Dear friends,

Welcome to summer, a time of year when heat records are rather more common than market records.  

What’s in your long/short fund?

Everybody’s talking about long/short funds.  Google chronicles 273,000 pages that use the phrase.  Bloomberg promises “a comprehensive list of long/short funds worldwide.”  Morningstar, Lipper and U.S. News plunk nearly a hundred funds into a box with that label.  (Not the same hundred funds, by the way.  Not nearly.)  Seeking Alpha offers up the “best and less long/short funds 2013.”

Here’s the Observer’s position: Talking about “long/short funds” is dangerous and delusional because it leads you to believe that there are such things.  Using the phrase validates the existence of a category, that is, a group of things where we perceive shared characteristics.  As soon as we announce a category, we start judging things in the category based on how well they conform to our expectations of the category.  If we assign a piece of fruit (or a hard-boiled egg) to the category “upscale dessert,” we start judging it based on how upscale-dessert-y it seems.  The fact that the assignment is random, silly and unfair doesn’t stop us from making judgments anyway.  The renowned linguist George Lakoff writes, “there is nothing more basic than categorization to our thought, perception, action and speech.”

Do categories automatically make sense?  Try this one out: Dyirbal, an Australian aboriginal language, has a category balan which contains women, fire, dangerous things, non-threatening birds and platypuses.

When Morningstar groups 83 funds together in the category “long/short equity,” they’re telling us “hey, all of these things have essential similarities.  Feel free to judge them against each other.”  We sympathize with the analysts’ need to organize funds.  Nonetheless, this particular category is seriously misleading.   It contains funds that have only superficial – not essential – similarities with each other.  In extended conversations with managers and executives representing a half dozen long/short funds, it’s become clear that investors need to give up entirely on this simple category if they want to make meaningful comparisons and choices.

Each of the folks we spoke to have their own preferred way of organizing these sorts of “alternative investment” funds.   After two weeks of conversation, though, useful commonalities began to emerge.  Here’s a manager-inspired schema:

1. Start with the role of the short portfolio.  What are the managers attempting to do with their short book and how are they doing it? The RiverNorth folks, and most of the others, agree that this should be “the first and perhaps most important” criterion. Alan Salzbank of the Gargoyle Group warns that “the character of the short positions varies from fund to fund, and is not necessarily designed to hedge market exposure as the category title would suggest.”  Based on our discussions, we think there are three distinct roles that short books play and three ways those strategies get reflected in the fund.
   

   Role	Portfolio tool	Translation
   Add alpha	Individual stock shorts	These funds want to increase returns by identifying the market’s least attractive stocks and betting against them
   Reduce beta	Shorting indexes or sectors, generally by using ETFs	These funds want to tamp market volatility by placing larger or smaller bets against the entire market, or large subsets of it, with no concern for the value of individual issues
   Structural	Various option strategies such as selling calls	These funds believe they can generate considerable income – as much as 1.5-2% per month – by selling options.  Those options become more valuable as the market becomes more volatile, so they serve as a cushion for the portfolio; they are “by their very nature negatively correlated to the market” (AS).

2. Determine the degree of market exposure.   Net exposure (% long minus % short) varies dramatically, from 100% (from what ARLSX manager Matt Moran laments as “the faddish 130/30 funds from a few years ago”) to under 25%.  An analysis by the Gargoyle Group showed three-year betas for funds in Morningstar’s long/short category ranging from 1.40 to (-0.43), which gives you an idea of how dramatically market exposure varies.  For some funds the net market exposure is held in a tight band (40-60% with a target of 50% is pretty common).   Some of the more aggressive funds will shift exposure dramatically, based on their market experience and projections.  It doesn’t make sense to compare a fund that’s consistently 60% exposure to the market with one that swings from 25% – 100%.

   Ideally, that information should be prominently displayed on a fund’s fact sheet, especially if the manager has the freedom to move by more than a few percent.  A nice example comes from Aberdeen Equity Long/Short Fund’s (GLSRX) factsheet:

   

   Greg Parcella of Long/Short Advisors  maintains an internal database of all of long/short funds and expressed some considerable frustration in discovering that many don’t make that information available or require investors to do their own portfolio analyses to discover it.  Even with the help of Morningstar, such self-generated calculations can be a bit daunting.  Here, for example, is how Morningstar reports the portfolio of Robeco Boston Partners Long/Short Equity BPLEX in comparison to its (entirely-irrelevant) long-short benchmark and (wildly incomparable) long/short equity peers:

   

   So, look for managers who offer this information in a clear way and who keep it current. Morty Schaja, president of RiverPark Advisors which offers two very distinctive long/short funds (RiverPark Long/Short Opportunity RLSFX and RiverPark/Gargoyle Hedged Value RGHVX) suggest that such a lack of transparency would immediately raise concerns for him as an investor; he did not offer a flat “avoid them” but was surely leaning in that direction.

3. Look at the risk/return metrics for the fund over time.  Once you’ve completed the first two steps, you’ve stopped comparing apples to rutabagas and mopeds (step one) or even cooking apples to snacking apples (step two).  Now that you’ve got a stack of closely comparable funds, many of the managers call for you to look at specific risk measures.  Matt Moran suggests that “the best measure to employ are … the Sharpe, the Sortino and the Ulcer Index [which help you determine] how much return an investor is getting for the risk that they are taking.”

As part of the Observer’s new risk profiles of 7600 funds, we’ve pulled all of the funds that Morningstar categorizes as “long/short equity” into a single table for you.  It will measure both returns and seven different flavors of risk.  If you’re unfamiliar with the varied risk metrics, check our definitions page.  Remember that each bit of data must be read carefully since the fund’s longevity can dramatically affect their profile.  Funds that were around in the 2008 will have much greater maximum drawdowns than funds launched since then.  Those numbers do not immediately make a fund “bad,” it means that something happened that you want to understand before trusting these folks with your money.

As a preview, we’d like to share the profiles for five of the six funds whose advisors have been helping us understand these issues.  The sixth, RiverNorth Dynamic Buy-Write (RNBWX), is too new to appear.  These are all funds that we’ve profiled as among their categories’ best and that we’ll be profiling in August.

Long/short managers aren’t the only folks concerned with managing risk.  For the sake of perspective, we calculated the returns on a bunch of the risk-conscious funds that we’ve profiled.  We looked, in particular, at the recent turmoil since it affected both global and domestic, equity and bond markets.

Downside protection in one ugly stretch, 05/28/2013 – 06/24/2013

Charles, widely-read and occasionally whimsical, thought it useful to share two stories and a bit of data that lead him to suspect that successful long/short investments are, like Babe Ruth’s “called home run,” more legend than history.

Notes from the Morningstar Conference

If you ever wonder what we do with contributions to the Observer or with income from our Amazon partnership, the short answer is, we try to get better.  Three ongoing projects reflect those efforts.  One is our ongoing visual upgrade, the results of which will be evident online during July.  More than window-dressing, we think of a more graphically sophisticated image as a tool for getting more folks to notice and benefit from our content.  A second our own risk profiles for more than 7500 funds.  We’ll discuss those more below.  The third was our recent presence at the Morningstar Investment Conference.  None of them would be possible without your support, and so thanks!

I spent about 48 hours at Morningstar and was listening to folks for about 30 hours.  I posted my impressions to our discussion board and several stirred vigorous discussions.  For your benefit, here’s a sort of Top Ten list of things I learned at Morningstar and links to the ensuing debates on our discussion board.

Day One: Northern Trust on emerging and frontier investing

Attended a small lunch with Northern managers.  Northern primarily caters to the rich but has retail share class funds, FlexShare ETFs and multi-manager funds for the rest of us. They are the world’s 5th largest investor in frontier markets. Frontier markets are currently 1% of global market cap, emerging markets are 12% and both have GDP growth 350% greater than the developed world’s. EM/F stocks sell at a 20% discount to developed stocks. Northern’s research shows that the same factors that increase equity returns in the developed world (small, value, wide moat, dividend paying) also predict excess returns in emerging and frontier markets. In September 2012 they launched the FlexShares Emerging Markets Factor Tilt Index Fund (TLTE) that tilts toward Fama-French factors, which is to say it holds more small and more value than a standard e.m. index.

Day One: Smead Value (SMVLX)

Interviewed Bill Smead, an interesting guy, who positions himself against the “brilliant pessimists” like Grantham and Hussman.  Smead argues their clients have now missed four years of phenomenal gains. Their thesis is correct (as were most of the tech investor theses in 1999) but optimism has been in such short supply that it became valuable.  He launched Smead Value in 2007 with a simple strategy: buy and hold (for 10 to, say, 100 years) excellent companies.  Pretty radical, eh?  He argues that the fund universe is 35% passive, 5% active and 60% overly active. Turns out that he’s managed it to top 1-2% returns over most trailing periods.  Much the top performing LCB fund around.  There’s a complete profile of the fund below.

Day One: Morningstar’s expert recommendations on emerging managers

Consuelo Mack ran a panel discussion with Russ Kinnel, Laura Lallos, Scott Burns and John Rekenthaler. One question: “What are your recommendations for boutique firms that investors should know about, but don’t? Who are the smaller, emerging managers who are really standing out?”

Dead silence. Glances back and forth. After a long silence: FPA, Primecap and TFS.

There are two possible explanations: (1) Morningstar really has lost touch with anyone other than the top 20 (or 40 or whatever) fund complexes or (2) Morningstar charged dozens of smaller fund companies to be exhibitors at their conference and was afraid to offend any of them by naming someone else.

Since we notice small funds and fund boutiques, we’d like to offer the following answers that folks could have given:

Well, Consuelo, a number of advisors are searching for management teams that have outstanding records with private accounts and/or hedge funds, and are making those teams and their strategies available to the retail fund world. First rate examples include ASTON, RiverNorth and RiverPark.

Or

That’s a great question, Consuelo.  Individual investors aren’t the only folks tired of dealing with oversized, underperforming funds.  A number of first-tier investors have walked away from large fund complexes to launch their own boutiques and to pursue a focused investing vision. Some great places to start would be with the funds from Grandeur Peak, Oakseed, and Seafarer.

Mr. Mansueto did mention, in his opening remarks, an upcoming Morningstar initiative to identify and track “emerging managers.”  If so, that’s a really good sign for all involved.

Day One: Michael Mauboussin on luck and skill in investing

Mauboussin works for Credit Suisse, Legg Mason before that and has written The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing (2012). Here’s his Paradox of Skill: as the aggregate level of skill rises, luck becomes a more important factor in separating average from way above average. Since you can’t count on luck, it becomes harder for anyone to remain way above average. Ted Williams hit .406 in 1941. No one has been over .400 since. Why? Because everyone has gotten better: pitchers, fielders and hitters. In 1941, Williams’ average was four standard deviations above the norm. In 2012, a hitter up by four s.d. would be hitting “just” .380. The same thing in investing: the dispersion of returns (the gap between 50th percentile funds and 90th percentile funds) has been falling for 50 years. Any outsized performance is now likely luck and unlikely to persist.

This spurred a particularly rich discussion on the board.

Day Two: Matt Eagan on where to run now

Day Two started with a 7:00 a.m. breakfast sponsored by Litman Gregory. (I’ll spare you the culinary commentary.) Litman runs the Masters series funds and bills itself as “a manager of managers.” The presenters were two of the guys who subadvise for them, Matt Eagan of Loomis Sayles and David Herro of Oakmark. Eagan helps manage the strategic income, strategic alpha, multi-sector bond, corporate bond and high-yield funds for LS. He’s part of a team named as Morningstar’s Fixed-Income Managers of the Year in 2009.

Eagan argues that fixed income is influenced by multiple cyclical risks, including market, interest rate and reinvestment risk. He’s concerned with a rising need to protect principal, which leads him to a neutral duration, selective shorting and some currency hedges (about 8% of his portfolios).

He’s concerned that the Fed has underwritten a hot-money move into the emerging markets. The fundamentals there “are very, very good and we see their currencies strengthening” but he’s made a tactical withdrawal because of some technical reasons (I have “because of a fund-out window” but have no idea of what that means) which might foretell a drop “which might be violent; when those come, you’ve just got to get out of the way.”

He finds Mexico to be “compelling long-term story.” It’s near the US, it’s capturing market share from China because of the “inshoring” phenomenon and, if they manage to break up Pemex, “you’re going to see a lot of growth there.”

Europe, contrarily, “is moribund at best. Our big hope is that it’s less bad than most people expect.” He suspects that the Europeans have more reason to stay together than to disappear, so they likely will, and an investor’s challenge is “to find good corporations in bad Zip codes.”

In the end:

• avoid indexing – almost all of the fixed income indexes are configured to produce “negative real yields for the foreseeable future” and most passive products are useful mostly as “just liquidity vehicles.”
• you can make money in the face of rising rates, something like a 3-4% yield with no correlation to the markets.
• avoid Treasuries and agencies
• build a yield advantage by broadening your opportunity set
• look at convertible securities and be willing to move within a firm’s capital structure
• invest overseas, in particular try to get away from the three reserve currencies.

Eagan manages a sleeve of Litman Gregory Masters Alternative Strategies (MASNX), which we’ve profiled and which has had pretty solid performance.

Day Two: David Herro on emerging markets and systemic risk

The other breakfast speaker was David Herro of Oakmark International.  He was celebrated in our May 2013 essay, “Of Oaks and Acorns,” that looked at the success of Oakmark international analysts as fund managers.

Herro was asked about frothy markets and high valuations. He argues that “the #1 risk to protect against is the inability of companies to generate profits – macro-level events impact price but rarely impact long-term value. These macro-disturbances allow long-term investors to take advantage of the market’s short-termism.” The ’08-early ’09 events were “dismal but temporary.”

Herro notes that he had 20% of his flagship in the emerging markets in the late 90s, then backed down to zero as those markets were hit by “a wave of indiscriminate inflows.” He agrees that emerging markets will “be the propellant of global economic growth for the next 20 years” but, being a bright guy, warns that you still need to find “good businesses at good prices.” He hasn’t seen any in several years but, at this rate, “maybe in a year we’ll be back in.”

His current stance is that a stock needs to have 40-50% upside to get into his portfolio today and “some of the better quality e.m. firms are within 10-15% of getting in.”  (Since then the e.m. indexes briefly dropped 7% but had regained most of that decline by June 30.) He seemed impressed, in particular, with the quality of management teams in Latin America (“those guys are really experienced with handling adversity”) but skeptical of the Chinese newbies (“they’re still a little dodgy”).

He also announced a bias “against reserve currencies.” That is, he thinks you’re better off buying earnings which are not denominated in dollars, Euros or … perhaps, yen. His co-presenter, Matt Eagan of Loomis Sayles, has the same bias. He’s been short the yen but long the Nikkei.

In terms of asset allocation, he thinks that global stocks, especially blue chips “are pretty attractively priced” since values have been rising faster than prices have. Global equities, he says, “haven’t come out of their funk.” There’s not much of a valuation difference between the US and the rest of the developed world (the US “is a little richer” but might deserve it), so he doesn’t see overweighting one over the other.

Day Two: Jack Bogle ‘s inconvenient truths

Don Phillips had a conversation with Bogle in a huge auditorium that, frankly, should dang well have had more people in it.  I think the general excuse is, “we know what Bogle’s going to say, so why listen?”  Uhhh … because Bogle’s still thinking clearly, which distinguishes him from a fair number of his industry brethren?  He weighed in on why money market funds cost more than indexed stock funds (the cost of check cashing) and argued that our retirement system is facing three train wrecks: (1) underfunding of the Social Security system – which is manageable if politicians chose to manage it, (2) “grotesquely underfunded” defined benefit plans (a/k/a pension plans) whose managers still plan to earn 8% with a balanced portfolio – Bogle thinks they’ll be lucky to get 5% before expenses – and who are planning “to bring in some hedge fund guys” to magically solve their problem, and (3) defined contribution plans (401k’s and such) which allow folks to wreck their long-term prospects by cashing out for very little cause.

Bogle thinks that most target-date funds are ill-designed because they ignore Social Security, described by Bogle as “the best fixed-income position you’ll ever have.”  The average lifetime SS benefit is something like $300,000.  If your 401(k) contains $300,000 in stocks, you’ll have a 50/50 hybrid at retirement.  If your 401(k) target-date fund is 40% in bonds, you’ll retire with a portfolio that’s 70% bonds (SS + target date fund) and 30% stocks.  He’s skeptical of the bond market to begin with (he recommends that you look for a serious part of your income stream from dividend growth) and more skeptical of a product that buries you in bonds.

Finally, he has a strained relationship with his successors at Vanguard.  On the one hand he exults that Vanguard’s structural advantage on expenses is so great “that nobody can match us – too bad for them, good for us.”  And the other, he disagrees with most industry executives, including Vanguard’s, on regulations of the money market industry and the fund industry’s unwillingness – as owners of 35% of all stock – to stand up to cultures in which corporations have become “the private fiefdom of their chief executives.”  (An issue addressed by The New York Times on June 29, “The Unstoppable Climb in CEO Pay.”)  At base, “I don’t disagree with Vanguard.  They disagree with me.”

Day Three: Sextant Global High Income

This is an interesting one and we’ll have a full profile of the fund in August. The managers target a portfolio yield of 8% (currently they manage 6.5% – the lower reported trailing 12 month yield reflects the fact that the fund launched 12 months ago and took six months to become fully invested). There are six other “global high income” funds – Aberdeen, DWS, Fidelity, JohnHancock, Mainstay, Western Asset. Here’s the key distinction: Sextant pursues high income through a combination of high dividend stocks (European utilities among them), preferred shares and high yield bonds. Right now about 50% of the portfolio is in stocks, 30% bonds, 10% preferreds and 10% cash. No other “high income” fund seems to hold more than 3% equities. That gives them both the potential for capital appreciation and interest rate insulation. They could imagine 8% from income and 2% from cap app. They made about 9.5% over the trailing twelve months through 5/31. 

Day Three: Off-the-record worries

I’ve had the pleasure of speaking with some managers frequently over months or years, and occasionally we have conversations where I’m unsure that statements were made for attribution.  Here are four sets of comments attributable to “managers” who I think are bright enough to be worth listening to.

More than one manager is worried about “a credit event” in China this year. That is, the central government might precipitate a crisis in the financial system (a bond default or a bank run) in order to begin cleansing a nearly insolvent banking system. (Umm … I think we’ve been having it and I’m not sure whether to be impressed or spooked that folks know this stuff.) The central government is concerned about disarray in the provinces and a propensity for banks and industries to accept unsecured IOUs. They are acting to pursue gradual institutional reforms (e.g., stricter capital requirements) but might conclude that a sharp correction now would be useful. One manager thought such an event might be 30% likely. Another was closer to “near inevitable.”

More than one manager suspects that there might be a commodity price implosion, gold included. A 200 year chart of commodity prices shows four spikes – each followed by a retracement of more than 100% – and a fifth spike that we’ve been in recently.

More than one manager offered some version of the following statement: “there’s hardly a bond out there worth buying. They’re essentially all priced for a negative real return.”

More than one manager suggested that the term “emerging markets” was essentially a linguistic fiction. About 25% of the emerging markets index (Korea and Taiwan) could be declared “developed markets” (though, on June 11, they were not) while Saudi Arabia could become an emerging market by virtue of a decision to make shares available to non-Middle Eastern investors. “It’s not meaningful except to the marketers,” quoth one.

Day Three: Reflecting on tchotchkes

Dozens of fund companies paid for exhibits at Morningstar – little booths inside the McCormick Convention Center where fund reps could chat with passing advisors (and the occasional Observer guy).  One time honored conversation starter is the tchotchke: the neat little giveaway with your name on it.  Firms embraced a stunning array of stuff: barbeque sauce (Scout Funds, from Kansas City), church-cooked peanuts (Queens Road), golf tees, hand sanitizers (inexplicably popular), InvestMints (Wasatch), micro-fiber cloths (Payden), flashlights, pens, multi-color pens, pens with styluses, pens that signal Bernanke to resume tossing money from a circling helicopter . . .

Ideally, you still need to think of any giveaway as an expression of your corporate identity.  You want the properties of the object to reflect your sense of self and to remind folks of you.  From that standard, the best tchotchke by a mile were Vanguard’s totebags.  You wish you had one.  Made of soft, heavy-weight canvas with a bottom that could be flattened for maximum capacity, they were unadorned except for the word “Vanguard.”  No gimmicks, no flash, utter functionality in a product that your grandkids will fondly remember you carrying for years.  That really says Vanguard.  Good job, guys!

The second-best tchotchke (an exceedingly comfortable navy baseball cap with a sailboat logo) and single best location (directly across from the open bar and beside Vanguard) was Seafarer’s.  

It’s Charles in Charge! 

My colleague Charles Boccadoro has spearheaded one of our recent initiatives: extended risk profiles of over 7500 funds.  Some of his work is reflected in the tables in our long/short fund story.  Last month we promised to roll out his data in a searchable form for this month.  As it turns out, the programmer we’re working with is still a few days away from a “search by ticker” engine.  Once that’s been tested, chip will be able to quickly add other search fields. 

As an interim move, we’re making all of Charles’ risk analyses available to you as a .pdf.  (It might be paranoia, but I’m a bit concerned about the prospect of misappropriation of the file if we post it as a spreadsheet.)  It runs well over 100 pages, so I’d be a bit cautious about hitting the “print” button. 

Charles’ contributions have been so thoughtful and extensive that, in August, we’ll set aside a portion of the Observer that will hold an archive of all of his data-driven pieces.  Our current plan is to introduce each of the longer pieces in this cover essay then take readers to Charles’ Balcony where complete story and all of his essays dwell.  We’re following that model in …

Timing method performance over ten decades

The Healthy Debate. In Professor David Aronson’s 2006 book, entitled “Evidence-Based Technical Analysis,” he argues that subjective technical analysis, which is any analysis that cannot be reduced to a computer algorithm and back tested, is “not a legitimate body of knowledge but a collection of folklore resting on a flimsy foundation of anecdote and intuition.”

He further warns that falsehoods accumulate even with objective analysis and rules developed after-the-fact can lead to overblown extrapolations – fool’s gold biased by data-mining, more luck than legitimate prediction, in same category as “literate monkeys, Bible Codes, and lottery players.”

Read the full story here.

Announcing Mutual Fund Contacts, our new sister-site

I mentioned some months ago a plan to launch an affiliate site, Mutual Fund Contacts.  June 28 marked the “soft launch” of MFC.  MFC’s mission is to serve as a guide and resource for folks who are new at all this and feeling a bit unsteady about how to proceed.  We imagine a young couple in their late 20s planning an eventual home purchase, a single mom in her 30s who’s trying to organize stuff that she’s not had to pay attention to, or a young college graduate trying to lay a good foundation.

