Dear friends,

Are you feeling better?  2011 saw enormous stock market volatility, ending with a total return of one-quarter of one percent in the total stock market.  Who then would have foreseen Q1 2012: the Dow and S&P500 posted their best quarter since 1998.  The Dow posted six consecutive months of gains, and ended the quarter up 8%.  The S&P finished up 12% and the NASDAQ up 18% (its best since 1991).

Strong performance is typical in the first quarter of any year, and especially of a presidential election year.  Investors, in response, pulled $9.4 billion out of domestic equity funds and – even with inflows into international funds – reduced their equity investments by $3.2 billion dollars.  They fled, by and large, into the safety of the increasingly bubbly bond market.

It’s odd how dumb things always seem so sensible when we’re in the midst of doing them.

Do You Need Something “Permanent” in your Portfolio?

The title derives from the Permanent Portfolio concept championed by the late Harry Browne.  Browne was an advertising executive in the 1960s who became active in the libertarian movement and was twice the Libertarian Party’s nominee for president of the United States.  In 1981, he and Terry Coxon wrote Inflation-Proofing Your Investments, which argued that your portfolio should be positioned to benefit from any of four systemic states: inflation, deflation, recession and prosperity.  As he envisioned it, a Permanent Portfolio invests:

25% in U.S. stocks, to provide a strong return during times of prosperity.

25% in long-term U.S. Treasury bonds, which should do well during deflation.

25% in cash, in order to hedge against periods of recession.

25% in precious metals (gold, specifically), in order to provide protection during periods of inflation.

The Global X Permanent ETF (PERM) is the latest attempt to implement the strategy.  It’s also the latest to try to steal business from Permanent Portfolio Fund (PRPFX) which has drawn $17.8 billion in assets (and, more importantly from a management firm’s perspective, $137 million in fees for an essentially passive strategy).  Those inflows reflect PRPFX’s sustained success: over the past 15 years, it has returned an average of 9.2% per year with only minimal stock market exposure.

PRPFX is surely an attractive target, since its success not attributable to Michael Cuggino’s skill as a manager.  His stock picking, on display at Permanent Portfolio Aggressive Growth (PAGRX) is distinctly mediocre; he’s had one splendid year and three above-average ones in a decade.  It’s a volatile fund whose performance is respectable mostly because of his top 2% finish in 2005.  His fixed income investing is substantially worse.  Permanent Portfolio Versatile Bond (PRVBX) and Permanent Portfolio Short Term Treasury (PRTBX) are flat-out dismal.  Over the past decade they trail 95% of their peer funds.  All of his funds charge above-average expenses.  Others might conclude that PRPFX has thrived despite, rather than because of, its manager.

Snowball’s annual rant: Despite having received $48 million as his investment advisory fee (Mr. Cuggino is the advisor’s “sole member,” president and CEO), he’s traditionally been shy about investing in his funds though that might be changing.  “As of April 30, 2010,” according to his Annual Report, “Mr. Cuggino owned shares in each of the Fund’s Portfolios through his ownership of Pacific Heights.” A year later, that investment is substantially higher but corporate and personal money (if any) remain comingled in the reports.  In any case, he “determines his own compensation.”  That includes some portion of the advisor’s profits and the $65,000 a year he pays himself to serve on his own board of trustees.  On the upside, the advisor has authorized a one basis point fee waiver, as of 12/31/11.  Okay, that’s over.  I promise I’ll keep quiet on the topic until the spring of 2013.

It’s understandable that others would be interested in getting a piece of that highly-profitable action.  It’s surprising that so few have made the attempt.  You might argue that Hussman Strategic Total Return (HSTRX) offers a wave in the same direction and the Midas Perpetual Portfolio (MPERX), which invests in a suspiciously similar mix of precious metals, Swiss francs, growth stocks and bonds, is a direct (though less successful) copy.  Prior to December 29, 2008, MPERX (then known as Midas Dollar Reserves) was a government money market fund.  That day it changed its name to Perpetual Portfolio and entered the Harry Browne business.

A simple portfolio comparison shows that neither PRPFX nor MPERX quite matches Browne’s simple vision, nor do their portfolios look like each other.

Should you invest in one, or any, of these vehicles?  If so, proceed with extreme care.  There are three factors that should give you pause.  First, two of the four underlying asset classes (gold and long-term bonds) are three decades into a bull market.  The projected future returns of gold are unfathomable, because its appeal is driven by psychology rather than economics, but its climb has been relentless for 20 years.  GMO’s most recent seven-year asset class projections show negative real returns for both bonds and cash.  Second, a permanent portfolio has a negative correlation with interest rates.  That is, when interest rates fall – as they have for 30 years – the funds return rises.  When interest rates rise, the returns fall.  Because PRPFX was launched after the Volcker-induced spike in rates, it has never had to function in a rising rate environment.  Third, even with favorable macro-economic conditions, this portfolio can have long, dismal stretches.  The fund posts its annual returns since inception on its website.  In the 14 years between 1988 and 2001, the fund returned an average of 4.1% annually.  During those same years inflation average 3% annually, which means PRPFX offered a real return of 1.1% per year.

And, frankly, you won’t make it to any longer-term goal with 1.1% real returns.

There are two really fine analyses of the Permanent Portfolio strategy.  Geoff Considine penned “What Investors Should Fear in the Permanent Portfolio” for Advisor Perspectives (2011) and Bill Bernstein wrote a short piece “Wild About Harry” for the Efficient Frontier (2010).

RiverPark Funds: Launch Alert and Fund Family Update

RiverPark Funds are making two more hedge funds available to retail investors, folks they describe as “the mass affluent.”  Given the success of their previous two ventures in that direction – RiverPark/Wedgewood Fund (RWGFX) and RiverPark Short Term High Yield (RPHYX, in which I have an investment) – these new offerings are worth a serious look.

RiverPark Long/Short Opportunity Fund is a long/short fund that has been managed by Mitch Rubin since its inception as a hedge fund in the fall of 2009.  The RiverPark folks believe, based on their conversation with “people who are pretty well versed on the current mutual funds that employ hedge fund strategies” that the fund has three characteristics that set it apart:

• it uses a fundamental, bottom-up approach
• it is truly shorting equities (rather than Index ETFs)
• it has a growth bias for its longs and tends to short value.

Since inception, the fund generated 94% of the stock market’s return (33.5% versus 35.8% for the S&P500 from 10/09 – 02/12) with only 50% of its downside risk (whether measured by worst month, worst quarter, down market performance or max drawdown).

While the hedge fund has strong performance, it has had trouble attracting assets.  Morty Schaja, RiverPark’s president, attributes that to two factors.  Hedge fund investors have an instinctive bias against firms that run mutual funds.  And RiverPark’s distribution network – it’s most loyal users – are advisors and others who are uninterested in hedge funds.  It’s managed by Mitch Rubin, one of RiverPark’s founders and a well-respected manager during his days with the Baron funds.  The expense ratio is 1.85% on the institutional shares and 2.00% on the retail shares and the minimum investment in the retail shares is $1000.  It will be available through Schwab and Fidelity starting April 2, 2012.

RiverPark/Gargoyle Hedged Value Fund pursued a covered call strategy.  Here’s how Gargoyle describes their investment strategy:

The Fund invests all of its assets in a portfolio of undervalued mid- to large-cap stocks using a quantitative value model, then conservatively hedges part of its stock market risk by selling a blend of overvalued index call options, all in a tax-efficient manner. Proprietary tools are used to maintain the Fund’s net long market exposure within a target range, allowing investors to participate as equities trend higher while offering partial protection as equities trend lower.

Since inception (January 2000), the fund has posted 900% of the S&P500’s returns (150% versus 16.4%, 01/00 – 02/12).  Much of that outperformance is attributable to crushing the S&P from 2000-2002 but the fund has still outperformed the S&P in 10 of 12 calendar years and has done so with noticeably lower volatility.  Because the strategy is neither risk-free nor strongly correlated to the movements of the stock market, it has twice lost a little money (2007 and 2011) in years in which the S&P posted single-digit gains.

Mr. Schaja has worked with this strategy since he “spearheaded a research effort for a similar strategy while at Donaldson Lufkin Jenrette 25 years ago.”  Given ongoing uncertainties about the stock market, he argues “a buy-write strategy, owning equities and writing or selling call options on the underlying portfolio offers a very attractive risk return profile for investors. . . investors are willing to give up some upside, for additional income and some downside protection.  By selling option premium of about 1 1/2% per month, the Gargoyle approach can generate attractive risk adjusted returns in most markets.”

The hedge fund has about $190 million in assets (as of 02/12).  It’s managed by Joshua Parker, President of Gargoyle, and Alan Salzbank, its Managing Partner – Risk Management.  The pair managed the hedge fund since inception (including of its predecessor partnership since its inception in January 1997).  The expense ratio is 1.25% on the institutional shares and 1.5% on the retail shares and the minimum investment in the retail shares is $1000.  The challenge of working out a few last-minute brokerage bugs means that Gargoyle will launch on May 1, 2012.

Other RiverPark notes:

RiverPark Large Growth (RPXFX) is coming along nicely after a slow start. It’s a domestic, mid- to large-cap growth fund with 44 stocks in the portfolio.  Mitch Rubin, who managed Baron Growth, iOpportunity and Fifth Avenue Growth as various points in his career, manages it. Its returns are in the top 3% of large-growth funds for the past year (through March 2012), though its asset base remains small at $4 million.

RiverPark Small Cap Growth (RPSFX) continues to have … uh, “modest success” in terms of both returns and asset growth.  It has outperformed its small growth peers in six of its first 17 months of operation and trails the pack modestly across most trailing time periods. It’s managed by Mr. Rubin and Conrad van Tienhoven.

RiverPark/Wedgewood Fund (RWGFX) is a concentrated large growth fund which aims to beat passive funds at their own game.  It’s been consistently at or near the top of the large-growth pack since inception.  David Rolfe, the manager, strikes me as bright, sensible and good-humored and the fund has drawn $200 million in assets in its first 18 months of operation.

RiverPark Short Term High Yield (RPHYX) pursues a distinctive, and distinctly attractive, strategy.  He buys a bunch of securities (called high yield bonds among them) which are low-risk and inefficiently priced because of a lack of buyers.  The key to appreciating the fund is to utterly ignore Morningstar’s peer rankings.  He’s classified as a “high yield bond fund” despite the fact that the fund’s objectives and portfolio are utterly unrelated to such funds.  It’s best to think of it as a sort of cash-management option.  The fund’s worst monthly loss was 0.24% and its worst quarter was 0.07%.   As of 3/28/12, the fund’s NAV ($10.00) is the same as at launch but its annual returns are around 4%.

Finally, a clarification.  I’ve fussed at RiverPark in the past for being too quick to shut down funds, including one mutual fund and several actively-managed ETFs.  Matt Kelly of RiverPark recently wrote to clear up my assumption that the closures were RiverPark’s idea:

Adam Seessel was the sub-adviser of the RiverPark/Gravity Long-Biased Fund. . . Adam became friendly with Frank Martin who is the founder of Martin Capital Management . . . a year ago, Frank offered Adam his CIO position and a piece of the company. Adam accepted and shortly thereafter, Frank decided that he did not want to sub-advise anyone else’s mutual fund so we were forced to close that fund.

Back in 2009, [RiverPark president Morty Schaja] teamed up with Grail Advisers to launch active ETFs. Ameriprise bought Grail last summer and immediately dismissed all of the sub-advisers of the grail ETFs in favor of their own managers.

Thanks to Matt for the insight.

FundReveal, Part 2: An Explanation and a Collaboration

For our “Best of the Web” feature, my colleague Junior Yearwood sorts through dozens of websites, tools and features to identify the handful that are most worth your while.  On March 1, he identified the low-profile FundReveal service as one of the three best mutual fund rating sites (along with Morningstar and Lipper).  The award was made based on the quality of evidence available to corroborate a ratings system and the site’s usability.

Within days, a vigorous and thoughtful debate broke out on the Observer’s discussion board about FundReveal’s assumptions.  Among the half dozen questions raised, two in particular seemed to resonate: (1) isn’t it unwise to benchmark everything – including gold and short-term bond funds – against the risk and return profile of the S&P 500?  And (2) you assume that past performance is not predictive, but isn’t your system dependent on exactly that?

I put both of those questions to the guys behind FundReveal, two former Fidelity executives who had an important role to play in changing the way trading decisions were made and employees rewarded.  Here’s the short version of their answers.  Fuller versions are available on their blog.

(1) Why does FundReveal benchmark all funds against the S&P? Does the analysis hold true if other benchmarks are used?

FundReveal uses the S&P 500 as a single, consistent reference for comparing performance between funds, for 4 of its 8 measures. The S&P also provides a “no-brainer” alternative to any other investments, including mutual funds. If an investor wishes to participate in the market, without selecting specific sectors or securities, an S&P 500 index fund or ETF provides that alternative.

Four of FundReveal’s eight measurements position funds relative to the index. Four others are independent of the S&P 500 index comparison.

An investor can compare a fund’s risk-return performance against any index fund by simply inserting the symbol of an index fund that mimics the index. Then the four absolute measures for a fund (average daily returns, volatility of daily returns, worst case return and number of better funds) can be compared against the chosen index fund.

ADR and Volatility are the most direct and closest indicators of a mutual fund’s daily investment and trading decisions. They show how well a fund is being managed. High ADR combined with low Volatility are indicators of good management. Low ADR with high Volatility indicates poor management.

(2) Why is it that FundReveal says that past total returns are not useful in deciding which funds to invest in for the future? Why do your measures, which are also calculated from past data, provide insight into future fund performance?

Past total returns cannot indicate future performance. All industry performance ratings contain warnings to this effect, but investors continue using them, leading to “return chasing investor behavior.”

[A conventional calculations of total return]  includes the beginning and ending NAV of a fund, irrespective of the NAVs of the fund during the intervening time period. For example, if a fund performed poorly during most of the days of a year, but its NAV shot up during the last week of the year, its total return would be high. The low day-to-day returns would be obscured. Total Return figures cannot indicate the effectiveness of investment decisions made by funds every day.

Mutual funds make daily portfolio and investment decisions of what and how much to hold, sell or buy. These decisions made by portfolio managers, supported by their analysts and implemented by their traders, produce daily returns: positive some days, and negative others. Measuring their average daily values and their variability (Volatility) gives direct quantitative information about the effectiveness of the daily investment decisions. Well managed funds have high ADR and low Volatility. Poorly managed funds behave in the opposite manner.

I removed a bunch of detail from the answers.  The complete versions of the S&P500 benchmark and past performance as predictor are available on their blog.

My take is two-fold: first, folks are right in criticizing the use of the S&P500 as a sole benchmark.  An investor looking for a conservative portfolio would likely find himself or herself discouraged by the lack of “A” funds.  Second, the system itself remains intriguing given the ability to make more-appropriate comparisons.  As they point out in the third paragraph, there are “make your own comparison” and “look only at comparable funds” options built into their system.

In order to test the ability of FundReveal to generate useful insights in fund selection, the Observer and FundReveal have entered into a collaborative arrangement.  They’ve agreed to run analyses of the funds we profile over the next several months.  We’ll share their reasoning and bottom line assessment of each fund, which might or might not perfectly reflect our own.  FundReveal will then post, free, their complete assessment of each fund on their blog.  After a trial of some months, we’re hoping to learn something from each other – and we’re hoping that all of our readers benefit from having a second set of eyes looking at each of these funds.

Both the Tributary and Litman Gregory profiles include their commentary, and the link to their blog appears at the end of each profile.  Please do let me know if you find the information helpful.

Lipper: Your Best Small Fund Company is . . .

GuideStone Funds.

GuideStone Funds?

Uhh … Lipper’s criterion for a “small” company is under $40 billion under management which is, by most standards, not small.  Back to GuideStone.

From their website: “GuideStone Funds, a controlled affiliate of GuideStone Financial Resources, provides a diversified family of Christian-based, socially screened mutual funds.”

Okay.  In truth, I had no prior awareness of the family.  What I’ve noticed since the Lipper awards is that the funds have durn odd names (they end in GS2 or GS4 designations), that the firm’s three-year record (on which Lipper made their selection) is dramatically better than either the firm’s one-year or five-year record.  That said, over the past five years, only one GuideStone fund has below-average returns.

Fidelity: Thinking Static

As of March 31, 2012, Fidelity’s Thinking Big viral marketing effort has two defining characteristics.  (1) it has remained unchanged from the day of its launch and (2) no one cares.  A Google search of the phrase Fidelity  +”Thinking Big” yields a total of six blog mentions in 30 days.

Morningstar: Thinking “Belt Tightening”

Crain’s Chicago Business reports that Morningstar lost a $12 million contact with its biggest investment management client.  TransAmerica Asset Management had relied on Morningstar to provide advisory services on its variable annuity and fund-of-funds products.  The newspaper reports that TransAmerica simplified things by hiring Tim Galbraith, Morningstar’s director of alternative investments, to handle the work in-house.  TransAmerica provided about 2% of Morningstar’s revenue last year.

Given the diversity of Morningstar’s global revenue streams, most reports suggest this is “unfortunate” rather than “terrible” news, and won’t result in job losses.  (source: “Morningstar loses TransAmerica work,” March 27 2012)

James Wang is not “the greatest investor you’ve never heard of”

Investment News gave that title to the reclusive manager of the Oceanstone Fund (OSFDX) who was the only manager to refuse to show up to receive a Lipper mutual fund award.  He’s also refused all media attempts to arrange an interview and even the chairman of his board of trustees sounds modestly intimidated by him.  Fortune has itself worked up into a tizzy about the guy.

Nonetheless, the combination of “reclusive” and an outstanding five-year record still don’t add up to “the greatest investor you’ve never heard of.”  Since you read the Observer, you’ve surely heard of him, repeatedly.  As I’ve noted in a February 2012 story:

1. the manager’s explanation of his investment strategy is nonsense.  He keeps repeating the magic formula: IV = IV divided by E, times E.  No more than a high school grasp of algebra tells you that this formula tells you nothing.  I shared it with two professors of mathematics, who both gave it the technical term “vacuous.”  It works for any two numbers (4 = 4 divided by 2, times 2) but it doesn’t allow you to derive one value from the other.
2. the shareholder reports say nothing. The entire text of the fund’s 2010 Annual Report, for example, is three paragraph.  One reports the NAV change over the year, the second repeats the formula (above) and the third is vacuous boilerplate about how the market’s unpredictable.
3. the fund’s portfolio turns over at triple the average rate, is exceedingly concentrated (20 names) and is sitting on a 30% cash stake.  Those are all unusual, and unexplained.

That’s not evidence of investing genius though it might bear on the old adage, “sometimes things other than cream rise to the top.”

Two Funds and Why They’re Really Worth Your While

Each month, the Observer profiles between two and four mutual funds that you likely have not heard about, but really should have.

Litman Gregory Masters Alternative Strategies (MASNX): Litman Gregory has assembled four really talented teams (order three really talented teams and “The Jeffrey”) to manage their new Alternative Strategies fund.  It has the prospect of being a bright spot in valuable arena filled with also-ran offerings.

Tributary Balanced, Institutional (FOBAX): Tributary, once identified with First of Omaha bank and once traditionally “institutional,” has posted consistently superb returns for years.  With a thoughtfully flexible strategy and low minimum, it deserves noticeably more attention than it receives.

The Best of the Web: A Week of Podcasts

Our second “Best of the Web” feature focuses on podcasts, portable radio for a continually-connected age.  While some podcasts are banal, irritating noise (Junior went through a month’s worth of Advil to screen for a week’s worth of podcasts), others offer a rare and wonderful commodity: thoughtful, useful analysis.

In “A Week of Podcasts,” Junior and I identified four podcasts to help power you through the week, three to help you unwind and (in an exclusive of sorts) news of Chuck Jaffe’s new daily radio show, MoneyLife with Chuck Jaffe.

We think we’ve done a good and honest job but Junior, especially, would like to hear back from readers about how the feature works for you and how to make it better, about sites we’ve missing and sites we really shouldn’t miss.  Drop us a line, we read and appreciate everything and respond to as much as we can.

Briefly noted . . .

Seafarer Overseas Growth and Income (SFGIX), managed by Andrew Foster, is up about 3% since its mid-February launch.  The average diversified emerging markets fund is flat over the same period.  The fund is now available no-load/NTF at Schwab and Scottrade.  For reasons unclear, the Schwab website (as of 3/31/12) keeps saying that it’s not available.  It is available and the Seafarer folks have been told that the problem lies in Schwab’s website, portions of which only update once a month. As a result, Seafarer’s availability may not be evident until April 11..

On the theme of a very good fund getting dramatically better, Villere Balanced Fund (VILLX) has reduced its capped expense ratio from 1.50% to 0.99%.  While the fund invests about 60% of the portfolio in stocks, its tendency to include a lot of mid- and small-cap names makes it a lot more volatile than its peers.  But it’s also a lot more rewarding: it has top 1% returns among moderate allocation funds for the past three-, five- and ten-year periods (as of 3/30/2012).  Lipper recently recognized it as the top “Mixed-Asset Target Allocation Growth Fund” of the past three and five years.

Arbitrage Fund (ARBFX) reopened to investors on March 15, 2012. The fund closed in mid-2010 was $2.3 billion in assets and reopened with nearly $3 billion.  The management team has also signed-on to subadvise Litman Gregory Masters Alternative Strategies (MASNX), a review of which appears this month.

Effective April 30, 2012, T. Rowe Price High Yield (PRHYX, and its advisor class) will close to new investors.  Morningstar rates it as a Four Star / Silver fund (as of 3/30/2012).

Neuberger Berman Regency (NBRAX) has been renamed Neuberger Berman Mid Cap Intrinsic Value and Neuberger Berman Partners (NPNAX) have been renamed Neuberger Berman Large Cap Value.  And, since there already was a Neuberger Berman Large Cap Value fund (NVAAX), the old Large Cap Value has now been renamed Neuberger Berman Value.  This started in December when Neuberger Berman fired Basu Mullick, who managed Regency and Partners.  He was, on whole, better than generating high volatility than high returns.  Partners, in particular, is being retooled to focus on mid-cap value stocks, where Mullick tended to roam.

American Beacon announced it will liquidate American Beacon Large Cap Growth (ALCGX) on May 18, 2012 in anticipation of “large redemptions”. American Beacon runs the pension plan for American Airlines.  Morningstar speculates that the termination of American’s pension plan might be the cause.

Aberdeen Emerging Markets (GEGAX) is merging into Aberdeen Emerging Markets Institutional (ABEMX). Same managers, same strategies.  The expense ratio will drop substantially for existing GEGAX shareholders (from 1.78% to 1.28% or so) but the investment minimum will tick up from $1000 to $1,000,000.

Schwab Premier Equity (SWPSX) closed at the end of March as part of the process of merging it into Schwab Core Equity (SWANX).

Forward is liquidating Forward International Equity Fund, effective at the end of April.  The combination of “small, expensive and mediocre” likely explains the decision.

Invesco has announced plans to merge Invesco Capital Development (ACDAX) into Invesco Van Kampen Mid Cap Growth (VGRAX) and Invesco Commodities Strategy (COAAX) Balanced-Risk Commodity Strategy (BRCAX).  In both mergers, the same management team runs both funds.

Allianz is merging Allianz AGIC Target (PTAAX) into Allianz RCM Mid-Cap (RMDAX), a move which will bury Target’s large asset base and modestly below-average returns into Mid-Cap’s record of modestly above-average returns.

ING Equity Dividend (IEDIX) will be rebranded as ING Large Cap Value.

