Objective and strategy

The fund seeks long-term capital appreciation by investing in micro-, small- and mid-cap financial services stocks with market caps up to $5 billion. The financial services industry includes banks, savings & loans, insurance, investment managers, brokers, and the folks who support them. The managers anticipate having 40% of the portfolio in non-U.S. stocks with up to 10% in the developing markets. The fund holds about 100 stocks. The managers look for companies with excellent business strengths, high internal rates of return, and low leverage. They buy when the stocks are trading at a significant discount.

Adviser

Royce & Associates, LLC, is owned by Legg Mason, though it retains autonomy over its investment process and day-to-day operations. Royce is a small-company specialist with 18 open-end funds, three closed-end funds, two variable annuity accounts, and a several separately managed accounts. It was founded by Mr. Royce in 1972 and now employs more than 100 people, including 30 investment professionals. As of 12/31/2015, Royce had $18.5 billion in assets under management. $111 million of that amount was personal investments by their staff. When we published our 2008 profile, Royce had 27 funds and $30 billion and slightly-higher internal investment.

Managers

Charles Royce and Chris Flynn. Mr. Royce is the adviser’s founder, CEO and senior portfolio manager. He often wears a bowtie, and manages or co-manages six other Royce funds. Mr. Flynn serves as assistant portfolio manager and analyst here and on three other funds. They’ve overseen the fund since inception.

Strategy capacity and closure

Royce estimates the strategy could handle $2 billion or so, and notes that they haven’t been hesitant to close funds when asset flows become disruptive.

Management’s stake in the fund

Mr. Royce has over $1,000,000 directly invested in the fund. Mr. Flynn has invested between $50,000 – 100,000. All told, insiders owned 5.70% of the fund’s shares as of November 30, 2015.

Opening date

December 31, 2003

Minimum investment

$2,000 for regular accounts, $1000 for IRAs.

Expense ratio

1.53% on an asset base of $26 million, as of July 2023, with a 1% redemption fee on shares held less than 30 days.

Comments

Royce Global Financial Services Fund is a financial sector fund unlike any other. First, it invests in smaller firms. The fund’s average market cap is about $2 billion while its average peer’s is $27 billion. Over 20% of the portfolio is invested in microcap stocks, against a norm of 2%. Second, it invests internationally. About 32% of the portfolio is invested internationally, which that rising steadily toward the 40% threshold required by the “global” name. For the average financial services fund, it’s 5%. Third, it pursues value investing. That’s part of the Royce DNA. Financial services firmly are famously tricky to value but, measured by things like price/cash flow, price/sales or dividend yield, the portfolio trades at about half the price of its average peer. And fourth, it doesn’t focus on banks and REITs. Just 11% of the fund is invested in banks, mostly smaller and regional, and real estate is nearly invisible. By contrast, bank stocks constitute 34% of the S&P Financial Sector Index and REITs add 18% more.

In short: it’s way different. The question is, should you make room for it in your portfolio? The answer to that question is driven by your answer to two others: (1) should you overweight the financial sector? And (2) if so, are there better options available?

On investing in the financial services sector.

Two wise men make the case. Illegal withdrawals specialist Willie Sutton is supposed to have answered the question “why do you rob banks?” with “because that’s where the money is.” And remember all that advice from Baron Rothschild that you swore you were going to take next time? The stuff about buying “when there’s blood in the streets” and the advice to “buy on the sound of cannons and to sell on the sound of trumpets”? Well, here’s your chance, little bubba!

Over the 100 months of the latest market cycle, the financial services sector has returned less than zero. From November 2007 to January 2016, funds in this category have lost 0.3% annually while the Total Stock Market gained 5.0%. If you had to guess what sector had suffered the worst losses in the six months from last July to January, you’d probably guess energy. And you’d be wrong: financials lost more, though by just a bit. In the first two months of 2016, the sector dropped another 10%.

That stock stagnation has occurred at the same time that the underlying corporations have been getting fundamentally stronger. The analysts at Charles Schwab (2016) highlight a bunch of positive developments:

Growing financial strength: Most financial institutions have paid back government loans and some are increasing share buybacks and dividend payments, illustrating their growing health and stability.

Improving consumer finances: Recent delinquent loan estimates have decreased among credit card companies, indicating improving balance sheets.

… the pace at which new rules and restrictions have been imposed is leveling off. With balance sheets solidified, financial companies are now being freed from some regulatory restrictions. This should allow them to make better business decisions, as well as raise dividend payments and increase share-buyback programs, which could help bolster share prices.

The combination of falling prices and strengthening fundamentals means that the sector as a whole is selling at huge discount. In mid-February, the sector was priced at 72% of fair value by Morningstar’s calculation. That’s comparable to discounts at the end of the 2000-02 bear and during the summer 2011 panic; the only deeper discounts this century occurred for a few weeks in the depths of the 2007-09 meltdown. PwC, formerly Price Waterhouse Coopers, looks at different metrics and reaches the same general conclusion. Valuations are even lower in Europe. The cheapest quintile in the Euro Stoxx 50 are almost all financial firms. Luca Paolini, chief strategist for Pictet Asset Management in London, worried that “There is some exaggerated concern about the systemic risk in the banking sector. The valuations seem extreme. The gap must close at some point this year.”