Most sites dedicated to small investors are raucous places with poor focus, too many features and a desperate need to grab attention.  Feh.  MFC will try to provide content and resources that don’t quite fit here but that we think are still valuable.  Each month we’ll provide a 1000-word story on the theme “the one-fund portfolio.”  If you were looking for one fund that might yield a bit more than a savings account without a lot of downside, what should you consider?  Each “one fund” article will recommend three options: two low-minimum mutual funds and one commission-free ETF.  We’ll also have a monthly recommendation on three resources you should be familiar with (this month, the three books that any financially savvy person needs to start with) and ongoing resources (this month: the updated “List of Funds for Small Investors” that highlights all of the no-load funds available for $100 or less – plus a couple that are close enough to consider).

The nature of a soft launch is that we’re still working on the site’s visuals and some functionality.  That said, it does offer a series of resources that, oh, say, your kids really should be looking at.  Feel free to drop by Mutual Fund Contacts and then let us know how we can make it better.

Everyone loves a crisis

Larry Swedroe wrote a widely quoted, widely redistributed essay for CBS MoneyWatch warning that bond funds were covertly transforming themselves into stock funds in pursuit of additional yield.  His essay opens with:

It may surprise you that, as of its last reporting date, there were 352 mutual funds that are classified by Morningstar as bond funds that actually held stocks in their portfolio. (I know I was surprised, and given my 40 years of experience in the investment banking and financial advisory business, it takes quite a bit to surprise me.) At the end of 2012, it was 312, up from 283 nine months earlier.

The chase for higher yields has led many actively managed bond funds to load up on riskier investments, such as preferred stocks. (Emphasis added)

Many actively managed bond funds have loaded up?

Let’s look at the data.  There are 1177 bond funds, excluding munis.  Only 104 hold more than 1% in stocks, and most of those hold barely more than a percent.  The most striking aspect of those funds is that they don’t call themselves “bond” funds.  Precisely 11 funds with the word “Bond” in their name have stocks in excess of 1%.  The others advertise themselves as “income” funds and, quite often, “strategic income,” “high income” or “income opportunities” funds.  Such funds have, traditionally, used other income sources to supplement their bond-heavy core portfolios.

How about Larry’s claim that they’ve been “bulking up”?  I looked at the 25 stockiest funds to see whether their equity stake should be news to their investors.  I did that by comparing their current exposure to the bond market with the range of exposures they’ve experienced over the past five years.  Here’s the picture, ranked based on US stock exposure, starting with the stockiest fund:

*WISEX invests within the constraints of Islamic principles.  As a result, most traditional interest-paying, fixed-income vehicles are forbidden to it.

From this most stock-heavy group, 10 funds now hold fewer bonds than at any other point in the past five years.  In many cases (see T Rowe Price Spectrum Income), their bond exposure varies by only a few percentage points from year to year so being light on bonds is, for them, not much different than being heavy on bonds.

The SEC’s naming rule says that if you have an investment class in your name (e.g. “Bond”) then at least 80% of your portfolio must reside in that class. Ave Maria Bond runs right up to the line: 19.88% US stocks, but warns you of that: “The Fund may invest up to 20% of its net assets in equity securities, which include preferred stocks, common stocks paying dividends and securities convertible into common stock.”  Eaton Vance Bond is 12% and makes the same declaration: “The Fund may invest up to 20% of its net assets in common stocks and other equity securities, including real estate investment trusts.”

Bottom line: the “loading up” has been pretty durn minimal.  The funds which have a substantial equity stake now have had a substantial equity stake for years, they market that fact and they name themselves to permit it.

Fidelity cries out: Run away!

Several sites have noted the fact that Fidelity Europe Cap App Fund (FECAX) has closed to new investors.  Most skip the fact that it looks like the $400 million FECAX is about to get eaten, presumably by Fidelity Europe (FIEUX): “The Board has approved closing Fidelity Europe Capital Appreciation Fund effective after the close of business on July 19, 2013, as the Board and FMR are considering merging the fund.” (emphasis added)

Fascinating.  Fidelity’s signaling the fact that they can no longer afford two Euro-centered funds.  Why would that be the case? 

I can only imagine three possibilities:

1. Fidelity no longer finds with a mere $400 million in AUM viable, so the Cap App fund has to go.
2. Fidelity doesn’t think there’s room for (or need for) more than one European stock strategy.  There are 83 distinct U.S.-focused strategies in the Fidelity family, but who’d need more than one for Europe?
3. Fidelity can no longer find managers capable of performing well enough to be worth the effort.
   

   	Expenses	Returns TTM	Returns 5 yr	Compared to peers – 5 yr
   Fidelity European funds for British investors
   Fidelity European Fund A-Accumulation	1.72% on $4.1B	22%	1.86	3.31
   Fidelity Europe Long-Term Growth Fund	1.73 on $732M	29	n/a	n/a
   Fidelity European Opportunities	1.73 on $723M	21	1.48	3.31
   Fidelity European funds for American investors
   Fidelity European Capital Appreciation	0.92% on $331M	24	(1.57)	(.81)
   Fidelity Europe	0.80 on $724M	23	(1.21)	(0.40)
   Fidelity Nordic	1.04% on $340M	32	(0.40)	The Morningstar peer group is “miscellaneous regions” – ignore it

   Converted at ₤1 = $1.54, 25 June 2013.

In April of 2007, Fidelity tried to merge Nordic into Europe, but its shareholders refused to allow it.  At the time Nordic was one of Fidelity’s best-performing international funds and had $600 million in assets.  The announced rationale:  “The Nordic region is more volatile than developed Europe as a whole, and Fidelity believes the region’s characteristics have changed sufficiently to no longer warrant a separate fund focused on the region.”  The nature of those “changes” was not clear and shareholders were unimpressed.

It is clear that Fidelity has a personnel problem.  When, for example, they wanted to bolster their asset allocation funds-of-funds, they added two new Fidelity Series funds for them to choose from.  One is run by Will Danoff, whose Contrafund already has $95 billion in assets, and the other by Joel Tillinghast, whose Low-Priced Stock Fund lugs $40 billion.  Presumably they would have turned to a young star with less on their plate … if they had a young star with less on their plate.  Likewise, Fidelity Strategic Adviser Multi-Manager funds advertise themselves as being run by the best of the best; these funds have the option of using Fidelity talent or going outside when the options elsewhere are better.  What conclusions might we draw from the fact that Strategic Advisers Core Multi-Manager (FLAUX) draws one of its 11 managers from Fido or that Strategic Advisers International Multi-Manager (FMJDX) has one Fido manager in 17?  Both of the managers for Strategic Advisers Core Income Multi-Manager (FWHBX) are Fidelity employees, so it’s not simply that the SAMM funds are designed to showcase non-Fido talent.

I’ve had trouble finding attractive new funds from Fidelity for years now.  It might well be that the contemplated retrenchment in their Europe line-up reflects the fact that Fido’s been having the same trouble.

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. 

Forward Income Builder (IAIAX): “income,” not “bonds.”  This is another instance of a fund that has been reshaped in recent years into an interesting offering.  Perception just hasn’t yet caught up with the reality.

Smead Value (SMVLX): call it “Triumph of the Optimists.”  Mr. Smead dismisses most of what his peers are doing as poorly conceived or disastrously poorly-conceived.  He thinks that pessimism is overbought, optimism in short supply and a portfolio of top-tier U.S. stocks held forever as your best friend.

Elevator Talk #5: Casey Frazier of Versus Capital Multi-Manager Real Estate Income Fund

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.

Versus Capital Multi-Manager Real Estate Income Fund is a closed-end interval fund.  That means that you can buy Versus shares any day that the market is open, but you only have the opportunity to sell those shares once each quarter.  The advisor has the option of meeting some, all or none of a particular quarter’s redemption requests, based on cash available and the start of the market. 

The argument for such a restrictive structure is that it allows managers to invest in illiquid asset classes; that is, to buy and profit from things that cannot be reasonably bought or sold on a moment’s notice.  Those sorts of investments have been traditionally available only to exceedingly high net-worth investors either through limited partnerships or direct ownership (e.g., buying a forest).  Several mutual funds have lately begun creating into this space, mostly structured as interval funds.  Vertical Capital Income Fund (VCAPX), the subject of our April Elevator Talk, was one such.  KKR Alternative Corporate Opportunities Fund, from private equity specialist Kohlberg Kravis Roberts, is another.

Casey Frazieris Chief Investment Officer for Versus, a position he’s held since 2011.  From 2005-2010, he was the Chief Investment Officer for Welton Street Investments, LLC and Welton Street Advisors LLC.  Here’s Mr. Frazier’s 200 (and 16!) words making the Versus case:

We think the best way to maximize the investment attributes of real estate – income, diversification, and inflation hedge – is through a blended portfolio of private and public real estate investments.  Private real estate investments, and in particular the “core” and “core plus” segments of private real estate, have historically offered steady income, low volatility, low correlation, good diversification, and a hedge against inflation.  Unfortunately institutional private real estate has been out of reach of many investors due to the large size of the real estate assets themselves and the high minimums on the private funds institutional investors use to gain exposure to these areas.  With the help of institutional consultant Callan Associates, we’ve built a multi-manager portfolio in a 40 Act interval structure we feel covers the spectrum of a core real estate allocation.  The allocation includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies.  We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7% – 9% range net of fees with 5% – 6% of that coming from income.  Operationally, the fund has daily pricing, quarterly liquidity at NAV, quarterly income, 1099 reporting and no subscription paperwork.

Versus offers a lot of information about private real estate investing on their website.  Check the “fund documents” page. The fund’s retail, F-class shares carry an annual expense of 3.30% and a 2.00% redemption fee on shares held less than one year.  The minimum initial investment is $10,000.  

Conference Call Upcoming: RiverNorth/Oaktree High Income, July 11, 3:15 CT

While the Observer’s conference call series is on hiatus for the summer (the challenge of coordinating schedules went from “hard” to “ridiculous”), we’re pleased to highlight similar opportunities offered by folks we’ve interviewed and whose work we respect.

In that vein, we’d like to invite you to join in on a conference call hosted by RiverNorth to highlight the early experience of RiverNorth/Oaktree High Income Fund.  The fund is looking for high total return, rather than income per se.  As of May 31, 25% of the portfolio was allocated to RiverNorth’s tactical closed-end fund strategy and 75% to Oaktree.  Oaktree has two strategies (high yield bond and senior loan) and it allocates more or less to each depending on the available opportunity set.

Why might you want to listen in?  At base, both RiverNorth and Oaktree are exceedingly successful at what they do.  Oaktree’s services are generally not available to retail investors.  RiverNorth’s other strategic alliances have ranged from solid (with Manning & Napier) to splendid (with DoubleLine).  On the surface the Oaktree alliance is producing solid results, relative to their Morningstar peer group, but the fund’s strategies are so distinctive that I’m dubious of the peer comparison.

If you’re interested, the RiverNorth call will be Thursday, July 11, from 3:15 – 4:15 Central.  The call is web-based, so you’ll be able to read supporting visuals while the guys talk.  Callers will have the opportunity to ask questions of Mr. Marks and Mr. Galley.  Because RiverNorth anticipates a large crowd, you’ll submit your questions by typing them rather than speaking directly to the managers. 

How can you join in?  Just click

You can also get there by visiting RiverNorthFunds.com and clicking on the Events tab.

Launch Alert

Artisan Global Small Cap (ARTWX) launched on June 25, after several delays.  It’s managed by Mark Yockey and his new co-managers/former analysts, Charles-Henri Hamker and Dave Geisler.  They’ll apply the same investment discipline used in Artisan Global Equity (ARTHX) with a few additional constraints.  Global Small will only invest in firms with a market cap of under $4 billion at the time of purchase and might invest up to 50% of the portfolio in emerging markets.  Global Equity has only 7% of its money in small caps and can invest no more than 30% in emerging markets (right now it’s about 14%). Just to be clear: this team runs one five-star fund (Global), two four-star ones (International ARTIX and International Small Cap ARTJX), Mr. Yockey was Morningstar’s International Fund Manager of the Year in 1998 and he and his team were finalists again in 2012.  It really doesn’t get much more promising than that. The expenses are capped at 1.50%.  The minimum initial investment is $1000.

RiverPark Structural Alpha (RSAFX and RSAIX) launched on Friday, June 28.  The fund will employ a variety of options investment strategies, including short-selling index options that the managers believe are overpriced.  A half dozen managers and two fund presidents have tried to explain options-based strategies to me.  I mostly glaze over and nod knowingly.  I have become convinced that these represent fairly low-volatility tools for capturing most of the stock market’s upside. The fund will be comanaged by Justin Frankel and Jeremy Berman. This portfolio was run as a private partnership for five years (September 2008 – June 2013) by the same managers, with the same strategy.  Over that time they managed to return 10.7% per year while the S&P 500 made 6.2%.  The fund launched at the end of September, 2008, and gained 3.55% through year’s end.  The S&P500 dropped 17.7% in that same quarter.  While the huge victory over those three months explains some of the fund’s long-term outperformance, its absolute returns from 2009 – 2012 are still over 10% a year.  You might choose to sneeze at a low-volatility, uncorrelated strategy that makes 10% annually.  I wouldn’t.  The fund’s expenses are hefty (retail shares retain the 2% part of the “2 and 20” world while institutional shares come in at 1.75%).  The minimum initial investment will be $1000.

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. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting.

Funds in registration this month won’t be available for sale until, typically, the end of August 2013. There were 13 funds in registration with the SEC this month, through June 25^th.  The most interesting, by far, is:

RiverPark Strategic Income Fund.  David Sherman of Cohanzick Management, who also manages the splendid but closed RiverPark Short Term High Yield Fund (RPHYX, see below) will be the manager.  This represents one step out on the risk/return spectrum for Mr. Sherman and his investors.  He’s giving himself the freedom to invest across the income-producing universe (foreign and domestic, short- to long-term, investment and non-investment grade debt, preferred stock, convertible bonds, bank loans, high yield bonds and up to 35% income producing equities) while maintaining a very conservative discipline.  In repeated conversations, it’s been very clear that Mr. Sherman has an intense dislike of losing his investors’ money.  His plan is to pursue an intentionally conservative strategy by investing only in those bonds that he deems “Money Good” and stocks whose dividends are secure.  He also can hedge the portfolio and, as with RPHYX, he intends to hold securities until maturity which will make much of the fund’s volatility more apparent than real.   The expense ratio is 1.25% for retail shares, 1.00% for institutional. The minimum initial investments will be $1000 for retail and $1M for institutional.

Details and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes

On a related note, we also tracked down a near-record 64 fund manager changes. 

Briefly Noted . . .

If you own a Russell equity fund, there’s a good chance that your management team just changed.  Phillip Hoffman took over the lead for a couple funds but also began swapping out managers on some of their multi-manager funds.  Matthew Beardsley was been removed from management of the funds and relocated into client service. 

SMALL WINS FOR INVESTORS

Seventeen BMO Funds dropped their 2.00% redemption fees this month.

BRC Large Cap Focus Equity Fund (BRCIX)has dropped its management fee from 0.75% to 0.47% and capped its total expenses at 0.55%.  It’s an institutional fund that launched at the end of 2012 and has been doing okay.

LK Balanced Fund (LKBLX) reduced its minimum initial investment for its Institutional Class Shares from $50,000 to $5,000 for IRA accounts.  Tiny fund, very fine long-term record but a new management team as of June 2012.

Schwab Fundamental International Small Company Index Fund (SFILX) and Schwab Fundamental Emerging Markets Large Company Index Fund (SFENX) have capped their expenses at 0.49%.  That’s a drop of 6 and 11 basis points, respectively.

CLOSINGS (and related inconveniences)

Good news for RPHYX investors, bad news for the rest of you.  RiverPark Short Term High Yield (RPHYX) has closed to new investors.  The manager has been clear that this really distinctive cash-management fund had a limited capacity, somewhere between $600 million and $1 billion.  I’ve mentioned several times that the closure was nigh.  Below is the chart of RPHYX (blue) against Vanguard’s short-term bond index (orange) and prime money market (green).

OLD WINE, NEW BOTTLES

For all of the excitement over China as an investment opportunity, China-centered funds have returned a whoppin’ 1.40% over the past five years.  BlackRock seems to have noticed and they’ve hit the Reset button on BlackRock China Fund (BACHX).  As of August 16, it will become BlackRock Emerging Markets Dividend Fund.  One wonders if the term “chasing last year’s hot idea” is new to them?

On or about August 5, 2013, Columbia Energy and Natural Resources Fund (EENAX, with other tickers for its seven other share classes) will be renamed Columbia Global Energy and Natural Resources Fund.  There’s no change to the strategy and the fund is already 35% non-U.S., so it’s just marketing fluff.

“Beginning on or about July 1, 2013, all references to ING International Growth Fund (IIGIX) are hereby deleted and replaced with ING Multi-Manager International Equity Fund.”  Note to ING: the multi-manager mish-mash doesn’t appear to be a winning strategy.

Effective May 22, ING International Small Cap Fund (NTKLX) may invest up to 25% of its portfolio in REITs.

Effective June 28, PNC Mid Cap Value Fund became PNC Mid Cap Fund (PMCAX).

Effective June 1, Payden Value Leaders Fund became Payden Equity Income Fund (PYVLX).  With only two good years in the past 11, you’d imagine that more than the name ought to be rethought.

OFF TO THE DUSTBIN OF HISTORY

Geez, the dustbin is filling quickly.

The Alternative Strategies Mutual Fund (AASFX) closed to new investors in June and will liquidate by July 26, 2013.  It’s a microscopic fund-of-funds that, in its best year, trailed 75% of its peers.  A 2.5% expense ratio didn’t help.

Hansberger International Value Fund (HINTX) will be liquidated on or about July 19, 2013.   It’s moved to cash pending dissolution.

ING International Value Fund (IIVWX) is merging into ING International Value Equity (IGVWX ), formerly ING Global Value Choice.   This would be a really opportune moment for ING investors to consider their options.   ING is merging the larger fund into the smaller, a sign that the marketers are anxious to bury the worst of the ineptitude.  Both funds have been run by the same team since December 2012.  This is the sixth management team to run the fund in 10 years and the new team’s record is no better than mediocre.    

In case you hadn’t noticed, Litman Gregory Masters Value Fund (MSVFX) was absorbed by Litman Gregory Masters Equity Fund (MSENX) in late June, 2013.  Litman Gregory’s struggles should give us all pause.  You have a firm whose only business is picking winning fund managers and assembling them into a coherent portfolio.  Nonetheless, Value managed consistently disappointing returns and high volatility.  How disappointing?  Uhh … they thought it was better to keep a two-star fund that’s consistently had higher volatility and lower returns than its peers for the past decade.  We’re going to look at the question, “what’s the chance that professionals can assemble a team of consistently winning mutual fund managers?” when we examine the record (generally parlous) of multi-manager funds in an upcoming issue.

Driehaus Large Cap Growth Fund (DRLGX) was closed on June 11 and, as of July 19, the Fund will begin the process of liquidating its portfolio securities. 

The Board of Fairfax Gold and Precious Metals Fund (GOLMX and GOLLX) “has concluded that it is in the best interests of the Fund and its shareholders that the Fund cease operations,” which they did on June 29, 2013

Forward Global Credit Long/Short Fund (FGCRX) will be liquidated on or around July 26, 2013.  I’m sure this fund seemed like a good idea at the time.  Forward’s domestic version of the fund (Forward Credit Analysis Long/Short, FLSRX) has drawn $800 million into a high risk/high expense/high return portfolio.  The global fund, open less than two years, managed the “high expense” part (2.39%) but pretty much flubbed on the “attract investors and reward them” piece.   The light green line is the original and dark blue is Global, since launch.

Henderson World Select Fund (HFPAX) will be liquidated on or about August 30, 2013.

The $13 million ING DFA Global Allocation Portfolio (IDFAX) is slated for liquidation, pending shareholder approval, likely in September.

ING has such a way with words.  They announced that ING Pioneer Mid Cap Value Portfolio (IPMVX, a/k/a “Disappearing Portfolio”) will be reorganized “with and into the following ‘Surviving Portfolio’ (the ‘Reorganization’):

So, in the best case, a shareholder is The Survivor?  What sort of goal is that?  “Hi, gramma!  I just invested in a mutual fund that I hope will survive?” Suddenly the Bee Gees erupt in the background with “stayin’ alive, stayin’ alive, ah, ah, ah … “  Guys, guys, guys.  The disappearance is scheduled to occur just after Labor Day.

Stephen Leeb wrote The Coming Economic Collapse (2008).  The economy didn’t, his fund did.  Leeb Focus Fund (LCMFX) closed at the end of June, having parlayed Mr. Leeb’s insights into returns that trailed 98% of its peers since launch. 

On June 20, 2013, the board of directors of the Frontegra Funds approved the liquidation of the Lockwell Small Cap Value Fund (LOCSX).  Lockwell had a talented manager who was a sort of refugee from a series of fund mergers, acquisitions and liquidations in the industry.  We profiled LOCSX and were reasonably positive about its prospects.  The fund performed well but never managed to attract assets, partly because small cap investing has been out of favor and partly because of an advertised $100,000 minimum.  In addition to liquidating the fund, the advisor is closing his firm. 

Tributary Core Equity Fund (FOEQX) will liquidate around July 26, 2013.  Tributary Balanced (FOBAX), which we’ve profiled, remains small, open and quite attractive. 

I’ve mentioned before that I believe Morningstar misleads investors with their descriptions of a fund’s fee level (“high,” “above average” and so on) because they often use a comparison group that investors would never imagine.  Both Tributary Balanced and Oakmark Equity & Income (OAKBX) have $1000 minimum investments.  In each case, Morningstar insists on comparing them to their Moderate Allocation Institutional group.  Why?

In Closing . . .

We have a lot going on in the month ahead: Charles is working to create a master listing of all the funds we’ve profiled, organized by strategy and risk.  Andrew and Chip are working to bring our risk data to you in an easily searchable form.  Anya and Barb continue playing with graphics.  I’ve got four profiles underway, based on conversations I had at Morningstar.

And … I get to have a vacation!  When you next hear from me, I’ll be lounging on the patio of LeRoy’s Water Street Coffee Shop in lovely Ephraim, Wisconsin, on the Door County peninsula.  I’ll send pictures, but I promise I won’t be gloating when I’m doing it.

Dear friends,

I am not, in a monetary sense, rich.  Teaching at a small college pays rather less, and raising a multi-talented 12-year-old costs rather more, than you’d imagine.  I tend to invest cautiously in low-minimum, risk-conscious funds. I have good friends, drink good beer, laugh a lot and help coach Little League (an activity to which the beer and laughter both contribute).

This comes up only because I was moved to sudden and profound pity over the cruel ways in which the poor, innocent rich folks are being ruthlessly exploited.  Two new articles highlight their plight.