Lord Abbett Mid-Cap Value (LAVLX) has changed its name to Lord Abbett Mid-Cap Stock Fund at the end of March.

With this month’s issue, we celebrate the first anniversary of the Observer’s launch.  I am delighted by our first year and delighted to still be here.  The Internet Archive places the lifespan of a website at 44-70 days.  It’s rather like “dog years.”  In “website lifespan years,” we are actually celebrating something between our fifth and eighth anniversary.  In truth, there’s no one we’d rather celebrate it with that you folks.

Highlights of a good year:

• We’ve seen 65,491 “Unique Visitors” from 103 countries. (Fond regards to Senegal!).
• Outside North America, Spain is far and away the source of our largest number of visits.  (Gracias!)
• Junior’s steady dedication to the site and to his “Best of the Web” project has single-handedly driven Trinidad and Tobago past Sweden to 24^th place on our visitor list.  His next target: China, currently in 23^rd.
• 84 folks have made financial contributions (some more than once) to the site and hundreds of others have used our Amazon link.   We have, in consequence, ended our first year debt-free, bills paid and spirits high.  (Thanks!)
• Four friends – Chip, Anya, Accipiter, and Junior – put in an enormous number of hours behind the scenes and under the hood, and mostly are compensated by a sense of having done something good. (Thank you, guys!)
• We are, for many funds, one of the top results in a Google search.  Check PIMCO All-Asset All-Authority (#2 behind PIMCO’s website), Seafarer Overseas Growth & Income (#4), RiverPark Short Term High Yield (#5), Matthews Asia Strategic Income (#6), Bretton Fund (#7) and so on.

That reflects the fact that we – you, me and all the folks here – are doing something unusual.  We’re examining funds and opportunities that are being ignored almost everywhere else.  The civility and sensibility of the conversation on our discussion board (where a couple hundred conversations begin each month) and the huge amount of insight that investors, fund managers, journalists and financial services professionals share with me each month (you folks write almost a hundred letters a month, almost none involving sales of “v1agre”) makes publishing the Observer joyful.

We have great plans for the months ahead and look forward to sharing them with you.

See you in a month!

Dear friends,

In the midst of the stock market’s recent generosity – 250 mutual funds booked returns of 20% or more in the first two months of 2012 – it’s easy to forget how bad 2011 was for the smart money crowd.  The average equity hedge fund, represented by the HFRX Equity Hedge Index, lost 19% for the year.  The value guys lost more than the growth guys. The Economist took some glee in reproducing a hypothetical letter from a hedge fund manager.  It reads, in part,

It is also time to move on from the concept of delivering “alpha”, the skill you’ve paid us such fat fees for. Upon reflection, we have decided that we’re actually much better at giving you “smart beta”. This term is already being touted at industry conferences and we hope shortly to be able to explain what it means. Like our peers we have also started talking a lot about how we are “multi-strategy” and “capital-structure agnostic”, and boasting about the benefits of our “unconstrained” investment approach. This is better than saying we don’t really understand what’s going on.

As an unofficial representative of the dumb money crowd, I’ll peel my eyes away from the spectacle of the Republican Party deciding which vital organ to stab next, just long enough to offer a cheery “nyah-nyah-nyah.”

The Observer in The Journal

As many of you know, The Wall Street Journal profiled the Observer in a February 6 article entitled “Professor’s Advice: It’s Best to Be Bored.” I talked a bit about the danger of “exciting” opportunities, offered leads on a dozen cool funds, and speculated about two emerging bubbles.  Neither should be a great surprise, but both carry potentially enormous consequences.

The bubbles in question are U.S. bonds and gold.  And those bubbles are scary because those assets have proven to be the last refuge for tens of millions of older investors (who, by the way, vote in huge numbers) whose portfolios were slammed by the stock market’s ferocious, pointless decade.  Tim Krochuk of GRT Capital Partners volunteers the same observation in a conversation this week.  “If rates return to normal – 4 or 5% – holders of long bonds are going to lose 40 – 50%.  If you thought that a 40% stock market fall led to blood in the streets, wait until you see what happens after a hit that big in retirees’ ‘safe’ portfolios.”  Folks from Roger Ibbotson to Teresa Kong have, this week, shared similar concerns.

For visual learners, here are the two graphs that seem best to reflect the grounds for my concern.

The first graph is the yield on benchmark 10-year Treasuries.  When the line is going up, Treasuries are in a bear market.  When the line is going down, they’re in a bull market.  Three things stand out, even to someone like me who’s not a financial professional:

• A bear market in bonds can last decades.
• The current bull market in bonds has proceeded, almost without interruption for 30 years.
• With current yields at 2% and inflation at 3% (i.e., there’s a negative real yield already), there’s nowhere much for the bull to go from here.

The second graph is the price of gold.  Since investing in gold is a matter of theology rather than economics, there’s not much to say beyond “gee, do you suppose it’ll rise forever?”

It might.  Thomas Sowell’s Basic Economics calculates that $1 investing in U.S. stocks in 1800 and held for about 200 years would be worth $500,000.   $1 in gold would be worth $0.78.  But this time’s different.  It always is.

In celebration of boring investments

In investing terms, “income” was once dismissed as the province of the elderly whose other eccentricities included reflection on the state of their bowel movements and strong convictions about Franklin Roosevelt.  Market strategies abjured dividend-paying firms, reasoning that dividends only arose when management was too timid or stupid to find useful things to do with their earnings.  And equity managers who were trapped by the word “income” in their fund name tried various dodges to avoid it.  In the mid-90s, for example, Fidelity Dividend Growth fund (FDGFX) invested in fast growing small caps, under the theory that  those firms had “the potential to increase (or begin paying) dividends in the future.”  Even today, it’s possible to find funds (Gabelli, Columbia, Huber, FAM) named “Equity Income” with yields below 0.6%.

The problem was compounded by organizational structures that isolated the equity and fixed-income teams from each other.  Even most stock/bond hybrid funds maintained the division: 60% of the portfolio was controlled by the equity manager, 40% by the fixed income manager.  Period.   Only a handful of managers – chief among them, David Winters at Wintergreen (WGRNX) and his forebears at the Mutual Series, Marty Whitman at Third Avenue Value (TAVFX), Steve Romick at FPA Crescent (FPACX) and Andrew Foster and Paul Matthews at Matthews Asian Growth and Income (MACSX) – had the freedom, the confidence and the competence to roam widely over a firm’s capital structure.

Today, some of the best analysis and most innovative product design is being done on income-sensitive funds.  That might reflect the simple fact that funds without income (alternately, gold exposure) have had a disastrous decade.  Jeremy Grantham observes in his latest quarterly letter

The U.S. market was terrible for the last 10 years, gaining a pathetic 0.5% per year overall, after inflation adjustments and even including dividends. Without dividends, the [S&P 500] index itself has not gone up a penny in real terms from mid-1997 to end-2011, or 14½ years. This is getting to be a long time!

Now dividend-stocks are (unwisely) declared as an alternative to bonds (“stock dividends, as an alternative or supplement to bonds, are shaping up to have better yields and less risk” notes a 2012 article in Investment News) and investors poured money into them in 2011.

The search for income is increasingly global.  Morningstar reports that “There now are 24 equity income funds that invest at least 25% of their assets outside of the U.S. and 30 funds that invest at least 75%, with the majority of those funds being launched in the last few years, according to Lipper.”

Among the cool options now available:

Calamos Evolving World Growth (CNWGX), which invests broadly in emerging market stocks, the stocks of developed market firms which derive at least 20% of sales in emerging markets, then adds convertibles or bonds to manage volatility. 4.75% front load, 1.68% e.r.

Global X Permanent ETF (PERM) which will pursue a Permanent Portfolio-like mix of 25% stocks, 25% gold and silver, 25% short-term bonds, and 25% long-term government bonds.  Leaving aside the fact that with Global X nothing is permanent, this strategy for inflation-proofing your portfolio has some merits.  We’ll look at PERM and its competitors in detail in our April issue.

Innovator Matrix Income Fund (IMIFX), which intends to rotate through a number of high-yielding surrogates for traditional asset classes.  Those include master limited partnerships, royalty trusts, REITs, closed end funds and business development companies.  In, for example, a low-inflation, low-growth environment, the manager would pursue debt REITs and closed-end bond funds to generate yield but might move to royalty trusts and equity REITs if both inflation and growth accelerated.  Hmmm.

iShares Morningstar Multi-Asset High Income Index Fund, still in registration, which will invest 20% in stocks, 60% in bonds (including high-yield corporates, emerging markets and international) and 20% in “alternative assets” (which means REITs and preferred shares).  Expenses not yet announced.

WisdomTree Emerging Markets Equity Income (DEM), which launched in 2007.  It holds the highest-paying 30% of stocks (about 300) in the WisdomTree Emerging Markets Dividend Index.  The fund has returned 28% annually over the past three years (through 1/31/12), beating the emerging markets average by 5% annually.  By Morningstar’s calculation, the fund outperforms its peers in both rising and falling markets. Expenses of 0.63%.

In September of 2010, I lamented “the best fund that doesn’t exist,” an emerging markets balanced fund.  Sophisticated readers searched and did find one closed-end fund that fit the bill, First Trust Aberdeen Emerging Opportunities (FEO), which I subsequently profiled as a “star in the shadows.”  A pack of emerging markets balanced funds have since comes to market:

AllianceBernstein Emerging Markets Multi Asset (ABAEX) will hold 0-65% bonds (currently 40%), with the rest in stocks and cash.  4.25% front load, 1.65% e.r.

Dreyfus Total Emerging Markets (DTMAX), which has an unconstrained allocation between stocks and bonds.  5.75% load, 1.65% e.r.

Fidelity Total Emerging Markets (FTEMX), launched in November and already approaching $100 million in assets, the fund has a pretty static 60/40 allocation.  No-load, 1.40% e.r.

First Trust/Aberdeen Emerging Opportunities (FEO), a closed-end fund and an Observer “Star in the Shadows” fund.  About 60% bonds, 40% stocks.  Exchange traded, 1.76% e.r.

Lazard Emerging Markets Multi-Strategy (EMMOX), which has a floating allocation between stocks, bonds (including convertibles) and currency contracts. No-load, 1.60% e.r.

PIMCO Emerging Multi-Asset (PEAAX), the most broadly constructed of the funds, is benchmarked against an index which invests 50/50 between stocks and bonds.  The fund itself can combine stocks, bonds, currencies and commodities. 5.5% load for the “A” shares, 1.74% expenses.

Templeton Emerging Markets Balanced (TAEMX), which must have at least 25% each in stocks and bonds but which is currently 65/30 in favor of stocks.  5.75% front load, 1.54% expenses.

While the options for no-load, low-cost investors remain modest, they’re growing – and growing in a useful direction.

Launch Alert (and an interview): Seafarer Overseas Growth and Income

In my February 2012 Commentary, I highlighted the impending launch of Seafarer Overseas Growth and Income (SFGIX and SIGIX).  I noted

The fund will be managed by Andrew Foster, formerly manager of Matthews Asia Growth & Income (MACSX) and Matthews’ research director and acting chief investment officer.

The great debate surrounding MACSX was whether it was the best Asia-centered fund in existence or merely one of the two or three best funds in existence.  Here’s the broader truth within their disagreement: Mr. Foster’s fund was, consistently and indisputably one of the best Asian funds in existence.

The launch provoked three long, thoughtful discussion threads about the prospects of the new fund, the Seafarer prospectus was our most downloaded document in the month of February and Chip, our sharp-eyed technical director, immediately began plotting to buy shares of the fund for her personal portfolio.

Mr. Foster and I agreed that the best way to agree potential investors’ questions was, well, to address potential investors’ questions.  He read through many of the comments on our discussion broad and we identified these seven as central, and often repeated.

Kenster1_GlobalValue:  Could he tell us more about his investment team? He will be lead manager but will there be a co-manager? If not, then an Assistant Manager? How about the Analysts – tell us more about them? Does he plan to add another analyst or two this year to beef up his team?

He’s currently got a team of four.  In addition to himself, he works with:

Michelle Foster, his wife, CFO, Chief Administrator and partner.  She has a remarkable investing resume.  She started as an analyst with JP Morgan, was a Principal at Barclay’s Global Investors (BGI) where she developed ETFs (including one that competed directly with Andrew’s India fund), and then joined investment advisory team at Litman/Gregory Asset Management.

William Maeck, his Associate Portfolio Manager and Head Trader.  William was actually Foster’s first boss at A. T. Kearney in Singapore where Andrew worked before joining Matthews.  Before joining Seafarer, he worked with Credit Suisse Securities as an investment advisor for high net worth individuals and family offices.  For now, William mostly monitors trading issues for the fund and has limited authority to execute trades at Foster’s direction.  With time, he should move toward more traditional co-manager responsibilities.

Kate Jaquet, Senior Research Analyst and Chief Compliance Officer.  Kate brings a lot of experience in fixed-income and high-yield investing and in Latin America.  She began her career in emerging markets in 1995 as an economic policy researcher for the international division of The Adam Smith Institute in London.  In 1997, she joined Credit Suisse First Boston as an investment banking and fixed-income analyst within their Latin America group. In 2000, she joined Seneca Capital Management in San Francisco as a senior research analyst in their high yield group.  She worked on high yield and distressed issuers, the metals & mining, oil & gas, and utilities industries, emerging market sovereigns and select emerging market corporate issuers.

AndyJ : I’m still mildly curious about the context of his leaving Matthews. Simply “pursuing other opportunities” might be the whole story, or it might not – even if perfectly true, there’s likely a context that would be interesting to know about.

Good and fair question.  Mr. Foster has a deep and abiding respect for Matthews and a palpable concern for his former shareholders.  When he joined Matthews in 1998, the firm managed $180 million.  It had grown a hundredfold by the time he left.  As a long-time member of the team, sometime chief investment officer, chief research officer and portfolio manager, he’d made a huge and rewarding commitment to the company.  About his leaving Mr. Foster made two points:

1. A fund like this has been on his mind for a decade.  It wasn’t clear, ten years ago, whether Matthews would remain purely Asia-focused or would broaden its geographic horizons.  As part of those deliberations, Paul Matthews asked Andrew to design a global version of MACSX.  He was very excited about the potential of such a fund.  After a long debate, Matthews concluded that it would remain an Asia specialist.  He respects their decision (indeed, as manager, helped make it pay off) but never gave up the dream of the broader fund and knew it would never fit at Matthews.
2. He did not leave until he was sure that his MACSX shareholders were in good hands.  He worked hard to build “an extremely capable team,” even celebrating the fact that he only hired “people smarter than me.”  He became convinced that the fund was in the hands of folks who’d put the shareholders first.  In order to keep it that way, he “made sure I didn’t do anything to advance [Seafarer] at the expense of Matthews.”  As a result, his current team is drawn from outside Matthews and he has not sought to aggressively recruit former shareholders out of the prior fund so as to drive growth in the new one.

Kenster1_GlobalValue: What does he see as potentially the top 3 countries in the fund if he were investing & managing the Seafarer fund right now? As an example – Indonesia looks great but what are his thoughts on this country? How would he rate it? Would he be lightly invested in Indonesia because he feels it might be too growthy at this time?

While he didn’t address Indonesia in particular, Mr. Foster did highlight six markets that were “particularly interesting.”  They are:

1. Vietnam
2. Brazil
3. Mexico
4. Turkey
5. Poland
6. South Africa

He argues that there are substantial political and cultural challenges in many of these countries, and that that turmoil obscures the fundamental strength of the underlying economy.  While it’s possible to conclude that you’d have to be nuts to sink your money in broken countries, Andrew notes that “broken can be good . . . the key is determining whether you’re experiencing chaos or progress, both raise a lot of dust.”  His general conclusion, having lived through generations of Asian crisis, “I’ve seen this story before.”

Maurice: I’d be interested in what Mr. Foster brings new to the table. Why would I not if invest new dollars with Matthews?

He thinks that two characteristics will distinguish Seafarer:

1. The Fund can provide exposure to multiple asset classes, as its strategy allows for investment in equities, convertible bonds, and fixed income.
2. The Fund has a broad geographical mandate. It’s not just broader than Asia, it’s also broader than “emerging markets.”   SFGIX / SIGIX  is pursuing exposure to emerging and frontier markets around the world, but Mr. Foster notes that in some instances the most effective way to gain such exposure is through the securities in neighboring countries.  For example, some of the best access to China is through securities listed in Singapore and Hong Kong; Australia plays a similar role for some Asian markets.

MikeM :  It seems to me that if you are looking for Asian exposure, this may not be your fund. This fund is not supposed to be an Asian concentrated fund like his previous fund at Matthews, MACSX.

Yes and no.  Mr. Foster can invest anywhere and is finding a lot of markets today that have the characteristics that Asia had ten years ago.  They’re fundamentally strong and under-recognized by investors used to looking elsewhere.  That said, he considers Asia to be “incredibly important” (a phrase he used four times during our conversation) and that “a large portion of the portfolio, particularly at the outset” will be invested in the Asian markets with which he’s intimately acquainted.

AndyJ: It’s danged expensive. There’s a closed-end fund, FEO, from the long-successful people at Aberdeen, which has a proven track record using a “balanced” EM strategy and costs the same as the investor shares of the Foster fund will. So, I’m not totally sure that Seafarer as a brand new entity is worthier of new $ at this point than FEO.

His response: “I hear you.”  His money, and his family’s, is in the fund and he wants it to be affordable. The fund’s opening expense ratio is comparable to what Matthews charged when they reached a billion in assets. He writes, “I view it as one of the firm’s central duties to ensure that expenses become more affordable with scale, and over time.” Currently, he can’t pass along the economies of scale, but he’s committed to do so as soon as it’s economically possible. His suspicion is that many funds get complacent with their expense structure, and don’t work to aggressively pursue savings.

fundalarm — it’s almost exclusively about pay. If you’re a star, and your name is enough to attract assets, why would you want to share the management fee with others when you can have your own shop. Really. Very. Simple.  Answer.

While Mr. Foster didn’t exactly chuckle when I raised this possibility, he did make two relevant observations.  First, if he were just interested in his own financial gain, he’d have stayed with Matthews. Second, his goal is to pursue asset growth only to the degree that it makes economic sense for his shareholders.  By his estimation, the fund is economically sustainable at $100-125 million in assets.  As it grows beyond that level, it begins accumulating economies of scale which will benefit shareholders.  At the point where additional assets begin impairing shareholder value, he’ll act to restrict them.

Seafarer represents a thoughtfully designed fund, with principled administration and one of the field’s most accomplished managers.  It’s distinctive, makes sense and has been under development for a decade.  It’s worthy of serious consideration and will be the subject of a fund profile after it has a few months of operation.

Launch Alert: Wasatch Frontier Emerging Small Countries Fund (WAFMX)

Just as one door closes, another opens. Wasatch closed their wildly successful Emerging Markets Small Cap Fund (WAEMX) to new investors on February 24, 2012.  The fund gathered $1.2 billion in assets and has returned 51% per year over the three years ending 2/29/2012. They immediately opened another fund in the same universe, run by the same manager.

Wasatch Frontier Emerging Small Countries Fund (WAFMX) became available to retail investors on March 1, 2012.  It has been open only to Wasatch employees for the preceding weeks.  It will be a non-diversified, all-cap fund with a bias toward small cap stocks.  The managers report:

In general, frontier markets and small emerging market countries, with the exception of the oil-producing Persian Gulf States, tend to have relatively low gross national product per capita compared to the larger traditionally-recognized emerging markets and the world’s major developed economies. Frontier and small emerging market countries include the least developed markets even by emerging market standards. We believe frontier markets and small emerging market countries offer investment opportunities that arise from long-term trends in demographics, deregulation, offshore outsourcing and improving corporate governance.

The Fund may invest in the equity securities of companies of any size, although we expect a significant portion of the Fund’s assets to be invested in the equity securities of companies under US$3 billion at the time of purchase.

We travel extensively outside the U.S. to visit companies and expect to meet with senior management. We use a process of quantitative screening followed by “bottom up” fundamental analysis with the objective of owning the highest quality growth companies tied economically to frontier markets and small emerging market countries.

The manager is Laura Geritz.  She has been a portfolio manager for the Wasatch Emerging Markets Small Cap Fund since 2009 and for the Wasatch International Opportunities Fund since 2011. The minimum investment is $2000, reduced to $1000 for accounts with an automatic investing plan.  The expense ratio will be 2.25%, after waivers.    We will, a bit after launch, try to speak with Ms. Geritz and will provide a full profile of the fund.

Fidelity is Thinking Big

(May God have mercy on our souls.)

Despite the ironic timing – they simultaneously announce a bunch of long overdue but still pretty vanilla bond funds at the same time they trumpet their big ideas – Fido has launched its first major ad campaign which doesn’t involve TV.  Fidelity is thinking big.

In one of those “did they have the gang at Mad Magazine write this?” press releases, Fido will be “showcasing thought-provoking insights” which “builds on Fidelity’s comprehensive thought leadership” “through an innovative new thought leadership initiative.”

Do you think so?

So what does “thinking big” look like?  At their “thinking big” microsite, it’s a ridiculous video that runs for under three minutes, links that direct you to publishers websites so that you can buy three to five year old books, and links to articles that are a year or two old.  The depth and quality of analysis in the video are on par with a one-page Time magazine essay.  It mixes fun facts (it takes 635 gallons of water to make one pound of hamburger), vacuous observations (water shortages “could further exacerbate regional water issues”) and empty exhortations (“think about it.  We do.”).

According to the Boston Business Journal, the campaign “was created by Fidelity’s internal ad agency, Fidelity Communications and Advertising. Arnold Worldwide, the mutual fund firm’s ad agency of record, did not work on the campaign.”  It shows.  While the VP for communications described this as “the first campaign where we’ve actually attempted to create a viral program without a large supporting TV effort,” he also adds that Fidelity isn’t taking a position on these issues, they’re just “stating the facts.”

Yep.  That’s the formula for going viral: corporate marketing footage, one talking head and a “just the facts” ethos.

A quick suggestion from the guy with a PhD in communication: perhaps if you stopped producing empty, boilerplate shareholder communications (have you read one of your annual reports?) and stopped focusing on marketing, you might actually educate investors.  A number of fund companies provide spectacularly good, current, insightful shareholder communications (T. Rowe Price and Matthews Asia come immediately to mind).  Perhaps you could, too?

The Best of the Web: A new Observer experiment

This month marks the debut of the Observer’s “best of the web” reviews.  The premise is simple: having a million choices leaves you with no choices at all.  When you’ve got 900 cable channels, you’ll almost always conclude “there’s nothing on” and default to watching the same two stations. It’s called “the paradox of choice.”  Too many options cause our brains to freeze and make us miserable.

The same thing is true on the web.  There are a million sites offering financial insight; faced with that daunting complexity, we end up sticking with the same one or two.  That’s comforting, but may deny you access to helpful perspectives.

One solution is to scan the Observer’s discussion board, where folks post and discuss a dozen or more interesting topics and articles each day.  Another might be our best of the web feature.  Each month, based on reader recommendations and his own evaluations, contributing editor Junior Yearwood will post reviews for three to five related sites.  Each is a page long and each highlights what you need know: what’s the site about, what does it do well, what’s our judgment?

The debut issue features fund rating sites.  Everyone knows Morningstar, but how many folks have considered the insights available from, and strengths or weaknesses of, its dozen smaller competitors?  Take the case of a single splendid fund, Artisan International Value (ARTKX).  Depending on who you ask, it’s seen as somewhere between incredibly excellent (for our money, it is) and utterly undistinguished.  Here’s the range of assessments from a variety of sites:

• BarCharts.com: 96% buy
• Morningstar: Five stars, Gold
• FundMojo: 89/100, a Master
• Lipper: 24 of 25 possible points, a Leader
• U.S. News: 8.1/100
• FundReveal: less risky, lower return
• MaxFunds 79/100, good
• TheStreet.com: C-, hold
• Zacks: 3/5, hold.

