Author Archives: Leigh Walzer

About Leigh Walzer

Mr. Walzer is the principal at Trapezoid LLC and publisher of He has 30 years of experience in the investment management industry as a portfolio manager and investment analyst including seven years at Franklin Mutual. In addition to his work evaluating active managers, he is well known for his work in the area of distressed debt and special situations. He received an AB in Statistics from Princeton University and an MBA from Harvard University.

Whose Fund Is It, Anyway?

By Leigh Walzer

The Closed End Fund (CEF) industry, with $200 billion in assets, is dwarfed in size by the open-ended mutual fund industry.   CEFs generally get little attention in Mutual Fund Observer and sites like Bogleheads. Trapezoid monitors most of the closed-end fund universe for manager skill in relation to expense ratio, using the same methodology and database as for open-end mutual funds. (MFO readers are invited to register for a free no-obligation demo which covers several mutual fund sectors)

There are many closed end funds trading at discounts to Net Asset Value (NAV). The average fund trades today at a 7% discount. This is not as big as it was a year ago, but still above the historic average. Exhibit I shows the average closed fund discount for all US CEFs (based on equal weighting) We are aware of 100 CEFs trading at discounts of 12% or greater. Sometimes those discounts persist so long they become Continue reading →

Trump, Bonds, and Inflation

By Leigh Walzer

(Making Your Portfolio Great Again)

The election 3 weeks ago ushered in a new investment paradigm.  To Make America Great Again, President-elect Trump is committed to lower taxes, run large deficits, and spent trillions on infrastructure. Trump is no friend of the bond market, and judging by the steep decline in bond prices over the following week, the feeling is mutual. Bondholders took note when Mr. Trump bragged on CNBC back in May that he had a lot of experience negotiating with bondholders which he could bring to bear in addressing the government’s debts.  But they were probably more spooked by the subsequent clarification that the government would never default because it could Continue reading →

Concentrated Solutions

By Leigh Walzer

Last month we discussed  Nuance Concentrated Value Fund (NCVLX.) The fund had some big exposures to less liquid names and the strategy was nearing its capacity. At some point the advisor is likely to soft-close the concentrated fund but continue to grow the smaller and more diversified midcap fund.

It is not unusual that fund purveyors offer a version with a higher concentration of the manager’s high-conviction ideas. Sometimes you can spot these derivative funds based on names like Focused or Select Opportunities.

Generally, the concentrated version is Continue reading →

Turning Over the Data

By Leigh Walzer

This month the index fund turned 40. Bloomberg wrote a story suggesting this remarkable bit of financial engineering has benefited investors by close to a trillion dollars. While we think there is an important role for active managers, we noted in this column last month that investors continue to overpay by at least $70 billion per year.

But we take exception to one facet of this otherwise excellent story. The author notes that Continue reading →

Woe! We’re Halfway There

By Leigh Walzer

Over the past eight years the US mutual fund industry has witnessed a massive shift from active to passive management. In the Trapezoid universe, 35% of equity funds are now passively managed compared with 28% a year ago. This figure is AUM weighted, includes exchange-traded and closed-end funds, captures flows through July. The fixed income universe gets less attention but we observe 12% of AUM are now passively managed. Continue reading →

Keeping A Watchful Eye on Your Manager

By Leigh Walzer

By Leigh Walzer

It’s summertime. You are reading this from the vacation house. Or perhaps you are at the ballgame like Professor Snowball, rooting for the Quad City River Bandits. There is no event risk on the horizon. You trust your fund managers.  The portfolios can stay on autopilot until Labor Day.

As advisors struggle with the new fiduciary rules, they may wonder how frequently manager selection decisions need to be reviewed. We set out to answer the question: What is the likelihood that a portfolio left on autopilot will go bad over time.

We compared the ratings on 7000 mutual funds to see how much the probability metrics changed over time. Trapezoid’s data and models (which can be trialled at tell us the probability a given fund class will deliver skill over the next 12 months. For most funds, skill is a function of value-added from security or sector selection.  Skill takes into account a manager’s returns each period adjusted for factor exposures and other attributes. Continue reading →

Liquid Alts: The Thrill is Gone

By Leigh Walzer

By Leigh Walzer

The tone of the 2016 Morningstar conference was decidedly subdued. Attendance was down sharply. Keynote speaker Bill McNabb of Vanguard took a “victory lap” to mark another year of rapid growth for passive funds. Active equity managers continue to get pummeled by outflows and rising distribution costs. These forces may have slowed in 2016 but the shakeout continues. Purveyors of actively managed funds are either reluctantly jumping on the ETF bandwagon or seeking defensible safe-havens like fixed-income, smart beta, and liquid alts.

Liquid Alts: Explained

Liquid alts received a lot of positive attention at the 2015 Morningstar Conference – and negative attention this year. Liquid alts are funds pursuing alternative investment strategies and offering daily liquidity. In other words, these are hedge funds marketed in “40 act” garb. Generally, investors look to alternative investments to deliver returns with below average market correlation.

Common investment strategies include Long/Short Equity, Long/Short Credit, Market Neutral, Managed Futures, Event-Driven, and Short-Selling. Fund managers can reduce risk by selling one security against another, hedging, or buying derivatives. Some are trying to deliver a market neutral return; others are trying to outperform an equity or fixed income benchmark with lower volatility. Sometimes the distinction between categories is a little blurry.

We identified a liquid alt universe of approximately 500 funds. Morningstar tracks 650 so either they use a more expansive definition or our “universe” has a few black holes. We apply two main criteria: (a) the fund describes itself or is widely categorized as an alternative strategy (b) in our assessment, it acts like an alternative fund, meaning we can’t replicate the returns using traditional strategies. We count approximately $280 billion of liquid alt assets under management.

Two thirds of these funds are single strategy, the balance are MultiStrategy. Fund of fund and sub-advisory structures are not uncommon. Some liquid alt vehicles offer investors performance which is pari passu with hedge fund classes. Others offer a separate account which may have tailored guidelines or a risk management overlay. For example, one of the fund managers we spoke to noted that he asked his subadvisors to dial down European risk before the Brexit vote. Implementation of alternative strategies in “40 Act” formats requires higher balances of cash and liquid assets – particularly for the pari passu offerings – which is a drag on returns. A few funds pay performance fees to subadvisors.

Even purveyors of these funds concede there is confusion in the marketplace about the proper role for these funds in investor portfolios. Nonetheless, the liquid alt industry has boomed over the past 8 years. The allure for investors has been access to strategies previously available only in hedge fund format. According to GSAM, Liquid Alts outperformed equity by 23% and fixed income by 16% during bear markets. The allure for fund companies has been an infusion of new assets earning higher expenses. The average expense ratio for long/short equity is 174 bps. Established managers who can raise money at 2 and 20 may not participate, but there are plenty of second-tier managers ready to step in.

The success of liquid alts has attracted a lot of new entrants. 45% of liquid alt funds are under 3 years old. (Our data for this article runs through April 30, 2016.) But the new funds have ramped slowly: only 13 % of the industry AUM are in those new funds. Growth stalled a year ago. Judging from the number of funds and the assets they attracted, the greatest interest is in Long/Short Equity and MultiStrategy funds. The biggest players in our database are BlackRock, GMO, AQR, Pimco, JPMorgan, and GSAM. Some of the industry giants like Fidelity and Cap Re have been notably absent.