Mark Hulbert published a fairly relentless critique, “The Verdict Is In: Hedge Funds Aren’t Worth the Money”(WSJ, 06/01/2013), (While we can’t link directly to the article, you should be able to Google the title and get in) that looks at the performance –both risk and returns – of the average hedge fund since the last market top (October 2007) and from the last market bottom (March 2009).  The short version of his findings:

• The average hedge fund has trailed virtually every conceivable benchmark (gold, the total bond market, the total stock market, a 60/40 index, and the average open-end mutual fund) whether measured from the top or the bottom
• The downside protection offered by hedge funds during the meltdown was not greater than what a simple balanced fund would offer.
• At best, one hedge fund manager in five outperforms their mutual fund counterparts, and those winners are essentially impossible to identify in advance.

Apparently Norway figured this out before you.  While the Yale endowment, led by David Swensen, was making a mint investing in obscure and complex alternatives, Jason Zweig (“Norway: The New Yale,” WSJ, 03/07/2013) reported that Norway’s huge pension fund has outperformed the stock market and, recently, Yale, through the simple expedient of a globally diversified, long-only portfolio biased toward “small” and “value.”  Both Swensen and the brilliantly cranky Bill Bernstein agree that the day of outsized profits from “alternative investments” has passed.  Given that fact that the herd is now gorging on alternative investments:

“it’s somewhere between highly probable and certain that you will underperform [a stock portfolio] if you are being sold commodities, hedge funds and private equity right now.”

Think of it like this, he says: “The first person to the buffet table gets the lobster. The people who come a little later get the hamburger. And the ones who come at the end get whatever happens to be stuck to the tablecloth.”

That doesn’t deny the fact that there’s huge money to be made in hedge fund investing. Barry Ritholz published a remarkable essay, “A hedge fund for you and me? The best move is to take a pass” (Washington Post, 05/24/2013) that adds a lot of evidence about who actually profits from hedge funds.  He reports on research by Simon Lack, author of The Hedge Fund Mirage,” who concludes that the usual 2 and 20 “fee arrangement is effectively a wealth transference mechanism, moving dollars from investors to managers.” Lack used to allocate money to hedge funds on behalf of JPMorgan Chase.  Among Lack’s findings

• From 1998 to 2010, hedge fund managers earned $379 billion in fees. The investors of their funds earned only $70 billion in investing gains.
• Managers kept 84% of investment profits, while investors netted only 16%.
• As many as one-third of hedge funds are funded through feeder funds and/or fund of funds, which tack on yet another layer of fees. This brings the industry fee total to $440 billion — that’s 98 %of all the investing gains, leaving the people whose capital is at risk with only 2%, or $9 billion.

Oh, poor rich people.  At the same time, the SEC is looking to relax restrictions on hedge fund marketing and advertising which means that even more of them might become subject to the cruel exploitation of … well, the richer people. 

On whole, I think I’m happy to be living down here in 40-Act Land.

Introducing MFO Fund Ratings

One of the most frequent requests we receive is for the reconstruction of FundAlarm’s signature “most alarming funds” database.  Up until now, we haven’t done anything like it.  There are two reasons: (1) Snowball lacked both the time and the competence even to attempt it and (2) the ratings themselves lacked evidence of predictive validity.  That is, we couldn’t prove that an “Honor Roll” fund was any likelier to do well in the future than one not on the honor roll.

We have now budged on the matter.  In the spirit of those beloved fund ratings, MFO will maintain a new system to highlight funds that have delivered superior absolute returns while minimizing down side volatility.  We’re making the change for two reasons. (1) Associate editor Charles Boccadoro, a recently-retired aerospace engineer, does have the time and competence.  And, beyond that, a delight in making sense of data. And (2) there is some evidence that risk persists even if returns don’t. That is, managers who’ve taken silly, out-sized, improvident risks in the past will tend to do so in the future.  We think of it as a variant of the old adage, “beauty is just skin-deep, but ugly goes all the way to the bone.”

There are two ways of explaining what we’re up to.  We think of them as “the mom and pop explanation” and the “Dr. Mom and Ph.D. Pop explanation.”  We’ll start with the M&P version, which should be enough for most of us.

Dear Mom and Pop,

Many risk measures look at the volatility or bounciness of a portfolio, both on the upside and the downside.  As it turns out, investors don’t mind having funds that outperform their peers in rising markets; that is, they don’t immediately reject upside volatility.  What they (we!) dread are excessive drawdowns: that is, having their returns go down far and hard.  What Charles has done is to analyze the performance of more than 7000 funds for periods ranging back 20 years.  He’s calculated seven different measures of risk for each of those funds and has assigned every fund into one of five risk groups from “very conservative” funds which typically absorb no more than 20% of a stock market decline to “very aggressive” ones which absorb more than 125% of the fall.  We’ve assembled those in a large spreadsheet which is on its way to becoming a large, easily searchable database.

For now, we’ve got a preview.  It focuses on the funds with the most consistently excellent 20-year returns (the happy blue boxes on the right hand side, under “return group”), lets you see how much risk you had to absorb to achieve those returns (the blue to angry red boxes under risk group) and the various statistical measures of riskiness.  In general, you’d like to see low numbers in the columns to the left of the risk group and high numbers in the columns to the right.

I miss the dog.  My roommate is crazy.  The pizza has been good.  I think the rash is mostly gone but it’s hard to see back there.  I’m broke.  Say “hi” to gramma.  Send money soon.

Love, your son,

Dave

And now back to the data and the serious explanation from Charles:

The key rating metric in our system is Martin ratio, which measures excess return divided by the drawdown (a/k/a Ulcer) index. Excess return is how much a fund delivers above the 90-day Treasury bill rate. Ulcer index measures depth and duration of drawdowns from recent peaks – a very direct gauge of unpleasant performance. (More detailed descriptions can be found at Ulcer Index and A Look at Risk Adjusted Returns.)

The rating system hierarchy is first by evaluation period, then investment category, and then by relative return. The evaluation periods are 20, 10, 5, 3, and 1 years. The categories are by Morningstar investment style (e.g., large blend). Within each category, funds are ranked based on Martin ratio. Those in the top 20 percentile are placed in return group 5, while those in bottom 20 percentile are in return group 1. Fund ratings are tabulated along with attendant performance and risk metrics, by age group, then category, then return group, and finally by absolute return.

MFO “Great Owl” designations are assigned to consistent top performers within the 20 and 10 year groups, and “Aspiring Great Owl” designations are similarly assigned within the 5 and 3 year groups.

The following fund performance and risk metrics are tabulated over each evaluation period:

A risk group is also tabulated for each fund, based simply on its risk metrics relative to SP500. Funds less than 20% of market are placed in risk group 1, while those greater than 125% are placed in risk group 5. This table shows sample maximum drawdowns by risk group, depicting average to worst case levels. 

Some qualifications:

• The system includes oldest share class only and excludes the following categories: money market, bear market, trading inverse and leveraged, volatility, and specialized commodities.
• The system does not account for category drift.
• Returns reflect maximum front load, if applicable.
• Funds are presented only once based on age group, but the return rankings reflect all funds existing. For example, if a 3 year fund scores a 5 return, it did so against all existing funds over the 3 year period, not just the 3 year olds.
• All calculations are made with Microsoft’s Excel using monthly total returns from the Morningstar database provided in Steele Mutual Fund Expert.
• The ratings are based strictly on historical returns.
• The ratings will be updated quarterly.

We will roll-out the new system over the next month or two. Here’s a short preview showing the MFO 20-year Great Owl funds – there are only 48, or just about 3% of all funds 20 years and older. 

31 May 2013/Charles

(p.s., the term “Great Owl” funds is negotiable.  We’re looking for something snazzy and – for the bad funds – snarky.  “Owl Chow funds”?  If you’re a words person and have suggestions, we’d love to hear them.  Heck, we’d love to have an excuse to trick Barb into designing an MFO t-shirt and sending it to you.  David)

The Implosion of Professional Journalism will make you Poorer

You’ve surely noticed the headlines.  Those of us who teach News Literacy do.  The Chicago Sun-Times laid off all of its photo-journalists (28 staff members) on the morning of May 30, 2013, in hopes that folks with iPhone cameras would fill in.  Shortly before the New York Daily News laid off 20, the Village Voice fired a quarter of its remaining staff, Newsweek closed its print edition and has announced that it’s looking for another owner. Heck, ESPN just fired 400 and even the revered Columbia Journalism Review cut five senior staff. The New York Times, meanwhile, has agreed to “native advertising” (ads presented as content on mobile devices) and is investigating “sponsored content;” that is, news stories identified and funded by their advertisers.  All of that has occurred in under a month.

Since the rest of us remain intensely interested in receiving (if not paying for) news, two things happen simultaneously: (1) more news originates from non-professional sources and (2) fewer news organizations have the resources to check material before they publish it.

Here’s how that dynamic played out in a recent series of stories on the worst mutual funds.

Step One: NerdWallet sends out a news release heralding “the 12 most expensive and worst-performing mutual funds.”

Well, no.  What they sent was a list of fund names, ticker symbols (mostly) for specific share classes of the fund and (frequently) inaccurate expense ratio reports. They report the worst of the worst as

1. Oppenheimer Commodity Strat. Total Return (QRACX): 2.2% e.r.

Actually QRACX is the “C” class for the Oppenheimer fund. Morningstar reports the e.r. at 2.09%. The “A” shares have a 1.26% e.r.  And where did the mysterious 2.20% number come from?  One of the folks at NerdWallet wrote, “it seems it was an error on the part of our data provider.”  NerdWallet promised to clear up the fund versus share class distinction and to get the numbers right.

But that’s not the way things work, because NerdWallet sent their press release to other folks, too.

Step Two: Investment News mindlessly reproduces the flawed information.

Within hours, they have grafted on some random photographs and turned the press release into a slide show, now entitled “Expensive – and underperforming – funds.”  NerdWallet receives credit on just one of the slides.  Apparently no one at Investment News stopped to double-check any of the details before going public. But they did find pretty pictures.

Step Three: Mutual Fund Wire trumpets Investment News’s study.

MFWire’s story touting of the article, “Investment News Unveils Mutual Fund Losers List,” might be better-titled “Investment News Reproduces another Press Release”.  You’ll note, by the way, that the actual source of the story has disappeared.

Step Four:   CNBC makes things worse by playing with the data.

On Friday, May 17, CNBC’s Jeff Cox posts ‘Dirty Dozen’: 12 Worst Mutual Funds.  And they promptly make everything worse by changing the reported results.

Here’s the original: 1. Oppenheimer Commodity Strat. Total Return (QRACX): 2.2% e.r.

Here’s the CNBC version: 1.  Oppenheimer Commodity Strategy Total Return (NASDAQ:QRAAX-O), -14.61 percent, 2.12 percent.

Notice anything different?  CNBC changed the fund’s ticker symbol, so that it now pointed to Oppenheimer’s “A” share class. And those numbers are desperately wrong with regard to “A” shares, which charge barely half of the claimed rate (which is, remember, wrong even from the high cost “C” shares).  They also alter the ticker symbol of Federated Prudent Bear, which started as the high cost “C” shares (PBRCX) but for which CNBC substitutes the low-cost “A” shares (BEARX).  For the remaining 10 funds, CNBC simply disregards the tickers despite the fact that these are all high-cost “B” and “C” share classes.

Step Five: And then a bunch of people read and forward the danged thing.

Leading MFWire to celebrate it as one of the week’s “most read” stories.  Great.

Step Six: NerdWallet themselves then draw an invalid conclusion from the data.

In a blog post, NerdWallet’s Susan Lyon opines:

As you can see, all of the funds listed above are actively managed, besides the Rydex Inverse S&P 500 Strategy Fund. Do the returns generated by actively managed mutual funds usually outweigh their costs?  No, a recent NerdWallet Investing study found that though actively managed funds earned 0.12% higher annual returns than index funds on average, because they charged higher fees, investors were left with 0.80% lower returns.

No.  The problem here isn’t that these funds are actively managed.  It’s that NerdWallet tracked down the effects of the predatory pricing model behind “C” share classes.  And investors have pretty much figured out the “expense = bad” thing, which explains why the Oppenheimer “C” shares that NerdWallet indicts have $68M in assets while the lower-cost “A” shares have $228M.

Step Seven: Word spreads like cockroaches.

The story, in one of its several variants, now appears on a bunch of little independent finance sites and rarely with NerdWallet’s own discussion of their research protocol, much less a thoughtful dissection of the data.

NerdWallet (at least their “investing silo”) is a new operation, so you can understand their goof as a matter of a young staff, start-up stumbles and all that. It’s less clear how you explain Investment News‘s mindless reproduction of the results (what? verify stuff before we publish it? Edit for accuracy? Who do you think we are, journalists?) or MFWire’s touting of the article as if it represented Investment News’s own work.

Before the Observer publishes a fund profile, we give the advisor a chance to review the text for factual accuracy. My standard joke is “I’m used to making errors of judgment, but I loathe making errors of fact and so would you please let us know if there are any factual misstatements or other material misrepresentations?” I entirely agree with NerdWallet’s original judgment: these are pricey under-performers. I just wish that folks all around were a bit more attentive to and concerned about accuracy and detail.

Then Morningstar makes it All Worse

When I began working on the story above, I checked the expense reports at Morningstar.  Here’s what I found for QRACX:

Ooookay.  2.09% is “Below Average.” But below average for what?  Mob ransom demands?  Apparently, below average for US Open-End Commodities Broad Basket Funds, right?

Well, no, not so much.  Here’s Morningstar’s detailed expense report for the fund:

The average commodities fund – that is, the average fund in QRACX’s category – has a 1.32% expense ratio.  So how on earth could QRACX at 2.09% be below average?  Because it’s below the “fee level comparison group median.” 

There are 131 funds in the “broad commodity basket” group. Exactly one has an expense ratio about 2.40%.  If there’s one commodity fund above 2.40% and 130 below 2.40%, how could 2.40% be the group median?

Answer: Morningstar has, for the purpose of making expense comparisons, assigned QRACX to a group that has effectively nothing to do with commodity funds.

Mr. Rekenthaler, in response to an emailed query, explains, “‘Below average’ means that QRACX has below average expenses for a C share that is an Alternative fund.”

Morningstar is not comparing QRACX to other commodity funds when they make their expense judgment.  No, no.  They’re comparing it only to other “C” share classes of other types of “alternative investment” funds.  Here are some of the funds that Morningstar is actually judging QRACX against:

And so if you were choosing between the “C” class shares of this commodity fund and the “C” shares of a leveraged-inverse equity fund and a multicurrency fund, you’d know that you were probably getting a bargain for your money.

Why on earth you’d possibly benefit from the comparison of such of group of wildly incomparable funds remains unknown.

This affects every fund and every expense judgment in Morningstar’s database.  It’s not just a problem for the miserable backwater that QRACX occupies.

Want to compare Artisan International (ARTIX) to the fund that Morningstar says is “most similar” to it, American Funds EuroPacific Growth, “A” shares (AEPGX)?  Both are large, four-star funds in the Foreign Large Blend group.  But for the purposes of an expense judgment, they have different “fee level comparison groups.”  Artisan is judged as “foreign large cap no load,” which median is 1.14% while American is judged against “foreign large cap front load,” where the median is 1.44%.  If Artisan charged 1.24% and American charged 1.34%, Artisan would be labeled “above average” and American “below average.”  Meanwhile American’s “C” shares carry a 1.62% expense ratio and a celebratory “low” price label.

For investors who assume that Morningstar is comparing apples to apples (or foreign large blend to foreign large blend), this has the potential for being seriously misleading.  I am very sympathetic to the complexity of Morningstar’s task, but they really need to be much clearer that these expense labels are not linked to the category labels immediately adjacent to them.

We Made the Cover!

Okay, so it wasn’t the cover of Rolling Stone.  It was the cover of the BottomLine Personal newsletter (05/15/2013).  And there wasn’t a picture (they reserved those for their two “Great Sex, Naturally” articles).  And it was just 75 words long.

But at least they misrepresented my argument, so that’s something!  The “Heard by our editors” column led off with “Consider ‘bear market funds’” and us.  The bulk of the story is contained in the following two sentence fragments: “Consider ‘bear market funds’ as a kind of stock market disaster insurance . . . [they] should make up no more than 5% of your stock portfolio.”

Uhhh … what I said to the editors was “these funds are a disaster for almost everybody who holds them.  By their nature, they’re going to lose money for you year after year … probably the best will cost you 7% a year in the long run.  The only way they’ve work is if they represented a small fraction of your portfolio – say 5% – and you were absolutely disciplined about rebalancing so that you kept pouring money down this particular rat hole in order to maintain it as 5% of your portfolio.  If you did that, you would indeed have a psychologically useful tool – a fund that might well soar in the face of our sharp downturn and that would help you stay disciplined and stay invested, rather than cutting and running.  That said, we’re not wired that way and almost no one has that discipline.  That why I think you’d be far better off recommending an equity fund with an absolute-returns discipline, such as Aston/River Road Independent Value, Cook and Bynum or FPA Crescent, or a reasonably priced long-short fund, like Aston/River Road Long-Short or RiverPark Long/Short Opportunity.”

They nodded, and wondered which specific bear market funds I’d recommend.  They were trying hard to address their readers’ expressed interests, had 75 words to work with and so you got my recommendation of Federated Prudent Bear (BEARX, available at NAV) and PIMCO StocksPLUS AR Short Strategy (PSSDX).

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. 

Bretton Fund (BRTNX): if you were a fund manager looking to manage just your own family’s finances for the next generation, this is probably what you’d be doing.

RiverPark/Gargoyle Hedged Value (RGHVX): RiverPark has a well-earned reputation for bringing brilliant managers from the high net worth world to us.  Gargoyle, whose discipline consistently and successfully marries stock selection and a substantial stake in call options, seems to be the latest addition to a fine stable of funds.

Scout Low Duration (SCLDX): there are very few fixed-income management teams that have earned the right to be trusted with a largely unconstrained mandate.  Scout is managed by one of them on behalf of folks who need a conservative fund but can’t afford the foolishness of 0.01% interest.

Conference Call Highlights: Stephen Dodson and Bretton Fund

Does it make sense to you that you could profit from following the real-life choices of the professionals in your life?  What hospital does your doctor use when her family needs one?  Where does the area’s best chef eat when he wants to go out for a weeknight dinner?  Which tablet computer gets Chip and her IT guys all shiny-eyed?

If that strategy makes sense to you, so will the Bretton Fund (BRTNX).

Bretton Fund (BRTNX) is managed by Stephen Dodson.  For a relatively young man, he’s had a fascinating array of experiences.  After graduating from Berkeley, he booked 80-100 hour weeks with Morgan Stanley, taking telecom firms public.  He worked in venture capital, with software and communications firms, before joining his father’s firm, Parnassus Investments.  At Parnassus he did everything from answering phones and doing equity research, to co-managing a fixed-income fund and presiding over the company.  He came to realize that “managing a family relationship and what I wanted in my career were incompatible at the time,” and so left to start his own firm.

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

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

And that’s what Bretton does.  It  holds 15-20 stocks in industries that the manager feels he understands really well. “Understands really well” translates to “do I think I understand who’ll be making money five years from now and what the sources of those earnings will be?” In some industries (biotech, media, oil), his answer was “no.” “Some really smart guys say oil will be $50/bbl in a couple years. Other equally smart analysts say $150. I have no hope of knowing which is right, so I don’t invest in oil.” He does invest in industries such as retail, financial services and transportation, where he’s fairly comfortable with his ability to make sense of their dynamics.

When I say “he does invest,” I mean “him, personally.”  Mr. Dodson reports that “I’ve invested all my investible net-worth, all my family members are invested in the fund.  My mother is invested in the fund.  My mother-in-law is invested in the fund (and that definitely sharpens the mind).”   Because of that, he can imagine Bretton Fund functioning almost as a family office.  He’s gathering assets at a steady pace – the fund has doubled in size since last spring and will be able to cover all of its ‘hard’ expenses once it hits $7 million in assets – but even if he didn’t get a single additional outside dollar he’d continue running Bretton as a mechanism for his family’s wealth management.   He’s looking to the prospect of some day having $20-40 million, and he suspects the strategy could accommodate $500 million or more.

Bottom Line: The fund is doing well – it has handily outperformed its peers since inception, outperformed them in 11 of 11 down months and 18 of 32 months overall.  It’s posted solid double-digit returns in 2012 and 2013, through May, with a considerable cash buffer.  It will celebrate its three-year anniversary this fall, which is the minimum threshold for most advisors to consider the fund. While he’s doing no marketing now, he’s open to talking with folks and imagines some marketing effort once he’s got a three year record to talk about.  Frankly, I think he has a lot to talk about already.

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

Launch Alert: T. Rowe and Vanguard

T. Rowe Price Global Allocation (RPGAX) launched on May 28, 2013.  Color me intrigued.  Price has always been good at asset allocation research and many of their funds allow for tactical tweaks to their allocations.  This is Price’s most ambitious offering to date.  The fund targets 60% stocks, 30% bonds and 10% hedge funds and other alternative investments and promises “an active asset allocation strategy” in pursuit of long-term capital appreciation and income.  The fund will be managed by Charles M. Shriver, who has been with Price since 1991. Mr. Shriver also manages Price Balanced (RPBAX) fund and its Spectrum and Personal Strategy line of funds.  The funds expenses are capped at 1.05% through 2016.  There’s a $2500 initial investment minimum, reduced to $1000 for IRAs.

Vanguard Emerging Markets Government Bond Index Fund (VGOVX) and its ETF clone (VWOB) will launch in early June.  The funds were open for subscription in May – investors could send Vanguard money but Vanguard wouldn’t invest it until the end of the subscription period. There are nearly 100 e.m. bond funds or ETFs already, though Vanguard’s will be the first index and the cheapest option (at 30-50 basis points).  Apparently the launch was delayed by more than a year because Vanguard didn’t like the indexes available for e.m. bonds, so they commissioned a new one: Barclays USD Emerging Markets Government RIC Capped Index.  The fund will invest only in bonds denominated in U.S. dollars.  Investor shares start at $3000 and 0.50% e.r.

Pre-launch Alerts: Artisan and Grandeur Peak, Globe-trotting Again

Artisan Global Small Cap Fund launches June 19. It will be run by Mark Yockey and team.  It’s been in registration for a while and its launch was delayed at least once.

Grandeur Peak Global Reach Fund (GPROX/GPRIX) will launch June 19, 2013 and will target owning 300-500 stocks, “with a strong bias” toward small and micro-caps in the American, developed, emerging and frontier markets.  There’s an intriguing tension here, since the opening of Global Reach follows just six weeks after the firm closed Global Opportunities to new investors.  At the time founder Robert Gardiner argued:

To be good small and micro cap investors it’s critical to limit your assets. Through my career I have seen time and again small cap managers who became a victim of their own success by taking in too many assets and seeing their performance languish.

Their claim is that they have six or seven potential funds in mind and they closed their first two funds early “in part to leave room for future funds that we intend to launch, like the Global Reach Fund.”

