interested parties really should …

RiverNorth is hosting a live webcast with Q&A on September 17, 2015 at 3:15pm CT / 4:15pm ET. Their hosts will be Patrick Galley, CIO, Portfolio Manager, and Allen Webb, Portfolio Specialist. Visit www.rivernorth.com/events to register.

Update: Finding a family’s first fund 

In August, we published a short guide to finding a family first fund. We started with the premise that lots of younger (and many not-so-younger) folks were torn between the knowledge that they should do something and the fear that they were going to screw it up. To help them out, we talked about what to look for in a first fund and proposed three funds that met our criteria: solid long term prospects, a risk-conscious approach, a low minimum initial investment and reasonable expenses.

How did the trio do in August? Not bad.

 Several readers wrote to commend Manning & Napier Pro-Blend Conservative (EXDAX) as a great “first fund” candidate as well.  We entirely agree. Unlike TIAA-CREF and Vanguard, it invests in individual securities rather than other funds. Like them, however, it has a team-managed approach that reduces the risk of a fund going awry if a single person leaves. It has a splendid 20 year record. We’ve added it to our original guide and have written a profile of the fund, which you can get to below in our Fund Profiles section.

We Are Where We Are, Or, If The Dog Didn’t Stop To Crap, He Would Have Caught The Rabbit

“I prefer the company of peasants because they have not been educated sufficiently to reason incorrectly.”

               Michel de Montaigne

At this point in time, rather than focus on the “if only” questions that tend to freeze people in their tracks in these periods of market volatility, I think we should consider what is important. For most of us, indeed, the vast majority of us, the world did not end in August and it is unlikely to end in September.  Indeed, for most Americans and therefore by definition most of us, the vagaries of the stock market are not that important.

What then is important? A Chicago Tribune columnist, Mary Schmich, recently interviewed Edward Stuart, an economics professor at Northeastern Illinois University as a follow-up to his appearance on a panel on Chicago Public Television’s “Chicago Tonight” show. Stuart had pointed out that the ownership of stock (and by implication, mutual funds) in the United States is quite unequal. He noted that while the stock market has done very well in recent years, the standard of living of the average American citizen has not done as well. Stuart thinks that the real median income for a household size of four is about $40,000 …. and that number has not changed since the late 70’s. My spin on this is rather simple – the move up the economic ladder that we used to see for various demographic groups – has stopped.

If you think about it, the evidence is before us. How many of us have friends whose children went to college, got their degrees, and returned home to live with their parents while they hunted for a job in their chosen field, which they often could not find? When one drives around city and suburban streets, how many vacancies do we see in commercial properties?  How many middle class families that used to bootstrap themselves up by investing in and owning apartment buildings or strip malls don’t now? What is needed is a growing economy that offers real job prospects that pay real wages. Stuart also pointed out that student debt is one of the few kinds of debt that one cannot expunge with bankruptcy.

As I read that piece of Ms. Schmick’s and reflected on it, I was reminded of another column I had read a few months back that talked about where we had gone off the rails collectively. The piece was entitled “Battle for the Boardroom” by Joe Nocera and was in the NY Times on May 9, 2015. Nocera was discussing the concept of “activist investors” and “shareholder value” specifically as it pertained to Nelson Peltz, Trian Investments, and a proxy fight with the management and board of DuPont.  And Nocera pointed out that Trian, by all accounts, had a good record and was often a constructive force once it got a board seat or two.

Nocera’s concern, which he raised in a fashion that went straight for the jugular, was simple. Have we really reached the point where the activist investor gets to call the tune, no matter how well run the company? What is shareholder value, especially in a company like DuPont? Trian’s argument was that DuPont was not getting a return on its spending on research and development? Yet R&D spending is what made DuPont, given the years it takes to often produce from scientific research a commercial product. Take away the R&D spending argued Nocera, and you have not just a poorer DuPont, but also a poorer United States. He closed by talking with and quoting Martin Lipton, a corporate attorney who has made a career out of disparaging corporate activists. Lipton said, “Activism has caused companies to cut R&D, capital investment, and, most significantly, employment,” he said. “It forces companies to lay off employees to meet quarterly earnings.”

“It is,” he concluded, “a disaster for the country.”

This brings me to my final set of ruminations. Some years ago, my wife and I were guests at a small dinner party at the home of a former ambassador (and patriot) living in Santa Fe.  There were a total of six of us at that dinner. One of the other guests raised the question as to whether any of us ever thought about what things would have been like for the country if Al Gore, rather than George W. Bush, had won the presidential election. My immediate response was that I didn’t think about such things as it was just far too painful to contemplate.

In like vein, having recently read Ron Suskind’s book Confidence Men, I have been forced to contemplate what it would have meant for the country if President-elect Barack Obama had actually followed through with the recommendations of his transition advisors and appointed his “A” Economic Team. Think about it – Paul Volcker as Secretary of the Treasury, the resurrection of Glass-Steagall, the break-up of the big investment banks – it too is just too painful to contemplate.  Or as the line from T.H. White’s Once and Future King goes, “I dream things that never were, and ask why not?”

Now, a few thoughts about the carnage and how to deal with it.  Have a plan and stick to it. Do not panic, for inevitably all panic does is lead to self-inflicted wounds. Think about fees, but from the perspective of correlated investments. That is, if five large (over $10B in assets) balanced funds are all positively correlated in terms of their portfolios, does it really make sense not to own the one with the lowest expense ratio (and depending on where it is held, taxes may come into play)? Think about doing things where other people’s panic does not impact you, e.g., is there a place for closed end funds in a long-term investment portfolio? And avoid investments where the bugs have not been worked out, as the glitches in pricing and execution of trades for ETF’s have shown us over the last few weeks.

There is a wonderful Dilbert cartoon where the CEO says “Asok, you can beat market averages by doing your own stock research. Asok then says, “So … You believe every investor can beat the average by reading the same information? “Yes” says the CEO. Asok then says, “Makes you wonder why more people don’t do it.” The CEO closes saying, “Just lazy, I guess.”

Edward A. Studzinski

Checking in on MFO’s 20-year Great Owls

MFO first introduced its rating system in the June 2013 commentary. That’s also when the first “Great Owl” funds were designated. These funds have consistently delivered top quintile risk adjusted returns (based on Martin Ratio) in their categories for evaluation periods 3 years and longer. The most senior are 20-year Great Owls. These select funds have received Return Group ranking of 5 for evaluation periods of 3, 5, 10, and 20 years. Only about 50 funds of the 1500 mutual funds aged 20 years or older, or about 3%, achieve the GO designation. An impressive accomplishment.

Below are the current 20-year GOs (excluding muni funds for compactness, but find complete list here, also reference MFO Ratings Definitions.)

Of the original 20-year GO list of 47 funds still in existence today, only 19 remain GOs. These include notables: Fidelity GNMA (FGMNX), PIMCO Foreign Bond – USD-Hedged I (PFORX), James Balanced: Golden Rainbow R (GLRBX), T. Rowe Price Capital Appreciation (PRWCX), Vanguard Wellington Inv (VWELX), Meridian Growth Legacy (MERDX), and Hennessy Gas Utility Investor (GASFX).

The current 20-year GOs also include 25 Honor Roll funds, based on legacy Fund Alarm ranking system. Honor Roll funds have delivered top quintile absolute returns in its category for evaluation periods of 1, 3, and 5 years. These include: AMG Managers Interm Dur Govt (MGIDX), PIMCO Foreign Bond – USD-Hedged I (PFORX), James Balanced: Golden Rainbow R (GLRBX), T. Rowe Price Capital Appreciation (PRWCX), and T. Rowe Price Mid-Cap Growth (RPMGX).

A closer look at performance of the original list of 20-year GOs, since they were introduced a little more than two years ago, shows very satisfactory performance overall, even with funds not maintaining GO designation. Below is a summary of Return Group rankings and current three-year performance.

Of the 31 funds in tables above, only 7 have underperformed on a risk adjusted basis during the past three years, while 22 have outperformed.

Some notable outperformers include: Vanguard Wellesley Income Inv (VWINX), Oakmark International I (OAKIX), Sequoia (SEQUX), Brown Capital Mgmt Small Co Inv (BCSIX), and T. Rowe Price New Horizons (PRNHX).

And the underperformers? Waddell & Reed Continental Inc A (UNCIX), AMG Yacktman (YACKX), Gabelli Equity Income AAA (GABEX), and Voya Corporate Leaders Trust (LEXCX).

A look at absolute returns shows that 10 of the 31 underperformed their peers by an average of 1.6% annualized return, while the remaining 21 beat their peers by an average of 4.8%.

Gentle reminder: MFO ratings are strictly quantitative and backward looking. No accounting for manager or adviser changes, survivorship bias, category drift, etc.

Will take a closer look at the three-year mark and make habit of posting how they have fared over time.

New Voices at the Observer: The Tale of Two Leeighs

We’re honored this month to be joined by two new contributors: Sam Lee and Leigh Walzer.

Sam is the founder of Severian Asset Management, Chicago. He is also former editor of Morningstar analyst and editor of their ETF Investor newsletter. Sam has been celebrated as one of the country’s best financial writers (Morgan Housel: “Really smart takes on ETFs, with an occasional killer piece about general investment wisdom”) and as Morningstar’s best analyst and one of their best writers (John Coumarianos: “Lee has written two excellent pieces [in the span of a month], and his showing himself to be Morningstar’s finest analyst”). Sam claims to have chosen “Severian” for its Latinate gravitas.

We’ll set aside, for now, any competing observations. For example, we’ll make no mention of the Severian Asset Management’s acronym. And certainly no reflections upon the fact that Severian was the name of the Journeyman torturer who serves as narrator in a series of Gene Wolfe’s speculative fiction. Nor that another Severian was a popular preacher and bishop. Hmmm … had I mentioned that one of Sam’s most popular pieces is “Losing My Religion”?

You get a better sense of what Sam brings to the table from his discussion of his approach to things as an investment manager:

Investing well is hard. We approach the challenge with a great deal of humility, and try to learn from the best thinkers we can identify. One of our biggest influences is Warren Buffett, who stresses that predictions about the future should be based on an understanding of economic fundamentals and human nature, not on historical returns, correlations and volatilities. He stresses that we should be skeptical of the false precision and unwarranted sense of control that come with the use of quantitative tools, such as Monte Carlo simulations and Markowitz optimizations. We take these warnings seriously.

Our approach is based on economic principles that we believe are both true and important:

• First and foremost, we believe an asset’s true worth is determined by the cash you can pull out of it discounted by the appropriate interest rate. Over the long run, prices tend to converge to intrinsic value … Where we differ with Buffett and other value investors is that we do not believe investment decisions should be made solely on the basis of intrinsic value. It is perfectly legitimate to invest in a grossly overpriced asset if one knows a sucker will shortly come along to buy it … The trick is anticipating what the suckers will do.
• Second, we believe most investors should diversify. As Buffett says, “diversification is protection against ignorance.” This should not be interpreted as a condemnation of the practice. Most investors are ignorant as to what the future holds. Because most of us are ignorant and blind, we want to maximize the protection diversification affords.
• Third, we believe risk and reward are usually, but not always, positively related … Despite equities’ attractive long-term returns, investors have managed to destroy enormous amounts of wealth while investing in them by buying high and selling low. To avoid this unfortunate outcome, we scale your equity exposure to your behavioral makeup, as well as your time horizon and goals.
• Fourth, the market makes errors, but exploiting them is hard.

We prefer to place actively managed funds (and other high-tax-burden assets) in tax-deferred accounts. In taxable accounts, we prefer tax-efficient, low-cost equities, either held directly or through mutual funds. Many exchange-traded funds are particularly tax-advantaged because they can aggressively rid themselves of low cost-basis shares without passing on capital gains to their investors.

In my experience, Sam’s writing is bracingly direct, thoughtful and evidence-driven. I think you’ll like his work and I’m delighted by his presence. Sam’s debut offering is a thoughtful and data rich profile of AQR Style Premia Alternative (QSPIX). You’ll find a summary and link to his profile under Observer Fund Profiles.

Leigh Walzer is now a principal of Trapezoid LLC and a former member of Michael Price’s merry band at the Mutual Series funds. In his long career, Leigh has brought his sharp insights and passion for data to mutual funds, hedge funds, private equity funds and even the occasional consulting firm.

We had a chance to meet during June’s Morningstar conference, where he began to work through the logic of his analysis of funds with me. Two things were quickly clear to me. First, he was doing something distinctive and interesting. As base, Leigh tried to identify the distinct factors that might qualify as types of managerial skill (two examples would be stock selection and knowing when to reduce risk exposure) and then find the data that might allow him to take apart a fund’s performance, analyze its component parts and predict whether success might persist. Second, I was in over my head. I asked Leigh if he’d be willing to share sort of bite-sized bits of his research so that folks could begin to understand his system and test the validity of its results. He agreed.

Here’s Leigh’s introduction to you all. His first analytic piece debuts next month.

Mutual Fund Observer performs a great service for the investment community. I have found information in these pages which is hard to obtain anywhere else. It is a privilege to be able to contribute.

I founded Trapezoid a few years ago after a long career in the mutual fund and hedge fund industry as an analyst and portfolio manager. Although I majored in statistics at Princeton many moons ago and have successfully modelled professional sports in the past, most of my investing was in credit and generally not quantitative in nature. As David Snowball mentioned earlier, I spent 7 years working for Mutual Shares, led by Michael Price. So the development of the Orthogonal Attribution Engine marks a return to my first passion.

I have always been interested in whether funds deliver value for investors and how accurately allocators and investors understand their managers.  My freshman economics course was taught by Burton Malkiel, author of a Random Walk Down Wall Street, who preached that the capital markets were pretty efficient. My experience in Wall Street and my work at Orthogonal have taught me this is not always true.  Sometimes a manager or a strategy can significantly outperform the market for a sustained period.  Of course, competitors react and capital flows until an equilibrium is achieved, but not nearly as quickly as Malkiel assumes.

There has been much discussion over the years about the active–passive debate.  John Bogle was generous in his time reviewing my work.  I generally agree with Jack and he is a giant in the industry to whom we all owe a great deal.  For those who are ready to throw in the towel of active investing, Bogle makes two (related) assumptions which need to be critically reviewed:

1. Even if an active manager outperforms the average, he is likely to revert to the mean.
2. Active managers with true skill (in excess of their fee structure) are hard to identify, so investors are better off with an index fund

I try to measure skill in a way which is more accurate (and multi-faceted) than Bogle’s definition and I look at skill as a statistical process best measured over an extended period of time. I try to understand how the manager is positioned at every point in time, using both holdings and regression data, and I try to understand the implications of his or her decisions.

My work indicates that the active-passive debate is less black and white than you might discern from the popular press or the marketing claims of mutual fund managers. The good news for investors is there are in fact many managers who have demonstrated skill over an extended period of time. Using statistical techniques, it is possible to identify managers likely to outperform in the future. There are some funds whose expected return over the next 12 months justifies what they charge. There are many other managers who show investment skill, but not enough to justify their expense structure.

Feel free to check out the website at www.fundattribution.com which is currently in beta test. Over 30,000 funds are modelled; users who register for demo access can see certain metrics measuring historic manager skill and likelihood of future success on a subset of the fund universe.

I look forward to sharing with you insights on specific funds in the coming months and provide MFO readers a way to track my results. Equally important, I hope to give you new insights to help you think about the role of actively managed funds in your portfolio and how to select funds. My research is still a work in process. I invite the readership of MFO to join me in my journey and invite feedback, suggestions, and collaboration.  You may contact me at [email protected].

We’re very much looking forward to October and Leigh’s first essay. Thanks to both. I think you’ll enjoy their good spirits and insight.

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, searchable, and filtered as never before. For the 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.

Court Decisions & Orders

• In the shareholder litigation regarding gambling-related securities held by the American Century Ultra Fund, the Eighth Circuit affirmed the district court’s grant of summary judgment in favor of American Century, agreeing that the shareholder could not bring suit against the fund adviser because the fund had declined to do so in a valid exercise of business judgment. Defendants included independent directors. (Seidl v. Am. Century Cos.)
• Setting the stage for a rare section 36(b) trial (assuming no settlement), a court denied parties’ summary judgment motions in fee litigation regarding multiple AXA Equitable funds. The court cited only “reasons set forth on the record.” (Sanford v. AXA Equitable Funds Mgmt. Group, LLC; Sivolella v. AXA Equitable Life Ins. Co.)
• A court gave its final approval to (1) a $24 million partial settlement of the state-law class action regarding Northern Trust‘s securities lending program, and (2) a $36 million settlement of interrelated ERISA claims. The state-law class action is still proceeding with respect to plaintiffs who invested directly in the program. (Diebold v. N. Trust Invs., N.A.; La. Firefighters’ Ret. Sys. v. N. Trust Invs., N.A.)
• In the long-running fee litigation regarding Oakmark funds that had made it all the way to the U.S. Supreme Court, the Seventh Circuit affirmed a lower court’s grant of summary judgment for defendant Harris Associates. The appeals court cited the lower court’s findings that (1) “Harris’s fees were in line with those charged by advisers for other comparable funds” and (2) “the fees could not be called disproportionate in relation to the value of Harris’s work, as the funds’ returns (net of fees) exceeded the norm for comparable investment vehicles.” Plaintiffs have filed a petition for rehearing en banc. (Jones v. Harris Assocs.)
• Extending the fund industry’s dismal record on motions to dismiss section 36(b) litigation, a court denied PIMCO‘s motion to dismiss an excessive-fee lawsuit regarding the Total Return Fund. Court: “Throughout their Motion, Defendants grossly exaggerate ‘the specifics’ needed to survive a 12(b)(6) motion, essentially calling for Plaintiff to prove his case now, before discovery.” (Kenny v. Pac. Inv. Mgmt. Co.)
• A court granted the motion to dismiss a state-law and RICO class action alleging mismanagement by a UBS investment adviser, but without prejudice to refile the state-law claims as federal securities fraud claims. (Knopick v. UBS Fin. Servs., Inc.)

The Alt Perspective: Commentary and news from DailyAlts.

As we all now know, August was anything but calm. Despite starting that way, the month delivered some tough love in the last two weeks, just when we were all supposed to be relaxing with family and friends. Select Morningstar mutual fund categories finished the month with the following returns:

• Large Blend (US Equity): -6.07%
• Intermediate-Term Bond: -0.45%
• Long/Short Equity: -3.57%
• Nontraditional Bonds: -0.91%
• Managed Futures: -2.52%

The one surprise of the five categories above is Managed Futures. This is a category that typically does well when markets are in turmoil and trending down. August proved to be an inflection point, and turned out to be challenging in what was otherwise a solid year for the strategies.

However, let’s take a look at balanced portfolio configurations. Using the above category returns, at traditional long-only 60/40 blend portfolio (60% stocks / 40% bonds) would have returned -3.82% in August, while an alternative balanced portfolio of 50% long/short equity, 30% nontraditional bonds and 20% managed futures would have returned -2.56%. Compare these to the two categories below:

• Moderate Allocation: -4.17%
• Multialternative: -2.22%

Moderate Allocation funds, which are relatively lower risk balance portfolios, turned in the lowest of the balanced portfolio configurations. The Multialternative category of funds, which are balanced portfolios made up of mostly alternative strategies, performed the best, beating the traditional 60/40 portfolio, the 50/30/20 alternative portfolio and the Moderate Allocation category. Overall, it looks like alternatives did their job in August.

August Highlights

Believe it or not, Vanguard launched its second alternative mutual fund in August. The new Vanguard Alternative Strategies Fund will invest across several alternative investment strategies, including long/short equity and event driven, and will also allocate some assets to currencies and commodities. Surprisingly, Vanguard will be managing the fund in-house, but does that the ability to outsource some or all of the management of the fund. Sticking with its low cost focus, Vanguard will charge a management fee of 0.18% – a level practically unheard of in the liquid alternatives space.

In a not quite so surprising move, Catalyst Funds converted its fourth hedge fund into a mutual fund in August with the launch of the Catalyts/Auctos Multi Strategy Fund. In this instance, the firm did go one step beyond prior conversions and actually acquired the underlying manager, Auctos Capital Management. One key benefit of the hedge fund conversion is the fact that the fund can retain its performance track record, which dates back to 2008.

Finally, American Century (yes, that conservative, mid-western asset management firm) launched a new brand called AC Alternatives under which it will manage a series of alternative mutual funds. The firm currently has three funds under the new brand, with two more in the works. Similar to Vanguard, the firm launched a market neutral fund back in 2005, and a value tilted version in 2011. The third fund, an alternative income fund, is new this year.

Let’s Get Together

Two notable acquisitions occurred in August. The first is the acquisition of Arden Asset Management, a long-time institutional fund-of-hedge funds manager, by Aberdeen. The latter has been on the acquisition trail over the past several years, with a keen eye on alternative investment firms. Through the transaction, Arden will get global distribution, while Aberdeen will pick up very specific hedge fund due diligence, manager research and portfolio construction capabilities. Looks like a win-win.

The second transaction was the acquisition of 51% of the Australian-based unconstrained fixed income shop Kapstream Capital by Janus for a cool $85 million. Janus also has the right to purchase the remainder of the firm, which has roughly $6 billion under management. Good for Kapstream as the valuation appears to be on the high end, but perhaps Bill Gross needed some assistance managed his unconstrained portfolios.

The Fall

A lot happens in the Fall. Back to school. Football. Interest rate hike. Changing leaves. Halloween. Thanksgiving. Federal debt ceiling. Maybe there is enough for us all to take our minds off the markets for just a bit and let things settle down. Time will tell, but until next month, enjoy the Labor Day weekend and the beginning of a new season.

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. 

AQR Style Premia Alternative (QSPIX). AQR’s new long-short multi-strategy fund takes factor investing to its logical extreme: It applies four distinct strategies–value, momentum, carry, and defensive–across stock, bond, commodity, and currency markets. The standard version of the fund targets a 10% volatility and a 0.7 Sharpe ratio while maintaining low to no correlation with conventional portfolios. In its short life, the fund has delivered in spades. Please note, this profile was written by our colleague, Sam Lee.

Manning & Napier Pro-Blend Conservative (EXDAX): this fund has been navigating market turbulences for two decades now. Over the course of the 21^st century, it’s managed to outperform the Total Stock Market Index with only one-third of the stocks and one-third of the volatility. And you can start with just $25!  

TCW/Gargoyle Hedged Value (TFHVX/TFHIX):  if you understand what you’re getting – a first-rate value fund with one important extra – you’re apt to be very happy. If you see “hedged” and think “tame,” you’ve got another thing coming.

Launch Alert: Falcon Focused SCV (FALCX)

The fact that newly-launched Falcon Focused SCV has negligible assets (it’s one of the few funds in the world where I could write a check and become the fund’s largest shareholder) doesn’t mean that it has negligible appeal.

The fund is run by Kevin Silverman whose 30 year career has been split about equally between stints on the sell side and on the buy side.  He’s a graduate of the University of Wisconsin’s well-respect Applied Securities Analysis Program . Early in his career he served as an analyst at Oakmark and around the turn of the century was one of the managers of ABN AMRO Large Cap Growth Fund. He cofounded Falcon Capital Management in April 2015 and is currently one of the folks responsible for a $100 million small cap value strategy at Dearborn Partners in Chicago. They’ve got an audited 14 year record.

I’m endlessly attracted to the potential of small cap value investing. The research, famously French and Fama’s, and common sense concur: this should be the area with the greatest potential for profits. It’s huge. It’s systemically mispriced because there’s so little analyst coverage and because investors undervalue value stocks. Growth stocks are all cool and sexy and you want to own them and brag to all your friends about them. Value stocks are generally goofed up companies in distressed industries. They’re boring and a bit embarrassing to own; on whole, they’re sort of the midden heap of the investing world.

The average investor’s unwillingness or inability to consider them raises the prospect that a really determined investor might find exceptional returns. Kevin and his folks try to build 5 to 10 year models for all of their holdings, then look seriously at years four and five. The notion is that if they can factor emotion out of the process (they invoke the pilot’s mantra, “trust your instruments”) and extend their vision beyond the current obsession with this quarter and next quarter, they’ll find opportunities that will pay off handsomely a few years from now. Their target is to use their models to construct a portfolio that has the prospect for returns “in the mid-20s over the next three years.” Mathematically, that works out to a doubling in just over three years.

I’m not sure that the guys can pull it off but they’re disciplined, experienced and focused. That puts them ahead of a lot of their peers.

The initial expense ratio, after waivers, is 1.25%. The no-load Institutional shares carry a $10,000 minimum, which is reduced to $5000 for tax-advantaged accounts and those set up with an automatic investing plan. The fund’s website is still pretty sparse (okay, just under “pretty sparse”), but you can find a bit more detail and one pretty panorama at the adviser’s website.

Launch Alert: Grandeur Peak Global Stalwarts Fund (GGSOX/GGSYX)

Grandeur Peak launched two “alumni” funds on September 1, 2015. Grandeur Peak’s specialty is global micro- and small-cap stocks, generally at the growth end of the spectrum. If they do a good job, their microcap stocks soon become small caps, their small caps become midcaps, and both are at risk of being ejected from the capitalization-limited Grandeur Peak funds.

Grandeur Peak was approached by a large investor who recognized the fact that many of those now-larger stocks were still fundamentally attractive, and asked about the prospect of a couple “alumni” funds to hold them. Such funds are attractive to advisors since you’re able to accommodate a much larger asset base when you’re investing in $10 billion stocks than in $200 million ones.

One investor reaction might be to label Grandeur Peak as sell-outs. They’ve loudly touted two virtues: a laser-like focus and a firm-wide capacity cap at $3 billion, total. With the launch of the Stalwarts funds, they’re suddenly in the mid-cap business and are imagining firmwide AUM of about $10 billion.

Grandeur Peak, however, provided a remarkable wide-ranging, thoughtful defense of their decision. In a letter to investors, dated July 15, they discuss the rationale for and strategies embodied by three new funds:

Grandeur Peak Global Micro Cap Fund (GPMCX): A micro-cap strategy primarily targeting companies in the $50M-350M market cap range across the globe; very limited capacity.

Grandeur Peak Global Stalwarts Fund (GGSOX/GGSYX): A small/mid-cap (SMID) strategy focused on companies above $1.5B market cap across the globe.

Grandeur Peak International Stalwarts Fund (GISOX/GISYX): A small/mid-cap strategy focused on companies above $1.5B market cap outside of the U.S.

They argue that they’d always imagined Stalwarts funds, but didn’t imagine launching them until the firm’s second decade of operation. Their success in identifying outstanding stocks and drawing assets brought high returns, a lot of attention and a lot of money. While they hoped to be able to soft-close their funds, controlling inflows forced a series of hard closes instead which left some of their long-time clients adrift. By adding the Stalwarts funds as dedicated vehicles for larger cap names (the firm already owns over 100 stocks in the over $1.5 billion category), they’re able to provide continuing access to their investors without compromising the hard limits on the micro- and nano-cap products. Here’s their detail:

As you know, capacity is a very important topic to us. We believe managing capacity appropriately is another critical competitive advantage for Grandeur Peak. We plan to initially close the Global Micro Cap Fund at around $25 million. We intend to keep it very small in order to allow the Fund full access to micro and nanocap companies …

Looking carefully at the market cap and liquidity of our holdings above $1.5 billion in market cap, the math suggests that we could manage up to roughly $7 billion across the Stalwarts family without sacrificing our investment strategy or desired position sizes in these names. This $7 billion is in addition to the roughly $3 billion that we believe we can comfortably manage below $1.5 billion in market cap.

Our existing strategies will remain hard closed as we are committed to protecting these strategies and their ability to invest in micro-cap and small-cap companies. We are very aware that many good small cap firms lose their edge by taking in too many assets and being forced to adjust their investment style. We will not do this! We are taking a more unique approach by partitioning the lower capacity, less liquid names and allowing additional assets in the higher capacity, liquid stocks where the impact will not be felt by the smaller-cap funds.

The minimum initial investment is $2000 for the Investor share class, which will be waived if you establish the account with an automatic investment plan. Unlike Global Micro Cap, there is no waiver of the institutional minimum available for the Stalwarts. Each fund will charge 1.35%, retail, after waivers. You might want to visit the Global Stalwarts or International Stalwarts homepages for details.

Funds in Registration

There are 17 new funds in registration this month. Funds in registration with the SEC are not available for sale to the public and the advisors are not permitted to talk about them, but a careful reading of the filed prospectuses gives you a good idea of what interesting (and occasionally appalling) options are in the pipeline. Funds currently in registration will generally be available for purchase in November.

Two of the funds will not be available for direct purchase: T. Rowe Price is launching Mid Cap and Small Cap index funds to use with 529 plans, funds-of-funds and so on. Of the others, there are new offerings from two solid boutiques: Driehaus Turnaround Opportunities will target “distressed” investing and Brown Advisory Equity Long/Short Fund will do about what you expect except that the filings bracket the phrase Equity Long/Short. That suggests that the fund’s final name might be different. Harbor is launching a clone of Vanguard Global Equity. A little firm named Gripman is launched a conservative allocation fund (I wish them well) and just one of the funds made my eyes roll. You’ll figure it out.

Manager Changes

We tracked down 60 or 70 manager changes this month; the exact number is imprecise because one dude was leaving a couple dozen Voya funds which we reduced to just a single entry. We were struck by the fact that about a dozen funds lost women from the management teams, but it appears only two funds added a female manager.

Sympathies to Michael Lippert, who is taking a leave from managing Baron Opportunity (BIOPX) while he recovers from injuries sustained in a serious bicycle accident. We wish him a speedy recovery.

Updates

A slightly-goofed SEC filing led us to erroneously report last month that Osterweis Strategic Investment (OSTVX) might invest up to 100% in international fixed-income. A “prospectus sticker” now clarifies the fact that “at the fund level OSTVX is limited to 50% foreign.” Thanks to the folks at Osterweis for sharing the update with us. Regrets for any confusion.