Recent Results

Despite the surge of interest (or perhaps because of it) results from liquid alts have been rather disappointing. Skill as measured by for liquid alts in the aggregate has been -1% per year over the past 36 months.

Maybe the free lunch of strong and uncorrelated returns doesn’t exist after all

The biggest negatives, not surprisingly, are Short Sellers, Commodities, and Momentum. Global Macro, Credit Focused, and Absolute Return also did poorly. Event Driven and Low Volatility strategies fared best while Market Neutral, Long/Short Equity, Long/Short Credit, Currency, and MultiStrategy had a modicum of skill. These are measures of excess return corresponding to the sS measure (explained here) on the website. (Mutual Fund Observer readers may register for a free demo. Currently, demo users can access funds in the Market Neutral and Large Value categories.)

Our sS measure adjusts the gross return of these funds for any return from equities, fixed income, commodities, or currency which we could have mathematically replicated with passive indices. Other metrics may assess skill differently. For example, alt funds (particularly Futures strategies) show slight pickup from Beta which might offset the negative skill. One way of interpreting our findings: as these strategies have gotten crowded, the performance which fueled interest has evaporated; and the cost of offsetting or hedging away risk exceeds the benefit.

Results by Strategy

Over the past 10 years, the Morningstar Market Neutral sector composite generated a return of only 0.5%. The Long/Short Equity sector, which takes more market risk, returned 1.5%. Maybe the free lunch of strong and uncorrelated returns doesn’t exist. But those sectors did show fairly good returns prior to 2006

Our take is that returns in Liquid Alts are governed by supply and demand. Just as individual managers have limited capacity, returns for the strategy suffer when too much money rushes in.

Managed Futures showed excellent returns through 2009 and poor results ever since. From what we can discern, this strategy tracks mainly commodities and currencies. While the funds are supposed to go both long and short there is a significant correlation between the category and the Barclay CTA Index. So when commodities suffer, it is hard for this strategy to work. These funds rely heavily on momentum and trend-following, a strategy which has been challenging of late.

Many hedge funds seek investments with asymmetric risk. And many strive to capture most of the market in bullish periods while declining less in a down market. However, our preliminary work suggests the major liquid alt strategies haven’t delivered on this promise. For example, using Morningstar data, the Long/Short equity category captured 41% of the upside of the S&P500 as compared with 61% of the downside.

Individual Liquid Alt Funds

Even if the market as a whole has become efficient, there is a wide range of returns among liquid alt funds. The standard deviation of sS is 3.3% for liquid alts (higher than for other asset classes we studied.) See Exhibit I. So even if sector returns disappoint, we can try and identify individual funds poised to outperform.

Exhibit I

Exhibit I

FundAttribution is a great starting point for comparing liquid alt funds. Funds in the same category may have very different correlations and factor exposures; but our metrics normalize the impact to permit clean comparisons. Even the drag from holding extra liquidity can be isolated.

For example, AQR Managed Futures Strategy (AQMIX) returned roughly 3.6% (4.7% gross return) on an annualized basis from inception through 3/31/16. We estimate that without directional bets on commodities and currency, that return would have declined to 2.6%. That return is fully explained by the fund’s exposure to credits markets. So we don’t ascribe any skill to the manager.

Here are some funds which show well. Some had strong sS over the past 3 years in relation to expense ratio. Others have done well over a longer period. Not all of these made the Trapezoid Honor Roll (implying 60% confidence that next year’s net return will be positive.) Some don’t have enough track record and others are too small.

Exhibit II

Exhibit II

One Honor Roll fund is Vanguard Market Neutral Fund (VMNIX). The fund has been around since 1998, costs are very low. (The minimum investment is $250k.) Around 2007 Vanguard replaced the subadvisor with its own Quantitative Equity Group; since then sS has been exceptional. Most of the return is based on buying stocks cheap using fundamental analysis and selling expensive stocks in the same sectors. The investment process is systematic but human judgement plays an important role. The strategy has grown from $0.3 billion to $1.7 billion over the past 18 months but there appears to be plenty of remaining capacity. Much of that growth has been through Schwab. We also observed an independently managed liquid alt parking its excess cash in VMNIX. Investors who register for the demo can access additional analysis of VMNIX and other Market Neutral funds at

The eight largest liquid alts in our universe registered negative sS over the past 3 years. One large player which has performed well is Boston Partners Long/Short Research Fund (BPIRX). Historically, net exposure has been 40 to 60%. BPIRX is closed to new investors. Boston Partners Global Long Short Research Fund (BGLSX) is currently open. We do not publish metrics on BGLSX because the management team has been on the job less than three years.

Event Driven has been one of the stronger liquid alt categories in recent years. For investors who want exposure, IQ Merger Arbitrage ETF (MNA) is a passive ETF managed by NY Life. which goes long announced deals and hedges out market risk by shorting equity indices. The event-driven category encompasses many strategies; this is one of the more vanilla. Demand in this category has been relatively stable which may have aided returns while supply (M&A volume) was robust. But M&A activity may be poised to fall.

New SEC Rules

The rapid expansion in liquid alts has not gone unnoticed by regulators. The SEC has moved recently to regulate use of derivatives by mutual funds, which it views as a form of leverage. A draft rule 18f-4 was circulated December 2015 and industry comments were submitted in March. An industry association estimates that funds managing $600 billion would be impacted by the rule. One of the nettlesome provisions would regulate leverage based on the gross notional value of derivative positions. A coalition led by AQR and John Hancock seeks to modify the rule. They note some asset classes like currencies and futures can sustain higher leverage. Among other things they want the limitations to reflect the value at risk, relax requirements to post cash, and give greater leeway if a fund temporarily exceeds the ratio. We also observe that funds like AQMIX have many offsetting risk positions. So while we share the SEC’s overall concern, their starting position seems extreme.


Everyone is taking potshots at hedge funds these days, that extends to liquid alts in “40- act wrap.” The growth phase is largely over; a few funds have closed. It will be interesting to see how much the SEC rules are relaxed and how fund structures hold up during periods of volatility.

We do find some funds which delivered in the past. We would not be quite so generous as Morningstar in awarding 4 or 5 stars, because the statistical significance of their short track records is simply too low.

Even if investors can identify skilled managers, they need to consider the timeliness of the strategies and monitor how quickly they gather assets. Opportunities (supply) in these markets come and go, demand is not always in synch. You can either skate to where the puck is going or be patient and diversify.

Slogo 2What’s the Trapezoid story? Leigh Walzer has over 25 years of experience in the investment management industry as a portfolio manager and investment analyst. He’s worked with and for some frighteningly good folks. He holds an A.B. in Statistics from Princeton University and an M.B.A. from Harvard University. Leigh is the CEO and founder of Trapezoid, LLC, as well as the creator of the Orthogonal Attribution Engine. The Orthogonal Attribution Engine isolates the skill delivered by fund managers in excess of what is available through investable passive alternatives and other indices. The system aspires to, and already shows encouraging signs of, a fair degree of predictive validity.