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. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

Funds in registration this month won’t be available for sale until, typically, the beginning of August 2013. We found 10 – 20 no-load, retail funds in the pipeline, notably:

The 11 new T. Rowe Price Target Retirement 2005 – 2055 Funds will pursue that usual goal of offering a one-stop retirement investing solution.  Each fund invests in a mix of other T. Rowe Price funds.  Each mix becomes progressively more conservative as investors approach and move through retirement.  T. Rowe Price already has an outstanding collection of retirement-date funds, called “Retirement [date]” where these will be “Target Retirement [date].”  The key is that the new funds will have a more conservative asset allocation than their siblings, assuming “bonds” remain “conservative.”  At the target date, the new funds will have 42.5% in equities while the old funds have 55% in equities.  For visual learners, here are the two glidepaths:

The new funds’ glidepath	The old fund’s glidepath

The relative weights within the asset classes (international vs domestic, for example) are essentially the same. Each fund is managed by Jerome Clark and Wyatt Lee.  The opening expense ratios vary from 0.60% – 0.77%, with the longer-dated funds incrementally more expensive than the shorter-dated ones (that is, 2055 is more expensive than 2005).  These expenses are within a basis point or two of the older funds’.  The minimum initial investment is $2500, reduced to $1000 for various tax-advantaged accounts.

This is a very odd time to be rolling out a bond-heavy line-up.  On May 15^th, The Great Gross tweeteth:

Gross: The secular 30-yr bull market in bonds likely ended 4/29/2013. PIMCO can help you navigate a likely lower return 2 – 3% future.

At least he doesn’t ramble when he’s limited to 140 characters. 

The inclusion of hedge funds is fascinating, given the emerging sense (see this month’s intro) that they’re not worth a pitcher of warm bodily fluid (had I mentioned that the famous insult attributed to John Gardner, that the vice presidency “isn’t worth a bucket of warm spit” actually focused on a different bodily fluid but the newspaper editors of the day were reticent to use the word Gardner used?).  The decision to shift heavily toward bonds at this moment, perplexing.

Details and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

MANAGER CHANGES

On a related note, we also tracked down 37 fund manager changes. 

Updates …

Oakseed Opportunity (SEEDX) released their first portfolio report (on a lovely form N-Q on file with the SEC).  The fund has about $48 million in its portfolio.  Highlights include:

32 well-known stocks, one ETF, two individual shorts and a tiny call option

The largest five stock holdings are Teva Pharmaceuticals, Leucadia National, AbbVie (a 2013 spin-off of Abbott’s pharmaceutical division), Ross Stores, and Loews Corp.

15.8% of the fund is in cash

2.8% is in three short positions, mostly short ETF

The three largest sectors are pharmaceuticals (15.4%, four stocks), insurance (7%, two stocks) and retail (6.6%, two stocks).

(Thanks to Denny Baran of lovely Great Falls, MT, for the heads up on Oakseed’s filing.)

Three more honors for RiverPark/Wedgewood (RWGFX).  In May, Wedgewood became one of the Morningstar 500, “the top 500 funds that should be on your radar.”  That same month, Wedgewood’s David Rolfe was recognized as SMA Manager of the Year at the Envestnet’s 2013 Advisor Summit.  SMA’s are “separately managed accounts,” a tool for providing personalized portfolios for high net-worth investors.  Wedgewood runs a bunch using the strategy behind the RiverPark/Wedgewood fund and they were selected from among 1600 management teams.  Finally, Wedgewood received one of overall Large Cap awards from Envestnet, a repeat of a win in 2011, for its Large-Cap Focused Growth strategy.   Those who haven’t listened to David talk about investing, should.  Happily, we have a recorded hour-long conversation with David.

Valley Forge Fund (VAFGX) closes the gap, a bit.  We reported in May that Valley Forge’s manager died on November 3, but that the Board of Directors didn’t seem to have, well, hired a new one.  We stand corrected.  First, according to an April proxy statement, the Board had terminated the manager three days before his actual, well, you know, termination.

The Board determined to terminate the Prior Advisory Agreement because of, among other things, (i) the Prior Advisor’s demonstrated lack of understanding of the requirements set forth in the Fund’s prospectus, policies and procedures, (ii) the Prior Advisor’s demonstrated lack of knowledge of the terms of the Prior Advisory Agreement, (iii) the Prior Advisor’s failure to adhere to directives from the Board of Directors with respect to the Fund’s portfolio holdings; and (iv) the Fund’s poor performance. 

That pretty much covers it.  According to the newest prospectus (May 01, 2013), they did have a manager.  Up until December 31^st.

Investment Adviser Portfolio Managers: Boyle Capital Management, LLC (BCM) from November 01, 2012 to December 31, 2012.

And, for the months of April and May, the Board of Trustees ran the fund.  Here’s the “principal risks” statement from the Prospectus:

Management Risk: for the months of April and May of 2013, the Board of Directors has taken over all trading pending the Shareholders’ Approval to be obtained in May 2013.

Still a bit unclear on January, February and March.  Good news: under the Board’s leadership, the fund crushed the market in April and May based on a jump in NAV during the first week of May.  Also a bit unclear about what happens now that it’s June: most of the Valley Forge website now leads to blank pages.  Stay tuned!

Security Alert: A Word from our IT Folks

We know that many of you – fund managers, financial planners, restaurateurs and all – maintain your own websites.  If, like the Mutual Fund Observer and 72.4 million others, your site runs on the WordPress software, you’re under attack.  WordPress sites have been targeted for a relentless effort to gain access to your admin controls and, through them, to the resources of your web-host’s servers. 

You’ve doubtless heard of “zombie computers,” individual PCs that have been compromised and which fall under the control of The Forces of Evil.  In some cases zombie PCs serve spammers and phishers.  In other cases, they’re used as part of coordinated distributed denial of service (DDoS) attacks directed against high-profile targets including MasterCard, the Federal Reserve Bank, Google, and others.

There are three very, very bad aspects of these attacks:

1. They’re aiming to seize control of enormously powerful network servers, using your website as a tool for achieving that.  If you can imagine a zombie PCs potential output as equivalent to a garden hose set on full, then you could imagine a server as a fire hose set on full.
2. They’re designed to keep you from knowing that you’ve been compromised; it’s not like a virus that goofs with your ability to use your machine or your site, these hacks are designed to be invisible to you.
3. Once compromised, the hackers install secret backdoors into your system; that means that installing security patches or protocols after the fact does not work, you can close the main door but they’ve already built a separate entrance for themselves.

MFO has periodically been the object of as many at 400 break-in attempts an hour.  Either manually or through our security software we’ve “blacklisted” nearly a thousand IP addresses, including a vast number from China.

Here are three quick recommendations for anyone responsible for a small business or family website using WordPress (these tips might work for other platforms, too):

1. Do not use the default administrator account! Rename it or create a new account with administrative rights. About 99% of the break-in attempts have been using some version of “admin” or “administrator” as the username.
2. Use strong passwords. Yes, I know you hate them. They’re a pain in the butt. Use them anyway. This recent attack uses a brute force method, attempting to log in with the most commonly used passwords first. You can find some basic tips and passwords to avoid at “The 25 most common passwords of 2012.”
3. Use security plug-ins. In WordPress, two to consider are Limit Login Attempts and Better WP Security. Both will temporarily lock out an IP address from which repeated login attempts occur. Better WP Security will allow you to easily make the temporary ban permanent, which is . . . strangely satisfying. (If you decide to try one of these, follow the directions carefully. It’s all too easy to lock yourself out!)

Good luck!  Chip and the MFO IT crowd

Meanwhile, in Footloose Famous Guys Land …

On May 3, hedge fund (and former Fidelity Magellan fund) manager Jeffrey Vinik announced plans to shut down his hedge fund and return all assets to his fund’s investors.  Again.  He did the same thing at the end of 2000, when he announced a desire to focus on his own investments.  Now, he wants to focus on his sports investments (he owns the NHL’s Tampa Bay Lightning), his foundation, and his family.  Given that he recently moved his family to Tampa to be closer to his hockey team, the priorities above might be rank-ordered.

The speculation is that three of Vinik’s managers (Doug Gordon, Jon Hilsabeck and Don Jabro) will band together to launch a long/short hedge fund based in Boston.

The fourth, David Iben, plans to start his own investment management firm.  Up until Vinik recruited him in March 2012, Iben was CIO for Nuveen Investments’ Tradewinds affiliate.  His departure, followed by the swift migration of three of Iben’s managers to Vinik (Isabel Satra, Alberto Jimenez Crespo and Gregory Padilla) cost Tradewinds billions in assets with a few days.   

Vinik left Magellan in 1995 after getting grief for an ill-timed macro bet: be bailed on tech stocks and bought bonds about four years too early.  The same boldness (dumping US stocks and investing in gold) cost his hedge fund dearly this year.

Former Janus Triton and Venture managers Chad Meade and Brian Schaub have joined Arrowpoint Partners, which has $2.3 billion in assets and a lot Janus refugees on staff.  Their six portfolio managers (founders David Corkins and Karen Reidy, Tony Yao, Minyoung Sohn, Meade and Schaub) and two senior executives (COO Rick Grove and Managing Director Christopher Dunne) were Janus employees.  Too, they own 100,000 shares of Janus stock.  Arrowpoint runs Fundamental Opportunity, Income Opportunity, Structured Opportunity and Life Science funds.  

For those who missed the earlier announcement, former T. Rowe Price Health Sciences Fund manager Kris Jenner will launch the Rock Springs Capital hedge fund by later this year.  He’s raised more than $100 million for the health and bio-tech hedge fund and has two former T. Rowe analysts, Mark Bussard and Graham McPhail, on-board with him.

Briefly Noted . . .

Alan Abelson (October 12, 1925 – May 9, 2013), Barron’s columnist and former editor, passed away at age 87.  He joined Barron’s the year I was born, began his “Up & Down Wall Street” column during the Johnson Administration and continued it for 47 years. His crankiness made him, for a long while, one of the folks I actively sought out each week.  In recent years he seemed to have become a sort of parody of his former self, cranky on principle rather than for any particular cause.  I’ll remember him fondly and with respect. Randall Forsyth will continue the column.

Speaking of cranks, John Rekenthaler has resumed his Rekenthaler Report with a vengeance.  During the lunatic optimism and opportunism of the 1990s (who now remembers Alberto Vilar, the NetNet and Nothing-but-Net funds, or mutual funds that clocked 200-300% annual returns?), Mr. R and FundAlarm founder Roy Weitz spent a lot of time kicking over piles of trash – often piles that had attracted hundreds of millions of dollars from worshipful innocents.  John had better statistical analyses, Roy had better snarky graphics.  At the end of 2000, John shifted his attention from columnizing to Directing Research.  Beginning May 22, he returned to writing a daily column at Morningstar which he bills as an attempt to leverage his quarter century in the industry to “put today’s investment stories into perspective.”  It might take him a while to return to his full stride, but column titles like “Die, Horse, Die!” do give you something to look forward to.

Shareholders of Kinetics Alternative Income Fund (formerly, the Kinetics Water Infrastructure Fund) participated in a 10:1 reverse split on May 30, 2013.  Insert: “Snowball rolls eyes” about here.  Neither the radical mission change nor the silly repricing strike me as signs of a distinguished operation.

SMALL WINS FOR INVESTORS

The Berwyn Cornerstone Fund’s (BERCX) minimum initial investment requirement for taxable accounts has been dropped from $3,000 to $1,000. It’s a tiny large cap value fund of no particular distinction.

Vanguard continues to press down its expense ratios.  Vanguard Dividend Appreciation Index (VDAIX), Dividend Appreciation ETF (VIG), Dividend Growth (VDIGX), Energy (VGENX), and Precious Metals and Mining (VGPMX) dropped their expenses by two to five basis points.

CLOSINGS (and related inconveniences)

Effective May 31, 2013, Invesco closed a bunch of funds to new investors.  The funds involved are

Invesco Constellation Fund (CSTGX)
Invesco Dynamics Fund (IDYAX)
Invesco High Yield Securities Fund (ACTHX)
Invesco Leaders Fund (VLFAX)
Invesco Leisure Fund (ILSAX)
Invesco Municipal Bond Fund (AMBDX)

The four equity funds, three of which were once legitimate first-tier growth options, are all large underperformers that received new management teams in 2010 and 2011.  The High Yield fund is very large and very good, while Muni is fine but not spectacular.  No word on why any of the closures were made.

Effective July 1, 2013, Frontegra MFG Global Equity Fund (FMGEX) is bumping its Minimum Initial Investment Amount from $100k to $1 million.

Effective at market close on June 14, 2013, the Matthews Asia Dividend Fund (MAPIX) will be closed to most new investors.

Oppenheimer Discovery (OPOCX) will close to new investors on June 28, 2013. Top-tier returns over the past three years led to a doubling of the fund’s size and its closure. 

Templeton Frontier Markets Fund (TFMAX) will close to new investors effective June 28, 2013.  This is another “trendy niche, hot money” story: the fund has done really well and has attracted over a billion in assets in a fairly thinly-traded market niche.

Wasatch’s management continues trying to manage Wasatch Emerging Markets Small Cap (WAEMX) popularity.  The fund continues to see strong inflows, which led Wasatch to implement a soft close in February 2012.  They’ve now extended their purchase restrictions.   As of June 7, 2013, investors who own shares through third-party distributions, such as Schwab and Scottrade, will not be able to add to their accounts.  In addition, some financial advisors are also being locked out. 

OLD WINE, NEW BOTTLES

American Century continues to distance itself from Lance Armstrong and his LiveStrong Foundation.  All of the LiveStrong target date funds (e.g., LIVESTRONG® 2015 Portfolio) are now One Choice target date funds.  No other changes were announced.

The Artio Global Funds (née Julius Baer) have finally passed away.  The equity managers have been replaced, some of the funds (Emerging Markets Local Debt, for example) have been liquidated and the remaining funds rechristened: 

The International Equity Fund, International Equity Fund II and the Select Opportunities Fund, Inc. will be managed by Aberdeen’s Global Equity team, a dedicated team of 16 professionals based in Edinburgh, Scotland. The Total Return Bond Fund and the Global High Income Fund will continue to be managed by their current portfolio managers, Donald Quigley and Greg Hopper, respectively, along with their teams.

BlackRock Long Duration Bond Portfolio is changing its name on July 29, 2013, to BlackRock Investment Grade Bond Portfolio.  They’ll also shift the fund’s primary investment strategies to allow for a wider array of bonds.

Having failed as a multisector long/short bond fund, the Board of Trustees of the Direxion Funds thought it would be a good idea to give HCM Freedom Fund (HCMFX) something more challenging.  Effective July 29, 2013, HCMFX goes from long/short global fixed income to long/short global fixed income and equities.  There’s no immediate evidence that the Board added any competence to the management team to allow them to succeed.

Fidelity U.S. Treasury Money Market Fund has been renamed Fidelity Treasury Only Money Market Fund because otherwise you might think . . . well, actually, I have no idea of why this makes any sense on earth.

GAMCO Mathers (MATRX) is a dour little fund whose mission is “to achieve capital appreciation over the long term in various market conditions without excessive risk of capital loss.”  Here’s a picture of what that looks like:

Apparently operating under the assumption that Mathers didn’t have sufficient flexibility to be as negative as they’d like, the advisor has modified their primary investment strategies to allow the fund to place 75% of the portfolio in short positions on stocks.  That’s up from an allowance of 50% short.  

Effective June 28, 2013, Lazard US Municipal Portfolio (UMNOX) becomes Lazard US Short Duration Fixed Income Portfolio.  In addition to shortening its target duration, the revamped fund gets to choose among “US government securities, corporate securities, mortgage-related and asset-backed securities, convertible securities, municipal securities, structured products, preferred stocks and inflation-indexed-securities.”  I’m always baffled by the decision to take a fund that’s overwhelmed by one task (buying munis) and adding a dozen more options for it to fumble.

On August 1, 2013 Oppenheimer U.S. Government Trust (OUSGX) will change its name to Oppenheimer Limited-Term Bond Fund.  Apparently Trust in Government is wavering.  The rechristened fund will be able to add corporate bonds to its portfolio.  Despite being not very good, the fund has drawn nearly a billion in assets

Pinnacle Capital Management Balanced Fund (PINBX) is about to become Pinnacle Growth and Income Fund.  The word “Balanced” in the name imposed a requirement “to have a specified minimum mix of equity and fixed income securities in its portfolio at all times.” By becoming un-Balanced, the managers gain the freedom to make more dramatic asset allocation shifts.  It’s a tiny, expensive 30-month old fund whose manager seems to be trailing most reasonable benchmarks.  I’m always dubious of giving more tools to folks who haven’t yet succeeded with the ones they have.

Pioneer Absolute Credit Return Fund (RCRAX) will, effective June 17, 2013, be renamed Pioneer Dynamic Credit Fund.  Two years old, great record, over $300 million in assets … don’t get the need for the change.

Vanguard MSCI EAFE ETF has changed its name to Vanguard FTSE Developed Markets ETF.

OFF TO THE DUSTBIN OF HISTORY

AllianceBernstein U.S. Strategic Research Portfolio and AllianceBernstein International Focus 40 Portfolio will both be liquidated by June 27, 2013.

The CAMCO Investors Fund (CAMCX) has closed and will liquidate on June 27, 2013.  After nine years of operation, it had earned a one-star rating and had gathered just $7 million in assets.

Litman Gregory will merge Litman Gregory Masters Value (MSVFX) into Litman Gregory Masters Equity (MSEFX) in June.  Litman Gregory’s claim is that they’re expert at picking and monitoring the best outside management teams for its funds.  In practice, none of their remaining funds has earned more than three stars from Morningstar (as of May, 2013).  Value, in particular, substantially lagged its benchmark and saw a lot of shareholder redemptions.  Litman Gregory Masters Alternative Strategies (MASNX), which we’ve profiled, has gathered a half billion in assets and continues to perform solidly.

Having neither performed nor preserved, the PC&J Performance Fund and PC&J Preservation Fund have been closed and will be liquidated on or about June 24, 2013.

ProShares Ultra High Yield and ProShares Ultra Investment Grade Corporate have been disappeared by their Board.  The cold text reads: “Effective May 23, 2013, all information pertaining to the Funds is hereby removed from the Prospectus.”

I’m saddened to report that Scout International Discovery Fund (UMBDX) is being liquidated for failure to attract assets.  It will be gone by June 28, 2013.  This was a sort of smaller-cap version of Scout International (UMBWX) which has long distinguished itself for its careful risk management and competitive returns. Discovery followed the same discipline, excelled at risk management but gave up more in returns than it earned in risk-control. This is Scout’s second recent closure of an equity fund, following the elimination of Scout Stock.

Tatro Tactical Appreciation Fund (TCTNX ) has concluded that it can best serve its shareholders by ceasing operation, which will occur on June 21, 2013.

Tilson Focus Fund (TILFX) has closed and will be liquidated by June 21, 2013. The fund had been managed by Whitney Tilson and Glenn Tongue, founders of T2 Partners Management.  Mr. Tilson removed himself from management of the fund a year ago. We’ve also found the fund perplexing and unattractive. It had two great years (2006 and 2009) in its seven full years of operation, but also four utterly horrible ones (2007, 2008, 2011, 2012), which meant that it was able to be bad in all sorts of market conditions. Mr. Tilson is very good at promotion but curiously limited at management it seems. Tilson Dividend Fund (TILDX), which we’ve profiled and which has a different manager, continues to thrive.

In Closing . . .

I will be at the Morningstar Investment Conference on your behalf, 12 – 14 June 2013. Friends have helped arrange interviews with several high-visibility professionals and there are a bunch of media breakfasts, media lunches and media dinners (some starting at hours that Iowans more associate with bedtimes than with meals). I also have one dinner and one warm beverage scheduled with incredibly cool people. I’m very excited. If you have leads you’d like me to pursue or if you’re going to be there and have a burning desire to graze the afternoon snack table with me, just drop me a note.

We’ll look for you.

As part of our visual upgrade, Barb (she of the Owl) has designed new business cards (which I’ll have for Morningstar) and new thank-you cards. I mention that latter because I need to extend formal thanks for three readers who’ve sent checks. Sorry about the ungracious delay, but I was sort of hoping to send grateful words along via the cards that haven’t yet arrived.

But will, soon!  Keep an eye out in the mail.

In addition to our continuing work on visuals, the MFO folks will spend much of June putting together some wide-ranging improvements. Junior has been busily reviewing all of our “Best of the Web” features, and we’ll be incorporating new text throughout the month. Chip and Charles are working to create a friendly, easy-to-use screener for our new fund risk ratings database. Barb and Anya are conspiring to let the Owl perch in our top banner. And I’ll be learning as much as I can at the conference. We hope you like what we’ll be able to share in July.

Until then, take care and celebrate your friends and family!

 

Dear friends,

I know that for lots of you, this is the season of Big Questions:

• Is the Fed’s insistence on destroying the incentive to save (my credit union savings account is paying 0.05%) creating a disastrous incentive to move “safe” resources into risky asset classes?
• Has the recent passion for high quality, dividend-paying stocks already consumed most of their likely gains for the next decade?
• Should you Sell in May and Go Away?
• Perhaps, Stay for June and Endure the Swoon?

My set of questions is a bit different:

• Why haven’t those danged green beans sprouted yet?  It’s been a week.
• How should we handle the pitching rotation on my son’s Little League team?  We’ve got four games in the span of five days (two had been rained out and one was hailed out) and just three boys – Will included! – who can find the plate.
• If I put off returning my Propaganda students’ papers one more day, what’s the prospect that I’ll end up strung up like Mussolini?

Which is to say, summer is creeping upon us.  Enjoy the season and life while you can!

Of Acorns and Oaks

It’s human nature to make sense out of things.  Whether it’s imposing patterns on the stars in the sky (Hey look!  It’s a crab!) or generating rules of thumb for predicting stock market performances (It’s all about the first five days of the day), we’re relentless in insisting that there’s pattern and predictability to our world.

One of the patterns that I’ve either discerning or invented is this: the alumni of Oakmark International seem to have startlingly consistent success as portfolio managers.  The Oakmark International team is led by David Herro, Oakmark’s CIO for international equities and manager of Oakmark International (OAKIX) since 1992.  Among the folks whose Oakmark ties are most visible:

The Oakmark alumni certainly extend far beyond this list and far back in time.  Ralph Wanger, the brilliant and eccentric Imperial Squirrel who launched the Acorn Fund (ACRNX) and Wanger Asset Management started at Harris Associates.  So, too, did Morningstar founder Joe Mansueto.  Wanger frequently joked that if he’d only hired Mansueto when he had the chance, he would not have been haunted by questions for “stylebox purity” over the rest of his career.  The original manager of Oakmark Fund (OAKMX) was Robert Sanborn, who got seriously out of step with the market for a bit and left to help found Sanborn Kilcollin Partners.  He spent some fair amount of time thereafter comparing how Oakmark would have done if Bill Nygren had simply held Sanborn’s final portfolio, rather than replacing it.

