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!

Dear friends,

Welcome to the end of a long, odd month.  The market bounced.  The pope took a long victory lap around St. Peter’s Square in his Popemobile before giving up the red shoes for life. King Richard III was discovered after 500 years buried under a parking lot with evidence of an ignominious wound in his nether regions.  At about the same time, French scientists discovered the Richard the Lionheart’s heart had been embalmed with daisies, myrtle, mint and frankincense and stored in a lead box.  A series of named storms (Nemo?  Really?  Q?) wacked the Northeast.

And I, briefly, had fantasies of enormous wealth.  My family discovered a long forgotten stock certificate issued around the time of the First World War in my grandfather’s name.  After some poking about, it appeared that a chain of mergers and acquisitions led from a small Ohio bank to Fifth Third Bank, to whom I sent a scan of the stock certificate.  While I waited for them to marvel at its antiquity and authenticity, I reviewed my lessons in the power of compounding.  $100 in 1914, growing at 5% per year, would be worth $13,000 now.  Cool.  But, growing at 10% per year – the amount long-term stock investors are guaranteed, right? – it would have grown to $13,000,000.  In the midst of my reverie about Chateau Snowball, Fifth Third wrote back with modestly deflating news: there was no evidence that the stock hadn’t been redeemed. There was also no evidence that it had been, but after 90 years presumption appears to shift in the bank’s favor. (Who’d have guessed?)  

It looks like I better keep my day job.  (Which, happily enough, is an immensely fulfilling one.)

Longleaf Global and its brethren

Two bits of news lay behind this story.  First, Longleaf freakishly closed its new Longleaf Partners Global Fund (LLGFX) after just three weeks.  Given that Longleaf hadn’t launched a fund in 15 years, it seemed odd that this one was so poorly-planned that they’d need to immediately close the door.  

At around the same time, I received a cheerful note from Tom Pinto, a long-time correspondent of ours and vice president at Mount & Nadler. Mount & Nadler (presided over, these last 33 years, by the redoubtable Hedda Nadler) does public relations for mutual funds and other money management folks. They’ve arranged some really productive conversations (with, for example, David Winters and Bruce Berkowitz) over the years and I tend to take their notes seriously. This one celebrated an entirely remarkable achievement for Tweedy Browne Global Value (TBGVX):

Incredibly, when measured on a rolling 10-year basis since its inception through 11/30/12 using monthly returns, the fund is batting 1000, having outperformed its benchmark – MSCI EAFE — in 115 out of 115 possible 10-year holding periods over the last 19 plus years it has been in existence. It also outperformed its benchmark in 91% of the rolling five-year periods and 82% of the rolling three-year periods. 

That one note combined three of my favorite things: (1) consistency in performance, (2) Tweedy, Browne and (3) Hedda.

Why consistency? It helps investors fight their worst enemy: themselves.  Very streaky funds have very streaky investors, folks who buy and sell excessively and, in most cases, poorly.  Morningstar has documented a regrettably clear pattern of investors earning less –sometimes dramatically less – than their funds, because of their ill-time actions.  Steady funds tend to have steady investors; in Tweedy’s case, “investor returns” are close to and occasionally higher than the fund’s returns.

Why Tweedy? It’s one of those grand old firms – like Dodge & Cox and Northern – that started a century or more ago and that has been quietly serving “old wealth” for much of that time.  Tweedy, founded in 1920 as a brokerage, counts Benjamin Graham, Walter Schloss and Warren Buffett among its clients.  They’ve only got three funds (though one does come in two flavors: currency hedged and not) and they pour their own money into them.  The firm’s website notes:

 As of December 31, 2012, the current Managing Directors and retired principals and their families, as well as employees of Tweedy, Browne had more than $759.5 million in portfolios combined with or similar to client portfolios, including approximately $101.9 million in the Global Value Fund and $57.9 million in the Value Fund, $6.8 million in the Worldwide High Dividend Yield Value Fund and $3.7 million in the Global Value Fund II — Currency Unhedged.

Value (low risk, four stars) and Global Value (low risk, five stars) launched in 1993.  The one with the long name (low risk, five stars) launched 14 years later, in 2007.  Our profile of the fund, Tweedy Browne Worldwide High Dividend Yield Value (TBHDX), appeared as soon as it was launched.  At that point, Global Value was rated by Morningstar as a two-star fund. Nonetheless, I plowed in with the argument that it represented a compelling opportunity:

They are really good stock-pickers.  I know, I know: “gee, Dave, can’t you read?  Two blinkin’ stars.”  Three things to remember.  First, the validity of Morningstar’s peer ratings depend on the validity of their peer group assignment.  In the case of Global Value, they’re categorized as small-mid foreign value (which has been on something of a tear in recent years), despite the fact that 60% of their portfolio is in large cap stocks.

Second, much of the underperformance for Global Value is attributable to their currency hedging.

Third, they provide strong absolute returns even when they have weak relative ones.  In the case of Global Value they have churned out returns around 17-18% over the trailing three- and five-year periods.  Combine that with uniformly “low” Morningstar risk scores for both funds and you get an awfully compelling risk/return profile.

Bottom Line: there’s a lot to be said, especially in uncertain times, for picking cautious, experienced managers and giving them broad latitude.  Worldwide High Dividend Yield has both of those attributes and it’s likely to be a remarkably rewarding instrument for folks who like to sleep well at night.

Why Hedda? I’ve never had the pleasure of meeting Hedda in person, but our long phone conversations over the years make it clear that she’s smart, funny, and generous and has an incredible institutional memory.  When I think of Hedda, the picture that pops into mind is Edna Mode from The Incredibles, darling. 

The Observer’s specialty are new and small funds.  The problem in covering Tweedy is that the next new fund is apt to launch around about the time that you folks start receiving copies of the Observer by direct neural implants.  I had similar enthusiasm for other long-interval launches, including Dodge and Cox Global (“Let’s be blunt about this. If this fund fails, it’s pretty much time for us to admit that the efficient market folks are right and give up on active management.”) and Oakmark Global Select (“both of the managers are talented, experienced and disciplined. Investors willing to take the risk are getting access to a lot of talent and a unique vehicle”).

That led to the question: what happens when funds that never launch new funds, launch new funds?

With the help of the folks on the Observer’s discussion board and, most especially, Charles Boccadoro, we combed through hundreds of records and tracked down all of the long-interval launches that we could. “Long-interval launches” were those where a firm hadn’t launched in anew fund in 10 years or more.  (Dodge & Cox – with five fund launches in 81 years – was close enough, as was FMI with a launch after nine-and-a-fraction years.) We were able to identify 17 funds, either retail or nominally institutional but with low minimum shares, that qualified. 

We looked at two measures: how did they do, compared to their Morningstar peers, in their first full year (so, if they launched in October 2009, we looked at 2010) and how have they done since launch? 

While this isn’t a sure thing, there are good explanations for the success.  At base, these are firms that are not responding to market pressures and that have extremely coherent disciplines.  The fact that they choose to launch after a decade or more speaks to a combination of factors: they see something important and they’re willing to put their reputation on the line.  Those are powerful motivators driving highly talented folks.

What might be the next funds to track?  Two come to mind.  Longleaf Global launched 15 years after Longleaf International (LLINX) and would warrant serious consideration when it reopens.  And BBH Global Core Select will be opening in the next month, 15 years after BBH Core Select (BBTRX and BBTEX).  Core Select has been wildly successful and has just closed to new investors. Global Core Select will use the same team and the same strategy. 

(Thanks to my collaborators on this piece: Mike M, Andrei, Charles and MourningStars.)

The Phrase, “Oh, that can’t be good” comes to mind

I read a lot of fund reports – annual, semi-annual and monthly.  I read most of them to find up what’s going on with the fund.  I read a few because I want to find up what’s going on with the world.  One of the managers whose opinion I take seriously is Steven Romick, of FPA Crescent (FPACX). 

They wanted to make two points. One: you were exactly right to notice that one paragraph in the Annual Report. It was, they report, written with exceeding care and intention. They believe that it warrants re-reading, perhaps several times. For those who have not read the passage in question:

Opportunity: When thinking about closing, we also think about the investing environment —both the current opportunity set and our expectations for future opportunities. Currently, we find limited prospects. However, we believe the future opportunity set will be substantial. As we have oft discussed, we are managing capital in the face of Central Bankers’ “grand experiment” that we do not believe will end well, fomenting volatility and creating opportunity. We continue to maintain a more defensive posture until the fallout. Though underperformance might be the price we pay in the interim should the market continue to rise, we believe in focusing on the preservation of capital before considering the return on it. The imbalances that we see, coupled with the current positioning of our Fund, give us confidence that over the long term, we will be able to invest our increased asset base in compelling absolute value opportunities.

Fund flows: We are sensitive to the negative impact that substantial asset flows (in or out) can have on the management and performance of a portfolio. At present, asset flows are not material relative to the size of the Fund, so we believe that the portfolio is not harmed. However, while members of the Investment Committee will continue to be available to existing clients, we have restricted discussions with new relationships so that our attention can be on investment management rather than asset gathering.

For now, we are satisfied with the team’s capabilities, the Fund’s positioning, and the impact of asset flows. As fellow shareholders, should anything cause us to doubt the likelihood of meeting our stated objectives we will close the Fund as we did before, and/or return capital to our shareholders.

What might be the sound bites in that paragraph? “We think about future opportunities. They will be substantial. For now we’ll focus on the preservation of capital. Soon enough, there will be billions of dollars’ worth of compelling absolute value opportunities.” In the interim, they know that they’re both growing and underperforming. They’ve cut off talk with potential new clients to limit the first and are talking with the rest of us so that we understand the second.

Point two: they’ve closed Crescent before. They’ll do it again if they don’t anticipate the opportunity to find good uses for new cash.

Artisan goes public.  Now what?

Artisan Partners are one on my favorite investment management firms.  Their policies are consistently shareholder friendly, their management teams are stable and disciplined, and their funds are consistently top-notch.

And now you’ll be able to own a piece of the action.  Artisan will offer shares to the public, with the proceeds used to resolve some debt and make it possible for some of the younger partners to gain an equity stake in the firm.  Three questions arise:

• Is this good for the investors in Artisan’s funds?
• Should you consider buying the stock?
• And would it all work a bit better with Godiva chocolate?

What happens now with the Artisan funds?

The concern is that Artisan is gaining a fiduciary responsibility to a large set of outside shareholders.   Their obligation to those shareholders is to increase Artisan’s earnings which, with other fund companies, has translated to (1) gather assets and (2) gather attention.  There’s only been one academic study on the difference in performance between publicly-owned and privately-held fund companies, and that study looked only at Canadian firms.  That study found:

… publicly-traded management companies invest in riskier assets and charge higher management fees relative to the funds managed by private management companies. At the same time, however, the risk-adjusted returns of the mutual funds managed by publicly-traded management companies do not appear to outperform those of the mutual funds managed by private management companies. This finding is consistent with both the risk reduction and agency cost arguments that have been made in the literature.  (M K Berkowitz, Ownership, Risk and Performance of Mutual Fund Management Companies, 2001)

The only other serious investigation that I know of was undertaken by Bill Bernstein, and reported in his book The Investor’s Manifesto.  Bernstein’s opinion of the financial services industry in general and of actively-managed funds in particular is akin to his opinions on astrology and reading goat entrails.  Think I’m kidding?  Here’s Bill:

The prudent investor treats almost the entirety of the financial industrial landscape as an urban combat zone. This means any stock broker or full-service brokerage firm, any newsletter, any advisor who purchases individual securities, any hedge fund. Most mutual fund companies spew more toxic waste into the investment environment than a third-world refinery. Most financial advisors cannot invest their way out a paper bag. Who can you trust? Almost no one.

Bill looked at the performance of 18 fund companies, five of which were not publicly-traded.  In particular, he looked at the average star ratings for their funds (admittedly an imperfect measure, but among the best we’ve got).  The privately-held firms placed 1st, 2nd, 3rd, 6th and 9^th in performance.  The lowest positions were all public firms with a record of peddling bloated, undistinguished funds to an indolent public.  His recommendation is categorical: “Do not invest with any mutual fund family that is owned by a publicly traded parent company.”

While the conflicts between the interests of the firm’s stockholders and the funds’ shareholders are real and serious, it’s also true that a number of public firms – the Affiliated Managers Group and T. Rowe Price, notably – have continued offered solid funds and reasonable prices.  While it’s possible that Artisan will suddenly veer off the path that’s made them so admirable, that’s neither necessary nor immediately probable.

So, should you buy the stock instead of the funds?

In investor mythology, the fund companies’ stock always seems the better bet than the fund company’s funds.  That seems, broadly speaking, true.  Fund company stock has broadly outperformed the stock market and the financial sector stocks over time.  I’ve gathered a listing of all of the publicly-traded mutual fund companies that I can identify, excluding only those instances where the funds are a tiny slice of a huge financial empire.

Here’s the performance of the companies’ stock, for various periods through February, 2013.

Several of the largest fund companies – Capital Group Companies, Fidelity Management & Research, and Vanguard – are all private.  Vanguard alone is owned by its fund shareholders.

Several high visibility firms – Janus and U.S. Global Investors – have had miserable performance and several others are extremely volatile.  The chart for Hennessy Advisors, for example, shows a 90% decline in value during the financial crisis, flat performance for three years, then a freakish 90% rise in the past three months. 

On whole, you’d have to conclude that “buy the company, not the funds” is no path to easy money.

Have They Even Considered Using Godiva as a Sub-advisor? 

Artisan’s upcoming IPO has been priced at $27-29 a share, which would give Artisan a fully-diluted market value of about $1.8 billion.  That’s roughly the same as the market capitalizations for Cheesecake Factory, Inc. (CAKE) or for Janus Capital Group (JNS).  

So, for $1.8 billion you could buy all of Artisan or at least all of the publicly-available stock for CAKE or JNS.  The question for all of you with $1.8 billion burning a hole in your pockets is “which one?”  While an efficient market investor might shrug and suggest a screening process that begins with the words “Eenie” and “Meenie,” we know that you depend on us for better.

Herewith, our comprehensive comparison of Artisan, Cheesecake Factory and Janus:

Jeez, that’s a tough call.  Brilliant management or chocolate?  Brilliant management or chocolate?  Oh heck, who am I kidding: 

USA Today launches a new portfolio tracker

In February, USA Today announced a partnership with SigFig (whose logo is a living piggy bank) to create a new and powerful portfolio tracker.  Always game for a new experience, I signed up (it’s free, which helps).  I allowed it to import my Scottrade portfolio and then to run an analysis on it. 

Two pieces of good news.  First, it made one sensible fund recommendation: that I sell Northern Global Tactical Asset Allocation (BBALX) and replace it with Buffalo Flexible Income (BUFBX).  BBALX is a fund of index funds which represents a sort of “best ideas” approach from Northern’s investment policy committee.  It has low expenses and I like the fact that it’s using index funds, which decreases complexity and increases predictability.  That said, the Buffalo fund is very solid and has certainly outperformed Northern over the past several years.  A FundAlarm profile of the fund, then called Buffalo Balanced, concluded:

This is clearly not a mild-mannered fund in the mold of Mairs & Power or Bridgeway.  It takes more risks but is managed by an immensely experienced professional who has a pretty clearly-defined discipline.  That has paid off, and likely will continue to pay off.

So, that’s sensible. 

Second bit of good news, the outputs are pretty:

Now the bad news:  the recommendations completely missed the problem.  Scottrade holds five funds for me.  They are RiverPark Short-Term High Yield (RPHYX), one of two cash-management accounts, Northern and three emerging markets funds.  Any reasonable analyst would have said: “Snowball, what are you thinking?  You’ve got over two-thirds of your money in the emerging markets, virtually no U.S. stocks and a slug of very odd bonds.  This is wrong, wrong, wrong!” 

None of which USAToday/SigFig noticed. They were unable even to categorize 40% of the portfolio, saw only 2% cash (it’s actually about 10%), saw no dividends (Morningstar calculates it at 2.4%) and had no apparent concern about my wild asset allocation skew.

Bottom line: look if you like, but look very skeptically at these outputs.  This system might work for a very conventional portfolio, but even that isn’t yet proven.

Fidelity spirals (and not upward)

Investors pulled nearly $36 billion from Fidelity’s funds in 2012.  That’s from Fido’s recently-released 2012 annual report.  Their once-vaunted stock funds (a) had a really strong year in terms of performance and (b) bled $24 billion in assets regardless (Fidelity Sees More Fund Outflows, 02/15/13).  The company’s operating income of $2.3 billion fell 29% compared with 2011. 

The most troubling sign of Fidelity’s long-term malaise comes from a January announcement.  Reuters reported that Fido’s target-date retirement funds were steadily losing market share to Vanguard.  As a result, they needed to act to strengthen them. 

Fidelity Investments’ target-date funds will start 2013 with more stock-picking firepower, as star money managers Will Danoff and Joel Tillinghast pick up new assignments to protect a No. 1 position under fire from rival Vanguard Group.

Why is that bad?  Because Tillinghast and Danoff seem to be all that they have left.  Danoff has been running Contrafund since 1990 and was moved in Fidelity Advisor New Insights in 2003 to beef up the Fidelity Advisor funds and now Fidelity Series Opportunistic Insights in 2012 to beef up the funds used by the target-date series.  Even before the first dollar goes to Opportunistic Insights, Danoff was managing $107 billion in equity investments.  Tillinghast has been running Low-Priced Stock, a $35 billion former small cap fund, since 1989 and now adds Fidelity Series Intrinsic Opportunities Fund.  This feels a lot like a major league ball team staking their playoff chances on two 39-year-old power hitters; the old guys have a world of talent but you have to ask, what’s happened to the farm system?

One more slap at Morningstar’s new ratings

There was a long, healthy, and not altogether negative discussion of Morningstar’s analyst ratings on the Observer’s discussion board.  For those trying to think through the weight to give a “Gold” analyst rating, it’s a really worthwhile use of your time.  Three concerns emerge:

1. There may be a positivity bias in the ratings.  It’s clear that the ratings are vastly skewed, so that negative assessments are few and far between.  Some writers speculate that Morningstar’s corporate interests (drawing advertising, for example) might create pressure in that direction.
2. There’s no clear relationship between the five pillars and the ultimate rating.  Morningstar’s analysts look at five factors (people, price, process, parent, performance – side note, be skeptical of any system designed for alliteration) and assign a positive, neutral or negative judgment to each. Some writers express bewilderment that one fund with a single “positive” might be silver while another with two positives might be “neutral.”
3. There’s no evidence, yet, that the ratings have predictive validity.  The anonymous author of the Wall Street Rant blog produced a fairly close look at the 2012 performance of the newly-rated funds.  Here’s the visual summary of Ranter’s research:

In short, “Not much really stands out after the first year. While there was a slight positive result for Gold and Silver rated funds, Neutral rated funds did even better.”  The complete analysis is in a post entitled Performance of Morningstar’s New Analyst Ratings For Mutual Funds in 2012 (02/17/2013)

My own view is in accord with what Morningstar says about their ratings (use them as one element of your due diligence in assessing a fund) but, in practice, Morningstar’s functional monopoly in the fund ratings business means that these function as marketing tools far more than as analytic ones.

Five-star and Gold is surely a lot better than one-star and negative, but it’s not nearly as good as a careful, time-consuming inquiry into what the manager does, what the risks look like, and whether this makes even marginal sense in your own portfolio.

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 #2: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX)

Mr. Harvey manages the Poplar Forest Partners (PFPFX and IPFPX), which launched on December 31, 2009.  For 16 years, Dale co-managed several of the flagship American Funds including Investment Company of America (AIVSX), Washington Mutual (AWSHX) and American Mutual (AMRMX).  Some managers start their own firms in order to get rich.  Others because asset bloat was making them crazy.  A passage from an internal survey that Dale completed, quoted by Morningstar, gives you some idea of his motivation:

Counselor Dale Harvey remarked that Capital should “[c]lose all the funds. Don’t just close the biggest or fastest growing. Doing that would simply shift the burden on to other funds. Keep them shut until we figure out the new unit structure and relieve the pressure of PCs managing $20 billion.”

Many of his first investors were former colleagues at the American Funds.

Dale offers these 152 words on why folks should check in:

This is a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.  The last was the late Howard Schow, who left to launch the Primecap Funds.

The real reason to leave is about size, the funds just kept taking in money.  There came a point where it was a real impediment to performance.  That will never be the case at Poplar Forest.  Everyone here invests heavily in our funds, so our interests are directly aligned with yours.

From a process perspective, we’re defined by a contrarian value perspective with a long-term time horizon.  This is a high conviction portfolio with no second choices or fillers.  Because we’re contrarian, we’ll sometimes be out of step with the market as we were in 2011.  But we’ve always known that the best time to invest in a four- or five-star fund is when it only has two stars.

The fund’s minimum initial investment is $25,000 for retail shares, reduced to $5,000 for IRAs. They maintain a minimal website for the fund and a substantially more informative site for their investment firm, Poplar Forest LLC. Dale’s most-recent discussion of the fund appears in his 2012 Annual Review. 

Conference Call Highlights

On February 19^th, about 50 people phoned-in to listen to our conversation with Andrew Foster, manager of Seafarer Overseas Growth and Income Fund (SFGIX and SIGIX).   The fund has an exceptional first year: it gathered $35 million in asset and returned 18% while the MSCI emerging market index made 3.8%. The fund has about 70% of its assets in Asia, with the rest pretty much evenly split between Latin America and Emerging Europe.   Their growth has allowed them to institute two sets of expense ratio reductions, one formal and one voluntary.

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

The SFGIX 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.

Among the highlights of the call, for me:

1. China has changed.   Andrew offered a rich discussion about his decision to launch the fund. The short version: early in his career, he concluded that emergent China was “the world’s most under-rated opportunity” and he really wanted to be there. By late 2009, he noticed that China was structurally slowing. That is, it was slow because of features that had no “easy or obvious” solution, rather than just slowly as part of a cycle. He concluded that “China will never be the same.” Long reflection and investigation led him to begin focusing on other markets, many of which were new to him, that had many of the same characteristics that made China exciting and profitable a decade earlier. Given Matthews’ exclusive and principled focus on Asia, he concluded that the only way to pursue those opportunities was to leave Matthews and launch Seafarer.
2. It’s time to be a bit cautious. As markets have become a bit stretched – prices are up 30% since the recent trough but fundamentals have not much changed – he’s moved at the margins from smaller names to larger, steadier firms.
3. There are still better opportunities in equities than fixed income; hence he’s about 90% in equities.
4. Income has important roles to play in his portfolio.  (1) It serves as a check on the quality of a firm’s business model. At base, you can’t pay dividends if you’re not generating substantial, sustained free cash flow and generating that flow is a sign of a healthy business. (2) It serves as a common metric across various markets, each of which has its own accounting schemes and regimes. (3) It provides as least a bit of a buffer in rough markets. Andrew likened it to a sea anchor, which won’t immediately stop a ship caught in a gale but will slow it, steady it and eventually stop it.

