Dear friends,

Welcome.  Do you think it a coincidence that the holiday season occurs at the least promising time of the year?  The days are getting shorter and, for our none-too-distant ancestors, winter represented a period of virtual house arrest.  Night was a time of brigands and beasts.  Even in the largest cities, respectable folks traveled abroad after dark only with armed guard.  In villages and on farms, travel on a clouded night risked disappearance and death.  The homes of all but the richest citizens were, contrary to your mental fantasy of roaring hearths and plentiful candles, often a single room that could boast a single flickering rushlight.  The hungry months of late winter were ahead.

And so they did what any sensible group would do.  They partied.  One day’s worth of oil became eight nights’ worth of light; Jewish friends gathered, ate and gifted.  Bacchus reigned from our Thanksgiving to the Winter Solstice, and the Romans drank straight through it.  The Kalash people of Pakistan sang, danced, lit bonfires and feasted on goat tripe “and other delicacies” (oh, yum!).  Chinese and Korean families gathered and celebrated with balls of glutinous rice (more yum!).  Welsh friends dressed up like wrens (yuh), and marched from home to home, singing and snacking.  Romans in the third century CE celebrated Dies Natalis Solis Invicti (festival of the birth of the Unconquered Sun) on December 25^th, a date later borrowed by Christians for their own mid-winter celebration.  Some enterprising soul, having consumed most of the brandy, inexplicably mashed together figs, stale bread and the rest of the brandy.  Figgy pudding was born and revelers refused to go until they got some (along with a glass of good cheer).

Few of these celebrations recognized a single day, they brought instead Seasons Greetings.  Fewer still celebrated individual success or personal enrichment, they instead brought to the surface the simple truth that we often bury through the rest of the year: we are infinitely poorer alone in our palaces than we are together in our villages.

Season’s greetings, dear friends.

But curb yer enthusiasm

Small investors and great institutions alike are partaking in one of the market’s perennial ceremonies: placing your investments atop an ever-taller pile of dried kindling and split logs.  All of the folks who hated stocks when they were cheap are desperate to buy them now that they’re expensive.

We have one word for you: Don’t.

Or, at the very least, don’t buy them until you’re clear why they weren’t attractive to you five years ago but are calling so loudly to you now.  We’re not financial planners, much like market visionaries, but some very careful folks forecast disappointment for starry-eyed stock investors in the years ahead.

Sam Lee, editor of Morningstar ETFInvestor, warned investors to “Expect Below-Average Stock Returns Ahead” based on his reading of the market’s cyclically-adjusted price/earnings ratio.  He wrote, on November 21, that:

The Shiller P/E recently hit 25. When you invert that you get is another measure that I like: the cyclically adjusted earnings yield. The inverse of the Shiller P/E, 1 divided by 25 is about 0.04, or 4%. And this is the smooth earnings yield of the market. This is actually, I think, a reasonable forecast for what the market can be expected to return during the next 10, 20 years. And a 4% real expected return is well below the historical average of 6.5%. 

The Shiller P/E is saying that the market is overvalued relative to history, that you can expect about 2 percentage points less per year over a long period of time. .. if you believe that the market is mean reverting to its historical Shiller P/E, and that the past is a reasonable guide to the future, then you can expect lower returns than the naive 4% forecast return that I provided.

The institutional investors at Grantham, Mayo, van Otterloo (GMO) believe in the same tendency of markets to revert to their mean valuations and profits to revert to their mean levels (that is, firms can’t achieve record profit levels forever – some combination of worker demands to share the wealth and predatory competitors drawn by the prospect of huge profits, will drive them back down).  After three years of research on their market projection models, GMO added some factors that slightly increased their estimate of the market’s fair value and still came away from the projection that US stocks are poised to trail inflation for the rest of this decade.  Ben Inker writes:

In a number of ways it is a “clean sheet of paper” look at forecasting equities, and we have broadened our valuation approach from looking at valuations through the lens of sales to incorporating several other methods. It results in about a 0.7%/year increase in our forecast for the S&P 500 relative to the old model. On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation.

On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. For those interested in the broader U.S. stock market, our forecast for the Wilshire 5000 is a bit worse, at -2.0%, due to the fact that small cap valuations are even more elevated than those for large caps.

In 2013, the average equity investor made inflation plus about 28%.  Through the remainder of the decade, optimists might give you inflation plus 2, 3 or 4%.  Bearish realists are thinking inflation minus 1 or 2%.

The Leuthold Group, looking at the market’s current valuation, is at most masochistically optimistic: they project that a “normal” bear market, starting now, would probably not trim much more than 25% off your portfolio.

What to do?  Diversify, keep expenses aligned with the value added by your managers, seek some income from equities and take time now – before you forget and before some market event makes you want to look away forever – to review your portfolio for balance and performance.  As an essential first step, remember the motto:

Off with their heads!