In recent times, the attention centers on alumni of the international side of Oakmark’s operation, which is almost entirely divorced from its domestic investment operation.  It’s “not just on a different floor, but almost on a different world,” one alumnus suggested.  And so I set out to answer the questions: are they really that consistently excellent? And, if so, why?

The answers are satisfyingly unclear.  Are they really consistently excellent?  Maybe.  Pierre Py made a couple interesting notes.  One is that there’s a fair amount of turnover in Herro’s analyst team and we only notice the alumni who go on to bigger and better things.  The other note is that when you’ve been recognized as the International Fund Manager of the Decade and you can offer your analysts essentially unlimited resources and access, it’s remarkably easy to attract some of the brightest and most ambitious young minds in the business.

What, other than native brilliance, might explain their subsequent success?  Dan O’Keefe argues that Herro has been successful in creating a powerful culture that teaches people to think like investors and not just like analysts.  Analysts worry about finding the best opportunities within their assigned industry; investors need to examine the universe of all of the opportunities available, then decide how much money – if any – to commit to any of them.  “If you’re an auto industry analyst, there’s always a car company that you think deserves attention,” one said.  Herro’s team is comprised of generalists rather than industry specialists, so that they’re forced to look more broadly.  Mr. Py compared it to the mindset of a consultant: they learn to ask the big, broad questions about industry-wide practices and challenges, rising and declining competitors, and alternatives.  But Herro’s special genius, Pierre suggested, was in teaching young colleagues how to interview a management team; that is, how to get inside their heads, understand the quality of their thinking and anticipate their strengths and mistakes.   “There’s an art to it that can make your investment process much better.”  (As a guy with a doctorate in communication studies and a quarter century in competitive debate, I concur.)

The question for me is, if it works, why is it rare?  Why is it that other teams don’t replicate Herro’s method?  Or, for that matter, why don’t they replicate Artisan Partner’s structure – which is designed to be (and has been) attractive to the brightest managers and to guard (as it has) against creeping corporatism and groupthink?  It’s a question that goes far beyond the organization of mutual funds and might even creep toward the question, why are so many of us so anxious to be safely mediocre?

Three Messages from Rob Arnott

Robert D. Arnott manages PIMCO’s All Asset (PAAIX) and leveraged All Asset All Authority (PAUIX) funds. Morningstar gives each fund five stars for performance relative to moderate and world allocation peers, in addition to gold and silver analyst ratings, respectively, for process, performance, people, parent and price. On PAAIX’s performance during the 2008 financial crises, Mr. Arnott explains: “I was horrified when we ended the year down 15%.” Then, he learned his funds were among the very top performers for the calendar year, where average allocation funds lost nearly twice that amount. PAUIX, which uses modest leverage and short strategies making it a bit more market neutral, lost only 6%.

Of 30 or so lead portfolio managers responsible for 110 open-end funds and ETFs at PIMCO, only William H. Gross has a longer current tenure than Mr. Arnott. The All Asset Fund was launched in 2002, the same year Mr. Arnott founded Research Affiliates, LLC (RA), a firm that specializes in innovative indexing and asset allocation strategies. Today, RA estimates $142B is managed worldwide using its strategies, and RA is the only sub-advisor that PIMCO, which manages over $2T, credits on its website.

On April 15^th, CFA Society of Los Angeles hosted Mr. Arnott at the Montecito Country Club for a lunch-time talk, entitled “Real Return Investing.” About 40 people attended comprising advisors, academics, and PIMCO staff. The setting was elegant but casual, inside a California mission-style building with dark wooden floors, white stucco walls, and panoramic views of Santa Barbara’s coast. The speaker wore one of his signature purple-print ties. After his very frank and open talk, which he prefaced by stating that the research he would be presenting is “just facts…so don’t shoot the messenger,” he graciously answered every question asked.

Three takeaways: 1) fundamental indexing beats cap-weighed indexing, 2) investors should include vehicles other than core equities and bonds to help achieve attractive returns, and 3) US economy is headed for a 3-D hurricane of deficit, debt, and demographics. Here’s a closer look at each message:

Fundamental Indexation is the title of Mr. Arnott’s 2005 paper with Jason Hsu and Philip Moore. It argues that capital allocated to stocks based on weights of price-insensitive fundamentals, such as book value, dividends, cash flow, and sales, outperforms cap-weighted SP500 by an average of 2% a year with similar volatilities. The following chart compares Power Shares FTSE RAFI US 1000 ETF (symbol: PRF), which is based on RA Fundamental Index (RAFI) of the Russell 1000 companies, with ETFs IWB and IVE:

And here are the attendant risk-adjusted numbers, all over same time period:

RAFI wins, delivering higher absolute and risk-adjusted returns. Are the higher returns a consequence of holding higher risk? That debate continues. “We remain agnostic as to the true driver of the Fundamental indexes’ excess return over the cap-weighted indexes; we simply recognize that they outperformed significantly and with some consistency across diverse market and economic environments.” A series of RAFIs exist today for many markets and they consistently beat their cap-weighed analogs.

All Assets include commodity futures, emerging market local currency bonds, bank loans, TIPS, high yield bonds, and REITs, which typically enjoy minimal representation in conventional portfolios. “A cult of equities,” Mr. Arnott challenges, “no matter what the price?” He then presents research showing that while the last decade may have been lost on core equities and bonds, an equally weighted, more broadly diversified, 16-asset class portfolio yielded 7.3% annualized for the 12 years ending December 2012 versus 3.8% per year for the traditional 60/40 strategy. The non-traditional classes, which RA coins “the third pillar,” help investors “diversify away some of the mainstream stock and bond concentration risk, introduce a source of real returns in event of prospective inflation from monetizing debt, and seek higher yields and/or rates of growth in other markets.”

Mr. Arnott believes that “chasing past returns is likely the biggest mistake investors make.” He illustrates with periodic returns such as those depicted below, where best performing asset classes (blue) often flip in the next period, becoming worst performers (red)…and rarely if ever repeat.

Better instead to be allocated across all assets, but tactically adjust weightings based on a contrarian value-oriented process, assessing current valuation against opportunity for future growth…seeking assets out of favor, priced for better returns. PAAIX and PAUIX (each a fund of funds utilizing the PIMCO family) employ this approach. Here are their performance numbers, along with comparison against some competitors, all over same period:

The All Asset funds have performed very well against many notable allocation funds, like OAKBX and VWENX, protecting against drawdowns while delivering healthy returns, as evidenced by high Martin ratios. But static asset allocator PRPFX has actually delivered higher absolute and risk-adjusted returns. This outperformance is likely attributed its gold holding, which has detracted very recently. On gold, Mr. Arnott states: “When you need gold, you need gold…not GLD.” Newer competitors also employing all-asset strategies are ABRYX and AQRIX. Both have returned handsomely, but neither has yet weathered a 2008-like drawdown environment.

The 3-D Hurricane Force Headwind is caused by waves of deficit spending, which artificially props-up GDP, higher than published debt, and aging demographics. RA has published data showing debt-to-GDP is closer to 500% or even higher rather than 100% value oft-cited, after including state and local debt, Government Sponsored Enterprises (e.g., Fannie Mae, Freddie Mac), and unfunded entitlements. It warns that deficit spending may feel good now, but payback time will be difficult.

“Last year, the retired population grew faster than the population of working age adults, yet there was no mention in the press.” Mr. Arnott predicts this transition will manifest in a smaller labor force and lower productivity. It’s inevitable that Americans will need to “save more, spend less, and retire later.” By 2020, the baby boomers will be outnumbered 2:1 by votes, implying any “solemn vows” regarding future entitlements will be at risk. Many developed countries have similar challenges.

Expectations going forward? Instead of 7.6% return for the 60/40 portfolio, expect 4.5%, as evidenced by low bond and dividend yields. To do better, Mr. Arnott advises investing away from the 3-D hurricane toward emerging economies that have stable political systems, younger populations, and lower debt…where fastest GDP growth occurs. Plus, add in RAFI and all asset exposure.

Are they at least greasy high-yield bonds?

One of the things I most dislike about ETFs – in addition to the fact that 95% of them are wildly inappropriate for the portfolio of any investor who has a time horizon beyond this afternoon – is the callous willingness of their boards to transmute the funds.  The story is this: some marketing visionary decides that the time is right for a fund targeting, oh, corporations involved in private space flight ventures and launches an ETF on the (invented) sector.  Eight months later they notice that no one’s interested so, rather than being patient, tweaking, liquidating or merging the fund, they simply hijack the existing vehicle and create a new, entirely-unrelated fund.

Here’s news for the five or six people who actually invested in the Sustainable North American Oil Sands ETF (SNDS): you’re about to become shareholders in the YieldShares High Income ETF.  The deal goes through on June 21.  Do you have any say in the matter?  Nope.  Why not?  Because for the Sustainable North American Oil Sands fund, investing in oil sands companies was legally a non-fundamental policy so there was no need to check with shareholders before changing it. 

The change is a cost-saving shortcut for the fund sponsors.  An even better shortcut would be to avoid launching the sort of micro-focused funds (did you really think there was going to be huge investor interest in livestock or sugar – both the object of two separate exchange-traded products?) that end up festooning Ron Rowland’s ETF Deathwatch list.

Introducing the Owl

Over the past month chip and I have been working with a remarkably talented graphic designer and friend, Barb Bradac, to upgrade our visual identity.  Barb’s first task was to create our first-ever logo, and it debuts this month.

Cool, eh?

We started by thinking about the Observer’s mission and ethos, and how best to capture that visually.  The apparent dignity, quiet watchfulness and unexpected ferocity of the Great Horned Owl – they’re sometimes called “tigers with wings” and are quite willing to strike prey three times their own size – was immediately appealing.  Barb’s genius is in identifying the essence of an image, and stripping away everything else.  She admits, “I don’t know what to say about the wise old owl, except he lends himself soooo well to minimalist geometric treatment just naturally, doesn’t he? I wanted to trim off everything not essential, and he still looks like an owl.”

At first, we’ll use our owl in our print materials (business cards, thank-you notes, that sort of thing) and in the article reprints that funds occasionally commission.  For those interested, the folks at Cook and Bynum asked for a reprint of Charles’s excellent “Inoculated by Value”  essay and our new graphic identity debuted there.  With time we’ll work with Barb and Anya to incorporate the owl – who really needs a name – into our online presence as well.

The Observer resources that you’ve likely missed!

Each time we add a new resource, we try to highlight it for folks.  Since our readership has grown so dramatically in the past year – about 11,000 folks drop by each month – a lot of folks weren’t here for those announcements.  As a public service, I’d like to highlight three resources worth your time.

The Navigator is a custom-built mutual fund research tool, accessible under the Resources tab.  If you know the name of a fund, or part of the name or its ticker, enter it into The Navigator.  It will auto-complete the fund’s name, identify its ticker symbols and  immediately links you to reports or stories on that fund or ETF on 20 other sites (Yahoo Finance, MaxFunds, Morningstar).  If you’re sensibly using the Observer’s resources as a starting point for your own due diligence research, The Navigator gives you quick access to a host of free, public resources to allow you to pursue that goal.

Featured Funds is an outgrowth of our series of monthly conference calls.  We set up calls – free and accessible to all – with managers who strike us as being really interesting and successful.  This is not a “buy list” or anything like it.  It’s a collection of funds whose managers have convinced me that they’re a lot more interesting and thoughtful than their peers.  Our plan with these calls is to give every interested reader to chance to hear what I hear and to ask their own questions.  After we talk with a manager, the inestimably talented Chip creates a Featured Fund page that draws together all of the resources we can offer you on the fund.  That includes an mp3 of the conference call and my take on the call’s highlights, an updated profile of the fund and also a thousand word audio profile of the fund (presented by a very talented British friend, Emma Presley), direct links to the fund’s own resources and a shortcut to The Navigator’s output on the funds.

There are, so far, seven Featured Funds:

• ASTON/RiverRoad Long/Short (ARLSX)
• Cook and Bynum (COBYX)
• Matthews Asia Strategic Income (MAINX)
• RiverPark Long/Short Opportunity (RLSFX)
• RiverPark Short-Term High Yield (RPHYX)
• RiverPark/Wedgewood (RWGFX)
• Seafarer Overseas Growth and Income (SFGIX)

Manager Change Search Engine is a feature created by Accipiter, our lead programmer, primarily for use by our discussion board members.  Each month Chip and I scan hundreds of Form 497 filings at the SEC and other online reports to track down as many manager changes as we can.  Those are posted each month (they’re under the “Funds” tab) and arranged alphabetically by fund name.  Accipiter’s search engine allows you to enter the name of a fund company (Fidelity) and see all of the manager changes we have on record for them.  To access the search engine, you need to go to the discussion board and click on the MGR tab at top.  (I know it’s a little inconvenient, but the program was written as a plug-in for the Vanilla software that underlies the discussion board.  It will be a while before Accipiter is available to rewrite the program for us, so you’ll just have to be brave for a bit.)

Valley Forge Fund staggers about

For most folks, Valley Forge Fund (VAFGX) is understandably invisible.  It was iconic mostly because it so adamantly rejected the trappings of a normal fund.  It was run since the Nixon Administration by Bernard Klawans, a retired aerospace engineer.  He tended to own just a handful of stocks and cash.  For about 20 years he beat the market then for the next 20 he trailed it.  In the aftermath of the late 90s mania, he went back to modestly beating the market.  He didn’t waste money on marketing or even an 800-number and when someone talked him into having a website, it remained pretty much one page long.

Mr. Klawans passed away on December 22, 2011, at the age of 90.  Craig T. Aronhalt who had co-managed the fund since the beginning of 2009 died on November 3, 2012 of cancer.  Morningstar seems not to have noticed his death: six months after passing away, they continue listing him as manager. It’s not at all clear who is actually running the thing though, frankly, for a fund that’s 25% in cash it’s having an entirely respectable year with a gain of nearly 10% through the end of April.

The more-curious development is the Board’s notice, entitled “Important information about the Fund’s Lack of Investment Adviser”

For the period beginning April 1, 2013 through the date the Fund’s shareholders approve a new investment advisory agreement (estimated to be achieved by May 17, 2013), the Fund will not be managed by an investment adviser or a portfolio manager (the “Interim Period”).  During the Interim Period, the Fund’s portfolio is expected to remain largely unchanged, subject to the ability of the Board of Directors of the Fund to, as it deems appropriate under the circumstances, make such portfolio changes as are consistent with the Fund’s prospectus.  During the Interim Period, the Fund will not be subject to any advisory fees.

Because none of the members of Fund’s Board of Directors has any experience as portfolio managers, management risk will be heightened during the Interim Period, and you may lose money.

How does that work?  The manager died at the beginning of November but the board doesn’t notice until April 1?  If someone was running the portfolio since November, the law requires disclosure of that fact.  I know that Mr. Buffett has threatened to run Berkshire Hathaway for six months after his death, so perhaps … ? 

If that is the explanation, it could be a real cost-savings strategy since health care and retirement benefits for the deceased should be pretty minimal.

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. 

FPA International Value (FPIVX): It’s not surprising that manager Pierre Py is an absolute return investor.  That is, after all, the bedrock of FPA’s investment culture.  What is surprising is that it has also be an excellent relative return vehicle: despite a substantial cash reserve and aversion to the market’s high valuations, it has also substantially outperformed its fully-invested peers since inception.

Oakseed Opportunity Fund (SEEDX): Finally!  Good news for all those investors disheartened by the fact that the asset-gatherers have taken over the fund industry.  Jackson Park has your back.

“Stars in the Shadows” are older funds that have attracted far less attention than they deserve. 

Artisan Global Value Fund (ARTGX): I keep looking for sensible caveats to share with you about this fund.  Messrs. Samra and O’Keefe keep making my concerns look silly, so I think I might give up and admit that they’re remarkable.

Payden Global Low Duration Fund (PYGSX): Short-term bond funds make a lot of sense as a conservative slice of your portfolio, most especially during the long bull market in US bonds.  The question is: what happens when the bull market here stalls out?  One good answer is: look for a fund that’s equally adept at investing “there” as well as “here.”  Over 17 years of operation, PYGSX has made a good case that they are that fund.

Elevator Talk #4: Jim Hillary, LS Opportunity Fund (LSOFX)

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.

Mr. Hillary manages Independence Capital Asset Partners (ICAP), a long/short equity hedge fund he launched on November 1, 2004 that serves as the sub-advisor to the LS Opportunity Fund (LSOFX), which in turn launched on September 29, 2010. Prior to embarking on a hedge fund career, Mr. Hillary was a co-founder and director of research for Marsico Capital Management where he managed the Marsico 21^st Century Fund (MXXIX) until February 2003 and co-managed all large cap products with Tom Marsico. In addition to his US hedge fund and LSOFX in the mutual fund space, ICAP runs a UCITS for European investors. Jim offers these 200 words on why his mutual fund could be right for you:

In 2004, I believed that after 20 years of above average equity returns we would experience a period of below average returns. Since 2004, the equity market has been characterized by lower returns and heightened volatility, and given the structural imbalances in the world and the generationally low interest rates I expect this to continue.  Within such an environment, a long/short strategy provides exposure to the equity market with a degree of protection not provided by “long-only” funds.

In 2010, we agreed to offer investors the ICAP investment process in a mutual fund format through LSOFX. Our process aims to identify investment opportunities not limited to style or market capitalization. The quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance. Our in-depth research and long-term orientation in our high conviction ideas provide us with a considerable advantage. It is often during times of stress that ICAP uncovers unusual investment opportunities. A contrarian approach with a longer-term view is our method of generating value-added returns. If an investor is searching for a vehicle to diversify away from long-only, balanced or fixed income products, a hedge fund strategy like ours might be helpful.

The fund has a single share class with no load and no 12b-1 fees. The minimum initial investment is $5,000 and net expenses are capped at 1.95%. More information about the Advisor and Sub-Advisor can be found on the fund’s website, www.longshortadvisors.com. Jim’s most recent commentary can be found in the fund’s November 2012 Semi-Annual Report.

RiverPark/Wedgewood Fund: Conference Call Highlights

I had a chance to speak with David Rolfe of Wedgewood Partners and Morty Schaja, president of RiverPark Funds. A couple dozen listeners joined us, though most remained shy and quiet. Morty opened the call by noting the distinctiveness of RWGFX’s performance profile: even given a couple quarters of low relative returns, it substantially leads its peers since inception. Most folks would expect a very concentrated fund to lead in up markets. It does, beating peers by about 10%. Few would expect it to lead in down markets, but it does: it’s about 15% better in down markets than are its peers. Mr. Schaja is invested in the fund and planned on adding to his holdings in the week following the call.

The strategy: Rolfe invests in 20 or so high-quality, high-growth firms. He has another 15-20 on his watchlist, a combination of great mid-caps that are a bit too small to invest in and great large caps a bit too pricey to invest in. It’s a fairly low turnover strategy and his predilection is to let his winners run. He’s deeply skeptical of the condition of the market as a whole – he sees badly stretched valuations and a sort of mania for high-dividend stocks – but he neither invests in the market as a whole nor are his investment decisions driven by the state of the market. He’s sensitive to the state of individual stocks in the portfolio; he’s sold down four or five holdings in the last several months nut has only added four or five in the past two years. Rather than putting the proceeds of the sales into cash, he’s sort of rebalancing the portfolio by adding to the best-valued stocks he already owns.

His argument for Apple: For what interest it holds, that’s Apple. He argues that analysts are assigning irrationally low values to Apple, somewhere between those appropriate to a firm that will never see real topline growth again and one that which see a permanent decline in its sales. He argues that Apple has been able to construct a customer ecosystem that makes it likely that the purchase of one iProduct to lead to the purchase of others. Once you’ve got an iPod, you get an iTunes account and an iTunes library which makes it unlikely that you’ll switch to another brand of mp3 player and which increases the chance that you’ll pick up an iPhone or iPad which seamlessly integrates the experiences you’ve already built up. As of the call, Apple was selling at $400. Their sum-of-the-parts valuation is somewhere in the $600-650 range.

On the question of expenses: Finally, the strategy capacity is north of $10 billion and he’s currently managing about $4 billion in this strategy (between the fund and private accounts). With a 20 stock portfolio, that implies a $500 million in each stock when he’s at full capacity. The expense ratio is 1.25% and is not likely to decrease much, according to Mr. Schaja. He says that the fund’s operations were subsidized until about six months ago and are just in the black now. He suggested that there might be, at most, 20 or so basis points of flexibility in the expenses. I’m not sure where to come down on the expense issue. No other managed, concentrated retail fund is substantially cheaper – Baron Partners and Edgewood Growth are 15-20 basis points more, Oakmark Select and CGM Focus are 15-20 basis points less while a bunch of BlackRock funds charge almost the same.

Bottom Line: On whole, it strikes me as a remarkable strategy: simple, high return, low excitement, repeatable and sustained for near a quarter century.

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

The RWGFX Conference Call

When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded. If the file downloads, instead, you may have to double-click to play it.

Conference Call Upcoming: Bretton Fund (BRTNX), May 28, 7:00 – 8:00 Eastern

Manager Steve Dodson, former president of the Parnassus Funds, is an experienced investment professional, pursuing a simple discipline.  He wants to buy deeply discounted stocks, but not a lot of them.  Where some funds tout a “best ideas” focus and then own dozens of the same large cap stocks, Mr. Dodson seems to mean it when he says “just my best.”

As of 12/30/12, the fund held just 16 stocks.  Nearly as much is invested in microcaps as in megacaps. In addition to being agnostic about size, the fund is also unconstrained by style or sector.  Half of the fund’s holdings are characterized as “growth” stocks, half are not.   The fund offers no exposure at all in seven of Morningstar’s 11 industry sectors, but is over weighted by 4:1 in financials. 

In another of those “don’t judge it against the performance of groups to which it doesn’t belong” admonitions, it has been assigned to Morningstar’s midcap blend peer group though it owns only one midcap stock.

Our conference call will be Tuesday, May 28, from 7:00 – 8:00 Eastern.

How can you join in?  Just click

Members of our standing Conference Call Notification List will receive a reminder, notes from the manager and a registration link around the 20^th of May.  If you’d like to join about 150 of your peers in receiving a monthly notice (registration and the call are both free), feel free to drop me a note.