After a month of reading, Junior and I identified three sites that warranted your time, and named eight more that you probably won’t be bookmarking any time soon.

If you’re wondering “what do those mean?”  Or “does Zacks know something that Morningstar doesn’t?” – or even if you’re not – we’re hoping you’ll check out “the best of the web.”

Numbers that you really shouldn’t trust

Claymore/Mac Global Solar Energy Index ETF (XTANX) is up 1120% YTD!

(Source: BarCharts.com, YTD Leaders, as of 2/29/2012)

Or not.  First, it’s a Guggenheim ETF now.  Second, there was a 10:1 reverse split on February 15.  BarCharts has a “strong buy” rating on the shares.

GMO Domestic Bond III (GMBDX) is up 767%!

(Same source)

Uhh.  No.  9:1 reverse split on January 17.

There are 77 T. Rowe Price funds that waive the investment minimum for investors with an automatic investing plan!

(Source: Morningstar premium fund screener, 2/29/2012)

Uhh. No.  T. Rowe discontinued those waivers on August 1, 2011.

The “real” expense of running Manning & Napier Dividend Focus (MNDFX) is 5.6%.

(Source: Manning and Napier website, 2/29/2012)

Likewise: no.  An M&N representative said that the figures represented the fund’s start-up state (high expenses, no shareholders) but that they weren’t allowed to change them yet.  (???)  The actual e.r. without an expense waiver is 1.05%, but they have no intention of discontinuing the waiver.

NorthRoad International is a five-star fund that offers tiny beta and huge alpha

(Source: Morningstar profile, 2/29/2011)

Uhh.  No.  Not even a little.  Why not?  Because until June 30, 2011, this was the Madison Mosaic Small/Mid-Cap Fund.  Because US smaller stocks were bouncing back from the bloody meltdown from October 2007 – March 2009, this fund returns that were great by international large cap standards and those returns have been folded seamlessly into Morningstar’s assessment.

In NorthRoad’s defense: the fund’s own publicity material makes the change very clear and refuses to include any comparisons that precede the fund’s new mandate.  And, since the change, it has been a distinctly above-average international fund with reasonable fees.  It’s just not the fund that Morningstar describes.

Any three-year performance number.  The market reached its bottom in the first week of March, 2009 and began a ferocious rally.  We are now entering the point where the last remnants of a fund’s performance during the market downturn are being cycled-out of the three-year averages.  As of 3/01/2012, there are 18 funds which have returned more than 50% per year, on average for the past three years.  Half of all funds have three-year returns above 21% per year.  Forester Value (FVALX), the great hero of 2008 and the recipient of a ton of money in 2009, now has three-year returns that trail 99% of its peers.

Two funds and why they’re worth your time . . .

Really, really worth your time.

Each month we provide in-depth profiles of two funds that you should know more about, one new and one well-established.

Matthews Asia Strategic Income (MAINX): most US investors have little or no exposure to Asian fixed-income markets, which are robust, secure and growing. Matthews, which already boasts the industry’s deepest corps of Asia specialists, has added a first-rate manager and made her responsible for the first Asian income fund available to U.S. retail investors.

GRT Value (GRTVX): what do you get when you combine one of the best and most experienced small cap investors, a corps of highly professional and supportive partners, a time-tested, risk-conscious strategy and reasonable expenses? GRTVX investors are finding out.

Briefly noted:

T. Rowe Price Real Assets (PRAFX) opened to retail investors in December, 2011.  The fund invests in companies that own “stuff in the ground.”  The fund was launched in May 2011 but was only available for use in other T. Rowe Price funds.  A 5% allocation to real assets became standard in their target-date funds, and might represent a reasonable hedge in most long-term portfolios.  The fund’s opening to retail investors was largely unexplained and unnoticed.

Wasatch Microcap Value (WAMVX) has reopened to new investors through Schwab, Fidelity, TD Ameritrade, and other intermediaries.

Talented managers with good marketers attract cash!  What a great system.  The folks at Grandeur Peaks passed $100 million in assets after four months of operation.  The exceedingly fine River Park /Wedgewood Fund (RWGFX) just passed $200 million.   When I first profiled the fund, July 2011, it had $200,000 in assets.  Dave Rolfe, the manager, estimates that the fund’s strategy can accommodate $5 billion.

Vanguard finally put Vanguard Asset Allocation out of its misery by merging it into Vanguard Balanced Index fund (VBINX) on 2/10/2012.  Last fall the Observer identified Vanguard Asset Allocation as one of the fund universe’s 12 worst funds based on its size and its wretched consistency.  We described funds on the list this way:

These funds that have finished in the bottom one-fourth of their peer groups for the year so far.  And for the preceding 12 months, three years, five years and ten years.  These aren’t merely “below average.”  They’re so far below average they can hardly see “mediocre” from where they are.

RiverNorth DoubleLine Strategic Income (RNSIX) will close to new investors on March 30, 2012. The fund, comanaged by The Great Gundlach, gathered $800 million in its first 14 months.

Wells Fargo will liquidate Wells Fargo Advantage Social Sustainability (WSSAX) and Wells Fargo Advantage Global Health Care (EHABX) by the end of March, 2012.  It’s also merging Wells Fargo Advantage Strategic Large Cap Growth (ESGAX) into Wells Fargo Advantage Large Cap Growth (STAFX), likely in June.

Bridgeway is merging Bridgeway Aggressive Investors 2 (BRAIX) into Bridgeway Aggressive Investors 1 (BRAGX) and Bridgeway Micro-Cap Limited (BRMCX) into Bridgeway Ultra-Small Company (BRUSX).   Bridgeway had earlier announced a change in BRUSX’s investment mandate to allow for slightly larger (though still tiny) stocks in its portfolio.  In hindsight, that appears to have been the signal of the impending merger.  BRUSX, which closed when it reached just $22.5 million in assets, is a legendary sort of fund.  $10,000 invested at its 1994 launch would now be worth almost $120,000 against its peers $50,000.

Invesco Small Companies (ATIIX) will close to new investors on March 5, 2012.  That’s in response to an entirely-regrettable flood of hot money triggered by the fund’s great performance in 2011.  Meanwhile, Invesco also said it will reopen Invesco Real Estate (IARAX) to new investors on March 16.

Delaware Large Cap Value (DELDX) is merging into Delaware Value (DDVAX), itself an entirely-respectable large cap value fund with noticeably lower expenses.

Likewise Lord Abbett is merged Lord Abbett Large-Cap Value (LALAX) into Lord Abbett Fundamental Equity (LDFVX).

Proving the adage that nothing in life is certain but death and taxes, State Street Global Advisors will kill its Life Solutions funds on May 15.  Among the soon-to-be decedents are Balanced, Growth and Income & Growth.  Also going are SSgA Disciplined Equity (SSMTX) and Directional Core Equity (SDCQX).

Speaking of death, the year’s second mass execution of ETFs occurred on February 17 when Global X took out eight ETFs at once: Farming, Fishing, Mexico Small Caps, Oil, Russell Emerging Markets Growth, Russell Emerging Markets Value, and Waste Management.  The 17 HOLDRS Trusts, which promised to “revolutionize stock investing” were closed in December and liquidated on January 9, 2012.

Our chief programmer, Accipiter, was looking for a bit of non-investing reading this month and asked folks on the board for book recommendations. That resulting outpouring was so diverse and thoughtful that we wanted to make it available for other readers. As a result, our Amazon store (it’s under Books, on the main menu bar) now has a “great non-investing reads” department. You’ll be delighted by some of what you find there.

Oh, and Accipiter: there will be a quiz over the readings.

Amazon’s time limit

If you’re one of the many people who support the Observer, thank you!  Thank you, thank you, thank you!  A dozen readers contributed to the Observer this month (thank you!) by mail or via PayPal.  That’s allowed us to more than offset the rising costs caused by our rising popularity.  You not only make it all worthwhile, you make it all possible.

If you’re one of the many people who support the Observer by using our link to Amazon.com, thank you – but here’s a warning: the link you create expires or can be wiped out as you navigate.

If you enter Amazon using the Observer’s link (consider bookmarking it), or any other Associate’s link, and put an item in your Shopping Cart, the item carries a special code which serves to identify the referring site (roughly: “us”).  It appears the link expires about 24 hours after you set it, so if something’s been in your shopping cart for six weeks (as sometimes happens with me), you might want to re-add it.

Which I mention because Amazon just restated their policy.

A WORD OF WARNING BEFORE YOU GO:

We are going try to cull dead accounts from our email list in the next month, since the monthly charge for sending our notice climbs precipitously after we pass 2500 names.  Anyone who has subscribed to receive an email notice but who has never actually opened one of them (it looks like more than a hundred folks) will be dropped.  We’d feel bad if we inadvertently lost you, so please do be sure to open the email notice (don’t just look at it in a preview pane) at least once so we know you’re still there.

Take great care and I’ll write again, soon.

Dear friends,

Welcome to the Year of the Dragon.  The Chinese zodiac has been the source of both enthusiasm (“Year of the Dragon and the scaly beast’s unmatched potency as a symbol for prosperity and success – as part of China’s own zodiac – promises an extra special 12 months”) and merriment (check the CLSA Asia-Pacific Market’s Feng Shui Report)  in the investing community.  The Dragon itself is characterized as “magnanimous, stately, vigorous, strong, self-assured, proud, noble, direct, dignified, eccentric, intellectual, fiery, passionate, decisive, pioneering, artistic, generous, and loyal. Can be tactless, arrogant, imperious, tyrannical, demanding, intolerant, dogmatic, violent, impetuous, and brash.”

Sort of the Gingrich of Lizards.

The Wall Street Journal reports (1/30/12) that Chinese investors have developed a passion for packing portfolios with “fungus harvested from dead caterpillars . . . homegrown liquors, mahogany furniture and jade, among other decidedly non-Western asset classes.”

Given that the last Year of the Dragon (2000) was a disappointment and a prelude to a disaster, I think I’ll keep my day job and look for really good sales on cases of peanut butter (nothing soothes the savaged investor quite like a PB&J . . . and maybe a sprinkle of caterpillar fungus).

Morningstar’s Fund Manager of the Year Awards

I’m not sure if the fund industry would be better off if John Rekenthaler had stayed closer to his bully pulpit, but I know the rest of us would have been.  Mr. Rekenthaler (JR to the cognoscenti) is Morningstar’s vice president of research but, in the 1990s and early part of the past decade, played the role of bold and witty curmudgeon and research-rich gadfly.   I’d long imagined a meeting of JR and FundAlarm’s publisher Roy Weitz as going something like this: 

The ugly reality is that age and gentility might have reduced it to something closer to: 

For now, I think I’ll maintain my youthful illusions.

Each year Morningstar awards “Fund Manager of the Year” honors in three categories: domestic equity, international equity and fixed-income.  While the recognition is nice for the manager and his or her marketers, the question is: does it do us as investors any good.  Is last year’s Manager of the Year, next year’s Dud of the Day?

One of the things I most respect about Morningstar is their willingness to provide sophisticated research on (and criticisms of) their own systems.  In that spirit, Rekenthaler reviewed the performance of Managers of the Year in the years following their awards.

His conclusions:

Domestic Fund Manager of the Year: “meh.”  On whole, awardees were just slightly above average with only three disasters, Bill Miller (1998), Jim Callinan (1999 – if you’re asking “Jim Who?” you’ve got a clue about how disastrous), and Mason Hawkins (2006).  Bruce Berkowitz will appear in due course, I fear.   JR’s conclusion: “beware of funds posting high returns because of financials and/or technology stocks.”

Fixed-Income Manager of the Year: “good” and “improving.”  On whole, these funds lead their peers by 50-80 basis points/year which, in the fixed income world, is a major advantage.  The only disaster has been a repeated disaster: Bob Rodriquez of FPA New Income earned the award three times and has been mediocre to poor in the years following each of those awards.  Rekenthaler resists the impulse to conclude that Morningstar should “quit picking Bob Rodriguez!” (he’s more disciplined than I’d be).  JR notes that Rodriquez is streaky (“two or three truly outstanding years” followed by mediocrity and disappointment before taking off again) and that “it’s a tough fund to own.”

International Fund Manager of the Year:  Ding! Ding! Ding!  Got it right in a major way.  As Rekenthaler puts it, “the Morningstar team selecting the International-Stock winners should open a hotline on NFL games.”  Twelve of the 13 international honorees posted strong returns in the years after selection, while the final honoree Dodge & Cox International (DODFX) has beaten its peer group but just by a bit.

Rekenthaler’s study, Do the Morningstar Fund Manager of the Year Awards Have Staying Power? is available at Morningstar.com, but seems to require a free log-in to access it.

Fun with Numbers: The Difference One Month Makes

Investors often look at three-year returns to assess a fund’s performance.  They reason, correctly, that they shouldn’t be swayed by very short term performance.  It turns out that short term performance has a huge effect on a fund’s long-term record.

The case in point is Matthews Asian Growth and Income (MACSX), a FundAlarm “Star in the Shadows” fund, awarded five stars and a “Silver” rating by Morningstar.  It’s in my portfolio and is splendid.  Unless you look at the numbers.  As of January 27 2011, it ranked dead last – the 100th percentile – in its Morningstar peer group for the preceding three years.  Less than one month earlier, it was placed in the 67^th percentile, a huge drop in 20 trading days.

Or not, since its trailing three-year record as of January 27 showed it returning 18.08% annually.  At the beginning of the month, its three-year return was 14.64%.

How much difference does that really make?  $10,000 invested on January 1 2009 would have grown to $15,065 in three years.  The same amount invested on January 27 2009 and left for three years would have grown to $16,482.  Right: the delay of less than a month turned a $5100 gain into a $6500 one.

What happened?   The January 27 calculation excludes most of January 2009, when MACSX lost 3.3% while its peers dropped 7.8% and it includes most of January 2012, when MACSX gained 4.8% but its peers rallied 10.2%.  That pattern is absolutely typically for MACSX: it performs brilliantly in falling markets and solidly in rising ones.  If you look at a period with sharp rises – even in a single month – this remarkably solid performer seems purely dreadful.

Here’s the lesson: you’ve got to look past the numbers.  The story of any fund can’t be grasped by looking at any one number or any one period.  Unless you understand why the fund has done what it has and what it supposed to be doing for your portfolio, you’re doomed to an endless cycle of hope, panic and missteps.  (From which we’re trying to save you, by the way.)

Looking Past the Numbers, Part Two: The Oceanstone Fund

Sometimes a look past the numbers will answer questions about a fund that looking dowdy. That’s certainly the case with MACSX. In order instances, it should raise them about a fund that’s looking spectacular. The Oceanstone Fund (OSFDX) is a case in point. Oceanstone invests in a diversified portfolio of undervalued stocks from micro- to mega-cap. Though it does not reflect the fund’s current or recent portfolio, Morningstar classifies it as a “small value” fund.  And I’ve rarely seen a fund with a more-impressive set of performance numbers:

In the approximately five years from launch through 1/30/2011, Oceanstone’s manager turned $10,000 into $59,000.  In 2009, powered by gains in Avis Budget Group and Dollar Thrifty Automotive (1,775 percent and 2,250 percent respectively), the fund made 264%.  And still, the fund has only $17 million in assets.

Time to jump in?  Send the big check, and wait to receive the big money?

I don’t know.  But you do owe it to yourself to look beyond the numbers first.  When you do that, you might notice:

1. that the manager’s explanation of his investment strategy is nonsense.  Here’s the prospectus description of what he’s doing:

In deciding which common stocks to purchase, the Fund seeks the undervalued stocks as compared to their intrinsic values. To determine a stock’s intrinsic value (IV), the Fund uses the equation: IV = IV/E x E. In this equation, E is the stock’s earnings per share for its trailing 4 quarters, and a reasonable range of its IV/E ratio is determined by a rational and objective evaluation of the current available information of its future earnings prospects.

Read that formula: IV = IV divided by E, times E.  No more than a high school grasp of algebra tells you that this formula tells you nothing.  I shared it with two professors of mathematics, who both gave it the technical term “vacuous.”  It works for any two numbers (4 = 4 divided by 2, times 2) but it doesn’t allow you to derive one value from the other.  If you know “the stock’s earnings” and are trying to determine it’s “investment value,” this formula can’t do it.

2. that the shareholder reports say nothing.  Here is the entire text of the fund’s 2010 Annual Report:

Oceanstone Fund (the Fund) started its 2011 fiscal year on 7/1/2010 at net asset value (NAV) of $28.76 per share. On 12/27/2010, the Fund distributed a short-term capital gain dividend of $2.7887 per share and a long-term capital gain dividend of $1.7636. On 6/30/2011, the Fund ended this fiscal year at NAV of $35.85 per share. Therefore, the Fund’s total return for this fiscal year ended 6/30/2011 is 42.15%. During the same period, the total return of S&P 500 index is 30.69%.

For portfolio investment, the Fund seeks undervalued stocks. To determine a stock’s intrinsic value (IV), the Fund uses the equation IV = IV/E x E, as stated in the Fund’s prospectus. To use this equation, the key is to determine a company’s future earnings prospects with reasonable accuracy and subsequently a reasonable range for its IV/E ratio. As a company’s future earnings prospects change, this range for its IV/E ratio is adjusted accordingly.

Short-term, stock market can be volatile and unpredictable. Long-term, the deciding factor of stock price, as always, is value. Going forward, the Fund strives to find at least some of the undervalued stocks when they become available in U.S. stock market, in an effort to achieve a good long-term return for the shareholders.

One paragraph reports NAV change, the second reproduces the vacuous formula in the prospectus and the third is equally-vacuous boilerplate about markets.  What, exactly, is the manager telling you?  And what does it say that he doesn’t think you deserve to know more?

3. that Oceanstone’s Board is chaired by Rajendra Prasad, manager of Prasad Growth (PRGRX).  Prasad Growth, with its frantic trading (1300% annual turnover), collapsing asset base and dismal record (bottom 1% of funds for the past 3-, 5- and 10-year period) is a solid candidate for our “Roll Call of the Wretched.”  How, then, does his presence benefit Oceanstone’s shareholders?

4. the fund’s portfolio turns over at triple the average rate, is exceedingly concentrated (20 names) and is sitting on a 30% cash stake.  Those are all unusual, and unexplained.

You need to look beyond the numbers.  In general, a first step is to read the managers’ own commentary.  In this case, there is none.  Second, look for coverage in reliable sources.  Except for this note and passing references to 2009’s blistering performance, none again.  Your final option is to contact the fund advisor.   The fund’s website has no email inquiry link or other means to facilitate contact, so I’ve left a request for an interview with the fund’s phone reps.  They seemed dubious.  I’ll report back, in March, on my success or failure.

And Those Who Can’t Teach, Teach Gym.

Those of us who write about the investment industry occasionally succumb to the delusion that that makes us good investment managers.  A bunch of funds have managers who at least wave in the direction of having been journalists:

• Sierra Strategic Income Fund: Frank Barbera, CMT, was a columnist for Financial Sense from 2007 until 2009.
• Roge Partners:  Ronald W. Rogé has been a guest personal finance columnist for ABCNews.com.
• Auer Growth:  Robert C. Auer, founder of SBAuer Funds, LLC, was from 1996 to 2004, the lead stock market columnist for the Indianapolis Business Journal “Bulls & Bears” weekly column, authoring over 400 columns, which discussed a wide range of investment topics.
• Astor Long/Short ETF Fund: Scott Martin, co-manager, is a contributor to FOX Business Network and a former columnist with TheStreet.com
• Jones Villalta Opportunity Fund: Stephen M. Jones was financial columnist for Austin Magazine.
• Free Enterprise Action Fund: The Fund’s investment team is headed by Steven J. Milloy, “lawyer, consultant, columnist, adjunct scholar.”

Only a handful of big-time financial journalists have succumbed to the fantasy of financial acumen.  Those include:

• Ron Insana, who left CNBC in March 2006 to start a hedge fund, lost money for his investors, closed the fund in August 2008, joined SAC Capital for a few months then left.  Now he runs a website (RonInsanaShow.com) hawking his books and providing one minute market summaries, and gets on CNBC once a month.
• Lou Dobbs bolted from hosting CNN’s highly-rated Moneyline show in 1999 in order to become CEO of Space.com.  By 2000 he was out of Space and, by 2001, back at CNN.
• Jonathan Clements left a high visibility post at The Wall Street Journal to become Director of Financial Education, Citi Personal Wealth Management.  Sounds fancy.  Frankly, it looks like he’s been relegated to “blogger.”  As I poke around the site, he seems to write a couple distinctly mundane, 400-word essays a week.
• Jim Cramer somehow got rich in the hedge fund world.  Since then he’s become a clown whose stock picks are, by pretty much every reckoning, high beta and zero alpha.   And value of his company, TheStreet.com’s, stock is down 94.3% since launch.
• Jim Jubak, who writes the “Jubak’s Picks” column for MSN Money, launched Jubak Global Equity (JUBAX), which managed to turn $10,000 at inception into $9100 by the end of 2011 while his peers made $11,400.

You might notice a pattern here.

The latest victim of hubris and comeuppance is John Dorfman, former Bloomberg and Wall Street Journal columnist.  You get a sense of Dorfman’s marketing savvy when you look at his investment vehicles.

Dorfman founded Thunderstorm Capital in 1999, and then launched The Lobster Fund (a long-short hedge fund) in 2000.  He planned launch of The Oyster Fund (a long-only hedge fund) and The Crab Fund (short-only) shortly thereafter, but that never quite happened.  Phase One: name your investments after stuff that’s found at low tide, snatched up, boiled and eaten with butter.

He launched Dorfman Value Fund in 2008. Effective June 30, 2009, the fund’s Board approved changing the name from Dorfman Value Fund to Thunderstorm Value Fund.  The reason for the name change is that the parent firm of Thunderstorm Mutual Funds LLC “has decided the best way to promote a more coherent marketing message is to rebrand all of its products to begin with the word ‘Thunderstorm’.”

Marketers to mutual fund: “Well, duh!”

Earth to Dorfman: did you really think that naming your fund after a character in Animal House (Kent Dorfman, an overweight, clumsy legacy pledge), especially one whose nickname was “Flounder,” was sharp to begin with? Name recognition is all well and good . . . . as long as your name doesn’t cause sniggering. I can pretty much guarantee that when I launch my mutual fund, it isn’t going to be Snowball Special (DAVYX).

Then, to offset having a half-way cool name, they choose the ticker symbol THUNX.  THUNX?  As in “thunks.”  Yes, indeed, because nothing says “trust me” like a vehicle that goes “thunk.”

Having concluded that low returns, high expenses, a one-star rating, and poor marketing aren’t the road to riches, the advisor recommended that the Board close (on January 17, 2012) and liquidate (on February 29, 2012) the fund.

Does Anyone Look at this Stuff Before Running It?

They’re at it again.  I’ve noted, in earlier essays, the bizarre data that some websites report.  In November, I argued, “There’s no clearer example of egregious error without a single human question than in the portfolio reports for Manning & Napier Dividend Focus (MNDFX).”  The various standard services reported that the fund, which is fully invested in stocks, held between 60 – 101% of its portfolio in cash.

And now, there’s another nominee for the “what happens when humans no longer look at what they publish” award.  In the course of studying Bretton Fund (BRTNX), I looked at the portfolios of the other hyper-concentrated stock funds – portfolios with just 10-15 stocks.