The stuff Leigh shares here reflects the richness of the analytics available on his site and through Trapezoid’s services. If you’re an independent RIA or an individual investor who need serious data to make serious decisions, Leigh offers something no one else comes close to. More complete information can be found at MFO readers can sign up for a free demo.

The Education of a Portfolio Manager

By Leigh Walzer

By Leigh Walzer

Like 3 million of his peers, my son will graduate college this spring. In the technology space many of the innovative companies seem to care less about which elite institution is named on his piece of sheepskin and more about the skillset he brings to the role.

Asset management companies and investors entrusting their money to fund managers might wonder if the guys with fancy degrees actually do better than the rest of the pack.

There is an old adage that that the A students work for the C students. I remember working for Michael Price many years ago. Michael was a proud graduate and benefactor of the University of Oklahoma. He sometimes referred to my group (which did primarily distressed debt) as “the Ivy Leaguers.”

Graduates of Stanford and Harvard outperformed their peers by 1% per year for the past three years

Thanks to the Trapezoid database, we were able to compile information to see if the Ivy Leaguers (like my son) actually perform. Our laboratory is the mutual fund universe. We looked at 4000 funds managed by graduates of 400 universities around the world. We focused for this study on results for the three years ending April 30, 2016.

exhibit IWe concede to purists and academics that our study lacks rigor. The mutual fund database does not capture separate accounts, hedge funds, etc. We excluded many funds (comprising 25% of the AUM in our universe) where we lacked biographical data on the manager. Successful active funds rely on a team so it may be unfair to ascribe success to a single individual; in some cases we arbitrarily chose the first named manager. We used the institution associated with the manager’s MBA or highest degree. Some schools are represented by just 1 or 2 graduates. We combined funds from disparate sectors. Active and rules-based funds are sometimes strewn together. And we draw comparisons without testing for statistical validity.

I was a little surprised at the mix of colleges managing the nation’s mutual funds. Villanova has an excellent basketball program. But I didn’t expect it to lead the money manager tables. However, nearly all the funds managed by Villanova were Vanguard index funds. The same is true for Shippensburg, St. Joseph’s, Lehigh, and Drexel.

When we concentrated on active funds, the leading schools were Harvard, Wharton, Columbia University, University of Chicago, and Stanford. Note that Queens College cracks the top 10 – this is attributable almost entirely to one illustrious grad: Dina Perry, a money manager at Capital Re.

Who performed the best over the last 3 years? By one measure, Stanford graduates did the best followed by Harvard, Queens College, Dartmouth, and University of Wisconsin. Trapezoid looks mainly at each manager’s skill form security selection. Institutions managing fewer assets have a higher bar to clear to make the list. Managers from these top five schools ranked, on average, in the 77th percentile (100 being best) in their respective categories in skill as measured by Trapezoid.

exhibit II

Exhibit III: Fund Analysis Report for TRAIX


If size and sample size were disregarded, some other colleges would score well. Notably, Hillsdale College benefitted from very strong performance by David Giroux, manager of the T Rowe Price Capital Appreciation Fund (TRAIX – closed to new investors). Wellington’s Jean Hynes lifted Wellesley College to the top echelon. Strong international programs include University of Queensland and CUNEF.

I searched in vain for an alum of Professor Snowball’s Augustana College in our database. Bear in mind though that any Viking who went on to earn a post-graduate degree elsewhere will show up under that school. (Snowball’s note: Augie is a purely undergraduate college and most managers accumulate a grad degree or three, so we’d be invisible. And the only fund manager on our Board of Trustees, Ken Abrams at Vanguard Explorer VEXPX, earned bot his degrees at that upstart institution in Palo Alto.)

By and large it doesn’t cost investors more to “hire” graduates of the leading schools. The average fee for active managers at these five schools is 69 bps compared with 87 bps for the overall universe.

It seems remarkable that graduates of Stanford and Harvard outperformed their peers by 1% per year for the past three years. If we add Chicago and Wharton (the next two highest ranked MBA institutions), the advantage for the elite graduates falls to 0.47%. If we expand it to include the 10 universities (as ranked by US News & World Report) the advantage falls to 30bps.

We confess we are a bit surprised by these findings. We wonder how efficient market proponents like Burton Malkiel and Jack Bogle would explain this. (Graduates of their institution, Princeton University, also outperformed the market by 1%.)

If we were recruiting for a mutual fund complex, we would focus on the leading MBA programs. Judging by the numbers many asset managers do precisely that; Over 20% of all active mutual fund managers come from these schools

Does it mean that investors should select managers on the basis of academic credentials? If the choice were between two active funds, the answer is yes. If the choice is between a fund managed actively managed by a Stanford MBA and a passive fund, the answer is less clear. We know for the past 3 years the return produced by a typical Stanford MBA adjusted for the portfolio’s characteristics exceeds expense. But we would need to be fairly confident our stable of well-educated managers would repeat their success over the long haul by a sufficient margin.

Trapezoid’s website allows registered users to review funds to see whether skill is likely to justify expense for a given fund class. We do this based on a probabilistic analysis which looks at the manager’s entire track record, not just the three-year skill rating. MFO readers may register at for a demo and see the probability for funds in certain investment categories.

Interestingly the school whose fund managers gave us the highest confidence is Dartmouth. But we wouldn’t draw too strong conclusion unless Dartmouth has figured out how to clone their star, Jeff Gundlach of DoubleLine.

Bottom Line:

Graduates of top schools seem to invest better than their peers. Our finding may not be surprising, but it contradicts the precept of efficient market theorists. Knowing the fund manager graduated a top school or MBA program is helpful at the margin but probably not sufficient to choose the fund over a low-cost passive alternative.

Slogo 2What’s the Trapezoid story? Leigh Walzer has over 25 years of experience in the investment management industry as a portfolio manager and investment analyst. He’s worked with and for some frighteningly good folks. He holds an A.B. in Statistics from Princeton University and an M.B.A. from Harvard University. Leigh is the CEO and founder of Trapezoid, LLC, as well as the creator of the Orthogonal Attribution Engine. The Orthogonal Attribution Engine isolates the skill delivered by fund managers in excess of what is available through investable passive alternatives and other indices. The system aspires to, and already shows encouraging signs of, a fair degree of predictive validity.

The stuff Leigh shares here reflects the richness of the analytics available on his site and through Trapezoid’s services. If you’re an independent RIA or an individual investor who need serious data to make serious decisions, Leigh offers something no one else comes close to. More complete information can be found at MFO readers can sign up for a free demo.

Drafting a Fixed Income Team

By Leigh Walzer

By Leigh Walzer

It is May 1. The time of flowers, maypoles and labor solidarity.

For football fans it is also time for that annual tradition, the NFL draft.  Representatives of every professional football team assemble in Chicago and conspire to divide up the rights to the 250 best college players.  The draft is preceded by an extensive period of due diligence.

Some teams are known to stockpile the best available talent. Other teams focus on the positions where they have the greatest need; if there are more skilled players available at other positions they try to trade up or down to get the most value out of their picks. Others focus on the players who offer the best fit, emphasizing size, speed, precision, character, or other traits.

The highly competitive world of professional sports offers a laboratory for investors selecting managers. Usually at Trapezoid we focus on finding the most skillful asset managers, particularly those with active styles who are likely to give investors their money’s worth. In the equity world, identifying skill is three quarters of the recipe for investment success.