Launch Alert: ASTON/LMCG Emerging Markets (ALEMX)

This is Aston’s latest attempt to give the public – or at least “the mass affluent” – access to managers who normally employ distinctive strategies on behalf of high net worth individuals and institutions.  LMCG is the Lee Munder Capital Group (no, not the Munder of Munder NetNet and Munder Nothing-but-Net fame – that’s Munder Capital Management, a different group).  Over the five years ended December 30, 2012, the composite performance of LMCG’s emerging markets separate accounts was 2.8% while their average peer lost 0.9%.  In 2012, a good year for emerging markets overall, LMCG made 24% – about 50% better than their average peer.  The fund’s three managers, Gordon Johnson, Shannon Ericson and Vikram Srimurthy, all joined LMCG in 2006 after a stint at Evergreen Asset Management.  The minimum initial investment in the retail share class is $2500, reduced to $500 for IRAs.  The opening expense ratio will be 1.65% (with Aston absorbing an additional 4.7% of expenses).  The fund’s homepage is cleanly organized and contains links to a few supporting documents.

Launch Alert II: Matthews Asia Focus and Matthews Emerging Asia

On May 1, Matthews Asia launched two new funds. Matthews Asia Focus Fund (MAFSX and MIFSX) will invest in 25 to 35 mid- to large-cap stocks. By way of contrast, their Asian Growth and Income fund has 50 stocks and Asia Growth has 55. The manager wants to invest in high-quality companies and believes that they are emerging in Asia. “Asia now [offers] a growing pool of established companies with good corporate governance, strong management teams, medium to long operating histories and that are recognized as global or regional leaders in their industry.” The fund is managed by Kenneth Lowe, who has been co-managing Matthews Asian Growth and Income (MACSX) since 2011. The opening expense ratio, after waivers, is 1.91%. The minimum initial investment is $2500, reduced to $500 for an IRA.

Matthews Emerging Asia Fund (MEASX and MIASX) invests primarily in companies located in the emerging and frontier Asia equity markets, such as Bangladesh, Cambodia, Indonesia, Malaysia, Myanmar, Pakistan, Philippines, Sri Lanka, Thailand and Vietnam. It will be an all-cap portfolio with 60 to 100 names. The fund will be managed by Taizo Ishida, who also manages managing the Asia Growth (MPACX) and Japan (MJFOX) funds. The opening expense ratio, after waivers, is 2.16%. The minimum initial investment is $2500, reduced to $500 for an IRA.

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. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

Funds in registration this month won’t be available for sale until, typically, the beginning of July 2013. We found fifteen no-load, retail funds (and Gary Black) in the pipeline, notably:

AQR Long-Short Equity Fund will seek capital appreciation through a global long/short portfolio, focusing on the developed world.  “The Fund seeks to provide investors with three different sources of return: 1) the potential gains from its long-short equity positions, 2) overall exposure to equity markets, and 3) the tactical variation of its net exposure to equity markets.”  They’re targeting a beta of 0.5.  The fund will be managed by Jacques A. Friedman, Lars Nielsen and Andrea Frazzini (Ph.D!), who all co-manage other AQR funds.  Expenses are not yet set.  The minimum initial investment for “N” Class shares is $1,000,000 but several AQR funds have been available through fund supermarkets for a $2500 investment.  AQR deserves thoughtful attention, but their record across all of their funds is more mixed than you might realize.  Risk Parity has been a fine fund while others range from pretty average to surprisingly weak.

RiverPark Structural Alpha Fund will seek long-term capital appreciation while exposing investors to less risk than broad stock market indices.  Because they believe that “options on market indices are generally overpriced,” their strategy will center on “selling index equity options [which] will structurally generate superior returns . . . [with] less volatility, more stable returns, and reduce[d] downside risk.”  This portfolio was a hedge fund run by Wavecrest Asset Management.  That fund launched on September 29, 2008 and will continue to operate under it transforms into the mutual fund, on June 30, 2013.  The fund made a profit in 2008 and returned an average of 10.7% annually through the end of 2012.  Over that same period, the S&P500 returned 6.2% with substantially greater volatility.  The Wavecrest management team, Justin Frankel and Jeremy Berman, has now joined RiverPark – which has done a really nice job of finding talent – and will continue to manage the fund.   The opening expense ratio with be 2.0% after waivers and the minimum initial investment is $1000.

Curiously, over half of the funds filed for registration on the same day.  Details on these funds and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes

On a related note, we also tracked down 37 fund manager changes. Those include Oakmark’s belated realization that they needed at least three guys to replace the inimitable Ed Studzinski on Oakmark Equity and Income (OAKBX), and a cascade of changes triggered by the departure of one of the many guys named Perkins at Perkins Investment Management.

Briefly Noted . . .

Seafarer visits Paris: Seafarer has been selected to manage a SICAV, Essor Asie (ESSRASI).  A SICAV (“sea cav” for the monolingual among us, Société d’Investissement À Capital Variable for the polyglot) is the European equivalent of an open-end mutual fund. Michele Foster reports that “It is sponsored by Martin Maurel Gestion, the fund advisory division of a French bank, Banque Martin Maurel.  Essor translates to roughly arising or emerging, and Asie is Asia.”  The fund, which launched in 1997, invests in Asia ex-Japan and can invest in both debt and equity.  Given both Mr. Foster’s skill and his schooling at INSEAD, it seems like a natural fit.

Out of exuberance over our new graphic design, we’ve poured our Seafarer Overseas Growth and Income (SFGIX) profile into our new reprint design template.  Please do let us know how we could tweak it to make it more visually effective and functional.

Nile spans the globe: Effective May 1, 2013, Nile Africa Fixed Income Fund became Nile Africa and Frontier Bond Fund.  The change allows the fund to add bonds from any frontier-market on the planet to its portfolio.

Nationwide is absorbing 17 HighMark Mutual Funds: The changeover will take place some time in the third quarter of 2013.  This includes most of the Highmark family and the plan is for the current sub-advisers to be retained.  Two HighMark funds, Tactical Growth & Income Allocation and Tactical Capital Growth, didn’t make the cut and are scheduled for liquidation.

USAA is planning to launch active ETFs: USAA has submitted paperwork with the SEC seeking permission to create 14 actively managed exchange-traded funds, mostly mimicking already-existing USAA mutual funds. 

Small Wins for Investors

On or before June 30, 2013, Artio International Equity, International Equity II and Select Opportunities funds will be given over to Aberdeen’s Global Equity team, which is based in Edinburgh, Scotland.  The decline of the Artio operation has been absolutely stunning and it was more than time for a change.  Artio Total Return Bond Fund and Artio Global High Income Fund will continue to be managed by their current portfolio teams.

ATAC Inflation Rotation Fund (ATACX) has reduced the minimum initial investment for its Investor Class Shares from $25,000 to $2,500 for regular accounts and from $10,000 to $2,500 for IRA accounts.

Longleaf Partners Global Fund (LLGLX) reopened to new investment on April 16, 2013.  I was baffled by its closing – it discovered, three weeks after launch, that there was nothing worth buying – and am a bit baffled by its opening, which occurred after the unattractive market had risen by another 3%.

Vanguard announced on April 3 that it is reopening the $9 billion Vanguard Capital Opportunity Fund (VHCOX) to individual investors and removing the $25,000 annual limit on additional purchases.  The fund has seen substantial outflows over the past three years.  In response, the board decided to make it available to individual investors while leaving it closed to all financial advisory and institutional clients, other than those who invest through a Vanguard brokerage account.  This is a pretty striking opportunity.  The fund is run by PRIMECAP Management, which has done a remarkable job over time.

Closings

DuPont Capital Emerging Markets Fund (DCMEX) initiated a “soft close” on April 30, 2013.

Effective June 30, 2013, the FMI Large Cap (FMIHX) Fund will be closed to new investors.

Eighteen months after launching the Grandeur Peak Funds, Grandeur Peak Global Advisors announced that it will soft close both the Grandeur Peak Global Opportunities Fund (GPGOX) and the Grandeur Peak International Opportunities (GPIOX) Fund on May 1, 2013.

After May 17, 2013 the SouthernSun Small Cap Fund (SSSFX) will be closed to new investors.  The fund has pretty consistently generated returns 50% greater than those of its peers.  The same manager, Michael Cook, also runs the smaller, newer, midcap-focused SouthernSun US Equity Fund (SSEFX).  The latter fund’s average market cap is low enough to suggest that it holds recent alumni of the small cap fund.  I’ll note that we profiled all four of those soon-to-be-closed funds when they were small, excellent and unknown.

Touchstone Merger Arbitrage Fund (TMGAX) closed to new accounts on April 8, 2013.   The fund raised a half billion in under two years and substantially outperformed its peers, so the closing is somewhere between “no surprise” and “reassuring.”

Old Wine, New Bottles

In one of those “what the huh?” announcements, the Board of Trustees of the Catalyst Large Cap Value Fund (LVXAX) voted “to change in the name of the Fund to the Catalyst Insider Buying Fund.” Uhh … there already is a Catalyst Insider Buying Fund (INSAX). 

Lazard U.S. High Yield Portfolio (LZHOX) is on its way to becoming Lazard U.S. Corporate Income Portfolio, effective June 28, 2013.  It will invest in bonds issued by corporations “and non-governmental issuers similar to corporations.”  They hope to focus on “better quality” (their term) junk bonds. 

Off to the Dustbin of History

Dreyfus Small Cap Equity Fund (DSEAX) will transfer all of its assets in a tax-free reorganization to Dreyfus/The Boston Company Small Cap Value Fund (STSVX).

Around June 21, 2013, Fidelity Large Cap Growth Fund (FSLGX) will disappear into Fidelity Stock Selector All Cap Fund (FDSSX). This is an enormously annoying move and an illustration of why one might avoid Fidelity.  FSLGX’s great flaw is that it has attracted only $170 million; FDSSX’s great virtue is that it has attracted over $3 billion.  FDSSX is an analyst-run fund with over 1100 stocks, 11 named managers and a track record inferior to FSLGX (which has one manager and 134 stocks).

Legg Mason Capital Management All Cap Fund (SPAAX) will be absorbed by ClearBridge Large Cap Value Fund (SINAX).  The Clearbridge fund is cheaper and better, so that’s a win of sorts.

In Closing …

If you haven’t already done so, please do consider bookmarking our Amazon link.  It generates a pretty consistent $500/month for us but I have to admit to a certain degree of trepidation over the imminent (and entirely sensible) change in law which will require online retailers with over a $1 million in sales to collect state sales tax.  I don’t know if the change will decrease Amazon’s attractiveness or if it might cause Amazon to limit compensation to the Associates program, but it could.

As always, the Amazon and PayPal links are just … uhh, over there —>

That’s all for now, folks!

Dear friends,

As most of you know, my day job is as a professor at Augustana College in Rock Island, Illinois. We have a really lovely campus (one prospective student once joked that we’re the only college he’d visited that actually looked like its postcards) and, as the weather has warmed, I’ve returned to taking my daily walk over the lunch hour.

We have three major construction projects underway, a lot for a school our size. We’re renovating Old Main, which was built in 1884, originally lit gas lanterns and warmed by stoves in the classrooms. After a century of fiddling with it, we finally resolved to strip out a bunch of “improvements” from days gone by, restore some of its original grandeur and make it capable of supporting 21^st century classes.

We’re also building Charles D. Lindberg Stadium, where our football team will finally get to have a locker room and seating for 1800. It’s emblematic that our football stadium is actually named for a national debate champion; we’re kind of into the whole scholar-athlete ethos. (We have the sixth greatest number of Academic All-Americans of any school in the country, just behind Stanford and well ahead of Texas.)

And we’re creating a Center for Student Life, which is “fused” to the 4^th floor of our library. The Center will combine dining, study, academic support and student activities. It’s stuff we do now but that’s scattered all over creation.

Two things occurred to me on my latest walk. One is that these buildings really are investments in our future. They represent acts of faith that, even in turbulent times, we need to plan and act prudently now to create the future we imagine. And the other is that they represent a remarkable balance: between curricular, co-curricular and extra-curricular, between mind, body and spirit, between strengthening what we’ve always had and building something new.

On one level, that’s just about one college and one set of hopes. But, at another, it strikes me as surprisingly useful guidance for a lot more than that: plan, balance, act, dare.

Oh! So that’s what a Stupid Pill looks like!

In a widely misinterpreted March 25^th column, Chuck Jaffe raises the question of whether it’s time to buy a bear market fund.  Most folks, he argues, are addicted to performance-chasing.  What better time to buy stocks than after they’ve doubled in price?  What better time to hedge your portfolio than after they’re been halved?  That, of course, is the behavior of the foolish herd.  We canny contrarians are working now to hedge our gains with select bets against the market, right?  

Talk to money managers and the guys behind bear-market funds, however, and they will tell you their products are designed mostly to be a hedge, diversifying risks and protecting against declines. They say the proper use of their offerings involves a small-but-permanent allocation to the dark side, rather than something to jump into when everything else you own looks to be in the tank.

They also say — and the flows of money into and out of bear-market issues shows — that investors don’t act that way.

At base, he’s not arguing for the purchase of a bear-market fund or a gold fund. He’s using those as tools for getting folks to think about their own short time horizons and herding instincts.

He generously quotes me as making a more-modest observation: that managers, no matter the length or strength of their track records, are quickly dismissed (or ignored) if they lag their peers for more than a quarter. Our reaction tends to be clear: the manager has taken stupid pills and we’re leaving.  Jeff Vinik at Magellan: Manager of the Year in 1993, Stupid Pill swallower in ’95, gone in ’96.  (Started a hedge fund, making a mint.) Bill Nygren at Oakmark Select: intravenous stupid drip around 2007.  (Top 1% since then on both his funds.)  Bruce Berkowitz at Fairholme: Manager of the Decade, slipped off to Walgreen’s in 2011 for stupid pills, got trashed and saw withdrawals of a quarter billion dollars a week. (Top 1% in 2012, closed his funds to new investments, launching a hedge fund now). 

By way of example, one of the most distinguished small cap managers around is Eric Cinnamond who has exercised the same rigorous absolute-return discipline at three small cap funds: Evergreen, Intrepid and now Aston/River Road.  His discipline is really simple: don’t buy or hold anything unless it offers a compelling, absolute value.  Over the period of years, that has proven to be a tremendously rewarding strategy for his investors. 

When I spoke to Eric late in March, he offered a blunt judgment: “small caps overall appear wildly expensive as people extrapolate valuations from peak profits.” That is, current valuations make sense only if you believe that firms experiencing their highest profits won’t ever see them drop back to normal levels.  And so he’s selling stuff as it becomes fully valued, nibbling at a few things (“hard asset companies – natural gas, precious metals – are getting treated as if they’re in a permanent depression but their fundamentals are strong and improving”), accumulating cash and trailing the market.  By a mile.  Over the twelve months ending March 29, 2013, ARIVX returned 7.5% – which trailed 99% of his small value peers. 

The top SCV fund over that period?  Scott Barbee’s microcap Aegis Value (AVALX) fund with a 32% return and absolutely no cash on the books.  As I noted in a FundAlarm profile, it’s perennially a one- or two-star fund with more going for it than you’d imagine.

Mr. Cinnamond seemed acquainted with the sorts of comments made about his fund on our discussion board: “I bailed on ARIVX back in early September,” “I am probably going to bail soon,” and “in 2012 to the present the funds has ranked, in various time periods, in the 97%-100% rank of SCV… I’d look at other SCV Funds.”  Eric nods: “there are investors better suited to other funds.  If you lose assets, so be it but I’d rather lose assets than lose my shareholders’ capital.”  John Deysher, long-time manager of Pinnacle Value (PVFIX), another SCV fund that insists on an absolute rather than relative value discipline, agrees, “it’s tough holding lots of cash in a sizzling market like we’ve seen . . . [cash] isn’t earning much, it’s dry powder available for future opportunities which of course aren’t ‘visible’ now.”

One telling benchmark is GMO Benchmark-Free Allocation IV (GBMBX). GMO’s chairman, Jeremy Grantham, has long argued that long-term returns are hampered by managers’ fear of trailing their benchmarks and losing business (as GMO so famously did before the 2000 crash).  Cinnamond concurs, “a lot of managers ‘get it’ when you read their letters but then you see what they’re doing with their portfolios and wonder what’s happening to them.” In a bold move, GMO launched a benchmark-free allocation fund whose mandate was simple: follow the evidence, not the crowd.  It’s designed to invest in whatever offers the best risk-adjusted rewards, benchmarks be damned.  The fund has offered low risks and above-average returns since launch.  What’s it holding now?  European equities (35%), cash (28%) and Japanese stocks (17%).  US stocks?  Not so much: just under 5% net long.

For those interested in other managers who’ve followed Mr. Cinnamond’s prescription, I sorted through Morningstar’s database for a list of equity and hybrid managers who’ve chosen to hold substantial cash stakes now.  There’s a remarkable collection of first-rate folks, both long-time mutual fund managers and former hedge fund guys, who seem to have concluded that cash is their best option.

This list focuses on no-load, retail equity and hybrid funds, excluding those that hold cash as a primary investment strategy (some futures funds, for example, or hard currency funds).  These folks all hold over 25% cash as of their last portfolio report.  I’ve starred the funds for which there are Observer profiles.

(We’re not endorsing all of those funds.  While I tried to weed out the most obvious nit-wits, like the guy who was 96% cash and 4% penny stocks, the level of talent shown by these managers is highly variable.)

Mr. Deysher gets to the point this way: “As Buffett says, Rule 1 is ‘Don’t lose capital.’   Rule 2 is ‘Don’t forget Rule 1.’”  Steve Romick, long-time manager of FPA Crescent (FPACX), offered both the logic behind FPA’s corporate caution and a really good closing line in a recent shareholder letter:

At FPA, we aspire to protect capital, before seeking a return on it. We change our mind, not casually, but when presented with convincing evidence. Despite our best efforts, we are sometimes wrong. We take our mea culpa and move on, hopefully learning from our mistakes. We question our conclusions constantly. We do this with the approximately $20 billion of client capital entrusted to us to manage, and we simply ask the same of our elected and appointed officials whom we have entrusted with trillions of dollars more.

Nobody has all the answers. Genius fails. Experts goof.  Rather than blind faith, we need our leaders to admit failure, learn from it, recalibrate, and move forward with something better. Although we cannot impose our will on this Administration as to Mr. Bernanke’s continued role at the Fed, we would at least like to make our case for a Fed chairman more aware (at least publicly) of the unintended consequences of ultra-easy monetary policy, and one with less hubris. As the author Malcolm Gladwell so eloquently said, “Incompetence is the disease of idiots. Overconfidence is the mistake of experts…. Incompetence irritates me. Overconfidence terrifies me.”

It’s clear that over-confidence can infest pessimists as well as optimists, which was demonstrated in a March Business Insider piece entitled “The Idiot-Maker Rally: Check Out All Of The Gurus Made To Look Like Fools By This Market.”  The article is really amusing and really misleading.  On the one hand, it does prick the balloons of a number of pompous prognosticators.  On the other, it completely fails to ask what happened to invalidate – for now, anyway – the worried conclusions of some serious, first-rate strategists?

Triumph of the optimists: Financial “journalists” and you

It’s no secret that professional journalism seems to be circling a black hole: people want more information, but they want it now, free and simple. That’s not really a recipe for thoughtful, much less profitable, reporting. The universe of personal finance journals is down to two (the painfully thin Money and Kiplinger’s), CNBC’s core audience viewership is down 40% from 2008, the PBS show “Nightly Business Report” has been sold to CNBC in a bid to find viewers, and collectively newspapers have cut something like 40% of their total staff in a decade.

One response has been to look for cheap help: networks and websites look to publish content that’s provided for cheap or for free. Often that means dressing up individuals with a distinct vested interest as if they were journalists.

Case in point: Mellody Hobson, CBS Financial Analyst

I was astounded to see the amiable talking heads on the CBS Morning News turn to “CBS News Financial Analyst Mellody Hobson” for insight on how investors should be behaving (Bullish, not a bubble, 03/18/2013). Ms. Hobson, charismatic, energetic, confident and poised, received a steady stream of softball pitches (“Do you see that there’s a bubble in the stock market?” “I know people are saying we’re entering bubble territory. I don’t agree. We’re far from it. It’s a bull market!”) while offering objective, expert advice on how investors should behave: “The stock market is not overvalued. Valuations are really pretty good. This is the perfect environment for a strong stock market. I’m always a proponent of being in the market.” Nods all around.

The problem isn’t what CBS does tell you about Ms. Hobson; it’s what they don’t tell you. Hobson is the president of a mutual fund company, Ariel Investments, whose only product is stock mutual funds. Here’s a snippet from Ariel’s own website:

Should CBS mention this to you? The Code of Ethics for the Society of Professional Journalists kinda hints at it:

Journalists should be free of obligation to any interest other than the public’s right to know.

Journalists should:

• Avoid conflicts of interest, real or perceived.
• Remain free of associations and activities that may compromise integrity or damage credibility.
• Refuse gifts, favors, fees, free travel and special treatment, and shun secondary employment, political involvement, public office and service in community organizations if they compromise journalistic integrity.
• Disclose unavoidable conflicts.

CBS’s own 2012 Business Conduct Statement exults “our commitment to the highest standards of appropriate and ethical business behavior” and warns of circumstances where “there is a significant risk that the situation presented is likely to affect your business judgment.” My argument is neither that Ms. Hobson was wrong (that’s a separate matter) nor that she acted improperly; it’s that CBS should not be presenting representatives of an industry as disinterested experts on that industry. They need to disclose the conflict. They failed to do so on the air and don’t even offer a biography page for Hobson where an interested party might get a clue.

MarketWatch likewise puts parties with conflicts of interest center-stage in their Trading Deck feature which lives in the center column of their homepage, but at least they warn people that something might be amiss:

That disclaimer doesn’t appear on the homepage with the teasers, but it does appear on the first page of stories written by people who . . . well, probably shouldn’t be taken at face value.

The problem is complicated when a publisher such as MarketWatch mixes journalists and advocates in the same feature, as they do at The Trading Deck, and then headline writers condense a story into eight or ten catchy, misleading words. 

The headline says “This popular mutual fund type is losing you money.”  The story says global stock funds could boost their returns by up to 2% per year through portfolio optimization, which is a very different claim.

The author bio says “Roberto Rigobon is the Society of Sloan Fellows Professor of Applied Economics at MIT’s Sloan School of Management.”  He is a first-class scholar.  The bio doesn’t say “and a member of State Street Associates, which provides consulting on, among other things, portfolio optimization.”

The other response by those publications still struggling to hold on is adamant optimism.

In the April 2013 issue of Kiplinger’s Personal Finance, editor Knight Kiplinger (pictured laughing at his desk) takes on Helaine Olen’s Pound Foolish: Exposing the Dark Side of the Personal Finance Industry (2012). She’s a former LA Times personal finance columnist with a lot of data and a fair grasp of her industry. She argues “most of the financial advice published and dished out by the truckload is useless” – its sources are compromised, its diagnosis misses the point and its solutions are self-serving. To which Mr. Kiplinger responds, “I know quite a few longtime Kiplinger readers who might disagree with that.” That’s it. Other than for pointing to Obamacare as a solution, he just notes that . . . well, she’s just not right.