Morningstar giveth: In mid-August, Morningstar initiated coverage of two teams we’ve written about. Vanguard Global Minimum Volatility (VMVFX) received a Bronze rating, mostly because it’s a Vanguard fund. Morningstar praises the low expenses, Vanguard culture and the “highly regarded–and generally successful–quantitative equity group.” The fund’s not quite two years old but has a solid record and has attracted $1.1 billion in assets.

Vulcan Value Partners (VVPLX) was the other Bronze honoree. Sadly, Morningstar waited until after the fund had closed before recognizing it. The equally excellent Vulcan Value Partners Small Cap (VVPSX) fund is also closed, though Morningstar has declined to recognize it as a medalist fund.

Morningstar taketh away: Fidelity Capital Appreciation (FDCAX) is no longer a Fanny Fifty Fund: it has been doing too well. There’s an incentive fee built into the fund’s price structure; if performance sucks, the e.r. drops. If performance soars, the e.r. rises.

Rewarding good performance sounds to the novice like a good idea. Nonetheless, good performance has had the effect of disqualifying FDCAX as a “Fantastic” fund. Laura Lutton explains why, in “These Formerly ‘Fantastic’ Funds Now Miss the Mark.”

In 2013, the fund outpaced that index by 2.47 percentage points, upping the expense ratio by 4 basis points to 0.81%. This increase moved the fund’s expenses beyond the category’s cheapest quintile…

Uhhh … yup. 247 basis points of excess return in exchange for 4 basis points of expense is clearly not what we expect of Fantastic funds. Out!

From Ira’s “What the hell is that?” file: A rare T Rowe flub

Ira Artman, a long-time friend of the Observer and consistently perceptive observer himself, shared the following WTF performance chart from T. Rowe Price:

Good news: T. Rowe Price Latin America (PRLAX) is magic! It’s volatility-free emerging market fund.

Bad news: the chart is rigged. The vertical axis is compressed so eliminate virtually all visible volatility. There’s a sparky discussion of the chart on our discussion board that provides both uncompressed versions of the chart and the note that the other T. Rowe funds did not receive similarly scaled axes. Consensus on the board: someone deserves a spanking for this one.

Thanks to Ira for catching and sharing.

Briefly Noted . . .

CRM Global Opportunity Fund (CRMWX) is becoming CRM Slightly-Less-Global Opportunity Fund, in composition if not in name. Effective October 28, the fund is changing its principal investment strategy from investing “a majority” of its assets outside the US to investing “at least 40%” internationally, less if markets get ugly. Given that the fund’s portfolio is just 39% global now (per Morningstar), I’m a little fuzzy on why the change will make a difference.

SMALL WINS FOR INVESTORS

Seafarer’s share class model is becoming more common, which is a good thing. Seafarer, like other independent funds, needs to be available on brokerage platforms like Schwab and Scottrade; those platforms allow for lower cost institutional shares so long as the minimum exceeds $100,000 and higher cost retail shares with baked-in 12(b)1 fees to help pay Schwab’s platform fees. Seafarer complied but allows a loophole: they’ll waive the minimum on the institutional shares if you (a) buy it directly from them and (b) set up an automatic investing plan so that you’re moving toward the $100,000 minimum. Whether or not you reach it isn’t the consideration. Seafarer’s preference is to think of their low-cost institutional class as their “universal share class.”

Grandeur Peak is following suit. They intend to launch their new Global Micro Cap Fund by year’s end, then to close it as soon as assets hit $25 million. That raises the real prospect of the fund being available for a day or two. During that time, though, they’ll offer institutional shares to retail investors who invest directly with them. They write:

We want the Global Micro Cap Fund to be available to both our retail and institutional clients, but without the 0.25% 12b-1 fee that comes with the Investor share class. Our intention is to make the Institutional class available to all investors, and waive the minimum to $2000 for regular accounts and $100 for UTMA accounts.

Invesco International Small Company Fund will reopen to all investors on September 11, 2015. Morningstar has a lot of confidence in it (the fund is “Silver”) and it has a slender asset base right now, $330 million, down from its peak of $700 million before the financial crisis. The fund has been badly out of step with the market in recent years, which is reflected in the fact that it has one of its peer group’s best ten-year record and worst five-year records. Since neither the team nor the strategy has changed, Morningstar remains sanguine.

Matthews Pacific Tiger Fund (MAPTX) has reopened to new investors.

Effective July 1, 2015 the shareholder servicing fee for the Investor Class Shares of each of the Meridian Funds was reduced from 0.25% to 0.05%. Somehow I missed it. Sorry for the late notice. The Investor shares continue to sport their bizarre $99,999 minimum initial investment.

Wells Fargo Advantage Index Fund (WFILX) reopens to new investors on October 1. It’s an over-priced S&P 500 Index fund. Assuming you can dodge the front load, the 0.56% expense ratio is a bit more than triple Vanguard’s (0.17% for Investor shares of Vanguard 500, VFINX). That difference adds up: over 10 years, a $10,000 investment in WFILX would have grown to $19,800 while the same money in VFINX grew to $20,700.

CLOSINGS (and related inconveniences)

Acadian Emerging Markets (AEMGX) is slated to close to new investors on October 1. The adviser is afraid that the fund’s ability to execute its strategy will be impaired “if the size of the Fund is not limited.” The fund has lost an average of 3.7% annually for the current market cycle, through July 2015. You’d almost think that losing money, trailing the benchmark and having higher-than-normal volatility would serve as automatic brakes limiting the size of the portfolio.” Apparently not so much.

M.D. Sass 1-3 Year Duration U.S. Agency Bond Fund (MDSHX) is closing the fund’s retail share class and converting them to institutional shares. It’s an okay fund in a low return category, which means expenses matter. Over the past three years, the retail shares trail 60% of their peer group while the institutional shares lead 60% of the group. The conversion will give existing retail shareholders a bit of a boost and likely cut the adviser’s expenses by a bit.

OLD WINE, NEW BOTTLES

Effective August 27, 2015 361 Global Managed Futures Strategy Fund (AGFQX) became the 361 Global Counter-Trend Fund. I wish them well, but the new prospectus language is redolent of magic wands and sparkly dust: “counter-trend strategy follows an investment model designed to perform in volatile markets, regardless of direction, by taking advantage of fluctuations.  Using a combination of market inputs, the model systematically identifies when to purchase and sell specific investments for the Fund.” What does that mean? What fund isn’t looking to identify when to buy or sell specific investments?

American Independence Laffer Dividend Growth Fund (LDGAX) has … laughed its last laff? Hmmm. Two year old fund run by Laffer Investments, brainchild of Arthur B. Laffer, the genius behind supply-side economics. Not, as it turns out, a very good two year old fund.  At the end of July, American Independence merged with FolioMetrix LLC to form RiskX Investments. Somewhere in the process, the fund was declared to be surplus.

Effective September 1, 2015, the name of the Anchor Alternative Income Fund (AAIFX) will be changed to Armor Alternative Income Fund.

Effective August 7, 2015, Eaton Vance Tax-Managed Small-Cap Value Fund became Eaton Vance Tax-Managed Global Small-Cap Fund (ESVAX).

The Hartford Emerging Markets Research Fund is now Hartford Emerging Markets Equity Fund (HERAX) while The Hartford Small/Mid Cap Equity Fund has become Hartford Small Cap Core Fund (HSMAX).  HERAX is sub-advised by Wellington. Back in May they switched out managers, with the new guy bringing a more-driven approach so they’ve also added “quantitative investing” as a risk factor in the prospectus.  For HSMAX, midcaps are now out.

In mid-November, three Stratton funds add “Sterling Capital” to their names: Stratton Mid Cap Value (STRGX) becomes Sterling Capital Stratton Mid Cap Value. Stratton Real Estate (STMDX) and Stratton Small Cap Value (STSCX) get the same additions.

Effective September 17, 2015, ROBO-STOX^TM Global Robotics and Automation Index ETF (ROBO) will be renamed ROBO Global^TM Robotics and Automation Index ETF. If this announcement affects your portfolio, consider getting therapy and a Lab puppy.

OFF TO THE DUSTBIN OF HISTORY

American Beacon is pretty much cleaning out the closet. They’ve announced liquidation of their S&P 500 Index Fund, Small Cap Index Fund, International Equity Index Fund, Emerging Markets Fund, High Yield Bond Fund, Intermediate Bond Fund, Short-Term Bond Fund and Zebra Global Equity Fund (AZLAX). With regard to everything except Zebra, the announcement speaks of “large redemptions which are expected to occur by the end of 2015” that would shrink the funds by so much that they’re not economically viable. American Beacon started as the retirement plan for American Airlines, was sold to one private equity firm in 2008 and then sold again in 2015. It appears that they lost the contract for running a major retirement plan and are dumping most of their vanilla funds in favor of their recent ventures into trendier fare. The Zebra Global Equity Fund was a perfectly respectable global equity fund that drew just $5 million in assets.

In case you’re wondering whatever happened to the Ave Maria Opportunity Fund, it was eaten by the Ave Maria Catholic Values Fund (AVEMX) at the end of July.

Eaton Vance announced liquidation of its U.S. Government Money Market Fund, around about Halloween, 2015. As new SEC money market regs kick in, we’ve seen a lot of MMFs liquidate.  

Eaton Vance Hexavest U.S. Equity Fund (EHUAX) is promoted to the rank of Former Fund on or about September 18, 2015, immediately after they pass their third anniversary.  What is a “hexavest,” you ask? Perhaps a protective garment donned before entering the magical realms of investing? Hmmm … haven’t visited WoW lately, so maybe. Quite beyond that it’s an institutional equity investment firm based in Montreal that subadvises four (oops, three) funds for Eaton Vance.  Likely the name derived from the fact that the firm had six founders (Greek, “hex”) who wore vests.

Rather more quickly, Eaton Vance also liquidated Parametric Balanced Risk Fund (EAPBX). The Board announced the liquidation on August 11; it was carried out August 28. And you could still say they might have been a little slow on the trigger:

The Eudora Fund (EUDFX) has closed and will liquidate on September 10, 2015.

Hundredfold Select Equity Fund (SFEOX) has closed and will discontinue its operations effective October 30, 2015. It’s the sort of closure about which I think too much. On the one hand, the manager (described on the firm’s Linked-In page as “an industry visionary”) is a good steward: almost all of the money in the fund is his own (over $1 million of $1.8 million), he doesn’t get paid to manage it, his Simply Distribute Foundation helps fund children’s hospitals and build orphanages. On the other hand, it’s a market-timing fund of funds will an 1100% turnover which has led the fund to consistently capture much more of the downside, and much less of the upside, than its peers. And, in a slightly disingenuous move, the Hundredfold Select website has already been edited to hide the fact that the Select Equity fund even exists.

Ticker symbols are sometimes useful time capsules, helping you unpack a fund’s evolution. Matthews Asian Growth and Income is “MACSX” because it once was their Asian Convertible Securities fund. Hundredfold Select is “SFEOX” because it once was the Direxion Spectrum Funds: Equity Opportunity fund.

KKM Armor Fund (RMRAX) was not, it appears, bullet-proof. Despite a 30% gain in August 2015, the 18 month old, $8 million fund has closed and will liquidate on September 24, 2015. RMRAX was one of only two mutual funds in the “volatility” peer group. The other is Navigator Sentry Managed Volatility (NVXAX). I bet you’re wondering, “why on earth would Morningstar create a bizarre little peer group with only two funds?” The answer is that there are a slug of ETFs that allow you to bet changes in the level of market volatility; they comprise the remainder of the group. That also illustrates why I prefer funds to ETFs: encouraging folks to speculate on volatility changes is a fool’s errand.

The Modern Technology Fund (BELAX) has closed and will liquidate on September 25, 2015.

There’s going to be one less BRIC in the wall: Goldman Sachs has announced plans to merge Goldman Sachs BRIC Fund (GBRAX) into their Emerging Markets Equity Fund (GEMAX) sometime in October.  The Trustees unearthed a new euphemism for “burying this dog.” They want “to optimize the Goldman Sachs Funds.” The optimized line-up removes a fund that, over the past five years, turned $10,000 into $8,500 by moving its assets into a fund that turned $10,000 into $10,000.

In an interesting choice of words, the Board of Directors authorized the “winding down” Keeley Alternative Value Fund (KALVX) and the Keeley International Small Cap Value Fund (KISVX). By the time you read this, the funds will already have been quite unwound. The advisor gave Alternative Value about four years to prove its … uhh, alternative value (it couldn’t). It gave International Small Cap all of eight months. Founder John Keeley passed away in June at age 75. The firm had completed their transition planning just a month before his passing.

PIMCO Tax Managed Real Return Fund (PXMDX) will be liquidated on or about October 30, 2015.  In addition, three PIMCO ETFs are getting deposited in the circular file: 3-7 Year U.S. Treasury Index (FIVZ), 7-15 Year U.S. Treasury Index (TENZ) and Foreign Currency Strategy Active (FORX) ETFs all disappear on September 30, 2015. “This date may be changed without notice at the discretion of the Trust’s officers.” Their average daily trading volume was just a thousand or two shares.

Ramius Hedged Alpha Fund (RDRAX) will undergo “termination, liquidation and dissolution,” all on September 4, 2015.

A reminder to all muddled Lutherans: your former Aid Association for Lutherans (AAL) Funds and/or your former Lutheran Brother Funds, which merged to become your Thrivent Funds, aren’t exactly thriving. The latest evidence is the decision to merge Small Value and Small Growth into Thrivent Small Cap, Mid Cap Value and Mid Cap Growth into Thrivent Mid Cap Stock and Natural Resources and Technology into Thrivent Large Cap Growth

Toroso Newfound Tactical Allocation Fund (TNTAX) has closed and will liquidate at the end of September, 2015.  The promise of riches driven by “a proprietary, volatility-adjusted and momentum driven model” never quite panned out for this tiny fund-of-ETFs.

In Closing . . .

Warren Buffett turned 85 on Sunday. I can only hope that we all have his wits and vigor when we reach a similar point in our lives. To avoid copyright infringement and the risk of making folks ears bleed, I didn’t sing “happy birthday” but I celebrate his life and legacy.

As you read this, I’m boring at bunch of nice folks in Cincinnati to tears. I was asked to chat with the folks at the Ultimus Fund Services conference about growth in uncertain times. It’s a valid concern and I’ll try to share in October the gist of the argument. In late August, a bright former student of mine, Jonathon Woo, had me visit with some of his colleagues in the mutual fund research group at Edward Jones. I won’t tell you what I said to them (it was all Q&A and I rambled) but what I should have said about how to learn (in this case about the prospect of an individual mutual fund) from talking with others. And, if the market doesn’t scramble things up again, we’ll finally run the stuff that’s been in the pipeline for two months.

We’re grateful to the folks who continue to support the Observer, both financially and with an ongoing stream of suggestions. Thanks to Tyler for his recent advice, and to Rick, Kirk, William, Beatrice, Courtney, Thaddeus, Kevin, Virginia, Sunil, and Ira (a donor advised fund – that’s so cool) for their financial support. You guys rock! A number of planning firms have also reaching out with support, kind words and suggestions. So thanks to Wealth Care, LLC, Evergreen Asset Management, and Integrity Financial Planning.  I especially need to track down our friends at Evergreen Asset Management for some beta testing questions. Too, we can’t forget the folks whose support comes from the use of our Amazon Affiliate link. Way to go on finding those back-to-school supplies!

I don’t mean to frighten anyone before Halloween, but historically September and October are the year’s most volatile months. Take a deep breath, try to do a little constructive planning on quiet days, pray for the Cubs (as I write, they’re in third place but with a record that would have them leading four of the six MLB divisions), cheer for the Pirates, laugh at the dinner table and remember that we’re thinking of you.

As ever,

Dear friends,

Welcome to the dog days.

“Dog days” didn’t originally have anything to do with dogs, of course. It derived from the ancient belief shared by Egyptians, Greeks and Romans that summer weather was controlled by Sirius, the Dog Star. Why? Because Sirius rises just at dawn in the hottest, most sultry months of the year.

FreeImages.com/superburg

In celebration of the fact that the dog days of summer have arrived and you should be out by the pool with family, we’re opening our annual summer-weight issue with some good news.

MFO is a charity case

And you just thought we were a basket case!

As a matter of economic and administrative necessity, the Observer has always been organized as a sole proprietorship. We’re pleased to announce that, in June, our legal status changed. On June 29, we became a non-profit corporation (Mutual Fund Observer, Inc.) under Iowa law. On July 6, the Internal Revenue Service “determined that [we’re] exempt from federal income tax under Internal Revenue Code Section 501(c)(3).”

Why does that matter?

1. It means that all contributions to the Observer are now tax-deductible. We’ve always taken a moment to send hand-written thanks to folks for their support; going forward, we’ll include a card for their tax records.
2. It means that any contribution made on or after May 27, 2015 is retroactively tax deductible. After this issue is live and we’ve handled the monthly cleanup chores, we’ll begin sending the appropriate documents to the folks involved.
3. It means we’re finding ways to become a long-term source of commentary and analysis.

It’s no secret that the Observer’s annual operating budget is roughly equivalent to what some … hmmmm, larger entities in the field spend on paperclips. That works as long as highly talented individuals work pro bono (technically pro bono publico, literally, “for the public good”). As we turn more frequently to outsiders, whether for access to fund data or programming services, we’ll need to strengthen our finances. These changes are part of that effort.

Other changes in the media environment lead us to conclude that there’s an increasingly important role for an independent, authoritative public voice speaking for (and to) smaller investors and smaller fund firms. At the June Morningstar conference, there was quiet, nervous conversation about the prospect that The Wall Street Journal staff had been forced to re-apply for their own jobs. The editors of the Journal announced, in June, a plan to reduce personal finance coverage in the paper:

We will be scaling back significantly our personal finance team, though we will continue to provide high quality reporting and commentary on topics of personal financial interest to our readers.

These closures and realignments do not reflect on the quality of the work done by these teams but simply speak to the pressing need to become more focused as a newsroom on areas we believe are ripe for growth.

We will be better-equipped and better able to exploit the opportunities that exist in the fastest growing parts of our business: with enhanced and improved coverage of the news that we know translates into additional circulation and long-term growth. 

Details of the restructuring emerged in July. At base, resources are being moved from serving individual investors to serving financial advisors. While that’s good for the Journal’s profits and might be good for the 300,000 or so financial advisers in the country (a number that’s dropping steadily), it represents a further shift from serious service to the rest of us. (Thanks to Ari Weinberg for leading us to good coverage of these changes.)

Being a non-profit makes sense for us. It allows us to maintain our independence and focus (a nonprofit corporation is legally owned by all the people of a state and chartered to serve the public interest).

The Observer has always tried to act responsibly and our new legal status reflects that commitment. In addition to that whole “giving voice to the voiceless” thing, we consciously try to act as good stewards. By way of examples:

We work hard to minimize the stress we place on the planet and its systems. We travel very little and, when we do, we purchase carbon offsets through Carbonfund. Carbonfund allows individuals or businesses to calculate the amount of carbon released by their activities and to offset them with investments in a variety of climate-friendly projects from building renewable power systems to recapturing the methane produced in landfills and helping farmers control the effects of animal containment facilities. They’re a non-profit, seem to generate consistently high ratings from folks who assess their operations and write sensibly. In general, we tend to be carbon-negative.

The Observer is hosted by GreenGeeks. They host over 300,000 sites and are distinguished for the environmental commitment. They promise “if we pull 1X of power from the grid we purchase enough wind energy credits to put back into the grid 3X of power having been produced by wind power. Your website hosted with GreenGeeks will be powered by 300% wind energy, making your website’s carbon footprint negative.”

We think of food banks as something folks need mid-winter, which misses the fact that many children receive their only hot meal of the day (sometimes, only meal of the day) as part of their school’s breakfast and lunch programs. That’s led some charities to characterize summer as “the hungriest time of the year” for children. There’s a really worthy federal summer meals program, but it only reaches 15% of the kids who are fed during the regular school year.

We use the same approach here as we do in investing: make a commitment and automate it. On the last day of every month, there’s an automatic transfer from our checking to the River Bend FoodBank. It’s a good group that spends under 3% on administration. Our contribution is not major – enough to provide 150 meals for hungry families – but it’s the sort of absolutely steady inflow that allows an organization to help folks and do a meaningful planning.

All of which is, by the way, exciting and terrifying.

If you’d like to support the Mutual Fund Observer, you have two options:

1. To make a tax deductible contribution, please use our PayPal button on the right, or visit our Support Us page for our address to mail a check. You’ll receive a thank you with a receipt for your tax records.
2. We also strongly encourage everyone who shops at Amazon, now America’s largest retailer (take that Walmart!), to bookmark our Amazon link. Every time you buy anything at Amazon, using our link, we get a small percentage of the sale, and it costs you nothing.

Finding a family’s first fund

I suspect that very few of our readers need advice on selecting a “first fund.” But I’m very certain that you know people who are, or should be, starting their first investment account. Our faithful research associate David Welsch is starting down that road: first “real” job, the prospect of his first modest apartment and the need for starting to put money aside. The contractor who did a splendid job rebuilding my rotted deck admitted that up until now he’s had to spend everything he’s made to support his family and company, but now is in a place to start (just start) thinking about the future. A friend had a passing conversation with a grocery cashier (we’re in the Midwest, this sort of stuff happens a lot) who was saddened by an elderly friend struggling with money in his 70s; my friend suggested that the young lady ought to begin a small account for her own sake. “I know,” she sighed, “I knooow.” For the young men and women serving in the armed forces and making $20,000-30,000 a year, the challenge is just as great.

Mostly they think it’s hard, don’t know where to start, don’t know who to ask and can’t imagine it will make a difference. And you’re feeling a bit guilty because you haven’t been as much help as you’d like.

Here’s what to do. Read the article below. Print it out (we’ve even created a nice .pdf of it for you). Hand it to a young friend with the simple promise, “this will make it easy to get started.”

“The journey of a thousand miles begins …

with one step.” Lao-Tzu.

Good news: you’re ready to take that step and we’re here to help make it happen. We’re going to guide you through the process of setting up your first investment account. There are only two things you need to know:

It’s easy and

It will make a big difference. You’ll be glad you did it.

It’s easy. A mutual fund is simply a way of sharing with others in the costs of hiring a professional to make investments on your behalf. Mostly your manager will invest in either stocks or bonds. Stocks give you part-ownership in a company (Apple, Google, Ford); if the value of the company rises, the value of your shares will rise too. Some companies will soar; others will crash so it’s wiser for investors to invest broadly in a bunch of companies than to try to find individual winners. Bonds are ways for governments or companies to borrow money and pay it back, with interest, over time. “Iffy” borrowers have to pay a bit more in interest, so you earn a bit more on loans to them; high quality borrowers pay you a bit less but you can be pretty sure that they’ll repay their borrowings promptly and fully.

Over very long periods, stocks make more money than bonds but, over shorter periods, stocks can lose a lot more money than bonds.  Your best path is to own some of each, rather than betting entirely on one or the other. If you look back over the last 65 years, you can see the pattern: stocks provide the most long-term gain but also the greatest short-term pain.

How do you read the table? As you double your exposure to stocks, going from 40% to 80%, you add 2.4% to your average annual return. That’s good, though the gain is not huge. At the same time, you increase by 30% the chance of finishing a year in the red and you triple the size of the loss you might expect.  

We searched through about 7000 mutual funds on your behalf, looking for really good first funds. We looked for four virtues:

• They can handle stormy weather. All investments rise and fall; we found ones that won’t fall far and long.
• They can handle sunny weather. Over time, things get better. The world’s economy grows, people have better lives and the world’s a richer place. We found funds that earned good returns over time so you could benefit from that growth.
• They don’t overcharge you. Your mutual fund is a business with bills to pay; as a shareholder in the fund you help pay those bills. Paying under 1% a year is reasonable. While 1% doesn’t seem like a lot, if your fund only makes 6% gains, you’d be returning 17% of those profits to the manager.
• They require only a small investment to get started. As low as $50 a month seemed within reach of folks who were determined to get started.

Getting the account set up requires about 20 minutes, a two page form and knowing your checking account numbers.

It will make a difference. How much can $50 a month get you? In one year, not so much. Over time, a surprising lot. Here’s how much your account might grow using three pretty conservative rates of return (5-7% per year) and four holding periods.

You read that correctly: if you’re a young investor able to put $50 a month away between now and retirement, just that contribution might translate to $100,000 or more.

Two things to remember: (1) Patience is your ally. Markets can be scary; sometimes they’re going down and you think they’ll never go up again. But they do. Always have. Here’s how to win: set up your account with a small automatic monthly investment, check in on it every year or so, add a bit more as your finances improve and go enjoy your life. (2) Small things add up over time. In the example above, if your fund pays you just 1% more it makes a 30% difference in how much you’ll have over the long term. Buying a fund with low expenses can make that 1% difference all by itself, and so can a small increase in the percentage of your account invested in stocks.

Three funds to consider. The August 2015 issue of Mutual Fund Observer, available free on-line, provides a more complete discussion of each of these funds. In addition to our own explanation of them, we’ve provided links to the form you’d need to complete to open an account, the most recent fact sheet provided by the fund company (it’s a two page “highlights of our fund” document) and a link to the fund’s homepage.

James Balanced: Golden Rainbow (ticker symbol: GLRBX). The fund invests about half of its money in stocks and half in bonds, though the managers have the ability to become much more cautious or much more daring if the situation calls for it. Mostly they’ve been cautious, successful investors; they’ve made about 6.9% per year over the past decade, with less risk than their peers. During the very bad period in 2008, the stock market fell about 40% while Golden Rainbow lost less than 6%. The fund’s operating expenses average 1.01% per year, which is low. Starting an account requires a monthly investment of $500 or a one-time investment of $2,000.

Why consider it? Very low starting investment, very cautious managers, very solid returns.

TIAA-CREF Lifestyle Conservative (TSCLX). TIAA-CREF’s traditional business has been providing low cost, conservatively managed investment accounts for people working at hospitals, universities and other non-profit organizations.  Today they manage about $630 billion for investors. The Lifestyle Conservative Fund invests about 40% of its money in stocks and 60% in bonds. It does that by investing in other TIAA-CREF mutual funds that specialize in different parts of the stock or bond market. This fund has only been around for four years but most of the funds in which it invests have long, solid records. The fund’s operating expenses average 0.87% per year, well below average. Starting an account requires a monthly investment of $100 or a one-time investment of $2,500.

Why consider it? The most conservative stock-bond mix in the group, solid lineup of funds it invests in, low expenses and a rock-solid advisor.

Vanguard STAR (VGSTX). Vanguard has a unique corporate structure; it’s owned by the shareholders in its funds. As a result, it has been famous for keeping its expenses amazingly low and its standards consistently high. They now manage over $3 trillion, which represents a powerful vote of confidence on the part of millions of investors. STAR is designed to be Vanguard’s first fund for beginning investors. STAR invests about 60% of its money in stocks and 40% in bonds. It does that by investing in other Vanguard funds. Over the past 10 years, it has earned about 6.8% per year and it lost 25% in 2008. The fund’s operating expenses are 0.34% per year, which is very low. Starting an account requires a one-time investment of $1,000.

Why consider it? The lowest expenses in the group, one-stop access to many of the best funds offered by the firm many consider the best in the world.

We’re targeting funds for you whose portfolios are somewhere around 40-60% stocks. Why so cautious? You might be thinking, “hey, these are Old People funds! I’m young. I’ve got time.  I want to invest in stocks, exciting 3D printing stocks!” Owning too many stocks is bad for your financial health. Imagine that you were really good, invested steadily and built a $10,000 portfolio. How would you feel if someone broke in, stole $5,000 from it and the police said that they thought it might take five to ten years to solve the crime and get your money back? In the meantime, you were out of luck. That’s essentially what happens from time to time in the stock market and it’s really discouraging. Those 3D printing stocks that seem so exciting? They’ve lost two-thirds of their value in the past year, many will never recover.

If you balance your portfolio, you get much better odds of success. Remember Table One, which gives you the tradeoff?  Balancing gives you a really good bargain, especially for the first step in your journey.

So what’s the next step? It’s easy. Pick the one that makes the most sense to you. Take 20 minutes to fill out a short account set-up form online. Tell them if you want to start by investing a little money or a lot. Fill it out, choose the option that says “reinvest my gains, please!” and go back to doing the stuff you really enjoy.

Two bits of follow-up for our regular readers. You might ask, why didn’t we tell folks to start with a six-month emergency fund? Two reasons. First, they are many good personal finance steps folks need to take: build a savings account, avoid eating out frequently, pay down high interest rate credit card debt and all. Since we’re not personal finance specialists, we decided to start where we could add value. Second, a conservative fund can act as a supplement to a savings account; if you’ve got a conservative $5,000 that will still hold $4,000-4,500 at the trough of a bear does provide emergency backup. In my own portfolio, I use T. Rowe Price Spectrum Income (RPSIX) and RiverPark Short-Term High Yield (RPHYX, closed) as my cash-management accounts. Both can lose money but both thump CDs and other “safe” choices most years while posting manageable losses in the worst of times.

Second, there may be other funds out there which would fit our parameters and provide a more-attractive profile than one of the three we’ve highlighted. If so, let us know at [email protected]! I’d love to follow-up next month with suggestions for other ways to help young folks who have neither the confidence nor the awareness to seek out a fully qualified financial advisor. One odd side-note: there are several “Retirement Income” funds with really good profiles; I didn’t mention them because I figured that 99% of young folks would reject them just for the name alone.

Where else might small investors turn for a second or third fund?

Once upon a time, the fund industry had faith in the discipline of average investors so they offered lots of funds with minuscule initial investments. The hope was that folks would develop the discipline of investing regularly on their own.

Oops. Not even I can manage that feat. As the industry quickly and painfully learned, if it’s not on auto-pilot, it’s not getting funded.