But when we apply our principles to fixed income investing, the story is a little different.  The difference in skill between the top 10% and bottom 10% is only half as great as for the equity world. In other words, time spent looking for the next Jeff Gundlach is only half as productive as time spent looking for the next Bill Miller.

Exhibit I

skill distribution

That assumes you can identify the good fixed income managers.  Allocators report the tools at their disposal to analyze fixed income managers are not as good as in equities.

Some people argue that in sports, as in investing, the efficient market hypothesis rules. The blog Five-thirty-eight argues that  No Team Can Beat the Draft. General managers who were seen as geniuses at one point in their career either reverted to the mean or strayed from their discipline.

Readers might at this point be tempted to simply buy a bond ETF or passive mutual fund like VTBXX. Our preliminary view is that investors can do better. Many fixed income products are hard to reproduce in indices; and the expense difference for active management is not as great. We measure skill (see below) and estimate funds in the top ten percentile add approximately 80 basis points over the long haul; this is more than sufficient to justify the added expense.

However, investors need to think about the topic a little differently. In fixed income, skillful funds exist but they are associated with a fund which may concentrate in a specific sector, duration, and other attributes.  It is often not practical to hedge those attributes – you have to take the bundle.  Below, we identify n emerging market debt fund which shows strong skill relative to its peers; but the sector has historically been high-risk and low return which might dampen your enthusiasm. It is not unlike the highly regarded quarterback prospect with off-the-field character issues.

When selecting managers, skill has to be balanced against not only the skill and the attractiveness of the sector but also the fit within a larger portfolio. We are not football experts. But we are sympathetic to the view that the long term success of franchises like the New England Patriots is based on a similar principle: finding players who are more valuable to them than the rest of the league because the players fit well with a particular system.

To illustrate this point, we constructed an idealized fixed income portfolio. We identified 22 skilled bond managers and let our optimizer choose the best fund allocation. Instead of settling upon the manager with the best track record or highest skill, the model allocated to 8 different funds. Some of those were themselves multi-sector funds. So we ended up fairly diversified across fixed income sectors.

Exhibit  I
Sector Diversification in one Optimized Portfolio

sector diversification

Characteristics of a Good Bond Portfolio

We repeated this exercise a number of times, varying the choice of funds, the way we thought of skill, and other inputs. We are mindful that not every investor has access to institutional classes and tax-rates vary. While the specific fund allocations varied considerably with each iteration, we observed many similarities throughout.:

BUSINESS CREDIT: Corporate bonds received the largest allocation; the majority of that went to high yield and bank loans rather than investment grade bonds

DON’T OVERLOAD ON MUNIs. Even for taxable investors, municipal funds comprised only a minority of the portfolio.

STAY SHORT: Shorter duration funds were favored. The example above had a duration of 5.1 years, but some iterations were much shorter

DIVERSIFY, UP TO A POINT:  Five to eight funds may be enough.

Bond funds are more susceptible than equity funds to “black swan” events. Funds churn out reliable yield and NAV holds steady through most of the credit cycle until a wave of defaults or credit loss pops up in an unexpected place.  It is tough for any quantitative due diligence system to ferret out this risk, but long track records help. In the equity space five years of history may be sufficient to gauge the manager’s skill. But in fixed income we may be reluctant to trust a strategy which hasn’t weathered a credit crunch. It may help to filter out managers and funds which weren’t around in 2008. Even then, we might be preparing our portfolio to fight the last war.

Identifying Skilled Managers

The recipe for a good fixed income portfolio is to find good funds covering a number of bond sectors and mix them just right. We showed earlier that fixed income manager skill is distributed along a classic bell curve. What do we mean by skill and how do we identify the top 10%? 

The principles we apply in fixed income are the same as for equities but the methodology is the same. While the fixed income model is not yet available on our website, readers of Mutual Fund Observer may sample the equity model by registering at  We value strong performance relative to risk. While absolute return is important, we see value in funds which achieve good results while sitting on large cash balances – or with low correlation to their sectors. And we look for managers who have outperformed their peer group -or relevant indices – preferably over a long period of time.  We also consider the trend in skill.

For fixed income we currently rely on a fitted regression model do determine skill. A few caveats are in order. This approach isn’t quite as sophisticated as what we do with equity funds. We don’t use the holdings data to directly measure what the manager is up to, we simply infer it. We don’t break skill down into a series of components. We rely on gross performance of subsectors rather than passive indices.  We haven’t back-tested this approach to see whether it makes relevant predictions for future periods.  And we don’t try to assess the likelihood that future skill will exceed expenses.  Essentially, the funds which show up well in this screen outperformed a composite peer group chosen by an algorithm over a considerable period of time. While we call them skillful, we haven’t ruled out that some were simply lucky. Or, worse, they could be generating good performance through a strategy which back to bite them in the long term. For all the reasons noted earlier, quantitative due diligence of portfolio managers has limitations. Ultimately, it pays to know what is inside the credit “black box”

Exhibit II lists some of the top-ranking funds in some of the major fixed income categories. We culled these from a list of 2500 fixed income funds, generally seeking top-decile performance, AUM of at least $200mm, and sufficient history with the fund and manager. 

exhibit 2

We haven’t reviewed these funds in detail. Readers with feedback on the list are welcome to contact me at [email protected]

From time to time, the media likes to anoint a single manager as the “bond king.” But we suggest that different shops seem to excel in different sectors. Four High Yield funds are included in the list led by Osterweis Strategic Income Fund (OSTIX).  In the Bank Loan Category several funds show better but Columbia Floating-Rate Fund (RFRIX) is the only fund with the requisite tenure. The multi-sector funds listed here invest in corporate, mortgage, and government obligations.  We are not familiar with Wasatch-Hoisington US Treasury Fund (WHOSX), but it seems to have outperformed its category by extending its duration.

FPA New Income Fund (FPNIX) is categorized with the Mortgage Funds, but 40% of its portfolio is in asset-backed securities including subprime auto.  Some mortgage-weighted funds with excellent five year records who show up as skillful but weren’t tested in the financial crisis or had a management change were excluded. Notable among those is TCW Total Return Bond Fund (TGLMX).

Skilled managers in the municipal area include Nuveen (at the short to intermediate end), Delaware, Franklin, and Blackrock (for High Yield Munis).


Style diversification seems less important in the equity area. We tried constructing a portfolio using 42 “best of breed” equity funds from the Trapezoid Honor Roll.  Our optimizer proposed investing 80% of the portfolio in the fund with the highest Sharpe Ratio. While this seems extreme, it does suggest equity allocators can in general look for the “best available athlete” and worry less about portfolio fit.

Bottom Line

Even though fixed income returns fall in a narrower range than their equity counterparts, funds whose skill justify their expense structure are more abundant. Portfolio fit and sector timeliness sometimes trumps skill; diversification among fixed income sectors seems to be very important; and the right portfolio can vary from client to client. If in doubt, stay short. Quantitative models are important but strive to understand what you are investing in.