Skipping the stories on “How to Learn to Love (Stocks) Again” and “The 7 Best ETFs to Buy Now,” we come to Jane Bennett Clark’s piece entitled “The Sky Isn’t Falling.” The good news about retirement: a study by the Investment Company Institute says that investment companies are doing a great job and that the good ol’ days of pensions were an illusion. (No mention, yet again, of any conflict of interest that the ICI might have in selecting either the arguments or the data they present.) The title claim comes from a statement of Richard Johnson of the Employee Retirement Benefit Institute, whose argument appears to be that we need to work as long as we can. The oddest statement in the article just sort of glides by: “43% of boomers … and Gen Xers … are at risk of not having enough to cover basic retirement expenses and uninsured health costs.” Which, for 43% of the population, might look rather like their sky is falling.

April’s Money magazine offered the same sort of optimistic take: bond funds will be okay even if interest rates rise, Japan’s coming back, transportation stocks are signaling “full steam ahead for the market,” housing’s back and “fixed income never gets scary.”

Optimism sells. It doesn’t necessarily encourage clear thinking, but it does sell.

Folks interested in examples of really powerful journalism might turn to The Economist, which routinely runs long and well-documented pieces that are entirely worth your time, or the radio duo of American Public Media (APM) and National Public Radio (NPR). Both have really first rate financial coverage daily, serious and humorous. The most striking example of great long-form work is “Unfit for Work: The startling rise of disability in America,” the NPR piece on the rising tide of Americans who apply for and receive permanent disability status. 14 million Americans – adults and children – are now “disabled,” out of the workforce (hence out of the jobless statistics) and unlikely ever to hold a job again. That number has doubled in a generation. The argument is that disability is a last resort for older, less-educated workers who get laid off from a blue collar job and face the prospect of never being able to find a job again. The piece stirred up a storm of responses, some of which are arguable (telling the story of hard-hit Hale County makes people think all counties are like that) and others seem merely to reinforce the story’s claim (the Center for Budget and Policy Priorities says most disabled workers are uneducated and over 50 – which seems consistent with the story’s claim).

Who says mutual funds can’t make you rich?

Forbes magazine published their annual list of “The Richest People on the Planet” (03/04/2013), tracking down almost 1500 billionaires in the process. (None, oddly, teachers by profession.)

MFWire scoured the list for “The Richest Fundsters in the Game” (03/06/2013). They ended up naming nine while missing a handful of others. Here’s their list with my additions in blue:

• Charles Brandes, Brandes funds, #1342, $1.0 billion
• Thomas Bailey, Janus founder, #1342, $1.0 billion
• Mario Gabelli, Gamco #1175, $1.2 billion
• Michael Price, former Mutual Series mgr, #1107, $1.3 billion
• Fayez Sarofim, Dreyfus Appreciation mgr, #1031, $1.4 billion
• Ron Baron, Baron Funds #931, $1.6 billion
• Howard Marks, TCW then Oaktree Capital, #922, $1.65 billion
• Joe Mansueto, Morningstar #793, $1.9 billion
• Ken Fisher, investment guru and source of pop-up ads, #792, $1.9 billion
• Bill Gross, PIMCO, #641, $2.3 billion
• Charles Schwab (the person), Charles Schwab (the company) #299, $4.3 billion
• Paul Desmarais, whose Power Financial backs Putnam #276, $4.5 billion
• Rupert Johnson, Franklin Templeton #215, $5.6 billion
• Charles Johnson, Franklin Templeton #211, $5.7 billion
• Ned Johnson, Fidelity #166, worth $7 billion
• Abby Johnson, Fidelity #74, $12.7 billion

For the curious, here’s the list of billionaire U.S. investors, which mysteriously doesn’t include Bill Gross. He’s listed under “finance.”

The thing that strikes me is how much of these folks I’d entrust my money to, if only because so many became so rich on wealth transfer (in the form of fees paid by their shareholders) rather than wealth creation.

Two new and noteworthy resources: InvestingNerd and Fundfox

I had a chance to speak this week with the folks behind two new (one brand-new, one pretty durn new) sites that might be useful to some of you folks.

InvestingNerd (a little slice of NerdWallet)

NerdWallet launched in 2010 as a tool to find the best credit card offers.  It claimed to be able to locate and sort five times as many offers as its major competitors.  With time they added other services to help consumers save money. For example the TravelNerd app to help travelers compare costs related to their travel plans, like finding the cheapest transportation to the airport or comparing airport parking prices, the NerdScholar has a tool for assessing law schools based on their placement rates. NerdWallet makes its money from finder’s fees: if you like one of the credit card offers they find for you and sign up for that card, the site receives a bit of compensation. That’s a fairly common arrangement used, for example, by folks like BankRate.com.

On March 27, NerdWallet launched a new site for its investing vertical, InvestingNerd. It brings together advice (TurboTax vs H&R Block: Tax Prep Cost Comparison), analysis (Bank Stress Test Results: How Stressful Were They?) and screening tools.

I asked Neda Jafarzadeh, a public relations representative over at InvestingNerd, what she’d recommend as most distinctive about the site.  She offered up three features that she thought would be most intriguing for investors in particular: 

• InvestingNerd recently rolled out a new tool – the Mutual Fund Screener. This tool allows investors to find, search and compare over 15,000 funds. In addition, it allows investors to filter through funds based on variables like the fund’s size, minimum required investment, and the fund’s expense ratio. Also, investors can screen funds using key performance metrics such as the fund’s risk-adjusted return rate, annual volatility, market exposure and market outperformance.
• In addition, InvestingNerd has a Brokerage Comparison Tool which provides an unbiased comparison of 69 of the most popular online brokerage accounts. The tool can provide an exact monthly cost for the investor based on their individual trading behavior.
• InvestingNerd also has a blog where we cover news on financial markets and the economy, release studies and analyses related to investing, in addition to publishing helpful articles on various other investment and tax related topics.

Their fund screener is . . . interesting.  It’s very simple and updates a results list immediately.  Want an equity fund with a manager who’s been around more than 10 years?  No problem.  Make it a small cap?  Sure.  Click.  You get a list and clickable profiles.  There are a couple problems, though.  First, they have incomplete or missing explanations of what their screening categories (“outperformance”) means.  Second, their results list is inexplicably incomplete: the same search in Morningstar turns up noticeably more funds.   Finally, they offer a fund rating (“five stars”) with no evidence of what went into it or what it might tell us about the fund’s future.  When I ask with the folks there, it seemed that the rating was driven by risk-adjusted return (alpha adjusted for standard deviation) and InvestingNerd makes no claim that their ratings have predictive validity.

It’s worth looking at and playing with.  Their screener, like any, is best thought of as a tool for generating a due diligence list: a way to identify some funds worth digging into.  Their articles cover an interesting array of topics (considering a gray divorce?  Shopping tips for folks who support gay rights?) and you might well use one of their tools to find the free checking account you’ve always dreamed of.

Fundfox

Fundfox is a site for those folks who wake in the morning and ask themselves, “I wonder who’s been suing the mutual fund industry this week?” or “I wonder what the most popular grounds for suing a fund company this year is?”

Which is to say fund company attorneys, compliance folks, guys at the SEC and me.

It was started by David Smith, who used to work for the largest liability insurance provider to the fund industry, as a simpler, cleaner, more specialized alternative to services such as WestLaw or Lexis. It covers lawsuits filed against mutual funds, period. That really reduces the clutter. The site does include a series of dashboards (what fund types are most frequently the object of suits?) and some commentary.

You can register for free and get a lot of information a la Morningstar or sign up for a premium membership and access serious quantities of filings and findings. There’s a two week trial for the premium service and I really respect David’s decision to offer a trial without requiring a credit card. Legal professionals might well find the combination of tight focus, easy navigation and frequent updates useful.

Introducing: The Elevator Talk

The Elevator Talk is a new feature which began in February. 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.

Elevator Talk #3: Bayard Closser, Vertical Capital Income Fund (VCAPX)

Mr. Closser is president of the Vertical Capital Markets Group and one of the guys behind Vertical Capital Income Fund (VCAPX), which launched on December 30, 2011. VCAPX is structured as an interval fund, a class of funds rare enough that Morningstar doesn’t even track them. An interval fund allows you access to your investment only at specified intervals and only to the extent that the management can supply redemptions without disrupting the portfolio. The logic is that certain sorts of investments are impossible to pursue if management has to be able to accommodate the demands of investors to get their money now. Hedge funds, using lock-up periods, pursue the exact same logic. Given the managers’ experience in structuring hedge funds, that seems like a logical outcome. They do allow for the possibility that the fund might, with time, transition over to a conventional CEF structure:

Vertical chose an interval fund structure because we determined that it is the best delivery mechanism for alternative assets. It helps protect shareholders by giving them limited liquidity, but also provides the advantages of an open-end fund, including daily pricing and valuation. In addition, it is easy to convert an interval fund to a closed-end fund as the fund grows and we no longer want to acquire assets.

Here’s what Bayard has to say (in a Spartan 172 words) about VCAPX:

A closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves through our sister company Vertical Recovery Management, which can even restructure loans for committed homeowners to help them keep current on monthly payments.

Increasingly, even small investors are seeking alternative investments to increase diversification. VCAPX can play that role, as its assets have no correlation or a slight negative correlation with the stock market.

While lenders are still divesting mortgages at a deep discount, the housing market is improving, creating a “Goldilocks” effect that may be “just right” for the fund.

VCAPX easily outperformed its benchmark in its first year of operation (Dec. 30, 2011 through Dec. 31, 2012), with a return of 12.95% at net asset value, compared with 2.59% for the Barclays U.S. Mortgage-Backed Securities (MBS) Index.

At the fund’s maximum 4.50% sales charge, the return was 7.91%. The fund also declared a 4.01% annualized dividend (3.54% after the sales charge).

The fund’s minimum initial investment is $5,000 for retail shares, reduced to $1,000 for IRAs. There’s a front sales load of 4.5% but the fund is available no-load at both Schwab and TDAmeritrade. They offer a fair amount of background, risk and performance information on the fund’s website. You might check under the “Resource Center” tab for copies of their quarterly newsletter.

The Cook and Bynum Fund, Conference Call Highlights

Recently published research laments the fact that actively-managed funds have become steadily less active and more index-like over time.

The changing imperatives of the fund industry have led many managers to become mediocre by design. Their response is driven by the anxious desire for so-called “sticky” assets. The strategy is simple: design a product to minimize the risk that it will ever spectacularly trail its peer group. If you make your fund very much like its benchmark, you will never be a singular disaster and so investors (retirement plan investors, particularly) will never be motivated to find something better. The fact that you never excel is irrelevant. The result is a legion of large, expensive, undistinguished funds who seek safety in the herd.

The Cook and Bynum Fund (COBYX) strikes me as the antithesis of those. Carefully constructed, tightly focused, and intentionally distinct. On Tuesday, March 5, we spoke with Richard Cook and Dowe Bynum in the first of three conversations with distinguished managers who defy that trend through their commitment to a singular discipline: buy only the best. For Richard and Dowe, that translates to a portfolio with only seven holdings and a 34% cash stake. Since inception (through early March, 2013), they managed to capture 83% of the market’s gains with only 50% of its volatility; in the past twelve months, Morningstar estimates that they captured just 7% of the market’s downside.

Among the highlights of the call for me:

1. The guys are willing to look stupid. There are times, as now, when they can’t find stocks that meet their quality and valuation standards. The rule for such situations is simply: “When compelling opportunities do not exist, it is our obligation not to put capital at risk.” They happily admit that other funds might well reap short-term gains by running with the pack, but you “have to be willing to look stupid.” Their current cash stake is about 34%, “the highest cash level ever in the fund.” That’s not driven by a market call; it’s a simple residue of their inability to find great opportunities.
2. The guys are not willing to be stupid. Richard and Dowe grew up together and are comfortable challenging each other. Richard knows the limits of Dowe’s knowledge (and vice versa), “so we’re less likely to hold hands and go off the cliff together.” In order to avoid that outcome, they spend a lot of time figuring out how not to be stupid. They relegate some intriguing possibilities to the “too hard pile,” those businesses that might have a great story but whose business model or financials are simply too hard to forecast with sufficient confidence. They think about common errors (commitment bias, our ability to rationalize why we’re not going to stop doing something once we’ve started, chief among them) and have generated a set of really interesting tools to help contain them. They maintain, for example, a list all of the reasons why they don’t like their current holdings. In advance of any purchase, they list all of the conditions under which they’d quickly sell (“if their star CEO leaves, we do too”) and keep that on top of their pile of papers concerning the stock.
3. They’re doing what they love. Before starting Cook & Bynum (the company), both of the guys had high-visibility, highly-compensated positions in financial centers. Richard worked for Tudor Investments in Stamford, CT, while Dowe was with Goldman Sachs in New York. The guys believe in a fundamental, value- and research-driven, stock-by-stock process. What they were being paid to do (with Tudor’s macro event-driven hedge fund strategies for Richard) was about as far from what they most wanted as they could get. And so they quit, moved back to Alabama and set up their own shop to manage their own money and the investments of high net-worth individuals. They created Cook & Bynum (the fund) in response to an investor’s request for a product accessible to family and friends.  The $250 million invested with them (about $100 million in the fund) includes 100% of their own liquid net worth, with their investment split between the fund and the partnerships. Since both sets of vehicles use the same fees and structure, there’s no conflict between the two.
4. They do prodigious research without succumbing to the “gotta buy something” impulse. While they spend the majority of their time in their offices, they’re also comfortable with spending two or three weeks at a time on the road. Their argument is that they’ve got to understand the entire ecosystem in which a firm operates – from the quality of its distribution network to the feelings of its customers – which they can only do first-hand. Nonetheless, they’ve been pretty good at resisting “deal momentum.”  They spent, for example, some three weeks traveling around Estonia, Poland and Hungary. Found nothing compelling. Traveled Greece and Turkey and learned a lot, including how deeply dysfunctional the Greek economy is, but bought nothing.
5. They’re willing to do what you won’t. Most of us profess a buy low / buy the unloved / break from the herd / embrace our inner contrarian ethos. And most of us are deluded. Cook and Bynum seem rather less so: they’re holding cash now while others buy stocks after the market has doubled and profits margins hit records but in the depth of the 2008 meltdown they were buyers. (They report having skipped Christmas presents in 2008 in order to have extra capital to invest.) As the market bottomed in March 2009, the fund was down to 2% cash.

Bottom Line: the guys seem to be looking for two elusive commodities. One is investments worth pursuing. The other is investing partners who share their passion for compelling investments and their willingness to let other investors charge off in a herd. Neither is as common as you might hope.

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

The COBYX conference call

When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded. If the file downloads, instead, you may have to double-click to play it.

We periodically invite our colleague, Charles Boccadoro, to share his perspectives on funds which were the focus of our conference calls. Charles’ ability to apprehend and assess tons of data is, we think, a nice complement to my strengths which might lie in the direction of answering the questions (1) does this strategy make any sense? And (2) what’s the prospect that they can pull it off? Without further ado, here’s Charles on Cook and Bynum

Inoculated By Value

To describe Richard P. Cook and J. Dowe Bynum (C&B) as value investors would be accurate, but certainly not adequate. Their website is rich with references to value investment principles championed by Benjamin Graham, John Burr Williams, Charlie Munger, and Warren Buffet. “The value investing inoculation took immediately,” C&B explain, after reading Mr. Buffett’s biography in high school. They have been investing together literally since childhood and at age 23 they actually tried to start their own mutual fund. That did not happen, but years later in 2001 they established Cook & Bynum Capital Management and in mid-2009 they launched their namesake The Cook & Bynum Fund COBYX, which turned out to be perfect timing.

Like many experienced investors on MFO, C&B do not view volatility as risk, but as opportunity. That said, the lack of volatility in 43 months of COBYX performance through February 2013 is very alluring and likely helped propel the fund’s popularity, now with $102M AUM. Its consistent growth rate resembles more a steady bond fund, say PONDX, than an equity fund. The fund received a 5-Star Morningstar Rating for the 3-year period ending mid-2012.

Other than strictly adhering to the three most important words of value investing (“Margin of Safety”) when assessing stock price against inherent value, C&B do not impose explicit drawdown control or practice dynamic allocation, like risk-parity AQRNX or long-short ARLSX. They try instead to buy wonderful businesses at discounted prices. To quote Mr. Buffett: “If you’re right about what, you don’t have to worry about when very much.”

Fortunately, history is on their side. The chart below depicts drawdowns for the last 50 years, comparing value versus growth large cap fund averages. Value funds indeed generally suffer smaller and shorter drawdowns. But not always. The term “value trap” became ubiquitous during the financial collapse of 2008, when many highly respected, long established, and top performing value funds (prime example DODGX) were simply hammered. And, when the forest is burning, all the trees go with it.

While Mr. Cook and Mr. Bynum must have managed their private accounts through such turbulent times, COBYX has enjoyed bull market conditions since its inception. (Perhaps a reluctant bull, but nonetheless…) Still, when the market dipped 7% in May 2012, COBYX did not drop at all. In September 2011, SP500 dropped 16%, COBYX dipped only 5%. Its biggest drawdown was June 2010 at 9% versus 13% for the market. The tame behavior is due partly to C&B’s propensity to hold cash. Not as a strategy, they explain, but as residual to value opportunities available. They unloaded Kraft, for example, shortly after the company split its international and domestic businesses. Here is an excerpt from COBYX’s 2012 annual report explaining their move:

Despite neither of the companies’ fundamental business prospects changing one iota, the market reacted to the news by trading both of the stocks higher. We used this opportunity to liquidate our stake in both companies. It is popular, even within our value discipline, for investors to advocate various financial engineering strategies in an attempt to drive near-term stock price appreciation rather than to focus on a company’s long-term cash flows – where real value resides.

C&B take pride in not being “closet indexers” to their benchmarks SP500 and MSCI All Country World Index (ACWI). So far they have tended to hold consumer defensive stocks, like Wal-Mart, Procter & Gamble, and Coca-Cola. Although more recently, they own Microsoft, which accounts for 16% of the portfolio. COBYX’s lifetime correlation to SP500 is 66% and its beta is only 0.47.

The strategy has delivered handsomely. Just how good is it? Below compares COBYX with several other Morningstar 5 star funds, including Charles Akre’s AKREX, Steven Romick’s FPA Crescent Fund, Donald Yacktman’s YAFFX, Sequoia Fund (perhaps the greatest fund ever), plus landmark Berkshire Hathaway.

Since COBYX inception, it has produced the highest risk adjusted returns, based on both Sharpe and Sortino Ratios, with the lowest standard and downside volatilities. It has delivered more than 90% of SP500 total return with less than 60% of its volatility. Interestingly, all of these top-performing mutual funds have low beta against SP500, like COBYX, but again for the record, C&B reject metrics like beta: “Risk is not volatility.”

COBYX is also highly concentrated. As of December 2012, it held only seven equities. C&B’s strategy is to focus only on companies whose businesses they can understand – depth of insight is the edge they seek. They employ Kelly Criterion to size positions in their portfolio, which represents an implicit form of risk management. John Kelly developed it in 1950s at AT&T’s Bell Labs to optimize transmission rate through long distance phone lines. Edward Thorpe then famously employed the technique to “Beat the Dealer” and later to help optimize his hedge fund investments at Princeton/Newport Partners. In C&B’s implementation, Kelly is edge over odds, or expected returns over range of outcomes. What is currently their biggest position? Cash at 34%.

Bottom-line: Hard not to love this young fund, performance to date, and philosophy employed by its managers. High ER, recently dropped from 1.88 to 1.49, has been its one detractor. Hopefully, ER reduction continues with AUM growth, since world-stock fund median is already a hefty 1.20 drag.

(Thank you, sir! David)

Conference Call Upcoming: RiverPark Wedgewood Growth, April 17

Large-cap funds, and especially large large-cap funds, suffer from the same tendency toward timidity and bloat that I discussed above. On average, actively-managed large growth funds hold 70 stocks and turn over 100% per year. The ten largest such funds hold 311 stocks on average and turn over 38% per year.

The well-read folks at Wedgewood see the path to success differently. Manager David Rolfe endorses Charles Ellis’s classic essay, “The Losers Game” (Financial Analysts Journal, July 1975). Reasoning from war and sports to investing, Ellis argues that losers games are those where, as in amateur tennis:

The amateur duffer seldom beats his opponent, but he beats himself all the time. The victor in this game of tennis gets a higher score than the opponent, but he gets that higher score because his opponent is losing even more points.

Ellis argues that professional investors, in the main, play a losers game by becoming distracted, unfocused and undistinguished. Mr. Rolfe and his associates are determined not to play that game. They position themselves as “contrarian growth investors.” In practical terms, that means:

1. They force themselves to own fewer stocks than they really want to. After filtering a universe of 500-600 large growth companies, Wedgewood holds only “the top 20 of the 40 stocks we really want to own.” Currently, 55% of the fund’s assets are in its top ten picks.
2. They buy when other growth managers are selling. Most growth managers are momentum investors, they buy when a stock’s price is rising. Wedgewood would rather buy during panic than during euphoria.
3. They hold far longer once they buy. The historical average for Wedgewood’s separate accounts which use this exact discipline is 15-20% turnover and the fund is around 25%.
4. And then they spend a lot of time watching those stocks. “Thinking and acting like business owners reduces our interest to those few businesses which are superior,” Rolfe writes, and he maintains a thoughtful vigil over those businesses.

David is articulate, thoughtful and successful. His reflections on “out-thinking the index makers” strike me as rare and valuable, as does his ability to manage risk while remaining fully invested.

Our conference call will be Wednesday, April 17, from 7:00 – 8:00 Eastern.

How can you join in?

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

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

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 lineup features:

The Cook and Bynum Fund (COBYX): an updated profile of this concentrated value fund.

Whitebox Long Short Equity (WBLSX): the former hedge fund has a reasonably distinctive, complicated strategy and I haven’t had much luck in communicating with fund representatives over the last month or so about the strategy. Given a continued high level of reader interest in the fund, it seemed prudent to offer, with this caveat, a preliminary take on what they do and how you might think about it.

Launch Alert: BBH Global Core Select (BBGRX)

There are two things particularly worth knowing about BBH (for Brown Brothers Harriman) Core Select (BBTRX): (1) it’s splendid and (2) it’s closed. It’s posted a very consistent pattern of high returns and low risk, which eventually drew $5 billion to the fund and triggered its soft close in November. At the moment that BBH closed Core Select, they announced the launch of Global Core Select. That fund went live on March 28, 2013.

Global Core Select will be co-managed by Regina Lombardi and Tim Hartch, two members of the BBH Core Select investment team. Hartch is one of Core Select’s two managers; Lombardi is one of 11 analysts. The Fund is the successor to the BBH private investment partnership, BBH Global Funds, LLC – Global Core Select, which launched on April 2, 2012. Because the hedge fund had less than a one year of operation, there’s no performance record for them reported. The minimum initial investment in the retail class is $5,000. The expense ratio is capped at 1.50% (which represents a generous one basis-point sacrifice on the adviser’s part).