One such fund is Biondo Focus (BFONX), an otherwise undistinguished fund that holds 15 stocks (and charges way too much).   One striking feature of the fund: Morningstar reports that the fund invested 30% of the portfolio in a bank in Jordan.  That big gray circle on the left represents BFONX’s stake in Union Bank.

There are, as it turns out, four problems with this report.

1. There is no Union Bank in Jordan.  It was acquired by, and absorbed in, Bank Al Etihad of Amman.
2. The link labeled Union Bank (Jordan) actually leads to a report for United Bankshares, Inc. (UBSI).  UBSI, according to Morningstar’s report, mostly does business in West Virginia and D.C.
3. Biondo Focus does not own any shares of Union or United, and never has.
4. Given the nature of data contracts, the mistaken report is now widespread.

Joe Biondo, one of the portfolio managers, notes that the fund has never had an investment in Union Bank of Jordan or in United Bankshares in the US.  They do, however, use Union Bank of California as a custodian for the fund’s assets.  The 30% share attributed to Union Bank is actually a loan run through Union Bank, not even a loan from Union Bank.

The managers used the money to achieve 130% equity exposure in January 2012.  That exposure powered the portfolio to a 21.4% gain in the first four weeks of January 2012, but didn’t offset the fund’s 24% loss in 2011.  From January 2011 – 2012, it finished in the bottom 1% of its peer group.

Google, drawing on Morningstar, repeats the error, as does MSN and USA Today while MarketWatch and Bloomberg get it right. Yahoo takes error in a whole new direction when provides this list of BFONX’s top ten holdings:

Uhhh, guys?  Even in daycare the kids managed to count past two on their way to ten.  For the record, these are holdings five and six.

Doesn’t Anyone at the SEC Look at their Stuff Before Posting It?

The Securities and Exchange Commission makes fund documents freely available through their EDGAR search engine.  In the relentless, occasionally mind-numbing pursuit of new funds, I review each day’s new filings.  The SEC posts all of that day’s filings together which means that all the filings should be from that day.  To find them, check “Daily Filings” then “Search Current Events: Most Recent Filings.”

Shouldn’t be difficult.  But it is.  The current filings for January 5, 2012 are actually dated:

• January 5, 2012
• October 14, 2011
• September 2, 2011
• August 15, 2011
• August 8, 2011
• July 27, 2011
• July 15, 2011
• July 1, 2011
• June 15, 2011
• June 6, 2011
• May 26, 2011
• May 23, 2011
• January 10, 2011

For January 3^rd, only 20 of 98 listings are correct.  Note to the SEC: This Isn’t That Hard!  Hire A Programmer!

Fund Update: HNP Growth and Preservation

We profiled HNP Growth and Preservation (HNPKX) in January 2012.  The fund’s portfolio is set by a strict, quantitative discipline: 70% is invested based on long-term price trends for each of seven asset classes and 30% is invested based on short-term price trends.  The basic logic is simple: try to avoid being invested in an asset that’s in the midst of a long, grinding bear market.  Don’t guess about whether it’s time to get in or out, just react to trend.  This is the same strategy employed by managed futures funds, which tend to suffer in directionless markets but prosper when markets show consistent long-term patterns.

Since we published our profile, the fund has done okay.  It returned 3.06% in January 2012, through 1/27.  That’s a healthy return, though it lagged its average peer by 90 bps.  It’s down about 5.5% since launch, and modestly trails its peer group.  I asked manager Chris Hobaica about how investors should respond to that weak initial performance.  His reply arrived too late to be incorporated in the original profile, but I wanted to share the highlights.

Coming into August the fund was fully invested on the long term trend side (fairly rare…) and overweight gold, Treasuries and real estate on the short term momentum side. . .  Even though the gold and Treasuries held up [during the autumn sell-off], they weren’t enough to offset the remaining assets that were being led down by the international and emerging assets.  Also, as is usually the case, assets class correlations moved pretty close to 1.

Generally though, this model isn’t designed to avoid short-term volatility, but rather a protracted bear market.  By the end of September, we had moved to gold, treasuries and cash.  So, the idea was that if that volatility continued into a bear market, the portfolio was highly defensive.

While we are never happy with negative returns, we explain to shareholders that the model was doing what it was supposed to do.  It became defensive when the trends reversed.  I am not worried by the short term drop (I don’t like it though), as there have been many other times over the backtest that the portfolio would have been down in the 8-10% range.

Three Funds, and why they’re worth your time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  One category is the most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month we’ll highlight three funds with outstanding heritages and fascinating prospects:

Bretton Fund (BRTNX): Bretton is an ultra-concentrated value fund managed by the former president of Parnassus Investments.  It has shown remarkable – and remarkably profitable – independence from style boxes, peers and indexes in its brief life.

Grandeur Peak Global Opportunities (GPGOX): here’s a happy thought.  Two brilliantly-successful managers who made their reputation running a fund just like this one have struck out on their own, worrying about a much smaller and more-nimble fund, charging less and having a great time doing it.

Matthews Asia Strategic Income (MAINX): Matthews, which already boasts the industry’s deepest corps of Asia specialists, has added a first-rate manager and made her responsible for the first Asian income fund available to U.S. retail investors.

Launch Alert: Seafarer Overseas Growth and Income

Seafarer Overseas Growth and Income (SFGIX) is set to launch in mid-February, 2012.  The fund’s final prospectus is available at SeafarerFunds.com. The fund will be managed by Andrew Foster, formerly manager of Matthews Asia Growth & Income (MACSX) and Matthews’ research director or acting chief investment officer.

The great debate surrounding MACSX was whether it was the best Asia-centered fund in existence or merely one of the two or three best funds in existence.  Here’s the broader truth within their disagreement: Mr. Foster’s fund was, consistently and indisputably one of the best Asian funds in existence.  That distinction was driven by two factors: the fund’s focus on high-quality, dividend-paying stocks plus its willingness to hold a variety of securities other than common stocks.  A signal of the importance of those other securities is embedded in the fund’s ticker symbol; MACSX reflects the original name, Matthews Asian Convertible Securities Fund.

Those two factors helped make MACSX one of the two least volatile and most profitable Asian funds.  Whether measured by beta, standard deviation or Morningstar’s “downside capture ratio,” it typically incurs around half of the risk of its peers. Over the past 15 years, the fund’s returns (almost 11% per year) are in the top 1% of its peer group.  The more important stat is the fund’s “investor returns.”  This is a Morningstar calculation that tries to take into account the average investor’s fickleness and inept market timing.  Folks tend to arrive after a fund has done spectacularly and then flee in the midst of it crashing.  While it’s an imperfect proxy, “investor returns” tries to estimate how much the average investor in a fund actually made.  With highly volatile funds, the average investor might have earned nothing in a fund that made 10%.

In the case of MACSX, the average investor has actually made more than the fund itself.  That occurs when investors are present for the long-haul and when they’re in the habit of buying more when the fund’s value is falling.  This is an exceedingly rare pattern and a sign that the fund “works” for its investors; it doesn’t scare them away, so they’re able to actually profit from their investment.

Seafarer will take the MACSX formula global.  The Seafarer prospectus explains the strategy:

The Fund attempts to offer investors a relatively stable means of participating in a portion of developing countries’ growth prospects, while providing some downside protection, in comparison to a portfolio that invests purely in the common stocks of developing countries. The strategy of owning convertible bonds and dividend-paying equities is intended to help the Fund meet its investment objective while reducing the volatility of the portfolio’s returns.

Mr. Foster writes: “I hope to marry Asia Pacific with other ‘emerging markets,’ a few carefully-selected ‘frontier’ markets, alongside a handful of ‘developed’ countries.  I am excited about the possibilities.”

The fund’s minimum investment is $2500 for regular accounts and $1000 for IRAs.  The initial expense ratio is 1.60%, an amount that Mr. Foster set after considerable deliberation.  He didn’t want to charge an unreasonable amount but he didn’t want to risk bankrupting himself by underwriting too much of the fund’s expenses (as is, he expects to absorb 0.77% in expenses to reach the 1.6% level).  While the fund could have launched on February 1, Mr. Foster wanted a couple extra weeks for finish arrangements with some of the fund supermarkets and other distributors.

Mr. Foster has kindly agreed to an extended conversation in February and we’ll have a full profile of the fund shortly thereafter.  In the meantime, feel free to visit Seafarer Funds and read some of Andrew’s thoughtful essays on investing.

Briefly Noted

Fidelity Low-Priced Stock (FLPSX) manager Joel Tillinghast has returned from his four-month sabbatical.  It looks suspiciously like a rehearsal for Mr. Tillinghast’s eventual departure.  The five acolytes who filled-in during his leave have remained with the fund, which he’d managed solo since 1989.  If you’d had the foresight to invest $10,000 in the fund at inception, you’d have $180,000 in the bank today.

Elizabeth Bramwell is retiring in March, 2012.  Bramwell is an iconic figure who started her investment career in the late 1960s.  Her Bramwell Growth Fund became Sentinel Capital Growth (SICGX) in 2006, when she also picked up responsibility for managing Sentinel Growth Leaders (SIGLX), and Sentinel Sustainable Growth Opportunities (CEGIX). Kelli Hill, her successor, seems to have lots of experience but relatively little with mutual funds per se.  She’s sometimes described as the person who “ran Old Mutual Large Cap Growth (OILLX),” but in reality she was just one of 11 co-managers.

Fidelity has agreed to pay $7.5 million to shareholders of Fidelity Ultra-Short Bond fund (FUSBX) (and their attorneys) in settlement of a class action suit.  The plaintiffs claimed that Fidelity did not exercise reasonable oversight of the fund’s risks.  Despite being marketed as a low volatility, conservative option, the fund invested heavily in mortgage-backed securities and lost 17% in value from June 2007 – May 2008.  Fidelity, as is traditional in such cases, “believes that all of the claims are entirely without merit.”  Why pay them then?  To avoid “the cost and distraction” of trial, they say.  (Court Approves a $7.5 Million Settlement, MFWire, 1/27/12).

Fidelity is changing the name of Fidelity Equity-Income II (FEQTX) to Fidelity Equity Dividend Income fund. Its new manager Scott Offen, who took over the fund in November 2011, has sought to increase the fund’s dividend yield relative to his predecessor Stephen Peterson.

Bridgeway Ultra-Small Company (BRUSX) is becoming just a little less “ultra.”  The fund has, since launch, invested in the tiniest U.S. stocks, those in the 10^th decile by market cap.  As some of those firms thrived, their market caps have grown into the next-higher (those still smaller than microcap) decile.  Bridgeway has modified its prospectus to allow the fund to buy shares in these slightly-larger firms

Invesco has announced the merger of three more Van Kampen funds, which follows dozens of mergers made after they acquired Morgan Stanley’s funds in 2010.  The latest moves: Invesco High Income Muni (AHMAX) will merge into Invesco Van Kampen High Yield Municipal (ACTFX).  Invesco US Mid Cap Value (MMCAX) and Invesco Van Kampen American Value (MSAJX), run by the same team, are about to become the same fund.  And Invesco Commodities Strategy (COAIX) disappears into the more-active Invesco Balanced Risk Commodity Strategy (BRCNX). The funds share management teams and similar fees, but Invesco Commodities Strategy has closely tracked its Dow-Jones-UBS Commodity Total Return Index benchmark, while Invesco Van Kampen Balanced Risk Commodity Strategy is more actively managed.

DWS Dreman Small Cap Value (KDSAX), which is already too big, reopened to all investors on February 1, 2012.

Managers Emerging Markets Equity (MEMEX) will liquidate on March 9, 2012. The fund added a bunch of co-managers three years ago, but it’s lagged its peer group in each of the past five years.  It’s attracted $45 million in assets, apparently not enough to making it worth the advisor’s while.

On March 23, 2012, the $34 million ING International Capital Appreciation (IACAX) will also liquidate, done in by performance that was going steadily from bad to worse.

I’d missed the fact that back in mid-October, RiverPark Funds liquidated their RiverPark/Gravity Long-Biased Fund.  RiverPark has been pretty ruthless about getting rid of losing strategies (funds and active ETFs) after about a year of weakness.

The Observer: Milestones and Upgrades

The folks who bring you the Observer are delighted to announce two milestones and three new features, all for the same reasonable rate as before.  Which is to say, free.

On January 27, 2012, folks launched the 2000^th discussion thread on the Observer’s lively community forum.  The thread in question focused on which of two Matthews Asia funds, Growth and Income (MACSX) or Asia Dividend (MAPIX), was the more compelling choice.  Sentiment seemed to lean slightly toward MAPIX, with the caveat that the performance comparison should be tempered by an understanding that MACSX was not a pure-equity play.  One thoughtful poster analogized it to T. Rowe Price’s stellar Capital Appreciation (PRWCX) fund, in that both used preferred and convertible shares to temper volatility without greatly sacrificing returns.  In my non-retirement account, I own shares of MACSX and have been durn happy with it.

Also on January 27, the Observer attracted its 50,000^th reader.  Google’s Analytics program labels you as “unique visitors.”  We heartily agree.  While the vast majority of our readers are American, folks from 104 nations have dropped by.  I’m struck that we’re had several hundred visits from each of Saudi Arabia, Israel, France, India and Taiwan.  On whole, the BRICs have dispatched 458 visitors while the PIIGS account for 1,017.

In March the Observer will debut a new section devoted to providing short, thoughtful summaries and analyses of the web’s best investment and finance websites.  We’ve grown increasingly concerned that the din of a million cyber voices is making it increasingly hard for folks to find reliable information and good insights as they struggle to make important life choices.  We will, with your cooperation, try to help.

The project team responsible for the effort is led by Junior Yearwood.  Those of you who’ve read our primer on Miscommunication in the Workplace know of Junior as one of the folks who helped edit that volume.   Junior and I met some years ago through the good offices of a mutual friend, and he’s always proven to be a sharp, clear-eyed person and good writer.  Junior brings what we wanted: the perspectives of a writer and reader who was financially literate but not obsessed with the market’s twitches or Fidelity’s travails.  I’ll let him introduce himself and his project:

It’s rare that a 19-year-old YouTube sensation manages to sum up the feelings of millions of Americans and people the world over.  But Tay Zonday, whose richly-baritone opening line is “are you confused about the economy?” did.  “Mama, Economy;  Make me understand all the numbers” explains it all.

The fact is we all could use a little help figuring it all out.  “We” might be a grandmother who knows she needs better than a zero percent savings account, a financial adviser looking to build moats around her clients’ wealth, or even me, the former plant manager and current freelance journalist. We all have something in common; we don’t know everything and we’re a bit freaked out by the economy and by the clamor.

My project is to help us sort through it.  The idea originated with the estimable Chuck Jaffe MarketWatch.   I am not a savvy investor nor am I a financial expert. I am a guy with a sharp eye for detail and the ability to work well with others.   My job is to combine your suggestions and considered analysis with my own research, into a monthly collection of websites that we believe are worth your time.  David will oversee the technical aspects of the project.   I’ll be reaching out, in the months ahead, to both our professional readership (investment advisers, fund managers, financial planners, and others) and regular people like myself.

Each month we will highlight and profile around five websites in a particular category. The new section will be launching in March with a review of mutual fund rating sites.  In the following months we’ll look at macro-level blogs run by investment professionals, Asian investing and many of the categories that you folks feel most interested in.   I’d be pleased to hear your ideas and I can be reached at [email protected]

A special word of thanks goes out to Chuck. We hope we can do justice to your vision.

Finally, I remain stunned (and generally humbled) by the talent and commitment of the folks who daily help the Observer out.  I’m grateful, in particular, to Accipiter, our chief programmer who has been both creative and tireless in his efforts to improve the function of the Observer’s discussion board software.  The software has several virtues (among them, it was free) but isn’t easy to scan.  The discussion threads look like this:

MACSX yield 3.03 and MAPIX yield 2.93. Why go with either as opposed to the other?

14 comments MaxBialystock January 27| Recent Kenster1_GlobalValue3:54PM Fund Discussions

Can’t really see, at a glance, what’s up with the 14 comments.  Accipiter wrote a new discussion summary program that neatly gets around the problem.  Here’s that same discussion, viewed through the Summary program:

MACSX yield 3.03 and MAPIX yield 2.93. Why go with either as opposed to the other? By – MaxBialystock viewed (468)

• 2012-01-28 – scott : I was going to say MACSX is ex-Japan, but I guess it isn’t – didn’t it used to …
• 2012-01-28 – MaxBialys : Reply to @scott: Yes, it’s SUPPOSED to be…….
• 2012-01-28 – scott : Reply to @MaxBialystock: Ah. I own a little bit left of it, but I haven’t looke…
• 2012-01-28 – MikeM : If you go to their web, site, they have a compare option where you can put the…
• 2012-01-28 – InformalE : Pacific Tigers, MAPTX, is ex-Japan. I don’t think MACSX was ever ex-Japan.In re…
• 2012-01-28 – msf : You can’t put too much stock in the category or benchmark with these funds. M…
• 2012-01-28 – MaxBialys : Lots of work, thought and information. And CLEARLY expressed. MACSX is still ab…
• 2012-01-28 – catch22 : Hi Max, Per your post, it appears you are also attempting to compare the dividen…
• 2012-01-28 – Investor : I recently sold all of MACSX and reinvested most in MAPIX. I just did not feel …
• 2012-01-28 – fundalarm : Reply to @Investor: as mentioned before, i have done the same at the end of Dec…
• . 07:27:27 . – msf : Reply to @fundalarm: Though figures show long term performance of MAPIX to be b…
• 2012-01-28 – MaxBialys : Ya, well, I kinda hogtied myself. I got 11 X more in MAPIX than MACSX, and MACS…

The Summary is easy to use.  Simply go to the Discussions page and look at the gray bar across the top.  The menu options are Discussions – Activity – Summary – Sign In.  Signing up and signing in are easy, free and give you access to a bunch of special features, but they aren’t necessary for using the Summary.  Simply click “Summary”  and, in the upper right, the “comments on/off” button.  With “comments on,” you immediately see the first line of every reply to every post.  It’s a fantastic tool for scanning the discussions and targeting the most provocative comments.

In addition to the Summary view, Chip, our diligent and crafty technical director, constructed a quick index to all of the fund profiles posted at the Observer.  Simply click on the “Funds” button on the top of each page to go to the Fund’s homepage.  There you’ll see an alphabetized list of the fifty profiles (some inherited from FundAlarm) that are available on-site.  Profiles dated “April 2011” or later are new content while many of the others are lightly-updated versions of older profiles.

I’m deeply grateful to both Accipiter and Chip for the passion and superb technical expertise that they bring.  The Observer would be a far poorer place without.  Thanks to you both.

In closing . . .

Thanks to all the folks who supported the Observer in the months just passed.  While the bulk of our income is generated by our (stunningly convenient!) link to Amazon, two or three people each month have made direct financial contributions to the site.  They are, regardless of the amount, exceedingly generous.  We’re deeply grateful, as much as anything, for the affirmation those gestures represent.  It’s good to know that we’re worth your time.

In March, there’ll be a refreshed and expanded profile of Matthews Asia Strategic Income (MAINX), profiles of Andrew Foster’s new fund, Seafarer Overseas Growth and Income (SFGIX) and ASTON/River Road Long-Short Fund (ARLSX) and a new look at an old favorite, GRT Value (GRTVX).

As ever,

Dear friends,

Welcome to a new year.  Take a moment, peer back at 2011 and allow yourself a stunned “what the hell was that about?”  After one of the four most volatile years the stock market’s seen in decades, after defaults, denunciations, downgrades, histrionics and the wild seesaw of commodity prices, stocks are back where they began.  After all that, Vanguard’s Total Stock Market Index (VTSMX) had, as of 12/29/11, risen by one-quarter of one percent for the year.

I have no idea what the year ahead brings (except taxes).  I’m dubious that the world will follow the Mayans into extinction on December 21^st.    My plan for the new year, and my recommendation for it: continue to live sensibly, invest cautiously and regularly, enjoy good wine and better cheese, celebrate what I have and rejoice at the fact that we don’t need to allow the stock market to run our lives.

All of which introduces a slightly-heretic thought.

Consider Taking a Chill Pill: Implications of a Stock-Light Portfolio

T. Rowe Price is one of my favorite fund companies, in part because they treat their investors with unusual respect.  Price’s publications depart from the normal marketing fluff and generally provide useful, occasionally fascinating, information.  I found two Price studies, in 2004 and again in 2010, particularly provocative.  Price constructed a series of portfolios representing different levels of stock exposure and looked at how the various portfolios would have played out over the past 50-60 years.

The original study looked at portfolios with 20, 40, 60, 80 and 100% stocks.  The update dropped the 20% portfolio and looked at 0, 40, 60, 80, and 100%.

As you think about your portfolio’s shape for the year ahead, you might find the Price data useful.  Below I’ve reproduced partial results for three portfolios.  The original 2004 and 2010 studies are available at the T. Rowe Price website.

What does that mean for you?  Statisticians would run a Monte Carlo Analysis to guide the answer.  They’d simulate 10,000 various decades, with different patterns and sizes of losses and gains (you could lose money in 6 of 10 years which, though very unlikely, has to be accounted for), to estimate the probabilities of various outcomes.

Lacking that sophistication, we can still do a quick calculation to give a rough idea of how things might play out.  Here’s how the simple math plays out.

Assuming no losing years, $10,000 invested conservatively for 10 years might grow to $20,900.  You might or might not have experienced a loss (historically, the portfolio lost money one year in 16). If your loss occurred in Year 10, your $10,000 would still have grown to $20,000.

Assuming no losing years, $10,000 invested moderately for 10 years might grow to $25,000.  You’ll likely have lost money twice, about 6.5% each year.  If you suffered an average loss in Year Five and again at Year Ten, your $10,000 would still have grown to $17,600.

Assuming no losing years, $10,000 invested aggressively for 10 years might grow to $29,900.  You’ll likely have lost money twice, about 12.5% each year.  If you suffered an average loss in Year Five and again at Year Ten, your $10,000 would still have grown to $18,385.

Measured against a conservative portfolio, a pure stock portfolio increases the probability of losing money by 400% (from a 6% chance to 23%), increases the size of your average loss by 2500% (from 0.5% to 12.5%) and triples your volatility.  With extraordinary luck, it doubles the conservative portfolio’s gain.  With average luck, it trails it. This is not a prediction of how stocks will do, in the short term, or the long term, but  is simply a reminder of the consequence of investing in them.

We can’t blithely assume that future returns will be comparable to past ones.  As Bob Cochran and others point out, bonds enjoyed a 30 year bull market which has now ended.  GMO foresees negative “real” returns for bonds and cash over the next seven years and substandard ones for US stocks as a whole.   That said, the Price studies show how even fairly modest shifts in asset allocation can have major shifts in your risk/reward balance.  As with Tabasco sauce, dribbles and not dollops offer the greatest gain.  Adding only very modest amounts of stock exposure to otherwise very conservative portfolios might provide all the heat you need (and all the heat you can stand).

Launch Alert: TIAA-CREF Lifestyle Income

On December 9, 2011, TIAA-CREF launched a new series of Lifestyle funds-of-funds.  In light of the T. Rowe Price research, Lifestyle Income (TSILX) might be worth your attention.  TSILX invests 20% of its assets in stocks, 40% in Short-Term Bond Fund (TCTRX) and 40% in their Bond (TIORX) and Bond Plus (TCBPX) funds.  The bond funds are all low cost offerings with index-like returns.  The equities sleeve is needlessly complicated with 11 funds, the smallest allocation being 0.2% to Mid-Cap Value.  That said, TSILX has a bearable expense ratio for a new fund (0.85%).  It’s run by the same team that has achieved consistent mediocrity with TIAA-CREF Managed Allocation (TIMIX), another fund of too many TIAA-CREF funds.   In this case, “mediocrity” isn’t bad and “consistent” is good.   The minimum initial investment is $2500.