Are valuations really low, here and abroad? Yes, definitely. Has the industry suffered carnage? Yes, definitely. Could things in the financial sector get worse? Yes, definitely. Does all of that raise the prospect of abnormal returns? Again yes, definitely.

On investing with Royce

There are two things to note here.

First, the Royce portfolio is structurally distinctive. Royce is a financial services firm and they believe they have an intimate understanding of their part of the industry. Rather than focusing on huge multinationals, they target the leaders in a whole series of niche markets, such as asset management, that they understand really well. They invest in WisdomTree (WETF), the only publicly-traded pure-play ETF firm. They own Morningstar (MORN), the folks who rate funds and ETFs, a half dozen stock exchanges and Charles Schwab (SCHW) where they’re traded, and MSCI (MSCI), the ones who provide investable indexes to them. When they do own banks, they’re more likely to own Umpqua Holdings (UMPQ) than Wells Fargo. Steve Lipper, a principal at Royce whose career also covers long stints with Lipper Analytics and Lord, Abbett, says, “Basically what we do is give capital to really bright people in good businesses that are undergoing temporary difficulties, and we do it in an area where we practice every day.”

These firms are far more attractive than most. They’re less capital-intense. They’re less reliant on leverage. They less closely regulated. And they’re more likely to have a distinct and defensible niche, which means they operate with higher returns on equity. Mr. Lipper describes them as “companies that could have 20% ROE perpetually but often overlooked.”

Second, Royce has done well. The data on the fund’s homepage makes a pretty compelling case for it. It’s beaten the Russell 2500 Financials index over the past decade and since inception. It’s earned more than 5% annually in 100% of the past rolling 10-year periods. It’s got below average volatility and has outperformed its benchmark in all 11 major (i.e., greater than 7.5%) drawdowns in its history. It’s got a lower standard deviation, smaller downside capture and higher Sharpe ratio than its peers.

Here are two ways of looking at Royce’s returns. First, the returns on $10,000 invested at the inception of RYFSX compared to its peers.

Second, those same returns during the current market cycle which began in October 2007, just before the crash.

The wildcard here is Mr. Royce’s personal future. He’s the lead manager and he’s 74 years old. Mr. Lipper explains that the firm is well aware of the challenge and is midway through a still-evolving succession plan. He’s the CEO but he’s no longer than CIO, a role now split among several colleagues. In the foreseeable future, he’s step away from the CEO role to focus on investment management. And Royce has reduced, and will continue to reduce, the number of funds for which Mr. Royce is responsible. And, firm wide, there’s been “a major rationalization” of the fund lineup to eliminate funds that lacked distinct identities or missions.

Bottom Line

There’s little question that Royce Global Financial will be a profitable investment in time. The two questions that you’ll need to answer are (1) whether you want a dedicated financial specialist and (2) whether you want to begin accumulating shares during a weak-to-wretched market. If you do, Royce is one of a very small handful of financial services funds with the distinct profile, experienced management and long record which warrant your attention.

Fund website

Royce Global Financial Services Fund. The fund’s factsheet is exceptionally solid, in a wonky sort of way, and the fund’s homepage is one of the best out there for providing useful performance analytics.

At the time of publication, this fund was named Cognios Market Neutral.

Objective and strategy

The fund seeks long-term growth of capital independent of stock market direction. The managers balance long and short positions in domestic large cap stocks within the S&P 500 universe. They calculate a company’s Return on Tangible Assets (ROTA) and Return on Market Value of Equity (ROME). The former is a measure of a firm’s value; the latter measures its stock valuation. They buy good businesses as measured by ROTA and significantly undervalued firms as measured by ROME. Their short positions are made up of poor businesses that are significantly overvalued. As a risk-management measure and to achieve beta neutrality, their individual short positions are generally a lower dollar amount, but constitute more names than the long portfolio.

Adviser

Cognios Capital LLC. Cognios, headquartered near Kansas City was founded in 2008. It’s an independent quantitative investment management firm that pursues both long-only and hedged strategies. As of December 31, 2015, they had $388 million in assets under management. They manage a hedge fund and accounts for individual and institutional clients as well as the mutual fund. The senior folks at Cognios are deeply involved with charitable organizations in the Kansas City area.

Manager

Jonathan Angrist, Brian Machtley and Francisco Bido. Mr. Angrist, Cognios’s cofounder, president and chief investment officer, has co-managed the fund since its inception. He co-owned and was a portfolio manager at Helzberg Angrist Capital, an alternative asset manager that was the predecessor firm to Cognios. He helped launch, and briefly managed, Buffalo Micro Cap fund. Mr. Machtley, Cognios’ chief operating officer, has co-managed the fund since its inception. Previously, Mr. Machtley served as an associate portfolio manager at a Chicago-based hedge fund manager focused on micro-capitalization equities. Mr. Bido is Cognios’ head of quantitative research. Prior to joining Cognios in 2013, Mr. Bido was a senior quantitative researcher with American Century Investments.

Strategy capacity and closure

At $3 billion, the managers would need to consider closing the fund. The strategy capacity is limited primarily by its short portfolio, which has more numerous but smaller positions than the long portfolio.

Management’s stake in the fund

Messrs. Angrist and Machtley have between $100,000 – 500,000 each in the fund. Mr. Bido has between $10,000 – 50,000.  One of the fund’s trustees has an investment of $10,000 – $50,000 in the fund. The vast majority of the fund’s shares – 98% of investor shares and 64% of institutional ones, as of the last Statement of Additional Information – were owned by the A. Joseph Brandmeyer Trust. Mr. Brandmeyer founded the medical supplies company Enturia and is the father of one of the Cognios founders.