That’s a real loss, even if a self-inflicted one, for small investors.  Nonetheless, there remain about 130 funds accessible to folks with modest budgets and the willingness to make a serious commitment to improving their finances.  By my best reading, there are thirteen smaller fund families still taking the risk of getting stiffed by undisciplined investors.  The families willing to waive their normal investment minimums are:

Potpourri

by Edward A. Studzinski

Some men are born mediocre, some men achieve mediocrity, and some men have mediocrity thrust upon them.

       Joseph Heller

We are now at the seven month mark. All would not appear to be well in the investing world. But before I head off on that tangent, there are some housekeeping matters to address.

First, at the beginning of the year I suggested that the average family unit should own no more than ten mutual funds, which would cover both individual and retirement assets. When my long-suffering spouse read that, the question she asked was how many we had. I stopped counting when I got to twenty-five, and told her the results of my search. I was then told that if I was going to tell others they should have ten or less per family unit, we should follow suit. I am happy to report that the number is now down to seventeen (exclusive of money market funds), and I am aiming to hit that ten number by year-end.

Obviously, tax consequences play a big role in this process of consolidation. One, there are tax consequences you can control, in terms of whether your ownership is long-term or short-term, and when to sell. Two, there are tax consequences you can’t control, which are tied in an actively-managed fund, to the decision by the portfolio manager to take some gains and losses in an effort to manage the fund in a tax-efficient manner. At least that is what I hope they are doing. There are other tax consequences you cannot control when the fund in question’s performance is bad, leading to a wave of redemptions. The wave of redemptions then leads to forced selling of equity positions, either en masse or on a pro rata basis, which then triggers tax issues (hopefully gains but sometimes not). The problem with these unintended or unplanned for tax consequences, is that in non-retirement accounts, you are often faced with a tax bill that you have not planned for at filing time, and need to come up with a check to pay the taxes due. A very different way to control the tax consequences, especially if you are of a certain age, is to own passive index funds, whose portfolios won’t change except for those issues going into or leaving the index. Turnover and hence capital gains distributions, tend to be minimized. And since they do tend to own everything as it were, you will pick up some of the benefit of merger and acquisition activity. However, index funds are not immune to an investor panic, which leads to forced selling which again triggers tax consequences.

In this consolidation process, one of the issues I am wrestling with is what to do with money market funds, given that later this year unless something changes again, they will be allowed to “break the buck” or no longer have a constant $1 share price. My inclination is to say that cash reserves for individuals should go back into bank certificates of deposit, up to the maximum amounts of the FDIC insurance. That will work until or unless, like Europe, the government through the banks decides to start charging a negative interest rate on bank deposits. The other issue I am wrestling with is the category of balanced funds, where I am increasingly concerned that the three usual asset classes of equities, fixed income, and cash, will not necessarily work in a complementary manner to reduce risk. The counter argument to that of course, is that most people investing in a balanced (or equity fund for that matter) investment, do not have a sufficiently long time horizon, ten years perhaps being the minimum commitment. If you look at recent history, it is extraordinary how many ten year returns both for equity funds and balanced funds, tend to cluster around the 8% annualized mark.

Morningstar, revisited:

One of the more interesting lunch meetings I had around the Morningstar conference that I did not attend, was with a Seattle-based father-son team with an outstanding record to date in their fund. One of the major research tools used was, shock of shock, the Value Line. But that should not surprise people. Many of Buffet’s own personal investments were, as he relates it, arrived at by thumbing through things like a handbook of Korean stocks. I have used a similar handbook to look at Japanese stocks. One needs to understand that in many respects, the purpose of hordes of analysts, producing detailed models and exhaustive reports is to provide the cover of the appearance of adequate due diligence. Years ago, when I was back in the trust investment world, I used to have various services for sale by the big trust banks (think New York and Philadelphia) presented to me as necessary. Not necessary to arrive at good investment decisions, but necessary to have as file drawer stuffers when the regulators came to examine why a particular equity issue had been added to the approved list. Now of course with Regulation FD, rather than individual access to managements and the danger of selective disclosure of material information, we have big and medium sized companies putting on analyst days, where all investors – buy side, sell side, and retail, get access to the same information at the same time, and what they make of it is up to them.

So how does one improve the decision making process, or rather, get an investment edge? The answer is, it depends on the industry and what you are defining as your circle of competency. Let’s assume for the moment it is property and casualty reinsurance. I would submit that one would want to make a point of attending the industry meetings, held annually, in Monte Carlo and Baden-Baden. If you have even the most rudimentary of social skills, you will come away from those events with a good idea as to how pricing (rate on line) is going to be set for categories of business and renewals. You will get an idea as to whose underwriting is conservative and whose is not. And you will get an idea as to who is under-reserved for prior events and who is not. You will also get a sense as to how a particular executive is perceived.

Is this the basis for an investment decision alone? No, but in the insurance business, which is a business of estimates to begin with, the two most critical variables are the intelligence and integrity of management (which comes down from the top). What about those wonderfully complex models, forecasting interest rates, pricing, catastrophic events leading to loss ratios and the like? It strikes me that fewer and fewer people have taken sciences in high school or college, where they have learned about the Law of Significant Numbers. Or put another way, perhaps appropriately cynical, garbage in/garbage out.

Now, many of you are sitting there thinking that it really cannot be this simple. And I will tell you that the finest investment analyst I have ever met, a contemporary of mine, when he was acting as an analyst, used to do up his research ideas by hand, on one or one and a half sheets of 8 ½ by 11 paper.

There would be a one or two sentence description of the company and lines of business, a simple income statement going out maybe two years beyond this year, several bullet points as to what the investment case was, with what could go right (and sometimes what could go wrong), and that was generally it, except for perhaps a concluding “Reasons to Own. AND HIS RETURNS WERE SPECTACULAR FOR HIS IDEAS! People often disbelieve me when I tell them that, so luckily I have saved one of those write-ups. My point is this – the best ideas are often the simplest ideas, capable of being presented and explained in one or two declarative sentences.

What’s coming?

And finally, for a drop of my usual enthusiasm for the glass half empty. There is a lot of strange stuff going on in the world at the moment, much of it not going according to plan, for governments, central banks, and corporations as one expected in January. Commodity prices are collapsing. Interest rates look to go up in this country, perhaps sooner rather than later. China may or may not have lost control of its markets, which would not augur well for the rest of us. I will leave you with something else to ponder. The “dot.com” crash in 2000 and the financial crisis of 2007-2008-2009 were water-torture events. Most of the people running money now were around for them, and it represents their experiential reference point. The October 1987 crash was a very different animal – you came in one day, and things just headed down and did not stop. Derivatives did not work, portfolio insurance did not work, and there was no liquidity as everyone panicked and tried to go through the door at once. Very few people who went through that experience are still actively running money. I bring this up, because I worry that the next event (and there will be one), will not necessarily be like the last two, where one had time to get out in orderly fashion. That is why I keep emphasizing – do not put at risk more than you can afford to lose without impacting your standard of living. Investors, whether professional or individual, need to guard mentally against always being prepared to fight the last war.

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, searchable, and filtered as never before. For the 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

• A new excessive-fee lawsuit targets five State Farm LifePath target-date funds. Complaint: “The nature and quality of Defendant’s services to the LifePath Funds in exchange for close to half of the net management fee are extremely limited. Indeed, it is difficult to determine what management services, if any, [State Farm] provides to the LifePath Funds, since virtually all of the investment management functions of the LifePath Funds are delegated” to an unaffiliated sub-adviser. (Ingenhutt v. State Farm Inv. Mgmt. Corp.)

Orders

• A court gave its final approval to the $27.5 million settlement of an ERISA class action that had challenged the selection of proprietary Columbia and RiverSource funds for Ameriprise retirement accounts. (Krueger v. Ameriprise Fin., Inc.)
• In a decision on motion to dismiss, a court allowed a plaintiff to add new Morgan Keegan defendants to previously allowed Securities Act claims regarding four closed-end funds, rejecting the new defendants’ statute-of-limitations argument. (Small v. RMK High Income Fund, Inc.)
• Further extending the fund industry’s losing streak, a court allowed excessive-fee allegations regarding five SEI funds to proceed past motion to dismiss: “While the allegations in the Amended Complaint may well not survive summary judgment, they are sufficient to survive the motion-to-dismiss stage.” (Curd v. SEI Invs. Mgmt. Corp.)
• A court mostly denied the motion by Sterling Capital to dismiss a fraud lawsuit filed by its affiliated bank’s customer. (Bowers v. Branch Banking & Trust Co.)
• A court consolidated excessive-fee litigation regarding the Voya Global Real Estate Fund. (In re Voya Global Real Estate Fund S’holder Litig.)

Briefs

• Parties filed their oppositions to dueling motions for summary judgment in fee litigation regarding eight Hartford mutual funds. Plaintiffs’ section 36(b) claims, first filed in 2011, previously survived Hartford’s motion to dismiss. The summary judgment papers are unavailable on PACER. (Kasilag v. Hartford Inv. Fin. Servs. LLC; Kasilag v. Hartford Funds Mgmt. Co.)

The Alt Perspective: Commentary and news from DailyAlts.

Despite being the summer, there was no slowdown in activity around liquid alternatives in July. Seven new alternative mutual funds and ETFs came to market, bringing the year to date total to 79. And in addition to the new fund launches, private equity titans Apollo and Carlyle both announced plans to launch alternative mutual funds later this year. For Carlyle, this is their second time to the dance and this time they have picked TCW as their partner. Carlyle purchased a majority interest in TCW early 2013 and will wisely be leveraging the firm’s distribution into the retail market. In a similar vein, Apollo has partnered with Ivy and will look to Ivy for distribution leadership.

Apollo and Carlyle’s plans follow on the heals of KKR’s partnership with Altegris for the launch of a private equity offering for the “mass affluent” earlier this year, and Blackstone’s partnership with Columbia on a multi-alternative fund, also announced earlier this year. Distribution is key, and the private equity shops are starting to figure that out.

Asset Flows

Asset flows into liquid alternative funds (mutual funds and ETFs combined) continued on their positive streak for the sixth consecutive month, with total flows in June of more than $2.2 billion according to Morningstar’s June 2015 U.S. Asset Flows Update report.

For the fifth consecutive month, multi-alternative funds have dominated inflows into liquid alternatives as investors look for a one-stop shop for their alternatives allocation. Both long/short equity and market neutral have experienced outflows every month in 2015, while non-traditional bonds has had outflows in 5 of 6 months this year. Quite a change from 2014 when both long/short equity and non-traditional bonds ruled the roost.

Twelve month flows look fairly consistent with June’s flows with multi-alternative and managed futures funds leading the way, and long/short equity, market neutral and non-traditional bonds seeing the largest outflows.

Trends and Research

There were several worthwhile publications distributed in July that provide more depth to the liquid alts conversation. The firsts is the annual Morningstar / Barron’s survey of financial advisors, which notes that advisors are more inclined to allocate to liquid alternatives than they were last year. A summary of the results can be found here: Morningstar and Barron’s Release National Alternatives Survey Results.

In addition to the survey, both Morgan Stanley and Goldman Sachs published research papers on liquid alternatives. Both papers are designed to help investors better understand the category of investments and how to use them in a portfolio:

• Morgan Stanley Publishes Liquid Alts Investment Primer
• Goldman Sachs: Viewing Liquid Alternatives Through a Hedge Fund Lens

Educational Videos

Finally, we published a series of video interviews with several portfolio managers of leading alternative mutual funds, as well as a three part series with Keith Black, Managing Director of Exams and Curriculum of the CAIA Association. All of the videos can be viewed here: DailyAlts Videos. More will be on the way over the next couple weeks, so check back periodically.

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.

This month’s profiles are unusual, in that they’re linked to our story on “first funds.” Two of the three are much larger and older than we normally cover, but they make a strong case for themselves.

James Balanced: Golden Rainbow (GLRBX). The fund invests about half of its money in stocks and half in bonds, though the managers have the ability to become much more cautious or much more daring if the situation calls for it. Mostly they’ve been cautious. Their professed goal is “to seek to grow our clients’ assets…while stressing the preservation of principal, and the reduction of risk.” With a loss of just 6% in 2008, they seem to be managing that balance quite well. FYI, this profile was written by our colleague Charles Boccadoro and is substantially more data-rich than most.

TIAA-CREF Lifestyle Conservative (TSCLX). TIAA-CREF’s traditional business has been providing low cost, conservatively managed investment accounts for people working at hospitals, universities and other non-profit organizations.  Lifestyle Conservative is a fund-of-funds with about 40% of its money in stocks and 60% in bonds. They’ve got a short track record, but substantially below-average expenses and a solid lineup of funds in which to invest.

Vanguard STAR (VGSTX). STAR is designed to be Vanguard’s first fund for beginning investors. It invests only in Vanguard’s actively-managed funds, with a portfolio that’s about 60% of its money in stocks and 40% in bonds. The fund’s operating expenses are 0.34% per year, which is very low. The combination of Vanguard + low minimum has always had it on my short-list of funds for new investors.

We delayed publication of July’s fund profile while we finished some due diligence. Sorry ‘bout that but we’d rather get the facts right than rush to print.

Eventide Healthcare & Life Sciences (ETNHX): Morningstar’s 2015 conference included a laudatory panel celebrating “up and coming” funds, including the five star, $2 billion Eventide Gilead. And yet as I talked with the Eventide professionals the talk kept returning to the fund that has them more excited, Healthcare & Life Sciences. The fund’s combination of a strong record with a uniquely qualified manager compels a closer look.

Launch Alert

Triad Small Cap Value Fund (TSCVX) launched on June 29, 2015. Triad promises a concentrated but conservative take on small cap investing.

The fund is managed by John Heldman and David Hutchison, both of Triad Investment Management. The guys both have experience managing money for larger firms, including Bank of America, Deutsche Bank and Neuberger Berman. They learned from the experience, but one of the things they learned was that “we’d had enough of working for larger firms … having our own shop means we have a much more flexible organization and we’ll be able do what’s right for our investors.” Triad manages about $130 million for investors, mostly through separate accounts.

The Adviser analyzes corporate financial statements, management presentations, specialized research publications, and general news sources specifically focused on three primary aspects of each company: the degree of business competitive strength, whether management is capable and co-invested in the business, and the Adviser’s assessment of the attractiveness of a security’s valuation.

The guys approach is similar to Bernie Horn and the Polaris team: invest only where you think you can meaningfully project a firm’s future, look for management that makes smart capital allocation decisions, make conservative assumptions and demand a 50% discount to fair value.

That discipline means that some good companies are not good investments. Firms in technology and biotech, for example, are subject to such abrupt disruption of their business models that it’s impossible to have confidence in a three to five year projection. Other fundamentally attractive firms have simply been bid too high to provide any margin of safety.

They’re looking for 30-45 names in the portfolio, most of which they’ve followed for years. The tiny fund and the larger private strategy are both fully invested now despite repeated market highs. While they agree that “there aren’t hundreds of great opportunities, not a huge amount at all,” the small cap universe is so large that they’re still finding attractive opportunities.

The minimum initial purchase is $5,000. The opening expense ratio is 1.5% with a 2.0% redemption fee on shares held under 90 days.

The fund’s website is still pretty rudimentary but there’s a good discussion of their Small Cap Equity strategy available on the advisor’s site. For reasons unclear, Mornignstar’s profile of the fund aims you to the homepage of the Wireless Fund (WIREX). Don’t go there, it won’t help.

Funds in Registration

There are 17 new funds in registration this month. Funds in registration with the SEC are not available for sale to the public and the advisors are not permitted to talk about them, but a careful reading of the filed prospectuses gives you a good idea of what interesting (and occasionally appalling) options are in the pipeline. Funds currently in registration will generally be available for purchase right around the end of September, which would allow the new funds to still report a full quarter’s worth of results in 2015.

The most important new registrations are a series of alternatives funds about to be launched by TCW. They’ve partnered with several distinguished sub-advisers, including our friends at Gargoyle who, at our first reading of the filings, are offered the best options including both Gargoyle Hedged Value and, separately, the unhedged Gargoyle long portfolio as a free-standing fund.

Manager Changes

There are 45 manager changes, at least if you don’t mind a bit of cheating on our part. Wyatt Lee’s arrival as co-manager marginally affected all the funds in the T. Rowe Price retirement series but we called that just one change. None are game-changers.

Updates

The Board at LS Opportunity Fund (LSOFX) just announced their interim plan for dealing with the departure of the fund’s adviser. Jim Hillary of Independence Capital Asset Partners and formerly of Marsico Capital, LLC ran LSOFX side-by-side with his ICAP hedge fund from 2010-2015. It’s been an above-average performer, though not a stunning one. DailyAlts reports that Mr. Hillary has decided to retire and return the hedge fund’s assets to its investors. The LS Board appointed Prospector Partners LLC to sub-advise the fund for now; come fall, they’ll ask shareholders for authority to add sub-advisors.

The Prospector folks come with excellent credentials but a spotty record. The managers have a lot of experience managing funds for White Mountains Insurance, T. Rowe Price (both Capital Appreciation and Growth Stock) and Neuberger Berman (Genesis). Prospector Capital Appreciation (PCAFX) was positioned as a nimbler version of T. Rowe Price Capital Appreciation (PRWCX), run by Cap App’s long-time manager. The fund did well during the meltdown but has trailed 99% of its peers since. Prospector Opportunity (POPFX) has done better, also by limiting losses in down markets at the price of losing some of the upside in rising ones.

The Board of Trustees has approved a change Zeo Strategic Income’s investment objective. Right now the fund seeks “income and moderate capital appreciation.” Effective August 31, 2015, the Fund’s investment objective will be to seek “low volatility and absolute returns consisting of income and moderate capital appreciation.” From our conversations with the folks at Zeo, that’s not a change; it’s an editorial clarification and a symbolic affirmation of their core values.

Briefly Noted . . .

Effective August 1, Value Line is imposing a 0.40% 12(b)1 fee on a fund that hasn’t been launched yet (Centurion) but then offers a 0.13% 12(b)1 waiver for a net 12(b)1 fee of 0.27%. Why? At the same time, they’ve dropped fees on their Core Bond Fund (VAGIX) by two basis points (woo hoo!). Why? Because the change drops them below the 1.0% expense threshold (to 0.99%), which might increase the number of preliminary fund screens they pass. Hard to know whether that will help: over the five years under its current management, the fund has been a lot more volatile (bigger maximum drawdown but much faster recovery) and more profitable than its peers; the question is whether, in uncertain times, investors will buy that combo – even after the generous cost reduction.

Thanks, as always, to The Shadow’s irreplaceable assistance on tracking down the following changes!

SMALL WINS FOR INVESTORS

Effective August 1, 2015, Aspiriant Risk-Managed Global Equity Fund’s (RMEAX) investment advisory fee will be reduced from 0.75% to 0.60%.

CLOSINGS (and related inconveniences)

Invesco International Growth Fund (AIIEX) will close to new investors on October 1, 2015. Nothing says “we’re serious” quite like offering a two-month window for hot money investors to join the fund. The $9 billion fund tends to be a top-tier performer when the market is falling and just okay otherwise.

Tweedy, Browne Global Value Fund II (TBCUX) has closed to new investors. Global Value II is the sibling to Global Value (TBGVX). The difference between them is that Global Value hedges its currency exposure and Global Value II does not. I don’t anticipate an extended closure. Global II has only a half billion in assets, against $9.3 billion in Global, so neither the size of the portfolio nor capacity constraints can explain the closure. A likelier explanation is the need to manage a large anticipated inflow or outflow caused, conceivably, by gaining or losing a single large institutional client.

OLD WINE, NEW BOTTLES

Effective July 9, 2015, the 3D Printing and Technology Fund (TDPNX) becomes the 3D Printing, Robotics and Technology Fund. The fact that General Electric is the fund’s #6 holding signals the essential problem: there simply aren’t enough companies whose earnings are driven by 3D printing or robotics to populate a portfolio, so firms where such earnings are marginal get drawn in.

Effective September 9, 2015, Alpine Accelerating Dividend Fund (AAADX) is getting renamed Alpine Rising Dividend Fund. The prospectus will no longer target “accelerating dividends” as an investment criterion. It’s simultaneously fuzzier and clearer on the issue of portfolio turnover: it no longer refers to the prospect of 150% annual turnover (the new language is “higher turnover”) but is clear that the strategy increases transaction costs and taxable short-term gains.

Calvert Tax-Free Bond Fund (CTTLX) has become Calvert Tax-Free Responsible Impact Bond Fund. “Impact investing” generally refers to the practice of buying the securities of socially desirable enterprises, for example urban redevelopment administrations, as a way of fostering their mission. At the start of September, Calvert Large Cap Value (CLVAX) morphs into Calvert Global Value Fund. The globalization theme continues with the change of Calvert Equity Income Fund (CEIAX) to Calvert Global Equity Income Fund. Strategy tweaks follow.

On September 22, 2015, Castlerigg Equity Event and Arbitrage Fund (EVNTX) becomes Castlerigg Event Driven and Arbitrage Fund. In addition to the name change, Castlerigg made what appear to be mostly editorial changes to the statement of investment strategies. It’s not immediately clear that either will address this:

Eaton Vance Small-Cap Value Fund has been renamed Eaton Vance Global Small-Cap Fund (EAVSX). Less value, more global. The fund trails more than 80% of its peers over pretty much every trailing measurement period. They’ve added Aidan M. Farrell as a co-manager. Good news: he’s managed Goldman Sachs International Small Cap (GISSX). Bad news: it’s not very good, either.

Effective July 13, 2015 Innovator Matrix Income® Fund became Innovator McKinley Income Fund (IMIFX), with the appointment of a new sub-advisor, McKinley Capital Management, LLC. The fund’s strategy was to harvest income primarily from high income securities which included master limited partnerships and REITs. The “income” part worked and the fund yields north of 10%. The “put the vast majority of your money into energy and real estate” has played out less spectacularly. The new managers bring a new quantitative model and modest changes in the investment strategy, but the core remains “income from equities.”

OFF TO THE DUSTBIN OF HISTORY

Effective October 23, 2015, Alpine Equity Income Fund (the “Fund”) and Alpine Transformations Fund (the “Fund”) will both be absorbed by Alpine Accelerating Dividend Fund. At the same time Alpine Cyclical Advantage Property Fund (the “Fund”) disappears into Alpine Global Infrastructure Fund (the “Acquiring Fund”).

Fidelity Fifty merged into Fidelity Focused Stock Fund (FTQGX) on July 24, 2015, just in case you missed it.

Forward is liquidating their U.S. Government Money Fund by the end of August.

MassMutual Select Small Company Growth Fund will be liquidated by September 28, 2015.

Neuberger Berman Global Thematic Opportunities Fund will disappear around August 21, 2015.

RiverNorth Managed Volatility Fund (RNBWX) is scheduled for a quick exit, on August 7, 2015.

The $1.2 million Stone Toro Long/Short Fund (STVHX) will be liquidated on or about August 19, 2015 following the manager’s resignation from the advisor.

UBS Equity Long-Short Multi-Strategy Fund (BMNAX) takes its place in history alongside the carrier pigeon on September 24, 2015. Advisors don’t have to explain why they’re liquidating a fund. In general, either the fund sucks or nobody is buying it. No problem. I do think it’s bad practice to go out of your way to announce that you’re about to explain your rationale and then spout gibberish.

Rationale for liquidating the Fund

Based upon information provided by UBS … the Board determined that it is in the best interests of the Fund and its shareholders to liquidate and dissolve the Fund pursuant to a Plan of Liquidation. To arrive at this decision, the Board considered factors that have adversely affected, and will continue to adversely affect, the ability of the Fund to conduct its business and operations in an economically viable manner.

Our rationale is that we “considered factors that have adversely affected, and will continue to adversely affect” the fund. Why is that even worth saying? The honest statement would be “we’re in a deep hole, the fund has been losing money for the advisor for five year and even the stronger performance of the past 18 months hasn’t made a difference so we’re cutting our losses.”

In Closing . . .

In the months ahead we’ll add at least a couple new voices to the Observer’s family. Sam Lee, a principal of Severian Asset and former editor of Morningstar’s ETF Investor, would like to profile a fund for you in September. Leigh Walzer, a principal of Trapezoid LLC and a former member of Michael Price’s merry band at the Mutual Series funds, will join us in October to provide careful, sophisticated quantitative analyses of the most distinguished funds in a core investment category.

We’ve mentioned the development of a sort of second tier at the Observer, where we might be able to provide folks with access to some interesting data, Charles’s risk-sensitive fund screener and such. We’re trying to be very cautious in talking about any of those possibilities because we hate over-promising. But we’re working hard to make good stuff happen. More soon!

Our September issue will start with the following argument: it’s not time to give up on managers who insist on investing in Wall Street’s most despised creature: the high-quality, intelligently managed U.S. corporation. A defining characteristic of a high-quality corporation is the capital allocation decisions made by its leaders. High-quality firms invest intelligently, consistently, successfully, in their futures. Those are “capital expenditures” and investors have come to loathe them because investing in the future thwarts our desire to be rich, rich, rich, now, now, now. In general I loathe the editorial pages of The Wall Street Journal since they so often start with an ideologically mandated conclusion and invent the necessary supporting evidence. William Galston’s recent column, “Hillary gets it right on short-termism” (07/29/2015) is a grand exception:

Too many CEOs are making decisions based on short-term considerations, regardless of their impact on the long-run performance of their firms.

Laurence Fink is the chairman of BlackRock … expressed his concern that “in the wake of the financial crisis, many companies have shied away from investing in the future growth of their companies,” choosing instead to reduce capital expenditures in favor of higher dividends and increased stock buybacks.

His worries rest on a sound factual foundation. For the 454 companies listed continuously in the S&P 500 between 2004 and 2013, stock buybacks consumed 51% of net income and dividends an additional 35%, leaving only 14% for all other purposes.

It wasn’t always this way. As recently as 1981, buybacks constituted only 2% of the total net income of the S&P 500. But when economist William Lazonick examined the 248 firms listed continuously in this index between 1984 and 2013, he found an inexorable rise in buybacks’ share of net income: 25% in the 1984-1993 decade; 37% in 1994-2003; 47% in 2004-13. Between 2004 and 2013, some of America’s best-known corporations returned more than 100% of their income to shareholders through buybacks and dividends.

He cites a 2005 survey of CEOs, 80% of whom would cut R&D and 55% would avoid long-term capex if that’s what it took to meet their quarterly earnings expectations. We’ve been talking with folks like David Rolfe of Wedgewood, Zac Wydra of Beck, Mack and others who are taking their lumps for refusing to play along. We’ll share their argument as well as bring our modestly-delayed story on the Turner funds, Sam’s debut, and Charles’ return.

We’ll look for you.

Dear friends,

We really hope you enjoy the extra start-of-summer profundity that we’ve larded (excuse the expression) into this issue. We took advantage of the extra time afforded by the June 30^th leap second and the extra light generated that night by the once-in-two-millennia conjunction of Venus and Jupiter to squeeze in a family-sized portion of insight into this month’s issue.

And it all started with Morningstar.

Mania at the McCormick!

Morningstar’s annual investor conference is always a bit of a zoo. Two thousand people jam together in a building the size of a shopping mall, driven by a long schedule and alternating doses of caffeine (6:00 a.m. to 6:00 p.m.) and alcohol (thereafter). There are some dozens of presentations, ranging from enormously provocative to freakish, mostly by folks who have something to sell but, for the sake of decorum, are trying not to mention that fact.

Okay: the damned thing’s a lot bigger than any shopping mall except the Mall of America. MoA has about 4.2 million square feet total, McCormick is around 3.4 million. We were in the West Building, whose main ballroom alone runs to 100,000 square feet. 500,000 square feet of exhibition space, 250,000 of meeting space, with something like 60 meeting rooms. That building alone cost about $900 million, and McCormick has three others.

What follows are three sets of idiosyncratic observations: mine, Charles and Ed’s. I’ve linked to Morningstar’s video, where available. The key is that their videos auto-launch, which can be mightily annoying. Be ready for it.

Jeremy Grantham: The World Will End, You’ve Just Got to be Patient for a Bit

Grantham, one of the cofounders of GMO, a highly respected institutional investment firm originally named Grantham, Mayo, van Otterloo, is regularly caricatured as a perma-bear. He responds to the charge by asserting “I’m not a pessimist. You’re simply optimists.”

Grantham argues that we’re heading for a massive stock market crash (something on the order of a 60% fall), just not for a while yet. GMO’s study of asset bubbles found that asset prices regularly become detached from reality but they’re not subject to crashing until they exceed their normal levels by about two standard deviations.  Roughly speaking, that translates to asset prices that are higher than they are 95% of the time. Right now, we’re about 1.5 standard deviations above average. If current trends continue – and Grantham does expect stocks to follow the path of least resistance, higher – then we’ll reach the two standard deviation mark around the time of the presidential election.

Merely being wildly overvalued doesn’t automatically trigger a crash (in the UK, home prices reached a three standard deviation peak – 99.7% – before imploding) but it’s extremely rare for such a market not to find a reason to crash. And when the crash comes, the market typically falls at about twice the rate that it rose.

As an aside, Grantham also notes that no stock market crash has occurred until after average investors have been dragged into the party’s frenzied last hours, too late to make much money but just in time to have their portfolios gutted (again). While optimism, measured by various investor attitude surveys, is high, it’s not manic. Yet.

So, we’ve got a bit to savor ill-garnered gains and to reassure ourselves that this time we’ll be sharp, discerning and well on our way to safety ere the crash occurs.

Oddly, Grantham expects a crash because capitalism does work, but regulation (mostly) does not. Under capitalism, capital flows to the area of greatest opportunity: if your lemonade stand is able to draw a million in revenue today, you can be pretty much guaranteed that there will be a dozen really cool lemonade stands in your neighborhood within the week. As a result, your profit will decline. More stands will be built, and profits will continue declining, until capitalists conclude that there’s nothing special in the lemonade stand biz and they resume the search for great opportunities. Today’s record corporate profit margins must draw new competitors in to drive those excess profits down, or capitalism is failing.