TSILX might, then, approximate T. Rowe Price’s conservative portfolio allocation.  They are, of course, not the only option.  Several of the “retirement income” funds offered by the major no-load families have the same general nature.  Here’s a rundown of them:

The Great Unanswered Question: “What Are Our Recommendations Worth?”

This is the time of year when every financial publication and most finance websites (not including the Observer), trumpet their “can’t miss” picks for the year ahead.  A search of the phrase “Where to Invest in 2012” produced 99,200 hits in Google (12/26/2011), which likely exceeds the number of sensible suggestions by about 99,100.

Before browsing, even briefly, such advice, you should ask “what are those recommendations worth?”  A partial answer lies in looking at how top publications did with their 2011 picks.  Here are The Big Four.

Morningstar, Where to Invest in 2011 was a report of about 30 pages, covering both general guidance and funds representing a variety of interests.  It no longer seems available on the various Morningstar websites, but copies have been posted on a variety of other sites.

Kiplinger, Where to Invest in 2011 began with the guess that “Despite tepid economic growth, U.S. stocks should produce respectable gains in the coming year.”  As long as you can respect 1.6% (Vanguard’s Total Stock Market Index through Christmas), they’re right. In a sidebar story, Steven Goldberg assured that “This Bull Market Has Room to Run.”  Again, if “into walls” and “off cliffs” count, they’re right.

The story focused on 11 stocks and, as a sort of afterthought, three funds.  In a particularly cruel move, the article quotes a half dozen fund managers in defense of its stock picks – then recommends none of their funds.

SmartMoney, Where to Invest in 2011, cheated a bit by not offering its recommendations until February.  Even then, it focused solely on a dozen individual stocks.  The worst of their picks, Oracle ORCL, was down 16% between the start of the year and the Christmas break.  The best, TJX Companies TJX, was up 49%. Six stocks lost money, six gained.  The portfolio gained 4.8%.  A rough conversion into fund terms would have you subtract 1.4% for operating expenses, leaving a return of 3.4%.  That would have it ranked in the top 14% of large cap core funds, through Christmas.  If you missed both the best and worst stock, your expense-adjusted returns would drop to 1.4%.

Money, Make Money in 2011: Your Investments discussed investing as a small part of their 2011 recommendations issue.  The offered a series of recommendations, generally a paragraph or two, followed by a fund or two from their Money 70 list.

Money’s strategic recommendations were: Favor stocks over bonds, favor large caps over small cap, good overseas carefully and don’t rush into emerging markets,  shorten up bond durations to hedge interest rate risks and add a few riskier bonds to boost yields

The Bottom Line: give or take the Fairholme implosion, Morningstar was mostly right on equities and mostly wrong on bonds and commodities, at least as measured by a single year’s return.  SmartMoney’s stock picks weren’t disastrous, but missing just one stock in the mix dramatically alters your results. Kiplinger’s got most of the forecasts wrong but chose funds with predictable, long term records.

Amateur Hour in Ratings Land, Part 1: TheStreet.com

How would you react to an article entitled “The Greatest Baseball Players You’ve Never Heard Of,” then lists guys named DiMaggio, Clemente and Kaline?  Unknown novelists: Herman Melville, Stephen King . . . ?

TheStreet.com, founded by frenetic Jim Cramer, is offering up mutual fund analysis.  In December, mutual fund analyst Frank Byrt offered up “10 Best Mutual Funds of 2011 You’ve Never Heard Of.”  The list made me wonder what funds the folks at TheStreet.com have heard of.  They start by limiting themselves to funds over $1 billion in assets, a threshold that suggests somebody has heard of them.  They then list, based on no clear criteria (they’ve been “leaders in their category”), some of  the industry’s better known funds:

Franklin Utilities (FKUTX) – $3.6 billion in assets under management

Fidelity Select Biotechnology (FBIOX) – $1.2 billion

Sequoia Fund (SEQUX) – $4.7 billion, the most storied, famously and consistently successful fund of the past four decades.

Federated Strategic Value Dividend Fund (SVAAX) – $4.9 billion

Delaware Smid Cap Growth (DFDIX) – $1 billion

GMO Quality (GQETX) – technically it’s GMO Quality III, and that number is important.  Investors wanting Quality III need only shell out $10 million to start while Quality IV requires $125 million, Quality V requires $250 million and Quality VI is $300 million.   In any case, $18 billion in assets has trickled in to this unknown fund.

Wells Fargo Advantage Growth (SGRNX) – the fund, blessed by a doubling of assets in 2011 and impending bloat, is closing to new investors. Mr. Byrt complains that “Ognar has wandered from the fund’s mandate,” which is proven solely by the fact that he owns more small and midcaps than his peers.  The prospectus notes, “We select equity securities of companies of all market capitalizations.”  As of 10/30/2011, he had 45% in large caps, 40% in mid caps and 15% in small names which sounds a lot like what they said they were going to do.  Mr Byrt’s ticker symbol, by the way, points investors to the $5 million minimum institutional share class of the $7.2 billion fund.  Po’ folks will need to pay a sales load.

Vanguard Health Care Admiral Fund (VGHAX) – a $20 billion “unknown,” with a modest $50,000 minimum and a splendid record.

SunAmerica Focused Dividend (FDSAX) – $1 billion

Cullen High Dividend Equity (CHDVX) – $1.3 billion.

Of the 10 funds on Mr. Byrt’s list, three have investment minimums of $50,000 or more, four carry sales loads, and none are even arguably “undiscovered.”  Even if we blame the mistake on an anonymous headline writer, we’re left with an unfocused collection of funds selected on unexplained criteria.

Suggestion from the peanut gallery: earn your opinion first (say, with serious study), express your opinion later.

Amateur Hour in Ratings Land, Part 2: Zacks Weighs In

Zacks Investment Research rates stocks.  It’s not clear to me how good they are at it.  Zacks’ self-description mixes an almost mystical air with the promise of hard numbers:

The guiding principle behind our work is that there must be a good reason for brokerage firms to spend billions of dollars a year on stock research. Obviously, these investment experts know something special that may be indicative of the future direction of stock prices. From day one, we were determined to unlock that secret knowledge and make it available to our clients to help them improve their investment results.

So they track earnings revisions.

Zacks Rank is completely mathematical. It”s cold. It”s objective.

(It’s poorly proofread.)

The Zacks Rank does not care what the hype on the street says. Or how many times the CEO appeared on TV. Or how this company could some day, maybe, if everything works perfectly, and the stars are aligned become the next Microsoft. The Zack Rank only cares about the math and whether the math predicts that the price will rise.

Momentum investing.  That’s nice.  The CXO Advisory service, in an old posting, is distinctly unimpressed with their performance.  Mark Hulbert discussed Zacks in a 2006 article devoted to “performance claims that bear little or no relationship with the truth.”

In a (poorly proofread) attempt to diversify their income stream, Zacks added a mutual fund rating service which draws upon the stock rating expertise to rank “nearly 19,000 mutual funds.”

There are three immediately evident problems with the Zacks approach.

There are only 8000 US stock funds, which is surely a problem for the 10,000 funds investing elsewhere.  Zacks expertise, remember, is focused on US equities.

The ratings for those other 10,000 funds are based “a number of key factors that will help find funds that will outperform.”  They offer no hint as to what those “key factors” might be.

The ratings are based on out-of-date information.  The SEC requires funds to disclose their holdings quarterly, but they don’t have to make that disclosure for 60 days after the end of the quarter.  If Zacks produces, in January, a forecast of the six-month performance of a fund based on a portfolio released in November of the fund’s holdings in September, you’ve got a problem.

Finally, the system doesn’t attend to trivial matters such as strategy, turnover, expenses, volatility . . .

All of which would be less important if there were reliable evidence that their system works.  But there isn’t.

Which brings us to Zack’s latest: a 12/20/11 projection of which aggressive growth funds will thrive in the first half of 2012 (“Top 5 Aggressive Growth Mutual Funds”).  Zacks has discovered that aggressive growth funds invest in “a larger number of” “undervalued stocks” to provide “a less risky route to investing in these instruments.”

Investors aiming to harness maximum gains from a surging market often select aggressive growth funds. This category of funds invests heavily in undervalued stocks, IPOs and relatively volatile securities in order to profit from them in a congenial economic climate. Securities are selected on the basis of their issuing company’s potential for growth and profitability. By holding a larger number of securities and adjusting portfolios keeping in mind market conditions, aggressive growth funds offer a less risky route to investing in these instruments.

Larger than what?  Less risky than what?  Have they ever met Ken Heebner?

Their five highest rated “strong buy” funds are:

Legg Mason ClearBridge Aggressive Growth A (SHRAX): ClearBridge is Legg Mason’s largest equity-focused fundamental investing unit.  SHRAX traditionally sports high expenses, below average returns (better lately), above average risk (ditto), a 5.75% sales load and a penchant for losing a lot in down markets.

Delaware Select Growth A (DVEAX): give or take high expenses and a 5.75% sales load, they’ve done well since the March 2009 market bottom (though were distinctly average before them).

Needham Aggressive Growth (NEAGX) which, they sharply note, is “a fund focused on capital appreciation.”  Note to ZIR: all aggressive growth funds focus on capital appreciation.  In any case, it’s a solid, very small no-load fund with egregious expenses (2.05%) and egregious YTD losses (down almost 15% through Christmas, in the bottom 2% of its peer group)

Sentinel Sustainable Growth Opportunities A (WAEGX): 5% sales load, above average expenses, consistently below average returns

American Century Ultra (TWCUX): a perfectly fine large-growth fund.  Though American Century has moved away from offering no-load funds, the no-load shares remain available through many brokerages.

So, if you like expensive, volatile and inconsistent . . . .  (Thanks to MFWire.com for reproducing, without so much as a raised eyebrow, Zacks list.  “Are These Funds Worth a Second Look?” 12/21/2011)

Two Funds, and Why They’re Worth your Time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s new fund:

HNP Growth and Preservation (HNPKX): one of the strengths and joys of small funds is that they offer the opportunity to try new approaches, rather than offering the next bloated version of an old one.  The HNP managers, learning from the experience of managed futures funds, offer a rigorous, quantitative approach to investing actively and cautiously across several asset classes.

Stars in the shadows: Small funds of exceptional merit. There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight of them.

The stars are all time-tested funds, many of which have everything except shareholders.

Tocqueville Select (TSELX): Delafield Fund is good.  Top 5% of the past three years.  And five years.  And ten and fifteen years, for that matter.  Could Tocqueville Select be better?  It offers the same talented team that runs Delafield, but allows them to construct a concentrated portfolio that needs to invest only one-twentieth of Delafield’s assets.

Launch Alert:

Matthews Asia Strategic Income Fund (MAINX) launched on November 30, 2011.  The fund will invest in a wide variety of bonds and other debt securities of Asian corporate and sovereign issuers in both local and hard currencies. The fund will draw on both Matthews’ expertise in Asian fixed-income investing, which dates to the firm’s founding, and on the expertise of its new lead manager, Teresa Kong. Ms. Kong was Head of Emerging Market Investments at Barclays Global Investors / BlackRock, where she founded and led the Fixed Income Emerging Markets team. She was a Senior Portfolio Manager for them, a Senior Securities Analyst at Oppenheimer Funds, and an analyst for JP Morgan Securities.  Matthews argues that the Asian fixed income market is large, diverse, transparent and weakly-correlated to Western markets. Because Asian firms and governments have less debt than their Western counterparts, they are only a small portion of global bond indexes which makes them attractive for active managers. The Matthews fund will have the ability to invest across the capital structure, which means going beyond bonds into convertibles and other types of securities. The minimum initial investment is $2500 for regular accounts, $500 for IRAs.  Expenses are capped at 1.40%.

Prelaunch Alert: RiverNorth Tactical Opportunities

RiverNorth Core Opportunities (RNCOX) exemplifies what “active management” should be.  The central argument in favor of RNCOX is that it has a reason to exist, a claim that lamentably few mutual funds can seriously make.  RNCOX offers investors access to a strategy which makes sense and which is not available through – so far as I can tell – any other publicly accessible investment vehicle. The manager, Patrick Galley, starts with a strategic asset allocation model (in the neighborhood of 60/40), modifies it with a tactical asset allocation which tilts the fund in the direction of exceptional opportunities, and then implements the strategy either by investing in low-cost ETFs or higher-cost closed-end funds.  He chooses the latter path only when the CEFs are selling at irrational discounts to their net asset value.  He has, at times, purchased a dollar’s worth of assets for sixty cents.

Closed-end funds are investment vehicles very much like mutual funds.  One important difference is that they can make greater use of leverage to boost returns.  The other is that, like stocks and exchanged-traded funds, they trade throughout the day in secondary markets.  When you buy shares, it’s from another investor in the fund rather than from the fund company itself.  That insulates CEFs from many of the cash-flow issues that plague the managers of open-ended funds.

RNCOX, since inception, has outperformed its average peer by about two-to-one, though the manager consistently warns that his strategy will be volatile.  After reaching about a half billion in assets, the fund closed in the summer of 2011.

In the fall of 2011, RiverNorth filed to launch a closed-end fund of its own, RiverNorth Tactical Opportunities.  The fund will invest in other closed-end funds, just as its open-ended sibling does.  The closed-end fund will have the ability to use leverage, which will magnify its movements.  The theory says that they’ll deploy leverage to magnify the upside but it would be hard to avoid catching downdrafts as well.

Morningstar’s Mike Taggart agrees that the strategy is “compelling.”  Mr. Galley, legally constrained from discussing a fund in registration, says only that the timing of launch is still unknown but that he’d be happy to talk with us as soon as he’s able.  Folks anxious for a sneak peek can read the fund’s IPO filing at the Securities and Exchange Commission.

Pre- Pre-Launch Alert:

Andrew Foster announced on Seafarer’s website that he’s “exploring” a strategy named Seafarer Overseas Growth and Income.  At this point there is no vehicle for the strategy, that is, nothing in registration with the SEC, but tracking Mr. Foster’s thinking is likely to be a very wise move.

Mr. Foster managed Matthews Asian Growth and Income (MACSX), a FundAlarm “star in the shadows” fund, from 2005-2011.   As its manager, he first worked with and then succeeded Paul Matthews, the firm’s founder.  Saying that he did an excellent job substantially understates his success.  MACSX was one of the most consistent, least volatile and most rewarding Asia-focused funds during his tenure. Andrew also served as Matthews’ director of research and chief investment officer.

Andrew left to found his own firm in 2011, with the announced intention of one day launching a thoroughly modern mutual fund that drew on his experience.  While this is not yet that fund, it does illustrate the direction of his planning.   Andrew writes:

This strategy attempts to offer a stable means of participating in a portion of developing countries’ growth prospects, while providing some downside protection relative to a strategy that invests only in the common stocks of emerging markets. The strategy’s objective is to provide long-term capital appreciation along with some current income. In order to pursue that objective, the strategy incorporates dividend-paying equities, convertible bonds and fixed income securities. It may also invest in companies of any size or capitalization, including smaller companies.

We’ll do our best to monitor the strategy’s development.

Mining for Hidden Gems among Funds

Journalist Javier Espinoza’s pursuit of “hidden gems” – great funds with under $100 million in assets – led him to the Observer.  His article Mining for Hidden Gems Among Funds ran in the Wall Street Journal’s “Investing in Funds” report (12/05/2011).  The Journal highlighted five funds:

Pinnacle Value (recommended David Snowball and profiled as a “star in the shadows”)

Marathon Value (another “star in the shadows,” recommended by Johanna Turner of Milestones Financial Planning and a supporter of both FundAlarm and the Observer)

Artio US Smallcap (recommended by Bob Cochran of PDS Planning, one of the most thoughtful and articulate members of the community here and at FundAlarm)

Bogle Small Cap Growth (recommended by Russel Kinnel, Morningstar’s venerable director of fund research)

Government Street Equity (recommended by Todd Rosenblut, mutual fund analysis for S&P Capital IQ)

Fund Update

RiverPark Wedgewood (RWGFX), which the Observer profiled in September as one of the most intriguing new funds, has an experienced manager and a focused portfolio of exceptionally high-quality firms.  Manager Dave Rolfe aims to beat index funds at their own game, by providing a low turnover, tightly-focused portfolio that could never survive in a big fund firm.

The fund is approached the end of 2011 with returns in the top 2% of its large growth peer group.  Manager Dave Rolfe has earned two distinctions from Morningstar.  His fund has been recognized with the new Bronze designation, which means that Morningstar’s analysts weigh it as an above-average prospect going forward.  In addition, he was featured in a special Morningstar Advisor report, Wedgewood’s Lessons Pay Off.  After lamenting the pile of cookie-cutter sales pitches for firms promising to invest in high-quality, reasonably-priced firms, Dan Culloton happily observes, “self-awareness, humility and patience set Wedgewood apart.”  I agree.

Briefly Noted . . .

Matthews International Capita Management reopened Matthews Asian Growth and Income Fund (MACSX) and the Matthews Asia Small Companies Fund (MSMLX) on January 4, 2012. The funds have been closed for about a year, but both saw substantial asset outflows as Asian markets got pummeled in 2011.  MACSX was identified as an Observer “Star in the Shadows” fund.  As usual, it’s one of the best Asian funds during market turbulence (top 15% in 2011) though it seems to be a little less splendid than under former manager Andrew Foster.  The young Small Companies fund posted blistering returns in 2009 and 2010.  Its 2011 returns have modestly trailed its Asian peers.  That’s a really reassuring performance, given the fund’s unique focus on smaller companies.

The Wall Street Journal reports on a fascinating initiative by the SEC.  They’ve been using quantitative screens to identify hedge funds with “aberrational performance,” which might include spectacularly high returns or inexplicably low volatility. They then target such funds for closer inspection.  The system is been so productive that they’re now adding mutual funds to the scan (“SEC Ups its Game to Identify Rogue Firms,” 12/29/11).

Artisan Partners has withdrawn their planned IPO, citing unfavorable market conditions.  The cash raised in the IPO would have allowed the firm to restructure a bit so that it would be easier for young managers to hold a significant equity stake in the firm.

Ed Studzinski, long-time comanager of Oakmark Equity & Income (OAKBX) retired on January 1, 2012, at age 62.  Clyde McGregor will now manage the fund alone.

ETrade daily publishes the list of “most searched” mutual funds, as an aid to folks wondering where investors’ attention is wandering.  If you can find any pattern in the post-Christmas list, I’d be delighted to hear of it:

• Rydex Russell 2000 2x Strategy (RYRSX)
• Managers PIMCO Bond (MBDFX)
• T. Rowe Price Emerging Markets Stock (PRMSX)
• Vanguard Energy (VGENX)
• T. Rowe Price New Horizons (PRNHX)

Highland Funds Asset Management will spin-off from Highland Capital Management next month and switch its name to Pyxis Capital.  Highland’s 19 mutual funds will be rebranded with the Pyxis name effective January 9.  Pyxis is a constellation in the southern sky and Latin for a mariner’s compass.  Pixies?  Pick Six?  Pick sis?  What do you suppose was going on at the meeting where someone first suggested, “hey, let’s change our name to something that no one has ever heard of, which is hard to say and whose sole virtue is an obscure reference that will be grasped by three Latin astronomers?”

Anya Z. and the Observer’s New Look

In December we unveiled the Observer’s new visual design, which is easier to navigate, easier to maintain and infinitely more polished.  I’d like to take a moment to recognize, and thank, the designer.  Anya Zolotusky is a Seattle area web designer who specializes in elegant and highly useable websites for small businesses.  Anya’s resume has entries so cool that they make me laugh.  Uhhh . . . she pioneered “cybercasts from uncomfortable places.”   One presumably uncomfortable place was a Mt Everest Basecamp, 18,000’ up from which she handled all communications, including live audio and video interviews with CNN and their ilk).

We talked a while about what I imagined the Observer should look like and Anya took it from there.  She describes her goal:

Primarily I wanted a more polished look that would better suit the spirit of the MFO and make using the site a more pleasant experience for visitors. I liked incorporating the energy of the exchange floor, but faded way back, because the MFO is a source of calm and reason in the midst of investment world chaos. The colors, the clean layout and clear navigation are all intended to create a calm backdrop for a topic that is anything but. And the iconic Wall Street bull is just a natural totem for the MFO. I’m happy to have contributed a little to what I hope is a long, bullish future for the MFO and all the Snowball Groupies (especially my mom)!

Anya’s mom is a Soviet émigré and long-time fan of FundAlarm.  Her encouragement, in a note entitled “Come on, Snowball.  Do it for mom!” helped convince me to launch the Observer in the first place.

And so, thanks to Anya and all the remarkably talented folks whose skill and dedication allows me to focus on listening and writing.  Anyone interested in seeing the rest of Anya’s work should check out her Darn Good Web Design.

Two New Observer Resources

The Observer continues to add new features which reflect the talents and passions of the folks who make up our corps of volunteer professionals.  I’m deeply grateful for their support, and pleased to announce two site additions.

The Navigator

Accipiter, our chief programmer and creator of the Falcon’s Eye, has been hard at work again. This time he’s turned his programming expertise to The Navigator, a valuable new tool for looking up fund and ETF information. Similar to the Falcon’s Eye, you can enter a ticker and receive links to major sources of information, 27 at last count. In added functionality, you can also enter a partial ticker symbol and see a dropdown list of all funds that begin with those characters. Additionally, you can search for funds by entering only part of a fund name and again seeing a dropdown list of all funds containing the string you entered. Choosing a fund from the dropdown then returns links to all 27 information sources. This all strikes me as borderline magical.  Please join me in thanking Accipiter for all he does.

Miscommunication in the Workplace

This ten-page guide, which I wrote as a Thanksgiving gift for the Observer’s readers, has been downloaded hundreds of times.  It has now found a permanent home in the Observer’s Resources section.  If you’ve got questions or comments about the guide, feel free to pass them along.  If we can make the guide more useful, we’ll incorporate your ideas and release a revised edition.

In Closing . . .

Augustana College bell tower panorama, photo by Drew Barnes, class of 2014.

Winter will eventually settle in to the Midwest.  The days are short and there are lots of reasons to stay inside, making it a perfect time to catch up on some reading and research.  I’ve begun a conversation with Steve Dodson, former president of Parnassus Investments and now manager of Bretton Fund (BRTNX) and I’m trying to track down James Wang, manager of the curious Oceanstone Fund (OSFDX).  Five years, five finishes at the top of the fund world, cash heavy, few assets and virtually no website.  Hmmm. Our plan is to review two interesting new funds, one primarily domestic and one primarily international, in each of the next several months. We’ll profile the new Grandeur Peak Global Opportunities (GPGOX) and Matthews Asia Strategic Income (MAINX) funds in February and March, respectively.

Observer readers have asked for consideration of a half dozen funds, including Conestoga Small Cap (CCASX) and Aston/Cornerstone Large Cap Value (RVALX).  I don’t know what I’ll find, but I’m delighted by the opportunity to learn a bit and to help assuage folk’s curiosity.

In addition, Junior Yearwood, who helped in editing the Miscommunication in the Workplace guide, has agreed to take on the task of bringing a long-stalled project to life.  Chuck Jaffe long ago suggested that it would be useful to have a launch pad from which to reach the highest-quality information sources on the web; a sort of one-stop shop for fund and investing insights.  While the Observer’s readers had a wealth of suggestions (and I’ll be soliciting more), I’ve never had the time to do them justice.  With luck, Junior’s assistance will make it happen.