Bottom-line: the valuations on emerging equities look good if you’ve got a three-to-five year time horizon, fixed-income globally strikes him as stretched, he expects to remain fully invested, reasonably cautious and reasonably concentrated.

Conference Call Upcoming: Cook and Bynum, March 5^th

Cook and Bynum (COBYX) is an intriguing fund.  COBYX holds only seven holdings and a 33% cash stake.  Since two-thirds of the fund is in the stock market, you might reasonably expect to harvest two-thirds of the market’s gains but suffer through just two-thirds of its volatility.  Cook and Bynum has done far better.  Since launch they’ve captured nearly 100% of the market’s gains with only one third of its volatility.  In the past twelve months, Morningstar estimates that they’ve captured just 7% of the market’s downside. 

We’ll have a chance to hear from Richard and Dowe (Cook and Bynum, respectively) about their approach to high-conviction investing and their amazing research efforts.  To help facilitate the discussion, they prepared a short document that walks through their strategy with you. You can download that document here.

Our conference call will be Tuesday, March 5, 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. 

This will be the first of three conversations with distinguished managers who defy that trend through their commitment to a singular discipline: buy only the best.  In the months ahead, we plan to talk with David Rolfe of RiverPark/Wedgewood Fund (RWGFX) and Stephen Dodson of Bretton Fund (BRTNX).

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:

Seafarer Overseas Growth & Income (SFGIX/SIGIX): The evidence is clear and consistent.  It’s not just different.  It’s better.

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 May 2013. We found a dozen funds in the pipeline, notably:

Grandeur Peak Emerging Markets Opportunities Fund will seek long-term growth of capital by investing in small and micro-cap companies domiciled in emerging or frontier markets.  They’re willing to consider common stock, preferred and convertible shares.   The most reassuring thing about it is the Grandeur Peak’s founders, Robert Gardiner & Blake Walker, are running the fund and have been successfully navigating these waters since their days at Wasatch.  The minimum initial investment is $2,000, reduced to $1,000 for accounts with an automatic investing plan and $100 for UGMA/UTMA or a Coverdell Education Savings Accounts.  Expenses not yet set.

Matthews Emerging Asia Fund will pursue long-term capital appreciation by investing in common and preferred stock and convertible securities of companies that have “substantial ties” to the countries of Asia, except Japan.  Under normal conditions, you might expect to see companies from Bangladesh, Cambodia, China, India, Indonesia, Laos, Malaysia, Mongolia, Myanmar, Pakistan, Papua New Guinea, Philippines, Sri Lanka, Thailand and Vietnam.  They’ll run an all-cap portfolio which might invest in micro-cap stocks.   Taizo Ishida, who serves on the management team of two other funds (Growth and Japan), will be in charge. The minimum initial investment in the fund is $2500, reduced to $500 for IRAs and Coverdell accounts. Expenses for both Investor and Institutional shares are capped at 1.90%.

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 31 fund manager changes, including the blockbuster departure of Kris Jenner from T. Rowe Price Health Sciences (PRHSX) and the departure, after nearly 20 years, of Patrick Rogers from Gateway Fund (GATEX).  

There was also a change on a slew of Vanguard funds, though I see no explanation at Vanguard for most of them.  The affected funds are a dozen Target Retirement Date funds plus

• Diversified Equity
• Extended Duration Treasury Index
• FTSE All-World ex-US Small Index
• Global ex-US Real  Estate
• Long-Term Bond Index
• Long-Term Government Bond Index
• Short-Term Bond Index
• STAR
• Tax-Managed Growth & Income
• Tax-Managed International

Vanguard did note that five senior executives were being moved around (including to and from Australia) and, at the end of that announcement, nonchalantly mentioned that “Along with these leadership changes, 15 equity funds, 11 fixed income funds, two balanced funds, and Vanguard Target Retirement Funds will have new portfolio managers rotate onto their teams.”  The folks being moved did actually manage the funds affected so the cause is undetermined.

Snowball and the fine art of Jaffe-casting

Despite the suspicion that I have a face made for radio but a voice made for print, Chuck Jaffe invited me to appear as a guest on the February 28 broadcast of MoneyLife with Chuck Jaffe.  (Ted tells me that I appear at the 34:10 mark and that you can just move the slider there if you’d like.) We chatted amiably for a bit under 20 minutes, about what to look for and what to avoid in the fund world.  I ended up doing capsule critiques of five funds that his listeners had questions about:

WisdomTree Emerging Markets Equity Income (DDEM) for Rick in York, Pa.  Certainly more attractive than the Vanguard index, despite high expenses.   High dividend-yield stocks.  Broader market cap diversification, lower beta – 0.8

Fidelity Total Emerging Markets (FTEMX), also for Rick.  I own it.  Why?  Not because it’s good but because it looks better than the alternatives in my 403(b).  Broad and deep management team but, frankly, First Trust/Aberdeen Emerging Opportunity (FEO) is vastly better. 

Fidelity Emerging Markets (FEMKX) for Jim in Princeton, NJ.  Good news, Jim.  They don’t charge much.  Bad news: they haven’t really earned what they do charge.  Good news: they got a new manager in October.  Sammy Simnegar.  Bad news: he’s not been very consistent, trades a lot, and is likely to tank tax efficiency in repositioning.  Seafarer Overseas Growth & Income (SFGIX) is vastly better.

Nile Pan Africa (NAFAX) for Bruce in Easton, Pa.  This fund will be getting its first Morningstar star rating this year.  Ignore it!  It’s a narrow fund being compared to globally-diversified ones.  75% of its money is in two countries, Nigeria and South Africa.  If this were called the Nile Nigeria and South Africa Fund, would you even glance at it?

EP Asia Small Companies (EPASX), also for Bruce.  Two problems, putting aside the question of whether you want to be investing in small Asian companies.  First, the manager’s record at his China fund is mediocre.  Second, he doesn’t actually seem to be investing in small companies.  Morningstar places them at just 10% of the portfolio.  I’d be more prone to trust Matthews.

I was saddened to learn that Chuck has lost the sponsor for his show.    His listenership is large, engaged and growing.  And his expenses are really pretty modest (uhhh … rather more than the Observer’s, rather less than the Pennysaver paper that keeps getting tossed on your porch).   If any of you want to become even a part-sponsor of a fairly high-visibility show/podcast, you should drop Chuck a line. Heck, he could even help you launch your own line of podcasts.

Briefly Noted ….

Kris Jenner’s curious departure

Kris Jenner, long-time manager of T. Rowe Price Health Sciences (PRHSX) left rather abruptly on February 15^th.  The fund carries a Gold rating and five stars from Morningstar (but see the discussion, above, about what that might mean) and Jenner was a finalist for Morningstar’s Domestic Manager of the Year award in 2011.  A doctor by training, Price long touted Jenner’s special expertise as one source of the fund’s competitive advantage.

So, what’s up?  No one who’s talking knows, and no one who knows is talking. The best coverage of his departure comes from Bloomberg, which makes four notes that many others skip:

1. Jenner left with two of his (presumably) top analysts from his former team of eight,
2. he reached out to lots of his contacts in the industry after he left,
3. he’s being represented by a public relations firms, Burns McClennan, Inc. and
4. he’s being coy as part of his p.r. campaign: “We cannot share our plans with you at this time, in part due to regulatory and reporting requirements.”

Price seems a bit offended at the breach of collegiality.  “They are leaving to pursue other opportunities,” Price spokesman Brian Lewbart told The Baltimore Sun. “They didn’t share what they are.”

My guess would be that some combination of the desire to be fabulously rich and the desire to facilitate medical innovation might well lead him to found something like a biotech venture capital firm or business development company.  Regardless, it seems certain that the mutual fund world has seen the last of one of its brighter stars.

FPA announces conversion to a pure no-load fund family

Effective April 1, 2013, all of the FPA Funds will be available as no-load funds.  This change will affect FPA Capital (FPPTX), New Income (FPNIX), Paramount (FPRAX) and Perennial Funds (FPPFX), since these funds are currently structured as front-load mutual funds. FPA Capital Fund will remain closed to new investors.  This also means that shareholders of FPA Crescent Fund (FPACX) and International Value Fund (FPIVX) will now be able to exchange into the other FPA Funds without incurring a sales charge.

And apologies to FPA: in the first version of our February issue, we misidentified the role Victor Liu will play on FPA’s International Value team.  Mr. Liu, who spent eight years with Causeway Capital Management as Vice President and Research Analyst, will serve in a similar capacity as FPA and will report to Pierre Py, portfolio manager of FPA International Value Fund [FPIVX].

Morningstar tracks down experienced managers in new funds

Morningstar recently “gassed up the Premium Fund Screener tool and set it to find funds incepted since 2010 that have Analyst Ratings of Gold, Silver, or Bronze” (Young Funds, Old Pros, 02/20/2013).  Setting aside the unfortunate notion of “gassing up” one’s software and the voguish “incepted,” here are editor Adam Zoll’s picks for new funds headed by highly experienced managers.

Royce Special Equity Multi-Cap (RSMCX), managed by Charlie Dreifus.  Dreifus has a great long-term record with the small cap Royce Special Equity fund.  This would be an all-cap application of that same discipline.  I’ll note, in passing, the Special hasn’t been quite as special in the past decade as in the one preceding it and Dreifus, in his mid60s, is closer to the conclusion of his career than its launch.    

PIMCO Inflation Response Multi-Asset (PZRMX) , managed by  Mihir Worah who also manages PIMCO Real Return (PRTNX), Commodity Real Return Strategy (PCRAX) and Real Estate Real Return Strategy (PETAX).  The fund combines five inflation-linked assets (TIPS, commodities, emerging market currencies, REITs and gold) to preserve purchasing power in times of rising inflation.  PIMCO’s reputation is such that after six months of meager performance, the fund is moving toward a quarter billion in assets. 

Ariel Discovery (ARDFX), managed by David Maley.  As I’ve noted before, Morningstar really likes the Ariel family of funds.  Maley has no prior experience in managing a mutual fund, though he has been managing the Ariel Micro-Cap Value separate accounts for a decade.  So far ARDFX has pretty consistently trailed its small-value peer group as well as most of the micro-cap funds (Aegis, Bridgeway, Wasatch) that I follow.

Rebalancing matters. 

In investigating the closure of Vanguard Wellington, I came across an interesting argument that the simple act of annual rebalancing can substantially boost returns.  It’s reflected in the difference in the first two columns.  The first column is what you’d have earned with a 65/35 portfolio purchased in 2002 and never rebalanced.  Column 2 shows the effect of rebalancing.  (Column 3 is the ad for the mostly-closed Wellington fund.) 

How big is the difference?  A $10,000 investment in 2002, split 65/35 and never again touched, would have grown to $18,500.  A rebalanced portfolio, which would have triggered some additional taxes unless it was in an IRA, would end a bit over $19,000.  Not bad for 10 minutes a year.

On a completely unrelated note, here’s one really striking fund in registration: NYSE Arca U.S. Equity Synthetic Reverse Convertible Index Fund?  Really? Two questions: (1) what on earth is that?  And (2) why does it strike anyone as “just what the doctor ordered”? 

Small Wins for Investors

Vanguard has dropped the expense ratios on three funds, while boosting them on two. 

Not much else to celebrate this month.

Closings

Fidelity closed Fidelity Small Cap Value Fund (FCPVX) on March 1, 2013. This is the second of Charles L. Myers’ funds to close this year.  Just one month ago they closed Fidelity Small Cap Discovery (FSCRX).   Between them they have ten stars and $8 billion in assets.

Huber Small Cap Value (HUSIX and HUSEX) is getting close to closing.  Huber is about the best small cap value fund still open and available to retail investors.  Its returns are in the top 1% of its peer group for the past one, three and five years.  It has a five-star rating from Morningstar.  It’s a Lipper Leader for Total Returns, Consistency of Returns and Tax Efficiency. 

“Effectively managing capacity of our strategies is one of the core tenets at Huber Capital Management, and we believe it is important in both small and large cap. Our small cap strategy has a capacity of approximately $1 billion in assets and our large cap/equity income strategy has a capacity of between $10 – $15 billion. As of 2/22/13, small cap strategy assets were over $810 mm and large cap/equity income strategy assets were over $1 billion. We are committed to closing our strategies in such a way as to maintain our ability to effectuate our process on behalf of investors who have been with us the longest.”

Vanguard has partially closed to giant funds.  The $68 billion Vanguard Wellington Fund (VWELX, VWENX) and the $39 billion Vanguard Intermediate-Term Tax-Exempt Fund (VWITX) closed to new institutional and advisor accounts on February 28^th.  Reportedly individual investors will be able to buy-in, but I wasn’t able to confirm that with Vanguard. 

RS Global Natural Resources Fund (RSNRX) will close on March 15, 2013.  It’s been consistently near the top of the performance charts, has probably improved with age and is dragging about $4.5 billion around.

Old Wine in New Bottles

Effective February 20, 2013, Frontegra SAM Global Equity Fund (FSGLX) became Frontegra RobecoSAM Global Equity Fund.  That’s because the sub-adviser of this undistinguished institutional fund went from being SAM to RobecoSAM USA.

PL Growth LT Fund has been renamed PL Growth Fund and MFS took over as the sub-advisor.  PL is Pacific Life and these are likely sold through the firm’s agents.

A peculiarly odd announcement from the folks at New Path Tactical Allocation Fund (GTAAX): “During the period from February 28, 2013 to April 29, 2013, the investment objective of Fund will be to seek capital appreciation and income.”  With turnover well north of 400% and returns well south of “awful,” there are more sensible things for New Path to seek than a revised objective.

The board of the Touchstone funds apparently had a rollicking meeting in February, where they approved nine major changes.  They approved reorganizing Touchstone Focused Equity Fund into the Touchstone Focused Fund.  Touchstone Micro Cap Value Fund will, at the end of April, become Touchstone Small Cap Growth Fund.  Sensibly, the strategy changes from investing in micro-caps to investing in small caps.  Oddly, the objective changes from “capital appreciation” to “long-term capital growth.”   The difference is, to an outsider, indiscernible.

Effective May 1, 2013, Western Asset High Income Fund (SHIAX) will be renamed Western Asset Short Duration High Income Fund.  The fund’s mandate will be changed to allow investing in shorter duration high yield securities as well as adjustable-rate bank loans, among others.  The sales load has been reduced to 2.25% and, in May, the expense ratio will also drop.

Off to the Dustbin of History

Guggenheim, after growing briskly through acquisitions, seems to be cleaning out some clutter.  Between the end of March and beginning of May, the following funds are slated for execution:

• Guggenheim Large Cap Concentrated Growth  (GIQIX)
• Small Cap Growth (SSCAX)
• Large Cap Value Institutional  (SLCIX)
• Global Managed Futures Strategy  (GISQX)
• All-Asset Aggressive Strategy  (RYGGX)
• All-Asset Moderate Strategy  (RYMOX)
• All-Asset Conservative Strategy  (RYEOX)

Guggenheim is also bumping off nine of their ETFs.  They are the  ABC High Dividend, MSCI EAFE Equal Weight,  S&P MidCap 400 Equal Weight,  S&P SmallCap 600 Equal Weight,  Airline,  2x S&P 500, Inverse 2x S&P 500, Wilshire 5000 Total Market, and Wilshire 4500 Completion ETFs.

Legg Mason Capital Management All Cap (SPAAX) will merge with ClearBridge Large Cap Value (SINAX) in mid-July.  Good news there, since the ClearBridge fund is a lot cheaper.

Shelton California Insured Intermediate (CATFX) is expected to cease operations, liquidate its assets and distribute the proceeds by mid-March. The fund evolved from “mediocre” to “bad” over the years and had only $4 million in assets.

The Board of Trustees of Sterling Capital approved the liquidation of the $7 million Sterling Capital Strategic Allocation Equity (BCAAX) at the end of April.

Back to the aforementioned Touchstone board meeting.  The board approved one merger and a series of executions.  The merge occurs when Touchstone Short Duration Fixed Income (TSDYX), a no-load, will merge into Touchstone Ultra Short Duration Fixed Income (TSDAX), a low-load one.  The dead walking are:

• Touchstone Global Equity (TGEAX)
• Touchstone Large Cap Relative Value (TRVAX)
• Touchstone Market Neutral Equity  (TSEAX) – more “reverse” than “neutral”
• Touchstone International Equity  (TIEAX)
• Touchstone Emerging Growth  (TGFAX)
• Touchstone U.S. Long/Short (TUSAX).  This used to be the Old Mutual Analytic U.S. Long/Short which, prior to 2006, didn’t short stocks.

The “walking” part ends on or about March 26, 2013.

In Closing . . .

Here’s an unexpectedly important announcement: we are not spam!  You can tell because spam is pink, glisteny goodness.  We are not.  I mention that because there’s a good chance that if you signed up to be notified about our monthly update or our conference calls, and haven’t been receiving our mail, it’s because we’ve been trapped by your spam filter.  Please check your spam folder.  If you see us there, just click on the “not spam” icon and things will improve.

It’s also the case that if you want to stop receiving our monthly emails, you should use the “unsubscribe” button and we’ll go away.  If you click on the “that’s spam” button instead (two or three people a month do that, for reasons unclear to me), it makes Mail Chimp anxious.  Please don’t.

In April, the Observer celebrates its second anniversary.  It wouldn’t be worthwhile without your readership and your thoughtful feedback.  And it wouldn’t be possible without your support, either directly or by using our Amazon link.  The Amazon system is amazingly simple and painless.  If you set our link as your default bookmark for Amazon (or, as I do, use Amazon as your homepage), the Observer receives a rebate from Amazon equivalent to 6% or more of the amount of your purchase.  It doesn’t change your cost by a penny since the money comes from Amazon’s marketing budget.  While 6% of the $11 you’ll pay for Bill Bernstein’s The Investor’s Manifesto (or 6% of a pound of coffee beans or Little League bat) seems trivial, it adds up to about 75% of our income.  Thanks for both!

In April, we’re going to look at closed-end s (CEFs) as an alternative to “regular” (or open-ended) mutual s and ETFs.  We’ve had a chance to talk with some folks whose professional work centered on trading CEFs.  We’ll talk through Morningstar’s recent CEF studies, a bit of what the academic literature says and the insights of the folks we’ve interviewed, and we’ll provide a couple intriguing possibilities.   That will be on top of – not in place of – our regular features.

See you then!

Yep, January’s been good.  Scary-good.  There are several dozen funds that clocked double-digit gains, including several scary-bad ones (Birmiwal Oasis?  Legg Mason Capital Management Opportunity C?) but no great funds.  So if your portfolio is up six or seven or eight percent so far in 2013, smile and then listen to Han Solo’s call: “Great, kid. Don’t get cocky.”  If, like mine, yours is up just two or three percent so far in 2013, smile anyway and say, “you know, Bill, Dan, Jeremy and I were discussing that very issue over coffee last week.  I mentioned your portfolio and two of the three just turned pale.  The other one snickered and texted something to his trading desk.”

American Funds: The Past Ten Years

In October we launched “The Last Ten,” a monthly series, running between then and February, looking at the strategies and funds launched by the Big Five fund companies (Fido, Vanguard, T Rowe, American and PIMCO) in the last decade.

Here are our findings so far:

Fidelity, once fabled for the predictable success of its new fund launches, has created no compelling new investment option in a decade.  

T. Rowe Price continues to deliver on its promises.  Investing with Price is the equivalent of putting a strong singles-hitter on a baseball team; it’s a bet that you’ll win with consistency and effort, rather than the occasional spectacular play.

PIMCO has utterly crushed the competition, both in the thoughtfulness of their portfolios and in their performance.

Vanguard’s launches in the past decade are mostly undistinguished, in the sense that they incorporate neither unusual combinations of assets (no “emerging markets balanced” or “global infrastructure” here) nor innovative responses to changing market conditions (as with “real return” or “inflation-tuned” ones).  Nonetheless, nearly two-thirds of Vanguard’s new funds earned four or five star ratings from Morningstar, reflecting the compounding advantage of Vanguard’s commitment to low costs and low turnover.

We’ve saved the most curious, and most disappointing, for last. American Funds has always been a sort of benevolent behemoth. They’re old (1931) and massive. They manage more than $900 billion in investments and over 50 million shareholder accounts, with $300 billion in non-U.S. assets. 

It’s hard to know quite what to make of American. On the one hand, they’re an asset-sucking machine.  They have 34 funds over $1 billion in assets, 19 funds with over $10 billion each in assets, and two over $100 billion.  In order to maximize their take, each fund is sold in 16 – 18 separate packages. 

By way of example, American Funds American Balanced is sold in 18 packages and has 18 ticker symbols: six flavors of 529-plan funds, six flavors of retirement plan accounts, the F-1 and F-2 accounts, the garden-variety A, B and C and a load-waived possibility.  Which plan you qualify for makes a huge difference. The five-year record for American Balanced R5 places it in the top 10% of its peer group but American Balanced 529B only makes it into the top 40%. 

On the other hand, they’re very conservative and generally quite successful. Every American fund is also a fund-of-funds; it has multiple managers … uhh, “portfolio counselors,” each of whom manages just one sleeve of the total portfolio.  In general, costs are below average to low, risk scores are below average to low and their Morningstar ratings are way above average.

In the past decade, the firm has launched almost no new funds and has made no evident innovations in strategy or product.

It’s The Firm that Time Forgot 

Over those 10 years, American Funds launched 31 funds.  Sort of.  In reality, they repackaged existing American Funds into 10 new target-date funds.  Then they repackaged existing American Funds into 16 new funds for college savings plans.  After that, they repackaged existing American Funds into new tax-advantaged bond funds.  In the final analysis, their new fund launches are three niche bond funds: two muni and one short-term. 

A huge firm. Ten tumultuous years.  And they manage to image three pedestrian bond funds, none of which they execute with any particular panache. 

Not to sound dire, but phrases like “rearranging the deck chairs” and “The Titanic was huge and famous, too” come unbidden to mind.