Grantham argues that capitalism is failing for now. He blames the rise of “stock option culture” and a complicit U.S. fed for the problem. Up to 80% of executive compensation now flows from stock options, which are tied to short-term performance of a company’s stock rather than long-term performance of the company. People respond to the incentives they’re given, so managers tend toward those actions which increase the value of their stock options. Investing in the company is slow, uncertain and risky, and so capital expenditures (“capex”) by publicly-traded firms is falling. Buying back stock (overpriced or not) and issuing dividends is quick, clean and safe, and so that sort of financial engineering expands. Interest rates at or near zero even encourage the issuance of debt to fund buybacks (“Peter, meet Paul”). It would be possible to constrain the exercise of options, but we choose not to. And so firms are not moving capital into new ventures or into improving existing capabilities which, in the short run, continues to underwrite record profit margins.

David Marcus: We’re in the Bottom of the Third

All value investing starts with fundamentally, sometimes appallingly, screwed-up companies that have the potential to do vastly better than they’ve been doing. The question is whether anything will unleash those potential gains. That’s not automatically true; 50 to a hundred publicly-traded companies go bankrupt each year as do something like 30,000 private ones.

On whole, investors would prefer that the firms they invest in not go belly up. In the U.S., they’ve got great leverage to encourage corporate restructurings – spinoffs, mergers, acquisitions, division closures – which might serve to release that locked-up potential. We also have a culture that, for better and worse, endorses the notion of maximizing shareholder (rather than stakeholder or community) value.

Traditionally the U.S. has been one of the few places that countenanced, much less encouraged, frequent corporate dislocations. Europeans encourage a stakeholder model focused on workers’ interests and Asians have a tradition of intricately interwoven corporate interests where corporations share a web of directorships and reciprocal investments in each other.

David Marcus manages Evermore Global Value (EVGBX) and tries to do so in the spirit of his mentor, Michael Price. As one of Price’s Mutual Series managers, he specialized in “special situations” investing, a term that describes the whole array of “rotten company teetering between damnation and salvation” thing. Later, as a private investor in Europe, he saw the beginnings of a change in corporate culture; the first intimations that European managers were willing to make tentative moves toward a shareholder-focused culture. In December 2009, he launched the Evermore funds to exploit that unrecognized change.

The first three years were trying: his flagship fund lost 10% over the period and trailed 95% of its peers. When we spoke several years ago, Mr. Marcus was frustrated but patient: he likened his portfolio to a spring that’s already been compressed a lot but, instead of releasing, was getting compressed even more. In the past three years, the spring rebounded: top third relative returns, 15% annualized ones, with two stretches at the very top of the global equity heap.

Mr. Marcus’s portfolio remains Euro-centric, about 66% against his peers’ 30%, but he foresees a rotation. The 2008 financial meltdown provided an opportunity for European corporate insiders to pursue a reform agenda. International members started appearing on corporate boards, for instance, and managers were given leeway to begin reducing inefficiency. ThyssenKrupp AG, a German conglomerate, had 27 separate IT departments operating with inconsistent policies and often incompatible software. They’ve whittled that down to five and are pursuing the crazy dream of just one IT department. Such moves create a certain momentum: at first, restructuring seems impossible, then a minor restructuring frees up a billion in capital and managers begin to imagine additional work that might reap another billion and a half. As the great Everett Dirksen once reflected, “A billion here, a billion there, and pretty soon you’re talking about real money.” Mr. Marcus believes that Europeans are pursuing such reforms with greater vigor but without wasting capital “on crappy IPOs” that continue to dog the U.S. market.

A bigger change might be afoot in Asia and, in particular, in Japan. Corporate executives are, for the first time, beginning to unwind the complex web of cross-ownership which had traditionally been a one-way move: you invest in another corporation but never, ever sell your stake. Increasingly, managers see those investments as “cash cows,” the source of additional capital that might be put to better use.

Ironically, the same social forces that once held capital captive might now be working to free it. Several new Japanese stock indexes attempt to recognize firms that are good stewards of shareholder capital. The most visible is the Nikkei 400 ROE index, which tracks companies “with high appeal for investors, which meet requirements of global investment standards, such as efficient use of capital and investor-focused management perspectives.” Failure to qualify for inclusion has been deeply embarrassing for some management teams, which subsequently reoriented their capital allocations. Nomura Securities launched a competing index focusing on companies that use dormant cash to repurchase shares, though the effects of that are not yet known.

Mr. Marcus’s sense that the ground might be shifting is shared by several outstanding managers. Andrew Foster of Seafarer (SFGIX) has speculated that conditions favorable to value investing (primarily institutions that might serve as catalysts to unlock value) are evolving in the emerging markets. Messrs. Lee and Richyal at JOHCM International Select Fund (JOHAX) have directly invoked the significance of the Nikkei ROE Index in their Japan investing. Ralf Scherschmidt at Oberweis International Opportunities (OBIOX) has made a career of noticing that investors fail to react promptly to such changes; he tries to react to news promptly then wait patiently for others to begin believing that change is really. All three are five-star funds.

I’ll continue my reviews in August. For now, here are Charles’s quick takes.

Morningstar Investment Conference 2015 Notes

In contrast to the perfect pre-autumnal weather of last year’s ETF conference, Chicago was hot and muggy this past week, where some 2000 attendees gathered for Morningstar’s Investment Conference located at the massive, sprawling, and remote McCormick Place.

Morningstar does a great job of quickly publishing conference highlights and greatly facilitates press … large press room wired with high-speed internet, ample snacks and hot coffee, as well as adjacent media center where financial reporters can record fund managers and speakers then quickly post perspectives, like Chuck Jaffe’s good series of audio interviews.

On the MFO Discussion Board, David attempts to post nightly his impressions and linkster Ted relays newly published conference articles. To say the event is well covered would be a colossal understatement.

Nonetheless, some impressions for inclusion in this month’s commentary …

If you are a financial adviser not catering to women and millennials, your days are numbered.

On women. Per Sallie Krawcheck, former president of BAC’s Global Wealth division and currently chair of the Ellevate network, which is dedicated to economic engagement of women worldwide, women live six to eight years longer than men … 80% of men die married, while 80% of women die unmarried … 70% of widows leave their financial advisers within a year of their husband’s death.

While women will soon account for majority of US millionaires, most financials advisors don’t include spouses in the conversation. The issue extends to the buy side as well. In a pre-conference session entitled, “Do Women Investors Behave Differently Than Men,” panels cited that women control 51% investable wealth and currently account for 47% of high net worth individuals, yet professional women money managers account for only 5% of assets under management. How can that be?

The consequence of this lack of inclusion is “lack of diversification, higher risk, and money left on table.” Women, they state, value wealth preservation many times more than men. One panelist actually argues that women are better suited to handle the stress hormone cortisol since they need not suffer adverse consequences of interaction with testosterone.

While never said explicitly, I could not help but wonder if the message or perhaps question here is: If women played a greater role in financial institutions and at the Fed in years leading up to 2007, would we have avoided the financial or housing crises?  

On millennials. Per Joel Brukenstein of Financial Planning Magazine and creator of Technology Tools for Today website, explains that the days of financial advisors charging 1% annual fee for maintaining a client portfolios of four or five mutual funds are no longer sustainable … replaced with a proliferation of robo-advisors, like Schwab Intelligent Portfolios, which charges “no advisory fees, no account service fees, no commissions, period.”

Ditto, if your services are not available on a smart phone. Millennials are beyond internet savvy and mobile … all data/tools must be accessible via the cloud.

Mr. Brukenstein went so far as to suggest that financial advisors not offering services beyond portfolio management should consider exiting the business.

Keynote highlights. Jeremy Grantham, British-born co-founder of Boston-based asset management firm GMO, once again reiterated his belief that US stocks are 30 – 60% overvalued, still paying for overvaluation sins of our fathers … the great bull run of 1990, which started in 1987, finished in 2000, and was right on the heels of the great bull run of the 1980s. No matter that investors have suffered two 50% drawdowns the past 15 years with the S&P 500 and only received anemic returns, “it will take 25 years to get things right again.” So, 10 more years of suffering I’m afraid.

He blames Greenspan, Bernanke, and Yellen for distorting valuations, the capital markets, the zero interest rate policy … leading to artificially inflated equity prices and a stock-option culture that has resulted in making leaders of publically traded companies wealthy at the expense of capital investment, which would benefit the many. “No longer any room for city or community altruism in today’s capitalism … FDR’s social contract no more.”

All that said he does not see the equity bubble popping just yet … “no bubble peaks before abnormal buyers and deals come to market.” He predicts steady raise until perhaps coming presidential election.

Mr. Grantham is not a believer in efficient market theory. He views the cycles of equity expansion and contraction quite inefficiently driven by career risk (never be wrong on your own …), herding, momentum, extrapolation, excursions from replacement value, then finally, arbitrage and mean reversion at expense of client patience. Round and round it goes.

David Kelly, JP Morgan’s Chief Global Strategist whose quarterly “Guide To Markets” now reaches 169 thousand individuals in 25 countries, also does not see a bear market on horizon, which he believes would be triggered by one or more of these four events/conditions: recession, commodity spike, aggressive fed tightening, and/or extreme valuation. He sees none of these.

He sees current situation in Greece as a tragedy … Germany was too tough during recession. Fortunately, 80% of Greek debt is held by ECB, not Euro banks, so he sees no lasting domino effect if it defaults.

On the US economy, he sees it “not booming, but bouncing back.” Seven years into recovery, which represents the fourth longest expansion dating back to 1900. “Like a Yankees/Red Sox game … long because it is slow.”

He disputes Yellen’s position that there is slack in the economy, citing that last year 60 million people were hired … an extraordinary amount. (That is the gross number; subtract 57 million jobs left, for a net of 3 million.) The biggest threat to continued expansion is lack of labor force, given retiring baby boomers, 12.5% of population with felony convictions, scores addicted to drug, and restrictions on foreign nationals, which he calls the biggest tragedy: “We bring them in. They want to be here. We educate them. They are top of class. Then, we send them home. It’s crazy. We need immigration reform to allow skilled workers to stay.”

Like Grantham, he does see QE helping too much of the wrong thing at this point: “Fertilizer for weeds.”

On oil, which he views like potatoes – a classic commodity: “$110 is too much, but $40 is too low.” Since we have “genetically evolved to waste oil,” he believes now is good time to get in cause “prices have stabilized and will gradually go up.”

Like last fall, he continues to see EM cheap and good long term opportunity. Europe valuations ok … a mid-term opportunity.

He closed by reminding us that investors need courage during bear markets and brains during bull markets.

Breakout sessions. Wasatch’s Laura Geritz was stand-out panelist in break-out session “Are Frontier Markets Worth Pursuing?” She articulates her likes (“Active manager’s dream asset class … capital held dear by phenomenal FM management teams … investments by strong subsidiaries, like Nestle … China’s investment in FM … ”) and dislikes (“No practical index … current indices remain too correlated due to lack of diversification … lack of market liquidity …”). She views FM as strictly long-term investment proposition with lots of ups and downs, but ultimately compelling. If you have not listened to her interview with Chuck Jaffe, you should.

Another break-out session, panelists discussed the current increasing popularity of “ESG Investing.” (ESG stands for environmental, social, and governance. ESG funds, currently numbering more than 200, apply these criteria in their investments.) “Ignore increasingly at your own peril … especially given that women and millennials represent the biggest demographic on horizon.” Interestingly, data suggest such funds do just as well if not slightly better than the overall market.

Lengthening Noses

By Edward Studzinski

“A sign of celebrity is that his name is often worth more than his services.”

Daniel J. Boorstin

So the annual Morningstar Conference has come and gone again, with couple thousand attendees in town hoping to receive the benefit of some bit of investment or business wisdom. The theme of this year’s conference appears to have been that the world of investors now increasingly is populated by and belongs to “Gen X’ers” and “Millennials.” Baby Boomers such as yours truly, are a thing of the past in terms of influence as well as a group from whom assets are to be gathered. Indeed, according to my colleagues, advisors should be focused not on the current decision maker in a client family but rather the spouse (who statistically should outlive) or the children. And their process of decision making will most likely be very different than that of the patriarch. We can see that now, in terms of how they desire to communicate, which is increasingly less by the written word or in face to face meetings.

In year’s past, the conference had the flavor of being an investment conference. Now it has taken on the appearance of a marketing and asset allocation advice event. Many a person told me that they do not come to attend the conference and hear the speakers. Rather, they come because they have conveniently assembled in one place a large number of individuals that they have been interested either in meeting or catching up with. My friend Charles’ observation was that it was a conference of “suits” and “skirts” in the Exhibitors’ Hall. Unfortunately I have the benefit of these observations only second and third hand, as for the first part of the week I was in Massachusetts and did not get back to Chicago until late Wednesday evening. And while I could have made my way to events on Thursday afternoon and Friday morning, I have found it increasingly difficult to take the whole thing seriously as an investment information event (although it is obviously a tremendous cash cow for Morningstar). Given the tremendous success of the conference year in and year out, one increasingly wonders what the correct valuation metric is to be applied to Morningstar equity. Is it the Google of the investment and financial services world? Nonetheless, given the focus of many of the attendees on the highest margin opportunities in the investment business and the way to sustain an investment management franchise, I wonder if, notwithstanding how she said it, whether Senator Elizabeth Warren is correct when she says that “the game is rigged.”

Friday apparently saw two value-oriented investors in a small panel presenting and taking Q&A. One of those manages a fund with $20 Billion in assets, which is a larger amount of money than he historically has managed. Charging a 1% fee on that $20B, his firm is picking up $200 Million in revenue from that one fund alone, notwithstanding that they have other funds. Historically he has been more of a small-midcap manager, with a lot of special situations but not to worry, he’s finding lots of things to invest in, albeit with 40% or so in cash or cash equivalents. The other domestic manager runs two domestic funds as the lead manager, with slightly more than $24 Billion in assets, and for simplicity’s sake, let’s call it a blended rate of 90 basis points in fees. His firm is seeing than somewhat in excess of $216 Million in revenue from the two funds. Now let me point out that unless the assets collapse, these fees are recurring, so in five years, there has been a billion dollars in revenue generated at each firm, more than enough to purchase several yachts. The problem I have with this is it is not a serious discussion of the world we are in at present. Valuation metrics for stocks and bonds are at levels approaching if not beyond the two standard deviation warning bells. I suppose some of this is to be expected, as if is a rare manager who is going to tell you to keep your money. However, I would be hard pressed at this time if running a fund, to have it open. I am actually reminded of the situation where a friend sent me to her family’s restaurant in suburban Chicago, and her mother rattled off the specials of the evening, one of which was Bohemian style duck. I asked her to go ask the chef how the duck looked that night, and after a minute she came back and said, “Chef says the duck looks real good tonight.” At that point, one of the regulars at the bar started laughing and said, “What do you think? The chef’s going to say, oh, the duck looks like crap tonight?”

Now, if I could make a suggestion in Senator Warren’s ear, it would be that hearings should be held about what kind of compensation in the investment management field is excessive. When the dispersion between the lowest paid employee and the highest results in the highest compensated being paid two hundred times more than the lowest, it seems extreme. I suppose we will hear that not all of the compensation is compensation, but rather some reflects ownership and management responsibilities. The rub is that many times the so-called ownership interests are artificial or phantom.

It just strikes that this is an area ripe for reform, for something in the nature of an excess profits tax to be proposed. After all, nothing is really being created here that redounds to the benefit of the U.S. economy, or is creating jobs (and yes Virginia, carried interest for hedge funds as a tax advantage should also be eliminated).

We now face a world where the can increasingly looks like it cannot be kicked down the road financially for either Greece or Puerto Rico. And that doesn’t even consider the states like Illinois and Rhode Island that have serious underfunded pension issues, as well as crumbling infrastructures. So, I say again, there is a great deal of risk in the global financial system at present. One should focus, as an investor, in not putting any more at risk than one could afford to write off without compromising one’s standard of living. Low interest rates have done more harm than good, for both the U.S. economy and the global economy. And liquidity is increasingly a problem, especially in the fixed income markets but also in stocks. Be warned! Don’t be one of the investors who has caught the disease known as FOMO or “Fear of Missing Out.”

It’s finally easy being green

The most widely accepted solution to Americans’ “retirement crisis” – our lifelong refusal to forego the joy of stuff now in order to live comfortably later – is pursuing a second (or third or fifth) career after we’ve nominally retired. Some of us serve as school crossing guards, greeters, or directors of mutual fund boards, others as consultants, carpenters and writers. Honorable choices, all.

But what if you could make more money another way, by selling cigarettes directly to adolescents in poor countries?  There’s a booming market, the U.S. Chamber of Commerce is working globally to be sure that folks keep smoking, and your customers do get addicted. A couple hours a day with a stand near a large elementary school or junior high and you’re golden.

Most of us would say “no.” Many of us would say “HELL NO.” The thought of imperiling the lives and health of others to prop up our own lifestyle just feels horribly wrong.

The question at hand, then, is “if you aren’t willing to participate directly in such actions, why are you willing to participate indirectly in them through your investments?” Your decision to invest in, for example, a tobacco company lowers their cost of capital, increases their financial strength and furthers their business. There’s no real dodging the fact: you become a part-owner of the corporation, underwrite its operations and expect to be well compensated for it.

And you are doing it. In the case of Phillip Morris International (PM), for example, 30% of the firm’s stock is owned by ten investment companies:

Capital World & Capital Research are the advisors to the American Funds. Barrow sub-advises funds for, among others, Vanguard and Touchstone.

That exercise can be repeated with a bunch of variations: what role would you like to play in The Sixth Great Extinction, the impending collapse of the Antarctic ice sheet, or the incineration of young people in footwear factories? In the past, many of us defaulted to one of two simple positions: I don’t have a choice or I can’t afford to be picky.

The days when socially-responsible investing was the domain of earnest clergy and tree-hugging professors are gone. How gone?  Here’s a quick quiz to help provide context: how many dollars are invested through socially-screened investment vehicles?

1. A few hundred million
2. A few billion
3. A few tens of billions
4. A few hundred billion
5. A few trillion
6. Just enough to form a really satisfying plug with which to muffle The Trump.

The answer is “E” (though I’d give credit, on principle, for “F”). ESG-screened investments now account for about one-sixth of all of the money invested in the U.S. —over $6.5 trillion— up by 76% since 2012. In the U.S. alone there are over 200 open-end funds and ETFs which apply some variety of environmental, social and governance screens on their investors’ behalf.

There are four reasons investors might have for pursuing, or avoiding, ESG-screened investments. They are, in brief:

1. It changes my returns. The traditional fear is that by imposing screening costs and limiting one’s investable universe, SRI funds were a financial drag on your portfolio. There have been over 1200 academic and professional studies published on the financial effects, and a dozen or so studies of the studies (called meta-analyses). The uniform conclusion of both academic and professional reviews is that SRI screens do not reduce portfolio returns. There’s some thin evidence of improved performance, but I wouldn’t invest based on that.
2. It changes my risk profile. The traditional hope is that responsible firms would be less subject to “headline risk” and less frequently involved in litigation, which might make them less risky investments. At least when examining SRI indexes, that’s not the case. TIAA-CREF examined a quarter century’s worth of volatility data for five widely used indexes (Calvert Social Index, Dow Jones Sustainability U.S. Index, FTSE4Good US Index, MSCI KLD 400 Social Index, and MSCI USA IMI ESG Index) and concluded that there were no systematic differences between ESG-screened indexes and “normal” ones.
3. It allows me to foster good in the world. The logic is simple: if people refuse to invest in a company, its cost of doing business rises, its products become less economically competitive and fewer people buy them. Conversely, if you give managers access to lots of capital, their cost of capital falls and they’re able to do more of whatever you want them to do. In some instances, called “impact investing,” you actually direct your manager to put money to work for the common ground through microfinance, underwriting housing construction in economically-challenged cities and so on.
4. It’s an expression of an important social value. In its simplest form, it’s captured by the phrase “I’m not giving my money to those bastards. Period.” Some critics of SRI have made convoluted arguments in favor of giving your money to the bastards on economic grounds and then giving other money to social causes or charities. The argument for investing in line with your beliefs seems to have resonated most strongly with Millennials (those born in the last two decades of the 20^th century) and with women. Huge majorities in both groups want to align their portfolio with their desires for a better world.

Our bottom line is this: you can invest honorably without weakening your future returns. There is no longer any credible doubt about it. The real problems you face are (1) sorting through the welter of funds which might impose both positive and negative screens on a conflicting collection of 20 different issues and (2) managing your investment costs.

We’ve screened our own data to help you get started. We divided funds into two groups: ESG Stalwarts, funds with long records and stable teams, and Most Intriguing New ESG Funds, those with shorter records, smaller asset bases and distinctly promising prospects. We derived those lists by looking for no-load options open to retail investors, then looking for folks with competitive returns, reasonable expenses and high Sharpe ratios over the full market cycle that began in October 2007.

In addition, we recommend that you consult the exceedingly cool, current table of SRI funds maintained by the Forum for Sustainable and Responsible Investment. The table, which is sadly not sortable, provides current performance data and screening criteria for nearly 200 SRI funds. In addition, it has a series of clear, concise summaries of each fund on the table.

ESG Stalwarts

Most intriguing new ESG funds

In the wings, socially responsible funds still in registration with the Securities and Exchange Commission which will be available by early autumn include:

Thornburg Better World Fund will seek long-term capital growth. The plan is to invest in international “companies that demonstrate one or more positive environmental, social and governance characteristics.” Details in this month’s Funds in Registration feature.

TIAA-CREF Social Choice International Equity Fund will seek a favorable long-term total return, reflected in the performance of ESG-screened international stocks. MSCI will provide the ESG screens and the fund will target developed international markets. This fund, and the next, will be managed by Philip James (Jim) Campagna and Lei Liao. The managers’ previous experience seems mostly to be in index funds.

TIAA-CREF Social Choice Low Carbon Equity Fund will seek a favorable long-term total return, reflected in the performance of ESG-screened US stocks. MSCI will provide the ESG screens, which will be supplemented by screens looking for firms with “demonstrate leadership in managing and mitigating their current carbon emissions and (2) have limited exposure to oil, gas, and coal reserves.”

Trillium All Cap Fund will seek long term capital appreciation by investing in an all-cap portfolio of “stocks with high quality characteristics and strong environmental, social, and governance records.” Up to 20% of the portfolio might be overseas. The fund will be managed by Elizabeth Levy and Stephanie Leighton of Trillium Asset Management. Levy managed Winslow Green Large Cap from 2009-11, Leighton managed ESG money at SunLife of Canada and Pioneer.

Trillium Small/Mid Cap Fund will seek long term capital appreciation by investing in a portfolio of small- to mid-cap “stocks with high quality characteristics and strong environmental, social, and governance records.” Small- to mid- is defined as stocks comparable in size to those in the S&P 1000, a composite of the S&P’s small and mid-cap indexes. Up to 20% of the portfolio might be overseas. The fund will be managed by Laura McGonagle and Matthew Patsky of Trillium Asset Management. Trillium oversees about $2.2 billion in assets. McGonagle was previously a research analyst at Adams, Harkness and Hill and is distantly related to Professor Minerva McGonagall. Patsky was Director of Equity Research for Adams, Harkness & Hill and a manager of the Winslow Green Solutions Fund.

We, now more than ever in human history, have a chance to make a difference. Indeed, we can’t avoid making a difference, for good or ill. In our daily lives, that might translate to helping our religious community, coaching youth sports, serving meals at a center for the marginally secure or turning our backs on that ever-so-manly Cadillac urban assault vehicle, the Escalade.

That’s all inconvenient, a bit limiting and utterly right, and so we do it. ESG advocates argue that we’ve reached the point where we can do the same things with our portfolios: we can make a difference, encourage good behavior and affirm important personal values, all with little or no cost to ourselves. It seems like a deal worth considering.

The league’s top rebounders

Even the best funds decline in value during either a correction or a bear market. Indeed, many of the best decline more dramatically than their peers because the high conviction, high independence portfolios that are signs of their distinction also can leave them exposed when things turn bad. The disastrous performance of the Dodge & Cox funds during the 2007-09 crash is a case in point.

The real question isn’t “will it fall?” We know the answer. The real question is “will the fall be so bad that I’ll get stupid and insist on selling at a painful loss (again), probably just before a rebound?” Two rarely discussed statistics address that question. The first is recovery time, which simply measures the number of months that it’s taken each fund to recover from its single worst drawdown. The second is the Ulcer Index, one of Charles’s favorite metrics if only because of the name, which was designed by Peter Martin to factor–in both the depth and duration of a fund’s drawdown.

For those casting about for tummy-calming options, we screened for funds that had been around for a full market cycle, then looked at funds which have the shortest recovery times and, separately, the lowest Ulcer Indexes over the current market cycle. That cycle started in October 2007 when the broad market peaked and includes both the subsequent brutal crash and ferocious rebound. Our general sense is that looking at performance across such a cycle is better than focusing on some arbitrary number of years (e.g., 5, 10 or 15 year results).

The first table highlights the funds with the fastest rebounders in each of six popular categories.

The rebound or recovery time doesn’t directly account for the depth of the drawdown. It’s possible, after all, for an utterly nerve-wracking fund to power dive then immediately rocket skyward again, leaving your stomach and sleep behind.  The Ulcer Index figures that in: two funds might each dive, swoop and recover in two months but the one dove least earned a better (that is, lower) Ulcer Index score.

Again, these calculations are looking at performance over the course of the current market cycle only.

How much difference does paying attention to risk make? Fully half of all international large cap funds are still underwater; 83 months after the onset of the crash, they have still not made their investors whole. That roster includes all of the funds indexed to the MSCI EAFE, the main index of large cap stocks in the developed world, as well as actively-managed managed funds from BlackRock, Goldman Sachs, Janus, JPMorgan and others.

In domestic large caps, both the median fund on the list and all major market index funds took 57 months to recover.

Bottom Line: the best time to prepare for the rain is while the sun is still shining. While you might not feel that a portfolio heavy on cash or short-term bonds meets your needs, it makes sense for you to investigate – within whatever asset classes you choose to pursue – funds likely to inflict only manageable amounts of pain. Metrics like recovery time and Ulcer Index should help guide those explorations.

FPA Perennial: Time to Go.

FPA Perennial (FPPFX) closed to new investors on June 15, 2015. The fund that re-opens to new investors at the beginning of October will bear no resemblance to it. If you are a current Perennial shareholder, you should leave now.

Perennial and its siblings, FPA Paramount (FPRAX) and the closed-end Source Capital (SOR), were virtual clones, managed by Steve Geist and Eric Ende. While the rest of FPA were hard-core absolute value guys, G&E ran splendid small- to mid-cap growth funds, fully invested in very high-quality companies, negligible turnover, drifting between small and mid, growth and blend. Returns were consistent and solid. Greg Herr was added to the team several years ago.

In 2013, FPA made the same transition at Paramount that’s envisaged here: the managers left, a new strategy was imposed and the portfolio was liquidated. Domestic growth became global value. Only the name remained the same.

With Perennial, not even the name will remain.

1. All of the managers are going. Mr. Geist retired in 2014 and Ende, at age 70, is moving toward the door. Mr. Herr is leaving to focus on Paramount. They are being replaced by Greg Nathan. Mr. Nathan is described as “the longest serving analyst for the Contrarian Value Strategy, including FPA Crescent Fund (FPACX).”
2. The strategy is going. Geist and Ende were small- to mid-cap growth. The new fund will be all-cap value. It will be the US equity manifestation of the stock-picking strategy used in Crescent, Paramount and International Value. It is a perfectly sensible strategy, but it bears no resemblance to the one for which the fund is known.
3. The portfolio is going. FPA warns that the change “will result in significant long-term capital gains.” Take that warning seriously.  Morningstar calculates your potential capital gains exposure at 63%, that is, 63% of the fund’s NAV is a result of so far untaxed capital gains. If the portfolio is liquidated, you could see up to $36/share in taxable distributions.  

   How likely is a hit of that magnitude? We can compare Paramount’s portfolio before and after the 2013 transition. Of the 31 stocks in Paramount’s portfolio:

   27 positions were entirely eliminated
   2 positions (WABCO and Zebra Technologies) were dramatically reduced
   1 position (Aggreko plc) was dramatically expanded
   1 position (Maxim Integrated Products) remained roughly equal

   During that transition, the fund paid out about 40% of its NAV in taxable gains including two large distributions over the course of two weeks at year’s end.

   Certainly the tax hit will vary based on your cost basis, but if your cost basis is high – $35/share or more – you might be better getting out before the big tax hit comes.

4. The name is going. The new fund will be named FPA S. Value Fund.

I rather like FPA’s absolute value orientation and FPA U.S. Value may well prove itself to be an excellent fund in the long-term. In the short term, however, it’s likely to be a tax nightmare led in an entirely new direction by an inexperienced manager. If you bought FPPFX because you likely want what Geist & Ende did, you might want to look at Motley Fool Great America (TMFGX). It’s got a similar focus on quality growth, low turnover and small- to mid-cap domestic stocks. It’s small enough to be nimble and we’ve identified it as a Great Owl Fund for its consistently excellent risk-adjusted returns.

The mills of justice turn slowly, but grind exceedingly fine.

The SEC this month announced sanctions against two funds for misdeeds that took place five to seven years ago while a third fund worked to get ahead of SEC concerns about its advisor.

On June 17, 2015, the SEC issued penalties to Commonwealth Capital Management and three former three independent members of its mutual fund board. The basic argument is that, between 2008 and 2010, the adviser fed crap to the board and they blindly gobbled it up. (Why does neither half of their equation surprise me?) The SEC’s exact argument is that the board provided misleading information about the fund to the directors and the independent directors failed to exercise reasonable diligence in examining the evidence before approving a new investment contract. The fund in question was small and bad; it quickly added “extinct” to its list of attributes.