Opening date

31 December 2012

Minimum investment

$1,000 for the investor shares (COGMX) and $100,000 for the institutional shares (COGIX).

Expense ratio

The net expense ratio is 3.88% which includes all the dividend expense on securities sold short, borrowing costs and brokerage expenses totaling 2.18%. The AUM is $20.6 million, as of June 2023. 

Comments

Market neutral funds, mostly, are a waste of time. In general, they invest $1 long in what they consider to be a great stock and $1 short in what they consider to be an awful one. Because there are equal long and short positions, the general movement of the stock market should be neutralized. At that point, the fund’s return is driven by the difference in performance between a great stock and an awful one: if the great stock goes up 10% and the awful one goes up 5%, the fund makes 5%. If the great stock drops 5% and the awful one drops 10%, the fund makes 5%.

Sadly, practice badly lags the theory. The average market neutral fund has made barely 1% annually over the past three and five year periods. On average, they lost money in the turbulent January 2016 with about 60% of the category in the red. Only two market neutral funds have managed to earn 5% or more over the past five years while two others have lost 5% or more. No matter how low you set the bar, the great majority of market neutral funds cannot clear it. In short, they charge hedge fund-like fees for the prospect of cash-like returns.

Why bother?

The short answer is, because we need risk mitigation and our traditional tool for it – investing in bonds – is likely to fail us. Bonds are generating very little income, with interest rates at or near zero there’s very little room for price appreciation (the price of bonds rise when interest rates fall), there are looming questions about liquidity in the bond market and central bankers have few resources left to boost markets.

Fortunately, a few market neutral funds seem to have gotten the discipline right. Cognios is one of them. The fund has returned 7.6% annually over the three years of its existence, while its peers made 1.2%. In January 2016, the fund returned 4.3% while the stock market dropped 5% and its peers lost a fraction of a percent. That record places it in the top 4% of its peer group in the company of two titans: BlackRock and Vanguard.

What has Cognios gotten right?

1. Their portfolio is beta neutral, rather than dollar neutral. In a typical dollar-neutral portfolio, there’s $1 long for $1 short. That can be a serious problem if the beta characteristics of the short portfolio don’t match those of the long portfolio; a bunch of high beta shorts paired with low beta long positions is a recipe for instability and under-performance. Cognios focuses on keeping the portfolio beta-neutral: if the beta of the short portfolio is high relative to the long, they reduce the size of the short portfolio. That more completely cancels the effects of market movements on the fund’s return.
2. Their long positions are in high-quality value stocks, rather than growth ones. They use a quantitative screen called ROTA/ROME ™. ROTA (Return on Tangible Assets) is a way of identifying high-quality businesses. At base, it measures a sort of capital efficiency: a company that generates $300 million in returns on a $1 billion in assets is doing better than a company that generates $150 million in returns on those same assets. Cognios research shows ROTA to be a stable identifier of high quality firms; that is, firms that use capital well in one period tend to continue doing so in the future. As Mr. Buffett has said, “A good business is one that earns high return on tangible assets. That’s pretty simple. The very best businesses are the ones that earn a high return on tangible assets and grow.” The combined quality and value screens skew the portfolio toward value. They also only invest in S&P 500 stocks – no use of derivatives, futures or swaps.
3. They target equity-like returns. Most market neutral managers strive for returns in the low single-digits, to which Mr. Angrist echoes the question: “why bother?” He believes that with a more concentrated portfolio – perhaps 50 long positions and 100 short ones – he’s able to find and exploit enough mispriced securities to generate substantially better returns.
4. They don’t second-guess their decisions. Their strategy is mechanical and repeatable. They don’t make top-down calls about what sectors are attractive, nor do they worry about the direction of the market, terrorism, interest rates, oil prices or the Chinese banking system. If they’ve managed to neutralize the effect of market movements on the portfolio, they’ve also made fretting about such things irrelevant. So they don’t.
5. They focus. This is their flagship product and their only mutual fund.

Bottom Line

A market neutral strategy isn’t designed to thrive in a bull market, where even bad companies are assigned ever-rising prices. These funds are designed to serve you in uncertain or falling markets. It’s unclear, with the prospect that both stocks and bonds might be volatile and falling, that traditional strategies will fully protect you. GMO’s December 2015 asset class returns suggest that a traditional 60/40 hybrid fund will lose 1.4% annually in real terms over the next five to seven years. Of the three market neutral funds with the best records (Vanguard Market Neutral VMNFX with a $250,000 minimum and BlackRock Event Driven Equity BALPX with a 5.75% load are the other two), Cognios is by far the smallest, most accessible and most interesting. You might want to learn more about it.

Fund website

AXS Market Neutral Fund

Objective and strategy

Leuthold Core pursues capital appreciation and income through the use of tactical asset allocation. Their objective is to avoid significant loss of capital and deliver positive absolute returns while assuming lower risk exposure and lower relative volatility than the S&P 500. Assets are allocated among stocks and ADRs, corporate and government bonds, REITs, commodities, an equity hedge and cash. At one time, the fund’s commodity exposure included direct ownership of physical commodities. Portfolio asset class weightings change as conditions do; exposure is driven by models that determine each asset class’s relative and absolute attractiveness. Equity and fixed-income exposure each range from 30-70% of the portfolio. At the end of 2013, equities comprised 67% of the portfolio. At the end of 2015, 55% of the portfolio was invested in “long” equity positions and 17% was short, for a net exposure under 40%.