We’re healthy, in good spirits, the discussion board is populated by a bunch of good and wise people, and I’m teaching two of my favorite classes, Propaganda and Advertising and Social Influence.  Life doesn’t get much better.

I’ll see you soon,

David

Dear friends,

Welcome to the Observer 2.0.  We worked hard over the past month to create a new look for the Observer: more professional, easier to read, easier to navigate and easier to maintain.  We hope you like it.

It’s hard to believe that, all the screaming aside, the stock market finished November at virtually the same point that it began.  Despite wild volatility and a ferocious month-end rally, Vanguard’s Total Stock Market Index Fund (VTSMX) ended the month with just a tiny loss.

Finding Funds that Lose at Just the Right Time

The best investors are folks who are able to think differently than do their peers: to find opportunities where others find only despair.  In our ongoing attempt to get you to think differently about how you find a good investment, we decided to ask: do you ever want funds that aren’t top performers?

The answer, for long term investors, is “yes.”  In general, you do not want to own the high-beta funds that have the best performance in “junk rallies.”  Junk rallies are periods where the least attractive investment options outperform everything else.  Those rallies push the riskiest, least prudent funds (temporarily) to the top.

One way to identify junk rallies is to look for markets where the performance of solid, high-quality companies dramatically lags the performance of far more speculative ones.  We did that by comparing the returns of index funds tracking the boring Dow Jones Industrial Average (blue chips) with the performance of funds tracking the endlessly exciting NASDAQ.  It turns out that there are three years where the Nazz outperformed the Dow by more than 1000 basis points (i.e., by 10 percentage points).  Those years are 2003 (Dow trails by 2100 bps), 2007 (1040 bps) and 2009 (3200 bps).

This month’s screen looks at funds that, over the past 10 years, are above average performers except during junk rallies.  In junk rally years, we looked for absolute returns of 10% or more.

As one reads the Morningstar coverage of these funds, the words that keep recurring are “disciplined,” “patient” and “concentrated.”  These are folks with a carefully articulated strategy who focus on executing it year after year, with little regard to what’s in vogue.

While this is not a “buy” list, it does point out the value of funds like Matthews Asian Growth & Income (MACSX), in which I’ve been invested for a good while.  MACSX puts up terribly relative performance numbers (bottom 10-15%) every time the Asian market goes wild and brilliant ones (top 5%) when the markets are in a funk.  If you’re willing to accept bad relative performance every now and then, you end up with excellent absolute and relative returns in the long-run.

Updating “The Observer’s Honor Roll, Unlike Any Other”

In November 2011, we generated an Honor Roll of funds.  Our criterion was simple: we looked for funds that were never abysmal.   We ignored questions of the upside entirely and focused exclusively on never finishing in a peer group’s bottom third.  That led us to two dozen no-load funds, including the Price and Permanent Portfolio funds highlighted above.

One sharp member of the discussion board community, claimu, noticed the lack of index funds in the list.  S/he’s right: I filtered them out, mostly because I got multiple hits for the same index. Eleven index funds would have made the list:

• four S&P 500 funds (California Investment, Dreyfus, Price, Vanguard)
• four more-or-less total market funds (Price, Schwab, Schwab 1000, Vanguard)
• one international (Price), one growth (Vanguard) and one small growth (Vanguard).

The story here might be the 67 S&P500 index funds that have a ten-year record but didn’t make the list. That is, 95% of S&P500 funds were screened-out because of some combination of high expenses and tracking error.

Those differences in expenses and trading efficiency add up.  An investment a decade ago in the Vanguard 500 Index Admiral Class (VFIAX) would have returned 2.45% annually over the decade while the PNC S&P 500 “C” shares (PPICX) earned only 1.14% – less than half as much.  $10,000 invested in Vanguard a decade ago would now (11/30/11) be worth $13,300 while a PNC investor would have $11,700 – for having taken on precisely the same risks at precisely the same time.

Press Release Journalism: CNBC and the End of the Western World

Does anyone else find it disturbing that CNBC, our premier financial news and analysis network, has decided to simply air press releases as news?   Case in point: the end of the world as we know it.  On 11/30/11, CNBC decided to share David Murrin’s fervent announcement that there’s nowhere worth investing except the emerging economies:

The Western world has run out of ideas and is “finished financially” while emerging economies across the world will continue to grow, David Murrin, CIO at Emergent Asset Management told CNBC on the tenth anniversary of coining of the so-called BRIC nations of Brazil, Russia, India and China, by Goldman Sachs’ Jim O’Neill.

“I still subscribe and I’ve spoken about it regularly on this show that this is the moment when the Western world realizes it is finished financially and the implications are huge, whereas the emerging BRIC countries are at the beginning of their continuation cycle,” Murrin told CNBC. (The Western World Is ‘Finished Financially’)

One outraged reader phrased it this way: “So why do reasonably respectable news outlets take as news the ravings of someone who has so obvious a financial stake in what is being said … News flash, “The CEO of Walmart declares the death of main street businesses . . . ” Good God!”

While Mr. Murrin is clearly doing his job by “talking his book,” that is, by promoting interest in the investment products he sells, is CNBC doing theirs?  If their job is either (a) providing marketing support for hedge funds or (b) providing inflammatory fodder, the answer is “yes.”  If, on the other hand, their job is . . .oh, to act like professional journalists, the answer is “no.”

What might they have done?  Perhaps examine Mr. Murrin’s credibility.  Ask even a few questions about his glib argument (here’s one: “the Chinese markets are at the mercy of the world’s largest and least accountable bureaucracy, one which forces the private markets to act as proxies for a political party.  To what extent should investors stake their financial futures on their faith in the continued alignment of that bureaucracy’s interests and theirs?”).  Perhaps interview someone who suspects that the expertise of companies domiciled in the Western world will allow them to out-compete firms domiciled elsewhere?  (Many thanks to Nick Burnett of CSU-Sacramento, both for pointing out the story and for supplying appropriate outrage.)

A Gift Freely Given

We’re deeply grateful for the support, financial, intellectual and moral, that you folks have offered during this first year of the Observer’s life.  It seemed fitting, in this season of thanksgiving and holidays, to say thanks to you all.  As a token of our gratitude, we wanted to share a small gift with each of you.  Chocolate was my first choice, but it works poorly as an email attachment.  After much deliberation, I decided to provide some practical, profitable advice from a field in which I have both academic credentials and lots of experience: communication.

Many of you know that I am, by profession and calling, a Professor of Communication Studies at Augustana College.  Over the years, the college has allowed me to explore a wide variety of topics in my work, from classical rhetoric and persuasion theory, to propaganda, persuasion and business communication practices.  Spurred by a young friend’s difficulties at work and informed by a huge body of research, I wrote a short, practical guide that I’d like to share with each of you.

Miscommunication in the Workplace: Sources, Prevention, Response is a 12-page guide written for bright adults who don’t study communication for a living.  It starts by talking about the two factors that make miscommunication so widespread.   It then outlines four practical strategies which will reduce the chance of being misunderstood and two ways of responding if it occurs anyway.  There’s a slightly-classy color version, but also a version optimized for print.  Both are .pdf files.

In the theme of thanksgiving, I should recognize the three people who most helped bring focus and clarity to my argument.  They are

Junior Yearwood, a friend and resident of Trinidad, brought a plant manager’s perspective, an editor’s sensibility and a sharp eye to several drafts of the guide.  Junior helped both clarify the document’s structure and articulate its conclusion.

Nicholas Burnett, an Associate Dean at Cal State – Sacramento, brought a quarter century’s experience in teaching and analyzing business and professional communication.  Nick pointed me to several lines of research that I’d missed and helped me soften claims that probably went beyond what the research supports.

Cheryl Welsch, a/k/a Chip, the Observer’s Technical Director and Director of Information Technology at SUNY-Sullivan, brought years of experience as a copy editor (as Hagrid would have it, she’s “a thumpin’ good one”).  She also helped me understand the sorts of topics that might be most pressing in helping folks like her staff.

The Harvard Business Review published Communicating Effectively (2011), which is a lot more expensive (well, this is free so pretty much everything is), longer (at 250 pages) and windier but covers much of the same ground.

If you have reactions, questions or suggested revisions, please drop a note to share them with me.  I’m more than willing to update the document.  If you really need guidance to the underlying research, it’s available.

Two other holiday leads for you.  QuoteArts.com offers a bunch of the most attractive, best written greeting cards (and refrigerator magnets) that I’ve seen.  The Duluth Trading Company offers some of the best made, best fitting men’s work clothing I’ve bought in years.  The Observer has no financial link to either of these firms and I know they have nothing to do with funds, but I’m really pleased with them and wanted to give you a quick heads-up about them.

Two Funds, and why they’re worth your time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s new fund:

Lockwell Small Cap Value (LOCSX): a product of The Great Morgan Stanley Diaspora, Lockwell is a new incarnation of a very solid institutional fund.  The manager, who has successfully run billions of dollars using this same discipline, is starting over with just a million or two.  While technically a high-minimum institutional fund, there might be room to talk.

Stars in the shadows: Small funds of exceptional merit. There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight of them.

The stars are all time-tested funds, many of which have everything except shareholders.

Artisan Small Cap (ARTSX): they’re baaaaaack!   ARTSX is the fund that launched Artisan had a blazing start in 1996: a chart-topping 35% gain, $300 million in assets, and a principled close within 11 months.  What followed were nearly 15 years of uninspiring performance.  In 2009, the management team that has brilliantly guided Artisan Mid Cap took over here and the results have been first rate.  Time for another look!

Fund Update: RiverPark Short-Term High Yield and RiverPark/Wedgewood

Two of the RiverPark funds that we’ve profiled are having banner years.

RiverPark/Wedgewood (RWGFX) offers a concentrated portfolio of exceedingly high-quality stocks.  They’ve got a great track record with this strategy, though mostly through separately-managed accounts.  I have some questions about whether the SMA success would translate to similar performance in their fund.  The answer appears to be “yes,” at least so far.  For 2011 (through 11/29), they’re in the top 2% of large growth funds. Their 2.2% gain places them about 750 basis points ahead of their average peer.  The fund has gathered $70 million in assets.

RiverPark Short Term High Yield (RPHYX) continues to be a model of stability.  Its unique portfolio of called high yield bonds and other orphan investments is yielding 4.2% and has returned 3.25% YTD (through 11/29/11).  Judged as a high-yield bond fund, that’s great: top 4% YTD with minimal share price volatility.  Viewed as a cash management tool, it’s even better.  Latest word is that assets are up to $35 million as more advisors come onboard.

In mid-November, Barron’s ran a nice profile, “Enjoying Their Freedom,” of RiverPark and of these two funds.

Closure alert: Aston/River Road Independent Value

In a November 18 filing with the SEC, Aston announced that ARVIX will close to new investors “if the net assets of the Fund reach a certain level in combination with other assets managed in the same investment strategy by … River Road Asset Management.  Currently, the Fund expects its Soft Close Level to be between $500 million and $600 million in net assets.”  Eric Cinnamond, the manager suggests that “given our sales pipeline,” the fund will likely close before December is over.  Existing investors will be permitted to add to their accounts but (with a few exceptions) no new investors will be allowed in.

In general, folks interested in a low volatility strategy crafted for high volatility markets really should look, and look quickly, to see whether ARVIX makes sense for their portfolios.  The Observer’s April 2011 profile of ARVIX makes clear that this is a strategy with a long, consistently and hugely successful trade record.  So far in 2011, it’s in the top 1% of small value funds.  Mr. Cinnamond is both modest and thoughtful, and tries to balance a celebration of the fund’s success with realism about the years ahead:

This year has set up nicely for the portfolio — ideal market for a flexible and opportunistic strategy.  Every year won’t be like this (the product has high tracking error) and if small caps go lot higher from here, the strategy will most likely lag as I continue to be positioned defensively with below average risk in the equity portfolio and above average cash levels.  That said, as you know, this can change quickly — hopefully recent volatility in the small cap market continues into 2012.

Right, “hopefully recent volatility … continues.”  Volatile markets create outsized opportunities that Mr. Cinnamond has, over the course of years, profitably exploited.  Two other takes on the fund are the fund’s most recent profile of itself and a new Morningstar essay which looks at the two best small-value funds in 2011: The Top Performing Funds in 2011’s Toughest Category.

Launch alert:

Forward Management introduced a new investor share class for the $1.2 billion, Forward Select Income Fund (FFSLX) at the end of November, 2011. The fund focuses on the preferred securities of REITs, rather than their common stock.  The fund’s yielding over 9% currently, and has pretty consistently finished near the top of the real estate fund stack by combining above average returns with low volatility.

This is the fifth Forward real estate fund to be offered directly (i.e., without a load) to retail investors.  The others are Forward International Real Estate (FFIRX), the Forward Real Estate Long/Short (FFSRX), Forward Real Estate and the Forward Global Infrastructure (FGLRX).  In each case, there’s a $4000 minimum which is reduced to $500 if you set up an account with an automatic investing plan.

Fidelity launched Fidelity Total Emerging Markets (FTEMX) on November 1^st.   FTEMX represents a really good idea: an emerging markets balanced fund.  The fund will invest about 60% of its assets in stocks and 40% in bonds, which should over time provide stock-like returns with greatly reduced volatility.  That might translate to higher shareholder returns, as folks encounter fewer dramatic declines and are less likely to be tempted to sell low.  The fund is managed by a team led by John Carlson.  Mr. Carlson has been doing really good work for years on Fidelity’s emerging markets bond fund, Fidelity New Market Income (FNMIX).  There’s a $2500 minimum investment and an expense ratio of 1.40%.

One landmine to avoid: don’t pay attention to the fund’s performance against its Morningstar peer group.  Morningstar doesn’t have an E.M. balanced group, and so assigned this fund to E.M. stock.

I’ve also profiled the closed-end First Trust/Aberdeen Emerging Opportunities (FEO) fund.  FEO has a higher expense ratio (1.80%) but can often be bought at a discounted price.

Alpine: A slight change in elevation

The good folks at the Alpine Funds have taken inspiration for their namesake mountain range.  Effective January 12, they’re increasing their minimum initial investment for stock funds by a thousand fold:  “For new shareholders after January 3, 2012, the minimum initial investment of the Institutional Class has increased from $1,000 to $1,000,000.” The minimum for bond rises will rise only a hundredfold: “For new shareholders after January 3, 2012, the minimum initial investment of the Institutional Class (formerly the Investor Class) has increased from $2,500 to $250,000.”

At the same time they’re renaming a bunch of funds and imposing a 5.5% front load.

Of the funds involved, Dynamic Transformations (ADTRX) is most worth a look before the no-load door closes.  It’s a relatively low turnover, relatively tax efficient mid-cap growth fund that invests in companies undergoing, well, dynamic transformations.  (After January, I guess the transformations can be rather less dynamic.)  That discipline parallels the discipline successfully applied at Artisan’s Mid Cap (ARTMX) fund.  As with Alpine’s other funds, risk management is not a particular strength and so it tends to be a high volatility / high return strategy; that is, it captures more of both the upside and the downside in any market movement.

(Thanks to the members of the Observer’s discussion board community, who read SEC filings even more closely – and with more enthusiasm, if you can imagine that – than I do.  Special thanks to TheShadow for triggering the discussion.)

Briefly Noted . . .

Normally “leaving” is followed by “coming back.”  Not so, at Fidelity.  Andy Sassine, manager of Fidelity Small Cap Stock (FSCLX) is taking a six-month year, but the firm made clear that it’s a one-way trip.  He might work at Fidelity again, but won’t work as a manager.  His fund is being taken over by Lionel Harris of Fidelity Small Cap Growth (FCPGX). Small Cap Growth will be taken over by Pat Venanzi, who manages two small slices of Fidelity Stock Selector Small Cap (FDSCX) and Fidelity Series Small Cap Opportunities (FSOPX).

In the 2012 first quarter, American Beacon will merge the Bridgeway Large Cap Value (BRLVX) fund into the newly created American Beacon Bridgeway Large Cap Value and retain Bridgeway as subadviser.   Bridgeway Social Responsibility, a previous Bridgeway offering, was acquired by Calvert Large Cap Growth. This past May, that fund merged into Calvert Equity (CSIEX), which is not subadvised by Bridgeway.

Allianz RCM Disciplined International Equity (ARDAX) will liquidate on Dec. 20, 2011.

American Beacon Evercore Small Cap Equity  (ASEAX) is closing ahead of its liquidation on or about Dec. 15, 2011.

Dreyfus has closed and plans to liquidate the Dreyfus Select Managers Large Cap Growth (DSLAX) as of Dec. 13, 2011.

In one of those “laws of unintended consequences moves,” Schwab gave in to advisors’ demands and changed the benchmark for the Schwab International Index Fund (SWISX).  Investors claimed that it was too hard to compare SWISX’s performance because it was the only fund using Schwab’s internally-generated benchmark.  In an entirely Pyrrhic victory, Schwab moved to the standard benchmark (MSCI EAFE) and thereby lost any reason for existence.  The move will require the fund to divest itself of a substantial, and entirely sensible, stake in Canadian stocks and make substantial investments in mid-cap stocks.

American Century International Value Fund (ACVUX) is being rebuilt: new management team, new discipline (quant rather than fundamental), new benchmark (MSCI EAFE Value)

In closing . . .

Many thanks to all of the folks who have used the Observer’s Amazon link.  It’s remarkable easy to use (click on it, set it as your default Amazon bookmark and you’re done) and helps a lot.

I’ve been working through three books that might be worth your year-end attention.

Robert Frank, wealth reporter for the WSJ, The High-Beta Rich: How the Manic Wealthy Will Take Us to the Next Boom, Bubble, and Bust. In some ways it’s a logical follow-up to his book Richistan: A Journey Through the American Wealth Boom and the Lives of the New Rich (2008).  The 8.5 million Richistanis, Frank discovered, own things like “shadow yachts,” which are the yachts which follow the rich guys’ yacht and carry their helicopters.  In The High-Beta Rich, Frank looks at the ugly implications of financial instability among the very wealthy.  Generally speaking, their worth is highly volatile and market dependent.  A falling market decreases the wealth of the very rich about three times more than it does for the rest of us.  Frank writes:

Suddenly, in 1982, the year I call the magic year for wealth, the 1 percent, which used to be like the teetotalers of our economy, became the binge drinkers.

And when times were good, they did two or three times better than everyone else. When times were bad, they did two or three times worse. So if you look at the last three recessions, the top 1 percent lost two to three times in income what the rest of America lost. And, you know, part of it has to do with more and more of today’s wealth is tied to the stock market, whether it’s executives who are paid in stock or somebody who’s starting a company and takes it public with an IPO.

And the stock market is more than 20 times as volatile as the real economy.

And, as it turns out, slamming the rich around has real implications for the financial welfare of the rest of us.  Frank appeared on NPR’s Talk of the Nation program on November 16.  There’s a copy of the program and excerpts from the book available on Talk of the Nation’s website.

Folks who find their faith useful in guiding their consumption and investments might enjoy a new book by a singularly bright, articulate younger colleague of mine, Laura Hartman.  Laura is an assistant professor of religion and author of The Christian Consumer: Living Faithfully in a Fragile World.  The fact that it’s published by Oxford University Press tells you something about the quality of its argument.  She argues:

At base, consumerism arises from a distorted view of human nature.  This ethos teaches that our wants are insatiable (and the provocations of advertising help make this so), that buying the new article of clothing or fancy gadget will answer our deepest longings.  That we are what we own.  Humans, then, are seen as greedy and lacking and shallow.  (192)

While this isn’t a “how-to” guide, Laura does offer new (or freshened) ways of thinking about how to consume what you need with celebration, and how to leave what others need untouched.

The most influential book I’ve read in years is Alan Jacobs’ Pleasures of Reading in an Age of Distraction.  Jacobs is a professor of English at Wheaton College in Illinois.  Despite that, he writes and thinks very well.  Jacobs takes on all of the wretched scolds who tell us we need to be reading “better” stuff and argues, instead, that we need to rediscover the joy of reading for the joy of reading.

One of Jacobs’ most compelling sections discussed the widespread feeling, even among hard-reading academics, that we’ve lost the ability to read anything for more than about five minutes.  It made me feel good to know that I wasn’t alone in that observation.  He has convinced me to try a Kindle which, he argues, has renewed in him the habit of reading which such passion that you sink into the book and time fades away.  The Kindle’s design makes it possible, he believes, to feel like we’re connected while at the same time disconnecting.

Regardless of what you buy or who you share our link with, thanks and thanks again!

In January, we’ll look at two interesting funds, the new HNP Growth & Preservation (HNPKX) which brings a “managed futures” ethos to other asset classes and Value Line Asset Allocation (VLAAX) which has one of the most intriguing performance patterns I’ve seen.  In addition, we’ll ring in the New Year by looking at the implication of following the “Where to Invest 2011” articles that were circulating a year ago.

Wishing you great joy in the upcoming holiday season,

David

Dear friends,

Welcome to David’s Market Timing Newsletter!  You’ll remember that, at the beginning of October, I pointed out that (1) you hated stocks and (2) you should be buying them.  One month and one large rally – small caps are up 17% for the month through 10/27 while large caps added 12% – later, I celebrate the fact that I’ve now tied Abby Joseph Cohen for great market timing calls (one each).  Unlike AJC, I promise never to do it again.

October brought more than a sizzling rally.  It brought record breaking heat to the U.K. and record-breaking snowfalls to New York and New England.  To my students and colleagues at Augustana College, it brought a blaze of color, cool mornings, warm afternoons, the end of fall trimester and a chance to slow down and savor the dance of the leaves.

Between the oppression of summer and the ferocity of winter, it’s good to have a few days in which to remember to breathe and celebrate life.  One of the pleasures of working at a small college is the opportunity to engage in that celebration with really bright, inquisitive kids.

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 first 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.  One of Morningstar’s most intriguing statistics are its “investor return” numbers, which attempt to see how the average investor in a fund did (rather than how the hypothetical buy-and-hold-for-ten-years investor did).  The numbers are daunting: Fidelity Leverage Company (FLVCX) made nearly 13% a year for the past decade while its average investor lost money over that same period.

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

All of these funds were rated as three stars, or better, by Morningstar (10/31/11).  Almost all took on average levels of risk, and almost all were above average performers in bear markets.  All of them had positive Sharpe ratios; that is, all of them more than rewarded investors for the risks they bore.  While we don’t offer this as a “buy” list, much less a “must have” list, investors looking for solid, long-term performance without huge risks might start their due diligence here.

Trust, But Verify

My first-year students have a child-like faith in The Internet.  They’re quite sure that the existence of the ‘net means that they can access all human knowledge and achieve unparalleled wisdom. One percipient freshman wrote that,

“As technology becomes more sophisticated, developing the capacity to help us make moral and ethical choices as well as more pragmatic decisions, what we call human wisdom will reach new levels” (quoting Marc Prensky, Digital Wisdom, 2009 – I’ll note that the term “claptrap” comes to mind whenever I read the Prensky essay) . . . our mind limits our wisdom, meaning that our daily distractions are holding us back from how intelligent we can really be. Technology however, fills those gaps with its vast memory. Technology is helping us advance our memory, helping us advance our creativity and imagination, and it is fixing our flaws . . . our digital wisdom is doing nothing but getting vaster.  Prensky makes a lot of good arguments as to why we are not in fact the stupidest generation to have walked this Earth, and I couldn’t agree more.

“Digital wisdom” remains a bit elusive, if only because of flaws in the digits that originally enter the . . . well, digits, into the databases.