On June 22, 2015, the Board of Trustees of the Vertical Capital Income Fund (VCAPX) terminated the investment advisory agreement with Vertical Capital Asset Management, LLC. The fund’s auditor has also resigned. The Board’s vaguely phrased concern is that VCAM “lacks sufficient resources to meet its obligations to the Fund, and failed to adequately monitor the actions of its affiliate Vertical Recovery Management in its duties as the servicing agent of the mortgage notes held by the Fund.”

On June 23, 2015, the SEC reached a settlement with Pekin Singer Strauss Asset Management (PSS), advisor to the Appleseed Fund (APPLX) and portfolio managers William Pekin and Joshua Strauss.  The SEC found “that the securities laws were violated in 2009 and 2010 when PSS did not conduct timely internal annual compliance reviews or implement and enforce certain policies and procedures.” PSS also failed to move clients from the higher-cost investor shares to the lower-cost institutional ones. No one admits or denies anything, though PSS were the ones who detected and corrected the share class issue on their own.

Morningstar, once a fan of the fund, has placed them “under review” as they sort out the implications. That’s got to sting since Appleseed so visibly positions itself as a socially-responsible fund.

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, searchable, and filtered as never before. For the 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.

Order

• The court gave its final approval to a $9.475 million settlement in the ERISA class action that challenged MassMutual‘s receipt of revenue-sharing payments from third-party mutual funds. (Golden Star, Inc. v. Mass Mut. Life Ins. Co.)

Briefs

• Calamos filed a motion to dismiss excessive-fee litigation regarding its Growth Fund. Brief: “Plaintiffs advance overwrought policy critiques of the entire mutual fund industry, legally inapt comparisons between services rendered to a retail mutual fund (such as the [Growth] Fund) and those provided to an institutional account or as sub-adviser, and conclusory assertions that the Fund grew over time but did not reduce its fees that are just the sort of allegations that courts in this Circuit have consistently dismissed for more than 30 years.” (Chill v. Calamos Advisors LLC.)
• Parties filed dueling motions for summary judgment in fee litigation regarding eight Hartford mutual funds. Plaintiffs’ section 36(b) claims, first filed in 2011, previously survived Hartford’s motion to dismiss. The summary judgment briefs are unavailable on PACER. (Kasilag v. Hartford Inv. Fin. Servs. LLC; Kasilag v. Hartford Funds Mgmt. Co.)
• New York Life filed a motion to dismiss excessive-fee litigation regarding four of its MainStay funds. Brief: Plaintiffs’ complaint “asserts in conclusory fashion that Defendant New York Life Investment Management LLC (‘NYLIM’) received excessive fees for management of four mutual funds, merely because NYLIM hired subadvisors to assist with its duties and paid them a portion of the total management fee. But NYLIM’s employment of this manager/subadvisor structure—widely utilized throughout the mutual fund industry and endorsed by NYLIM’s regulator—cannot itself constitute a breach of NYLIM’s fiduciary duty under Section 36(b) of the Investment Company Act . . . .” (Redus-Tarchis v. N.Y. Life Inv. Mgmt., LLC.)

The Alt Perspective: Commentary and news from DailyAlts.

Survey Says…

The spring is the season for surveys and big opinion pieces. Perhaps it is the looming summer vacations of readers that prompt companies to survey the market for opinions and views on particular topics before everyone heads out of the office for a long break. Regardless, the survey results are in, the results have been tallied and in the world of liquid alternatives, it appears that the future looks good.

Two industry surveys that were completed recently are cited in the articles below. The first provides the results of a survey of financial advisors about their allocations to alternative investments, and notes that more than half of the financial advisors surveyed think that their clients should allocate between 6% and 15% to alternative investments – a significant increase from today’s levels.

The second report below provides big picture industry thinking from Citi’s Business Advisory Services unit, and projects the market for liquid alternatives to double over the next five years, increasing to more than $1.7 trillion in assets.

• Majority of Advisors Plan to Continue Recommending Alternatives
• Citi Sees Boom in Unconstrained Long, Smart Beta and Liquid Alts

While industry surveys and big picture industry reports can often over-project the optimism and growth of a particular product group, the directional trends are important to watch. And in this case, the trends continue to be further growth of the liquid alternatives market, both here in the U.S. and abroad.

Monthly Liquid Alternative Flows

Consistent with the reports above, investors continued to allocate to alternative mutual funds and ETFs in May of this year. Investors allocated a net total of $2 billion to the space in May, a healthy increase from April’s level of $723 million, and a return to levels we saw earlier in the year.

While only two categories had positive inflows last month, this month has four categories with positive inflows. Once again, multi-alternative funds that combine multiple styles of investing, and often multiple asset managers, all into a single fund had the most significant inflows. These funds pulled in $1.8 billion in net new assets. Managed futures are once again in second place with just over $520 million in new inflows.

While the outflows from long/short equity funds have moved closer to $0, they have yet to turn positive this year. With equity market conditions as they are, this has the potential to shift to net inflows over the coming months. Commodity funds continued to struggle in May, but investors kicked it up a notch and increased the net outflows to more than $1.5 billion, more than a double from April’s level.

Diversification and one stop shopping continue to be an important theme for investors. Multi-alternative fund and managed futures funds provide both. Expect asset flows to liquid alternatives to continue on their current course of strong single-digit to low double-digit growth. Should the current Greek debt crisis or other global events cause the markets to falter, investors will look to allocate more to liquid alternatives.

New Fund Launches

We have seen 66 new funds launched this year, up from 53 at the end of April. This includes alternative beta funds as well as non-traditional bond funds, both of which provide investors with differentiated sources of return. In May, we logged 13 new funds, with nearly half being alternative beta funds. The remaining funds cut across multi-alternative, non-traditional bonds and hedged equity.

Two of the funds that were launched in May were unconstrained bond funds, one of the more popular categories for asset inflows in 2014. This asset category is meant to shield investors from the potential rise in interest rates and the related negative impact of bond prices. Both Virtus and WisdomTree placed a bet on the space in May with their new funds that give the portfolio managers wide latitude to invest across nearly all areas of the global fixed income market on a long and short basis.

While significant assets have flowed into this category of funds over the past several years, the rise in interest rates has yet to occur. This may change come September, and at that point we will find out if the unconstrained nature of these funds is helpful.

For more details on new fund launches, you can visit our New Funds 2015 page.

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. 

Eventide Healthcare & Life Sciences (ETNHX): Morningstar’s 2015 conference included a laudatory panel celebrating “up and coming” funds, including the five star, $2 billion Eventide Gilead. At yet as I talked with the Eventide professionals the talk kept returning to the fund that has them more excited, Healthcare. The fund looks fascinating and profitable. Unfortunately, we need answers to two final questions before publishing the profile. We’re hopeful of having those answers in the first couple days of July; we’ll notify the 6000 members of our mailing list as soon as the profile goes live

Launch Alert

Thornburg Developing World (THDAX) is one of the two reasons for being excited about Artisan Developing World (ARTYX). Artisan’s record for finding and nurturing outstanding management teams is the other.

Lewis Kaufman managed Thornburg Developing World from inception through early 2015. During that time, he amassed a remarkable record for risk-sensitive performance.  A $10,000 investment at inception would have grown to $15,700 on the day of Mr. Kaufman’s departure, while his peers would have earned $11,300. Morningstar’s only Gold-rated emerging markets fund (American Funds New World Fund NEWFX) would have clocked in at $13,300, a gain about midway between mediocre and Mr. Kaufmann.

By all of the risk and risk/return measures we follow, he achieved those gains with lower volatility than did his peers.

Mr. Kaufman pursues a compact, primarily large-cap portfolio. He’s willing to invest in firms tied to, but not domiciled in, the emerging markets. And he has a special interest in self-funding companies; that is, firms that generate free cash flow sufficient to cover their operating and capital needs. That allows the firms insulate themselves from both the risk of international capital flight and dysfunctional capital markets that are almost a defining feature of the emerging markets. Andrew Foster of Seafarer Overseas Growth & Income (SFGIX) shares that preference for self-funding firms and it has been consistently rewarding.

There are, of course, two caveats. First, Thornburg launched after the conclusion of the 2007-09 market crisis. That means that it only dealt with one sharply down quarter (3Q2011) and it trailed the pack then. Second, Thornburg’s deep analyst core doubtless contributed to Mr. Kaufmann’s success. It’s unclear how reliance on a smaller team will affect him.

In general, Artisan’s new funds have performed exceptionally well (the current E.M. product, which wasn’t launched in the retail market, is the exception). Artisan professes only ever to hire “category killers,” then gives them both great support and great autonomy. That process has worked exceptionally well. I suggested on our discussion board “that immediately upon launch, our short-list of emerging markets funds quite worth your money’ will grow by one.” I’m pretty comfortable with that prediction.

Artisan Developing World (ARTYX) has a 1.5% initial expense ratio and a $1,000 investment minimum.

Funds in Registration

There are eight new funds in registration this month. Funds in registration with the SEC are not available for sale to the public and the advisors are not permitted to talk about them, but a careful reading of the filed prospectuses gives you a good idea of what interesting (and occasionally appalling) options are in the pipeline. Funds currently in registration will generally be available for purchase in September or early October.

Two funds sort of pop out:

RiverNorth Marketplace Lending Fund will invest in loans initiated by peer-to-peer lenders such as LendingClub and Prosper.com. It’s structured as a non-listed closed-end fund which will likely offer only periodic liquidity; that is, you might be able to get out just once a month or so. The portfolio’s characteristics should make it similar to high-yield bonds, offering the chance for some thrills and interest rate insulation plus high single-digit returns. It’s a small market; about $7 billion in loans were made last year, which makes it most appropriate to a specialist boutique firm like RiverNorth.

Thornburg Better World will be an international fund with strong ESG screens. Thornburg’s international funds are uniformly in the solid-to-outstanding range, though the departure of Lewis Kaufmann and some of his analysts for Artisan certainly make a dent. That said, Thornburg’s analyst core is large and well-respected and socially-responsible investing has established itself as an entirely mainstream strategy.

Manager Changes

This month there were only 38 funds reporting partial or complete changes in their management teams. This number is slightly inflated by the departure of Wayne Crumpler from eleven American Beacon funds. The most notable changes include Virginie Maisonneuve’s departure from another PIMCO fund, and Thomas Huber stepping down from T. Rowe Price Growth & Income. The good news is that he’s remaining at T. Rowe Price Dividend Growth where he’s had a longer record and more success.

Updates

In May we ran The Dry Powder Gang, a story highlighting successful funds that are currently holding exceptionally high levels of cash. After publication, we heard from two advisors who warned that their funds’ cash levels were dramatically lower than we’d reported: FMI International (FMIJX) and Tocqueville International Value (TIVFX).

The error came from, and remains in, the outputs from Morningstar’s online fund screener.  Here is Morningstar’s report of the most cash-heavy international funds, based on a June 30 2015 screening:

Cool, except for the fact the Brown is 9% cash, not 66%; FMI is 20%, not 62%; AQR is 7%, not 56% … down to Tocqueville which is 6%, not 38%.

Where do those lower numbers come from? Morningstar, of course, on the funds’ “quote” and “portfolio” pages.

We promptly corrected our misreport and contacted Morningstar. Alexa Auerbach, a kind and crafty wizard there, explained the difficulty: the cash levels reported in the screener are “long rescaled” numbers. If a fund has both long and short positions, which is common in international funds which are hedging their currency exposures, Morningstar recalculates the cash position as a percentage of the fund’s long portfolio. “So,” I asked, “if a fund was 99% short and 1% long, including a 0.3% cash position, the screener would report a 30% cash stake?” Yep.

When I mentioned that anomaly to John Rekenthaler, Morningstar’s resident thunderer and former head of research, he was visibly aroused. “Long-rescaled? I thought I’d killed that beast five years ago!” And, grabbing a cudgel, he headed off again in the direction of IT.

I’ll let you know how the quest goes. In the interim, we will, and you should be a bit vigilant in checking curious outputs from the software.

Trust but Verify

On December 9, 2014, BlackRock president Larry Fink told a Bloomberg TV interviewer, “I am absolutely convinced we will have a day, a week, two weeks where we will have a dysfunctional market. It’s going to create some sort of panic, create uncertainty again.” That’s pretty much the argument that Ed and I have made, in earlier months, about ongoing liquidity constraints and an eventual crisis. It’s a reasonably widespread topic of conversation about serious investment professionals, as well as the likes of us.

Fink’s solution was electronic bond trading and his fear was not the prospect of the market crisis but, rather, of regulators reacting inappropriately. In the interim, BlackRock applied for permission to do inter-fund lending: if one of their mutual funds needed cash to meet redemptions, they could take a short-term loan from a cash-rich BlackRock fund in lieu of borrowing from the banks or hastily selling part of the portfolio. It is a pretty common provision.

Which you’d never know from one gold bug’s conclusion that Fink sounded “BlackRock’s Warning: Get Your Money Out Of All Mutual Funds.” It’s the nature of the web that that same story, generally positioned as “What They Don’t Want You to Know,” appeared on a dozen other websites, some with remarkably innocuous names. Those stories stressed that the problem would last “days or even weeks,” which is not what Fink said.

Briefly Noted . . .

On June 4, 2015, John L. Keeley, Jr., the president and founder of Keeley Asset Management and a portfolio manager to several of the Keeley funds passed away at a still-young 75. He’s survived by his wife of 50+ years and a large family. His rich life, good works and premature departure remind us all of the need to embrace our lives while we can, rather than dully plodding through them.

Conestoga SMid Cap Fund (CCSMX) just gained, with shareholder approval, a 12(b)1 fee. (Shareholders are a potentially valuable source of lanolin.) Likewise, the Hennessy Funds are asking shareholders to raise their costs via a 12(b)1 fee on the Investor Class of the Hennessy Funds.

In the “let’s not be too overt about this” vein, Janus quietly added a co-manager to Janus Unconstrained Global Bond (JUCAX).  According to the WSJ, Janus bought the majority stake in an Australian bond firm, Kapstream Capital Pty Ltd., then appointed Kapstream’s founder to co-manage Unconstrained Bond.  Kumar Palghat, the co-manager in question, is a former PIMCO executive who managed a $22 billion bond portfolio for PIMCO’s Australian division. He resigned in 2006, reportedly to join a hedge fund.

It’s intriguing that Gross, who once managed $1.8 trillion, is struggling with one-tenth of one percent of that amount. Janus Unconstrained is volatile and underwater since launch. Its performance trails that of PIMCO Unconstrained (PFIUX), the BarCap Aggregate, its non-traditional bond peer group, and most other reasonable measures.

PIMCO has announced reverse share-splits of 2:1 or 3:1 for a series of its funds: PIMCO Commodity Real Return Strategy Fund (PCRAX), PIMCO RAE Fundamental Advantage PLUS Fund (PTFAX), PIMCO Real Estate Real Return Strategy Fund (PETAX) and PIMCO StocksPLUS Short Fund (PSSAX). Most of the funds have NAVs in the neighborhood of $2.50-4.00. At that level, daily NAV changes of under 0.25% don’t get reflected (they round down to zero) until a couple consecutive unreported changes pile up and trigger an unusually large one day move.

O Canada! Your home and native land!! Vanguard just noticed that Canada exists and that it is (who knew?) a developed market. As a result, the Vanguard Developed Markets Index Fund will now track the FTSE Developed All Cap ex US Index rather than the FTSE Developed ex North America Index. The board has also approved the addition of the Canadian market to the Fund’s investment objective. Welcome, o’ land of pines and maples, stalwart sons and gentle maidens!

Vanguard’s Emerging Markets, Pacific and European stock index funds will also get new indexes, some time late in 2015. Vanguard’s being intentionally vague on the timing of the transition to try to prevent front-running by hedge funds and others. In each case, the new index will include a greater number of small- to mid-cap names. The Emerging Markets index will, in addition, include Chinese “A” shares. One wonders if recent events are causing them to reconsider?

Villere Balanced Fund (VILLX) and Villere Equity Fund (VLEQX) may, effective immediately, lend securities – generally, that means “to short sellers” – “in order to generate return.”

SMALL WINS FOR INVESTORS

AMG Yacktman (YACKX) and AMG Yacktman Focused (YAFFX) both reopened to new investors on June 22, 2015. The reopening engendered a lively debate on our discussion board. One camp pointed out that these are top 1% performers over the past 10- and 15-year periods. The other mentioned that they’re bottom 10% performers over the past 3- and 5-year periods. The question of asset bloat (about $20 billion between them) came up as did the noticeable outflows ($4 billion between them) in the last several years. There was a sense that the elder Mr. Yacktman was brilliant and a phenomenally decent man but, really, moving well into the “elder” ranks. Son Steve, who has been handling the funds’ day-to-day operations for 15 years is … hmmm, well, a piece of work.

The Barrow Funds, Barrow Value Opportunity Fund (BALAX/BALIX) and Barrow Long/Short Opportunity Fund (BFLSX/BFSLX) are converting from two share classes to one. The investor share class closed to new purchases on June 2 and merged into the institutional share class on June 30. At that same time, the minimum investment requirement for the institutional shares dropped from $250,000 to $2,500.  The net effect is that Barrow gets administrative simplicity and their investors, current and potential, get a price break.

Effective immediately, the name of the Hatteras Hedged Strategies Fund has changed to Hatteras Alternative Multi-Manager Fund (HHSIX).  Here’s the “small wins” part: they’ve sliced their minimum initial investment from $150 million to $1 million! Woo hoo! And here’s the tricky part: the fund has only $97 million in assets which implies that the exalted minimum was honored mostly in the breach.

The Royce Funds reduced their advisory fees for their European Smaller-Companies Fund, Global Value, International Smaller-Companies, International Micro-Cap and International Premier funds on July 1, 2015. The reductions are about 15 basis points, which translates to a drop in the funds’ expense ratios of about 10%.

Nota bene: the Royce Funds make me crazy. After a series of liquidations in April, there are 22 funds left which will drop to 21 in a couple of months. Of those, two have above average returns for the past five years while 16 trail at least 80% of their peers. The situation over the past decade is better, but not much. If you screen out the sucky, high risk and economically unviable Royce funds, you get down to about five: Global Financial Services and a bunch that existed before Legg Mason bought the firm and got them to start churning out new funds.

Effective June 1, 2015, the Schroder U.S. Opportunities Fund (SCUIX), which had been closed to new investors, will become available for purchase by investors generally. Actually with a $250,000 investment minimum, it “became available for purchase by really rich investors generally.”

CLOSINGS (and related inconveniences)

Effective as of the close of business on July 15, 2015, Brown Advisory Small-Cap Fundamental Value Fund (BIAUX) will stop accepting new purchases through most broker-dealer firms.

Eaton Vance Atlanta Capital Horizon Growth Fund (EXMCX) announced its plan to close to new investors on July 13, 2015. I wouldn’t run for your checkbook just yet. The fund has only $34 million in assets and has trailed pretty much everybody in its peer group, pretty much forever:

INTECH U.S. Core Fund (JDOAX) closed to new investors on June 30, 2015. Why, you ask? Good question. It’s a small fund that invests in large companies with a doggedly mediocre record. Not “bad,” “mediocre.” Over the past decade, it’s trailed the S&P 500 by 0.11% annually with no particular reduction of volatility. The official reason: “because Janus Capital and the Trustees believe continued sales are not in the best interests of the Fund.”

OLD WINE, NEW BOTTLES

The Calvert Social Index Fund is now Calvert U.S. Large Cap Core Responsible Index Fund (CSXAX). At the same time, the adviser reduced the fund’s expense ratio by nearly one-third, from 0.75% down to 0.54% for “A” shares.  

Effective June 2, 2015, Columbia LifeGoal Growth Portfolio, a fund of funds, became Columbia Global Strategic Equity Fund (NLGIX). At the same time the principal investment strategies were revised (good plan! It trails 90% of its peers over the past 1, 3 and 5 years) to eliminate a lot of the clutter about how much goes into which Columbia fund. The proviso that the fund will invest at least “40% of its net assets in foreign currencies, and equity and debt securities” implies a currency-hedged portfolio.

FPA Perennial (FPPFX) has closed for a few months while it becomes an entirely different fund using the same name.

Effective immediately, the name of the Hatteras Hedged Strategies Fund has changed to Hatteras Alternative Multi-Manager Fund (HHSIX). 

On August 31, 2015: iShares MSCI USA ETF (EUSA) becomes iShares MSCI USA Equal Weighted ETF. We’ll leave it to you to figure out how they might be changing the portfolio.

Natixis Diversified Income Fund (IIDPX) becomes Loomis Sayles Multi-Asset Income Fund on August 31, 2015. The investment strategy gets tweaked accordingly.

-er, don’t panic! A handful of Royce funds have lost their –ers. On June 15, Royce International Smaller-Companies Fund became Royce International Small-Cap Fund (RYGSX), European Smaller-Companies Fund became European Small-Cap Fund (RISCX) and Royce Financial Services Fund became Royce Global Financial Services Fund (RYFSX). In the former two cases, the managers wanted to highlight the fact that they focused on a stock’s capitalization rather than the size of the underlying firm. In the latter case, RYFSX has about five times the international exposure of its peers. Given that excellent performance (top 2% over the past decade) and a distinctive portfolio (their market cap is one-twentieth of their peers) hasn’t drawn assets, I suppose they’re hoping that a new name will. At the very least, with eight funds – over a third of their lineup – renamed in the past three months, that’s the way they’re betting.

Oppenheimer Flexible Strategies Fund (QVOPX) becomes Oppenheimer Fundamental Alternatives Fund on August 3, 2015. There’s no change in the fund’s operation, so apparently “strategies” are “alternatives,” just not trendy alternatives.

On June 22, 2015, the Sterling Capital Strategic Allocation Conservative Fund (BCGAX) morphed into Sterling Capital Diversified Income Fund. Heretofore it’s been a fund of Sterling funds. With the new name comes the ability to invest in other funds as well.

In case you hadn’t noticed, on June 18, 2015, the letters “TDAM” were replaced by the word “Epoch” in the names of a bunch of funds: Epoch U.S. Equity Shareholder Yield Fund, Epoch U.S. Large Cap Core Equity Fund, Epoch Global Equity Shareholder Yield Fund, Epoch Global All Cap Fund, and Epoch U.S. Small-Mid Cap Equity Fund. The funds, mostly bad, have two share classes each and have authorization to launch eight additional share classes. Except for U.S. Small-Mid Cap, they have $3-6 million in assets.

Effective July 31, 2015 Virtus Global Dividend Fund (PGUAX), a perfectly respectable fund with lots of global infrastructure exposure, becomes Virtus Global Infrastructure Fund.

Effective August 28, 2015, the West Shore Real Return Income Fund (NWSFX) becomes West Shore Real Return Fund. They’re also changing their objective from “capital growth and current income” to “preserving purchasing power.” They’ve pretty much completely rewritten their “principal strategies” text so that it’s hard to know how exactly the portfolio will change, though the addition of a risk statement concerning the use of futures and other derivatives does offer a partial answer. I’ve been genially skeptical of the fund for a long while. Their performance chart doesn’t materially reduce that skepticism:

At a reader’s behest, I spoke at length with one of the managers whose answers seemed mostly circular and who was reluctant to share information about the fund. He claimed that they have a great record as a private strategy, that they’ve shown to the board, but that they’re not interested in sharing with others. His basic argument was: “we don’t intend to make information about the fund, our strategies or insights available on the web. Our website is just a pick-up point for the prospectus. We expect that people will either know us already or will follow our success and be drawn.” At the end of the call, he announced that he and co-manager James Rickards were mostly the public faces of the fund and that the actual work of managing it fell to the third member of the trio. Mr. Rickards has since left to resume his career as doom-sayer.

OFF TO THE DUSTBIN OF HISTORY

Aftershock Strategies Fund (SHKIX/SHKNX) has closed and will discontinue its operations effective July 6, 2015.

You’ll need to find an alternative to AMG FQ Global Alternatives Fund (MGAAX), which is in the process of liquidating. Apparently they’re liquidating (or solidifying?) cash:

Final shutdown should occur by the end of July.

Elessar SCV Fund has morphed into the Emerald Small Cap Value Fund (ELASX)

Franklin Templeton has delayed by a bit the liquidation of Franklin Global Allocation Fund (FGAAX). The original date of execution was June 30 but “due to delays in liquidating certain portfolio securities,” they anticipate waiting until October 23. That’s a fascinating announcement since it implies liquidity problems though that’s not listed as an investment risk in the prospectus.

Guggenheim Enhanced World Equity Fund “ceased operations, liquidated its assets, and distributed the liquidation proceeds to shareholders of record at the close of business on June 26, 2015.”

Salient recently bought the Forward Funds complex “in an effort to build scale in the rapidly growing liquid alternatives space.” The brilliance of the deal is debatable (Forward favors liquid alts investing, but only three of its 30 funds – Select Emerging Markets Dividend, Credit Analysis Long/Short (whose founding managers were sacked a year ago) and High Yield Bond – have outperformed their peers since inception). As it turns out, Forward Small Cap Equity Fund (FFSCX) and Forward Income & Growth Allocation Fund (AOIAX) fell into neither of those camps: good or alternative. Both are scheduled to be liquidated on August 12, 2015.

HSBC RMB Fixed Income Fund (HRMBX), an exceptionally strong EM bond fund with no investors, will be liquidated on or about July 21, 2015.

MainStay ICAP Global Fund (ICGLX) will be liquidated on or about September 30, 2015. Small, middling performer, culled from the herd.

Sometimes a picture is worth a thousand words. Other times a picture leaves me speechless. Such is the case with the YTD price chart for Merk Currency Enhanced U.S. Equity Fund (MUSFX).

Yuh. That’s a one-day spike of about 60%, followed by a 60% fall the next day for a net loss of a third over two days, at which point the fund was no longer “pursuing its investment objective.” The fund is scheduled to be liquidated July 15.

Montibus Small Cap Growth Fund (SGWAX) joins the legion of the dearly departed on August 24, 2015.

Nationwide HighMark Balanced Fund (NWGDX) will, pending shareholder approval, vanish on or about October 23, 2015. At about the same time Nationwide HighMark Large Cap Growth (NWGLX) is slated to merge into Nationwide Large Cap Core Equity while Nationwide HighMark Value (NWGTX) gets swallowed by Nationwide Fund (NWFAX). The latter has been rallying after getting a new manager in 2013, so we’ll be hopeful that this is a gain for shareholders.

At the end of July, shareholders will vote on a proposal to merge the small and sad Royce Select Fund (RYSFX) into the much larger and sadder Royce 100 (RYOHX). The proxy assures investors that “the Funds have identical investment objectives, employ substantially similar principal investment strategies to pursue those investment objectives, and have the same portfolio managers,” which raises the question of why they launched Select in the first place.

The previously announced liquidation of the half million dollar Rx Tax Advantaged Fund (FMERX) has been delayed until July 31, 2015. 

On or about August 25, 2015, the Vantagepoint Model Portfolio All-Equity Growth Fund (VPAGX) becomes Vantagepoint Model Portfolio Global Equity Growth Fund and increases its equity exposure to non-U.S. securities by adding an international index fund to its collection. The fund has about a billion in assets. Who knew?

Relationships come and relationships go. One of the few proprieties that my students observe is, if you’ve actually met and gone out in person, you should be willing to break up in person. Breaking up by text is, they agreed, cruel and cowardly. I suspect that they’re unusually sympathetic with the managers of Wells Fargo Advantage Emerging Markets Local Bond Fund (WLBAX) and Wells Fargo Advantage Emerging Markets Equity Select Fund (WEMTX). “At a telephonic meeting held on June 15, 2015, the Board of Trustees unanimously approved the liquidation of the Funds.” Cold, dude. If you’d like to extend your sympathies, best send the text before July 17, 2015.

Wilmington Mid-Cap Growth Fund (AMCRX) will liquidate on or about August 3, 2015. Being “not very good” (they’ve trailed two-thirds of their peers for the past five and ten years) didn’t stop them from accumulating a quarter billion in assets but somehow the combination wasn’t enough to keep them around. Wilmington Small-Cap Strategy Fund (WMSIX), a small institutional fund with a pretty solid record and stable management, goes into the vortex that same day.

In Closing . . .

Thank you, once again, to those whose support keeps the lights on at the Observer. To Diane & Tom, Allen & Cleo, Hjalmar, Ed (cool and mysterious email address, sir!): we appreciate you!  A great, big thanks to those who use the Observer’s Amazon link for all their Amazon purchases. Your consistency, and occasional exuberant purchase, continues to help us beat our normal pattern of declining revenue in the summer months. We’d also be remiss if we forgot to thank the faithful Deborah and Greg, our honorary subscribers and PayPal monthly contributors. Many thanks to you both.

Lots to do for August. We’ve been watching the folks at the Turner Funds thrash about, both in court and in the marketplace. We’ll try to give you some perspective on what some have called The Fall of the House of Turner. In addition, we’d like to look at the question, “where should you start out?” That is, if you or a young friend of yours is a 20-something with exceedingly modest cash flow but a determination to build a sensible, durable foundation, which funds might serve as your (or their) best first investment: conservative, affordable, sensible.

And, too, I’ve got to prepare for a couple presentations: a talk with some of the young analysts at Edward Jones in St. Louis and with the folks attending Ultimus Fund Solution’s client conference at the end of August and beginning of September. If I find something fun, you’ll be the second to know!

As ever,

Dear friends,

They’re gone. Five hundred and twenty-six Augie students who we’ve jollied, prodded, chided, praised, despaired of and delighted in for the past four years have been launched on the rest of you. They’re awfully bright-eyed, occasionally in reflection of the light coming from their cell phone screens. You might suspect that they’re not listening, but if you text them, they’ll perk right up.

This is usually the time for graduation pictures but I’ve never found those engaging since they reflect the dispersion of our small, close-knit community. I celebrate rather more the moments of our cohesion; the times when small and close were incredibly powerful.