Slogo 2What’s the Trapezoid story? Leigh Walzer has over 25 years of experience in the investment management industry as a portfolio manager and investment analyst. He’s worked with and for some frighteningly good folks. He holds an A.B. in Statistics from Princeton University and an M.B.A. from Harvard University. Leigh is the CEO and founder of Trapezoid, LLC, as well as the creator of the Orthogonal Attribution Engine. The Orthogonal Attribution Engine isolates the skill delivered by fund managers in excess of what is available through investable passive alternatives and other indices. The system aspires to, and already shows encouraging signs of, a fair degree of predictive validity.

The stuff Leigh shares here reflects the richness of the analytics available on his site and through Trapezoid’s services. If you’re an independent RIA or an individual investor who need serious data to make serious decisions, Leigh offers something no one else comes close to. More complete information can be found at MFO readers can sign up for a free demo.

Shake Your Money Market

By Leigh Walzer

Reports of the death of the money market fund (“MMF”) are greatly exaggerated. Seven years of financial repression and 7-day yields you can only spot under a microscope have made surprisingly little dent in the popularity of MMF’s. According to data from the Investment Company Institute, MMF flows have been flat the past few years. The share of corporate short term assets deposited in MMFs has remained steady.

However, new regulations will be implemented this October, forcing MMFs holding anything other than government instruments to adopt a floating Net Asset Value. These restrictions will also allow fund managers to put up gates during periods of heavy outflows.

MMFs were foundational to the success of firms like Fidelity, but today they appear to be marginally profitable for most sponsors. Of note, Fidelity is taking advantage of the regulatory change to move client assets from less remunerative municipal MMFs to government money market funds carrying higher fees (management fees net of waived amounts.)

While MMFs offer liquidity and convenience, the looming changes may give investors and advisors an impetus to redeploy their assets. In a choppy market, are there safe places to park cash?  A popular strategy over the past year has been high-dividend / low-volatility funds. We discussed this in March edition of MFO. This strategy has been in vogue recently but with a beta of 0.7 it still has significant exposure to market corrections.

Short Duration Funds:  Investors who wish to pocket some extra yield with a lower risk profile have a number of mutual fund and ETF options. This month we highlight fixed income portfolios with durations of 4.3 years or under.

We count roughly 300 funds with short or ultraShort Duration from approximately 125 managers. Combined assets exceed 500 billion dollars.  Approximately one quarter of those are tax-exempt.  For investors willing to risk a little more duration, illiquidity, credit exposure, or global exposure there are roughly 1500 funds monitored by Trapezoid.

Duration is a measure of the effective average life of the portfolio. Estimates are computed by managers and reported either on or on the manager’s website. There is some discretion in measuring duration, especially for instruments subject to prepayment.  While duration is a useful way to segment the universe, it is not the only factor which determines a fund’s volatility.

Reallocating from a MMF to a Short Duration fund entails cost. Expenses average 49 basis points for Short Term funds compared with 13 basis points for the average MMF.  Returns usually justify those added costs. But how should investors weigh the added risk. How should investors distinguish among strategies and track records? How helpful is diversification?

To answer these questions, we applied two computer models, one to measure skill and another to select an optimal portfolio.

We have discussed in these pages Trapezoid’s Orthogonal Attribution Engine which measures skill of actively managed equity portfolio managers. MFO readers can learn more and register for a demo at Our fixed income attribution model is a streamlined adaptation of that model and has some important differences. Among them, the model does not incorporate the forward looking probabilistic analysis of our equity model. Readers who want to learn more are invited to visit our methodology page. The fixed income model is relatively new and will evolve over time.

We narrowed the universe of 1500 funds to exclude not only unskilled managers but fund classes with AUM too small, duration too long, tenure too short (<3 years), or expenses too great (skill had to exceed expenses, adjusted for loads, by roughly 1%). We generally assumed investors could meet institutional thresholds and are not tax sensitive. For a variety of reasons, our model portfolio might not be right for every investor and should not be construed as investment advice.

exhibit i

DoubleLine Total Return Bond (DBLTX), MassMutual Premier High Yield Fund (MPHZX), and PIMCO Mortgage Opportunities Fund (PMZIX) all receive full marks from Morningstar and Lipper (except in the area of tax efficiency.)  Diversifying among credit classes and durations is a benefit – but the model suggests these three funds are all you need.

Honorable Mentions: The model finds Guggenheim Total Return Bond Fund (GIBIX) is a good substitute for DBLTX and Shenkman Short Duration High Income Fund (SCFIX) is a serviceable substitute for MPHZX. We ran some permutations in which other funds received allocations. These included: Victory INCORE Fund for Income (VFFIX), Nuveen Limited term Municipal Bond (FLTRX), First Trust Short Duration High Income Fund (FDHIX), Guggenheim Floating Rate Strategies (GIFIX), and Eaton Vance High Income Opportunities Fund (EIHIX). 

exhibit ii

The Trapezoid Model Portfolio generated positive returns over a 12 and 36-month time frame. (Our data runs through January 2016.) The PIMCO Mortgage fund wasn’t around 5 years ago, but it looks like the five-year yield would have been close to 6%.

The portfolio has an expense ratio of 53 basis points. Our algorithms reflect Trapezoid’s skeptical attitude to high cost managers.  There are alternative funds in the same asset classes with expense ratios of 25 basis points of better. But superb performance more than justifies the added costs. Our analysis suggests the rationale for passive managers like Vanguard is much weaker in this space than in equities. However, investors in the retail classes may see higher expenses and loads which could change the analysis.

No Return Without Risk: How much risk are we taking to get this extra return? The duration of this portfolio is just under 3.5 years.  There is some corporate credit risk: MPHZX sustained a loss in the twelve months ending January. It is mostly invested in BB and B rated corporate bonds. To do well the fund needs to keep credit loss under 3%/yr.  Although energy exposure is light, we see dicey credits including Valeant, Citgo, and second lien term loans. The market rarely gives away big yields without attaching strings.

The duration of this portfolio hurt returns over the past year. What advice can we give to investors unable to take 3.5 years of duration risk? We haven’t yet run a model but we have a few suggestions.

  1. For investors who can tolerate corporate credit risk, Guggenheim Floating Rate Strategies (GIFIX) did very well over the past 5 years and weathered last year with only a slight loss.
  2. A former fixed income portfolio manager who now advises clients at Merrill Lynch champions Pioneer Short Term Income Fund (PSHYX). Five-year net return is only 2.2%, but the fund has a duration of only 0.7 years and steers clear of corporate credit risk.
  3. A broker at Fidelity suggested Touchstone UltraShort Duration Fixed Income Fund (TSDOX) which has reasonable fees and no load.

Short Duration funds took a hit during the subprime crisis.  At the trough bond fund indices were down 7 to 10% from peak, depending on duration. Funds with concentrations in corporate credit and mortgage paper were down harder while funds like VFFIX which stuck to government or municipal bonds held up best. MassMutual High Yield was around during that period and fell 21% (before recovering over the next 9 months.) The other two funds were not yet incepted; judging from comparable funds the price decline during the crisis was in the mid-single digits. Our model portfolio is set up to earn 2.5% to 3% when rates and credit losses are stable. Considering that their alternative is to earn nothing, investors deploying cash in Short Duration funds appear well compensated, even weighing the risk of a once-in-a-generation 10% drawdown.