Morningstar, Part One: Rating the Rater

Morningstar’s “analyst ratings” have come in for a fair amount of criticism lately.  Chuck Jaffe notes that, like the stock analysts of yore, Morningstar seems never to have met a fund that it doesn’t like. “The problem,” Jaffe writes, “is the firm’s analysts like nearly two-thirds of the funds they review, while just 5% of the rated funds get negative marks.  That’s less fund watchdog, and more fund lap dog” (“The Fund Industry’s Worst Offenders of 2012,” 12/17/12). Morningstar, he observes, “howls at that criticism.” 

The gist of Morningstar’s response is this: “we only rate the funds that matter, and thousands of these flea specks will receive neither our attention nor the average investor’s.”  Laura Lallos, a senior mutual-fund analyst for Morningstar, puts it rather more eloquently. “We focus on large funds and interesting funds. That is, we cover large funds whether they are ‘interesting’ or not, because there is a wide audience of investors who want to know about them. We also cover smaller funds that we find interesting and well-managed, because we believe they are worth bringing to our subscribers’ attention.”

More recently Javier Espinoza of The Wall Street Journal noted that the different firms’ rating methods create dramatically different thresholds for being recognized as excellent  (“The Ratings Game,”  01/04/13). Like Mr. Jaffe, he notes the relative lack of negative judgments by Morningstar: only 235 of 4299 ratings – about 5.5% – are negative.

Since the Observer’s universe centers on funds too small or too new to be worthy of Morningstar’s attention, we were pleased at Morningstar’s avowed intent to cover “smaller funds that we find interesting and well-managed.”  A quick check of Morningstar’s database shows:

2390 funds with under $100 million in assets.

41 funds that qualify as “worthy of our subscribers’ attention.”  It could be read as good news that Morningstar thinks 1.7% of small funds are worth looking at.  One small problem.  Of the 41 funds they rate, 34 are target-date or retirement income funds and many of those target-date offerings are actually funds-of-funds.  Which leaves …

7 actual funds that qualify for attention.  That would be one-quarter of one percent of small funds.  One quarter of one percent.  Uh-huh.

But that also means that the funds which survive Morningstar’s intense scrutiny and institutional skepticism of small funds must be SPLENDID!  And so, here they are:

Ariel Discovery Investor (ARDFX), rated Bronze.  This is a small cap value fund that we considered profiling shortly after launch, but where we couldn’t discern any compelling argument for it.  On whole, Morningstar rather likes the Ariel funds despite the fact that they don’t perform very well.  Five of the six Ariel funds have trailed their peers since inception and the sixth, the flagship Ariel Fund (ARGFX) has trailed the pack in six of the past 10 years.  That said, they have an otherwise-attractive long-term, low-turnover value orientation. 

Matthews China Dividend Investor (MCDFX), rated Bronze.  Also five stars, top 1% performer, low risk, low turnover, with four of five “positive” pillars and the sponsorship of the industry’s leading Asia specialist.  I guess I’d think of this as rather more than Bronze-y but Matthews is one of the fund companies toward which I have a strong bias.

TCW International Small Cap (TGICX), rated Bronze also only one of the five “pillars” of the rating is actually positive.  The endorsement is based on the manager’s record at Oppenheimer International Small Company (OSMAX).  Curiously, TGICX turns its portfolio at three times the rate of OSMAX and has far lagged it since launch.

The Collar (COLLX), rated Bronze, uses derivatives to offset the stock market’s volatility.  In three years it has twice made 3% and once lost 3%.  The underlying strategy, executed in separate accounts, made a bit over 4% between 2005-2010.  Low-risk, low-return and different from – if not demonstrably better than – other options-based funds.

Quaker Akros Absolute Return (AAARFX) rated Neutral.  Well … this fund does have exceedingly low risk, about one-third of the beta of the average long/short fund.  On the other hand, over the eight years between inception and today, it managed to turn a $10,000 investment into a $10,250 portfolio.  Right.  Invest $10,000 and make a cool $30/year.  Your account would have peaked in September 2009 (at $11,500) and have drifted down since then.

Quaker Event Arbitrage A (QEAAX), rated Neutral.  Give or take the sales load, this is a really nice little fund that the Observer profiled back when it was the no-load Pennsylvania Avenue Event Driven Fund (PAEDX).  Same manager, same discipline, with a sales force attached now.

Van Eck Multi-Manager Alternatives A (VMAAX), which strikes me as the most baffling pick of the bunch.  It has a 5.75% load, 2.84% expense ratio, 250% turnover (stop me when I get to the part that would attract you), and 31 managers representing 14 different sub-advisers.  Because Van Eck cans managers pretty regularly, there are also 20 former managers of the fund.  Morningstar rates the fund as “Neutral” with the sole positive pillar being “people.” It’s not clear whether Morningstar was endorsing the fund on the dozens already fired, the dozens recently hired or the underlying principle of regularly firing people (see: Romney, Mitt, “I like firing people”).

I’m afraid that on a Splendid-o-meter, this turns out to be one Splendid (Matthews), one Splendid-ish (Quaker Event Driven), four Meh and one utterly baffling (Van Ick).

Of 57 small, five-star funds, only one (Matthews) warrants attention?  Softies that we are, the Observer has chosen to profile seven of those 57 and a bunch of non-starred funds.  We’re actually pretty sure that they do warrant rather more attention – Morningstar’s and investors’ – than they’ve received.  Those seven are:

Huber Small Cap Value (HUSIX)

Marathon Value (MVPFX)

Pinnacle Value (PVFIX)

Stewart Capital Mid Cap (SCMFX)

The Cook and Bynum Fund (COBYX)

Tilson Dividend (TILDX)

Tributary Balanced (FOBAX)

Introducing: The Elevator Talk

Being the manager of a small fund can be incredibly frustrating.  You’re likely very bright.  You have a long record at other funds or in other vehicles.  You might well have performed brilliantly for a long time: top 1% for the trailing year, three years and five years, for example.  (There are about 10 tiny funds with that distinction.)  And you still can’t get anybody to notice you.

Dang.

The Observer helps, both because we’ve got 11,000 or so regular readers and an interest in small and new funds.  Sadly, there’s a limit to how many funds we can profile; likely somewhere around 20 a year.  I’m frequently approached by managers, asking if we’d consider profiling their funds.  When we say “no,” it’s as often because of our resource limits as of their records.

Frustration gave rise to an experimental new feature: The Elevator Talk.  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 #1: Tom Kerr, Rocky Peak Small Cap Value (RPCSX)

Mr. Kerr manages the Rocky Peak Small Cap Value Fund (RPCSX), which launched on April 2, 2012. He co-managed RCB’s Small Cap Value strategy and the CNI Charter RCB Small Cap Value Fund (formerly RCBAX, now CSCSX) fund. Tom offers these 200 words on why folks should check in:

Although this is a new Fund, I have a 14-years solid track record managing small cap value strategies at a prior firm and fund. One of the themes of this new Fund is improving on the investment processes I helped develop.  I believe we can improve performance by correcting mistakes that my former colleagues and I made such as not making general or tactical stock market calls, or not holding overvalued stocks just because they are perceived to be great quality companies.

The Fund’s valuation process of picking undervalued stocks is not dogmatic with a single approach, but encompasses multivariate valuation tools including discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics. Taken together those don’t give up a single “right number” but range of plausible valuations, for which our shorthand is “the Circle of Value.”

As a small operation with one PM, two intern analysts and one administrative assistant, I can maintain patience and diligence in the investment process and not be influenced by corporate politics, investment committee bureaucracy and water cooler distractions.

The Fund’s goal is to be competitive in up markets but significantly outperform in down markets, not by holding high levels of cash (i.e. making a market call), but by carefully buying stocks selling at a discount to intrinsic value and employing a reasonable margin of safety. 

The fund’s minimum initial investment is $10,000, reduced to $1,000 for IRAs and accounts set up with AIPs. The fund’s website is Rocky Peak Funds . Tom’s most-recent discussion of the fund appears in his September 2012 Semi-Annual Report.  If you meet him, you might ask about the story behind the “rocky peak” name.

Morningstar, Part Two: “Speaking of Old Softies”

There are, in addition, 123 beached whales: funds with more than a billion in assets that have trailed their peer groups for the past three, five and ten years.  Of those, 29 earn ratings in the Bronze to Gold range, 31 are Neutral and just six warrant Negative ratings.  So, being large and consistently bad makes you five times more likely to earn a positive rating than a negative one. 

Hmmm … what about being very large and consistently wretched?  There are 25 funds with more than two billion in assets that have trailed at least two-thirds of their peers for the past three, five and ten years.  Of those, seven earn Bronze or Silver ratings while just three are branded with the Negative.  So, large and wretched still makes you twice as likely to earn Morningstar’s approval as their disapproval.

What are huge and stinkin’ like Limburger cheese left to ripen in the August sun? Say $5 billion and trailing 75% of your peers?  There are five such funds, and not a Negative in sight.

Morningstar’s Good Work

Picking on Morningstar is both fun and easy, especially if you don’t have the obligation to come up with anything better on your own.  It’s sad that much of the criticism, as when pundits claim that Morningstar’s system has no predictive validity (check our “Best of the Web” discussion: Morningstar has better research to substantiate their claims than any other publicly accessible system), is uninformed blather.  I’d like to highlight two particularly useful pieces that Morningstar released this month.

Their annual “Buy the Unloved” recommendations were released on January 24.  This is an old and alluring system that depends on the predictable stupidity of the masses in order to make money.  At base, their recommendation is to buy in 2013 funds in the three categories that saw the greatest investor flight in 2012.  Conversely, avoiding the sector that others have rushed to, is wise.  Katie Rushkewicz Reichart reports that

From 1993 through 2012, the “unloved” strategy gained 8.4% annualized to the “loved” strategy’s 5.1% annualized. The unloved strategy has also beaten the MSCI World Index’s 6.9% annualized gain and has slightly beat the Morningstar US Market Index’s 8.3% return.

So, where should you be buying?  Large cap U.S. stocks of all flavors.  “The most unloved equity categories are also the most unpopular overall: large growth (outflows of $39.5 billion), large value (outflows of $16 billion), and large blend (outflows of $14.4 billion).”

A second thought-provoking feature offered a comparison that I’ve never before encountered.  Within each broad fund category, Morningstar tracked the average performance of mutual funds in comparison to ETFs and closed-end funds.  In terms of raw performance, CEFs were generally superior to both mutual funds and ETFs.  That makes some sense, at least in rising markets, because CEFs make far greater use of leverage than do other products.  The interesting part was that CEFs maintained their dominance even when the timeframe included part of the 2007-09 meltdown (when leverage was deadly) and even when risk-adjusted, rather than raw, returns are used.

There’s a lot of data in their report, entitled There’s More to Fund Investing Than Mutual Funds (01/29/13), and I’ll try to sort through more of it in the month ahead.

Matthews Asia Strategic Income Conference Call

We spent an hour on Tuesday, January 22, talking with Teresa Kong of Matthews Asia Strategic Income. The fund is about 14 months old, has about $40 million in assets, returned 13.6% in 2012 and 11.95% since launch (through Dec. 31, 2012).

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

Quick highlights:

1. this is designed to offer the highest risk-adjusted returns of any of the Matthews funds. In this case “risk-adjusted” is measured by the fund’s Sharpe ratio. Since launch, its Sharpe ratio has been around 2.0 which would be hard for any fixed-income fund to maintain indefinitely. They’ve pretty comfortable that they can maintain a Sharpe of 1.0 or so.
2. the manager describes the US bond market, and most especially Treasuries, as offering “asymmetric risk” over the intermediate term. Translation: more downside risk than upside opportunity. She does not embrace the term “bubble” because that implies an explosive risk (i.e., “popping”) where she imagines more like the slow leak of air out of a balloon. (Thanks for Joe N for raising the issue.)
3. given some value in having a fixed income component of one’s portfolio, Asian fixed-income offers two unique advantages in uncertain times. First, the fundamentals of the Asian fixed-income market – measures of underlying economic growth, market evolution, ability to pay and so on – are very strong. Second, Asian markets have a low beta relative to US intermediate-term Treasuries. If, for example, the 5-year Treasury declines 1% in value, U.S. investment grade debt will decline 0.7%, the global aggregate index 0.5% and Asia fixed-income around 0.25%.
4. MAINX is one of the few funds to have positions in both dollar-denominated and local currency Asian debt (and, of course, equities as well). She argues that the dollar-denominated debt offers downside protection in the case of a market disruption since the panicked “flight to quality” tends to benefit Treasuries and linked instruments while local currency debt might have more upside in “normal” markets. (Jeff Wang’s question, I believe.)
5. in equities, Matthews looks for stocks with “bond-like characteristics.” They target markets where the dividend yield in the stock market exceeds the yield on local 10-year bonds. Taiwan is an example. Within such markets, they look for high yielding, low beta stocks and tend to initiate stock positions about one-third the size of their initial bond positions. A new bond might come in at 200 basis points while a new stock might be 75. (Thanks to Dean for raising the equities question and Charles for noticing the lack of countries such as Taiwan in the portfolio.)
6. most competitors don’t have the depth of expertise necessary to maximize their returns in Asia. Returns are driven by three factors: currency, credit and interest rates. Each country has separate financial regimes. There is, as a result, a daunting lot to learn. That will lead most firms to simply focus on the largest markets and issuers. Matthews has a depth of expertise that allows them to do a better job of dissecting markets and of allocating resources to the most profitable part of the capital structure (for example, they’re open to buying Taiwanese equity but find its debt market to be fundamentally unattractive). There was an interesting moment when Teresa, former head of BlackRock’s emerging markets fixed-income operations, mused, “even a BlackRock, big as we were, I often felt we were a mile wide and [pause] … not as deep as I would have preferred.” The classic end of the phrase, of course, is “and an inch deep.” That’s significant since BlackRock has over 10,000 professionals and about $1.4 trillion in assets under management.

AndyJ, one of the members of the Observer’s discussion board and a participant in the call, adds a seventh highlight:

1. TK said explicitly that they have no neutral position or target bands of allocation for anything, i.e., currency exposure, sovereign vs. corporate, or geography. They try to get the biggest bang for the level of risk across the portfolio as a whole, with as much “price stability” (she said that a couple of times) as they can muster.

Matthews Asia Strategic Income, Take Two

One of the neat things about writing for you folks is the opportunity to meet all sorts of astonishing people.  One of them is Charles Boccadoro, an active member of the Observer’s discussion community.  Charles is renowned for the care he takes in pulling together data, often quite powerful data, about funds and their competitors.  After he wrote an analysis of MAINX’s competitors, Rick Brooks, another member of the board, encouraged me to share Charles’s work with a broader audience.  And so I shall.

By way of background, Charles describes himself as

Strictly amateur investor. Recently retired aerospace engineer. Graduated MIT in 1981. Investing actively in mutual funds since 2002. Was heavy FAIRX when market headed south in 2008, but fortunately held tight through to recovery. Started reading FundAlarm in 2007 and have followed MFO since inception in May 2011. Tries to hold fewest funds in portfolio, but many good recommendations by MFO community make in nearly impossible (e.g., bought MAINX after recent teleconference). Live in Central Coast California.

Geez, the dude’s an actual rocket scientist. 

After carefully considering eight funds which focus on Asian fixed-income, Charles concludes there are …

Few Alternatives to MAINX

Under normal market conditions, the Strategic Income Fund seeks to achieve its investment objective by investing at least 80% of its total net assets…in the Asia region. ASIA: Consists of all countries and markets in Asia, including developed, emerging, and frontier countries and markets in the Asian region.

Fund manager Teresa Kong references two benchmarks: HSBC Asian Local Bond Index (ALBI) and J.P. Morgan Asia Credit Index (JACI), which cover ten Asian countries, including South Korea, Hong Kong, India, Singapore, Taiwan, Malaysia, Thailand, Philippines, Indonesia and China. Together with Japan, these eleven countries typically constitute the Asia region. Recent portfolio holdings include Sri Lanki and Australia, but the latter is actually defined as Asia Pacific and falls into the 20% portfolio allocation allowed to be outside Asia proper.

As shown in following table, the twelve Asian countries represented in the MAINX portfolio are mostly republics established since WWII and they have produced some of the world’s great companies, like Samsung and Toyota. Combined, they have ten times the population of the United States, greater overall GDP, 5.1% GDP annual growth (6.3% ex-Japan) or more than twice US growth, and less than one-third the external debt. (Hong Kong is an exception here, but presumably much of its external debt is attributable to its role as the region’s global financial center.)

Very few fixed income fund portfolios match Matthews MAINX (or MINCX, its institutional equivalent), as summarized below. None of these alternatives hold stocks.

Aberdeen Asian Bond Fund CSBAX and WisdomTree ETF Asian Local Debt ALD cover the most similar geographic region with debt held in local currency, but both hold more government than corporate debt. CSBAX recently dropped “Institutional” from its name and stood-up investor class offerings early last year. ALD maintains a two-tier allocation across a dozen Asian countries, ex Japan, monitoring exposure and rebalancing periodically. Both CSBAX and ALD have about $500M in assets. ALD trades at fairly healthy volumes with tight bid/ask spreads. WisdomTree offers a similar ETF in Emerging Market Local Debt ELD, which comprises additional countries, like Russia and Mexico. It has been quite successful garnering $1.7B in assets since inception in 2010. Powershares Chinese Yuan Dim Sum Bond ETF DSUM (cute) and similar Guggenheim Yuan Bond ETF RMB (short for Renminbi, the legal tender in mainland China, ex Hong Kong) give US investors access to the Yuan-denominated bond market. The fledgling RMB, however, trades at terribly low volumes, often yielding 1-2% premiums/discounts.

A look at life-time fund performance, ranked by highest APR relative to 3-month TBill:

Matthews Strategic Income tops the list, though of course it is a young fund. Still, it maintains low down side volatility DSDEV and draw down (measured by Ulcer Index UI). Most of the offerings here are young. Legg Mason Western Asset Global Government Bond (WAFIX) is the oldest; however, last year it too changed its name, from Western Asset Non-U.S. Opportunity Bond Fund, with a change in investment strategy and benchmark.

Here’s look at relative time frame, since MAINX inception, for all funds listed:

Charles, 25 January 2013

February’s Conference Call: Seafarer Overseas Growth & Income

As promised, we’re continuing our moderated conference calls through the winter.  You should consider joining in.  Here’s the story:

• Each call lasts about an hour
• About one third of the call is devoted to the manager’s explanation of their fund’s genesis and strategy, about one third is a Q&A that I lead, and about one third is Q&A between our callers and the manager.
• The call is, for you, free.  Your line is muted during the first two parts of the call (so you can feel free to shout at the danged cat or whatever) and you get to join the question queue during the last third by pressing the star key.

Our next conference call features Andrew Foster, manager of Seafarer Overseas Growth and Income (SFGIX).  It’s Tuesday, February 19, 7:00 – 8:00 p.m., EST.

Why you might want to join the call?

Put bluntly: you can’t afford another lost decade.  GMO is predicting average annual real returns for U.S. large cap stocks of 0.1% for the next 5-7 years.  The strength of the January 2013 rally is likely to push GMO’s projections into the red.  Real return on US bonds is projected to be negative, about -1.1%.  Overseas looks better and the emerging markets – source of the majority of the global economy’s growth over the next decade – look best of all.

The problem is that these markets have been so volatile that few investors have actually profited as richly as they might by investing in them.  The average e.m. fund dropped 55% in 2008, rose 75% in 2009, then alternated between gaining and losing 18% per year before 2010 – 2012.  That sort of volatility induces self-destructive behavior on most folk’s part; over the past five years (through 12/30/12), Vanguard’s Emerging Market Stock Index fund lost 1% per year but the average investor in that fund lost 6% per year.  Why?  Panicked selling in the midst of crashes, panicked buying at the height of upbursts.

In emerging markets investing especially, you benefit from having an experienced manager who is as aware of risks as of opportunities.  For my money (and he has some small pile of my money), no one is better at it than Andrew Foster of Seafarer.  Andrew had a splendid record as manager of Matthews Asian Growth and Income (MACSX), which for most of his watch was the least risky, most profitable way to invest in Asian equities.  Andrew now runs Seafarer, where he runs an Asia-centered portfolio which has the opportunity to diversify into other regions of the world.  He’ll join us immediately after the conclusion of Seafarer’s splendid first year of operation to talk about the fund and emerging markets as an opportunity set, and he’ll be glad to take your questions as well.

How can you join in?

Click on the “register” button and you’ll be taken to Chorus Call’s site, where you’ll get a toll free number and a PIN number to join us.  On the day of the call, I’ll send a reminder to everyone who has registered.

Would an additional heads up help?

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

Bonus Time!  RiverNorth Explains Dynamic Buy-Write

A couple months ago we profiled RiverNorth Dynamic Buy-Write Fund (RNBWX), which uses an options strategy to pursue returns in excess of the stock market’s with only a third of the market’s volatility.  RiverNorth is offering a webcast about the fund and its strategy for interested parties.  It will be hosted by Eric Metz, RNBWX’s manager and a guy with a distinguished record in options investing.  He’s entitled the webcast “Harnessing Volatility.”  The webcast will be Wednesday, February 20th, 2013 3:15pm CST – 4:15pm CST.

The call will feature:

• Overview of volatility
• Growth of options and the use of options strategies in a portfolio
• How volatility and options strategies pertain to the RiverNorth Dynamic Buy-Write Fund (RNBWX)
• Advantages of viewing the world with volatility in mind

To register, navigate over to www.rivernorthfunds.com and click on the “Events” link.

Cook & Bynum On-Deck

Our March conference call will occur unusually early in the month, so I wanted to give you advance word of it now.  On Tuesday, March 5, from 7:00 – 8:00 CST, we’ll have a chance to talk with Richard Cook and Dow Bynum, of The Cook and Bynum Fund (COBYX).  The guys run an ultra-concentrated portfolio which, over the past three years, has produced returns modestly higher than the stock market’s with less than half of the volatility. 

You’d imagine that a portfolio with just seven stocks would be wildly erratic.  It isn’t.  Our bottom line on our profile of the fund: “It’s working.  Cook and Bynum might well be among the best.  They’re young.  The fund is small and nimble.  Their discipline makes great sense.  It’s not magic, but it has been very, very good and offers an intriguing alternative for investors concerned by lockstep correlations and watered-down portfolios.”

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.

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:

Artisan Global Equity (ARTHX): after the January 11 departure of lead manager Barry Dargan, the argument for ARTHX is different but remains compelling.