Augie’s basketball team finished second in the nation in 2015, doing rather better in our division than the Kentucky Mildcats did in theirs, eh? We did not play in a grand arena but instead in a passionate one: Carver Gymnasium, home of the Carver Crazies. It was a place where the football team (the entire football team) jammed the sidelines of every game, generally shoulder to shoulder with the women’s basketball team and the choir, all shouting … hmmm, deprecations at opposing players.

When the team boarded buses at 5:00 a.m. for the trip east to compete in the Final Four, they were cheered off by hundreds of students and staff who stood in happy gaggles in the dark. A day later, hundreds more boarded buses and jammed in cars to follow them east. And when they came home, one win shy of a championship, they were greeted with the sound of trumpets and cheers.

And while the basketball players won’t go to the NBA, a fair number – over half of our juniors – will go to med school. And so perhaps we’ll yet meet the Kentuckians at an NBA contest as our guys patch together theirs.

I rather like kids, maddened though we make each other.

MFO on FOMO

No, FOMO is not that revolutionary white spray foam that’s guaranteed to remove the toughest pet stains from your carpet; neither is it a campaign rallying cry (“FOMO years! FOMO years!”).

FOMO is “fear of missing out” and it’s one of the more plausible explanations for the market’s persistent rise. There’s an almost-universal agreement that financial assets are, almost without exception, overpriced. Some (bonds) are more badly overpriced than others (small Japanese stocks), but that’s about the best defense that serious investors make of current conditions: they’re finding pockets of relative value rather than much by way of absolute value.

The question is: why are folks hanging around when they know this is going to end badly (again)? The surprising answer is, because everyone else is hanging around. It’s a logic reminiscent of those anxious moments back in our early high school years. We’d get invited to a party (surprise!), it would be great for a while then it would begin to drag. But really, you couldn’t be the first kid to leave. First off, everyone would notice and brand you as a wuss, or worse. Second, while it was late, all the cool kids were still around and that meant, you know, that something cool might happen.

And so you lingered until just after that kid from the football team threw up near the food, one of the girls used “the F word” kinda in your face and someone – no one knows who – knocked over the nice table lamp which really pissed off Emily’s dad. Then everyone was anxious to squeeze as quickly through the door as possible. On whole, the night would have been a lot better if you’d left just a little earlier but still …

It’s like that for professional investors, too. Reuters columnist James Saft points to research that shows professionals falling victim to the same pressures:  

Call it status anxiety, call it greed or just call it clever momentum trading, but the fear of missing out is an under-appreciated force in financial markets. No one likes to miss out on a good thing, especially when they see their friends, neighbors and rivals cashing in.

Much of this may be driven by concerns about relative wealth, or how much you have compared to those in your group, a force explored in a 2007 paper by Peter DeMarzo and Ilan Kramer of Stanford University and Ron Kaniel of Duke University. They found that even when traders understand that prices are too high they may stay in the market because they fear losing out as the overvaluation persists and extends.

Investors want to keep pace with their peers, and fear not having as much wealth. That raises, in a certain way, the risk of selling into a bubble. That status and group-motivated anxiety can blind investors towards other, seemingly obvious risks. (“The power of the fear of missing out,” 05/29/2015.)

You might think of it as a financial manifestation of Newton’s first law of motion: “unless acted upon by an outside force, an object in motion tends to stay in motion in the same direction and speed.” It’s sometimes called “the law of inertia.” One technical analyst, looking at the “pattern we have seen for much of 2015, namely choppy with a slight upward bias,” opined that despite “an increasing number of clouds gathering on the horizon  …  the path of least resistance likely remains to the upside.”

And so the smart money people remain, anxiously, present. Business Insider reporter Linette Lopez, covering the huge SALT Las Vegas hedge fund conference, observes that leading hedge fund strategists:

Across the board … believe asset prices are too high. Mostly bonds, sometimes stocks. Still, everyone is long the market. No one wants to be the first person out of the market as long as they’re making money. This is a huge issue on Wall Street, and everyone at this conference is now looking for a warning signal. (“We’ve already seen the beginning of the quake that could be coming,” 05/06/2015) – didn’t discuss h.f. fees (steadily rising) or h.f. performance (steadily lagging)…

In the same week that the hedgies were meeting in Las Vegas, the Buffett Believers gathered in Omaha. There renowned value investors, such as Jean-Marie Eveillard, now a senior advisor to First Eagle funds, fret that the market was overvalued, kept alive by artificial stimulus that’s coming to an end. Eveillard says investors don’t seem to be factoring that in. “Either everyone is thinking I will just keep dancing until the music stops, or they don’t see the risks that I do.” (“At Berkshire annual meeting, Warren Buffett hosts cautious investors,” 05/02/2015.)

In an interview with Reuters, Joel Tillinghast – one of Fidelity’s two best managers – captured the yin and yang of it:

“I think [the level of the financial markets are] colossally artificial, but I don’t see it ending. How long can we party with our bad selves?” Mr. Tillinghast asked. “You want to know so you can party on until five minutes before it ends.” (“Top Fidelity stockpicker: Financial markets are ‘colossally artificial,’” 05/26/2015)

We raised last month the notion of a “roach motel,” where getting in is easy and getting out is impossible. In the case of bugs, the problem is stickum. In the case of investors, it’s liquidity. At base, you may find that there’s no one willing to pay anything even vaguely like what you think your holdings are worth. Kevin Kinsella, president of a venture capital firm, notes that investors have been making 30% per quarter on privately traded shares, like Uber.

Given the various stratospheric private valuations some of these unicorn companies are reaching, there will be no trade buyers, and it is doubtful whether a sane investment bank would take such companies public at these market caps.

Investors historically delude themselves by concocting rationales as to why the insanity will continue, why it is completely reasonable and why an implosion won’t happen to them. They are always wrong. 

How will it end? When interest rates ultimately start to tick up and vast pools of capital begin to shift toward fixed income away from equities. It’s a historic cyclical shift. When the music stops and everyone needs to scramble for their chair, there will be a lot of fannies left hanging out there.

Predicting that this will happen is easy; predicting exactly when, not so easy. But my prediction is that it is not far off. (“Tech Boom 2015: What’s Driving Investor Insanity?” Forbes, 05/21/2015)

Michael Novogratz, head of the $67 billion Fortress hedge fund operation, shared that concern at the SALT gathering:

“I’m going to argue that I think something has fundamentally changed.” He is worried because even though managers know assets are expensive, they are still long. This is a recipe for a difficult exit once all they want to close their positions. The liquidity will disappear and assets will reprice. As legendary trader Stanley Druckenmiller said, assets need a lot of volume and money to go up and much less to crash.  (Michael Novogratz CEO of Fortress Investments Is Worried About The Markets)

The question is, what’s a fund investor to do? Five things come to mind:

1. Do a quick check on your asset allocation and risk exposure. Any idea of how long a core equity fund might remain underwater; that is, how many months it takes for a fund to rebound from a bad decline? I scanned MFO’s premium fund screener for large-cap core funds that had been around 10 years or more. The five best funds took, on average, over two years to rebound. The average large cap fund took 58 months, on average, to recover from their maximum drawdown. Here’s the test: look at your portfolio value today and ask whether you’re capable of waiting until April, 2020 to ever see a number that high again. That’s the worst case for a large cap stock portfolio. For a conservative asset allocation, the recovery time is a year or two. For a moderate portfolio, three or so years. At base, decide now how long you can wait and adjust accordingly.
2. Join the Dry Powder Gang. We profiled, last month, a couple dozen entirely admirable funds that are holding substantial cash stakes. Some have been badly punished for their caution, both by investors and raters, but all have strong, stable management teams, coherent strategies and a record of deploying cash when prices get juicy.
3. Allocate some to funds that have won in up and down markets. They’re rare. Daren Fonda at Barron’s recommends “[f]unds such as FPA Crescent (FPACX) and First Eagle Global (SGENX) have flexible strategies and defensive-minded managers.”  Charles identified a handful of long-term stalwarts in his April 2015 essay “Identifying Bear-Market Resistant Funds During Good Times.” Among the notable funds (not all open to new investors) he highlighted:
   
4. Cautiously approach the alt-fund space. There are some alt funds which have a plausible claim to thrive on volatility. We’ve profiled RiverPark Structural Alpha (RSAFX), for instance, and our colleagues at DailyAlts.com regularly highlight intriguing options.
5. Try to leave when everyone else heads out, too. The Latin word for those massive exits was “vomitaria” which would make you …

Liquidity Problem – What Liquidity Problem?

By Edward A. Studzinski

“Moon in a barrel: you never know just when the bottom will fall out.”

 Mabutsu

So as David Snowball mentioned in his May commentary, I have been thinking about the potential consequences of illiquidity in the fixed income market. Obviously, if you have a portfolio in U.S. Treasury issues, you assume you can turn it into cash overnight. If you can’t, that’s a potential problem. That appears to be a problem now – selling $10 or $20 million in Treasuries without moving the market is difficult. Part of the problem is there are not a lot of natural buyers, especially at these rates and prices. QE has given the Federal Reserve their fill of them. Banks have to hold them as part of the Dodd-Frank capital requirements, but are adding to their holdings only when growing their assets. And those people who always act in the best interests of the United States, namely the Chinese, have been liquidating their U.S. Treasury portfolio. Why? As they cut rates to stimulate their economy, they are trying to sterilize their currency from the effects of those rate cuts by selling our bonds, part of their foreign reserve holdings. Remember, the goal of China is to supplant, with their own currency, the dollar as a reserve currency, especially in Asia and the developing world. And our Russian friends have similarly been selling their Treasury holdings, but in that instance using the proceeds to purchase gold bullion to add to their reserves.

Who is there to buy bonds today? Bond funds? Not likely. If you are a fund manager and thought a Treasury bond was a cash equivalent, it is not. But if there are redemptions from your fund, there is a line of credit to use until you can sell securities to cover the redemptions, right? And it is a committed line of credit, so the bank has to lend on it, no worries! In the face of a full blown market panic, with the same half dozen banks in the business of providing lines of credit to the fund industry, where will your fund firm fall in the pecking order of mutual fund holding companies, all of whom have committed lines of credit? It now becomes more understandable why the mutual fund firms with a number of grey hairs still around, have been raising cash in their funds, not just because they are running out of things to invest in that meet their parameters. It also gives you a sense as to who understands their obligations to their shareholder investors.

We also saw this week, through an article in The Wall Street Journal, that there is a liquidity problem in the equity markets as well. There are trading volumes at the open. There are trading volumes, usually quite heavy, at the end of the day. The rest of the time – there is no volume and no liquidity. So if you thought you had protected yourself from another tsunami by having no position in your fund composed of more than three days average volume of a large or mega cap stock, surprise – you have again fought the last war. And heaven help you if you decide to still sell a position when the liquidity is limited and you trigger one or more parameters for the program and quant traders.

As Lenin asked, “What is to be done?” Jason Zweig, whom I regard as the Zen Philosopher King of financial columnists, wrote a piece in the WSJ on May 23, 2015 entitled “Lessons From A Buffett Believer.” It is a discussion about the annual meeting of Markel Corporation and the presentation given by its Chief Investment Officer, Tom Gayner. Gayner, an active manager, has compiled a wonderful long-term investment record. However, he also has a huge competitive advantage. Markel is a property and casualty company that consistently underwrites at a profitable combined ratio. Gayner is always (monthly) receiving additional capital to invest. He does not appear to trade his portfolio. So the investors in Markel have gotten a double compounding effect both at the level of the investment portfolio and at the corporation (book value growth). And it has happened in a tax-efficient manner and with an expense ratio in investing that Vanguard would be proud of in its index funds.

I recently was speaking with a friend in Japan, Alex Kinmont, who has compiled a very strong record as a deep value investor in the Japanese market, in particular the small cap end of the market. We were discussing the viability of a global value fund and whether it could successfully exist with an open-ended mutual fund as its vehicle. Alex reminded me of something that I know but have on occasion forgotten in semi-retirement, which is that our style of value can be out of favor for years. Given the increased fickleness today of mutual fund investors, the style may not fit the vehicle. Robert Sanborn used to say the same thing about those occasions when value was out of favor (think dot.com insanity). But Robert was an investment manager who was always willing to put the interests of his investors above the interests of the business.

Alex made another point which is more telling, which is that Warren Buffett has been able to do what is sensible in investing successfully because he has permanent capital. Not for him the fear of redemptions. Not for him the need to appear at noon on the Gong Show on cable to flog his investment in Bank America as a stroke of genius. Not for him the need to pander to colleagues or holding company managers more worried about their bonuses than their fiduciary obligations. Gayner at Markel has the same huge competitive advantage. Both of them can focus on the underlying business value of their investments over the long term without having to worry about short-term market pricing volatility.

What does this mean for the average fund investor? You have to be very careful, because what you think you are investing in is not always what you are getting. You can see the whole transformation of a fund organization if you look carefully at what Third Avenue was and how it invested ten years ago. And now look at what its portfolios are invested in with the departure of most of the old hands.

The annual Morningstar Conference happens in a few weeks here in Chicago. Steve Romick of FPA Advisors and the manager of FPA Crescent will be a speaker, both at Morningstar and at an Investment Analysts Society of Chicago event. Steve now has more than $20B in assets in Crescent. If I were in a position to ask questions, one of them would be to inquire about the consequences of style drift given the size of the fund. Another would be about fees, where the fee breakpoints are, and will they be adjusted as assets continue to be sought after.

I believe in 2010, Steve’s colleague Bob Rodriguez did a well-deserved victory lap as a keynote speaker at Morningstar and also as well at another Investment Analysts Society of Chicago meeting. And what I heard then, both in the presentation and in the q&a by myself and others then has made me wonder, “What’s changed?” Of course, this was just before Bob was going on a year’s sabbatical, leaving the business in the hands of others. But, he said we should not expect to see FPA doing conference calls, or having a large marketing effort. And since all of their funds at that time, with the exception of Crescent, were load funds I asked him why they kept them as load funds? Bob said that that distribution channel had been loyal to them and they needed to be loyal to it, especially since it encouraged the investors to be long term. Now all the FPA Funds are no load, and they have marketing events and conference calls up the wazoo. What I suspect you are seeing is the kind of generational shift that occurs at organizations when the founders die or leave, and the children or adopted children want to make it seem like the success of the organization and the investment brilliance is solely due to them. For those of us familiar with the history of Source Capital and FPA, and the involvement of Charlie Munger, Jim Gipson, and George Michaelis, this is to say the least, disappointing.

Does Your Fund Manager Consistently Beat the Stock Market?

I saw the headline at Morningstar and had two immediate thoughts: (1) uhh, no, and (2) why on earth would I care since “beating the stock market” is not one of my portfolio objectives?

Then I read the sub-title: “Probably not–but you shouldn’t much care.”

“Ah! Rekenthaler!” I thought. And I was right.

John recounts a column by Chuck Jaffe, lamenting the demise of the star fund manager.  Rekenthaler’s questions are (1) are they actually gone? And (2) should you care? The answers are “yes” and “no, not much,” respectively.

Morningstar researchers looked to determine how long “winning streaks” last; that is, for how many consecutive years might a fund manager beat his or her benchmark. Over the past 10 years, none of the 1000 U.S. stock funds have beaten the S&P500 for more than six years. Ten funds managed six year streaks, but four of those were NASDAQ 100 index funds. Worse yet, active managers performed worse than simple luck would dictate.

Outliers

“At the extreme outer edge of what is statistically plausible” is how Malcom Gladwell defines an outlier in his amazing book, Outliers: The Story of Success (2008).

The MFO Rating System ranks funds based on risk adjusted return within their respective categories across various evaluation periods. The rankings are by quintile. Those in the top 20 percentile are assigned a 5, while those in the bottom 20 percentile are assigned a 1.

The percentile is not determined from simple rank ordering. For example, say there are 100 funds in the Large Growth category. The 20 funds with the highest risk adjusted return may not necessarily all be given a 5. That’s because our methodology assumes fund performance will be normally distributed across the category, which means terms like category mean and standard deviation are taken into account.

It’s similar to grading tests in school using a bell curve and, rightly or wrongly, is in deference to the random nature of returns. While not perfect, this method produces more satisfactory ranking results than the simple rank order method because it ensures, for example, that the bottom quintile funds (Return Group 1) have returns that are so many standard deviations below the mean or average returning funds (Return Group 3). Similarly, top quintile funds (Return Group 5) will have returns that are so many standard deviations above the mean.

All said, there remain drawbacks. At times, returns can be anything but random or “normally” distributed, which was painfully observed when the hedge fund Long-Term Capital Management (LTCM) collapsed in 1998. LTCM used quant models with normal distributions that underestimated the potential for extreme under performance. Such distributions can be skewed negatively, creating a so-called “left tail” perhaps driven by a market liquidity crunch, which means that the probability of extreme under-performance is higher than depicted on the left edge of the bell curve above.

Then there are outliers. Funds that over- or under-perform several standard deviations away from the mean. Depending on the number of funds in the category being ranked, these outliers can meaningfully alter the mean and standard deviation values themselves. For example, if a category has only 10 funds and one is an outlier, the resulting rankings could have the outlier assigned Return Group 5 and all others relegated to Return Group 1.

The MFO methodology removes outliers, anointing them if you will to bottom or top quintile, then recalculates rankings of remaining funds. It keeps track of the outliers across the evaluation periods ranked. Below please find a list of positive outliers, or extreme over-performers, based on the latest MFO Ratings of some 8700 funds, month ending April 2015.

The list contains some amazing funds and warrants a couple observations:

• Time mitigates outliers, which seems to be a manifestation of reversion to the mean, so no outliers are observed presently for periods beyond 205 or so months, or about 17 years.
• Outliers rarely repeat across different time frames, sad to say but certainly not unexpected as observed in In Search of Persistence.
• Outliers typically protect against drawdown, as evidenced by low Bear Decile score and Great Owl designations (highlighted in dark blue – Great Owls are assigned to funds that have earned top performance rank based on Martin for all evaluation periods 3 years or longer).

The following outliers have delivered extreme over-performance for periods 10 years and more (the tables depict 20 year or life metrics, as applicable):

Here are the outliers for periods 5 years and more (the tables depict 10 year or life metrics, as applicable):

Finally, the outliers for periods 3 years and more (the tables depict 5 year or life metrics, as applicable):

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, searchable, and filtered as never before. For the 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.

Order

The Tenth Circuit vacated a district court’s order that had granted class certification in the prospectus disclosure lawsuit regarding the Oppenheimer California Municipal Bond Fund, finding that “[t]he district court’s class certification order at issue here did not analyze either the Rule 23(a) or 23(b) factors.” Defendants include independent directors. (In re Cal. Mun. Fund.)

New Lawsuits

A new securities fraud class action targets four Virtus funds, alleging that defendants misrepresented the performance track record of the funds’ “AlphaSector” strategy (created by an unaffiliated sub-adviser). Defendants include independent directors. (Youngers v. Virtus Inv. Partners, Inc.)

A new antitrust lawsuit alleges that Waddell & Reed and Ivy Funds “financed and aided” Al Haymon’s illegal efforts to monopolize professional boxing. (Golden Boy Promotions LLC v. Haymon.)

Briefs

Davis filed a reply brief in support of its motion to dismiss fee litigation regarding its New York Venture Fund. (In re Davis N.Y. Venture Fund Fee Litig.)

PIMCO filed a reply brief in support of its motion to dismiss fee litigation regarding its Total Return Fund (Kenny v. Pac. Inv. Mgmt. Co.)

Having lost in district court, plaintiffs filed their opening appellate brief defending their state-law claims regarding investments of Vanguard mutual fund assets in foreign gambling businesses. Defendants include independent directors. (Hartsel v. Vanguard Group, Inc.)

Amended Complaint

Plaintiffs filed a second amended complaint in fee litigation regarding four MainStay funds issued by New York Life. (Redus-Tarchis v. N.Y. Life Inv. Mgmt., LLC.)

Answer

Having lost on appeal, Putnam filed an answer to fraud and negligence claims, filed by the insurer of a swap transaction, regarding Putnam’s collateral management services to a CDO. (Fin. Guar. Ins. Co. v. Putnam Advisory Co.)

The Alt Perspective: Commentary and news from DailyAlts

Every month Brian J. Haskin, founder, publisher and editor of DailyAlts shares news, perspective and commentary on the alt-space with the Observer’s readers. DailyAlts is the only website with a sole focus on liquid alternative investments.  They seek to provide 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. We’re always grateful for Brian’s commentary and he welcomes folks to drop by DailyAlts for more news in great depth. For now, the highlights:

The Access Revolution

There is an access revolution taking place in today’s investment world, especially with alternative investments. It started a number of years ago with platforms such as Kickstarter and Kiva, where everyday citizens could help others get their new idea off the ground. Today, individual investors can access a broad array of investments with just a few clicks of the mouse:

• Private equity via closed-end mutual funds
• Real estate lending and investing through crowdsourcing platforms
• Angel investing via online venture capital portals
• Private lending via online lending platforms

The list goes on, but the good news is that individual investors have far greater choice today than they did just a few years ago.

Much of the change taking place is due to changes in securities regulations that permit advertising and public promotion of private investment offerings. Other changes are driven by capital flowing to new technology-driven platforms and the broader use of existing investment vehicles.

Just this past month we had two new private equity offerings come to market in closed-end interval funds, one from Altegris / StepStone / KKR and the other from Pomona Capital / Voya:

• New Altegris Fund Gives Accredited Investors Exposure to Private Equity
• Pomona Capital and Voya Team Up on New Private Equity Fund

While these are not pure liquid alternatives (they don’t have daily liquidity, thankfully), they fall into the “near” liquid grouping. And furthermore, they give the mass-affluent access to investments that have never been available for as little as $25,000.

Expect to see more products such as these from the big name financial firms, as well as more access to alternatives through online investment portals. There is a revolution taking place.

Now, onto the liquid part of the alternatives market.

Monthly Liquid Alternative Flows

Investors allocated a total of $982 million to actively managed alternative mutual funds and ETFs in April, according to Morningstar’s most recent asset flows report, but pulled $259 million from passively managed alternative funds. Net flows totaled $723 million for the month, down from the healthy $2.8 billion of net new asset flows seen in March.

Interestingly, only two categories had positive flows in April: Multi-alternative funds and managed futures. Clearly a sign that advisors and investors are looking for either a one-stop shop for an alternatives allocation, or are looking to allocate to wholly uncorrelated strategies alongside equity and fixed income allocations. Managed futures strategies are generally expected to perform well during times of crisis, such as during the 2008 credit crisis, and when there are strong directional trends in markets, such as those we have seen in the past year with oil prices and the US dollar.

Last year was the year of non-traditional bonds, while 2015 is looking much stronger for several other strategies. Volatility based funds topped the charts for 12-month growth rates, with managed futures and multi-alternative funds not too far behind. And despite strong growth in 2014, non-traditional bond funds are only modestly keeping their head above water with a 12-month growth rate of 2.6%.

Based on growth rates and asset flows, diversification appears to be the primary focus of investors and allocators. In 2014, long/short equity fought against the $7.8 billion of outflows from the MainStay Marketfield Fund and still posted $6.4 billion of net inflows for the year. 2015 is looking quite different. Year-to-date, the long/short equity category is down $1.5 billion. While market neutral strategies can provide low levels of correlation with the equity markets, investors appear to be moving away from these strategies in favor of managed futures, volatility and multi-alternative funds.

Expect asset flows to liquid alternatives to continue on their current course of strong single-digit to low double-digit growth. Should markets falter, investors will look to allocate more to liquid alternatives.

New Fund Launches

We have seen 53 new funds launched this year, including alternative beta funds. In May, we logged 12 new funds, with nearly half being alternative beta funds. The remaining funds cut across multi-alternative, market neutral, non-traditional bonds, volatility and commodities. 

Two intriguing funds in the volatility space came to market in May:

• AccuShares Spot CBOE VIX Up Shares (VXUP)
• AccuShares Spot CBOE VIX Down Shares (VXDN)

These two funds are different because they provide direct exposure to the VIX Index, whereas other VIX related products are indexed to futures contracts on the VIX, and thus can have very high holding costs over the course of a month. Some time is needed on the new AccuShares ETFs, but if VIX is your game, these are worth keeping an eye on.

For more details, you can visit our New Funds 2015 page to see a full listing.

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.

JOHCM International Select II (JOHAX): it’s the single best performing international large growth fund in existence over the past 1, 3 and 5 years. It’s got five stars. It’s a Great Owl. You’ve probably never heard of it and it’s closing in mid-July. Now does any of that offer a compelling reason to add it to your portfolio?

Elevator Talk: Jon Angrist, Cognios Market Neutral Large Cap

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.

Market-neutral funds are, on whole, dumb investments. They’re funds with complex strategies, high expenses and low returns which provide questionable protection for their investors. By way of simple illustration, the average market-neutral fund charges 1.70% while returning 1.25% annually over the past five years. Right: 60% of the portfolio’s (modest) returns go to the adviser in the form of fees, 40% go to you.

About the best you can say for them is that, as a group, they lost only a little money in 2008: about 0.3%. The worst you can say is that they also lost a little money in 2009. And then a little more in 2010. And yet again in 2011 before their … uh, ferocious rebound led to a 0.18% gain in 2012.

Into the mess steps Jon Angrist, Brian J. Machtley and the folks at Cognios Capital. In 2008, Messrs. Angrist and Machtley co-founded Cognios (from the Latin for “to learn” or “to inquire”) which manages about $325 million, mostly for high net worth individuals. Mr. Angrist, the lead manager, has experience managing investments through limited partnerships (Helzberg Angrist Capital), private equity firms (Harvest Partners) and mutual funds (Buffalo Microcap Fund, now called Buffalo Emerging Opportunities BUFOX).

Cognios argues that most market-neutral managers misconstruct their portfolios. Most managers simply balance their short and long books: if 5% gets invested in an attractively valued car company then another 5% is devoted to shorting an unattractively valued car company. The problem is that an over-priced company might well be more volatile than an underpriced one, which means that the portfolio ceases to be market-neutral. The twist at Cognios, then, is to use quant tools to construct an attractive large cap portfolio while changing the relative sizes of the long and short books to neutralize beta. Cognios Market Neutral Large Cap describes itself as providing a “beta-adjusted market neutral” portfolio.

In a Beta-adjusted market neutral portfolio the size of the short book can be larger or smaller than the size of the long book. If the Beta of the long book is higher than the Beta of the short book, the short book needs to be larger than the size of the long book in order to remove all of the market’s broad movements (i.e., to remove the market’s Beta) … Even though the portfolio will be net short on an absolute dollar basis in [this] example (i.e., more shorts than longs) … [it] both would be market neutral on a Beta-adjusted basis.

So far, this seems to be a profitable strategy. Below is the comparative performance of Cognios (blue line) since inception, against its market neutral peer group.

Here are Jon’s 264 words on why this might become a standout strategy:

Brian and I have been working in value investing for most of our careers and about three years ago, as we looked at the mutual fund universe, we saw a huge gap in market neutral offerings for individual investors. Even today, there are less than 40 market neutral mutual funds (not share classes). In today’s market environment, I believe a market neutral allocation, beta market neutral in particular, is a critical diversification tool in an investor’s overall asset allocation as it is the only strategy that strives to remove the impact of the market and macro events from the return of the strategy. Unlike most market neutral strategies that target risk-free rates of return, our fund targets equity-like returns over full market cycles because, in my opinion, if an investor wants Treasury-like returns why wouldn’t he/she just buy Treasuries?

There was a real need in the market for which our strategy could provide a solution if packaged in a mutual fund wrapper and because we only invest in large, liquid companies in the S&P 500, we didn’t have to change our strategy in order to deploy it in a mutual fund. Investors and their advisors are looking for strategies that seek to reduce volatility, standard deviation and downside risk in a portfolio, which is the primary objective of our fund. This fund has made it possible for a wide range of investors to access the same strategy that we provide to our institutional clients in other structures. As investors in our own fund, we have a very strong conviction about what we are doing.

Cognios Market Neutral Large Cap (COGMX/COGIX) has a $1000 minimum initial investment for its retail class and $100,000 for the institutional class. Both are modest in comparison to the $25 million minimum for a separately managed account. Expenses are capped at 1.95% on the investor shares, at least through early 2016. The fund has about gathered about $16 million in assets since its December 2012 launch. More information can be found at the fund’s homepage. There’s also a quick slideshow on a third-party website that walks through the basics of the fund’s strategy.

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 July or August and some of the prospectuses do highlight that date.

This month our research associate David Welsch tracked down eight no-load retail funds in registration, which represents our core interest. Of those, four carry ESG screens (two from TIAA-CREF and two from Trillium) and three represent absolute value or absolute return strategies, while one is a short-term bond index. Interesting cluster of interests.

Manager Changes

This month 66 funds reported partial or complete changes in their management teams, a number slightly inflated by a dozen partial team changes in the AB (formerly AllianceBernstein) retirement date funds. The most striking were the imminent departures of PIMCO’s global equities CIO Virginie Maisonneuve plus several equity managers and analysts as PIMCO pulls back on their attempt to make a mark in pure equity investing. There was, in addition, announcement of the planned departure of Robert Mohn, Domestic Chief Investment Officer of Columbia Wanger Asset Management and Vice President of Wanger Advisors Trust who will step down in the fourth quarter of 2015. The change was announced for Wanger USA (WUSAX) but will presumably ripple through a series of Columbia Acorn funds eventually. In addition, Matt Paschke of the Leuthold Funds is taking a leave of absence to pursue personal interests for a bit. He’s a good and level-headed guy and we wish him well.

Updates

Andrew Foster, manager of Seafarer Overseas Growth & Income (SFGIX), was the guest on a sort-of video interview with Morningstar’s Jason Stipp in mid-May. The interview, entitled “Seeking Sustainable Growth in Emerging Markets,” covers much of the same ground as our recent conference call with Mr. Foster. One difference is that he spoke at greater length about China in his conversation with Mr. Stipp. I’ve designed it as a “sort of” video call because Jason was on-camera while Andrew was on a phone, with his picture superimposed on the screen.