Bottom Line: The impact of new money market fund regulations is not clear. Investors with big cash holdings have good alternatives.  Expenses matter but there is a strong rationale for selecting active managers with good records, even when costs are above average.  Investors get paid to take risk but must understand their exposure and downside. A moderate amount of diversification among asset classes seems to be beneficial. Our model portfolio is a good starting point but should be tailored to the needs of particular investors.

Looking for Bartolo Colon

By Leigh Walzer

Bartolo Colon is a baseball pitcher; he is the second oldest active major leaguer.  Ten years ago he won the coveted Cy Young award. Probably no investment firm has asked Colon for an endorsement but maybe they should. More on this shortly.


A reader in Detroit who registered but has not yet logged into  writes: “We find little use for back tested or algorithmic results [and prefer an] index-based philosophy for clients.” 

Index funds offer a great approach for anyone who lacks the time or inclination to do their homework. We expect they will continue to gain share and pressure the fees of active managers.

Trapezoid does not advocate algorithmic strategies, as the term is commonly used. Nor do we oppose them. Rather, we rigorously test portfolio managers for skill. Our “null hypothesis” is that a low-cost passive strategy is best. We look for managers which demonstrate their worth, based on skill demonstrated over a sufficient period of time. Specifically, Honor Roll fund classes must have a 60% chance of justifying their expenses. Less than 10% of the fund universe satisfies this test.  Trapezoid does rate some quantitative funds, and we wrote in the November edition of Mutual Fund Observer about some of the challenges of evaluating them.

We do rely on quantitative methods, including back testing, to validate our tests and hone our understanding of how historic skill translates into future success.


A wealth manager (and demo client) from Denver asks our view of his favorite funds, Vulcan Value Partners (VVPLX). Vulcan was incepted December 2009.Prior to founding Vulcan, the manager, C.T. Fitzpatrick, worked for many years at Southeastern under famed value investor O. Mason Hawkins.  Currently it is closed to new investors.

Should investors abandon all their confidence when a good manager retires and passes the baton? Should investors give the fund a mulligan when a poor performer is replaced? Probably not.

VVPLX has performed very well in its 6 years of history. By our measure, investors accumulated an extra 20% compared to index funds based on the managers’ stock selection skill alone. We mentioned it favorably in the October edition of MFO.

Vulcan’s expense structure is 1.08%, roughly 90bps higher than an investor would require to hold a comparable ETF. Think of that as the expense premium to hire an active manager. Based on data through October, we assigned VVPLX a 55% probability of justifying its active expense premium. (This is down from 68% based on our prior evaluation using data through July 2015 and places them outside the Honor Roll.)

The wealth manager questioned why we classify VVPLX as large blend?  Vulcan describes itself as a value manager and the portfolio is heavily weighted toward financial services.

VVPLX is classified as large blend because, over its history, it has behaved slightly more like the large blend aggregate than large value. We base this on comparisons to indices and active funds. One of our upcoming features identifies the peer funds, both active and passive, which most closely resemble a given fund. For a majority of our funds, we supplement this approach by looking at historic holdings. We currently consider factors like the distribution of forward P/E ratios over time. Our categorization and taxonomy do not always conform to services like Morningstar and Lipper, but we do consider them as a starting point, along with the manager’s stated objective.  We frequently change classifications and welcome all input. While categories may be useful in screening for managers, we emphasize that the classifications have no impact on skill ratings, since we rely 100% on objective criteria such as passive indices.

The client noted we identified a few managers following similar strategies to VVPLX who were assigned higher probabilities. How is this possible considering VVPLX trounced them over its six-year history?

Broadly speaking, there are three reasons:

  • Some of the active managers who beat out VVPLX had slightly lower expenses
  • While VVPLX did very well since 2010, some other funds have proven themselves over much longer periods. We have more data to satisfy ourselves (and our algorithms) that the manager was skillful and not just lucky. 
  • VVPLX’s stock selection skill was not entirely consistent which also hurts its case. From April to October, the fund recorded negative skill of approximately 4%. This perhaps explain why management felt compelled to close the fund 4/22/15

Exhibit I

    Mgr. Tenure   sS*   sR* Proj.  Skill (Gross) Exp.   ∆   ± Prob.  
Boston Partners All-Cap Value Fund [c] BPAIX 2005   1.4%   0.3% 0.88% 0.80%(b)   23   1.5% 56.1
Vulcan Value Partners Fund VVPLX 2010   3.8%   1.5% 1.19% 1.08%  .25   1.8% 55.2
  1. Annualized contribution from stock selection or sector rotation over manager tenure
  2. Expenses increased recently by 10bps as BPAIX’s board curtailed the fee waiver
  3. Closed to new investors

Exhibit II: Boston Partners All-Cap Value Fund

exhibit ii

Exhibit I compares VVPLX to Boston Partners All-Cap Value Fund. BPAIX is on the cusp of value and blend, much like VVPLX. Our model sees a 56.1% chance that the fund’s skill over the next 12 months will justify its expense structure. According to John Forelli, Senior Portfolio Analyst, the managers screen from a broader universe using their own value metrics. They combine this with in-depth fundamental analysis. As a result, they are overweight sectors like international, financials, and pharma relative to the Russell 3000 (their avowed benchmark.) Boston Partners separately manages approximately $10 billion of institutional accounts which closely tracks BPAIX.

Any reader with the demo can pull up the Fund Analysis for VVPLX.  The chart for BPAIX is not available on the demo (because it is categorized in Large Value) so we present it in Exhibit II.  Exhibit III presents a more traditional attribution against the Russell 3000 Value Fund. Both exhibits suggest Boston Partners are great stock pickers. However, we attribute much less skill to Allocation because our “Baseline Return” construes they are not a dyed-in-the-wool value fund.

VVPLX has shown even more skill over the manager’s tenure than BPAIX and is expected to have more skill next year[1]. But even if VVPLX were open, we would prefer BPAIX due to a combination of cost and longer history. (BPAIX investors should keep an eye on expenses: the trustees recently reduced the fee waiver by 10bps and may move further next year.)

Trapezoid has identified funds which are more attractive than either of these funds. The Trapezoid Honor Roll consists of funds with at least 60% confidence. The methodology behind these findings is summarized at here.

[1] 12 months ending November 2016.


Our review of VVPLX raises a broader question. Investors often have to choose between a fund which posted stellar returns for a short period against another whose performance was merely above average over a longer period.

niese and colonFor those of you who watched the World Series a few months ago, the NY Mets had a number of very young pitchers with fastballs close to 100 miles per hour.  They also had some veteran pitchers like John Niese and the 42-year-old ageless wonder Bartolo Colon who couldn’t muster the same heat but had established their skill and consistency over a long period of time. We don’t know whether Bartolo Colon drank from the fountain of youth; he served a lengthy suspension a few years ago for using a banned substance. But his statistics in his 40s are on par with his prime ten year ago.  

exhibit iii

Unfortunately, for every Bartolo Colon, there is a Dontrelle Willis. Willis was 2003 NL Rookie of the year for the Florida Marlins and helped his team to a World Series victory. He was less effective his second year but by his third year was runner up for the Cy Young award. The “D-Train” spent 6 more years in the major leagues; although his career was relatively free of injuries, he never performed at the same level

Extrapolating from a few years of success can be challenging. If consistency is so important to investors, does it follow that a baseball team should choose the consistent veterans over the promising but less-tested young arms?