Matthews Asia Strategic Income (MAINX):  the events of 2012 and early 2013 make an already-intriguing fund much more interesting.

PIMCO Short Asset Investment, “D” shares (PAIUX): Bill Gross trusts this manager and this strategy to management tens of billions in cash for his funds.  Do you suppose he might be good enough to warrant your attention to?

Whitebox Long Short Equity, Investor shares (WBLSX): yes, I know I promised a profile of Whitebox for this month.   This converted hedge fund has two fundamentally attractive attributes (crushing its competition and enormous amounts of insider ownership), but I’m still working on the answer to two questions.  Once I get those, I’ll share a profile.  But not yet.

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.

Funds in registration this month won’t be available for sale until, typically, the beginning of March 2013. We found a dozen funds in the pipeline, notably:

Artisan Global Small Cap Fund (ARTWX) will be Artisan’s fourth overly-global fund and also the fourth for Mark Yockey and his team.  They’re looking pursue maximum long-term capital growth by investing in a global portfolio of small-cap growth companies.  .  The plan is to apply the same investing discipline here as they do with Artisan International Small Cap (ARTJX) and their other funds.  The investment minimum is $1000 and expenses are capped at 1.5%.

Driehaus Event Driven Fund seeks to provide positive returns over full-market cycles. Generally these funds seek arbitrage gains from events such as bankruptcies, mergers, acquisitions, refinancings, earnings surprises and regulatory rulings.  They intend to have a proscribed volatility target for the fund, but have not yet released it.  They anticipate a concentrated portfolio and turnover of 100-200%.  K.C. Nelson, Portfolio Manager for Driehaus Active Income (LCMAX) and Driehaus Select Credit (DRSLX), will manage the fund.  The minimum initial investment is $10,000, reduced to $2000 for IRAs.  Expenses not yet set.

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.

On a related note, we also tracked down 20 fund manager changes, including a couple high profile departures.

Launch Alert: Eaton Vance Bond

On January 31, Eaton Vance launched Eaton Vance Bond Fund (EVBAX), a multi-sector bond fund that can invest in U.S. investment grade and high yield bonds, floating-rate bank loans, non-U.S. sovereign and corporate debt, convertible securities and preferred stocks.  Why should you care?  Its lead manager is Kathleen Gaffney, once the investing partner of and heir apparent to Dan Fuss.  Fuss and Gaffney managed Loomis Sayles Bond (LSBRX), a multisector fund strikingly similar to the new fund, to an annualized return of 10.6% over their last decade together.  That beat 94% of their peers, as well as beating the long-term record of the stock market.  “A” class shares carry a 4.75% front load, expenses after waivers of 0.95% and a minimum initial investment of $1000.

Launch Alert: Longleaf Global Opens

On Jan. 2, Southeastern Asset Management rolled out its first U.S. open-end fund since 1998 and its first global mutual fund ever available in the United States. The new fund is Longleaf Global (LLGLX), a concentrated fund that invests at least 40% of its assets outside the U.S. A version of the strategy already is available in Europe.

Mason Hawkins and Staley Cates, who received Morningstar’s Domestic-Stock Fund Manager of the Year award in 2006, manage the fund. Like other Longleaf funds, the portfolio targets holding between 15 and 25 companies. The fund will have an unconstrained portfolio that invests in companies of all market capitalizations and geographies. Its expense ratio is capped at 1.65%.

Sibling funds   Longleaf Partners (LLPFX) and   Longleaf Partners Small-Cap (LLSCX) receive Morningstar Analyst Ratings of Gold while   Longleaf Partners International (LLINX) is rated Bronze.

Launch Just-A-Second-There: Longleaf Global Closes

After just 18 trading days, Longleaf Global closed to new investors.  The fund drew in a manageable $28 million and then couldn’t manage it.  On January 28, the fund closed without warning and without explanation.  The fund’s phone reps said they had “no idea of why” and the fund’s website contained a single line noting the closure.

A subsequent mailing to the fund’s investors explained that there simply was nowhere immediately worth investing.  The $16 trillion U.S. stock market didn’t contain $30 million in investible good ideas.  With the portfolio 50% in cash, their judgment was that the market offered no more than about $15 million in worthwhile opportunities.

Here’s the official text:

We are temporarily closing Longleaf Partners Global Fund to new investors. Although the Fund was only launched on December 31, 2012, our Governing Principles guide our decision to close until we can invest the large cash position currently in the Fund. Since October when we began planning to open the Global Fund, stock prices have risen rapidly, leaving few good businesses that meet our 60% of appraisal discount. Limited qualifying investments, combined with relatively quick inflows from shareholders, have left us with more cash than we can invest. Remaining open would dilute existing investors by further raising our cash level.

Our Governing Principle, “We will consider closing to new investors if closing would benefit existing clients,” has caused us to close the three other Longleaf Funds at various times over the past 20 years. When investment opportunities enable us to put the Fund’s cash to work, and additional inflows will benefit our partners, we will re-open the Global Fund to new investors.

Artisan Gets Active

One of my favorite fund advisers are the Artisan Partners.  I’ve had modest investments with the Artisan Funds since 1996 when I owned Artisan Small Cap (ARTSX) and Artisan International (ARTIX).  I sold my Small Cap stake when Small Cap Value (ARTVX) became available and International when International Value (ARTKX) opened, but I’ve stayed with Artisan throughout.  The Observer has profiles of five Artisan funds.

Why?  Three reasons.  (1) They do consistently good work. (2) Their funds build upon their teams’ expertise.  And (3) their policies – from low minimums to the willingness to close funds – are shareholder friendly.

And they’ve had a busy month.

Two of Artisan’s management teams were finalists for Morningstar’s international fund manager of the year honors: David Samra and Daniel O’Keefe of Artisan International Value (ARTKX) and Artisan Global Value (ARTGX) and the team headed by Mark Yockey of Artisan International (ARTIX) and Artisan International Small Cap (ARTJX).

In a rarity, one of the managers left Artisan.  Barry Dargan, formerly of MFS International and lead manager of Artisan Global Equity (ARTHX), left the firm following a year-end conversation with Yockey and others.  ARTHX was managed by a team led by Mr. Dargan and it employed a consistent, well-articulated discipline.  The fund will continue being managed by the same team with the same discipline, though Mr. Yockey will now take the lead. 

Artisan has filed to launch Artisan Global Small Cap Fund (ARTWX), which will be managed by Mark Yockey, Charles-Henri Hamker and David Geisler.  Yockey and Hamker co-manage other funds together and Mr. Geisler has been promoted to co-manager in recognition of his excellent work as a senior analyst on the team.   Artisan argues that their teams have managed such smooth transitions from primarily domestic or primary international charges into global funds because all of their investing has a global focus.  The international managers need to know the U.S. market inside and out since, for example, they can’t decide whether Fiat is a “buy” without knowing whether Ford is a better buy.  We’ll offer more details on the fund when it comes to market.

Briefly Noted …

FPA has announced the addition of a new analyst, Victor Liu, for FPA International Value (FPIVX).  The fund started with two managers, Eric Bokota and Pierre Py.  Mr. Bokota left suddenly for personal reasons and FPA has been moving carefully to find a successor for him.  Mr. Py expects Victor Liu to become that successor. Prior to joining FPA, Mr. Liu was a Vice President and Research Analyst for a highly-respected firm, Causeway Capital Management LLC, from 2005 until 2013.  The fund posted top 2% results in 2012 and investors have reason to be optimistic about the year ahead.

Rivers seem to be all the rage in the mutual fund world.  In addition to River Road Asset Management which sub-advises several ASTON funds, there’s River Oak Discovery (RIVSX) and the Riverbridge, RiverFront (note the trendy mid-word capitalization), RiverNorth, RiverPark and RiverSource fund families.  Equally-common bits of geography seem far less popular.  Hills (Beech, Cavanal, Diamond), lakes (Great and Partners), mounts (Lucas), and peaks (Aquila, Grandeur, Rocky) are uncommon while ponds, streams, creeks, gorges and plateaus are invisible.  (Swamps and morasses are regrettably common, though seldom advertised.)

Small Wins for Investors

Calamos Growth & Income (CVTRX) reopened to new investors in January. Despite a lackluster return in 2012, the fund has a strong long-term record, beating 99% of its peers during the trailing 15-year period through December 2012. In August 2012, Calamos announced that lead manager and firm co-CIO Nick Calamos would be leaving the firm. Gary Black, former Janus CIO, joined the management team as his replacement.

The folks at FPA have lowered the expense ratio for FPA International Value (FPIVX). FPA has also extended the existing fee waiver and reduced the Fund’s fees effective February 1, 2013.  FPA has contractually capped the Fund’s fees at 1.32% through June 30, 2015, several basis points below the current rate.

Scout Unconstrained Bond (SUBYX and SUBFX) is now available in a new, lower-cost retail package.  On December 31, 2012, the old retail SUBFX became the institutional share class with a $100,000 minimum.  At the same time Scout launched new “Y” shares that are no-load with the same minimum investment as the old shares, but also with a substantial expense reduction. When we profiled the fund in November, the after-waiver e.r. was 99 basis points while the “Y” shares are at 80 bps.  Scout also reduces the minimum initial investment to $100 for accounts set up with an automatic investing plan.

Scout has also released “Unconstrained Fixed-Income Investing: A Timely Alternative in a Perilous Environment.” They argue that unconstrained investing:

• Has the potential to make portfolios less vulnerable to higher interest rates and enduring economic uncertainty;
• May better position assets to grow long term purchasing power;
• Is worth consideration as investors may need to consider more opportunistic strategies to complement or replace the core strategies that have worked well so far.

They also explain the counter-cyclical investment approach which they have successfully employed for more than three decades.  Mark Egan and team were also finalists for 2012 Fixed Income Manager of the Year honors.

Vanguard has cut expense ratios on four more funds, by 1 -3 basis points.  Those are Equity Income, PRIMECAP Core, Strategic Equity and Strategic Small Cap Equity.  It raised the e.r. on Growth Equity by 2 basis points. 

Closings

ASTON/River Road Independent Value (ARVIX) closed to new investors on January 18 after being reopened just four months. I warned you.

Fairholme Fund (FAIRX) is closing on February 28, 2013. Here’s the perfect illustration of the risks and rewards of high-conviction investing: top 1% in 2010, bottom 1% in 2011, top 1% in 2012, closed in 2013.  The smaller Fairholme Allocation (FAAFX), which has actually outperformed Fairholme since launch, and Fairholme Focused Income (FOCIX) funds are closing at the same time.

Fidelity Small Cap Discovery (FSCRX) closed to new investors on January 31.  The fund has been a rarity for Fidelity: a really good small cap fund.  Most of its success has come under manager Chuck Myers.  Fans of his work might still check out Fidelity Small Cap Value (FCPVX).  It’s nearly as big as Discovery ($3.1 versus $3.9 billion) but hasn’t had to deal with huge inflows. 

JPMorgan Mid Cap Value (JAMCX) will close to new investors at the end of February.

MainStay Large Cap Growth Fund closed to new investors on January 17.  They ascribe the decision to “a significant increase in the net assets” and a desire “to moderate cash flows.”

Virtus announced it will close Virtus Emerging Markets Opportunities (HEMZX) to new investors on Feb. 1. The fund had strong inflows in recent years, ending 2012 with more than $6.8 billion in assets.  Rajiv Jain was named Morningstar International-Stock Fund Manager of the Year for 2012. In three of the past five calendar years the fund has outpaced more than 95% of its peers (it landed in the bottom decile of its category for 2009, despite a 48% return for the year, and placed in the top half of the category in 2011).

Old Wine in New Bottles

DWS is changing the names of its three Dreman Value Management-run funds, including the Neutral-rated  DWS Dreman Small Cap Value (KDSAX), to drop the subadvisor’s name. Dreman’s assets under management have shrunk dramatically to just $4.1 billion today from $20 billion in 2007. The firm previously subadvised a large-cap value fund for DWS but was dropped after that fund (now called DWS Equity Dividend (KDHAX)) lost 46% in 2008, leading to massive outflows. The three funds Dreman subadvises for DWS now account for roughly half of the firm’s total assets under management.

We noted earlier in fall that several of the Legg Mason affiliates are shrinking from the Legg name.  The most recent manifestations: Legg Mason Global Currents International All Cap Opportunity and Legg Mason Global Currents International Small Cap Opportunity changed their names to ClearBridge International All Cap Opportunity (SBIEX) and ClearBridge International Small Cap Opportunity (LCOAX) on Dec. 5, 2012.

Off to the Dustbin of History

ASTON Dynamic Allocation (ASENX) has been closed to new investment and will be shut down on January 30.  The fund’s performance has been weak and 2012 was its worst year yet.   The fact that it drew only $22 million in investments and carried a one-star rating from Morningstar likely contributed to the decision. The fund, subadvised by Smart Portfolios, was launched early 2008. This  will be ASTON’s third closure of late, following the shutdown of ASTON/Cardinal Mid Cap Value and ASTON/Neptune International in mid-autumn.

Fidelity plans to merge the Fidelity 130/30 Large Cap (FOTTX) and Fidelity Advisor Strategic Growth (FTQAX) into Fidelity Stock Selector All Cap  (FDSSX) in June in June.  Neither of the deadsters had distinguished records and neither drew much in assets, at least by Fidelity’s standards.

Invesco Powershares will liquidate thirteen more ETFs on February 26.  Those are  

• Dynamic Insurance Portfolio (PIC)
• Morningstar StockInvestor Core Portfolio (PYH)
• Dynamic Banking Portfolio (PJB)
• Global Steel Portfolio (PSTL)
• Active Low Duration Portfolio (PLK)
• Global Wind Energy Portfolio (PWND)
• Active Mega-Cap Portfolio (PMA)
• Global Coal Portfolio (PKOL)
• Global Nuclear Energy Portfolio (PKN)
• Ibbotson Alternative Completion Portfolio (PTO)
• RiverFront Tactical Balanced Growth Portfolio (PAO)
• RiverFront Tactical Growth & Income Portfolio (PCA)
• Convertible Securities Portfolio (CVRT)

Just when you thought the industry was all dull and normal, along comes Janus.   Janus’s Board approved the merger of Janus Global Research into Janus Worldwide (JAWWX) on March 15, 2013.  Now in a dull and normal world, that would mean the disappearance of the Global Research fund.  Not with Janus!  Global Research will merge into Worldwide, resulting in “the Combined Fund.”  The Combined Fund will then be named “Janus Global Research,” will adopt Global Research’s management team and will use Global Research’s performance record.  Investors get rewarded with a four basis point decrease in their expense ratio.

The RS Capital Appreciation Fund will be merged with RS Growth Fund in March.  In the interim, RS removed Cap App’s entire management team and replaced them with Growth’s:  Stephen Bishop, Melissa Chadwick-Dunn, and D. Scott Tracy.

RiverPark Small Cap Growth (RPSFX) liquidated on Jan. 25, 2013.  I like and respect Mr. Rubin and the RiverPark folks as a whole, but this fund never struck me as particularly compelling.  With only $4.5 million in assets, it seems the others agreed.  On the upside, this leaves the managers free to focus on their noticeably-promised RiverPark Long/Short Opportunity (RLSFX) fund. 

Scout Stock (UMBSX) will liquidate in March. Scout has always been a very risk averse fund for which Morningstar and the Observer both had considerable enthusiasm.  The problem is that the combination of low risk with below average returns was not compelling in the marketplace and assets have dropped by well over half in the past decade.

In a move fraught with covert drama, Sentinel Asset Management is merging the $51 million Sentinel Mid Cap II (SYVAX) into Sentinel Mid Cap (SNTNX). The drama started when Sentinel fired Mid Cap II’s management team in 2011.  The fund’s shareholders then refused to ratify a new management team.  Sentinel responded by converting Mid Cap II into a clone of Mid Cap with the same management team.  Then in August 2012, that management team resigned to join a competitor.  Sentinel rotated in the team that manages Sentinel Common Stock (SENCX) to manage both and, soon, to manage just the survivor.

Torray Institutional (TORRX) liquidated at the end of December.  Like many institutional funds, it was hostage to one or two large accounts.  When a major investor pulled out, the fund was left with too few assets to be profitable.  Torray Fund (TORYX), on which it was based, has had a long stretch of wretched performance (in the bottom quartile of its large cap peer group for six of the past 10 years) but retains over $300 million in assets.

In Closing . . .

We received a huge and humbling stack of mail in January, very little of which I’ve yet responded to.  Some folks, including some professional practices, shared contributions (including one in the … hmm, “mid three digit” range) for which we’re really grateful.  Other folks shared holiday greetings (Zak, Hoyt and River Road Asset Management won, hands down, for the cutest and classiest card of the season), offers, reflections and requests.  Augustana settles into Spring Break in early February and I’m resolved to settle in for an afternoon and catch up with you folks.  Preliminary notes include:

• Major congratulations, Maryrose!  Great news.
• Pretty much any afternoon during Spring Break, Peter
• Thanks for sharing the Fund Investor’s Classroom, Richard.  I’ll sort through it as soon as I’m out of my own classroom.
• Rick, Mohan, it’s always good to hear from old friends
• Fraud Catcher, fascinating book and a fascinating life.  Thanks for sharing it, Tom.
• And, to you all, it’s always good to hear from new friends.

Thanks, as always, for your support and encouragement.  It makes a world of difference.   Do consider joining us for the Seafarer conference call in a couple weeks.  Otherwise, I’ll see you all in March.

Dear friends,

We’ve been listening to REM’s “It’s the End of the World (as we know it)” and thinking about copyrighting some useful terms for the year ahead.  You know that Bondpocalypse and Bondmageddon are both getting programmed into the pundits’ vocabulary.  Chip suggests Bondtastrophe and Bondaster.  

Bad asset classes (say, TIPs and long bonds) might be merged in the Frankenfund.  Members of the Observer’s discussion board offered bond doggle (thanks, Bee!), the Bondfire of the Vanities (Shostakovich’s entry and probably our most popular), the New Fed (which Hank thinks we’ll be hearing by year’s end) which might continue the racetodebase (Rono) and bondacious (presumably blondes, Accipiter’s best).  Given that snowstorms now get their own names (on the way to Pittsburgh, my son and I drove through the aftermath of Euclid), perhaps market panics, too?  We’d start of course with Market Crisis Alan, in honor of The Maestro, but we haven’t decided whether that would rightly be followed by Market Crisis Ben, Barack or Boehner.  Hopeful that they couldn’t do it again, we could honor them all with Crash B3 which might defame the good work done by vitamin B3 in regulating sex and stress.

Feel free to join in on the 2013 Word of the Year thread, if only if figure out how Daisy Duke got there.

The Big Bond Bubble Boomnanza?

I’m most nervous when lots of other folks seem to agree with me.  It’s usually a sign that I’ve overlooked something.

I’ve been suggesting for quite a while now that the bond market, as a whole, might be in a particularly parlous position.   Within the living memory of almost the entire investing community, investing in bonds has been a surefire way to boost your portfolio.  Since 1981, the bond market has enjoyed a 31-year bull market.  What too many investors forget is that 1981 was preceded by a 35-year year bear market for bonds.  The question is: are we at or near another turning point?

The number of people reaching that conclusion is growing rapidly.  Floyd Norris of The New York Times wrote on December 28^th: “A new bear market almost certainly has begun” (Reading Pessimism in the Market for Bonds).  The Wall Street Journal headlined the warning, “Danger Lurks Inside the Bond Boom amid Corporate-Borrowing Bonanza, Some Money Managers Warn of Little Room Left for Gains” (12/06/2012).  Separately, the Journal warned of “a rude awakening” for complacent bond investors (12/24/2012).  Barron’s warns of a “Fed-inflated bond bubble” (12/17/2012). Hedge fund manager Ray Dalio claims that “The biggest opportunity [in 2013] will be – and it isn’t imminent – shorting bond markets around the world” (our friends at LearnBonds.com have a really good page of links to commentaries on the bond market, on which this is found).

I weighed in on the topic in a column I wrote for Amazon’s Money and Markets page.  The column, entitled “Trees Do Not Grow to the Sky,” begins:

You thought the fallout from 2000-01 was bad?  You thought the 2008 market seizure provoked anguish?  That’s nothing, compared to what will happen when every grandparent in America cries out, as one, “we’ve been ruined.”

In the past five years, investors have purchased one trillion dollars’ worth of bond mutual fund shares ($1.069 trillion, as of 11/20/12, if you want to be picky) while selling a half trillion in stock funds ($503 billion).

Money has flowed into bond mutual funds in 53 of the past 60 weeks (and out of stock funds in 46 of 60 weeks).

Investors have relentlessly bid up the price of bonds for 30 years so they’ve reached the point where they’re priced to return less than nothing for the next decade.

Morningstar adds that about three-quarters of that money went to actively-managed bond funds, a singularly poor bet in most instances.

I included a spiffy graph and then reported on the actions of lots of the country’s best bond investors.  You might want to take a quick scan of their activities.  It’s fairly sobering.

Among my conclusions:  

Act now, not later. “Act” is not investment advice, it’s communication advice.  Start talking with your spouse, financial adviser, fund manager, and other investors online, about how they’ve thought about the sorts of information I’ve shared and how they’ve reacted to it.  Learn, reflect, then act.

We’re not qualified to offer investment advice and we’re not saying that you should be abandoning the bond market. As we said to Charles, one of our regular readers,

I’m very sensitive to the need for income in a portfolio, for risk management and for diversification so leaving fixed-income altogether strikes me as silly and unmanageable.  The key might be to identify the risks your exposing yourself to and the available rewards.  In general, I think folks are most skeptical of long-term sovereign debt issued by governments that are … well, broke.  Such bonds have the greatest interest rate sensitivity and then to be badly overpriced because they’ve been “the safe haven” in so many panics.  

So I’d at the very least look to diversify my income sources and to work with managers who are not locked into very narrow niches. 

MFWire: Stock Fund Flows Are Turning Around

MF Wire recently announced “Stock Funds Turn Around” (December 28, 2012), which might also be titled “Investors continue retreat from U.S. stock funds.” In the last full week of 2012, investors pulled $750 million from US stock funds and added $1.25 billion into international ones.

Forbes: Buy Bonds, Sleep Well

Our take might be, Observer: buy bonds, sleep with the fishes.  On December 19^th, Forbes published 5 Mutual Funds for Those Who Want to Sleep Well in 2013.  Writer Abram Brown went looking for funds that performed well in recent years (always the hallmark of good fund selection: past performance) and that avoided weird strategies.  His list of winners:

PIMCO Diversified Income (PDVDX) – a fine multi-asset fund.