Adviser

Leuthold Weeden Capital Management (LWCM). The Leuthold Group began in 1981 as an institutional investment research firm. Their quantitative analyses eventually came to track several hundred factors, some with data dating back to the Great Depression. In 1987, they founded LWCM to direct investment portfolios using the firm’s financial analyses. They manage $1.6 billion through five mutual funds, separate accounts and limited partnerships.

Manager

Doug Ramsey, Chun Wang, Jun Zhu and Greg Swenson. Mr. Ramsey joined Leuthold in 2005 and is their chief investment officer. Mr. Swenson joined Leuthold in 2006 from FactSet Research. Ms. Zhu came to Leuthold in 2008 after earning an MBA from the Applied Security Analysis Program at the University of Wisconsin-Madison. While there, she co-managed a $60 million university endowment fund run by students at the program. Mr. Wang joined in 2009 after a stint with a Hong Kong-based hedge fund and serving as director of research for Ned Davis Research. Collectively the team shares responsibility for testing and refining the firm’s quantitative models and for managing four of their five funds, Grizzly Short (GRZZX) excepted.

Strategy capacity and closure

About $5 billion. Core was hard-closed in 2006 when it reached $2 billion in assets. That decision was driven by limits imposed by the manager’s ability to take a meaningful position in the smallest of the 155 industry groups (e.g. industrial gases) that they then targeted. Following Steve Leuthold’s retirement to lovely Bar Harbor, Maine, the managers studied and implemented a couple refinements to the strategy (somewhat fewer but larger industry groups, somewhat less concentration) that gave the strategy a bit more capacity.

Management’s stake in the fund

Three of the fund’s four managers have investments in the fund, ranging from Mr. Swenson’s $50,000 – 100,000 on the low end to Mr. Ramsey at over $1 million on the high end. All four of the fund’s trustees have substantial investments either directly in the fund or in a separately-managed account whose strategy mirrors the fund’s.

Opening date

November 20, 1995.

Minimum investment

$10,000, reduced to $1,000 for IRAs. The minimum for the institutional share class (LCRIX) is $1,000,000.

Expense ratio

1.16% on assets of $871 million, as of January 2016.

Comments

Leuthold Core Investment was the original tactical asset allocation fund. While other, older funds changed their traditional investment strategies to become tactical allocation funds when they came in vogue three or four years ago, Leuthold Core has pursued the same discipline for two decades.

Core exemplifies their corporate philosophy: “Our definition of long-term investment success is making money . . . and keeping it.”

It does both of those things. Here’s how:

Leuthold’s asset allocation funds construct their portfolios in two steps: (1) asset allocation and (2) security selection. They start by establishing a risk/return profile for the bond market and establishing the probability that stocks will perform better. That judgment draws on Leuthold’s vast experience with statistical analysis of the market and the underlying economies. Their “Major Trends Index,” for example, tracks over 100 variables. This judgment leads them to set the extent of stock exposure. Security selection is then driven by one of two strategies: by an assessment of attractive industries or of individually attractive stocks.

Core focuses on industry selection and its equity portfolio is mirrored in Leuthold Select Industries. Leuthold uses its quantitative screens to run through over 115 industry-specific groups composed of narrow themes, such as Airlines, Health Care Facilities, and Semiconductors to establish the most attractive of them. Core and Select Industries then invest in the most attractive of the attractive sectors. Mr. Ramsey notes that they’ll only consider investing in the most attractive 20% of industries; currently they have positions in 16 or 17 of them. Within the groups, they target attractively priced, financially sound industry leaders. Mr. Ramsay’s description is that they function as “value investors within growth groups.” They short the least attractive stocks in the least attractive industries.

Why should you care? Leuthold believes that it adds value primarily through the strength of its asset allocation and industry selection decisions. By shifting between asset classes and shorting portions of the market, it has helped investors dodge the worst of the market’s downturns. Here’s a simple comparison of Core’s risk and return performance since inception, benchmarked against the all-equity S&P 500.

	APR	MaxDD	Months Recover	Std Dev	Downside Dev	Ulcer Index	Bear Dev	Sharpe Ratio	Sortino Ratio	Martin Ratio
Good if …	Higher	Lower	Lower	Lower	Lower	Lower	Lower	Higher	Higher	Higher
Leuthold Core	8.4	-36.5	35	11.0	7.5	8.9	6.8	0.55	0.81	0.68
S&P 500 Monthly Reinvested Index	8.2	-50.9	53	15.3	10.7	17.5	10.3	0.38	0.55	0.34
Leuthold:

Over time, Core has had slightly higher returns and substantially lower volatility than has the stock market. Morningstar and Lipper have, of course, different peer groups (Tactical Allocation and Flexible Portfolio, respectively) for Core. It has handily beaten both. Core’s returns are in the top 10% of its Morningstar peer groups for the past 1, 3, 5, 10 and 15 year periods.