Seafarer, with a three year record and five star rating, seems to have found its footing in the marketplace. The fund now boasts over a quarter billion in well-deserved assets.

Briefly Noted . . .

Ted, The Linkster and long-time stalwart of our discussion board, cheers for Dodge & Cox shareholders. He shared a USA Today story “3 AOL Investors Bag a Quick $200M” that calculates the gain to D&C shareholders from Verizon’s bid to acquire AOL. The Dodge & Cox funds own 15% of the outstanding shares of AOL, which netted them $95,000,000 in a single day. Sadly, the D&C funds are so big that AOL contributed just a fraction of a percent to returns that day. Iridian Asset Management and BlackRock finished second and third in total gains.

Ted also reports that the famously frugal Vanguard Group decided to chuck $200,000 at Bill Clinton in exchange for a 2012 speech for Vanguard’s institutional clients. That’s not an exceptional amount to hear from the former First Saxophonist; The Washington Post shows Bill pocketing $105 million for 542 speeches from the time he left the White House until the time Hilary Rodham-Clinton left the State Department. That comes to an average of $194,000 which suggests that Vanguard might have gotten just a bit flabby on their cost containment with this talk. The record might have been $300,000 paid by Dell that same year.

SMALL WINS FOR INVESTORS

Hmmm … does “nothing really bad has happened yet” qualify as a win? Other than that, we’ve got the reopening of BlackRock Event Driven Equity Fund (BALPX) on or about July 27, 2015. Bad news: BALPX is tiny, expensive and sucks. Good news: they brought in a new manager in early May, 2015. Mark McKenna left Harvard’s endowment team and joined BlackRock last year to run an event-driven hedge fund. He’s now been moved here. The other bad news: Harvard’s performance was surprisingly poor during McKenna’s tenure, which doesn’t say McKenna was responsible for the poor performance, just that he didn’t live up to the vaunted Harvard standard. As a result, this is a small win.

CLOSINGS (and related inconveniences)

American Century Small Cap Value Fund sort of closed on May 1. In an increasingly common move, the adviser left the door open for those who invest directly with the fund and for “certain financial intermediaries selected by American Century.”

ASTON/River Road Dividend All Cap Value Fund (ARDEX) and ASTON/Fairpointe Mid Cap Fund (CHTTX) have each been soft-closed. Each management team has a second fund still open.

Effective June 12, 2015, $4.2 billion Diamond Hill Long-Short Fund (DIAMX) will close to most new investors. The fund has exceptional returns for an exceptional period. Its 3-, 5- and 10-year records cluster around the 25^th percentile of all long-short funds. Potential investors need to take two factors into consideration when deciding whether to jump in: (1) performance is driven primarily by the strength of its long portfolio and (2) the lead manager for the long portfolio, Chuck Bath, is stepping aside. He’ll remain as a sort of backup manager but wants to focus his attention on Diamond Hill Large Cap. There’s no easy way of guessing how much his reorientation will cost the fund, so proceed thoughtfully if at all.

Effective as of the close of business on July 15, 2015, the $2.8 billion, five-star JOHCM International Select Fund (JOHIX) will be soft-closed. As friend Marjorie Pannell points out, the fund is an MFO Great Owl with eye-popping performance:

1 year – top 1% – (1 out of 339 funds) 
3 year – top 1% – (1 out of 293 funds) 
5 year – top 1% – (1 out of 277 funds)

Vulcan Value Partners (VVLPX) closed on June 1, rather later than originally planned. Out of respect for manager C.T. Fitzpatrick’s excellent long-term record here and at the Longleaf Funds, we sent out a notice of the extended window of opportunity to the 6000 or so folks on our email list.The $14 billion T. Rowe Price Health Sciences Fund (PRHSX) closed to new investors on June 1, 2015. Morningstar covered the fund avidly until the departure of star manager Kris Jenner. Over 13 years, Jenner nearly doubled the annualized returns of his benchmark. He left with two analysts, leaving the remaining analyst to take the reins. There was about $6 billion in the fund when Jenner (and Morningstar) left. Since then the fund has been much more T. Rowe Price-like: it has converted consistent, modest outperformance and risk consciousness into a fine record under manager Taymour Tamaddon.

OLD WINE, NEW BOTTLES

Barrow All-Cap Core Fund (BALAX) is now Barrow Value Opportunity Fund and Barrow All-Cap Long/Short Fund (BFLSX) has been renamed Barrow Long/Short Opportunity Fund. Morningstar hasn’t caught up with the change yet.

Brown Capital Management Mid-Cap Fund is now Brown Capital Management Mid Company Fund (BCSMX). Rather than investing in mid-cap stocks, the fund will target mid-sized companies: those with total operating revenues of $500 million to $10 billion.

Catalyst Absolute Total Return Fund, will undergo a name and objective change to Catalyst Intelligent Alternative Fund in July.

Over the course of the past month, The Hartford Emerging Markets Research Fund (HERAX) was … uhh, tweaked a bit so that it has a new investment mandate, lower management fee (though no break on the bottom line expense ratio), new manager (Cheryl Duckworth is out, David Elliott of Wellington is in) and new name, Hartford Emerging Markets Equity Fund. One striking element of the change was the introduction of a new “related accounts performance” table, which shows how Mr. Elliott’s other EM porfolios perform before and after deductions for Hartford’s sales charges and expenses. Since inception, Elliott’s portfolio has returned 6.9% which crushes his benchmark’s 3.6%. Deduct sales charges and expenses and investors would pocket only 3.9%. That is, 56% of the manager’s raw performance gets routed to The Hartford and 44% goes to his investors. Other than for that, it was pretty much status quo in Hartford.

Roxbury/Mar Vista Strategic Growth Fund was recently rechristened as the Mar Vista Strategic Growth Fund (MVSGX) while Roxbury/Hood River Small-Cap Growth Fund became Hood River Small-Cap Growth Fund (HRSMX). Both are tiny but have really solid records. Heck, in Hood River’s case, it has a top tier 3-, 5- and 10 year record

On July 1, 2015, the T. Rowe Price Strategic Income Fund (PRSNX) will change its name to the T. Rowe Price Global Multi-Sector Bond Fund.

Effective May 30, 2015, the name of Turner Spectrum Fund was changed to Turner Titan II Fund. . Under its new dispensation, the fund “invests primarily in equity securities of companies with large capitalization ranges across major industry sectors using a long/short strategy in seeking to capture alpha, reduce volatility, and preserve capital in declining markets.”

On May 1, 2015, the European Equity Fund (VEEEX) became the Global Strategic Income Fund. Morningstar continues its membership in the European equity peer group despite the fact that, well, it ain’t.

OFF TO THE DUSTBIN OF HISTORY

It was a bad month for both alternative strategy and bond funds. Of the 23 funds that went extinct this month, five pursued alternative strategies, four were fixed-income funds – mostly international – and two were stock/bond hybrids.

361 Market Neutral Fund (ALSQX) underwent “termination, liquidation and dissolution” on May 29, 2015. The fund had an all-star management team, spotty record and trivial asset base.

As of March 9, 2015, AllianzGI Opportunity Fund merged into AllianzGI Small-Cap Blend Fund (AZBAX). The topic came up in a mid-May SEC filing, so I thought I’d mention.

Ancora Equity Fund (ANQIX) will be liquidated and dissolved on or about June 26, 2015.

Ave Maria Opportunity Fund (AVESX), a tiny small-value fund with a lot of faith in energy stocks, will merge into Ave Maria Catholic Values Fund (AVEMX) at the end of July.

Catalyst Event Arbitrage Fund (CEAAX), which was a good hedge fund and a bad mutual fund, will be liquidated on June 15, 2015.

Clear River Fund (CLRVX) will liquidate on June 30, 2015. No, I’ve never heard of it, either. The closest to a fun fact about the fund is that it never managed to finish any calendar year with above-average returns relative to its Morningstar peer group.

A new speed record: The Trustees of Context Capital Funds launched the Context Alternative Strategies Fund (CALTX) with two managers and seven sub-advisers in March, 2014. Performance started out as mediocre but by December turned ugly. Having been patient for more than a year(!), the Trustees dismissed their two managers on May 18, then filed a prospectus supplement on Friday, May 29, 2015 that announced the liquidation of the fund on the next business day, Monday, June 1, 2015. That liquidation leaves Context with one fund, Context Macro Opportunities (CMOTX), which nominally launched in December, hasn’t traded yet, has $100,000 in assets and a $1,000,000 minimum.

Encompass Fund (ENCPX) liquidated on May 27, 2015. They launched about seven years ago, convinced that it was time to focus on materials stocks. They were right, then they were very wrong; the fund tended to finish in the top 1% or the bottom 1% of its noticeably volatile natural resources peer group. At the end, they had $2 million in AUM and were dead last in their peer group. The managers and trustees, to their great credit if not to their personal gain, held about half of the fund’s total assets.

That said, the managers wrote a thoughtful and appropriate eulogy for the fund in their last letter to shareholders.

We want the shareholders to know that we resigned with a keen sense of disappointment. After posting exceptional returns in 2009 and 2010, we were optimistic that the Fund’s overweight in precious and industrial metals would continue to enable Encompass to excel. However, the last 4 years were difficult ones for resource companies and the Fund has underperformed. We did increase exposure to the energy sector in late 2013 and early 2014. Those stocks performed very well until oil prices shocked investors by declining more than 50% in the second half of 2014.

More recently we increased the Fund’s exposure to the health care, cybersecurity and airline industries with good results. However, the resource companies have continued to weigh on overall portfolio performance even though exposure to metals has been significantly reduced.

When we launched Encompass in mid-2006, we believed the time was right for a diversified mutual fund that emphasized resource companies. For several years we were proven right, but despite fundamentals that historically have been good for metals companies, the last few years have been very challenging. The Fund has not been able to grow and thus we came to the very difficult decision that we should resign as Manager. The Fund’s independent Trustees considered various alternatives and concluded that the Fund should be liquidated.

We have begun liquidating the Fund’s holdings, and intend to complete the process in the next couple of weeks. Of course, we are attempting to maximize the proceeds for the benefit of shareholders.

Guggenheim Enhanced World Equity Fund (GEEWX) will liquidate on June 26, 2015. $6 million in assets with a 600% annual turnover which, I presume, is the “enhancement” implied by the name.

Innealta Capital Global All Asset Opportunity Fund (ROMAX) will discontinue operations on June 19^th. The fund managed to rake in just about $3 million in its two years of high expense/high turnover/low returns operations.

In mid-July, Jamestown Balanced Fund (JAMBX) will ask its shareholders for permission to merge into Jamestown Equity Fund (JAMEX). The rationale is that the funds have “similar investment objectives, investment strategies and risk factors,” which is true give or take the nearly 50% higher volatility that investors in the equity fund experience over investors in the balanced one.

The trustees of the fund have authorized the liquidation of the Pioneer Emerging Markets Local Currency Debt Fund (LCEMX) which will occur on August 7, 2015. To put the decision in context: over the past couple years, investing in emerging markets bonds (the orange line) has been a bad idea, investing in EM bonds denominated in local currencies (green) has been a worse idea and investing in the Pioneer fund (blue) has been a thorough disaster.

On the upside, with only $10 million in assets, no one much was hurt. As of the last SAI, the manager hadn’t invested a single dinar, rupee or pataca in the fund so his portfolio was pretty much unscathed.

The Listed Private Equity Plus Fund become unlisted on May 18, 2015.

On May 15, 2015, the Loomis Sayles International Bond Fund was liquidated. A subsequent SEC filing helpfully notes: “The Fund no longer exists, and as a result, shares of the Fund are no longer available for purchase or exchange.”

PIMCO is retreating from the equity business with the liquidation of PIMCO Emerging Multi-Asset (PEAAX), PIMCO EqS^® Emerging Markets (PEQAX) and PIMCO EqS Pathfinder (PATHX) funds, all on July 14, 2015. Pathfinder, with nearly $900 million in assets, was supposed to be a vehicle to showcase the talents of two Franklin Mutual Series managers who defected to PIMCO. That didn’t play out during the fund’s five year history, arguably because it was better positioned for down markets than for rising ones. PEAAX was a small, sucky fund of PIMCO funds. PEQAX was a slightly less small, slightly less sucky fund that was supposed to be the star vehicle for an imported GSAM team. Oops.

Rx Tax Advantaged Fund (FMERX) will liquidate soon. It managed to parlay high expenses and a low-return asset class (muni bonds) into a tiny, money-losing proposition.

Templeton Constrained Bond Fund (FTCAX) goes the way of the dodo bird on August 27, 2015 which “may be delayed if unforeseen circumstances arise.” I can’t for the life of me figure out what the “constraint” in the fund name referred to. The prospectus announces:

Under normal market conditions, the Fund invests at least 80% of its net assets in “bonds.” Bonds include debt obligations of any maturity, such as bonds, notes, bills and debentures.

The constraint is that the bond fund must buy “bonds”? The last portfolio report shows them at 90% cash in a $10 million portfolio.

Touchstone International Fixed Income Fund (TIFAX), in recognition of “its small size and limited growth potential,” will liquidate on July 21, 2015. “An overweight to peripheral and speculative issuers” helped performance, right up to the moment when it didn’t:

Okay, they really, really mean it this time: The Turner Funds determined to close and liquidate the Turner Titan Fund (TTLFX), effective on or about June 19, 2015. The Fund had previously been scheduled to close and liquidate on or about June 1, 2015. That’s followed its closure at the end of 2014 and previously announced plans to liquidate in mid-March and late April.

V2 Hedged Equity Fund (VVHEX/VVHIX), responding to “an anticipated decline in Fund assets,” liquidated in early May.

I appreciate thoroughness: “Effective April 30, 2015, the Virtus Global Commodities Stock Fund … was liquidated. The Fund has ceased to exist and is no longer available for sale. Accordingly, the prospectus and SAI are no longer valid.” Any questions?

In Closing . . .

Thanks, as always, to the folks who support the Observer. To Binod, greetings and good luck with the rising waters in Houston. We feel for you! Thanks to Joe for the thumbs-up on our continuing redesign of the Observer’s site; it’s always good to get an endorsement from a pro! Tom, thank you, we’re so glad that you find our site useful. Thanks, finally, to the folks who’ve bookmarked the Observer’s link to Amazon. Normally our Amazon revenue tails off dramatically at mid-year. So far this season, it’s held up reasonably well and we’re grateful.

We’ll look for you at Morningstar. I’ll be the one dressed like a small oak. It’s a ploy! John Rekenthaler (Bavarian for “thunder talker,” I think) recently mused “I don’t actually get invited to parties, but if I did, I’d be chatting with the potted plants.” I figure that with proper foliage I might lure the Great Man into amiable conversation.

If any of you would like to join Hedda, Jake, (maybe) Tadas and the good folks from the Queens Road funds (they’ve promised me fresh peanuts) in diverting my attention and saving John from my interminable prattle, please do drop us a note and we’ll set up a time to meet. The Observer folks should be around the conference from early Wednesday until well past its Friday close.

As always, we’ll post daily conference highlights on MFO’s discussion board. (No, I don’t tweet and you can’t make me.) If you miss them there, we’ll share them in our July issue. In addition, we have profiles of some new ESG/green funds – equity, income and hybrid – on tap. We’ll explain why in July!

As ever,

Dear friends,

It’s May, a sweet and anxious time at college. The End is tantalizingly close; just two weeks remain in the academic year and, for many, in their academic career.  Both the trees on the Quad and summer wardrobes are bursting out. The days remaining and the brain cells remaining shrink to a precious few. We all wonder where another year (my 31^st here) went, holding on to its black-robed closing days even as we long for the change of pace and breathing space that summer promises.

For investors too summer holds promise, for days away and for markets unhinged. Perhaps thinking a bit ahead while the hinges remain intact might be a prudent course and a helpful prologue to lazy, hazy and crazy.

The Dry Powder Crowd

A bunch of fundamentally solid funds have been hammered by their absolute value orientation; that is, their refusal to buy stocks when they believe that the stock’s valuations and the underlying corporation’s prospects simply do not offer a sufficient margin of safety for the risks they’re taking, much less compelling opportunities. The mere fact that a fund sports just one lonely star in the Morningstar system should not disqualify it from serious consideration. Many times a low star rating reflects the fact that a particular style or perspective is out-of-favor, but the managers were unwilling to surrender their discipline to play to what’s popular.

That strikes us as admirable.

Sometimes a fund ends up with a one-star rating simply because it’s too independent to fit into one of Morningstar’s or Lipper’s predetermined boxes.

We screened for one-star equity funds with over 20% cash. From that list we looked for solid, disciplined funds whose Morningstar ratings have taken a pounding. Those include:

Frankly, any one of the funds above has the potential to be the best performer in your portfolio over the next five years especially if interest rates and valuations begin to normalize.

The challenge of overcoming cash seems so titanic that it’s worth noting, especially, the funds whose managers have managed to marry substantial cash strong with ongoing strong absolute and relative returns. These funds all have at least 20% cash and four- or five-star ratings from Morningstar, as of April 2015.

Fans of large funds (or Goodhaven) might want to consult Morningstar’s recommended list of “Cash-Heavy Funds for the Cautious Investor” which includes five names:

It’s time for an upgrade

The story was all over the place on the morning of April 20^th:

• Reuters: “Carlyle to shutter its two mutual funds”
• Bloomberg: “Carlyle to close two mutual funds in liquid alts setback”
• Ignites: “Carlyle pulls plug on two mutual funds”
• ValueWalk: “Carlyle to liquidate a pair of mutual funds”
• Barron’s: “Carlyle closing funds, gold slips”
• MFWire dutifully linked to three of them in its morning link list

Business Insider gets it closest to right: “Private equity giant Carlyle Group is shutting down the two mutual funds it launched just a year ago,” including Carlyle Global Core Allocation Fund.

What’s my beef? 

1. Carlyle doesn’t have two mutual funds, they have one. They have authorization to launch the second fund, but never have. It’s like shuttering an unbuilt house. Reuters, nonetheless, solemnly notes that the second fund “never took off [and] will also be wound down,” implying that – despite Carlyle’s best efforts, it was just an undistinguished performer.
2. The fund they have isn’t the one named in the stories. There is no such fund as Carlyle Global Core Allocation Fund, a fund mentioned in every story. Its name is Carlyle Core Allocation Fund(CCAIX/CCANX). It’s rather like the Janus Global Unconstrained Bond Fund that, despite Janus’s insistence, didn’t exist at the point that Mr. Gross joined the team. “Global” is a description but not in the name.
3. The Carlyle fund is not newsworthy. It’s less than one year old, it has a trivial asset base ($50 million) and has not yet made a penny ($10,000 at inception is now $9930).

If folks wanted to find a story here, a good title might be “Another big name private investor trawls the fund space for assets, doesn’t receive immediate gratification and almost immediately loses interest.” I detest the practice of tossing a fund into the market then shutting it in its first year; it really speaks poorly of the adviser’s planning, understanding and commitment but it seems distressingly common.

What’s my solution?

Upgrade. Most news outlets are no longer capable of doing that for you; they simply don’t have the resources to do a better job or to separate press release from self-serving bilge from news so you need to do it for yourself.

Switch to Bloomberg TV from, you know, the screechy guys. If it’s not universally lauded, it does seem broadly recognized as the most thoughtful of the financial television channels.

Develop the habit of listening to Marketplace, online or on public radio. It’s a service of American Public Media and I love listening to Kai Ryssdal and crew for their broad, intelligent, insightful reporting on a wide range of topics in finance and money.

Read the Saturday Wall Street Journal, which contains more sensible content per inch than any other paper that lands on my desk. Jason Zweig’s column alone is worth the price of admission. His most recent weekend piece, “A History of Mutual-Fund Doors Opening and Closing,” is outstanding, if only because it quotes me.  About 90% of us would benefit from less saturation with the daily noise and more time to read pieces that offer a bit of perspective.

Reward yourself richly on any day when your child’s baseball score comes immediately to mind but you can honestly say you have no earthly clue what the score of the Dow Jones is. That’s not advice for casual investors, that’s advice for professionals: the last thing on earth that you want is a time horizon that’s measured in hours, days, weeks or months. On that scale the movement of markets is utterly unpredictable and focusing on those horizons will damage you more deeply and more consistently than any other bad habit you can develop.

Go read a good book and I don’t mean financial porn. If your competitive advantage is seeing things that other people (uhh, the herd) don’t see, then you’ve got to expose yourself to things other people don’t experience. In a world increasingly dominated by six inch screens, books – those things made from trees – fit the bill. Bill Gates recommends The Bully Pulpit, by Doris Kearns Goodwin. Goodwin “studies the lives of America’s 26th and 27th presidents to examine a question that fascinates me: How does social change happen?” That is, Teddy Roosevelt and William Taft. Power down your phone while you’re reading. The aforementioned Mr. Zweig fusses that “you can’t spend all day reading things that train your brain to twitch” and offers up Daniel Kahneman’s Thinking, Fast and Slow. Having something that you sip, rather than gulp, does help turn reading from an obligation to a calming ritual. Nina Kallen, a friend, insurance coverage lawyer in Boston and one of the sharpest people we know, declares Roger Fisher and William Ury’s Getting to Yes: Negotiating Agreement Without Giving In to be “life-changing.” In her judgment, it’s the one book that every 18-year-old should be handed as part of the process of becoming an adult. Chip and I have moved the book to the top of our joint reading list for the month ahead. Speaking of 18-year-olds, it wouldn’t hurt if your children actually saw you reading; perhaps if you tell them they wouldn’t like it, they’d insist on joining you.

How Good Is Your Fund Family? An Update…

Baseball season has started. MLB.TV actually plays more commercials than it used to, which sad to say I enjoy more than the silent “Commercial Break In Progress” screen, even if they are repetitive.

One commercial is for The Hartford Funds. The company launched a media campaign introducing a new tagline, “Our benchmark is the investor℠,” and its focus on “human-centric investing.”

Its website touts research they have done with MIT on aging, and its funds are actually sub-advised by Wellington Management.

A quick look shows 66 funds, each with some 6 share classes, and just under $100B AUM. Of the 66, most charge front loads up to 5.5% with an average annual expense ratio of just over 1%, including 12b-1 fee. And, 60 have been around for more than 3 years, averaging 15 years in fact.

How well have their funds performed over their lifetimes? Just average … a near even split between funds over-performing and under-performing their peers, including expenses.

We first started looking at fund family performance last year in the piece “How Good Is Your Fund Family?” Following much the same methodology, with all the same qualifications, below is a brief update. Shortly, we hope to publish an ongoing tally, or “Fund Family Score Card” if you will, because … during the next commercial break, while watching a fund family’s newest media campaign, we want to make it easier for you to gauge how well a fund family has performed against its peers.

The current playing field has about 6200 US funds packaged and usually marketed in 225 families. For our tally, each family includes at least 5 funds with ages 3 years or more. Oldest share class only, excluding money market, bear, trading, and specialized commodity funds. Though the numbers sound high, the field is actually dominated by just five families, as shown below:

It is interesting that while Vanguard represents the largest family by AUM, with nearly twice its nearest competitor, its average annual ER of 0.22% is less than one third either Fidelity or American Funds, at 0.79% and 0.71%, respectively. So, even without front loads, which both the latter use to excess, they are likely raking in much more in fees than Vanguard.

Ranking each of the 225 families based on number of funds that beat their category averages produces the following score card, by quintile, best to worst:

Of the five families, four are in top two quintiles: Vanguard, American Funds, Fidelity, and T. Rowe Price.  In fact, of Vanguard’s 145 funds, 119 beat their peers. Extraordinary. But BlackRock is just average, like Hartford.

The difference in average total return between top and bottom fund families on score card is 3.1% per year!

The line-ups of some of the bottom quintile families include 100% under-performers, where every fund has returned less than its peers over their lifetimes: Commonwealth, Integrity, Lincoln, Oak Associates, Pacific Advisors, Pacific Financial, Praxis, STAAR. Do you think their investors know? Do the investors of Goldman Sachs know that their funds are bottom quintile … written-off to survivorship bias possibly?

Visiting the website of Oberweis, you don’t see that four of its six funds under-performed. Instead, you find: TWO FUNDS NAMED “BEST FUND” IN 2015 LIPPER AWARDS. Yes, its two over-performers.

While the line-ups of some top quintile families include 100% over-performers: Cambiar, Causeway, Dodge & Cox, First Eagle, Marsico, Mirae, Robeco, Tocqueville.

Here is a summary of some of the current best and worst:

While not meeting the “five funds” minimum, some other notables: Tweedy Browne has 4 of 4 over-performers, and Berwyn, FMI, Mairs & Power, Meridian, and PRIMECAP Odyssey all have 3 of 3.

(PRIMECAP is an interesting case. It actually advises 6 funds, but 3 are packaged as part of the Vanguard family. All 6 PRIMECAP advised funds are long-term overperformers … 3.4% per year across an average of 15 years! Similarly with OakTree. All four of its funds beat their peers, but only 2 under its own name.)

As well as younger families off to great starts: KP, 14 of 14 over-performers, Rothschild 7 of 7, Gotham 5 of 5, and Grandeur Peak 4 of 4. We will find a way to call attention to these funds too on the future “Fund Family Score Card.”

Ed is on assignment, staking out a possible roach motel

Our distinguished senior colleague Ed Studzinski is a deep-value investor; his impulse is to worry more about protecting his investors when times turn dark than in making them as rich as Croesus when the days are bright and sunny. He’s been meditating, of late, on the question of whether there’s anything a manager today might do that would reliably protect his investors in the case of a market crisis akin to 2008.

Ed is one of a growing number of investors who are fearful that we might be approaching a roach motel; that is, a situation where it’s easy to get into a particular security but where it might be impossible to get back out of it when you urgently want to.

Structural changes in the market and market regulations have, some fear, put us at risk for a liquidity crisis. In a liquidity crisis, the ability of market makers to absorb the volume of securities offered for sale and to efficiently match buyers and sellers disappears. A manager under pressure to sell a million dollars’ worth of corporate bonds might well find that there’s only a market for two-thirds of that amount, the remaining third could swiftly become illiquid – that is, unmarketable – securities.

David Sherman, president of Cohanzick Asset Management and manager of two RiverPark’s non-traditional bond funds addressed the issue in his most recent shareholder letter. I came away from it with two strong impressions:

There may be emerging structural problems in the investment-grade fixed-income market. At base, the unintended consequences of well-intended reforms may be draining liquidity from the market (the market makers have dramatically less cash and less skin in the game than they once did) and making it hard to market large fixed-income sales. An immediate manifestation is the problem in getting large bond issuances sold.

Things might get noticeably worse for folks managing large fixed-income portfolios. His argument is that given the challenges facing large bond issues, you really want a fund that can benefit from small bond issues. That means a small fund with commitments to looking beyond the investment-grade universe and to closing before size becomes a hindrance.

Some of his concerns are echoed on a news site tailored for portfolio managers, ninetwentynine.com. An article entitled “Have managers lost sight of liquidity risk?” argues:

A liquidity drought in the bond space is a real concern if the Fed starts raising rates, but as the Fed pushes off the expected date of its first hike, some managers may be losing sight of that danger. That’s according to Fed officials, who argue that if a rate hike catches too many managers off their feet, the least they can expect is a taper tantrum similar to 2013, reports Reuters. The worst-case-scenario is a full-blown liquidity crisis.

The most recent investor letter from the managers of Driehaus Active Income Fund (LCMAX) warns that recent structural changes in the market have made it increasingly fragile:

Since the end of the credit crisis, there have been a number of structural changes in the credit markets, including new regulations, a reduced size of broker dealer trading desks, changes in fund flows, and significant growth of larger index-based mutual funds and ETFs. The “new” market environment and players have impacted nearly all aspects of the market, including trading liquidity. The transfer of risk is not nearly as orderly as it once was and is now more expensive and volatile … one thing nearly everyone can agree on is that liquidity in the credit markets has decreased materially since the credit crisis.

The federal Office of Financial Research concurs: “Markets have become more brittle because liquidity may be less available in a downturn.” Ben Inker, head of GMO’s asset allocation group, just observed that “the liquidity in [corporate credit] markets has become shockingly poor.”

More and more money is being stashed in a handful of enormous fixed income funds, active and passive. In general, those might be incredibly regrettable places to be when liquidity becomes constrained:

Generally speaking, you’re going to need liquidity in your bond fund when the market is stressed. When the market is falling apart, the ETFs are the worst place to be, as evidenced by their underperformance to the index in 2008, 2011 and 2013. So yes, you will have liquidity, but it will be in something that is cratering.

What does this mean for you?

1. Formerly safe havens won’t necessarily remain safe.
2. You need to know what strategy your portfolio manager has for getting ahead of a liquidity crunch and for managing during it. The Driehaus folks list seven or eight sensible steps they’ve taken and Mr. Sherman walks through the structural elements of his portfolio that mitigate such risks.
3. If your manager pretend not to know what the concern is or suggests you shouldn’t worry your pretty little head about it, fire him.

In the interim, Mr. Studzinski is off worrying on your behalf, talking with other investors and looking for a safe(r) path forward. We’re hoping that he’ll return next month with word of what he’s found.

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 the 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.

Orders

• The SEC charged BlackRock Advisors with breaching its fiduciary duty by failing to disclose a conflict of interest created by the outside business activity of a top-performing portfolio manager. BlackRock agreed to settle the charges and pay a $12 million penalty.
• In a blow to Putnam, the Second Circuit reinstated fraud and negligence-based claims made by the insurer of a swap transaction. The insurer alleges that Putnam misrepresented the independence of its management of a collateralized debt obligation. (Fin. Guar. Ins. Co. v. Putnam Advisory Co.)

New Appeals

• Plaintiffs have appealed the lower court’s dismissal of an ERISA class action regarding Fidelity‘s practices with respect to the so-called “float income” generated from plan participants’ account transactions. (In re Fid. ERISA Float Litig.)