MFS Research Bond R3 (MRBHX) – R3 shares are only available through select retirement plans.  The publicly available “A” shares carry a sales load, which has trimmed about a percent a year off its returns.

Russell Strategic Bond (RFCEX) – this is another unavailable share class; the publicly available “A” shares have higher expenses, a load, and a lower Morningstar rating.

TCW Emerging Markets Income (TGEIX) – a fine fund whose assets have exploded in three years, from $150 million to $6.2 billion.

Loomis Sayles Bond (LBFAX) – the article points you to the fund’s Administrative shares, rather than the lower-cost Retail shares (LSBRX) but I don’t know why.

Loomis might illustrate some of the downsides to investing in the past.  Its famous lead manager, Dan Fuss, is now 79 years old and likely in the later stages of his career.  His heir apparent, Kathleen Gaffney, recently left the firm.  That leaves the fund in the hands of two lesser-known managers.

I’m not sure of how well most folks will sleep when their manager’s toting 40-100% emerging markets exposure or 60% junk bonds when the next wave crashes over the market, but it’s an interesting list.

Forbes is, by the way, surely a candidate for the most badly junked up page in existence, and one of the least useful.  Only about a third of the screen is the story, the rest are ads and misleading links.  See also “10 best mutual funds” does not lead to a Forbes story on the subject – it leads to an Ask search results page with paid results at top.

Vanguard: The Past 10 Years

In October we launched “The Last Ten,” a monthly series, running between now and February, looking at the strategies and funds launched by the Big Five fund companies (Fido, Vanguard, T Rowe, American and PIMCO) in the last decade.

Here are our findings so far:

Fidelity, once fabled for the predictable success of its new fund launches, has created no compelling new investment option and only one retail fund that has earned Morningstar’s five-star designation, Fidelity International Growth (FIGFX).  We suggested three causes: the need to grow assets, a cautious culture and a firm that’s too big to risk innovative funds.

T. Rowe Price continues to deliver on its promises.  Of the 22 funds launched, only Strategic Income (PRSNX) has been a consistent laggard; it has trailed its peer group in four consecutive years but trailed disastrously only once (2009).  Investing with Price is the equivalent of putting a strong singles-hitter on a baseball team; it’s a bet that you’ll win with consistency and effort, rather than the occasional spectacular play.

PIMCO has utterly crushed the competition, both in the thoughtfulness of their portfolios and in their performance.  PIMCO has, for example, about three times as many five-star funds – both overall and among funds launched in the last decade – than you’d predict.

The retirement of Gus Sauter, Vanguard’s long-time chief investment officer, makes this is fitting moment to look back on the decade just past.

Measured in terms of the number of funds launched or the innovativeness of their products, the decade has been unremarkable.  Vanguard:

• Has 112 funds (which are sold in over 278 packages or share classes)
• 29 of their funds were launched in the past decade
• 106 of them are old enough to have earned Morningstar ratings
• 8 of them has a five star rating (as of 12/27/12)
• 57 more earned four-star ratings.

Morningstar awards five-stars to the top 10% of funds in a class and four-stars to the next 22.5%.  The table below summarizes what you’d expect from a firm of Vanguard’s size and then what they’ve achieved.

What does the chart suggest?  Vanguard is less likely to be “spectacular” than the numbers would suggest but more than twice as likely to be “really good.”  That makes a great deal of sense given the nature of Vanguard’s advantage: the “at cost” ethos and tight budget controls means that they enter each year with a small advantage over the market.  With time that advantage compounds but remains modest.

The funds launched in the past decade are mostly undistinguished, in the sense that they incorporate neither unusual combinations of assets (no “emerging markets balanced” or “global infrastructure” here) nor innovative responses to changing market conditions (as with “real return” or “inflation-tuned” ones).   The vast bulk are target-date funds, other retirement income products, or new indexed funds for conventional market segments.

They’ve launched about five new actively-managed retail funds which, as a group, peak out at “okay.”

This is not to suggest that Vanguard has been inattentive of their shareholders best interests.  Rather they seem to have taken an old adage to heart: “be like a duck, stay calm on the surface but paddle like hell underwater.”  I’m indebted to Taylor Larimore, co-founder of the Bogleheads, for sharing the link to a valedictory interview with Gus Sauter, who points out that Vanguard’s decided to shift the indexes on which their funds are based.  That shift will, over time, save Vanguard’s investors hundreds of millions of dollars.  It also exemplifies the enduring nature of Vanguard’s competitive advantage: the ruthless pursuit of many small, almost invisible gains for their investors, the sum of which is consistently superior results.

Celebrating Small Cap Season

The Observer has, of late, spent a lot of time talking about the challenge of managing volatility.  That’s led us to discussions of long/short, covered call, and strategic income funds.  The two best months for small cap funds are January and February.  Average returns of U.S. small caps in January from 1927 to 2011 were 2.3%, more than triple those in February, which 0.72%.  And so we teamed up again with the folks at FundReveal to review the small cap funds we’ve profiled and to offer a recommendation or two.

You can reach the individual profiles by clicking in the “Funds” tab on our main navigation bar.  We’re in the process of updating them all during January.  Because our judgments embody a strong qualitative element, we asked our resolutely quantitative friends at FundReveal to look at our small caps and to offer their own data-driven reading of some of them. Their full analysis can be found on their blog.

FundReveal’s strategy is to track daily return and volatility data, rather than the more common monthly or quarterly measures.  They believe that allows them to look at many more examples of the managers’ judgment at work (they generate 250 data points a year rather than four or twelve) and to arrive at better predictions about a fund’s prospects.  One of FundReveal’s key measures is Persistence, the likelihood that a particular pattern of risk and return repeats itself, day after day.  In general, you can count on funds with higher persistence. Here are their highlights:

The MFO funds display, in general, higher volatility than the S&P 500 for both 2012 YTD and the past 5 years.  The one fund that had lower volatility in both time horizons is Pinnacle Value (PVFIX).   PVFIX demonstrates consistent performance with low volatility, factors to be combined with subjective analysis available from other sources.

Two other funds have delivered high ADR (Average Daily Return), but also present higher risk than the S&P.  In this case Southern Sun Small Cap (SSSFX) and Walthausen Small Cap (WSCVX) have high relative volatility, but they have delivered high ADR over both time horizons.  From the FundReveal perspective, SSSFX has the edge in terms of decision-making capability because it has delivered higher ADR than the S&P in 10 Quarters and lower ADR in 6 Quarters, while WSCVX had delivered higher ADR than the S&P in 7 Quarters and lower ADR in 7 Quarters.  

So, bottom line, from the FundReveal perspective PVFIX and SSSFX are the more attractive funds in this lineup. 

Some Small Cap funds worthy of consideration:

Small Blend 

• Schwartz Value fund (RCMFX): Greater than S&P ADR, Lower Volatility (what we call “A” performance) for 2012 YTD and 2007-2012 YTD.  It has a high Persistence Rating (40%) that indicates a historic tendency to deliver A performance on a quarterly basis. 
• Third Avenue Small-Cap Fund (TVSVX): Greater than S&P ADR, Lower Volatility with a medium Persistence Rating (33%).

Small Growth

• Wasatch Micro Cap Value fund (WAMVX): Greater than  S&P ADR, Lower Volatility 2007-2012 YTF, with a medium Persistence Rating (30%).  No FundReveal covered Small Growth funds delivered “A” performance in 2012 YTD. (WAMVX is half of Snowball’s Roth IRA.)

Small Value

• Pinnacle Value Fund (PVFIX): An MFO focus fund, discussed above.  It has a high Persistence Rating (50%).
• Intrepid Small Cap Fund (ICMAX ): Greater than  S&P ADR, Lower Volatility for 2007-2012 YTF, with a high Persistence Rating (55%). Eric Cinnamond, who now manages Aston River Road Independent Value, managed ICMAX from 2005-10.
• ING American Century Small-Mid Cap Value (ISMSX): Greater than  S&P ADR, Lower Volatility for 2007-2012 YTF, with a medium Persistence Rating (25%).

If you’re intrigued by the potential for fine-grained quantitative analysis, you should visit FundReveal.  While theirs is a pay service, free trials are available so that you can figure out whether their tools will help you make your own decisions.

Ameristock’s Curious Struggle

Nick Gerber’s Ameristock (AMSTX) fund was long an icon of prudent, focused investing but, like many owner-operated funds, is being absorbed into a larger firm.  In this case, it’s moving into the Drexel Hamilton family of funds.

Or not.  While these transactions are generally routine, a recent SEC filing speaks to some undiscussed turmoil in the move.  Here’s the filing:

As described in the Supplement Dated October 9, 2012 to the Prospectus of Ameristock Mutual Fund, Inc. dated September 28, 2012, a Special Meeting of Shareholders of the Ameristock Fund  was scheduled for December 12, 2012 at 11:00 a.m., Pacific Time, for shareholders to vote on a proposed Agreement and Plan of Reorganization and Termination pursuant to which the Ameristock Fund would be reorganized into the Drexel Hamilton Centre American Equity Fund, a series of Drexel Hamilton Mutual Funds, resulting in the complete liquidation and termination of the Ameristock Fund. The Special Meeting convened as scheduled on December 12, 2012, but was adjourned until … December 27, 2012.   … The Reconvened Special Meeting was reconvened as scheduled on December 27, 2012, but has again been adjourned and will reconvene on Thursday, January 10, 2012 …

Uh-huh. 

Should Old Acquaintance Be Forgot and Never Brought to Mind?

Goodness, no.

How long can a fund be incredibly, eternally awful and still survive?  The record is doubtless held by the former Steadman funds, which were ridiculed as the Deadman funds and eventually hid out as the Ameritor funds. They managed generations of horrible ineptitude. How horrible?  In the last decade of their existence (through 2007), they lost 98.98%.  That’s the transformation of $10,000 into $102. Sufficiently horrible that they became a case study at Stanford’s Graduate School of Business.

In celebrating the season of Auld Lang Syne, I set out to see whether there were any worthy successors on the horizon.  I scanned Morningstar’s database for funds which trailed at least 99% of the peers this year.  And over the past five years.  And 10 and 15 years.

Five funds actually cropped up as being that bad that consistently.  The good news for investors is that the story isn’t quite as bleak as it first appears.

Jaffe’s Year-End Explosion

I’m not sure that Chuck Jaffe is the hardest-working man in the fund biz, but he does have periods of prodigious output.  December is one of those periods.   Chuck ran four features this month worth special note.

• Farewell to Stupid Investments.  After nearly a decade, Chuck has ended down his “Stupid Investment of the Week” column.  Chuck’s closing columns echoes Cassius, in Shakespeare’s Julius Caesar: “The fault, dear Brutus, is not in our stars, But in ourselves, that we are underlings.”  Or perhaps Pogo, “we have met the enemy and he is us.”
• 17^th Annual Lump of Coal Awards, December 10 and December 17.  This is the litany of stupidity surrounding the fund industry, from slack-wit regulators to venal managers.  One interesting piece discusses Morningstar’s analyst ratings.  Morningstar’s ratings roughly break the universe down into good ideas (gold, silver, bronze), okay ideas (neutral) and bad ideas (negative).  Of the 1000+ funds rated so far, only 5%qualify for negative ratings.  Morningstar’s rejoinder is that there are 5000 unrated funds, the vast bulk of which don’t warrant any attention.  So while the 5% might be the tip of a proverbial iceberg, they represent the funds with the greatest risk of attracting serious investor attention.

  My recommendation, which didn’t make Chuck’s final list, was to present a particularly grimy bit o’ bituminous to the fund industry for its response to the bond mania.  Through all of 2012, the industry closed a total of four funds to new investment while at the same time launching 39 new bond funds.  That’s looks a lot like the same impulse that led to the launch of B2B Internet Services funds (no, I’m not making that up) just before the collapse of the tech bubble in 2000; a “hey, people want to buy this stuff so we’ve got an obligation to market it to them” approach.

• Tales from the Mutual Fund Crypt, December 26: stories of recently-departed funds.  A favorite: the Auto-Pilot fund’s website drones on, six months after the fund’s liquidation.  It continues to describe the fund as “new,” six years after launch.

  My nominee was generic: more funds are being shut down after 12 – 18 months of operation which smacks of hypocrisy (have you ever heard of a manager who didn’t preach the “long-term investor” mantra yet the firms themselves have a short-term strategy) and incompetence (in fund design and marketing both).

Chuck’s still podcasting, MoneyLife with Chuck Jaffe.  One cool recent interview was with Doug Ramsey, chief investment officer for the Leuthold Funds.

ASTON/River Road Long-Short Conference Call

On December 17, about fifty readers joined us for an hour-long conversation with Matt Moran and Daniel Johnson, managers of ASTON/River Road Long-Short (ARLSX).  For folks interested but unable to join us, here’s the complete audio of the hour-long conversation.  It starts with Morty Schaja, River Road’s president, talking about the fund’s genesis and River Road’s broader discipline and track record: 

If you’d like a preview before deciding whether you listen in, you might want to read our profile of ARLSX (there’s a printable .pdf of the profile on Aston’s website and an audio profile, which we discuss below).  Here are some of the highlights of the conversation:

Quick highlights:

1. they believe they can outperform the stock market by 200 bps/year over a full market cycle. Measuring peak to peak or trough to trough, both profit and stock market cycles average 5.3 years, so they think that’s a reasonable time-frame for judging them.
2. they believe they can keep beta at 0.3 to 0.5. They have a discipline for reducing market exposure when their long portfolio exceeds 80% of fair value. The alarms rang in September, they reduce expose and so their beta is now at 0.34, near their low.
3. risk management is more important than return management, so all three of their disciplines are risk-tuned. The long portfolio, 15-30 industry leaders selling at a discount of at least 20% to fair value, tend to be low-beta stocks. Even so their longs have outperformed the market by 9%.
4. River Road is committed to keeping the fund open for at least 8 years. It’s got $8 million in asset, the e.r. is capped at 1.7% but it costs around 8% to run. The president of River Road said that they anticipated slow asset growth and budgeted for it in their planning with Aston.
5. The fund might be considered an equity substitute. Their research suggests that a 30/30/40 allocation (long, long/short, bonds) has much higher alpha than a 60/40 portfolio.

An interesting contrast with RiverPark, where Mitch Rubin wants to “play offense” with both parts of the portfolio. Here the strategy seems to hinge on capital preservation: money that you don’t lose in a downturn is available to compound for you during the up-cycle.

Conference Calls Upcoming: Matthews, Seafarer, Cook & Bynum on-deck

As promised, we’re continuing our moderated conference calls through the winter.  You should consider joining in.  Here’s the story:

• Each call lasts about an hour
• About one third of the call is devoted to the manager’s explanation of their fund’s genesis and strategy, about one third is a Q&A that I lead, and about one third is Q&A between our callers and the manager.
• The call is, for you, free.  Your line is muted during the first two parts of the call (so you can feel free to shout at the danged cat or whatever) and you get to join the question queue during the last third by pressing the star key.

Our next conference call features Teresa Kong, manager of Matthews Asia Strategic Income (MAINX).  It’s Tuesday, January 22, 7:00 – 8:00 p.m., EST.

Matthews is the fund world’s best, deepest, and most experienced team of Asia investors.  They offer a variety of funds, all of which have strong – and occasionally spectacular – long-term records investing in one of the world’s fastest-evolving regions.  While income has been an element of many of the Matthews portfolios, it became a central focus with the December 2011 launch of MAINX.  Ms. Kong, who has a lot of experience with first-rate advisors including BlackRock, Oppenheimer and JPMorgan, joined Matthews in 2010 ahead of the launch of this fund. 

Why might you want to join the call? 

Bonds across the developed world seem poised to return virtually nothing for years and possibly decades. For many income investors, Asia is a logical destination. Three factors support that conclusion:

1. Asian governments and corporations are well-positioned to service their debts. Their economies are growing and their credit ratings are being raised.
2. Most Asian debt supports infrastructure, rather than consumption.
3. Most investors are under-exposed to Asian debt markets. Bond indexes, the basis for passive funds and the benchmark for active ones, tend to be debt-weighted; that is, the more heavily indebted a nation is, the greater weight it has in the index. Asian governments and corporations have relatively low debt levels and have made relatively light use of the bond market. An investor with a global diversified bond portfolio (70% Barclays US Aggregate bond index, 20% Barclays Global Aggregate, 10% emerging markets) would have only 7% exposure to Asia. However you measure Asia’s economic significance (31% of global GDP, rising to 38% in the near future or, by IMF calculations, the source of 50% of global growth), even fairly sophisticated bond investors are likely underexposed.

The question isn’t “should you have more exposure to Asian fixed-income markets,” but rather “should you seek exposure through Matthews?” The answer, in all likelihood, is “yes.” Matthews has the largest array of Asia investment products in the U.S. market, the deepest analytic core and the broadest array of experience. They also have a long history of fixed-income investing in the service of funds such as Matthews Asian Growth & Income (MACSX). Their culture and policies are shareholder-friendly and their success has been consistent. Ms. Kong has outstanding credentials and has had an excellent first year.

How can you join in? 

Click on the “register” button and you’ll be taken to Chorus Call’s site, where you’ll get a toll free number and a PIN number to join us.  On the day of the call, I’ll send a reminder to everyone who has registered.

Would an additional heads up help? 

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

Podcasts and Profiles

If you look at our top navigation bar, you’ll see a new tab and a new feature for the Observer. We’re calling it our Podcast page, but it’s much more.  It began as a suggestion from Ira Artman, a talented financial services guy and a longtime member of the FundAlarm and Observer community.  Ira suggested that we archive together the audio recordings of our conference calls and audio versions of the corresponding fund profiles. 

Good idea, Ira!  We went a bit further and create a resource page for each fund.  The page includes:

• The fund’s name, ticker symbols and its manager’s name
• Written highlights from the conference call
• A playable/downloadable .mp3 of the call
• A link to the fund profile
• A playable/downloadable .mp3 of the fund profile.  The audio profiles start with the print profile, which we update and edit for aural clarity.  Each profile is recorded by Emma Presley, a bright and mellifluous English friend of ours.
• A link to the fund’s most recent fact sheet on the fund’s website.

We have resource pages for RiverPark Short Term High-Yield, RiverPark Long/Short Opportunity and Aston/River Road Long Short.  The pages for Matthews Asia Strategic Income, Seafarer Overseas Growth & Income, and Cook and Bynum are in the works.

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 a single Star in the Shadows:

Bridgeway Managed Volatility (BRBPX): Dick Cancelmo appreciates RiverNorth Dynamic Buy-Write’s strategy and wishes them great success, but also points out that others have been successful using a similar strategy for well over a decade.  Indeed, over the last 10 years, BRBPX has quietly produced 70% of the stock market’s gains with just 40% of its volatility.

BRBPX and the Mystery of the Incredible Shrinking Fund

While it’s not relevant to the merit of BRBPX and doesn’t particularly belong in its profile, the collapse of the fund’s asset base is truly striking.  In 2005, assets stood around $130 million.  Net assets have declined in each of the past five years from $75 million to $24 million.  The fund has made money over that period and is consistently in the top third of long/short funds.

Why the shrinkage?  I don’t know.  The strategy works, which should at least mean that existing shareholders hang on but they don’t.  My traditional explanation has been, because this fund is dull. Dull, dull, dull.  Dull stocks and dull bonds with one dull (or, at least, technically dense) strategy to set them apart.  Part of the problem is Bridgeway.  This is the only Bridgeway fund that targets conservative, risk-conscious investors which means the average conservative investor would find little to draw them to Bridgeway and the average Bridgeway investor has limited interest in conservative funds.  Bridgeway’s other funds have had a performance implosion.  When I first profiled BRBPX, five of the six funds rated by Morningstar had five-star designations.  Today none of them do.  Instead, five of eight rated funds carry one or two stars.  While BRBPX continues to have a four-star rating, there might be a contagion effect. 

Mr. Cancelmo attributes the decline to Bridgeway’s historic aversion to marketing.  “We had,” he reports, “the ‘if you build a better mousetrap’ mindset.  We’ve now hired a business development team to help with marketing.”  That might explain why they weren’t drawing new assets, but hardly explains have 80% of assets walking out the door.

If you’ve got a guess or an insight, I’d love to hear of it.  (Dick might, too.)  Drop me a note.

As a side note, Bridgeway probably offers the single best Annual Report in the industry.  You get a startling degree of honesty, thoughtfulness and clarity about both the funds and their take on broader issues which impact them and their investors.  I was particularly struck by a discussion of the rising tide of correlations of stocks within the major indices.  Here’s the graphic they shared:

What does it mean?  Roughly, a generation ago you could explain 20% of the movement of the average stock’s price by broader movements in the market.   As a greater and greater fraction of the stock market’s trades are made in baskets of stocks (index funds, ETFs, and so on) rather than individual names, more and more of the fate of each stock is controlled by sentiments surrounding its industry, sector, peers or market cap.  That’s the steady rise of the line overall.  And during a crisis, almost 80% of a stock’s movement is controlled by the market rather than by a firm’s individual merits.  Bridgeway talks through the significance of that for their funds and encourages investors to factor it into their investment decisions.

The report offers several interesting, insightful discussions, making it the exact opposite of – for example – Fidelity’s dismal, plodding, cookie cutter reports.

Here’s our recommendation: if you run a fund, write such like Bridgeway’s 2012 Annual Report.  If you’re trying to become a better investor, read it!

Launch Alert: RiverNorth/Oaktree High Income (RNHIX, RNOTX)

RiverNorth/Oaktree High Income Fund launched on December 28.  This is a collaboration between RiverNorth, whose specialty has been tactical asset allocation and investing in closed-end funds (CEFs), and Oaktree.  Oaktree is a major institutional bond investor with about $80 billion under management.  Oaktree’s clientele includes “75 of the 100 largest U.S. pension plans, 300 endowments and foundations, 10 sovereign wealth funds and 40 of the 50 primary state retirement plans in the United States.”  Their specialties include high yield and distressed debt and convertible securities.  Until now, the only way for retail investors to access them was through Vanguard Convertible Securities (VCVSX), a four-star Gold rated fund.