Our Lipper data does not allow us to establish Leuthold’s percentile rank against its peer group but does show a strikingly consistent picture of higher upside and lower downside than our “flexible portfolio” funds. In the table below, Cycle 4 is the period from the dot-com crash to the start of the ’08 market crisis while Cycle 5 is from the start of the market crisis to the end of 2015. The 20-year report is the same as the “since inception” would be.

	Time period	Flexible Portfolio	Leuthold Core	Leuthold
Annualized Percent Return	20 Year	7.1	8.4
	10 Year	4.9	5.3
	5 Year	4.1	5.6
	3 Year	3.3	8.6
	1 Year	-5.2	-1.0
	Cycle 4	7.3	11.9
	Cycle 5	2.8	3.1
Maximum Drawdown	20 Year	-38.6	-36.5
	10 Year	-36.5	-36.5
	5 Year	-14.9	-15.4
	3 Year	-11.1	-3.7
	1 Year	-9.4	-3.2
	Cycle 4	-23.8	-21.8
	Cycle 5	-36.9	-36.5
Recovery Time, in months	20 Year	50	35
	10 Year	43	35
	5 Year	18	23	X
	3 Year	12	4
	1 Year	8	7
	Cycle 4	39	26
	Cycle 5	43	35
Standard Deviation	20 Year	11.9	11.0
	10 Year	11.7	12.0	X
	5 Year	9.3	8.5
	3 Year	8.1	7.0
	1 Year	8.7	4.9
	Cycle 4	9.9	10.4	X
	Cycle 5	12.7	12.9	X

Modestly higher short-term volatility is possible but, in general, more upside and less downside than other similarly active funds. And, too, Leuthold costs a lot less: 1.16% with Leuthold rather than 1.42% for its Morningstar peers.

Bottom Line

At the Observer, we’re always concerned about the state of the market because we know that investors are much less risk tolerant than they think they are. The years ahead seem particularly fraught to us. Lots of managers, some utterly untested, promise to help you adjust to quickly shifting conditions. Leuthold has delivered on such promises more consistently, with more discipline, for a longer period than virtually any competitor. Investors who perceive that storms are coming, but who don’t have the time or resources to make frequent adjustments to their portfolios, should add Leuthold Core to their due-diligence list.

Investors who are impressed with Core’s discipline but would like a higher degree of international exposure should investigate Leuthold Global (GLBLX). Global applies the same discipline as Core, but starts with a universe of 5000 global stocks rather than 3000 domestic-plus-ADRs one.

Fund website

Leuthold Core Investment Fund

THIS IS AN UPDATE OF THE FUND PROFILE ORIGINALLY PUBLISHED IN June 2011. YOU CAN FIND THAT ORIGINAL PROFILE HERE.

Objective and strategy

The fund seeks long-term capital appreciation and income, while trying to maintain a sense of “prudent investment risk over the long-term.” RNCOX is a “balanced” fund with several twists. First, it adjusts its long-term asset allocation in order to take advantage of tactical allocation opportunities. Second, it invests primarily in a mix of closed-end mutual funds and ETFs. Lipper’s designation, as a Global Macro Allocation fund, provides a more realistic comparison than Morningstar’s Moderate Allocation assignment.

Adviser

RiverNorth Capital Management. RiverNorth is a Chicago-based firm, founded in 2000 with a distinctive focus on closed-end fund arbitrage. They have since expanded their competence into other “under-followed, niche markets where the potential to exploit inefficiencies is greatest.” RiverNorth advises three limited partnerships and the four RiverNorth funds: RiverNorth/Oaktree High Income (RNOTX), Equity Opportunity (RNEOX), RiverNorth/DoubleLine Strategic Income (RNDLX) and this one. They manage about $3.0 billion through limited partnerships, mutual funds and employee benefit plans.

Managers

Patrick Galley and Stephen O’Neill. Mr. Galley is RiverNorth’s President, Chairman and Chief Investment Officer. He also manages all or parts of three RiverNorth funds with Mr. O’Neill. Before joining RiverNorth Capital in 2004, he was a Vice President at Bank of America in the Global Investment Bank’s Portfolio Management group. Mr. O’Neill specializes in qualitative and quantitative analysis of closed-end funds and their respective asset classes. Prior to joining RiverNorth in 2007, he was an Assistant Vice President at Bank of America in the Global Investment Bank’s Portfolio Management group. Messrs Galley and O’Neill manage about $1.7 billion in other pooled assets.

Strategy capacity and closure

The fund holds almost as much money as it did when it closed to new investors. The managers describe themselves as “comfortable now” with the assets in the fund. Three factors would affect their decision to close it again. First, market volatility makes them predisposed to stay open. That volatility feeds the CEF discounts which help drive market neutral alpha. Second, strong relative performance will draw “hot money” again, which they’d prefer to avoid dealing with. Finally, they prefer a soft close which would leave “a runway” for advisors to allocate to their clients.

Active share

“Active share” measures the degree to which a fund’s portfolio differs from the holdings of its benchmark portfolio. High active share indicates management which is providing a portfolio that is substantially different from, and independent of, the index. An active share of zero indicates perfect overlap with the index, 100 indicates perfect independence. RiverNorth does not calculate active share, though the distinctiveness of its portfolio implies a very high level of activity.

Management’s stake in the fund

Messrs. Galley and O’Neill each have between $100,000 – 500,000 in the fund. Three of the four independent trustees have relatively modest ($10,000-100,000) investments in the fund while one has no investments with RiverNorth.