Briefs

• Plaintiffs filed their opposition to Davis‘s motion to dismiss excessive-fee litigation regarding the New York Venture Fund. Brief: “Defendants’ investment advisory fee arrangements with the Davis New York Venture Fund . . . epitomize the conflicts of interest and potential for abuse that led Congress to enact § 36(b). Unconstrained by competitive pressures, Defendants charge the Fund advisory fees that are as much as 96% higher than the fees negotiated at arm’s length by other, independent mutual funds . . . for Davis’s investment [sub-]advisory services.” (In re Davis N.Y. Venture Fund Fee Litig.)
• Plaintiffs filed their opposition to PIMCO‘s motion to dismiss excessive-fee litigation regarding the Total Return Fund. Brief: “In 2013 alone, the PIMCO Defendants charged the shareholders of the PIMCO Total Return Fund $1.5 billion in fees, awarded Ex-head of PIMCO, Bill Gross, a $290 million bonus and his second-in-command a whopping $230 million, and ousted a Board member who dared challenge Gross’s compensation—all this despite the Fund’s dismal performance that trailed 70% of its peers.” (Kenny v. Pac. Inv. Mgmt. Co.)
• In the purported class action regarding alleged deviations from two fundamental investment objectives by the Schwab Total Bond Market Fund, the Investment Company Institute and Independent Directors Council filed an amici brief in support of Schwab’s petition for rehearing (and rehearing en banc) of the Ninth Circuit’s 2-1 decision allowing the plaintiffs’ state-law claims to proceed. Brief: “The panel’s decision departs from long-standing law governing mutual funds and creates confusion and uncertainty nationwide.” Defendants include independent directors. (Northstar Fin. Advisors, Inc. v. Schwab Invs.)

Amended Complaint

• Plaintiffs filed a new complaint in the fee litigation against New York Life, adding a fourth fund to the case: the MainStay High Yield Opportunities Fund. (Redus-Tarchis v. N.Y. Life Inv. Mgmt., LLC.)

Answer

• P. Morgan filed an answer in an excessive-fee lawsuit regarding three of its bond funds. (Goodman v. J.P. Morgan Inv. Mgmt., Inc.)

The Alt Perspective: Commentary and News from Daily Alts

The spring has brought new life into the liquid alternatives market with both March and April seeing robust activity in terms of new fund launches and registrations, as well as fund flows. Touching on new fund flows first, March saw more than $2 billion of new asset flow into alternative mutual funds and ETFs, while US equity mutual funds and ETFs had combined outflows of nearly $6 billion.

At the top of the inflow rankings were international equity and fixed income, which provides a clear indication that investors were seeking both potentially higher return equity markets (non-US equity) and shelter (fixed income and alternatives). With increased levels of volatility in the markets, I wouldn’t be surprised to see this cash flow trend continue on into April and May.

New Funds Launched in April

We logged eight new liquid alternative funds in April from firms such as Prudential, Waycross, PowerShares and LoCorr. No particular strategy stood out as being dominant among the eight funds as they ranged from long/short equity and alternative fixed income strategies, to global macro and multi-strategy. A couple highlights are as follows:

1) LoCorr Multi-Strategy Fund – To date, LoCorr has done a thoughtful job of brining high quality managers to the liquid alts market, and offers funds that cover managed futures, long/short commodities, long/short equity and alternative income strategies. In this new fund, they bring all of these together in a single offering, making it easier for investors to diversify with a single fund.

2) Exceed Structured Shield Index Strategies Fund – This is the first of three new mutual funds that provide investors with a structured product that is designed to protect downside volatility and provide a specific level of upside participation. The idea of a more defined outcome can be appealing to a lot of investors, and will also help advisors figure out where and how to use the fund in a portfolio.

New Funds Registered in April

Fund registrations are where we see what is coming a couple months down the road – a bit like going to the annual car show to see what the car manufacturers are going to be brining out in the new season. And at this point, it looks like June/July will be busy as we counted 9 new alternative fund registration in April. A couple interesting products are listed below:

1) Hatteras Market Neutral Fund – Hatteras has been around the liquid alts market for quite some time, and with this fund will be brining multiple managers in as sub-advisors. Market neutral strategies are appealing at times when investors are looking to take risk off the table yet generate returns that are better than cash. They can also serve as a fixed income substitute when the outlook is flat to negative for the fixed income market.

2) Franklin K2 Long Short Credit Fund – K2 is a leading fund of hedge fund manager that works with large institutional investors to invest in and manage portfolios of hedge funds. The firm was acquired by Franklin Templeton back in 2012 and has so far launched one alternative mutual fund. The fund will be managed by multiple sub-advisors and will allocate to several segments of the fixed income market. 

Debunking Active Share

High active share does not equal high alpha. I’ll say that again. High active share does not equal high alpha. This is the finding in a new AQR white paper that essentially proves false two of the key tenents of a 2009 research paper (How Active is Your Fund Manager? A New Measure That Predicts Performance) by Martijn Cremers and Antti Petajisto. These two tenents are:

1) Active Share predicts fund performance: funds with the highest Active Share significantly outperform their benchmarks, both before and after expenses, and they exhibit strong performance persistence.

2) Non-index funds with the lowest Active Share underperform their benchmarks.

AQR explains that other factors are in play, and those other factors actually explain the outperformance that Cremers and Petajisto found in their work. You can read more here: AQR Deactivates Active Share in New White Paper.

And finally, for anyone considering the old “Sell in May and Go Away” strategy this month, be sure to have a read of this article, or watch this video. Or, better yet, just make a strategic allocation to a few solid alternative funds that have some downside protection built into them.

Feel free to stop by DailyAlts.com for more coverage of liquid alternatives.

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.

Seafarer Overseas Growth & Income (SFGIX/SIGIX): Our contention has always been that Seafarer represents one of the best possible options for investors interested in approaching the emerging markets. A steadily deepening record and list of accomplishments suggests that we’re right.

Towle Deep Value Fund (TDVFX): This fund positions itself a “an absolute value fund with a strong preference for staying fully invested.” For the past 33 years, Mr. Towle & Co. have been consistently successful at turning over more rock – in under covered small caps and international stocks alike – to find enough deeply undervalued stocks to populate the portfolio and produce eye-catching results.

Conference Call Highlights: Seafarer Overseas Growth & Income

Here are some quick highlights from our April 16^th conversation with Andrew Foster of Seafarer.

Seafarer’s objective: Andrew’s hope is to outperform his benchmark (the MSCI EM index) “slowly but steadily over time.” He describes the approach as a “relative return strategy” which pursues growth that’s more sustainable than what’s typical in developing markets while remaining value conscious.

Here’s the strategy: you need to start by understanding that the capital markets in many EM nations are somewhere between “poorly developed” and “cruddy.” Both academics and professional investors assume that a country’s capital markets will function smoothly: banks will make loans to credit-worthy borrowers, corporations and governments will be able to access the bond market to finance longer-term projects and stocks will trade regularly, transparently and at rational expense.

None of that may safely be assumed in the case of emerging markets; indeed, that’s what might distinguish an “emerging” market from a developed one. The question becomes: what are the characteristics of companies that might thrive in such conditions.

The answer seems to be (1) firms that can grow their top line steadily in the 7-15% per annum range and (2) those that can finance their growth internally. The focus on the top line means looking for firms that can increase revenues by 7-15% without obsessing about similar growth in the bottom line. It’s almost inevitable that EM firms will have “stumbles” that might diminish earnings for one to three years; while you can’t ignore them, you also can’t let them drive your investing decisions. “If the top line grows,” Andrew argues, “the bottom line will follow.” The focus on internal financing means that the firms will be capable of funding their operations and plans without needing recourse to the unreliable external sources of capital.

Seafarer tries to marry that focus on sustainable moderate growth “with some current income, which is a key tool to understanding quality and valuation of growth.” Dividends are a means to an end; they don’t do anything magical all by themselves. Dividends have three functions. They are:

An essential albeit crude valuation tool – many valuation metrics cannot be meaningfully applied across borders and between regions; there’s simply too much complexity in the way different markets operate. Dividends are a universally applicable measure.

A way of identifying firms that will bounce less in adverse market conditions – firms with stable yields that are just “somewhat higher than average” tend to be resilient. Firms with very high dividend yields are often sending out distress signals. 

A key and under-appreciated signal for the liquidity and solvency of a company – EMs are constantly beset by liquidity and credit shocks and unreliable capital markets compound the challenge. Companies don’t survive those shocks as easily as people imagine. The effects of liquidity and credit crunches range from firms that completely miss their revenue and earnings forecasts to those that drown themselves in debt or simply shutter. Against such challenges dividends provide a clear and useful signal of liquidity and solvency.

It’s certainly true that perhaps 70% of the dispersion of returns over a 5-to-10 year period are driven by macro-economic factors (Putin invades-> the EU sanctions-> economies falter-> the price of oil drops-> interest rates fall) but that fact is not useful because such events are unforecastable and their macro-level impacts are incalculably complex (try “what effect will European reaction to Putin’s missile transfer offer have on shadow interest rates in China?”). 

Andrew believes he can make sense of the ways in which micro-economic factors, which drive the other 30% of dispersion, might impact individual firms. He tries to insulate his portfolio, and his investors, from excess volatility by diversifying away some of the risk, imagining a “three years to not quite forever” time horizon for his holdings and moving across a firm’s capital structure in pursuit of the best risk-return balance.

While Seafarer is classified as an emerging markets equity fund, common stocks have comprised between 70-85% of the portfolio. “There’s way too much attention given to whether a security is a stock or bond; all are cash flows from an issuer. They’re not completely different animals, they’re cousins. We sometimes find instruments trading with odd valuations, try to exploit that.” As of January 2015, 80% of the fund is invested directly in common stock; the remainder is invested in ADRs, hard- and local-currency convertibles, government bonds and cash. The cash stake is at a historic low of 1%.

Thinking about the fund’s performance: Seafarer is in the top 3% of EM stock funds since launch, returning a bit over 10% annually. With characteristic honesty and modesty, Andrew cautions against assuming that the fund’s top-tier rankings will persist in the next part of the cycle:

We’re proud of performance over the last few years. We have really benefited from the fact that our strategy was well-positioned for anemic growth environments. Three or four years ago a lot of people were buying the story of vibrant growth in the emerging markets, and many were willing to overpay for it. As we know, that growth did not materialize. There are signs that the deceleration of growth is over even if it’s not clear when the acceleration of growth might begin. A major source of return for our fund over 10 years is beta. We’re here to harness beta and hope for a little alpha.

That said, he does believe that flaws in the construction of EM indexes makes it more likely that passive strategies will underperform:

I’m actually a fan of passive investing if costs are low, churn is low, and the benchmark is soundly constructed. The main EM benchmark is disconnected from the market. The MSCI EM index imposes filters for scalability and replicability in pursuit of an index that’s easily tradable by major investors. That leads it to being not a really good benchmark. The emerging markets have $14 trillion in market capitalization; the MSCI Core index captures only $3.8 trillion of that amount and the Total Market index captures just $4.2 trillion. In the US, the Total Stock Market indexes capture 80% of the market. The comparable EM index captures barely 25%.

Highlights from the questions:

As a practical matter, a 4-5% position is “huge for us” though he has learned to let his winners run a little longer than he used to, so the occasional 6% position wouldn’t be surprising.

A focus on dividend payers does not imply a focus on large cap stocks. There are a lot of very stable dividend-payers in the mid- to small-cap range; Seafarer ranges about 15-20% small cap and 35-50% midcap.

The fundamental reason to consider investing in emerging markets is because “they are really in dismal shape, sometimes the horrible things you read about them are true but there’s an incredibly powerful drive to give your kids a better life and to improve your life. People will move mountains to make things better. I followed the story of one family who were able to move from a farmhouse with a dirt floor to a comfortable, modern townhouse in one lifetime. It’s incredibly inspiring, but it’s also incredibly powerful.”

With special reference to holdings in Eastern Europe, you need to avoid high-growth, high-expectation companies that are going to get shell-shocked by political turmoil and currency devaluation. It’s important to find companies that have already been hit and that have proved that they can survive the shock.

Bottom line: Andrew has a great track record built around winning by not losing. His funds have posted great relative returns in bad markets and very respectable absolute returns in frothy ones. While he is doubtless correct in saying that the fund was unique well-suited to the current market and that it won’t always be a market leader, it’s equally correct to say that this is one of the most consistently risk-conscious, more consistently shareholder-sensitive and most consistently rewarding EM funds available. Those are patterns that I’ve found compelling.

We’ve also updated our featured fund page for Seafarer.

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 June and some of the prospectuses do highlight that date.

This month our research associate David Welsch tracked down 14 no-load retail funds in registration, which represents our core interest. By far the most interest was stirred by the announcement of three new Grandeur Peak funds:

• Global Micro Cap
• International Stalwarts
• Global Stalwarts

The launch of Global Micro Cap has been anticipated for a long time. Grandeur Peak announced two things early on: (1) that they had a firm wide strategy capacity of around $3 billion, and (2) they had seven funds in the works, including Global Micro, which were each allocated a set part of that capacity. Two of the seven projected funds (US Opportunities and Global Value) remain on the drawing board. President Eric Huefner remarks that “Remaining nimble is critical for a small/micro cap manager to be world-class,” hence “we are terribly passionate about asset capping across the firm.” 

The surprise comes with the launch of the two Stalwarts funds, whose existence was previously unanticipated. Folks on our discussion board reacted with (thoughtful) alarm. Many of them are GP investors and they raised two concerns: (1) this might signal a change in corporate culture with the business managers ascendant over the asset managers, and (2) a move into larger capitalizations might move GP away from their core area of competence.

Because they’re in a quiet period, Eric was not able to speak about these concerns though he did affirm that they’re entirely understandable and that he’d be able to address them directly after launch of the new funds.

Mr. Gardiner, Guardian Manager, at work

While I am mightily amused by the title GUARDIAN MANAGER given to Robert Gardiner to explain his role with the new funds, I’m not immediately distressed by these developments. “Stalwarts” has always been a designation for one of the three sorts of stocks that the firm invests in, so presumably these are stocks that the team has already researched and invested in. Many small cap managers find an attraction in these “alumni” stocks, which they know well and have confidence in but which have outgrown their original fund. Such funds also offer a firm the ability to increase its strategy capacity without compromising its investment discipline. I’ll be interested in hearing from Mr. Heufner later this summer and, perhaps, in getting to tap of Mr. Gardiner’s shield.

Manager Changes

A lot of funds were liquidated this month, which means that a lot of managers changed from “employed” to “highly motivated investment professional seeking to make a difference.” Beyond that group, 43 funds reported partial or complete changes in their management teams. The most striking were:

• The departure of Independence Capital Asset Partners from LS Opportunity Fund, about which there’s more below.
• The departure of Robert Mohn from both Columbia Acorn Fund (ACRNX) and Columbia Acorn USA (AUSAX) and from his position as their Domestic CIO. Mr. Mohn joined the fund in late 2003 shortly after the retirement of the legendary Ralph Wanger. He initially comanaged the fund with John Park (now of Oakseed Opportunity SEEDX) and Chuck McQuaid (now manager of Columbia Thermostat (CTFAX). Mr. Mohn is being succeeded by Zachary Egan, President of the adviser, and the estimable Fritz Kaegi, one of the managers of Columbia Acorn Emerging Markets (CAGAX). They’ll join David Frank who remained on the fund.

Updates

Centaur Total Return (TILDX) celebrated its 10-year anniversary in March, so I wish we’d reported the fact back then. It’s an interesting creature. Centaur started life as Tilson Dividend, though Whitney Tilson never had a role in its management. Mr. Tilson thought of himself (likely “thinks of himself”) as a great value investor, but that claim didn’t play out in his Tilson Focus Fund so he sort of gave up and headed to hedge fund land. (Lately he’s been making headlines by accusing Lumber Liquidators, a company his firm has shorted, of deceptive sales practices.) Mr. Tilson left and the fund was rechristened as Centaur.

Centaur’s record is worth puzzling over.  Morningstar gives it a ten-year ranking of five stars, a three-year ranking of one star and three stars overall. Over its lifetime it has modestly better returns and vastly lower risks than its peers which give it a great risk-adjusted performance.

Mostly it has great down market protection and reasonable upmarket performance, which works well if the market has both ups and downs. When the market has a whole series of strong gains, conservative value investors end up looking bad … until they look prescient and brilliant all over again.

There’s an oddly contrarian indicator in the quick dismissal of funds like Centaur, whose managers have proven adept and disciplined. When the consensus is “one star, bunch of worthless cash in the portfolio, there’s nothing to see here,” there might well be reason to start thinking more seriously as folks with a bunch of …

In any case, best anniversary wishes to manager Zeke Ashton and his team.

Briefly Noted . . .

American Century Investments, adviser to the American Century Funds, has elected to support the America’s Best Communities competition, a $10 million project to stimulate economic revitalization in small towns and cities across the country. At this point, 50 communities have registered first round wins. The ultimate winner will receive a $3 million economic development grant from a consortium of American firms.

In the interim, American Century has “adopted” Wausau, Wisconsin, which styles itself “the Chicago of the north.” (I suspect many of you think of Chicago as “the Chicago of the north,” but that’s just because you’re winter wimps.) Wausau won $35,000 which will be used to develop a comprehensive plan for economic revival and cultural enrichment. American Century is voluntarily adding another $15,000 to Wausau’s award and will serve as a sort of consultant to the town as they work on preparing a plan. It’s a helpful gesture and worthy of recognition.

LS Opportunity Fund (LSOFX) is about to become … well, something else but we don’t know what. The fund has always been managed by Independence Capital Asset Partners in parallel with ICAP’s long/short hedge fund. On April 23, 2015, the fund’s board terminated ICAP’s contract because of “certain portfolio management changes expected to occur within the sub-adviser.” On April 30, the board named Prospector Partners LLC has the fund’s interim manager, presumably with the expectation that they’ll be confirmed in June as the permanent replacement for ICAP. Prospector is described as “an investment adviser registered with the Securities and Exchange Commission with its principal offices [in] Guilford, CT. Prospector currently provides investment advisory services to corporations, pooled investment vehicles, and retirement plans.” Though they don’t mention it, Prospector also serves as the adviser to two distinctly unexciting long-only mutual funds: Prospector Opportunity (POPFX) and Prospector Capital Appreciation (PCAFX). LSOFX is a rated by Morningstar as a four-star fund with $170 million in assets, which makes the change both consequential and perplexing. We’ll share more as soon as we can.

Northern Global Tactical Asset Allocation Fund (BBALX) has added hedging via derivatives to the list of its possible investments: “In addition, the Fund also may invest directly in derivatives, including but not limited to forward currency exchange contracts, futures contracts and options on futures contracts, for hedging purposes.”

Gargoyle is on the move. RiverPark Funds is in the process of transferring control of RiverPark Gargoyle Hedged Value Fund (RGHVX) to TCW where it will be renamed … wait for it … TCW/Gargoyle Hedged Value Fund. It’s a solid five star fund with $73 million in assets. That latter number is what has occasioned the proposed move which shareholders will still need to ratify.

RiverPark CEO Morty Schaja notes that the strategy has spectacular long-term performance (it was a hedge fund before becoming a mutual fund) but that it’s devilishly hard to market. The fund uses two distinct strategies: a quantitatively driven relative value strategy for its stock portfolio and a defensive options overlay. While the options provide income and some downside protection, the fund does not pretend to being heavily hedged much less market neutral. As a result, it has a lot more downside volatility than the average long-short fund (it was down 34% in 2008, for example, compared with 15% for its peers) but also a more explosive upside (gaining 42% in 2009 against 10% for its peers). That’s not a common combination and RiverPark’s small marketing team has been having trouble finding investors who understand and value the combination. TCW is interested in developing a presence in “the liquid alts space” and has a sales force that’s large enough to find the investors that Gargoyle is seeking.

Expenses will be essentially unchanged, though the retail minimum will be substantially higher.

Zacks Small-Cap Core Fund (ZSCCX) has raised its upper market cap limit to $10.3 billion, which hardly sounds small cap at all.  That’s the range of stocks like Staples (SPLS) and L-3 Communications (LLL) which Morningstar classifies as mid-caps.

SMALL WINS FOR INVESTORS

Touchstone Merger Arbitrage Fund (TMGAX) has reopened to a select subset of investors: RIAs, family offices, institutional consulting firms, bank trust departments and the like. It’s fine as market-neutral funds go but they don’t go very far: TMGAX has returned under 2% annually over the past three years.  On whole, I suspect that RiverPark Structural Alpha (RSAFX) remains the more-attractive choice.

CLOSINGS (and related inconveniences)

Effective May 15, 2015, Janus Triton (JGMAX) and Janus Venture (JVTAX) are soft closing, albeit with a bunch of exceptions. Triton fans might consider Meridian Small Cap Growth, run by the team that put together Triton’s excellent record.

Effective at the close of business on May 29, 2015, MFS International Value Fund (MGIAX) will be closed to new investors

Effective June 1, 2015, the T. Rowe Price Health Sciences Fund (PRHSX) will be closed to new investors. 

Vulcan Value Partners (VVLPX) has closed to new investors. The firm closed its Small Cap strategy, including its small cap fund, in November of 2013, and closed its All Cap Program in early 2014. Vulcan closed, without advance notice, its Large Cap Programs – which include Large Cap, Focus and Focus Plus in late April. All five of Vulcan Value Partners’ investment strategies are ranked in the top 1% of their respective peer groups since inception.

OLD WINE, NEW BOTTLES

Effective April 30, 2015, American Independence Risk-Managed Allocation Fund (AARMX) was renamed the American Independence JAForlines Risk-Managed Allocation Fund. The objective, strategies and ticker remained the same. Just to make it unsearchable, Morningstar abbreviates it as American Indep JAFrl Risk-Mgd Allc A.

Effective on June 26, 2015 Intrepid Small Cap Fund (ICMAX) becomes Intrepid Endurance Fund and will no longer to restricted to small cap investing. It’s an understandable move: the fund has an absolute value focus, there are durned few deeply discounted small cap stocks currently and so cash has built up to become 60% of the portfolio. By eliminating the market cap restriction, the managers are free to move further afield in search of places to deploy their cash stash.

Effective June 15, 2015, Invesco China Fund (AACFX) will change its name to Invesco Greater China Fund.

Effective June 1, 2015, Pioneer Long/Short Global Bond Fund (LSGAX) becomes Pioneer Long/Short Bond Fund. Since it’s nominally not “global,” it’s no longer forced to place at least 40% outside of the U.S. At the same time Pioneer Multi-Asset Real Return Fund (PMARX) will be renamed Pioneer Flexible Opportunities.

As of May 1, 2015 Royce Opportunity Select Fund (ROSFX) became Royce Micro-Cap Opportunity Fund. For their purposes, micro-caps have capitalizations up to $1 billion. The Fund will invest, under normal circumstances, at least 80% of its net assets in equity securities of companies with stock market capitalizations up to $1 billion. In addition, the Fund’s operating policies will prohibit it from engaging in short sale transactions, writing call options, or borrowing money for investment purposes.

At the same time, Royce Value Fund (RVVHX) will be renamed Royce Small-Cap Value Fund and will target stocks with capitalizations under $3 billion. Royce Value Plus Fund (RVPHX) will be renamed Royce Smaller-Companies Growth Fund with a maximum market cap at time of purchase of $7.5 billion.

OFF TO THE DUSTBIN OF HISTORY

AlphaMark Small Cap Growth Fund (AMSCX) has been terminated; the gap between the announcement and the fund’s liquidation was three weeks. It wasn’t a bad fund at all, three stars from Morningstar, middling returns, modest risk, but wasn’t able to gain enough distinction to become economically viable. To their credit, the advisor stuck with the fund for nearly seven years before succumbing.

American Beacon Small Cap Value II Fund (ABBVX) will liquidate on May 12. The advisor cites a rare but not unique occurrence to explain the decision: “after a large redemption which is expected to occur in April 2015 that will substantially reduce the Fund’s asset size, it will no longer be practicable for the Manager to operate the Fund in an economically viable manner.”

Carlyle Core Allocation Fund (CCAIX) and Enhanced Commodity Real Return (no ticker) liquidate in mid-May.  

The Citi Market Pilot 2030 (CFTYX) and 2040 (CFTWX) funds each liquidated on about one week’s notice in mid-April; the decision was announced April 9 and the portfolio was liquidated April 17. They lasted just about one year.

The Trustees have voted to liquidate and terminate Context Alternative Strategies Fund (CALTX) on May 18, 2015.

Contravisory Strategic Equity Fund (CSEFX), a tiny low risk/low return stock fund, will liquidate in mid-May. 

Dreyfus TOBAM Emerging Markets Fund (DABQX) will be liquidated on or about June 30, 2015.

Franklin Templeton is thinning down. They merged away one of their closed-end funds in April. They plan to liquidate the $38 million Franklin Global Asset Allocation Fund (FGAAX) on June 30. Next the tiny Franklin Mutual Recovery Fund (FMRAX) is looking, with shareholder approval, to merge into the Franklin Mutual Quest Fund (TEQIX) likely around the end of August.

The Jordan Fund (JORDX) is merging into the Meridian Equity Income Fund (MRIEX), pending shareholder approval. The move is more sensible than it looks. Mr. Jordan has been running the fund for a decade but has little to show for it. He had five strong years followed by five lean ones and he still hasn’t accumulated enough assets to break even. Minyoung Sohn took over MRIEX last October but has only $26 million to invest; the JORDX acquisition will triple the fund’s size, move it toward financial equilibrium and will get JORDX investors a noticeable reduction in fees.

Leadsman Capital Strategic Income Fund (LEDRX) was liquidated on April 7, 2015, based on the advisor’s “representations of its inability to market the Fund and the Adviser’s indication that it does not desire to continue to support the Fund.” They lost interest in it? Okay, on the one hand there was only $400,005 in the fund. On the other hand, they launched it exactly six months before declaring failure and going home. I’m perpetually stunned by advisors who pull the plug after a few months or a year. I mean, really, what does that say about the quality of their business planning, much less their investment acumen?

I wonder if we should make advisers to new funds post bail? At launch the advisor must commit to running the fund for no less than a year (or two or three). They have to deposit some amount ($50,000? $100,000?) with an independent trustee. If they close early, they forfeit their bond to the fund’s investors. That might encourage more folks to invest in promising young funds by hedging against one of the risks they face and it might discourage “let’s toss it against the wall and see if anything sticks” fund launches.

Manning & Napier Inflation Focus Equity Series (MNIFX) will liquidate on May 11, 2015.

Merk Hard Currency ETF (formerly HRD) has liquidated. Hard currency funds are, at base, a bet against the falling value of the US dollar. Merk, for example, defines hard currencies as “currencies backed by sound monetary policy.” That’s really not been working out. Merk’s flagship no-load fund, Merk Hard Currency (MERKX), is still around but has been bleeding assets (from $280M to $160M in a year) and losing money (down 2.1% annually for the past five years). It’s been in the red in four of the past five years and five of the past ten. Here’s the three-year picture.

Presumably if investors stop fleeing to the safe haven of US Treasuries there will be a mighty reversal of fortunes. The question is whether investors can (or should) wait around until then. Can you say “Grexit”?

Effective May 1, 2015, Royce Select Fund I (RYSFX) will be closed to all purchases and all exchanges into the Fund in anticipation of the fund being absorbed into the one-star Royce 100 Fund (ROHHX). Mr. Royce co-manages both but it’s still odd that they buried a three-star small blend fund into a one-star one.

The Turner Funds will close and liquidate the Turner Titan Fund (TTLFX), effective on or about June 1, 2015. It’s a perfectly respectable long/short fund in which no one had any interest.

The two-star Voya Large Cap Growth Fund (ILCAX) is slated to be merged into the three-star Voya Growth Opportunities Fund (NLCAX). Same management team, same management fee, same performance: it’s pretty much a wash.

In Closing . . .

The first issue of the Observer appeared four years ago this month, May 2011. We resolved from the outset to try to build a thoughtful community here and to provide them with insights about opportunities and perspectives that they might never otherwise encounter. I’m not entirely sure of how well we did, but I can say that it’s been an adventure and a delight. We have a lot yet to accomplish and we’re deeply hopeful you’ll join us in the effort to help investors and independent managers alike. Each needs the other.

Thanks, as ever, to the folks – Linda, who celebrates our even temperament, Bill and James – who’ve clicked on our elegantly redesigned PayPal link. Thanks, most especially, to Deb and Greg who’ve been in it through thick and thin. It really helps.

A word of encouragement: if you haven’t already done so, please click now on our Amazon link and either bookmark it or set it as one of the start pages in your browser. We receive a rebate equivalent to 6-7% of the value of anything you purchase (books, music, used umbrellas, vitamins …) through that link. It costs you nothing since it’s part of Amazon’s marketing budget and if you bookmark it now, you’ll never have to think about it again.

We’re excited about the upcoming Morningstar conference. All four of us – Charles, Chip, Ed and I – will be around the conference and at least three of us will be there from beginning to end, and beyond. Highlights for me:

• The opportunity to dine with the other Observer folks at one of Ed’s carefully-vetted Chicago eateries.
• Two potentially excellent addresses – an opening talk by Jeremy Grantham and a colloquy between Bill Nygren and Steve Romick
• A panel presentation on what Morningstar considers off-the-radar funds: the five-star Mairs & Power Small Cap (MSCFX, which we profiled late in 2011), Meridian Small Cap Growth (MSGAX, which we profiled late in 2014) and the five-star Eventide Gilead Fund (ETAGX, which, at $1.6 billion, is a bit beyond our coverage universe).
• A frontier markets panel presented by some “A” list managers.
• The opportunity to meet and chat with you folks. If you’re going to be at Morningstar, as exhibitor or attendee, and would like a chance to chat with one or another of us, drop me a note and we’ll try hard to set something up. We’d love to see you.

As ever,