Patrick Galley, RiverNorth’s CIO, stresses that this is “a core credit fund (managed by Oaktree) with a high income opportunistic CEF strategy managed by RiverNorth.”  The fund has three investment strategies, two managed by Oaktree.  While, in theory, Oaktree’s share of the portfolio could range from 0 – 100%, as a normal matter they’ll manage the considerable bulk of the portfolio.  Oaktree will have the freedom to allocate between their high-yield and senior loan strategies.  RiverNorth will focus on income-producing CEFs.

For those already invested in RiverNorth funds, Mr. Galley explained the relationship of RNHIX to its siblings:

We are staying true to the name and focusing on income producing closed-end funds, but unlike RNSIX (which focuses on income producing fixed income) and RNDIX (which focuses on income producing equities) and RNCOX (which doesn’t have an income mandate and only distributes once a year), RNHIX will invest across the CEF spectrum (i.e. all asset classes) but with a focus on income without sacrificing/risking total return.

The argument for considering this fund is similar to the argument for considering RiverNorth/DoubleLine Strategic Income.  You’re hiring world-class experts who work in inefficient segments of the fixed-income universe. 

RiverNorth had the risk and return characteristics for a bunch of asset classes charted.

You might read the chart as saying something like: this is a strategy that could offer equity-like returns with more nearly bond-like volatility.  In a world where mainstream, investment-grade bonds are priced to return roughly nothing, that’s an option a reasonable person would want to explore.

The retail expense ratio is capped at 1.60% and the minimum initial investment is $5000.

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.

Funds in registration this month won’t be available for sale until, typically, the beginning of March 2013. We found 15 funds in the pipeline, notably:

Investors Variable NAV Money Market Fund, one of a series of four money markets managed by Northern Trust, all of which will feature variable NAVs.  This may be a first step in addressing a serious problem: the prohibition against “breaking the buck” is forcing a lot of firms to choose between underwriting the cost of running their money funds or (increasingly) shutting them down.

LSV Small Cap Value Fund is especially notable for its management team, led by Josef Lakonishok is a reasonably famous academic who did some of the groundbreaking work on behavioral finance, then translated that research into actual investment strategies through private accounts, hedge funds, and his LSV Value Equity Fund (LSVEX) fund.

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.

On a related note, we also tracked down 31 fund manager changes, including a fair number of folks booted from ING funds.

Briefly Noted

According to a recent SEC filing, Washington Mutual Investors Fund and its Tax-Exempt Fund of Maryland and Tax-Exempt Fund of Virginia “make available a Spanish translation of the above prospectus supplement in connection with the public offering and sale of its shares. The English language prospectus supplement above is a fair and accurate representation of the Spanish equivalent.”  I’m sure there are other Spanish-language prospectuses out there, but I’ve never before seen a notice about one.  It’s especially interesting given that tax-exempt bond funds target high income investors. 

Effective January 1, DWS is imposing a $20/year small account service fee for shareholders in all 49 of their funds.  The fee comes on top of their sales loads.  The fee applies to any account with under $10,000 which is regrettable for a firm with a $1,000 minimum initial investment.  (Thanks to chip for having spotted this filing in the SEC’s database.  Regrets for having gotten friends into the habit of scanning the SEC database.)

Closings

Eaton Vance Atlanta Capital SMID-Cap (EAASX) is closing to new investors on Jan. 15.  More has been pouring in (on the order of $1.5 billion in a year); at least in part driven by a top-notch five-year rating.

Walthausen Small Cap Value (WSCVX) closed to new investors at the end of the year.  At the same time, the minimum initial investment for the $1.7 million Walthausen Select Value Investor Class (WSVIX) went from $10,000 to $100,000.  WSCVX closed on January 1 at $560 million which might explain was they’re making the other fund’s institutional share class harder to access.

William Blair International Growth (WBIGX) closed to new investors, effective Dec. 31.

Old Wine in New Bottles

American Century Inflation Protection Bond (APOIX) has been renamed American Century Short Duration Inflation Protection Bond. The fund has operated as a short-duration offering since August 2011, when its benchmark changed to the Barclays U.S. 1-5 Year Treasury Inflation Protected Securities Index.

Federated Prudent Absolute Return (FMAAX) is about to become less Prudent.  They’re changing their name to Federated Absolute Return and removed the manager of the Prudent Bear fund from the management team.

Prudential Target Moderate Allocation (PAMGX) is about to get a new name (Prudential Defensive Equity), mandate (growth rather than growth and income) and management structure (one manager team rather than multiple).  It is, otherwise, virtually unchanged. 

Prudential Target Growth Allocation (PHGAX) is merging into Prudential Jenison Equity Income (SPQAX).

U.S. Global Investors Global MegaTrends (MEGAX) is now U.S. Global Investors MegaTrends and no longer needs to invest outside the U.S. 

William Blair Global Growth (WGGNX) will change its name to William Blair Global, and William Blair Emerging Leaders Growth (WELNX) will change its name to William Blair Emerging Markets Leaders.

Small wins for investors

Cook & Bynum Fund (COBYX), a wildly successful, super-concentrated value fund, has decided to substantially reduce their expense ratio.  President David Hobbs reports:

… given our earlier dialogue about fees, I wanted to let you know that as of 1/1/13 the all-in expense ratio for the fund will be capped at 1.49% (down from 1.88%).  This is a decision that we have been wrestling with for some time internally, and we finally decided that we should make the move to broaden the potential appeal of the fund. . . .  With the fund’s performance (and on-going 5-star ratings with Morningstar and S&P Capital IQ), we decided to take a calculated risk that this new fee level will help us grow the fund.

Our 2012 profile of the fund concluded, “Cook and Bynum might well be among the best.  They’re young.  The fund is small and nimble.  Their discipline makes great sense.  It’s not magic, but it has been very, very good and offers an intriguing alternative for investors concerned by lockstep correlations and watered-down portfolios.”  That makes the decreased cost especially welcome.  (They also have a particularly good website.)

Effective January 2, 2013, Calamos Growth and Income and Global Growth and Income Funds re-opened to new investors. (Thanks to The Shadow for catching this SEC filing.)

ING Small Company (AESAX) has reopened.  It’s reasonably large and not very good, really.

JPMorgan (JPM) launched Total Emerging Markets (TMGGX), an emerging-markets allocation fund.

Fund firms have been cutting expenses of late as they pressure to gather and hold assets builds. 

Fidelity has reduced the minimum investment on its Advantage share class from $100,000 to $10,000.  The Advantage class has lower expense ratios (which is good) and investors who own more than $10,000 in a fund’s retail Investor class will be moved automatically to the less-expensive Advantage class.

Fido also dropped the minimums on nearly two dozen index and enhanced index products from $10,000 to $2,500, which gives a lot more folks access to low-cost passive (or nearly-passive) shares. 

Fido also cut fees on eight Spartan index funds, between one to eight basis points.  The Spartan funds had very low expenses to begin with (10 basis points in some cases), so those cuts are substantial.

GMO Benchmark-Free Allocation (GBMFX) has decreased its expense ratio from 87 basis points down to 81 bps by increasing its fee waiver.  The fund is interesting and important not because I intend to invest in in soon (the minimum is $10 million) but because it represents where GMO thinks that an investor who didn’t give a hoot about other people’s opinions (that’s the “benchmark-free” part) should invest.

Effective January 1, Tocqueville Asset Management L.P. capped expenses for Tocqueville International Value at 1.25% of the fund’s average daily net assets.  Until now investors have been paying 1.56%. 

Also effective January 1, TCW Investment Management Company reduced the management fees for the TCW High Yield Bond Fund from 0.75% to 0.45%.

Vanguard has cut fees on 47 products, which include both ETFs and funds. Some of the cuts went into effect on Dec. 21, while others went into effect on Dec. 27th.  The reductions on eleven ETFs — four stock and seven bond — on December 21. Those cuts range from one to two basis points. That translates to reductions of 3 – 15%.

Off to the Dustbin of History

The board of trustees of Altrius Small Cap Value (ALTSX) has closed the fund and will likely have liquidated it by the time you read this.  On the one hand, the fund only drew $180,000 in assets.  On the other, the members of the board of trustees receive $86,000/year for their services, claim to be overseeing between 97 – 100 funds and apparently have been doing so poorly, since they received a Wells Notice from the SEC in May 2012.  They were bright even not to place a penny of their own money in the fund.  One of the two managers was not so fortunate: he ate a fair portion of his own cooking and likely ended up with a stomach cramp.

American Century will liquidate American Century Equity Index (ACIVX) in March 2013. The fund has lost 75% of its assets in recent years, a victim of investor disillusionment with stocks and high expenses.  ACIVX charged 0.49%, which seems tiny until you recall that identical funds can be had for as little as 0.05% (Vanguard, naturally).

Aston Asset Management has fired the Veredus of Aston/Veredus Small Cap Growth (VERDX) and will merge the fund in Aston Small Cap Growth (ACWDX).  Until the merger, it will go by the name Aston Small Cap.

The much-smaller Aston/Veredus Select Growth (AVSGX) will simply be liquidated.  But were struggling.

Federated Capital Appreciation, a bottom 10% kind of fund, is merging Federated Equity-Income (LEIFX).  LEIFX has been quite solid, so that’s a win.

GMO is liquidating GMO Inflation Indexed Plus Bond (GMIPX).  Uhh, good move.  Floyd Norris, in The New York Times, points out that recently-auctioned inflation-protected bonds have been priced to lock in a loss of about 1.4% per year over their lifetimes.   If inflation spikes, you might at best hope to break even.

HSBC will liquidate two money-market funds, Tax-Tree and New York Tax-Free in mid-January.

ING Index Plus International Equity (IFIAX) has closed and is liquidating around Feb. 22, 2013.  No, I don’t know what the “Plus” was.

Invesco is killing off, in April, some long-storied names in its most recent round of mergers.  Invesco Constellation (CSTGX) and Invesco Leisure (ILSAX) are merging into American Franchise (VAFAX).  Invesco Dynamics (IDYAX) goes into Mid Cap Growth (VGRAX), Invesco High-Yield Securities (HYLAX) into High Yield (AMHYX), Invesco Leaders (VLFAX) into Growth Allocation (AADAX), and Invesco Municipal Bond (AMBDX) will merge into Municipal Income (VKMMX).   Any investors in the 1990s who owned AIM Constellation (I did), Invesco Dynamics and Invesco Leisure would have been incredibly well-off.

Leuthold Global Clean Technology (LGCTX) liquidated on Christmas Eve Day. Steve Leuthold described this fund, at its 2009 launch, as “the investment opportunity of a generation.”  Their final letter to shareholders lamented the fund’s tiny, unsustainable asset base despite “strong performance relative to its comparable benchmark index” and noted that “the Fund operates in a market sector that has had challenging.”  Losses of 20% per year are common for green/clean/alternative funds, so one can understand the limited allure of “strong relative performance.”

Lord Abbett plan to merge Lord Abbett Stock Appreciation (LALCX) into Lord Abbett Growth Leaders (LGLAX) in late spring, 2013.

Munder International Equity (MUIAX) is merging into Munder International Core Equity (MAICX).

Natixis Absolute Asia Dynamic Equity (DEFAX) liquidated in December.  (No one noticed.)

TCW Global Flexible Allocation Fund (TGPLX) and TCW Global Moderate Allocation Fund (TGPOX) will be liquidated on or about February 15, 2013.  Effective the close of business on February 8, 2013, the Funds will no longer sell shares to new investors or existing shareholders.  These consistent laggards, managed by the same team, had only $10 million between them.  Durn few of those $10 million came from the managers.  Only one member of the management team had as much as a dollar at risk in any of TCW’s global allocation funds.  That was Tad Rivelle who had a minimal investment in Flexible.

In Closing …

Thank you all for your support in 2012. There are a bunch of numerical measures we could use. The Observer hosted 78,645 visitors and we averaged about 11,000 readers a month.  Sixty folks made direct contributions to the Observer and many others picked up $88,315.15 worth of cool loot (3502 items) at Amazon.  And a thousand folks viewed something like 1.6 million discussion topics. 

But, in many ways, the note that reads “coming here feels like sitting down with an old friend and talking about something important” is as valuable as anything we could point to. 

So thanks for it all.

If you get a chance and have a suggestion about how to make the Observer better in the year ahead, drop me a note and let me know.  For now, we’ll continue offering (and archiving) our monthly conference calls.  During January we’ll be updating our small cap profiles and February will see new profiles for Whitebox Long Short Equity (WBLSX) and PIMCO Short Asset Investment (PAIUX).

Until then, take care.

With hopes for a blessed New Year,

Dear friends,

And now, we wait.  After the frenzy of recent months, that seems odd and unnatural.

Will and his minions wait for the holidays, anxious for the last few weeks of school to pass but secure in the knowledge that their folks are dutifully keeping the retail economy afloat.

Photo by Drew Barnes ’14, Augustana Photo Bureau

My colleagues at Augustana are waiting for winter and then for spring.  The seemingly endless string of warm, dry weeks has left much of our fall foliage intact as we enter December. As beautiful as it is, we’re sort of rooting for winter, or at least the hope of seasonal weather, to reassert itself. And we’re waiting for spring, when the $13 million renovation of Old Main will be complete and we escape our warren of temporary offices and ersatz classrooms. I’ve toured the half-complete renovation. It’s going to be so cool.

And investors wait. Most of us are waiting for a resolution of “the fiscal cliff” (alternately: fiscal slope, obstacle course, whatchamacallit or, my favorite, Fiscal Clifford the Big Red Dog), half fearful that they won’t find a compromise and half fearful that they will.

Then there are The Two Who Wouldn’t Wait. And they worry me. A lot. We’ve written for a year or so about our concerns that the bond market is increasingly unstable. That concern has driven our search for tools, other than Treasuries or a bond aggregate, that investors might use to manage volatility. In the past month, the urgency of that search has been highlighted by The Two. One of The Two is Jeffrey Gundlach, founder of the DoubleLine funds and widely acknowledged as one of the best fixed-income managers anyway. Gundlach believes that “[d]eeply indebted countries and companies, which Gundlach doesn’t name, will default sometime after 2013” (Bond Investor Gundlach Buys Stocks, Sees ‘Kaboom’ Ahead, 11/30/2012). Gundlach says, “I don’t believe you’re going to get some sort of an early warning. You should be moving now.”  Gundlach, apparently, is moving into fine art.

GMO, the other of The Two, has moved. GMO (Grantham, Mayo, van Otterloo) has an outstanding record for anticipating asset class crashes. They moved decisively in 2000 and again in 2007, knowing that they were likely early and knowing that leaving the party early would cost them billions (one quarter of the firm’s assets) as angry investors left. But when the evidence says “run,” they ran. In a late-November interview with the Financial Times, GMO’s head of asset allocation revealed that, firm-wide, GMO had sold off all of their bond holdings (GMO abandons bond market, 11/26/2012). “We’ve largely given up on traditional fixed income,” Inker says, including government and corporate debt in the same condemnation. They don’t have any great alternatives (high quality US stocks are about the best option), but would prefer to keep billions in cash to the alternatives.

I don’t know whether you should wait. But I do believe that you should acquaint yourself with those who didn’t.

The Last Ten: PIMCO in the Past Decade

In October we launched “The Last Ten,” a monthly series, running between now and February, looking at the strategies and funds launched by the Big Five fund companies (Fido, Vanguard, T Rowe, American and PIMCO) in the last decade.

Here are our findings so far:

Fidelity, once fabled for the predictable success of its new fund launches, has created no compelling new investment option and only one retail fund that has earned Morningstar’s five-star designation, Fidelity International Growth (FIGFX).  We suggested three causes: the need to grow assets, a cautious culture and a firm that’s too big to risk innovative funds.

T. Rowe Price continues to deliver on its promises.  Of the 22 funds launched, only Strategic Income (PRSNX) has been a consistent laggard; it has trailed its peer group in four consecutive years but trailed disastrously only once (2009).  Investing with Price is the equivalent of putting a strong singles-hitter on a baseball team; it’s a bet that you’ll win with consistency and effort, rather than the occasional spectacular play.

And just as you’re about to conclude that large fund companies will necessarily produce cautious funds that can aspire just to “pretty good,” along comes PIMCO.  PIMCO was once known as an almost purely fixed-income investor.  Its flagship PIMCO Total Return Fund has gathered over a quarter trillion dollars in assets and tends to finish in the top 10% of its peer group over most trailing time periods.

But PIMCO has become more.  This former separate accounts managers for Pacific Life Insurance Company now declares, “We continue to evolve. Throughout our four decades we have been pioneers and continue to evolve as a provider of investment solutions across all asset classes.”

Indeed they have.  PIMCO has spent more time thinking about, and talking about, the global economic future than any firm other, perhaps, than GMO.  More than talk about the changing sources of alpha and the changing shape of risk, PIMCO has launched a bunch of unique funds targeting emerging challenges and opportunities that other firms would prefer simply to ignore (or to eventually react to).

Perhaps as a result, PIMCO has created more five-star funds in the last decade than any other firm and, among larger firms, has a greater fraction of their funds earning four- or five-stars than anyone else.  Here’s the snapshot:

• PIMCO has 84 funds (which are sold in over 536 packages or share classes)
• 56 of their funds were launched in the past decade
• 61 of them are old enough to have earned Morningstar ratings
• 20 of them have five-star ratings (as of 11/14/12)
• 15 more earned four-star ratings.

How likely this that?  In each Morningstar category, the top 10 percent of funds receive five stars, the next 22.5 percent receive four stars, and the next 35 percent receive three.  In the table below, those are the “expected values.”  If PIMCO had just ordinary skill or luck, you’d expect to see the numbers in the expected values column.  But you don’t.

Only their RealRetirement funds move between bad and mediocre, and even those funds made yet be redeemed.  The RealRetirement funds, like PIMCO’s other “Real” funds, are designed to be especially sensitive to inflation.  That’s the factor that poses the greatest long-term risk to most of our portfolios, especially as they become more conservative.  Until we see a sustained uptick in inflation, we can’t be sure of how well the RealRetirement funds will meet their mandates.  But, frankly, PIMCO’s record counsels patience.

Here are all of the funds that PIMCO has launched in the last 10 years, which their Morningstar rating (as of mid-November, 2012), category and approximate assets under management.

In January, we’ll continue the series of a look at Vanguard.  We know that Vanguard inspires more passion among its core investors than pretty much any other firm.  Since we’re genial outsiders to the Vanguard culture, if you’ve got insights, concerns, tips, kudos or rants you’d like to share, dear Bogleheads, drop me a note.

RiverPark Long/Short Opportunity Conference Call

Volatility is tremendously exciting for many investment managers.  You’d be amazed by the number who get up every morning, hoping for a market panic.  For the rest of us, it’s simply terrifying.

For the past thirty years, the simple, all-purpose answer to unacceptable volatility has been “add Treasuries.”  The question we began debating last spring is, “where might investors look if Treasuries stop functioning as the universal answer?”  We started by looking at long/short equity funds as one possible answer.  Our research quickly led to one conclusion, and slowly to a second.

The quick conclusion: long/short funds, as a group, are a flop. They’re ridiculously expensive, with several dozen charging 2.75% or more plus another 1.5-2% in short interest charges.  They offered some protection in 2008, though several did manage to lose more that year than did the stock market.  But their longer term returns have been solidly dismal.  The group returned 0.15% over the past five years, which means they trailed far behind the stock market, a simple 60/40 hybrid, moderate allocation funds, very conservative short-term bond funds . . . about the only way to make this bunch look good is to compare them to “market neutral” funds (whose motto seems to be, “we can lose money in up markets and down!”).

The slower conclusion: some long-short funds have consistently, in a variety of markets, managed to treat their investors well and a couple more show the real promise of doing so. The indisputable gold standard among such funds, Robeco Long Short (BPLEX) returned 16% annually over the past five years.  The second-best performer, Marketfield (MFLDX) made 9% while funds #3 (Guggenheim Alpha) and #4 (Wasatch Long/Short) made 4%. Sadly, BPLEX is closed to new investors, Guggenheim has always had a sales load and Marketfield just acquired one. Wasatch Long-Short (FMLSX), which we first profiled three years ago, remains a strong, steady performer with reasonable expenses.

Ultimately we identified (and profiled) just three, newer long-short funds worthy of serious attention: Marketfield, RiverPark Long/Short Opportunity (RPLSX) and ASTON/River Road Long Short (ARLSX).

For about an hour on November 29th, Mitch Rubin, manager of RiverPark Long/Short Opportunity(RLSFX) fielded questions from Observer readers about his fund’s strategy and its risk-return profile.  Nearly 60 people signed up for the call.

For folks interested but unable to join us, here’s the complete audio of the hour-long conversation.  It starts with Morty Schaja, RiverPark’s president, talking about the fund’s genesis and Mr. Rubin talking about its strategy.  After that, I posed five questions of Rubin and callers chimed in with another half dozen.

If you’d like a preview before deciding whether you listen in, you might want to read our profile of RLSFX (there’s a printable .pdf of the profile on RiverPark’s website).  Here are some of the highlights of the conversation:

Rubin believes that many long/short mutual fund managers (as opposed to the hedge fund guys) are too timid about using the leverage allowed them.  As a result, they’re not able to harvest the full returns potential of their funds.  Schaja describes RLSFX’s leverage as “moderate,” which generally means having investments equal to 150-200% of assets.

The second problem with long/short managers as a group, he believes, is that they’re too skittish.  They obsess about short-term macro-events (the fiscal cliff) and dilute their insights by trying to bet for or against industry groups (by shorting ETFs, for example) rather than focusing on identifying the best firms in the best industries.

One source of RLSFX’s competitive advantage is the team’s long history of long investing.  They started following many of the firms in their portfolio nearly two decades ago, following their trajectory from promising growth stocks (in which they invested), stodgy mature firms (which they’d sold) and now old firms in challenged industries (which are appearing in the short portfolio).

A second source of advantage is the team’s longer time horizon.  Their aim is to find companies which might double their money over the next five years and then to buy them when their price is temporarily low.

I’d like to especially thank Bill Fuller, Jeff Mayer and Richard Falk for the half dozen really sharp, thoughtful questions that they posed during the closing segment.  If you catch no other part of the call, you might zoom in on those last 15 minutes to hear Mitch and the guys in conversation.

Mr. Rubin is an articulate advocate for the fund, as well as being a manager with a decades-long record of success.  In addition to listening to his conversation, there are two documents on the Long/Short fund’s homepage that interested parties should consult.  First, the fund profile has a lot of information about the fund’s performance back when it was a hedge fund which should give you a much better sense of its composition and performance over time.  Second, the manager’s commentary offers an intriguing list of industries which they believe to be ascendant or failing.  It’s sort of thought-provoking.