Opening date

December 27, 2006. The fund added an institutional share class (RNCIX) on August 11, 2014.

Minimum investment

$5,000, reduced to $1,000 for IRAs.

Expense ratio

3.56% on assets of $45.2 million, as of July 2023. The expense ratio is heavily influenced by the pass-through expense from the closed-end funds in which it invests. 

Comments

Normally the phrase “balanced fund” causes investor’s eyes to grow heavy and their heads to nod. Traditional balanced funds make a good living by being deadly dull. They have a predictable asset allocation, 60% equities and 40% bonds. And they execute that allocation with predictable investments in blue-chip domestic companies and investment grade bonds. Their returns are driven more by expenses and avoiding mistakes than any great talent.

Morningstar places RiverNorth Core Opportunity there. They don’t belong. Benchmarking them against the “moderate allocation” group is far more likely to mislead than inform.

RiverNorth’s strategy involves pursuing both long- and short-term opportunities. They set an asset allocation then ask whether they see more opportunities in executing the strategy through closed-end funds (CEFs) or low-cost ETFs.  While both CEFs and ETFs trade like stocks, CEFs are more like active mutual funds. Because their price is set by investor demands, a share of a CEF might trade for more than the value of its holdings when greed seizes the market or far less than the value of its holdings when fear does. The managers’ implement their asset allocation with CEFs when they’re available at irrational discounts; otherwise, they use low-cost ETFs.

In general, the portfolio is 50-70% CEFs. Mr. Galley says that it’s rare to go over 70% but they did invest 98% in CEFs toward the end of during the market crisis. That move primed their rocket-like rise in 2009: their 49% gain more than doubled their peer group’s and was nearly double the S&P 500’s 26%. It’s particularly impressive that the fund’s loss in 2008 was no greater than its meek counterparts.

That illustrates an essential point: this isn’t your father’s Buick. It’s distinctive and more opportunistic. Over the fund’s life, it’s handsomely rewarded its investors with outsized returns and quick bounce backs from its declines. Here’s RiverNorth’s performance against the best passive and active options at Vanguard.

The comparison against Rivernorth’s more opportunistic peer group shows an even more stark advantage.

The fund is underwater by 3.4% in 2015, through October 30, after a ferocious October rally. That places them about 3.5% behind their Morningstar peer group. The short-term question for investors is whether that lag represents a failure of RiverNorth’s strategy or another example of the portfolio-as-compressed-spring? The managers observe that CEF discounts widen to levels not seen since the financial crisis. That’s led them to place 76% of the portfolio in CEFs, many that use leverage in their own portfolios. That’s well above their historic norms and implies a considerable confidence on their part.

Bottom Line

Core Opportunity offers unique opportunity, more suited to investors comfortable with an aggressive strategy than a passive one. Since inception, the fund has outperformed the S&P 500 with far less volatility (beta = 76) and has whomped similarly-aggressive funds. That long-term strength comes at the price of being out of step with, and more volatile than, traditional 60/40 funds. That’s making them look weak now. If history is any guide, that judgment is subject to a dramatic and sudden reversal. It’s well worth investigating.

Fund website

RiverNorth Core Opportunity.

Objective and strategy

The fund’s first objective is to provide preservation of capital. Its secondary concerns are to provide income and long-term growth of capital. The fund invests primarily in fixed-income securities. It tilts toward shorter-term, investment grade issues while having the ability to go elsewhere when the opportunities are compelling. It also invests in foreign and domestic stocks, with a preference for dividend-paying equities. Finally, it may invest a bit in a managed futures strategy as a hedge. In general, though, bonds are 55-85% of the portfolio. In the past five years, stocks have accounted for 25-35% of the portfolio though they might be about 10% higher or lower if conditions warrant.

Adviser

Manning & Napier. Manning & Napier was founded in 1970 by Bill Manning and Bill Napier. They’re headquartered near Rochester, NY, with offices in Columbus, OH, Chicago and St. Petersburg. They serve a diversified client base of high-net-worth individuals and institutions, including 401(k) plans, pension plans, Taft-Hartley plans, endowments and foundations. It’s a publicly-traded company (symbol: MN) with $43 billion in assets under management. Of that, about $18 billion are in their team-managed mutual funds and the remainder in a series of separately-managed accounts.

Manager

The fund is managed by a seven-person team, headed by Jeffrey Herrmann and Marc Tommasi. Both of them have been with the fund since its launch. The same team manages all of Manning & Napier’s Pro-Blend and Target Date funds.

Management’s stake in the fund

We generally look for funds where the managers have placed a lot of their own money to work beside yours.  The managers work as a team on about 10 funds. While few of them have any investment in this particular fund, virtually all have large investments between the various Pro-Blend and Lifestyle funds.

Opening date

November 1, 1995.

Minimum investment

$2,000. That is reduced to $25 if you sign up for an automatic monthly investing plan.

Expense ratio

0.88% on $384.1 million in assets, as of July 2023.

Comments

Pro-Blend Conservative offers many of the same attractions as Vanguard STAR (VGSTX) but does so with a more conservative asset allocation. Here are three arguments on its behalf.