There’s no clearer example of egregious error without a single human question than in the portfolio reports for Manning & Napier Dividend Focus (MNDFX).  Focus remains almost fully-invested in common stocks, with 2-4% in a money market.  I used the Observer’s incredibly helpful Falcon’s Eye fund search to track down all the major reports of MNDFX’s portfolio.  I discovered that, as of July 31 2011:

$65 million was held in a money market, and $47 million was in stocks.  That would be a 58% cash stake.  Source: Manning & Napier month-end holdings, July 31 2011.

That 61% of the fund’s assets were shorting cash and that 94% was long cash, for a net cash stake of 33%.  Source: Morningstar.

That 100.28% of the fund’s assets were invested in two Dreyfus Money Market funds.  The top ten holdings combined contributed 127% of the fund’s assets.  Good news: the money market funds had returned 10.5% each in the first seven months of 2011.  Source: Yahoo Finance.

That the fund’s top holding was one Dreyfus money market (94% of assets), the fund’s cash Hybrid must be 33%. Source: USA Today.  U.S. News and MSN both agree.

SmartMoney’s undated portfolio report shows 3.9% cash.  The Wall Street Journal’s 8/31/11 portfolio lists the Dreyfus fund at 3.02% of the portfolio.

The most striking thing is the invisibility of the error.  No editor caught it, no data specialist questioned it, no writer looked further.  It seems inevitable that given the sheer volume of information out there, you owe it to yourselves to check – and check again – on the reliability of the information you’ve received before putting your money down.

Two Funds, and why they’re worth your time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s new fund:

Manning & Napier Dividend Focus (MNDFX): Manning & Napier is likely the best management team you’ve never heard of.  Focusing on dividends is likely the best strategy to follow.  And this fund gives you the lowest cost way to combine the two.

Stars in the shadows: Small funds of exceptional merit. There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight of them.

The stars are all time-tested funds, many of which have everything except shareholders.

Pinnacle Value (PVFIX): John Deysher does micro-caps right.  Sensible, skeptical, and cash-heavy, Pinnacle Value offers a remarkably smooth version of the micro-cap ride.

Small Funds Doing Well, and Doing Good

Saturna Capital has been recognized by the Mutual Fund Education Alliance for its philanthropic efforts.  On October 27^th, they (and American Century Investments) received MFEA’s Community Investment Award for 2011.  Saturna, which advises the Sextant and Amana funds, pledged over $2.5 million toward construction of the St. Paul’s Academy Upper School.  Saturna’s leadership galvanized other constituencies in the Bellingham, Washington, community to support the project.  Their efforts played a key role in securing $6 million in bank financing and over $1 million in private donations.

The past two winners were Aberdeen Asset Management (2010) and Calvert Investments (2009).

Matthews Asia shared the award for best retail communications with Saturna.  Both Saturna’s Market Navigator newsletter and Matthews’ collection of Asia-focused newsletters, including the flagship Asia Insight, were recognized for their excellent design and content.   This is Saturna’s 15^th communication award since 2008.

Northern Funds made a series of often dramatic reductions in the fees it charges to retail investors.  They accomplished that by raising the expense waivers on three dozen funds, effective January 1, 2012. The most striking reductions include lopping 45 basis points of the expenses charged by their Emerging Markets Equity Index fund – a drop of more than half, making it less expensive than Vanguard’s offering – and 35 basis points on the Global Sustainability Index.  None of the Northern indexes will charge more than 0.30% after the changes.  Expenses on Northern’s money market funds will be cut by 10 basis points, from 0.45% to 0.35%.

Morningstar’s Halloween Tricks and Treats

Russel Kinnel, Morningstar’s director of stuff, offered up a set of “portfolio-eating zombie funds” as part of his annual Halloween review (“Yikes … These Funds Have Been Bludgeoned….” 10/31/11). He focused simply on the greatest year-to-date losses, excluding leveraged index funds.  The most ghoulish of the creatures:

1. YieldQuest Core Equity (YQCEX), down 56%.  YieldQuest, with whose adviser I had a cranky exchange when I first profiled these funds, earns a Special Dishonorable Mention for fielding three funds, in three different asset classes, each of which has lost 40% or more this year.  The other funds place 4^th and 5^th on the list of losers: 4. YieldQuest Total Return Bond (YQTRX) and 5. YieldQuest Tax Exempt Bond (YQTEX).
2. Birmiwal Oasis (BIRMX), down 55%.  Feeling a bit playful, Mr. Kinnel offers “Lesson one: Don’t invest in a fund that sounds like a tiki bar.”
3. The USX China (HPCCX), down 54% in 2011 and 14% annually for the past five years.

At #6 on Kinnel’s list is Apex Mid Cap Growth (BMCGX), down 35%, “aided” in part by a 7% expense ratio.  Apex also qualified for the Observer’s Rollcall of the Wretched (October 2011) for finishing in the bottom 25% of its peer group for the past 1, 3, 5 and 10 years plus having above average risk and high expenses.  Our happiest note about Apex:

The good news: not many people trust Suresh Bhirud with their money.  His Apex Mid Cap Growth (BMCGX) had, at last record, $293,225.  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 8% over the past 15 years, has mostly impoverished himself.

Tenth on the list is Legg Mason Capital Management Opportunity (LMOPX), down 29%.  Another Roll Call of the Wretched honoree, I noted of LMOPX, “You know you’ve got problems when trailing 91% of your peers represents one of your better recent performances.”  Alarmed at the accusation, the fund promptly settled down and now trails all of its peers (through 10/27/2011).

At the end of September, though, he offered up a basket of autumn treats: his nominees for the best funds launched in the past three years.  Kinnel highlighted 19 funds, the five which are “most ready to buy” are:

Dodge & Cox Global Stock (DODWX), “a fine bet right now.”  Low expenses, great family.

PIMCO EqS Pathfinder (PTHDX), headed by Mutual Series veterans Anne Gudefin and Chuck Lahr.

DoubleLine Total Return Bond (DBLTX).  His court trial is over and he won, but might still need to pay millions.  The one thing that the trial does make clear is that the very talented Mr. Gundlach is not a good person.  The evidence at trial paints him as an egomaniac (“I am the “A” team”), anxious to be sure no one else detracted from his glory (he had TCW meticulously remove all references to his co-manager from press mentions of his Morningstar Manager of the Year award).  Evidence not permitted at trial dealt with sexual liaisons with co-workers, drugs and porn.  I’m sure he’s as talented as he thinks he is (as for that matter is Mr. Berkowitz), but it’s hard to imagine a world in which I’d trust him with my money.

American Funds International Growth and Income (IGAAX) is “a similar story to Dodge & Cox Global.”

Hotchkis and Wiley High Yield (HWHAX) offers two former PIMCO managers running a small, good fund.

Among the funds that made both Mr. Kinnel’s list and were profiled at the Observer or at FundAlarm: Akre Focus (AKREX), Tweedy Browne Global Value II Currency Unhedged (TBCUX) and Evermore Global Value (EVGBX).

Launch alert:

Motley Fool Epic Voyage Fund launched on November 1, 2011.  It’s an international small-cap value offering, managed by the same folks who run Motley Fool Independence (FOOLX) and Great America (TMFGX) funds.  FOOLX is a global equities fund, Great America is smaller-cap domestic.  Both are above-average performers and both tend to invest broadly between market caps and styles.  $3000 investment minimum and 1.35% expenses, after waivers.

Grandeur Peak Global Opportunities (GPGOX) and Grandeur Peak International Opportunities (GPIOX) both launched October 17, 2011.  The funds are currently available directly from Grandeur Peak (http://www.grandeurpeakglobal.com or 1.855.377.PEAK), or through Schwab or Scottrade. President Eric Huefner reports that, “We expect to be available at Fidelity, Pershing, E*Trade, and various other platforms within the next few weeks.”  They’re also working with TD Ameritrade, but apparently that’s going really slow.

Former Wasatch managers Robert Gardiner and Blake Walker are attempting to build on their past success at Wasatch Global Opportunities (WAGOX) and Wasatch International Opportunities (WAIOX).  My August story, Grandeur Peaks and the road less traveled, details the magnitude (hint: considerable) of those successes.

Both funds launched with $2.00 per share prices, while the industry standard is $10.00.  Folks on the Observer’s discussion board noted the anomaly and speculated that it might be a strategy for masking volatility.  At $2.00, another change under 0.5% gets reported as “zero.”  Mr. Huefner offered a more benign explanation: “that’s what we always did at Wasatch and since we’re all from Wasatch, we decided to do it again.”

Wasatch’s rationale was symbolic: since their original offerings were all micro- to small-cap funds which would need to close with still-small asset bases, they thought the $2.00 NAV nicely reinforced the message “we’re different, we’re the small fund guys.”

Briefly Noted . . .

RiverPark Short-Term High-Yield (RPHYX) was the subject of a very positive Forbes article, entitled “For fixed-income investors, another way to beat Treasurys” (October 21 2011).  Forbes was struck by the same risk minimization that we were: “the principal, and interest payments, are virtually guaranteed.  It might not always work. But investors who can sleep at night knowing they’re holding junk bonds might be better off than investors who are barely beating inflation in the Treasury and money markets.”  The fund’s assets under management are around $25 million, up from $20 million in summer.  Almost three-quarters of that money comes from institutional investors.

T. Rowe Price Emerging Europe and Mediterranean is trying to become T. Rowe Price Emerging Europe.  Two factors are driving the change.  First, Israel was been reclassified as a “developed” market which meant that the fund eliminated its investments there.  Second, it had only limited exposure to Turkey and Egypt, which made the “and Mediterranean” designation somewhat misleading.  If shareholders (the sheep) approve, the change will become effective in March, 2012.  The fund’s manager and wretched recent record (up 15.5% annually over the past 10 years, but down 4% annually over the past five) both remain.

Meet “the New Charlie.”  Having dispatched “my Charlie” Fernandez, Bruce Berkowitz found a Fred, instead.  Fred Fraenkel joins the firm as Chief Research Officer for whom Job Number One is . . . research?  Not so much.  “As our Chief Research Officer, Fred’s first task is to find ways to better communicate with clients as to which Fairholme’s best is yet to come,” says Berkowitz.

Effective on October 18, nine Old Mutual funds disappeared into a bunch of Touchstone funds.  These include Old Mutual Analytic U.S. Long/Short Fund which melted into Touchstone U.S. Long/Short and Old Mutual Barrow Hanley Value disappeared into Touchstone Value.

Eaton Vance Global Macro Absolute Return (EAGMX) reopened to new investors on Oct. 19, 2011.  The Morningstar analyst, perhaps bewilderingly, says: “Eaton Vance Global Macro Absolute Return is like the duck on smooth water whose hidden legs are pedaling furiously under the surface.”  The data says: steadily deteriorating performance and in the basement, overall.

Eaton Vance Equity Asset Hybrid (EEAAX) will liquidate at the end of December, 2011.

Harbor Funds’ Board of Trustees announced on Halloween Day that Harbor Small Company Value Fund (HISMX) will be liquidated (and dissolved!  What a Halloween-ish image) by year’s end.  HISMX was a perfectly solid little fund (top 10% of its peer group over the past three years) that never managed to become economically sustainable.  Harbor’s ongoing need to underwrite the expenses of a $10 million fund made its death inevitable.  The Board’s assertion that this was in the best interests of the fund’s shareholders, who were holding a good investment for which Harbor offers no obvious alternative, is polite drivel.  (Thanks to TheShadow for quickly noticing, and posting, the announcement.)

In closing . . .

A million thanks to the folks who have been supporting the Observer, whether through direct contributions or by using our Amazon link.  Special thanks for the ongoing support of our Informal Economist and John S, and to the new contributors this month.  I’ve been a putz about getting out thank-you notes, but they’re coming!

As you begin planning holiday shopping, please do use – and share – the link.  It costs nothing and takes no effort, but does make a real difference.

We’re hoping that by December you’ll actually see that difference.  The Observer actually has a secret identity.  Buried beneath our quiet exterior is a really attractive, highly-functional WordPress site waiting to get out.  We haven’t had the resources before to exploit those capabilities.  But now, with the combined efforts of Anya Z., a friend of the Observer who has redesigned the site, and Chip and her dedicated staff, we’re close to rolling out a new look.  Clean, functional, and easier to use: all made possible by your moral, intellectual and financial support.

And so, as we approach the season of Thanksgiving, here’s a sincere thanks and “see ya!” to one and all.

David

Dear friends,

Welcome to fall.  I know you’re not happy.  The question is: are you buying?  You said you were going to.  “Blood in the streets.  Panic in the markets.”  As wretched as conditions are, there’s reason to pause:

By Morningstar’s calculation, every sector of the market is now selling at a discount to fair value.  Most are discounted by 20% and only two defensive sectors (utilities and consumer defensives) are even close to fair value.

Also by their calculation, the bluest chip stocks (those with “wide moats”) are priced at an 18% discount, nearly identical to the discount on junk stocks (20%).

GMO’s most recent seven-year asset class return forecasts (as of 08/31/11), have US High Quality, International Large Caps and Emerging Markets Stocks set for real (i.e., inflation-adjusted) returns of 5.8 – 7.2% per year – very close to the “normal” long-term returns on the stock market.

It’s hard and it may turn out to be insane, but you have to ask: is this the time to be running away from, or toward, the sound of gunfire?

Why Google Flu Should Be Worrying the Fund Industry Sick

The flu is A Bad Thing, for flu sufferers and society alike.  Unpleasant, expensive and potentially fatal.  If you want to find out how bad the flu is in any particular part of the country, you’ve got two choices:

contact the Centers for Disease Control and receive information that tells you about the severity of the problem a week or two ago, or

check Google Flu Trends – which reports real-time on where people are searching flu-related terms – to get an accurate read, instantly.

It turns out that when people are interested in a topic, they Google it (who knew?).  As their interest grows, the number of searches rises.  As it ebbs, search activity dries up.  Google can document trends in particular topics either worldwide, by country, region or city.  Research on the method’s usefulness as an early warning indicator, conducted jointly by researchers from Google and the Centers for Disease Control, was published in Nature.

The funny thing is that interest in flu isn’t the only thing Google can track.  For any phenomenon which is important to huge numbers of people, Google can generate a seven-year chart of the changing level of people’s interest in topic.

Which brings us to mutual funds or, more narrowly, the apparent collapse of public interest in the topic.  Here’s the continually updated Google trend chart for mutual funds:

If you want to play, you can locate the search here. There’s a second Google trend analysis here, which generated a very similar graph but different secondary search options.  (It’s geeky cool.  You’re welcome.)

That trend line reflects an industry that has lost the public’s attention.  If you’ve wondered how alienated the public is, you could look at fund flows –much of which is captive money – or you could look at a direct measure of public engagement.   The combination of scandal, cupidity, ineptitude and turmoil – some abetted by the industry – may have punched an irreparable hole in industry’s prospects.

And no, the public interest hasn’t switched to ETFs.  Add that as a second search term and you’ll see how tiny their draw is.

The problem of Alarming Funds and the professionals who sustain them isn’t merely a problem for their shareholders.  It’s a problem for an entire industry and for the essential discipline which that industry must support.  Americans must save and invest, but the sort of idiocy detailed in our next story erodes the chance that will ever happen.

Now That’s Alarming!

FundAlarm maintained a huge database of wretched funds.  Some were merely bad (or Alarming), some were astoundingly bad (Three-Alarm) and some were astoundingly bad pretty much forever (the Most Alarming, Three-Alarm funds).

While we don’t have the resources to maintain a Database of Dismal, we do occasionally scan the underside of the fund universe to identify the most regrettable funds.  This month’s scan (run 09/02/2011) looked at funds that have finished in the bottom one-fourth of their peer groups for the year so far.  And for the preceding 12 months, three years, five years and ten years.  These aren’t merely “below average.”  They’re so far below average they can hardly see “mediocre” from where they are.

There are 151 consistently awful funds, the median size for which is $70 million.  Since managers love to brag about the consistency of their performance, here are the most consistently awful funds that have over a billion in assets:

September saw dramatic moves involving the two largest mutts.

Fidelity Magellan

Fidelity removed Harry Lange as manager of Fidelity Magellan (FMAGX).  Once the largest, and long the most famous, fund in the world, Magellan seems cursed.  It’s lost over $100 billion in assets under management and has chewed up and spit out several of Fidelity’s best and brightest managers.  Those include:

Jeffrey Vinik (1992-96): Vinik was a gun-slinging manager who guided Magellan to 17% annualized returns.  In late ’95 and ’96, he made a market-timing move – selling tech, buying bonds – that infuriated the Magellan faithful.  He inherited a $20 billion fund, left a $50 billion fund (in a huff), launched a hedge fund with made 50% per year, then closed the fund in 2000.  Presumably bored, he launched another hedge fund which has half its money in ETFs and bought two professional sports franchises.

Robert Stansky (1996-2005): Stansky, a former Fidelity Growth Company (FDGRX) star, inherited a $50 billion fund and – after a decade – left a $52 billion fund behind.  Those end points mask Magellan’s huge growth to $110 billion in the late 90s and subsequent collapse.  Stansky transformed Magellan from a mid-cap to a mega-cap fund, which made sense since his prior fund, a large-growth creature, so substantially crushed the competition (13% annually at Gro Co to 10% for the peer group).  A hopeful start ended with a series of weak years and Stansky opted for retirement.  He surfaced briefly as part of an abandoned plan to launch a series of Fidelity multi-manager funds.

Harry Lange (2005-11): Lange ran Fidelity Capital Appreciation (FDCAX) for a decade before taking on Magellan, and ran Fidelity Advisor Small Cap (FSCTX) for about seven years.   Described by Morningstar as “one of Fidelity’s very best managers,” FDCAX outpaced its peers by almost 50% over his tenure.  Lange inherited a $52 billion fund and left a $17 billion one.  Early in his tenure, he dumped Stansky’s blue chip names for smaller, riskier names.  That strategy worked brilliantly for three years, and then flopped badly enough that Lange left with the fund trailing 96% of its peers over his last five years.

And now it’s Jeff Feingold’s turn.  Like all the rest, Feingold is a star.  Ran a smaller fund.  Ran it well.  And now has a chance to run Magellan into . . . well, that is the cursed question, isn’t it?  Frankly, I can’t imagine any reason to put my money at risk here.

Vanguard Asset Allocation

Morningstar said: “This fund has merit for investors who are seeking an asset-allocation vehicle for the long haul…” (Analyst Report, “This mutual fund takes full advantage of its flexibility,” 2/22/11).

Vanguard, talking plainly, said “no, it doesn’t.”  On September 30, Vanguard fired the fund’s long-time managers and announced a plan to turn the firm’s most active fund into its most passive one.  Since launch, VPAAX moved its assets between three asset classes and had the ability to park 100% of the assets into any one of the classes.  Effective October 1, the fund will move toward a static, passively-managed 60/40 stock/bond split.  By year’s end, the firm will seek approval to merge it into Vanguard Balanced Index Fund (VBINX).

Just when you thought it couldn’t get any worse

I then refined the search with the Observer’s “insult to injury” criteria: funds that combined wretched performance with above-average to high risk and above average fees.  The good news: not many people trust Suresh Bhirud with their money.  His Apex Mid Cap Growth (BMCGX) had, at last record, $293,225.  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 8% over the past 15 years, has mostly impoverished himself.

The bad news: lots of people trust Bill Miller with their money.   With over $4 billion still tied up in his Legg Mason Value (LMVTX) and Legg Mason Opportunity (LMOPX), Miller has done a lot of damage.  Value spent four of the past five years at the bottom of the large-core heap (that is, it has trailed at least 93% of its peers in each of those years) and clocks in with an annualized loss of 2.3% for the past decade.   In a bizarre vote of confidence, the Board of Legg Mason closed its American Leading Companies fund and rolled all of the assets into Value.   The fund responded by losing 16.75% of that money over the next four months (rather worse than the market or its pees).   Morningstar’s bold judgment:  “We like the management but can’t recommend this bold offering as a core holding.” (emphasis mine)

The complete Roll Call of Wretched:

Trust Us: We’re Professionals, Part One

The poor schmoos invested in these wretched funds didn’t get there alone.  They had professional assistance.   52% of all the funds in Morningstar’s database carry a sales load or other arrangement designed to compensate the financial professional who advised you to buy that fund.  By contrast 88% of all large awful funds and 70% of roll call of the wretched funds are designed to be sold by financial professionals.  (I’m confident that none of the investors or advisors in these wretches are Observer readers.)

Trust Us: We’re Professionals, Part Two

Every mutual fund is overseen by a Board of Trustees, who is responsible for making sure that the fund operates in the best interests of its shareholders.  By law, a majority of those trustees must be independent of the management company.  And, by law, the trustees must explain – publicly, in print, annually – their decision about whether to keep or fire the manager.  Those discussions appear in the fund’s annual or semi-annual report.

So how do these independent trustees justify keeping the same losers atop these truly bad funds every blessed year?  To find out, I read the Boards’ justifications for each of these funds for the past couple years.  The typical strategy: “yes, but…”  As in, “yes, the fund is bad but…”  Boards typically

1. Go to great lengths to show how careful they’ve been
2. Don’t mention how bad the fund has
3. And find one bright spot – any bright spot – as grounds for ratifying the contract and retaining their profitable spots on the board.

Here’s the Legg Mason Opportunity board at work:

The Board received and reviewed performance information for the Fund and for a group of funds selected by Lipper, an independent provider of investment company data. The Board was provided with a description of the methodology Lipper used to determine the similarity of the Fund with the funds included in the Performance Universe. The Lipper data also included a comparison of the Fund’s performance to a benchmark index selected by Lipper. The Board also received from the independent contract consultant analysis of the risk adjusted performance of the Fund compared with its corresponding Lipper benchmark index. The Board also reviewed performance information for the Fund showing rolling returns based upon trailing performance. In addition, the Directors noted that they also had received and discussed at periodic intervals information comparing the Fund’s performance to that of its benchmark index.

So, they’ve gotten a huge amount of data and have intimate knowledge of how the data was compiled.

The Board noted the Fund’s underperformance during the 3, 5 and 10 years ended June 30, 2010 and noted more recent favorable performance . . .

You’ll notice that they don’t say “The Board noted that the fund has trailed 99-100% of its peers for every trailing standard period from one to ten years.”  But it has.  Back to the board:

which resulted in first quintile performance for the one-year ended June 30, 2010.

There’s the ray of light.  The Board might have – but didn’t – note that this was a rebound from the fund’s horrendous performance in the preceding twelve months.

The Board further considered the Adviser’s commitment to, and past history of, continual improvement and enhancement of its investment process, including steps recently taken by the Adviser to improve performance and risk awareness. As a result, the Board concluded that it was in the best interest of the Fund to approve renewal of the Management and Advisory Agreements.

Each Trustee receives $132,500 annually from Legg Mason for the part-time job of “somber ratifier.”

The Alger Board of Wobblies Trustees simply hid Alger Mid Cap Growth in the crowd:

. . . the performance for the near term (periods of 1 year or less through 6/30/10) of some of the Funds (Small Cap, Growth Opportunities, Convertible) generally surpassed (sometimes by a wide margin) or matched their peer group and benchmark, while others (Mid Cap, SMid Cap, Health Sciences) generally fell short (again, sometimes by a wide margin) of those measures, and the performance of still others (Large Cap, Capital Appreciation, Balanced) was mixed . . . (emphasis added)

The Board does not, anywhere, acknowledge the fund’s above average risks.  Of the high expenses they say:

All of the Funds’ expense ratios, except those of Health Sciences Fund, exceeded their peer median. The Trustees determined that such information should be taken into account . . . [for the funds as a group] the profit margin in each case was not unacceptable.

And still, without confronting the fact that Mid-Cap Growth trails 90% of its peers (technically, 87-95% depending on which share class you’re looking at) over the past one, three, five and ten years, “The Board determined that the Funds’ overall performance was acceptable.”