Conference Calls Upcoming: Great managers on-deck

As promised, we’re continuing our moderated conference calls through the winter.  You should consider joining in.  Here’s the story:

• Each call lasts about an hour
• About one third of the call is devoted to the manager’s explanation of their fund’s genesis and strategy, about one third is a Q&A that I lead, and about one third is Q&A between our callers and the manager.
• The call is, for you, free.  Your line is muted during the first two parts of the call (so you can feel free to shout at the danged cat or whatever) and you get to join the question queue during the last third by pressing the star key.

Our next conference call features Matt Moran and Dan Johnson, co-managers of ASTON / River Road Long Short (ARLSX).   I’ve had several conversations with the team and they strike me as singularly bright, articulate and disciplined.  When we profiled the fund in June, we noted:

The strategy’s risk-management measures are striking.  Through the end of Q1 2012, River Road’s Sharpe ratio (a measure of risk-adjusted returns) was 1.89 while its peers were at 0.49.  Its maximum drawdown (the drop from a previous high) was substantially smaller than its peers, it captured less of the market’s downside and more of its upside, in consequence of which its annualized return was nearly four times as great.

Among the crop of newer offerings, few are more sensibly-constructed or carefully managed that ARLSX seems to be.  It deserves attention.

If you’d like to share your attention with them, our call with ASTON / River Road Long  Short is Monday, December 17, from 7:00 – 8:00 Eastern.  To register for the call, just click on this link and follow the instructions.  I’ll send a reminder email on the day of the call to all of the registered parties.

As a service to our readers, we’ve constructed a mailing list that we’ll use to notify folks of upcoming conference call opportunities.  If you’d like to join but haven’t yet, feel free to drop me a note.

Fidelity’s Advice to Emerging Markets Investors: Avoid Us

Fidelity runs several distinct sets of funds, including Fidelity, Fidelity Advisor, Fidelity Select, and Fidelity Series.  In many ways, the most interesting are their Strategic Adviser funds which don’t even bear the Fidelity name.  The Strategic Adviser funds are “exclusive to clients of Portfolio Advisory Services. . . They allow Strategic Advisers to hire (and fire) sub-advisers as well as to buy, sell, and hold mutual funds and exchange-traded funds (ETFs) within the fund.”  In short, these are sort of “best ideas”  funds, two of which are funds of funds.

Which led to the question: would the smartest folks Fidelity could find, who could choose any funds around which to build a portfolio, choose Fidelity?

In the case of emerging markets, the answer is “uhh … no.”  Here’s the portfolio for Strategic Advisers Emerging Markets Fund of Funds (FLILX).

What should you notice?

1. The fund’s managers seem to find many funds more compelling than Fidelity Emerging Markets, and so it ends up sixth on the list.  Fidelity’s corporate folks seem to agree and they replaced the long-time manager of this one-star fund in mid October, 2012.
2. Measured against the March 2012 portfolio, Fidelity E.M. has seen the greatest decrease in its weighing (about 3.2%) of any fund in the portfolio.
3. Missing entirely from the list: Fidelity’s entire regional lineup including China Region, Emerging Asia, Emerging Middle East and Latin America.
4. For that matter, missing entirely from the list are anything but diversified large cap emerging markets stock funds.

Fidelity does noticeably better in the only other Strategic Advisers fund of funds, the Strategic Advisers^® Income Opportunities Fund of Funds (FSADX).

Why, exactly, the managers have invested in three different classes of the same Fidelity fund is a bit unclear but at least they are willing to invest with Fido.  It may also speak to the continuing decline of the Fidelity equity-investing side of the house while fixed-income becomes increasingly

A Site Worth Following: Learn Bonds

Junior Yearwood, our friend and contributing editor who has been responsible for our Best of the Web reviews, has been in conversation with Marc Prosser, a Forbes contributor and proprietor of the Learn Bonds website.  While the greatest part of Marc’s work focuses broadly on bond investing, he also offers ratings for a select group of bond mutual funds.  He has a sort of barbell approach, focusing on the largest bond fund companies and on the smallest.  His fund ratings, like Morningstar’s analyst ratings, are primarily qualitative and process-focused.

Marc doesn’t yet have data by which to assess the validity of his ratings (and, indeed, is articulately skeptical of that whole venture), so we can’t describe him as a Best of the Web site.  That said, Junior concluded that his site was clean, interesting, and worth investigating.  It was, he concluded, a new and notable site.

Launch Alert: Whitebox Long Short Equity (WBLSX,WBLRX,WBLFX)

On November 1, Whitebox Advisors converted their Whitebox Long Short Equity Partners hedge fund into the Whitebox Long Short Equity Fund which has three share classes.  As a hedge fund, Whitebox pretty much kicked butt.  From 2004 – 2012, it returned 15.8% annually while the S&P500 earned 5.2%.  At last report, the fund was just slightly net-long with a major short against the Russell 2000.

There’s great enthusiasm among the Observer’s discussion board members about Whitebox’s first mutual fund, Whitebox Tactical Opportunities (WBMAX) , which strongly suggests this one warrants some attention, if only from advisors who can buy it without a sales load. The Investor shares carry at 4.5% front load, 2.48% expense ratio and a $5000 minimum initial investment.  You might check the fund’s homepage for additional details.

Observer Fund Profiles

Had I mentioned that we visited RiverNorth?

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

Artisan Global Equity Fund (ARTHX):  you know a firm is in a good place when the most compelling alternatives to one of their funds are their other funds.  Global, run by Mark Yockey and his team, extends on the long-term success of Artisan International and International Small Cap.

RiverNorth Dynamic Buy Write (RNBWX): one of the most consistently successful (and rarely employed) strategies for managing portfolios in volatile markets is the use of covered calls.  After spending several hours with the RiverNorth team and several weeks reading the research, we may have an answer to a version of the old Ghostbusters question, “who you gonna (covered) call?”

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.

Funds in registration this month won’t be available for sale until, typically, the beginning of February 2013. Since firms really like launching by December 31^st if they can, the number of funds in the pipeline is modest: seven this month, as compared to 29 last month.  That said, two of the largest fixed-income teams are among those preparing to launch:

DoubleLine Floating Rate Fund, the tenth fund advised or sub-advised by DoubleLine, will seek a high level of current income by investing in floating rate loans and “other floating rate investments.”  The fund will be managed by Bonnie Baha and Robert Cohen.  Ms. Baha was part of Mr. Gundlach’s original TCW team and co-manages Multi-Asset Growth, Low-Duration Bond and ASTON/DoubleLine Core Plus Fixed Income.

PIMCO Emerging Markets Full Spectrum Bond Fund will invest in “a broad range of emerging market fixed income asset classes, such as external debt obligations of sovereign, quasi-sovereign, and corporate entities; currencies, and local currency-denominated obligations of sovereigns, quasi-sovereigns, and corporate issuers.”  The manager has not yet been named but, as we noted in our lead story, the odds are that this is going to be a top-of-class performer.

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.

On a related note, we also tracked down 40 fund manager changes, down from last month’s bloodbath in which 70 funds changed management.

The Observer in the News

Last month, we ran our annual Honor Roll of Consistently Bearable Funds, which asks the simple question:  “which mutual funds are never terrible?”  Our basic premise is that funds that earn high returns but crash periodically are, by and large, impossible for investors to hold.  And so we offered up a list of funds that have avoided crashing in any of the past ten years.  As it turns out, by managing beta, those funds ended up with substantial alpha.  In English: they made good money by avoiding losing money.

Chuck Jaffe has been looking at a related strategy for years, which led him to talk about and elaborate on our article.  His story, “A fund-picking strategy for nervous investors,” ran on November 19^th, ended up briefly (very briefly: no one can afford fifteen minutes of fame any more) on the front page of Google News and caused a couple thousand new folks to poke their heads in at the Observer.

Briefly Noted . . .

Artisan Partners has again filed for an initial public offering.  They withdrew a 2011 filing in the face of adverse market conditions.  Should you care?  Investors can afford to ignore it since it doesn’t appear that the IPO will materially change operations or management; it mostly generates cash to buy back a portion of the firm from outsiders and to compensate some of the portfolio guys.  Competitors, frankly, should care.  Artisan is about the most successful, best run small firm fund that I know of: they’ve attracted nearly $70 billion in assets, have a suite of uniformly strong funds, stable management teams and a palpable commitment to serving their shareholders.  If I were in the business, I’d want to learn a lot – and think a lot – about how they’ve managed that feat.  Sudden access to a bunch more information would help.

One of The Wall Street Journal columnists surveyed “financial advisers, mutual-fund experts and academics” in search of the five best books for beginning investors.  Other than for the fact that they missed Andrew Tobias’s The Only Investment Guide You’ll Ever Need, it’s a pretty solid list with good works from the efficient market and behavioral finance folks.

SMALL WINS FOR INVESTORS

Clipper (CFIMX), Davis New York Venture (NYVTX), and Selected American Shares (SLASX) have waived their 30-day trading restriction for the rest of 2012, in case investors want to do some repositioning in anticipation of higher capital gains tax rates in 2013.

Dreyfus/The Boston Company Small Cap Growth (SSETX) reopened to new investors on Nov. 1.

Victoria 1522 (VMDIX/VMDAX), an emerging markets stock fund, is cutting its expense ratio by 40 basis points. That’s much better news than you think. Glance at Morningstar’s profile of the lower-minimum Advisor shares and you’ll see a two-star fund and move on.  That reading is, for two reasons, short-sighted.  First, the lower expense ratio would make a major difference; the institutional shares, at 25 bps below the Advisor shares, gain a star (as of 11/30/12) and this reduction gives you 40 bps.  Second, the three-year record masks an exceedingly strong four-plus year record.  From inception (10/08) through the end of 11/12, Victoria 1522 would have turned a $10,000 investment into $19,850.  Its peer over the same period would have returned $13,500. That’s partly attributable to good luck: the fund launched in October 2008 and made about 3% in the quarter while its peers dropped nearly 21%.  Even excluding that great performance (that is, looking at 1/09 – 11/12), the fund has modestly outperformed its peer group despite the drag of its soon-to-be-lowered expenses.  ManagerJosephine Jiménez has a long, distinguished record, including long stints running Montgomery Asset Management’s emerging markets division.  (Thanks to Jake Mortell of Candlewood Advisory for the heads up!)

Wells Fargo has reopened the Class A shares of its Wells Fargo Advantage Dow Jones Target funds: Target Today, 2010, 2020, 2030 and 2040.

CLOSINGS

AllianceBernstein Small Cap Growth (QUASX) will close to new investors on January 31, 2013. That’s all I noticed this month.

OLD WINE, NEW BOTTLES

Calvert Enhanced Equity (CMIFX) will be renamed Calvert Large Cap Core in January 2013.

Actually, this one is a little bit more like “old vinegar in new bottles.”  Dominion Insight Growth Fund was reorganized into the Shepherd Large Cap Growth Fund in 2002.  Shepherd LCG changed its name to the Shepherd Fund in 2008. Then Shepherd Fund became Foxhall Global Trends Fund in 2009, and now Foxhall Global Trends has become Fairfax Global Trends Fund (DOIGX). In all of the name changes, some things have remained constant: low assets, high expenses, wretched performance (they’ve finished in the 98^th -99^th percentile for the trailing one, three, five and ten year periods).

Forward Aggressive Growth Allocation Fund became Forward Multi-Strategy Fund on December 3, 2012, which is just a bit vanilla. The 50 other multi-strategy funds in Morningstar’s database include Dynamic, Ethical, Global, Hedged and Progressive flavors of the marketing flavor du jour.

In non-news, Marathon Value Portfolio (MVPFX) is moving from the Unified Series Trust to  Northern Lights Fund Trust III. That’s their third move and I mention it only because the change causes the SEC to flag MVPFX as a “new” fund.  It isn’t new, though it is a five-star, “Star in the Shadows” fund and worth knowing about.

Wells Fargo Advantage Total Return Bond (MBFAX) will be renamed Wells Fargo Advantage Core Bond sometime in December.

OFF TO THE DUSTBIN OF HISTORY

Geez, the dustbin of history is filling up fast . . .

BNY Mellon Intermediate U.S. Government (MOVIX) is merging into BNY Mellon Intermediate Bond (MIIDX) in February, though the manager is the same for both funds.

Buffalo plans to merge Buffalo China (BUFCX) into Buffalo International (BUFIX) in January, 2013. The fund was originally sub-advised by Jayhawk Capital and I long ago wrote a hopeful profile of the then-new fund. Jayhawk ran it for three years, making huge amounts twice (2007 and 2009), lost a huge amount once (2008), lived in the basement of a highly volatile category and were replaced in 2009 by an in-house management team. The fund has been better but never rose to “good” and never drew assets.

Dreman is killing off five of the six funds: Contrarian International Value (DRIVX), Contrarian Mid Cap Value (DRMVX), Contrarian Value Equity (DRVAX), High Opportunity (DRLVX), and Market Over-Reaction (DRQLX).  Mr. Dreman has a great reputation and had a great business sub-advising load-bearing funds.  Around 2003, Dreman launched a series of in-house, no-load funds.  That experiment, by and large, failed.  The funds were rebranded and repriced, but never earned their way.  The fate of their remaining fund, Dreman Contrarian Small Cap Value (DRSVX), is unknown.

Dreyfus/The Boston Company Small Cap Tax-Sensitive Equity (SDCEX) will liquidate on January 8, 2013 and Dreyfus Small Cap (DSVAX) disappears a week later. Dreyfus is also liquidating a bunch of money market and state bond funds.

Fidelity is pulling a rare 5:1 reverse split by merging Tax Managed Stock (FTXMX), Advisor Strategic Growth (FTQAX), Advisor 130/30 Large Cap (FOATX), and Large Cap Growth (FSLGX) into Fidelity Stock Selector All Cap (FSSKX).

Guggenheim Flexible Strategies (RYBSX) (formerly Guggenheim Long Short Interest Rate Strategies) is slated to merge into Guggenheim Macro Opportunities (GIOAX).

Henderson Global is liquidating their International All Cap Equity (HFNAX) and the Japan Focus (HFJAX) funds in December.

Legg Mason has decided to liquidate Legg Mason Capital Management Disciplined Equity Research (LGMIX), likely on the combination of weak performance and negligible assets.

Munder International Equity (MUIAX) will merge into Munder International Core Equity (MAICX) on Dec. 7.

The board of Northern Funds approved the liquidation of Northern Global Fixed Income (NOIFX) for January 2013.

Pear Tree Columbia Micro Cap (MICRX) just liquidated.  They gave the fund all of one year before declaring it to be a failed experiment.

RidgeWorth plans to merge RidgeWorth Large Cap Core Growth Stock (CRVAX) will be absorbed by RidgeWorth Large Cap Growth Stock (STCIX).

Turner is merging Turner Concentrated Growth (TTOPX) into Turner Large Growth (TCGFX) in early 2013.

Westwood has decided to liquidate Westwood Balanced (WHGBX) less than a year after the departure of longtime lead manager Susan Byrne.

In February, Wells Fargo Advantage Diversified Small Cap (NVDSX) disappears into Wells Fargo Advantage Small Company Growth (NVSCX), Advantage Equity Value (WLVAX) into Advantage Intrinsic Value (EIVAX) and Advantage Small/Mid Cap Core (ECOAX) into Advantage Common Stock (SCSAX).

Well Fargo is also liquidating its Wells Fargo Advantage Core builder Series (WFBGX) in early 2013.

Coming Attractions!

The Observer is trying to help two distinct but complementary groups of folks.  One group are investors who are trying to get past all the noise and hype.  (CNBC’s ratings are dropping like a rock, which should help.)  We’re hoping, in particular, to help folks examine evidence or possibilities that they wouldn’t normally see.  The other group are the managers and other folks associated with small funds and fund boutiques.  We believe in you.  We believe that, as the industry evolves, too much emphasis falls on asset-gathering and on funds launched just for the sake of dangling something new and shiny (uhh … the All Cap Insider Sentiment ETF).  We believe that small, independent funds run by smart, passionate investors deserve a lot more consideration than they receive.  And so we profile them, write about them and talk with other folks in the media about them.

As the Observer has become a bit more financially sustainable, we’re now looking at the prospect of launching two sister sites.  One of those sites will, we hope, be populated with the best commentaries gathered from the best small fund managers and teams that we can find.  Many of you folks write well and some write with grace that far exceeds mine.  The problem, managers tell me, is that fewer people than you’d like find their way to your sites and to your insights.

Our technical team, which Chip leads, thinks that they can create an attractive, fairly vibrant site that could engage readers and help them become more aware of some of the smaller fund families and their strategies.  We respect intellectual property, and so we’d only use content that was really good and whose sharing was supported by the adviser.

That’s still in development.  If you manage a fund or work in support of one and would like to participate in thinking about what would be most helpful, drop Chip a note and we’ll find a way to think through this together.  (Thanks!)

Small cap funds tend to have their best performance in the first six weeks of each year and so we’re planned a smallcapfest for our January issue, with new or revised profiles of the most sensible small cap funds as well as a couple outside perspectives on where you might look.

In Closing . . .

I wanted to share leads on three opportunities that you might want to look in on.  The Observer has no financial stake in any of this stuff but I like sharing word of things that strike me as really first-rate.

QuoteArts.com is a small shop that consistently offers a bunch of the most attractive, best written greeting cards (and refrigerator magnets) that I’ve seen.  Steve Metivier, who runs the site, gave us permission to reproduce one of their images (normally the online version is watermarked):

The text reads “A time to quiet our hearts… (inside) to soften our edges, clear our minds, enjoy our world, and to share best wishes for the season. May these days and all the new year be joyful and peaceful.”  It strikes me as an entirely-worthy aspiration.

The best book there is on the subject of practical persuasion is Robert Cialdini’s Influence: The Psychology of Persuasion (revised edition, 2006).  Even if you’re not impressed that I’ve used the book in teaching persuasion over the past 20 years, you might be impressed by Charlie Munger’s strong endorsement of it.  In a talk entitled “The Psychology of Human Misjudgment,” Munger reports being so impressed with Cialdini’s work that he read the book, gave copies of it to all his children and sent Cialdini (“chawl-dee-nee,” if you care) a share of Berkshire Hathaway in thanks.   Cialdini has since left academe, founded the consulting group Influence at Work and now offers Principles of Persuasion workshops for professionals and the public. While I have not researched the workshops in any depth, I suspect that if I were a small business owner, marketer or financial planner who needed to both attract clients and change their behavior for the better. I’d take a serious look.

Finally, at Amazon’s invitation, I contributed an essay that will be posted at their new “Money and Markets” store from December 5th until about the 12th.  Its original title was, “It’s time to go,” but Amazon’s project director and I ended up settling on the less alarming “Trees don’t grow to the sky.”  If you’ve shopped at, say, Macy’s, you’re familiar with the store-within-a-store notion: free-standing, branded specialty shops (Levenger’s, LUSH, FAO Schwarz) operating within a larger enterprise.  It looks like Amazon is trying an experiment in the same direction and, in November, we mentioned their “Money and Markets” store.  Apparently the Amazonians noticed the fact that some of you folks went to look around, they followed your footprints back here and did some reading of their own.  One feature of the Money and Markets store is a weekly guest column and the writers have included Jack Bogle and Tadas Viskanta, the founder of Abnormal Returns which is one of the web’s two best financial news aggregators.  In any case, they asked if I’d chip in a piece during the second week of December.   We’re not allowed to repost the content for a week or so, but I’ll include it in the January cover essay.  Feel free to drop by if you’re in the area.

In the meanwhile, I wanted to extend sincere thanks from all of the folks here (chip, Anya, Junior, Accipiter and me) for the year you’ve shared with us.  You really do make it all worthwhile and so blessings of the season on you and yours.

As ever,

Dear friends,

I had imagined this as the “post-storm, pre-cliff” edition of the Observer but it appears that “post-storm” would be a very premature characterization.  For four million of our friends who are still without power, especially those along the coast or in outlying areas, the simple pleasures of electric lighting and running water remain a distant hope.  And anything that looks like “normal” might be months in their future.  Our thoughts, prayers, good wishes and spare utility crews go out to them.

I thought, instead, I’d say something about the U.S. presidential election.  This is going to sting, but here it is:

It’s going to be okay.

Hard to believe, isn’t it?  We’re acculturated into viewing the election if as it were some apocalyptic video game whose tagline reads: “America can’t survive .”  The reality is, we can and we will.  The reality is that both Obama and Romney are good guys: smart, patriotic, obsessively hard-working, politically moderate, fact-driven, given to compromise and occasionally funny.  The reality is that they’re both trapped by the demands of electoral politics and polarized bases.

But, frankly, freed of the constraints of those bases, these guys would agree on rather more than they disagree on.  In a less-polarized world, they could run together as a ticket (Obomney 2020!) and do so with a great deal of camaraderie and mutual respect. (Biden-Ryan, on the other hand, would be more than a little bit scary.)  Neither strikes me as a great politician or polished communicator; that’s going to end up constraining – and perhaps crippling – whoever wins.

Why are we so negative?  Because negative (“fear and loathing on the campaign trail”) raises money (likely $6 billion by the time it’s all done) and draws viewers.  While it’s easy to blame PACs, super PACs and other dark forces for that state, the truth is that the news media – mainstream and otherwise – paint good men as evil.  A startling analysis conducted by the Project for Excellence in Journalism found that 72% of all character references to Messrs. Obama and Romney are negative, one of the most negative set of press portrayals on record.

I live in Iowa, labeled a “battleground state,” and I receive four to six (largely poisonous) robo-calls a day.  And so here’s the final reality: Iowa is not a battleground and we’d all be better off if folks stopped using the term.  It’s a place where a bunch of folks are worried, a bunch of folks (often the same ones) are hopeful and we’re trying to pick as best we can.

The Last Ten: T. Rowe Price in the Past Decade

In October we launched “The Last Ten,” a monthly series, running between now and February, looking at the strategies and funds launched by the Big Five fund companies (Fido, Vanguard, T Rowe, American and PIMCO) in the last decade.  We started with Fidelity, once fabled for the predictable success of its new fund launches.  Sadly, the pattern of the last decade is clear and clearly worse: despite 154 fund launches since 2002, Fidelity has created no compelling new investment option and only one retail fund that has earned Morningstar’s five-star designation, Fidelity International Growth (FIGFX).  We suggested three causes: the need to grow assets, a cautious culture and a firm that’s too big to risk innovative funds.