First, the fund invests in a way that is broadly diversified and pretty conservative. The portfolio holds something like 200 stocks and 500 bonds, plus a few dozen other holdings. Collectively those represent perhaps 25 different asset classes. No stock position occupies as much as 1% of the portfolio and it currently has much less direct foreign investment than its peers.

Second, Manning & Napier is very good. The firm does lots of things right, and they’ve been doing it right for a long while. Their funds are all team-managed, which tends to produce more consistent, risk-conscious decisions. Their staff’s bonuses are tied to the firm’s goal of absolute returns, so if investors lose money, the analysts suffer, too. The management teams are long-tenured – as with this fund, 20 year stints are not uncommon – and most managers have substantial investments alongside yours.

Third, Pro-Blend Conservative works. Their strategy is to make money by not losing money. That helps explain a paradoxical finding: they might make only half as much as the stock market in a good year but they managed to outperform the stock market over the past 15. Why? Because they haven’t had to dig themselves out of deep holes first. The longer a bull market goes on, the less obvious that advantage is. But once the market turns choppy, it reasserts itself.

At the same time, the fund has the ability to become more aggressive when conditions warrant.  It just does so carefully. Chris Petrosino, one of the Managing Directors at Manning, explained it this way:

We have the ability to be more aggressive. For us, that’s based on current market conditions, fundamentals, pricing and valuations. It may appear contrarian, but valuations dictate our actions. We use those valuations that we see in various asset classes (not only in equities), as our road map. We use our flexibility to invest where we see opportunities, which means that our portfolio often looks very different than the benchmark.

Bottom Line

Pro-Blend Conservative has been a fine performer since launch. It has returned over 6% since launch and 5.4% annually over the past 15 years. That’s about 1% per year better than either the Total Stock Market or its conservative peers. In general, the fund has managed to make between 4-5% each year; more importantly, it has made money for its investors in 19 of the past 20 years. It is an outstanding first choice for cautious investors.

Fund website

Manning & Napier Pro-Blend Conservative homepage. 

Fact Sheet

Objective and strategy

This fund of funds seeks to provide long-term capital appreciation and income. As a fund of funds, Vanguard STAR invests in other Vanguard mutual funds.  It places 60% to 70% of its assets in common stocks through eight stock funds; 20% to 30% of its assets in bonds through two bond funds; and 10% to 20% of its assets in short-term investments through a short-term bond fund. The stock funds emphasize larger, well-established companies and the bond funds focus on securities issued by highly-rated borrowers. Vanguard calls it their “one fund option for investors looking for broad diversification across asset classes who can tolerate moderate market risk that comes from the volatility of the stock and bond markets.”

Adviser

The Vanguard Group, Inc. The Japanese bestow the designation “Living National Treasure” on individuals of incomparable skill who work to preserve precious elements of the culture. If the US had such as designation, Vanguard founder Jack Bogle would certainly qualify for it. He founded Vanguard in May, 1975 as the industry’s only non-profit, investor-owned fund complex; in the succeeding decades he has been consistently, successfully critical of marketing-driven investing fads and high expenses. Vanguard advertises “at cost” investing and their investor expenses are consistently the industry’s lowest. They advise 160 U.S. funds (including variable annuity portfolios) and about 120 funds for non-U.S. investors. In total they have 20 million investors and are responsible for more than $3 trillion in assets.

Managers

Michael Buek, William Coleman and Walter Nejman. The guys are mostly responsible for which of the portfolio’s funds get a bit more money and which get a bit less. The list of which funds they use hasn’t changed since 2001 and the fund’s asset allocation wobbles just a little. Their responsibilities are so administrative that from 1985 to 2009, the fund listed itself as having “no manager.”

Management’s stake in the fund

In general, you should look for funds whose managers invest a lot of their own money alongside your money. In this case, the managers have almost no investment in the fund but that’s not very important since their responsibilities are so limited.

Opening date

March 29, 1985

Minimum investment

$1,000. While Vanguard offers an automatic investing plan option, they don’t reduce the minimum for such accounts. That said, the STAR minimum is one-third of what Vanguard normally expects and the monthly minimum once you’ve opened an account is $1.

Expense ratio

0.34% on assets of $22.7 billion, as of July 2023.

Comments

Why invest in Vanguard STAR? There are three reasons to consider it.

First, the fund invests in a way that is broadly diversified and reasonably cautious. 60-70% of its money is invested in stocks, 20-30% in bonds and 10-20% in conservative short-term investments. Its stock portfolio mostly focuses on large, well-established companies and it gives you more exposure to the world beyond the U.S. than most of its peers do. International stocks constitute 21% of the portfolio but are only 13% for its average peer. That means investors are being given access to some additional sources of gain that most comparable funds skip.

Second, Vanguard is very good. There are two sorts of funds, those which simply buy all of the stocks or bonds in a particular index without trying to judge whether they’re good or bad (these are called “passive” funds) and those whose managers try to invest in only the best stocks or bonds (called “active” funds). Vanguard typically hires outside firms to manage their active funds and they do a very good job of finding and overseeing good managers. Vanguard and its funds operate with far lower expenses than its peers, on average, 0.19% per year for funds investing primarily in U.S. stocks. Even Vanguard’s most expensive funds charge less than half as much as their industry peers. Every dollar not spent on running the fund is a dollar that remains in your account.