Alger’s Board members receive between $74,000 – 88,000 for their work.  None, by the way, has any investment in this fund.

The most bizarre judgment, though, was rendered by the Board of the Tanaka Growth Fund:

The Board next considered the investment performance of the Fund and the Advisor’s performance.  The Board generally approved of the Fund’s performance.  The Board noted with approval the Advisor’s ongoing efforts to maintain such consistent investment discipline.

Tanaka trails 95%, 97%, 99%, 97% and 96% of its peers (in order) for 2011 YTD and the past 1, 3, 5 and 10 year periods.  Consistent, indeed.

Mutual Fund Math: Fun Facts to Figure

Folks on the Observer discussion board occasionally wonder, “how many funds are there?” The best answer to which is, “uh-huh.”

There are 21,705 funds listed in Morningstar’s database, as of 09/30/11.  But that’s not the answer since many of the funds are simply different share classes of the same product.  The Alger Mid Cap Growth Fund, lamented above, comes in 10 different packages.  Many of the American Funds (for example, American Funds AMCAP) come with 18 different share classes.

Ask the database to report only “distinct portfolios,” and the total drops to 6628.  That includes neither closed-end nor exchange-traded funds.

The average no-load fund now has 2.7 share classes (often Retail, Institutional, Advisor).  The average load-bearing fund has 4.1 classes.

Investing as monkey business

Mental Floss, a bi-monthly magazine which promises to “help you feel smart again,” declared September/October 2011 to be their money issue.  It’s a wonderful light read (did you know that the symbol for the British pound was derived from the Latin for “pound,” since one pound of silver was used to strike 240 pound coins?) that featured one fascinating article on monkeys as investors.  Researchers, interested in the question of whether our collective financial incompetence is rooted in genetics, actually taught a colony of monkeys to use money in order to buy food.

Among the findings: monkeys showed precisely the same level of loss aversion that humans do.  In rough terms, both species find losses about three times more painful than they find gains pleasurable.  As a result, the monkey pursued risk-averse strategies in allocating their funds.

Despite the pain, we, in general, do not.  Instead, we pursue risk-averse strategies after allocating our funds: we tend to buy painfully risky investments (often at their peak) and then run off howling (generally at their nadir).

Would you like some pasta with your plans?

The Wall Street Journal recently profiled investment advisors who publish weekly, monthly or quarterly newsletters as a way to keep their clients informed, focused and reassured (“Keys to Making the Write Investments,” 09/19/11).  Among the firms highlighted is Milestones Financial Planning of Mayfield, Kentucky whose owner (Johanna Turner) is a long-time reader of, and supporter of, both FundAlarm and the Observer.  In addition to her monthly “mutual fund find” feature, Johanna shares recipes (mostly recently for vegetarian spaghetti – which would be all the better with a side of meatballs).  Her most recent newsletter, and recipe, is here.

Two Funds, and why they’re worth your time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s new fund:

Mairs & Power Small Cap (MSCFX): Mairs & Power rolls out a new fund about, oh, every half century or so.  Their last launch before this was 1961.  The firm specializes in long-term, low-turnover, low-flash investing.  Their newest fund, a pure extension of the Mairs & Power Growth Fund discipline, is sure to appeal to fans of The Newhart Show, fly-tying, the Duluth Trading Company and other sensible, sensibly-paced pursuits.

Stars in the shadows: Small funds of exceptional merit. There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight of them.

The stars are all time-tested funds, many of which have everything except shareholders.

SouthernSun Small Cap Fund (SSSFX): measured as a small-cap value fund, SSSFX has been one of the two top in the field lately.  But it’s actually more of a smid-cap core fund.  And, surprisingly, it’s also one of the top two funds there, too.  With an incredibly compact, high-quality portfolio and low-turnover style, it’s surprising so few have heard of it.

Launch alert:

Grandeur Peak Global Opportunities and Grandeur Peak International Opportunitiesboth launch October 17, 2011.

Former Wasatch managers Robert Gardiner and Blake Walker are attempting to build on their past success with  Wasatch Global Opportunities (WAGOX) and Wasatch International Opportunities (WAIOX).  My August story, Grandeur Peaks and the road less traveled, details the magnitude (hint: considerable) of those successes.

Briefly Noted . . .

SEC time travel continues.  The SEC’s current filings page for September 6 contained 62 prospectus filings – of which precisely two are for September 6.  The other 60 had originally been filed as early as October 14, 2010.  Still no explanation for why “today’s filings” include 14 month old filings.

Effective November 4, Nakoma Absolute Return (NARFX) will become Schooner Global Absolute Return Fund.   Very few details are available, but since the change did not require shareholder approval, it seems likely that the Nakoma team and objectives will – for better and worse – remain in place.

In another sign of the direction in which the marketing winds are blowing, Jensen Fund (JENSX) is changing its name to Jensen Quality Growth Fund.

Federated Balanced Allocation (BAFAX) will merge into Federated Asset Allocation (FSTBX) on Sept. 30, 2012.

Value Line Convertible (VALCX) will merge into Value Line Income & Growth (VALIX) on Dec. 16, 2011.

GMO will liquidate GMO Tobacco-Free Core Fund (GMTCX) at the end of December, 2011 and GMO Tax-Managed U.S. Equities Fund (GTMUX) at the end of October, 2011.

Munder Asset Allocation Balanced (MUBAX) will liquidate on Oct. 14.

Invesco Van Kampen Global Tactical Asset Allocation (VGTAX) will liquidate on Oct. 28.  Despite an exceptionally solid record and an exceptionally trendy name, the fund drew only $21 million in assets in just under three years and so it’s a deadster.

Four small Highmark Funds (did you even know there were Highmark funds?) will be merged out of existence in October, 2011.  The dead funds walking are HighMark Fundamental Equity (HMFAX), HighMark Small Cap Value (HMSCX), HighMark Diversified Equity Allocation (HEAAX) and HighMark Income Plus Allocation (HMPAX).

Allianz RCM Global Resources (ARMAX) is now Allianz RCM Global Commodity Equity.  Alec Patterson joined as co-manager.

In closing . . .

Dwindling consumer confidence is reflected in the Observer’s Amazon revenue, which drifted down by a third from August to September.  If you’ve looking to a particularly compelling purchase, consider picking up a copy of Baumeister and Tierney’s Willpower: Rediscovering the Greatest Human Strength (Penguin, 2011).  Roy Baumeister is an Eminent Scholar (really, that’s part of his official title) doing research in social psychology at Florida State.  John Tierney is a very skilled science journalist with The New York Times.  I first heard about Baumeister’s research in a story on National Public Radio, picked up the book and have found it pretty compelling.  Here’s a précis of their argument:

• Willpower is central to success in life,
• You have a limited supply of it, so that exercising will in one area (quitting smoking) leaves you powerless to cope with another (controlling your diet) but
• Your stock of willpower can be quickly and substantially increased through exercise.

The implications of this research, from how we invest to how we teach our children, are enormous.  This is a particularly readable way into that literature.

That said, a number of people contributed to the Observer through our PayPal link in September and I’d especially like to thank Old_Joe and CathyG for their continuing support, both financial and intellectual.  Thanks, guys!

Speaking of support, we’ve added short biographies of the two people who do the most to actually make the site function: Accipiter and Chip.  If you’d like to learn just a bit more about them and their work here, it’s in the About Us section.

Keep those cards and letters coming!  We appreciate them all and do as much as we can to accommodate your insights and concerns.

Be brave – October is traditionally one of the two scariest months for the stock market – and celebrate the golden hues of autumn.  I’ll see you again just after Halloween!

With respect,

David

Dear friends,

Almost all of the poems about the end of summer and beginning of fall are sad, wistful things.  They’re full of regrets about the end of the season of growth and crammed with metaphors for decline, decay, death and despair.

It’s clear that poets don’t have investment portfolios.

The fact that benchmarks such as the Dow Jones Industrial average and Vanguard Total Bond Market are both showing gains for the year masks the trauma that has led investors to pull money out of long-term funds for six consecutive weeks.  Whether having the greatest outflows since the market bottom in March 2009 is a good thing remains to be seen.

Roller coasters are funny things.  They’re designed to scare the daylights out of you, and then deposit you back exactly where you started.  It might be a sign of age (or, less likely, wisdom) that I’d really prefer a winding garden path or moving walkway to the thrills now on offer.

The Latest Endangered Species: Funds for Small Investors

Beginning in the mid-1990s, I maintained “The List of Funds for Small Investors” at the old Brill/Mutual Funds Interactive website.  I screened for no-load funds with minimums of $500 or less and for no-load funds that waived their investment minimums for investors who were willing to start small but invest regularly.  That commitment was made through an Automatic Investing Plan, or AIP.

At the time, the greatest challenge was dealing with the sheer mass of such funds (600 in all) and trying to identify the couple dozen that were best suited to new investors trying to build a solid foundation.

Over the years, almost all of those funds ceased to be “funds for small investors.”  Some closed and a fair number added sales loads but the great majority simply raised their investment minimums.  In the end, only one major firm, T. Rowe Price, persevered in maintaining that option.

And now they’re done with it.

Effective on August 1, Price eliminated several policies which were particularly friendly to small investors.  The waiver of the minimum investment for accounts with an Automatic Asset Builder (their name for the AIP) has been eliminated. Rather than requiring a $50 minimum and $50/month thereafter, AAB accounts now require $2500 minimum and $100/thereafter.

The minimum subsequent investment on retail accounts was raised from $50 to $100.

The small account fee has been raised to $20 per account under $10,000. The fee will be assessed in September. You can dodge the fee by signing up for electronic document delivery.

Price changed the policies in response to poor behavior on the part of investors. Too many investors started with $50, built the account to $300 and then turned off the asset builder. Price then had custody of a bunch of orphaned accounts which were generating $3/year to cover management and administrative expenses.  It’s not clear how many such accounts exist. Bill Benintende, one of Price’s public relations specialists, explains “that’s considered proprietary information so it isn’t something we’d discuss publicly.”  This is the same problem that long-ago forced a bunch of firms to raise their investment minimums from $250- 500 to $2500.

Two groups escaped the requirement for larger subsequent investments.  Mr. Benintende says that 529 college savings plans remain at $50 and individuals who already have operating AAB accounts with $50 investments are grandfathered-in unless they make a change (for example, switching funds or even the day of the month on which an investment occurs).

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

There are, in addition, a number of individual funds with minimums reduced or waived for folks willing to commit to an automatic investment.  Those include Barrett  Opportunity (SAOPX), Cullen High Dividend Equity (CHDEX), Giordano (GIORX), Primary Trend (PTFDX), Sector Rotation (NAVFX), and Stonebridge Small Cap Growth (SBAGX).

On a related note: Fidelity would like a little extra next year

Fidelity will begin charging an “annual index fund fee” of $10.00 per fund position to offset shareholder service costs if your fund balance falls below $10,000, effective December 2011.  They’re using the same logic: small accounts don’t generate enough revenue to cover their maintenance costs.

The Quiet Comeback of Artisan Small Cap (ARTSX)

The second fund in which I ever invested (AIM Constellation was the first) was Artisan Small Cap (ARTSX). Carlene Murphy Ziegler had been a star manager at Stein, Roe and at Strong.  With the support of her husband, Andrew, she left to start her own fund company and to launch her own fund.  Artisan Small Cap was a solid, mild-manned growth-at-a-reasonable price creature that drew a lot of media attention, attracted a lot of money, helped launch a stellar investment boutique, and quickly closed to new investors.

But, somewhere in there, the fund got out of step with the market.  Rather than being stellar, it slipped to okay and then “not too bad.”  It had some good years and was never terrible, but it also never managed to have two really good years back-to-back.  The firm added co-managers including Marina Carlson, who had worked so successful with Ziegler at the Strong Funds.  Ziegler stepped aside in 2008 and Carlson in 2009.

At that point, manager responsibilities were given to Andrew Stephens and the team that runs Artisan Mid Cap Fund (ARTMX).  ARTMX has posted remarkably strong, consistent results for over a decade.  It’s been in the top 10-15% of midcap growth funds for the past 1, 3, 5 and 10 year periods.  It has earned four or five star ratings from Morningstar for the past 3, 5, and 10 year periods.

Since taking over in October 2009, ARTSX has outperformed its peers.  $10,000 invested on the day the new team arrived would have gain to $13,900, compared to $13,100 at its peers.   Both year to date and for the three, turbulent summer months, it’s in the top 2% of small growth funds.  It has a top 5% record over the past year and top 15% over the past three.

Artisan has a very good record of allowing successful teams to expand their horizons. Scott Satterwhite’s team from Artisan Small Cap Value (ARTVX) inherited Artisan Mid Cap Value (ARTQX) and the large cap Artisan Value (ARTLX) funds, and has reproduced their success in each.  The same occurred with the Artisan International Value team running Artisan Global Value and Artisan International running Artisan International Small Cap.

Given that track record and the fund’s resurgence under the Stephen’s team, it might be time to put Artisan Small Cap back on the radar.

Fund Update: RiverPark Short-Term High Yield

We profiled RPHYX in July as one of the year’s most intriguing new funds. It’s core strategy – buying, for example, called high yield bonds – struck me “as a fascinating fund.  It is, in the mutual fund world, utterly unique . . .  And it makes sense.  That’s a rare and wonderful combination.”

The manager, David Sherman of Cohanzick Management, has been in remarkably good spirits, if not quite giddy, because market volatility plays into the fund’s strengths.  There are two developments of note.

The manager purchased a huge number of additional shares of RPHYX after the market rout on Monday, August 8.  (An earlier version of this note, on the Observer’s discussion board, specified an amount and he seemed a bit embarrassed by the public disclosure so I’ve shifted to the demure but accurate ‘huge number’ construction.)

The fund’s down about 0.4% since making its monthly distribution (which accounts for most of its NAV changes). For those keeping score, since August 1, Fidelity Floating Rate High Income (FFHRX, a floating-rate loan fund that some funds here guessed would parallel RiverPark) is down 4%, their new Global High-Income fund (FGHNX) is down 5% and Fidelity High Income (SPHIX) is down 4.5%.

Fortunately, the fund generates huge amounts of cash internally. Because durations are so short, he’s always got cash from the bonds which are being redeemed. When we spoke on August 10^th, he calculated that if he did nothing at all with the portfolio, he’d get a 6% cash infusion on August 16, a 10% infusion on August 26th, and cash overall would reach 41% of the portfolio in the next 30 days. While he’s holding more cash than usual as a matter of prudent caution, he’s also got a lot to buy with.

And the market has been offering a number of exceptional bargains. He pointed to called HCA bonds which he first bought on July 27 at a 3.75% annualized yield. This week he was able to buy more at a 17% yield. Since the bonds would be redeemed at the end of August by a solidly-profitable company, he saw very little risk in the position. Several other positions (Las Vegas Sands public preferred and Chart Industries convertibles) have gone from yielding 3-3.5% to 5-6% available yields in the last two weeks.

He was also shortening up the portfolio to take advantage of emerging opportunities. He’s selling some longer-dated bonds which likely won’t be called in order to have more cash to act on irrational bargains as they present themselves. Despite an ultra-short duration, the fund is now yielding over 5%. The Fed, meanwhile, promises “near zero” interest rates for the next two years.

Mr. Sherman was at pains to stress that he’s not shilling for the fund. He doesn’t want to over-promise (this is not the equivalent of a savings account paying 5%) and he doesn’t want to encourage investors to join based on unrealistic hopes of a “magic” fund, but he does seem quite comfortable with the fund and the opportunity set available to him.

Note to the Securities and Exchange Commission: Hire a programmer!

Every day, the SEC posts all of its just-received filings online and every day I read them.  (Yep.  Really gotta get a life.) Here is a list of all of today’s prospectus filings.  In theory, if you visit on September 1^st and click on “most recent,” you’ll get a screen full of filings dated September 1^st.

Except when you don’t.  Here, for example, is a screen cap of the SEC new filings for August 22, 2011:

Notice how very far down this list you have to go before finding even one filing from August 22^nd (it’s the ING Mutual Funds listing).  On July 25th, 43 of 89 entries were wrong (including one originally filed in 2004).

Two-thirds of all Wall Street trades emanate from high-frequency traders, whose computers execute trades in 250 microseconds (“Not So Fast,” The Economist, 08/06/11).  Those trades increase market volatility and asset correlations, to the detriment of most investors.  The SEC’s difficulty in merely getting the date right on their form postings doesn’t give me much confidence in their ability to take on the problems posed by technology.

Four Funds, and why they’re worth your time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s two new funds:

RiverPark/Wedgewood (RWGFX): David Rolfe makes it seem so simple.  Identify great companies, buy only the best of them, buy only when they’ve on sale, and hold on.  For almost 19 years he’s been doing to same, simple thing – and doing it with unparalleled consistency and success.  His strategy is now available to retail investors.

Walthausen Select Value (WSVRX): the case for this focused small- to mid-cap fund is simple.  Manager John Walthausen has performed brilliantly with the last three funds he’s run and his latest fund seeks to build on one of those earlier models.

Stars in the shadows: Small funds of exceptional merit. There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight of them.

The stars are all time-tested funds, many of which have everything except shareholders.

Northern Global Tactical Asset Allocation (BBALX): up until August 1^st, you could access to the best ideas of Northern Investment Policy Committee only if you had $5 million to meet this fund’s minimum or $500 million in assets at Northern.  And then it became a retail fund ($2500) with an institutional pedigree and expenses (0.68%).  Folks looking for a conservative core fund just stumbled onto a really solid option.

Walthausen Small Cap Value (WSCVX): we profiled this fund shortly after launch as one of the year’s best new funds.  Three years on, it’s running rings around its competition and starting to ask about when it will be necessary to close to new investors.  A somewhat volatile choice, it has produced remarkable results.

Briefly noted . . .

Berwyn Income (BERIX) will reopen to new investors on Sept. 19. The $1.3 billion fund closed in November 2010, but says the board, “recent volatility in the market has led to new investment opportunities for the Fund.”  BERIX makes a lot of sense in turbulent markets: modest stake in dividend-paying stocks and REITs, plus corporate bonds, preferred shares, convertibles and a slug of cash.  Lots of income with some prospect for capital growth.  The fund more than doubled in size between 2008 and 2009, then doubled in size again between 2009 and 2010.  At the end of 2008, it was under $240 million.  Today it carries a billion more in heft.  Relative performance has drifted down a bit as the fund has grown, but it remains really solid.

Fidelity is bringing out two emerging market funds in mid-October. The less interesting, Emerging Markets Discovery, will be their small- to mid-cap fund. Total Emerging Markets will be a 60/40 balanced fund. The most promising aspect of the balanced fund is the presence of John Carlson, who runs New Markets Income (FNMIX) at the head of the management team.  FNMIX has a splendid long-term record (Carlson’s been there for 16 years) but it’s currently lagging because it focuses on dollar-denominated debt rather than the raging local currency variety.  Carlson argues that local currencies aren’t quite the safe haven that newbies believe and that, in any case, they’re getting way overvalued.  He’ll have a team of co-managers who, I believe, run some of Fidelity’s non-U.S. funds.  Fido’s emerging markets equity products have not been consistently great, so investors here might hope for index-like returns and a much more tolerable ride than a pure equity exposure would offer. The opening expense ratio will be 1.4% and the minimum investment will be $2500.

Northern Funds are reducing the operating expenses on all of their index funds, effective January 1, 2012.  The seven funds involved are:

Nicely done!

Forward Management introduced a new no-load “investor” share class for Forward International Real Estate Fund (FFIRX), the Forward Real Estate Long/Short Fund (FFSRX), and the Forward Global Infrastructure Fund (FGLRX). Forward Real Estate (FFREX) already had a no-load share class.  The funds are, on whole, respectable but not demonstrably great. The minimum investment is $4,000.

DWS Strategic Income (KSTAX) becomes DWS Unconstrained Income on Sept. 22, 2011. At that point, Philip Condon will join the management team of the fund.  “Unconstrained” is the current vogue term for income funds, with PIMCO leading the pack by offering unconstrained Bond (also packaged as Harbor Unconstrained Bond), Tax-Managed Bond and Fixed Income funds.  All of them have been underperformers in their short lives, suggesting that the ability to go anywhere doesn’t immediately translate into the wisdom to go somewhere sensible.

Litman Gregory Asset Management has renamed its entire line of Masters’ Select funds as Litman Gregory Masters Funds name.

PIMCO Developing Local Markets (PLMIX) has changed its name to PIMCO Emerging Markets Local Currency, presumably to gain from the “local currency debt” craze.

Dreyfus S&P Stars Opportunities (BSOBX) will change its name to Dreyfus MidCap Core on Nov. 1, 2011.

DWS RREEF Real Estate Securities (RRRRX) will close Sept. 30, 2011.

JPMorgan U.S. Large Cap Core Plus (JLCAX) closed to new investors on Sept. 2, 2011.

Scout TrendStar Small Cap (TRESX) is merging into Scout Small Cap (UMBHX).

MFS Core Growth (MFCAX) merged into MFS Growth (MFEGX) in August.

Effective Sept. 15, 2011, GMO Global Balanced Asset Allocation Fund (GMWAX) will be renamed GMO Global Asset Allocation Fund and it will no longer be bound to keep at least 25% each in stocks and bonds.

Forward Funds is changing Forward Large Cap Equity (FFLAX), a mild-mannered fund with a slight value bias, into Forward Large Cap Dividend Fund.  After November 1, at least 80% of the portfolio will be in . . . well, large cap, dividend-paying stocks.   Not to rain on anybody’s parade, but all of its top 25 holdings are already dividend-paying stocks which implies marketing rather than management drove the change.

Likewise, Satuit Capital Micro Cap has been changed to the Satuit Capital U.S. Emerging Companies Fund (SATMX).   The Board hastened to assure shareholders that the change was purely cosmetic: “there are no other changes to the Fund being contemplated as a result of this name change.”  Regardless, it’s been a splendid performer (top 1% over the past decade) with an elevated price tag (1.75%)

DWS Climate Change (WRMAX) becomes DWS Clean Technology on October 1, 2011.

A few closing notes . . .

We’re very pleased to announce the launch of The Falcon’s Eye.  Originally written by a FundAlarm board member, Falcon, the Eye provides a quick and convenient link to each of the major profiles for any particular fund.  Simply click on “The Falcon’s Eye” link on the main menu bar atop this page and enter one or more ticker symbols.  A new windows pops up, giving the fund name and direct links to ten major source of information:

And, of course, the Observer itself.

Mark whichever sources interest you, click, and the Eye will generate direct links to that site’s profile of or reporting on your fund.  Thanks to Accipiter for his tireless work on the project, and to Chip, Investor, Catch22 and others for their support and beta testing of it.  It is, we think, a really useful tool for folks who are serious about understanding their investments.

Thanks to all of you for using or sharing the Observer’s link to Amazon.com, which is providing a modest but very steady revenue stream.  Special thanks for the folks who’ve chosen to contribute to the Observer this month and, especially, to the good folks at Milestones Financial Planning in Kentucky for their ongoing support.  We’re hoping for a major upgrade in the site’s appearance, in addition to the functionality upgrades that Chip and Accipiter have worked so faithfully on.

Looking for the archive? There is an archive of all Observer and later FundAlarm commentaries, links to which usually appear at the top of this page. This month we encountered a software glitch that was scrambling the list, so we’ve temporarily hidden it. Once out tech folks have a chance to play with the code, it’ll be back where it belongs. Thanks for your patience!

Keep those cards and letters, electronic or otherwise, coming.  I love reading your thoughts.

See you in October!

David