T. Rowe Price is a far smaller firm.  Where Fidelity has $1.4 trillion in assets under management, Price is under $600 billion.  Fidelity manages 340 funds.  Price has 110.  Fidelity launched 154 funds in a decade, Price launched 22.

What are the patterns?

1. Most Price funds reflect the firm’s strength in asset allocation and emerging asset classes. Price does really first-rate work in thinking about which assets classes make sense and in what configuration. They’ve done a good job of communicating that research to their investors, making things clear without making them childish.
2. Most Price funds succeed. Of the funds launched, only Strategic Income (PRSNX) has been a consistent laggard; it has trailed its peer group in four consecutive years but trailed disastrously only once (2009).
3. Most Price funds remain reasonably nimble. While Fido funds quickly swell into the multi-billion range, a lot of the Price funds have remaining under $200 million which gives them both room to grow and to maneuver. The really large funds are the retirement-date series, which are actually funds of other funds.
4. Price continues to buck prevailing wisdom. There’s no sign of blossoming index fund business or the launch of a series of superfluous ETFs. There’s a lot to be said for knowing your strengths and continuing to develop them.

Finally, Price continues to deliver on its promises. Investing with Price is the equivalent of putting a strong singles-hitter on a baseball team; it’s a bet that you’ll win with consistency and effort, rather than the occasional spectacular play. The success of that strategy is evident in Price’s domination of . . .

The Observer’s Honor Roll, Unlike Any Other

Last month, in the spirit of FundAlarm’s “three-alarm” fund list, we presented the Observer’s second Roll Call of the Wretched.  Those were funds that managed to trail their peers for the past one-, three-, five- and ten-year periods, with special commendation for the funds that added high expenses and high volatility to the mix.

This month, I’d like to share the Observer’s Honor Roll of Consistently Bearable Funds.  Most such lists start with a faulty assumption: that high returns are intrinsically good.

Wrong!

While high returns can be a good thing, the practical question is how those returns are obtained.  If they’re the product of alternately sizzling and stone cold performances, the high returns are worse than meaningless: they’re a deadly lure to hapless investors and advisors.  Investors hate losing money much more than they love making it.

In light of that, the Observer asked a simple question: which mutual funds are never terrible?  In constructing the Honor Roll, we did not look at whether a fund ever made a lot of money.  We looked only at whether a fund could consistently avoid being rotten.  Our logic is this: investors are willing to forgive the occasional sub-par year, but they’ll flee in terror in the face of a horrible one.  That “sell low” – occasionally “sell low and stuff the proceeds in a zero-return money fund for five years” – is our most disastrous response.

We looked for no-load, retail funds which, over the past ten years, have never finished in the bottom third of their peer groups.   And while we weren’t screening for strong returns, we ended up with a list of funds that consistently provided them anyway.

U.S. stock funds

International stock funds

Blended asset funds

Specialty funds

Reflections on the Honor Roll

These funds earn serious money.  Twenty-nine of the 33 funds earn four or five stars from Morningstar.  Four earn three stars, and none earn less.  By screening for good risk management, you end up with strong returns.

This is consistent with the recent glut of research on low-volatility investing.  Here’s the basic story: a portfolio of low-volatility stocks returns one to two percent more than the stock market while taking on 25% less risk.

That’s suspiciously close to the free lunch we’re not supposed to get.

There’s a very fine, short article on low-volatility investing in the New York Times: “In Search of Funds that Don’t Rock the Boat” (October 6, 2012).  PIMCO published some of the global data, showing (at slightly numbing length) that the same pattern holds in both developed and developing markets: “Stock Volatility: Not What You Might Think” (January 2012). There are a slug of ETFs that target low-volatility stocks but I’d be hesitant to commit to one until we’d looked at other risk factors such as turnover, market cap and sector concentration.

The roster is pretty stable.  Only four funds that qualified under these screens at the end of 2011 dropped out in 2012.  They are:

FPA Crescent (FPACX) – a 33% cash stake isn’t (yet) helping.  That said, this has been such a continually excellent fund that I worry more about the state of the market than about the state of Crescent.

New Century Capital (NCCPX) – a small, reasonably expensive fund-of funds that’s trailing 77% of its peers this year.  It’s been hurt, mostly, by being overweight in energy and underweight in resurgent financials.

New Century International (NCFPX) – another fund-of-funds that’s trailing about 80% of its peers, hurt by a huge overweight in emerging markets (primarily Latin), energy, and Canada (which is sort of an energy play).

Permanent Portfolio (PRPFX) – it hasn’t been a good year to hold a lot of Treasuries, and PRPFX by mandate does.

The list shows less than half of the turnover you’d expect if funds were there by chance.

One fund deserves honorable mention.  T. Rowe Price Capital Appreciation (PRCWX) has only had one relatively weak year in this century; in 2007, it finished in the 69^th percentile which made it (barely) miss inclusion.

What you’ve heard about T. Rowe Price is true.  You know all that boring “discipline, consistency, risk-awareness” stuff.  Apparently so.  There are 10 Price funds on the list, nearly one-third of the total.  Second place: Fidelity and Vanguard, far larger firms, with six funds.

Sure bets?  Nope.  Must have?  Dear God, no.  A potentially useful insight into picking winners by dodging a penchant for the occasional disaster?  We think so.

In dullness there is strength.

“TrimTabs ETF Outperforms Hedge Funds”

And underperforms pretty much everybody else.  The nice folks at FINAlternatives (“Hedge Fund and Private Equity News”) seem to have reproduced (or condensed) a press release celebrating the first-year performance of TrimTabs Float Shrink ETF (TTFS).

(Sorry – you can get to the original by Googling the title but a direct-link always takes you to a log-in screen.)

Why is this journalism?  They don’t offer the slightest hint about what the fund does.  And, not to rain on anybody’s ETF, but their trailing 12-month return (21.46% at NAV, as of 10/18) places them 2050th in Morningstar’s database.  That list includes a lot of funds which have been consistently excellent (Akre Focus, BBH Core Select (closing soon – see below), ING Corporate Leaders, Mairs & Power Growth and Sequoia) for decades, so it’s not immediately clear what warrants mention.

Seafarer Rolls On

Andrew Foster’s Seafarer Overseas Growth & Income Fund (SFGIX) continues its steady gains.

The fund is outperforming every reasonable benchmark: $10,000 invested at the fund’s inception has grown to $10,865 (as of 10/26/12).  The same amount invested in the S&P’s diversified emerging markets, emerging Asia and emerging Latin America ETFs would have declined by 5-10%.

Assets are steadily rolling in: the fund is now at $17 million after six months of operation and has been gaining nearly two million a month since summer.

Opinion-makers are noticing: Andrew and David Nadel of Royce Global Value (and five other funds ‘cause that’s what Royce managers do) were the guests on October 26th edition of Wealth Track with Consuelo Mack.  It was good to hear ostensible “growth” and “value” investors agree on so much about what to look for in emerging market stocks and which countries they were assiduously avoiding.  The complete interview on video is available here.  (Thanks to our endlessly vigilant Ted for both the heads-up and the video link.)

Legg Mason Rolls Over

Legg Mason seems to be struggling.  On the one hand we have the high visibility struggles of its former star manager, Bill Miller, who’s now in the position of losing more money for more people than almost any manager.  Their most recent financial statement, released July 27, shows that assets, operating revenue, operating income, and earnings are all down from the year before.   Beside that, there’s a more fundamental struggle to figure out what Legg Mason is and who wants to bear the name.

On October 5 2009 Legg announced a new naming strategy for its funds:

Most funds that were formerly named Legg Mason or Legg Mason Partners will now include the Legg Mason name, the name of the investment affiliate and the Fund’s strategy (such as the Legg Mason ClearBridge Appreciation Fund or the Legg Mason Western Asset Managed Municipals Fund).

The announced rationale was to “leverage the Legg Mason brand awareness.”

Welcome to the age of deleveraging:  This year those same funds are moving to hide the Legg Mason taint.  Western Asset dropped the Legg Mason number this summer.  Clearbridge is now following suit, so that the Legg Mason ClearBridge Appreciation Fund is about to become just Clearbridge Appreciation.

Royce, another Legg Mason affiliate, has never advertised that association.  Royce has always had a great small-value discipline. Since being acquired by Legg Mason in 2001, the firm acquired two other, troubling distinctions.

1. Managers who are covering too many funds.  By way of a quick snapshot, here are the funds managed by 72-year-old Chuck Royce (and this is after he dropped several):
   

   Since …	He’s managed …
   12/2010	Royce Global Dividend Value
   08/2010	Royce Micro-Cap Discovery
   04/2009	Royce Partners
   06/2008	Royce International Smaller-Companies
   09/2007	Royce Enterprise Select
   12/2006	Royce European Smaller Companies
   06/2005	Royce Select II
   05/2004	Royce Dividend Value
   12/2003	Royce Financial Services
   06/2003	Royce 100
   11/1998	Royce Select I
   12/1995	Royce Heritage
   12/1993	Royce Total Return
   12/1991	Royce Premier
   11/1972	Royce Pennsylvania Mutual

    

   Their other senior manager, Whitney George, manages 11 funds.  David Nadel works on nine, Lauren Romeo helps manage eight.

2. A wild expansion out of their traditional domestic small-value strength.  Between 1962 and 2001, Royce launched nine funds – all domestic small caps.  Between 2001 and the present, they launched 21 mutual funds and three closed-end funds in a striking array of flavors (Global Select Long/Short, International Micro-Cap, European Smaller Companies).  While many of those later launches have performed well, many have found no traction in the market.  Fifteen of their post-2001 launches have under $100 million in assets, 10 have under $10 million.  That translates into higher expenses in some already-expensive niches and a higher hurdle for the managers to overcome.Legg reports progressively weaker performance among the Royce funds in recent years:
   

   Three out of 30 funds managed by Royce outperformed their benchmarks for the 1-year period; 4 out of 24 for the 3-year period; 12 out of 19 for the 5-year period; and all 11 outperformed for the 10-year period.

That might be a sign of a fundamentally unhealthy market or the accumulated toll of expenses and expansion.  Shostakovich, one of our discussion board’s most experienced correspondents, pretty much cut to the chase on the day Royce reopened its $1.1 billion micro-cap fund to additional investors: “Chuck sold his soul. He kept his cashmere sweaters and his bow ties, but he sold his soul. And the devil’s name is Legg Mason.”  Interesting speculation.

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

Scout Unconstrained Bond (SUBFX): If these guys have a better track record than the one held by any bond mutual fund (and they do), why haven’t you heard of it?  Worse yet, why hadn’t I?

Stewart Capital Mid-Cap (SCMFX):  If this is one of the top two or three or ten mid-cap funds in operation (and it is), why haven’t you heard of it?  Worse yet, why hadn’t I?

Launch Alert: RiverNorth Dynamic Buy-Write Fund (RNBWX)

On  October 12, 2012, RiverNorth launched their fourth fund, RiverNorth Dynamic Buy-Write Fund.  “Buy-write” describes a sort of “covered call” strategy in which an investor might own a security and then sell to another investor the option to buy the security at a preset price in a preset time frame.  It is, in general, a defensive strategy which generates a bit of income and some downside protection for the investor who owns the security and writes the option.

As with any defensive strategy, you end up surrendering some upside in order to avoid some of the downside.  RiverNorth’s launch announcement contained a depiction of the risk-return profiles for a common buy-write index (the BXM) and three classes of stock:

A quick read is that the BXM offered 90% of the upside of the stock market with only 70% of the downside, which seems the very definition of a good tradeoff.

RiverNorth believes they can do better through active management of the portfolio.  The fund will be managed by Eric Metz, who joined RiverNorth in 2012 and serves as their Derivatives Strategist.  He’s been a partner at Bengal Capital, a senior trader at Ronin Capital and worked at the Chicago Mercantile Exchange (CME) and Chicago Board Options Exchange (CBOE).   The investment minimum is $5000.  Expenses are capped at 1.80%.

Because the strategy is complex, the good folks at RiverNorth have agreed to an extended interview at their offices in Chicago on November 8^th.  With luck and diligence, we’ll provide a full profile of the fund in our December issue.

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.

Twenty-nine new no-load funds were placed in registration this month.  Those include three load-bearing funds becoming no-loads, two hedge funds merging to become one mutual fund, one institutional fund becoming retail and two dozen new offerings.  An unusually large number of the new funds feature very experienced managers.  Four, in particular, caught our attention:

BBH Global Core Select is opening just as the five-star BBH Core Select closes.  Core Select invests about 15% of its money outside the U.S., while the global version will place at least 40% there.  One of Core Select’s managers will co-manage the new fund with a BBH analyst.

First Trust Global Tactical Asset Allocation and Income Fund will be an actively-managed ETF that “seek[s] total return and provide income [and] a relatively stable risk profile.”  The managers, John Gambla and Rob A. Guttschow, had been managing five closed-end funds for Nuveen.

Huber Capital Diversified Large Cap Value Fund, which will invest in 40-80 large caps that trade “at a significant discount to the present value of future cash flows,” will be run by Joseph Huber, who also manages the five-star Huber Small Cap Value (HUSIX) and Huber Equity Income (HULIX) funds.

Oakseed Opportunity Fund is a new global fund, managed by Greg L. Jackson and John H. Park. These guys managed or co-managed some “A” tier funds (Oakmark Global, Acorn, Acorn Select and Yacktman) before moving to Blum Capital, a private equity firm, from about 2004-2012.

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.

On a related note, we also tracked down about 50 fund manager changes, including the blockbuster announcement of Karen Gaffney’s departure from Loomis Sayles.

RiverPark Long/Short Opportunity conference call

Based on the success of our September conference call with David Sherman of Cohanzick Asset Management and RiverPark’s president, Morty Schaja, we have decided to try to provide our readers with one new opportunity each month to speak with an “A” tier fund manager.

The folks at RiverPark generously agreed to participate in a second conference call with Observer readers. It will feature Mitch Rubin, lead manager of RiverPark Long/Short Opportunity (RLSFX), a fund that we profiled in August as distinctive and distinctly promising.  This former hedge fund crushed its peers.

I’ll moderate the call.  Mitch will open by talking a bit about the fund’s strategy and then will field questions (yours and mine) on the fund’s strategies and prospects. The call is November 29 at 7:00 p.m., Eastern. Participants can register for the conference by navigating to  http://services.choruscall.com/diamondpass/registration?confirmationNumber=10020992

We’ll have the winter schedule in our December issue.  For now, I’ll note that managers of several really good funds have indicated a willingness to spend serious time with you.

Small Funds Communicating Smartly

The Mutual Fund Education Alliance announced their 2012 STAR Awards, which recognize fund companies that do a particularly good job of communicating with their investors.  As is common with such awards, there’s an impulse to make sure lots of folks get to celebrate so there are 17 sub-categories in each of three channels (retail, advisor, plan participant) plus eleven overall winners, for 62 awards in total.

US Global Investors was recognized as the best small firm overall, for “consistency of messaging and excellent use of the various distribution outlets.”  Matthews Asia was celebrated as the outstanding mid-sized fund firm.  Judges recognized them for “modern, effective design [and] unbelievable branding consistency.”

Ironically, MFEA’s own awards page is danged annoying with an automatic slide presentation that makes it hard to read about any of the individual winners.

Congratulations to both firms.  We’d also like to point you to our own Best of the Web winners for most effective site design: Seafarer Funds and Cook & Bynum Fund, with honorable mentions to Wintergreen, Auxier Focus and the Tilson Funds.

Briefly Noted . . .

Artio meltdown continues.  The Wall Street Journal reports that Richard Pell, Artio’s CEO, has stepped down.  Artio is bleeding assets, having lost nearly 50% of their assets under management in the past 12 months.  Their stock price is down 90% since its IPO and we’d already reported the closure of their domestic-equity funds.  This amounts to a management reshuffle, with Artio’s president becoming CEO and Pell remaining at CIO.  He’ll also continue to co-manage the once-great (top 5% over 15 years, bottom 5% over the past five years) Artio International Equity Fund (BJBIX) with Rudolph-Riad Younes.

SMALL WINS FOR INVESTORS

Dreyfus/The Boston Company Small Cap Growth Fund (SSETX) reopened to new investors on November 1, 2012. It’s a decent little fund with below average expenses.  Both risk and return tend to be below average as well, with risk further below average than returns.

Fidelity announced the launch of a dozen new target-date funds in its Strategic Advisers Multi-Manager Series, 2020 through 2055 and Retirement Income.  The Multi-Manager series allows Fidelity to sell the skills of non-Fidelity managers (and their funds) to selected retirement plans.  Christopher Sharpe and Andrew Dierdorf co-manage all of the funds.

CLOSINGS

The board of BBH Core Select (BBTEX) has announced its imminent closure.  The five-star large cap fund has $3.2 billion in assets and will close at $3.5 billion.  Given its stellar performance and compact 30-stock portfolio, that’s certainly in its shareholders’ best interests.  At the same time, BBH has filed to launched a Global Core fund by year’s end.  It will be managed by one of BBTEX’s co-managers.  For details, see our Funds in Registration feature.

Invesco Balanced-Risk Commodity Strategy (BRCAX) will close to new investors effective November 15, 2012.

Investment News reports that 86 ETFs ceased operations in the first 10 months of 2012.  Wisdom Tree announced three more in late October (LargeCap Growth ROI,  South African Rand SZR and Japanese Yen JYF). Up until 2012, the greatest number of closures in a single calendar year was 58 during the 2008 meltdown.  400 more (Indonesian Small Caps, anyone?) reside on the ETF Deathwatch for October 2012; ETFs with tiny investor bases and little trading activity.  The hidden dimension of the challenge provided by small ETFs is the ability of their boards to dramatically change their investment mandates in search of new assets.  Investors in Global X S&P/TSX Venture 30 Canada ETF (think “Canadian NASDAQ”) suddenly found themselves instead in Global X Junior Miners ETF (oooo … exposure to global, small-cap nickel mining!).

OLD WINE, NEW BOTTLES

Under the assumption that indecipherable is good, Allianz announced three name changes: Allianz AGIC Structured Alpha Fund is becoming AllianzGI Structured Alpha Fund. Allianz AGIC U.S. Equity Hedged Fund becomes AllianzGI U.S. Equity Hedged Fund and Allianz NFJ Emerging Markets Value Fund becomes AllianzGI NFJ Emerging Markets Value Fund.

BBH Broad Market (BBBIX) has changed its name to BBH Limited Duration Fund.

Effective December 3, 2012, the expensive, small and underperforming Forward Aggressive Growth Allocation Fund (ACAIX) will be changed to the Forward Multi-Strategy Fund. Along with the new name, this fund of funds gets to add “long/short, tactical and other alternative investment strategies” to its armamentarium.  Presumably that’s driven by the fact that the fund does quite poorly in falling markets: it has trailed its benchmark in nine of the past nine declining quarters.  Sadly, adding hedge-like funds to the portfolio will only drive up expenses and serve as another drag on performance.

Schwab Premier Income (SWIIX) will soon become Schwab Intermediate-Term Bond, with lower expenses but a much more restrictive mandate.  At the moment the fund can go anywhere (domestic, international and emerging market debt, income- and non-income-producing equities, floating rate securities, REITs, ETFs) but didn’t, while the new fund will invest only in domestic intermediate term bonds.

Moving in the opposite direction, Alger Large Cap Growth Institutional (ALGRX) becomes Alger Capital Appreciation Focus at the end of the year. The fund will adopt an all-cap mandate, but will shrink the target portfolio size from around 100 stocks to 50.

OFF TO THE DUSTBIN OF HISTORY

The Board of Directors of Bhirud Funds Inc. has approved the liquidation of Apex Mid Cap Growth Fund (BMCGX) effective on or about November 14, 2012. In announcing Apex’s place on our 2012 “Roll Call of the Wretched,” we noted:

The good news: not many people trust Suresh Bhirud with their money.  His Apex Mid Cap Growth (BMCGX) had, at last record, $192,546 – $100,000 below last year’s level.  Two-thirds of that amount is Mr. Bhirud’s personal investment.  Mr. Bhirud has managed the fund since its inception in 1992 and, with annualized losses of 9.2% over the past 15 years, has mostly impoverished himself.

We’re hopeful he puts his remaining assets in a nice, low-risk index fund.

The Board of Trustees of Dreyfus Investment Funds approved the liquidation of Dreyfus/The Boston Company Small Cap Tax-Sensitive Equity Fund (SDCEX) on January 8, 2013.  Ironically, this fund has outperformed the larger, newly-reopened SSETX.  And, while they were at it, the Board also approved the liquidation of Dreyfus Small Cap Fund (the “Fund”), effective on January 16, 2013

ING will liquidate ING Alternative Beta (IABAX) on December 7, 2012.  In addition to an obscure mandate (what is alternative beta?), the fund has managed to lose money over the past three years while drawing only $18 million in assets.

Munder International Equity Fund (MUIAX) is slated to be merged in Munder International Fund — Core Equity (MAICX), on December 7, 2012.

Uhhh . . .

Don’t get me wrong.  MUIAX is a bad fund (down 18% in five years) and deserves to go.  But MAICX is a worse fund by far (it’s down 29% in the same period).  And much smaller.  And newer.

This probably explains why I could never serve on a fund’s board of directors.  Their logic is simply too subtle for me.

Royce Mid-Cap (RMIDX) is set to be liquidated on November 19, 2012. It’s less than three years old, has performed poorly and managed to draw just a few million in assets.  The management team is being dispersed among Royce’s other funds.

It was named Third Millennium Russia Fund (TMRFX) and its charge was to invest “in securities of companies located in Russia.”  This is a fund that managed to gain or lose more than 70% in three of the past 10 years.  Investors have largely fled and so, effective October 10, 2012, the board of trustees tweaked things.  It’s now called Toreador International Fund and its mandate is to invest “outside of the United States.”  As of this writing, Morningstar had not yet noticed.

In Closing . . .

We’ve added an unusual bit of commercial presence, over to your right.  Amazon created a mini-site dedicated to the interests of investors.  In addition to the inevitable links to popular investing books, it features a weekly blog post, a little blog aggregator at the bottom (a lot of content from Bloomberg, some from Abnormal Returns and Seeking Alpha), and some sort of dead, dead, dead discussion group.  We thought you might find some of it useful or at least browseable, so we decided to include it for you.

And yes, it does carry MFO’s embedded link.  Thanks for asking!

Thanks, too, to all the folks (Gary, Martha, Dean, Richard, two Jacks, and one Turtle) who contributed to the Observer in October.

We’ll look for you in December.