Third, STAR is the most accessible way to build a Vanguard portfolio. STAR builds its portfolio around 11 actively-managed Vanguard funds.  They are:

If you wanted to buy that same collection of funds one-by-one, you’d need to have $33,000 to invest. Dan Wiener, publisher of the well-respected Independent Advisor for Vanguard Investors newsletter, suggests eight funds in a model portfolio akin to STAR. That would require $24,000 upfront and you’d have to deal with the fact that PRIMECAP is no longer accepting new investors.

Bottom Line

STAR has been around for 30 years and has been a quiet, reliable performer. Its portfolio represents a cautious approach to some investment types (for example, stocks in the emerging markets) that its peers mostly avoid. Coupled with its substantial cost advantage over its peers, STAR has been able to outperform three-quarters of its peers. It has returned about 7% per year over the past decade, about 1% per year above the competition, but has been a little less risky. It’s a great all-around fund designed to do well year after year rather than post eye-popping returns over the short term.

Fund website

Vanguard STAR profile. You can keep track of your account by downloading the Vanguard app which works with iPhones, Android and Kindle. When you go to Vanguard’s “invest with us” page, here’s what you’ll see:

So you’ll need just seven pieces of information (eight if you include “your name”) to get started. When you’re asked what you’d like done with your dividends and capital gains, choose “reinvest them” so that the money stays in your account and keeps growing. Otherwise you’ll get them deducted from your account and mailed to you as a check.

Objective and strategy

The fund seeks long-term total return, consisting of both current income and capital appreciation. It is a “fund of funds” that invests in the low-cost Institutional Class shares of other TIAA-CREF funds. It is designed for investors targeting a conservative risk-return profile. In general, 40% of the fund’s assets are invested in stocks and 60% in bonds. The managers can change those allocations by as much as 10% up or down depending upon current market conditions and outlook.

Adviser

TIAA-CREF. It stands for “Teachers Insurance and Annuity Association – College Retirement Equities Fund,” which tells you a lot about them. They were founded in 1918 to help secure the retirements of college teachers; their original backers were Andrew Carnegie and his Carnegie Foundation. Their mission eventually broadened to serving people who work in the academic, research, medical and cultural fields. More recently, their funds became available to the general public. TIAA-CREF manages almost $900 billion dollars for its five million investors. Because so much of their business is with highly-educated professionals concerned about their retirement, TIAA-CREF focuses on fundamentally sound strategies with little trendiness or flash and on keeping expenses as lower as possible. 70% of their investment products have earned four- or five-star ratings from Morningstar and the company is consistently rated as one of America’s best employers.

Manager

John Cunniff and Hans Erickson, who have managed the fund since its inception.

Management’s stake in the fund

We generally look for funds where the managers have placed a lot of their own money to work beside yours. Mssrs. Cunniff and Erickson each have $500,001 – $1,000,000 invested in the fund, which qualifies as “a lot.”

Opening date

December 9, 2011. Many of the funds in which the managers invest are much older than that.

Minimum investment

$2,500. That is reduced to $100 if you sign up for an automatic investing plan.

Expense ratio

0.76% on $310 million in assets, as of July 2023. 

Comments

Lifestyle Conservative offers many of the same attractions as Vanguard STAR (VGSTX) but does so with a more conservative asset allocation. Here are three arguments on its behalf.

First, the fund invests in a way that is broadly diversified and pretty conservative. 40% of its money is invested in stocks, 40% in high-quality bonds and the last 20% in short-term bonds. That’s admirably cautious. They then take measured risks within their various investments (for example, their stock portfolio is more tilted toward international stocks and emerging markets stocks than are their peers) to help boost returns.

Second, TIAA-CREF is very good. There are two sorts of funds, those which simply buy all of the stocks or bonds in a particular index without trying to judge whether they’re good or bad (these are called “passive” funds) and those whose managers try to invest in only the best stocks or bonds (called “active” funds). TSCLX invests in a mix of the two with active funds receiving about 90% of the cash. CREF’s management teams tend to be pretty stable (the average tenure is close to nine years); most managers handle just one or two funds and most invest heavily (north of $100,000 per manager per fund) in their funds. CREF and its funds operate with far lower expenses than its peers, on average, 0.43% per year for funds investing primarily in U.S. stocks. Even their most expensive fund charges 40% less than their industry peers. Every dollar not spent on running the fund is a dollar that remains in your account.

Third, Lifestyle Conservative is a very easy way to build a very well-diversified portfolio.  Lifestyle Conservative builds its portfolio around 15 actively-managed and three passively-managed TIAA-CREF funds.  They are:

Bottom Line

Lifestyle Conservative has been a fine performer since launch. It has returned 7.5% annually over the past three years. That’s about 2% per year better than average, which places it in the top 20% of all conservative hybrid funds. While it trails more venturesome funds such as Vanguard STAR in good markets, it holds up substantially better than they do in falling markets.  That combination led Morningstar to award it four stars, their second-highest rating.

Fund website

TIAA-CREF Lifestyle Conservative homepage there is also another website from which you can download the fact sheet which gives you updated information on what the fund has been investing in and how it’s doing. From there it’s easy to open a mutual fund account and set up your AIP.

If you’ve got an iPhone, you can manage your account with their TIAA-CREF Savings Simplifier app. If instead, you sport an Android device (all the cool kids do!), head over to the Play store and check out the TIAA-CREF app there. It doesn’t offer all the functionality of the iOS app, but it does come with much higher customer ratings.