The strategy snapshot is this: they’ll invest in 30-40 mid- to large-cap companies in both developed and developing markets. They’ll place at least 40% outside the US. The strategy seems identical to Core Select’s: established, cash generative businesses that are leading providers of essential products and services with strong management teams and loyal customers, and are priced at a discount to estimated intrinsic value. They profess a “buy and own” approach.

What are the differences: well, Global Core Select is open and Core Select isn’t. Global will double Core’s international stake. And Global will have a slightly-lower target range: its investable universe starts at $3 billion, Core’s starts at $5 billion.

I’ll suggest three reasons to hesitate before you rush in:

1. There’s no public explanation of why closing Core and opening Global isn’t just a shell game. Core is not constrained in the amount of foreign stock it owns (currently under 20% of assets). If Core closed because the strategy couldn’t handle the additional cash, I’m not sure why opening a fund with a nearly-identical strategy is warranted.
2. Expenses are likely to remain high – even with $5 billion in a largely domestic, low turnover portfolio, BBH charges 1.25%.
3. Others are going to rush in. Core’s record and unavailability is going to make Global the object of a lot of hot money which will be rolling in just as the market reaches its seasonal (and possibly cyclical) peak.

That said, this strategy has worked elsewhere. The closed Oakmark Select (OAKLX) begat Oakmark Global Select (OAKWX) and closed Leuthold Core (LCORX) led to Leuthold Global (GLBLX). In both cases, the young fund handily outperformed its progenitor. Here’s the nearly empty BBH Global Core Select homepage.

Launch Alert: DoubleLine Equities Small Cap Growth Fund (DLESX)

DoubleLine continues to pillage TCW, the former home of its founder and seemingly of most of its employees. DoubleLine, which manages more than $53 billion in mostly fixed income assets, has created a DoubleLine Equity LP division. The unit’s first launch, DoubleLine Equities Small Cap Growth Fund, occurs April 1, 2013. Growth Fund (DLEGX) and Technology Fund (DLETX) are close behind in the pipeline.

Husam Nazer, who oversaw $4-5 billion in assets in TCW’s Small and Mid-Cap Growth Equities Group, will manage the new fund. DoubleLine hired Nazer’s former TCW investing partner, Brendt Stallings, four stock analysts and a stock trader. Four of the new hires previously worked for Nazer and Stallings at TCW.

The fund will invest mainly in stocks comparable in size to those in the Russell US Growth index (which tops out at around $4 billion). They’ll invest mostly in smaller U.S. companies and in foreign small caps which trade on American exchanges through ADRs. The manager professes a “bottom up” approach to identify investment. He’s looking for a set of reasonable and unremarkable characteristics: consistent and growing earnings, strong balance sheet, good competitive position, good management and so on. The minimum initial investment in the retail class is $2,000, reduced to $500 for IRAs. The expense ratio is capped at 1.40%.

I’ll suggest one decent reason to hesitate before you bet that DoubleLine’s success in bonds will be matched by its success in stocks:

Mr. Nazer’s last fund wasn’t really all that good. His longest and most-comparable charge is TCW Small Cap Growth (TGSNX). Morningstar rates it as a two-star fund. In his eight years at the fund, Mr. Nazer had a slow start (2005 was weak) followed by four very strong years (2006-2009) and three really bad ones (2010-2012). The fund’s three-year record trails 97% of its peers. It has offered consistently above-average to high volatility, paired with average to way below-average returns. Morningstar’s generally-optimistic reviews of the fund ended in July 2011. Lipper likewise rates it as a two-star fund over the past five years.

The fund might well perform brilliantly, assuming that Mr. Gundlach believed he had good reason to import this team. That said, the record is not unambiguously positive.

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. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

Funds in registration this month won’t be available for sale until, typically, the beginning of June 2013. We found a handful of no-load, retail funds in the pipeline, notably:

Robeco Boston Partners Global Long/Short Fund will offer a global take on Boston Partner’s highly-successful long/short strategy. They expect at least 40% international exposure, compared to 10% in their flagship Long/Short Equity Fund (BPLEX) and 15% in the new Long/Short Research Fund (BPRRX). There are very few constraints in the prospectus on their investing universe. The fund will be managed by Jay Feeney, an original Boston Partner, co-CEO and CIO-Equities, and Christopher K. Hart, Equity Portfolio Manage. The minimum initial investment in the retail class is $2,500. The expense ratio will be 3.77% after waivers. Let me just say: “Yikes.” At the risk of repeating myself, “Yikes!” With a management fee of 1.75%, this is likely to remain a challenging case.

T. Rowe Price Global Allocation Fund will invest in stocks, bonds, cash and hedge funds. Yikes! T. Rowe is getting you into hedge funds. They’ll active manage their asset allocation. The baseline is 30% US stocks, 30% international stocks, 20% US bonds, 10% international bonds and 10% alternative investments. A series of macro judgments will allow them to tweak those allocations. The fund will be managed by Charles Shriver, lead manager for their Balanced, Personal Strategy and Spectrum funds. The minimum initial purchase is $2500, reduced to $1000 for IRAs. Expense ratio will be 1.05%.

Details on these funds and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes: Two giants begin to step back

On a related note, we also tracked down 71 fund manager changes. Those include decisions by two fund company founders to begin lightening their loads. Nicholas Kaiser, president of Saturna Investments which advises the Sextant and Amana funds, no longer co-manages Sextant Growth (SSGFX) and John Kornitzer, founder of Kornitzer Capital which advises the Buffalo funds, stepped back from Buffalo Dividend Focus (BUFDX) four months after launch.

Snowball on the transformative power of standing around, doing little

I’m occasionally asked to contribute 500 words to Amazon’s Money & Markets blog. Amazon circulates a question (in this case, “how should investors react to sequestration?”) and invites responses. I knew they won’t publish “oh, get real,” so I wrote something just slightly longer.

Don’t Just Do Something. Stand There.

When exactly did the old midshipman’s rule, “When in danger or in doubt, run in circles, scream and shout,” get enshrined as investing advice?

There are just three things we don’t know about sequestration: (1) what will happen, (2) how long it will last and (3) what will follow. Collectively, they tell you that the most useful thing a stock investor might do in reaction to the sequestration is, nothing. Whatever happens will certainly roil the markets but stock markets are forever being roiled. This one is no different than all of the others. Go check your portfolio and ask four things:

1. Do I have an adequate reserve in a cash-management account to cover my basic expenses – that is, to maintain a normal standard of living – if I need six months to find a new job?
2. Do I have very limited stock exposure (say, under 20%) in the portion of the portfolio that I might reasonably need to tap in the next three or five years?
3. Do I have a globally diversified portfolio in the portion that I need to grow over a period of 10 years or more?
4. Am I acting responsibly in adding regularly to each?

If yes, the sequestration is important, but not to your portfolio. If no, you’ve got problems to address that are far more significant than the waves caused by this latest episode of our collective inability to manage otherwise manageable problems. Address those, as promptly and thoughtfully as you can.

The temptation is clear: do something! And the research is equally clear: investors who reactively do something lose. Those who have constructed sensible portfolios and leave them be, win.

Be a winner: stand there.

Happily, the other respondents were at least as sensible. There’s the complete collection.

Briefly Noted ….

Vanguard is shifting

Perhaps you should, as well? Vanguard announced three shifts in the composition of income sleeve of their Target Retirement Funds.

• They are shifting their bond exposure from domestic to international. Twenty percent of each fund’s fixed income exposure will be reallocated to foreign bonds through investment in Vanguard Total International Bond Index Fund.
• Near term funds are maintaining their exposure to TIPS but are shifting all of their allocation to the Short-Term Inflation-Protected Securities Index Fund rather than Vanguard Inflation-Protected Securities Fund.
• The Retirement Income and Retirement 2010 funds are eliminating their exposure to cash. The proceeds will be used to buy foreign bonds.

PIMCO retargets

As of March 8, 2013 the PIMCO Global Multi-Asset Fund changed its objective from “The Fund seeks total return which exceeds that of a blend of 60% MSCI World Index/40% Barclays U.S. Aggregate Index” to “The Fund seeks maximum long-term absolute return, consistent with prudent management of portfolio volatility.” At the same time, the Fund’s secondary index is the 1 Month USD LIBOR Index +5% which should give you a good idea of what they expect the fund to be able to return over time.

PIMCO did not announce any change in investment policies but did explain that the new, more conservative index “is more closely aligned with the Fund’s investment philosophy and investment objective” than a simple global stock/bond blend would be.

Capital Group / American Funds is bleeding

Our recent series on new fund launches over the past decade pointed out that, of the five major fund groups, the American Funds had – by far – the worst record. They managed to combine almost no innovation with increasingly bloated funds whose managers were pleading for help. A new report in Pensions & Investments (Capital Group seeking to rebuild, 03/18/2013) suggests that the costs of a decade spent on cruise control were high: the firm’s assets under management have dropped by almost a half-trillion dollars in six years with the worst losses coming from the institutional investment side.

Matthews and the power of those three little words.

Several readers have noticed that Matthews recently issued a supplement to the Strategic Income Fund (MAINX) portfolio. The extent of the change is this: the advisor dropped the words “and debt-related” from a proviso that at least 50% of the fund’s portfolio would be invested in “debt and debt-related securities” which were rated as investment-grade.

In talking with folks affiliated with Matthews, it turns out that the phrase “and debt-related” put them in an untenable bind. “Debt-related securities” includes all manner of derivatives, including the currency futures contracts which allow them to hedge currency exposure. Such derivatives do not receive ratings from debt-rating firms such as Fitch meaning that it automatically appeared as if the manager was buying “junk” when no such thing was happening. That became more complicated by the challenge of assigning a value to a futures contract: if, hypothetically, you buy $1 million in insurance (which you might not need) for a $100 premium, do you report the value of $100 or $1 million?

In order to keep attention focused on the actual intent of the proviso – that at least 50% of the debt securities will be investment grade – they struck the complicating language.

Good news and bad for AllianzGI Opportunity Fund shareholders

Good news, guys: you’re getting a whole new fund! Bad news: it’s gonna cost ya.

AllianzGI Opportunity Fund (POPAX) is a pretty poor fund. During the first five years of its lead manager’s ten year tenure, it wasn’t awful: two years with well above average returns, two years below average and one year was a draw. The last five have been far weaker: four years way below average, with 2013 on course for another. Regardless of returns, the fund’s volatility has been consistently high.

The clean-up began March 8 2013 with the departure of co-manager Eric Sartorius. On April 8 2013, manager Mike Corelli departs and the fund’s investment strategy gets a substantial rewrite. The current strategy “focuses on bottom-up, fundamental analysis” of firms with market caps under $2 billion. Ironically, despite the “GI” designation in the name (code for Growth & Income, just as TR is Total Return and AR is Absolute Return), the prospectus assures us that “no consideration is given to income.” The new strategy will “utilize a quantitative process to focus on stocks of companies that exhibit positive change, sustainability, and timely market recognition” and the allowable market cap will rise to $5.3 billion.

Two bits of bad news. First, it’s likely to be a tax headache. Allianz warns that “the Fund will liquidate a substantial majority of its existing holdings” which will almost certainly trigger a substantial 2013 capital gains bill. Second, the new managers (Mark Roemer and Jeff Parker) aren’t very good. I’m sure they’re nice people and Mr. Parker is CIO for the firm’s U.S. equity strategies but none of the funds they’ve been associated with (Mr. Roemer is a “managed volatility” specialist, Mr. Parker focuses on growth) have been very good and several seem not to exist anymore.

Direxion splits

A bunch of Direxion leveraged index and reverse index products split either 2:1 or 3:1 at the close of business on March 28, 2013. They were

Small Wins for Investors

Effective April 1, 2013, Advisory Research International Small Cap Value Fund’s (ADVIX) expense ratio is capped at 1.25%, down from its current 1.35%. Morningstar will likely not reflect this change for a while

Aftershock Strategies Fund (SHKNX) has lowered its expense cap, from 1.80 to 1.70%. Their aim is to “preserve capital in a challenging investment environment.” Apparently the absence of a challenging investment environment inspired them to lose capital: the fund is down 1.5% YTD, through March 29, 2013.

Good news: effective March 15, 2013, Clearwater Management increased its voluntary management fee waiver for three of its Clearwater Funds (Core, Small Companies, Tax-Exempt Bond). Bad news, I can’t confirm that the funds actually exist. There’s no website and none of the major the major tracking services now recognizes the funds’ ticker symbols. Nothing posts at the SEC suggests cessation, so I don’t know what’s up.

Fidelity is offering to waive the sales loads on an ever-wider array of traditionally load-only funds through its supermarket. I learned of the move, as I learn of so many things, from the folks at MFO’s discussion board. The list of load-waived funds is detailed in msf’s thread, entitled Fidelity waives loads. A separate thread, started by Scott, with similar good news announces that T. Rowe Price funds are available without a transaction fee at Ameritrade.

Vanguard is dropping expenses on two more funds including the $69 billion Wellington (VWELX) fund. Wellington’s expenses have been reduced in three consecutive years.

Closings

American Century Equity Income (TWEAX) closed to new investors on March 29, 2013. The fund recently passed $10 billion in assets, a hefty weight to haul. The fund, which has always been a bit streaky, has trailed its large-value peers in five of the past six quarters which might have contributed to the decision to close the door.

The billion-dollar BNY Mellon Municipal Opportunities Fund (MOTIX) closed to new investors on March 28, 2013.

Effective April 30, 2013 Cambiar Small Cap Fund (CAMSX) will close to new investors. It’s been a very strong performer and has drawn $1.4 billion in assets.

Prudential Jennison Mid Cap Growth (PEEAX) will close to new investors on April 8, 2013. The fund’s assets have grown substantially over the past three years from under $2 billion at the beginning of 2010 to over $8 billion as of February 2013. While some in the media describe this as “a shareholder-friendly decision,” there’s some question about whether Prudential friended its shareholders a bit too late. The fund’s 10 year performance is top 5%, 5-year declines to top 20%, 3 year to top 40% and one year to mediocre.

Effective April 12, 2013, Oppenheimer Developing Markets Fund (ODMAX) closed to both new and existing shareholders. In the business jargon, that’s a “hard close.”

Touchstone Sands Capital Select Growth (PTSGX) and Touchstone Sands Institutional Growth (CISGX), both endorsed by Morningstar’s analysts, will close to new investors effective April 8, 2013. Sands is good and also subadvises from for GuideStone and MassMutual.

Touchstone has also announced that Touchstone Merger Arbitrage (TMGAX), subadvised by Longfellow Investment Management, will close to new investors effective April 8. The two-year old fund has about a half billion in assets and management wants to close it to maintain performance.

Effective April 29, 2013, Westcore International Small-Cap Fund (WTIFX) will close to all purchase activity with the exception of dividend reinvestment. That will turn the current soft-close into a hard-close.

Old Wine in New Bottles

On or about May 31, 2013. Alger Large Cap Growth Fund (ALGAX) will become Alger International Growth Fund, but its investment objective to seek long-term capital appreciation will not change. The Fund will be managed by Pedro V. Marcal. At the same time, Alger China-U.S. Growth Fund (CHUSX) will become Alger Global Growth Fund, but its investment objective to seek long-term capital appreciation will not change. The Fund will continue to be managed by Dan Chung and Deborah Vélez Medenica, with the addition of Pedro V. Marcal. These are both fundamentally sorrowful funds. About the only leads I have on Mr. Marcal is that he’s either a former Olympic fencer for Portugal (1960) or the author of a study on market timing and technical analysis. I’m not sure which set of skills would contribute more here.

Effective April 19, BlackRock S&P 500 Index (MASRX) will merge into BlackRock S&P 500 Stock (WFSPX). Uhhh … they’re both S&P500 index funds. The reorganization will give shareholders a tiny break in expenses (a drop from 13 bps to 11) but will slightly goof with their tax bill.

Buffalo Micro Cap Fund (BUFOX) will become Buffalo Emerging Opportunities Fund, around June 3, 2013. That’s a slight delay in the scheduled renaming, which should have already taken place under the original plan. The renamed beast will invest in “domestic common stocks, preferred stocks, convertible securities, warrants and rights of companies that, at the time of purchase by the Fund, have market capitalizations of $1 billion or less.

Catalyst Large Cap Value Fund (LVXAX) will, on May 27 2013, become Catalyst Insider Buying Fund. The fund will no longer be constrained to invest in large cap value stocks.

Effective April 1, 2013, Intrepid All Cap Fund (ICMCX) changed its name to Intrepid Disciplined Value Fund. There was a corresponding change to the investment policies of the fund to allow it to invest in common stocks and “preferred stocks, convertible preferred stocks, warrants and foreign securities, which include American Depositary Receipts (ADRs).”

PIMCO Worldwide Fundamental Advantage TR Strategy (PWWIX) will change its name to PIMCO Worldwide Fundamental Advantage AR Strategy. Also, the fund will change from a “total return” strategy to an “absolute return” strategy, which has more flexibility with sector exposures, non-U.S. exposures, and credit quality.

Value Line changed the names of Value Line Emerging Opportunities Fund to the Value Line Small Cap Opportunities Fund (VLEOX) and the Value Line Aggressive Income Trust to the Value Line Core Bond Fund (VAGIX).

Off to the Dustbin of History

AllianzGI Focused Opportunity Fund (AFOAX) will be liquidated and dissolved on or about April 19, 2013.

Armstrong Associates (ARMSX) is merging into LKCM Equity Fund (LKEQX) effective on or about May 10, 2013. C.K. Lawson has been managing ARMSX for modestly longer – 45 years – than many of his peers have been alive.

Artio Emerging Markets Local Debt (AEFAX) will liquidate on April 19, 2013.

You thought you invested in what? The details of db X-trackers MSCI Canada Hedged Equity Fund will, effective May 31 2013, be tweaked just a bit. The essence of the tweak is that it will become db X-trackers MSCI Germany Hedged Equity Fund (DBGR).

The Forward Focus and Forward Strategic Alternatives funds will be liquidated pursuant to a Board-approved Plan of Liquidation on or around April 30, 2013.

The Guardian Fund (LGFAX) guards no more. It is, as of March 28, 2013, a former fund.

ING International Value Choice Fund (IVCAX) will merge with ING International Value Equity Fund (NIVAX, formerly ING Global Value Choice Fund), though the date is not yet set.

Janus Global Research Fund merged into Janus Worldwide Fund (JAWWX) effective on March 15, 2013.

In a minor indignity, Dreman has been ousted as the manager of MIST Dreman Small Cap Value Portfolio, an insurance product distributed by MET Investment Series Trust (hence “MIST”) and replaced by J.P. Morgan Investment Management. Effective April 29, 2013, the fund becomes JPMorgan Small Cap Value Portfolio. No-load investors can still access Mr. Dreman’s services through Dreman Contrarian Small Cap Value (DRSVX). Folks with the attention spans of gnats and a tendency to think that glancing at the stars is the same as due diligence, will pass quickly by. This small fund has a long record of outperformance, marred by 2010 (strong absolute returns, weak relative ones) and 2011 (weak relative and absolute returns). 2012 was so-so and 2013, through March, has been solid.

Munder Large-Cap Value Fund was liquidated on March 25, 2013.

JPMorgan is planning a leisurely merger JPMorgan Value Opportunities (JVOIX) into JPMorgan Large Cap Value (HLQVX), which won’t be effective until Oct. 31, 2014. The funds share the same manager and strategy and . . . . well, portfolio. Hmmm. Makes you wonder about the delay.

Lord Abbett Stock Appreciation Fund merged into Lord Abbett Growth Leaders Fund (LGLAX) on March 22, 2013.

Pioneer Independence Fund is merging into Pioneer Disciplined Growth Fund (SERSX) which is expected to occur on or about May 17, 2013. The Disciplined Growth management team, fees and record survives while Independence’s vanishes.

Effective March 31, 2013 Salient Alternative Strategies Fund, a hedge fund, merged into the Salient Alternative Strategies I Fund (SABSX) because, the board suddenly discovered, both funds “have the same investment objectives, policies and strategies.”

Sentinel Mid Cap II Fund (SYVAX) has merged into the Sentinel Mid Cap Fund (SNTNX).

Target Growth Allocation Fund would like to merge into Prudential Jennison Equity Income Fund (SPQAX). Shareholders consider the question on April 19, 2013 and approval is pretty routine but if they don’t agree to merge the fund away, the Board has at least resolved to firm Marsico as one of the fund’s excessive number of sub-advisers (10, currently).

600,000 visits later . . .

609,000, actually. 143,000 visitors since launch. About 10,000 readers a month nowadays. That’s up by 25% from the same period a year ago. Because of your support, either direct contributions (thanks Leah and Dan!) or use of our Amazon link (it’s over there, on the right), we remain financially stable. And a widening circle of folks are sharing tips and leads with us, which gives us a chance to serve you better. And so, thanks for all of that.

The Observer celebrates its second anniversary with this issue. We are delighted and honored by your continuing readership and interest. You make it all worthwhile. (And you make writing at 1:54 a.m. a lot more manageable.) We’re in the midst of sprucing the place up a bit for you. Will, my son, clicked through hundreds of links to identify deadsters which Chip then corrected. We’ve tweaked the navigation bar a bit by renaming “podcasts” as “featured” to better reflect the content there, and cleaned out some dead profiles. Chip is working to track down and address a technical problem that’s caused us to go offline for between two and 20 minutes once or twice a week. Anya is looking at freshening our appearance a bit, Junior is updating our Best of the Web profiles in advance of adding some new, and a good friend is looking at creating an actual logo for us.

Four quick closing notes for the months ahead:

1. We are still not spam! Some folks continue to report not receiving our monthly reminders or conference call updates. Please check your spam folder. If you see us there, just click on the “not spam” icon and things will improve.
2. Morningstar is coming. Not the zombie horde, the annual conference. The Morningstar Investor Conference is June 12-14, in Chicago. I’ll be attending the conference on behalf of the Observer. I had the opportunity to spend time with a dozen people there last year: fund managers, media relations folks, Observer readers and others. If you’re going to be there, perhaps we might find time to talk.
3. We’re getting a bit backed-up on fund profiles, in several cases because we’ve had trouble getting fund reps to answer their mail. Our plan for the next few months will be to shorten the cover essay by a bit in order to spend more time posting new profiles. If you have folks who strike you as particularly meritorious but unnoticed, drop me a note!
4. Please do use the Amazon link, if you don’t already. We’re deeply grateful for direct contributions but they tend to be a bit unpredictable (many months end up in the $50 range while one saw many hundreds) while the Amazon relationship tends to produce a pretty predictable stream (which makes planning a lot easier). It costs you nothing and takes no more effort than clicking and hitting the “bookmark this page” button in your browser. After that, it’s automatic and invisible.

Take great care!