Sometimes there is a tradeoff between expected outcome (∆) and certitude (±).  The crafty veteran capable of keeping your team in the game for five innings may not be best choice in the seventh game of the World Series; but he might be the judicious choice for a general manager trying to stretch his personnel budget. The same is true for investment managers. Vulcan may have the more skillful management team. But considering its longevity, consistency, and expense Boston Partners is the surer bet.


How long a track record is needed before an investor can bet confident in a portfolio manager? This is not an easy question to answer.

Skill, even when measured properly, is best evaluated over a long period.

In the December edition of MFO( When_Good_Managers_Go_Bad  ) we profiled the Clearbridge Aggressive Growth fund which rode one thesis successfully for 20 years. Six years of data might tell us less about them than a very active fund.   

Here is one stab at answering the question.  We reviewed the database to see what percentage of fund made the Trapezoid Honor Roll as a function of manager tenure. 

exhibit ivRecall the Trapezoid Honor Roll consists of fund classes for which we have 60% confidence that future skill will justify expense structure.  In Exhibit IV the Honor Roll fund classes are shown in blue while the funds we want no part of are in yellow.  16% of those fund classes where the manager has been on the job for twenty-five years make the Honor Roll compared with just 2% for those on the job less than three years.  The relationship is not a smooth line, but generally managers with more longevity give us more data points allowing us to be more confident of their skill.. or more likely persuade us they lack sufficient skill. 

There is an element of “survivorship” bias in this analysis. Every year 6% of funds disappear; generally, they are the smallest or worst performers. “All-stars” managers are more likely to survive for 20 years. But surprisingly a lot of “bad” managers survive for a long time. The percentage of yellow funds increases just as quickly as the blue.

exhibit vIt seems reasonable to ask why so many “bad” managers survive in a Darwinian business. We surveyed the top 10. (Exhibit V) We find that in the aggregate they have a modicum of skill, but nowhere sufficient to justify what they charge.  We can say with high confidence all these investors would be better off in index funds or (ideally) the active managers on the Trapezoid honor roll.

exhibit vi'We haven’t distinguished between a new manager who takes over an old fund and a brand new fund. Should investors abandon all their confidence when a good manager retires and passes the baton? Should investors give the fund a mulligan when a poor performer is replaced?  Probably not.  From a review of 840 manager changes with sufficient data (Exhibit VI), strong performers tend to remain strong which suggests we may gain confidence by considering the track record of the previous manager.

The “rookie confidence” problem is a challenge for investors. The average manager tenure is about six years and only a quarter of portfolio managers have been on the job longer than 10 years. It is also a challenge for asset managers marketing a new fund or a new manager of an existing fund.  Without a long track record, it is hard to tell if a fund is good – investors have every incentive to stick with the cheaper index fund.  Asset managers incubate funds to give investors a track record but studies suggest investors shouldn’t take much comfort from incubated track records. (Richard Evans, CFA Digest, 2010.) We see many sponsors aggressively waiving fees for their younger funds.   Investors will take comfort when the individuals have a prior track record at another successful fund. C.T. Fitzpatrick’s seventeen years’ experience under Mason Hawkins seems to have carried over to Vulcan.

BOTTOM LINE:  It is hard to gain complete trust that any active fund is better than an index fund. It is harder when a new captain takes the helm, and harder yet for a brand new fund. The fund with the best five-year record is not necessarily the best choice. Veteran managers are over represented in the Trapezoid Honor Roll — for good reason.

Unlike investing, baseball will always have rookies taking jobs from the veterans. But in 2016 we can still root for Bartolo Colon.

Snow Tires and All-Weather portfolios

By Leigh Walzer

Leigh Walzer, founder and principal of Trapezoid, LLC. Leigh’s had a distinguished career working in investment management, in part in the tricky field of distressed securities analysis. He plied that trade for seven years with Michael Price and the Mutual Series folks. He followed that with a long stint as a director at Angelo, Gordon & Co., a well-respected alternatives manager and a couple private partnerships. Through it all, Leigh has been insatiably curious about not just “what works?” but, more importantly, “why does it work?” That’s the work now of Trapezoid LLC.

Leigh Walzer, founder and principal of Trapezoid, LLC. Leigh’s had a distinguished career working in investment management, in part in the tricky field of distressed securities analysis. He plied that trade for seven years with Michael Price and the Mutual Series folks. He followed that with a long stint as a director at Angelo, Gordon & Co., a well-respected alternatives manager and a couple private partnerships. Through it all, Leigh has been insatiably curious about not just “what works?” but, more importantly, “why does it work?” That’s the work now of Trapezoid LLC.

By Leigh Walzer

Readers of a certain age will remember when winter meant putting on the snow tires. All-season tires were introduced in 1978 and today account for 96% of the US market. Not everyone is sure this is a good idea; concludes “snow and summer tires provide clear benefits to those who can use them.”

As we begin 2016, most of the country is getting its first taste of winter weather. “Putting on the snow tires” is a useful metaphor for investors who are considering sacrificing performance for safety. Growth stocks have had a great run while the rest of the market sits stagnant.  Fed-tightening, jittery credit markets, tight-fisted consumer, commodity recession, and sluggishness outside the US are good reasons for investor caution.

Some clients have been asking if now is a good time to dial back allocations to growth. In other words, should they put the snow tires on their portfolio.

The dichotomy between growth and value and the debate over which is better sometimes approaches theological overtones.  Some asset allocators are convinced one or the other will outperform over the long haul. Others believe each has a time and season. There is money to be made switching between growth and value, if only we had 20/20 hindsight about when the business cycle turns.

When has growth worked better than value?

Historically, the race between growth and value has been nearly a dead heat. Exhibit 1 shows the difference in the Cumulative return of Growth and Value strategies over the past twenty years. G/V is a measure of the difference in return between growth and value in a given period Generally speaking, growth performed better in the 90s, a period of loose money up to the internet bust. Value did better from 2000-2007. Since 2007, growth has had the edge despite a number of inflections.  Studies going back 50 years suggest value holds a slight advantage, particularly during the stagflation of the 1970s.

Exhibit I


Growth tends to perform better in up-markets. This relationship is statistically valid but the magnitude is almost negligible. Over the past twenty years Trapezoid’s US Growth Index had a beta of 1.015 compared with 0.983 for Value.

Exhibit II


The conventional wisdom is that growth stocks should perform better early to mid-cycle while value stocks perform best late in the business cycle and during recession. That might loosely describe the 90s and early 2000s. However, in the run up the great recession, value took a bigger beating as financials melted down. And when the market rebounded in April 2009, value led the recovery for the first six months.

Value investors expect to sacrifice some upside capture in order to preserve capital during declining markets. Exhibit III, which uses data from about their Large Growth (“LG”) and Large Value (“LV”) fund categories, shows the reality is less clear. In 2000-2005 LV lived up to its promise: it captured 96% of LG’s upside but only 63% of its downside. But since 2005 LV has actually participated more in the downside than LG.

Exhibit III

2001-2005 2006-2010 2011- 2015
LG Upside Capture 105% 104% 98%
LG Downside Capture 130% 101% 106%
LV Upside Capture 101% 99% 94%
LV Downside Capture 82% 101% 111%
LV UC / LG Up Capt 96% 95% 97%
LV DC / LG Dn Capt 63% 100% 104%

Recent trend

In 2015 (with the year almost over as of this writing), value underperformed growth by about 5%. Value funds are overweight energy and underweight consumer discretionary which contributed to the shortfall.

Can growth/value switches be predicted accurately?

In the long haul, the two strategies perform nearly equally. If the weatherman can’t predict the snow, maybe it makes sense to leave the all-season tires on all year.

We can look through the historical Trapezoid database to see which managers had successfully navigated between growth and value. Recall that Trapezoid uses the Orthogonal Attribution Engine to attribute the performance of active equity managers over time to a variety of skills. Trapezoid calculates the contribution to portfolio return from overweighting growth or value in a given period. We call this sV.

Demonstrable skill shifting between growth and value is surprisingly scarce.

Bear in mind that Trapezoid LLC does not call market turns or rate sectors for timeliness. And Trapezoid doesn’t try to forecast whether growth or value will work better in a given period. But we do try to help investors make the most of the market. And we look at the historic and projected ability of money managers to outperform the market and their peer group based on a number of skills.

The Trapezoid data does identify managers who scored high in sV during particular periods. Unfortunately, high sV doesn’t seem to carry over from period to period. As Professor Snowball would say, sV lacks predictive validity; the weatherman who excelled last year missed the big storm this year. However, the data doesn’t rule out the possibility that some managers may have skill. As we have seen, growth or value can dominate for many years, and few managers have sufficient tenure to draw a strong conclusion.

We also checked whether market fundamentals might help investors allocate between growth and value. We are aware of one macroeconomic model (Duke/Fuqua 2002) which claims to successfully anticipate 2/3 of growth and value switches over the preceding 25 years.

One hypothesis is that value excels when valuations are stretched while growth excels when the market is not giving enough credit to earnings growth.   In principle this sounds almost tautologically correct. However, implementing an investment strategy is not easy.  We devised an index to see how much earnings growth the market is pricing in a given time (S&P500 E/P less 7-year AAA bond yield adjusted for one year of earning growth).  When the index is high, it means either the equity market is attractive relative bonds or that the market isn’t pricing in much earnings growth.  Conversely, when the index is low it means valuations of growth stocks are stretched and therefore investors should load up on value. We looked at data from 1995-2015 and compared the relative performance of growth and value strategies over the following 12 months.  We expected that when the index is high growth would do better.

Exhibit IV


There are clearly times when investors who heeded this strategy would have correctly anticipated investing cycles. We found the index was directionally correct but not statistically significant. Exhibit IV shows the Predictor has been trending lower in 2015 which would suggest that the growth cycle is nearly over.

All-Weather Managers

Since it is hard to tell when value will start working, investors could opt for all-weather managers, i.e. managers with a proven ability to thrive during value and growth periods.

We combed our database for active equity managers who had an sV contribution of at least 1%/year in both the growth era since 1q07 and the value market which preceded it.  Our filter excludes a large swath of managers who haven’t been around 9 years. Only six funds passed this screen – an indication that skill at navigating between growth and value is rare. We knocked out four other funds because, using Trapezoid’s standard methodology, projected skill is low or expenses are high.  This left just two funds

Century Shares Trust (CENSX), launched in 1928, is one of the oldest mutual funds in the US.  The fund tracks itself against the Russell 1000 Growth Index but does not target a particular sector mix and apply criteria like EV/EBITDA more associated with value. Expenses run 109bps. CENSX’s performance has been strong over the past three years. Their long-term record selecting stocks and sectors is not sufficient for inclusion in the Trapezoid Honor Roll. 

exhibit5Does CENSX merit extra consideration because of the outstanding contribution from rotating between growth and value? Serendipity certainly plays a part.  As Exhibit V illustrates, the current managers inherited in 1999 a fund which was restricted by its charter to financials, especially insurance. That weighting was very well-suited to the internet bust and recession which followed. They gradually repositioned the portfolio towards large growth. And he has made a number of astute switches. Notably, he emphasized consumer discretionary and exited energy which has worked extremely well over the past year. We spoke to portfolio manager Kevin Callahan. The fund is managed on a bottom-up fundamentals basis and does not have explicit sector targets.  But he currently screens for stocks from the Russell 1000 Growth Index and seem reluctant to stray too far from its sector weightings, so we expect growth/value switching will be much more muted in the future.


The other fund which showed up is Cohen & Steers Global Realty Fund (CSSPX). The entire real estate category had positive sV over the past 15-20 years; real estate (both domestic and global) clobbered the market during the value years, gave some back in the run-up to the financial crisis, and has been a market performer since then.

We are not sure how meaningful it is that CSSPX made this list over some other real estate funds with similar focus and longevity. Investors may be tempted to embrace real estate as an all-weather sector. But over the longer haul real estate has had a more consistent market correlation with beta averaging 0.6 which means it participated equally in up and down markets.

More complete information can be found at MFO readers can sign up for a free demo. Please click the link from the Model Dashboard (login required) to the All-Weather Portfolio

The All-Season Portfolio

Since we are not sure that good historic sV predicts future success and managers with a good track record in this area are scarce, investors might take a portfolio approach to all-season investing. 

  1. Find best of breed managers. Use Trapezoid’s OAE to find managers with high projected skill relative to cost.  While the Trapezoid demo rates only Large Blend managers (link to the October issue of MFO), the OAE also identifies outstanding managers with a growth or value orientation.
  2. Strike the right balance. Many thoughtful investors believe “value is all you need” and some counsel 100% allocation to growth. Others apply age-based parameters. Based on the portfolio-optimization model I consulted and my dataset, the recommended weighting of growth and value is nearly 50/50.  In other words: snow tires on the front, summer tires on the back. (Note this recommendation is for your portfolio, for auto advice please ask a mechanic.) I used 20 years of data; using a longer time frame, value might look better 

Bottom line:

It is hard to predict whether growth or value will outperform in a given year.  Demonstrable skill shifting between growth and value is surprisingly scarce.  Investors who are content to be passive can just stick to funds which index the entire market. A better strategy is to identify skillful growth and value managers and weight them evenly.

Slogo 2What’s the Trapezoid story? Leigh Walzer has over 25 years of experience in the investment management industry as a portfolio manager and investment analyst. He’s worked with and for some frighteningly good folks. He holds an A.B. in Statistics from Princeton University and an M.B.A. from Harvard University. Leigh is the CEO and founder of Trapezoid, LLC, as well as the creator of the Orthogonal Attribution Engine. The Orthogonal Attribution Engine isolates the skill delivered by fund managers in excess of what is available through investable passive alternatives and other indices. The system aspires to, and already shows encouraging signs of, a fair degree of predictive validity.

The stuff Leigh shares here reflects the richness of the analytics available on his site and through Trapezoid’s services. If you’re an independent RIA or an individual investor who need serious data to make serious decisions, Leigh offers something no one else comes close to. More complete information can be found at MFO readers can sign up for a free demo.