As the Thanksgiving holiday passes and you begin year-end financial planning, we say it’s time to toss out the turkeys.  There are some funds that we’re not impressed with but which have the sole virtue that they’re not rolling disasters. You know: the overpriced, bloated index-huggers that seemed like the “safe” choice long ago. And now, like mold or lichen, they’ve sort of grown on you.

Fine. Keep ‘em if you must. But at least get rid of the rolling disasters you’ve inherited. There are a bunch of funds whose occasional flashes of adequacy and earnest talk of new paradigms, great rotations, sea changes, and contrarian independence simply can’t mask the fact that they suck. A lot. For a long time.

It’s time to work through your portfolio, fund by fund, and answer the simple question: “if I didn’t already own this fund, is there any chance on earth I’d buy it?” If the answer is “no,” sell.

Mutual Fund Observer is an outgrowth of FundAlarm, whose iconic Three Alarm Funds list continually identified the worst of the worst in the fund industry. For the last several years we’ve published our own Roll Call of the Wretched, an elite list of funds whose ineptitude stretches over a decade or more. In response to requests that arrive every month, we’re happy to announce the re-introduction of the Three Alarm Funds list which will remain an ongoing service of the Observer. So here we go!

The Observer’s Annual “Roll Call of the Wretched”

If you’re resident in one of the two dozen states served by Amazon’s wine delivery service, you might want to buck up your courage with a nice 2007 Domaine Gerard Charvin Chateauneuf du Pape Rhône Valley Red before you settle in to enjoy the Observer’s annual review of the industry’s Most Regrettable funds. Just as last year, we looked at funds that have finished in the bottom one-fourth of their peer groups for the year so far. And for the preceding 12 months, three years, five years and ten years. These aren’t merely “below average.” They’re so far below average they can hardly see “mediocre” from where they are.

When we ran the screen in 2011, there were 151 consistently awful funds, the median size for which is $70 million. In 2012 there were . . . 151 consistently awful funds, the median size for which is $77 million. And now? 152 consistently awful funds (I love consistency), the median size of which is $91 million.

Since managers love to brag about the consistency of their performance, here are the most consistently awful funds that have over a billion in assets. Funds repeating from last year are flagged in red.

Some funds did manage to escape this year’s Largest Wretched Funds list, though the strategies vary: some went extinct, some took on new names, one simply shrank below our threshold and a few rose all the way to mediocrity. Let’s look:

While most Roll Call funds are small enough that they’re unlikely to trouble you, there are 50 more funds with assets between $100 million and a billion. Check to see if any of these wee beasties are lurking around your portfolio:

Morningstar maintains a favorable analyst opinion on three Wretched funds, is Neutral on three (Brandywine BRWIX, Fidelity Freedom 2000 FFFMX and Pioneer PIODX) and Negative on just four (Hussman Strategic Growth HSGFX, Oppenheimer Flexible Strategies QVOPX and two State Farm LifePath funds). The medalist trio are:

And now (drum roll, please), it’s the return of a much-loved classic …

Three Alarm Funds Redux

Roy Weitz first published the legacy Three Alarm fund list in 1996. He wanted to help investors decide when to sell mutual funds. Being on the list was not an automatic sell, but a warning signal to look further and see why.

“I liken the list to the tired old analogy of the smoke detector. If it goes off, your house could be on fire. But it could also be cobwebs in the smoke detector, in which case you just change the batteries and go back to sleep,” he explained in a 2002 interview.

Funds made the list if they trailed their benchmarks for the past 1, 3, and 5 year periods. At the time, he grouped funds into only five equity (large-cap, mid-cap, small-cap, balanced, and international) and six specialty “benchmark categories.” Instead of pure indices, he used actual funds, like Vanguard 500 Index Fund VFINX, as benchmarks. Occasionally, the list would catch some heat because “mis-categorization” resulted in an “unfair” rating. Some things never change.

At the end of the day, however, Mr. Weitz wanted “to highlight the most serious underperformers.” In that spirit, MFO will resurrect the Three Alarm fund list, which will be updated quarterly along with the Great Owl ratings. Like the original methodology, inclusion on the list will be based entirely on absolute, not risk-adjusted, returns over the past 1, 3, and 5 year periods.

Since 1996, many more fund categories exist. Today Morningstar assigns over 90 categories across more than 7500 unique funds, excluding money market, bear, trading, volatility, and specialized commodity. MFO will rate the new Three Alarm funds using the Morningstar categories. We acknowledge that “mis-categorization” may occasionally skew the ratings, but probably much less than if we tried to distill all rated funds into just 11 or so categories.

For more than two-thirds of the categories, one can easily identify a reasonable “benchmark” or reference fund, thanks in part to the proliferation of ETFs. Below is a sample of these funds, sorted first by broad investment Type (FI – Fixed Income, AA – Asset Allocation, EQ – Equity), then Category:

Values in the table include the 3-year annualized standard deviation percentage (STDEV), as well as annualized return percentages (APR) for the past 1, 3, and 5 year periods.

A Return Rating is assigned based how well a fund performs against other funds in the same category during the same time periods. Following the original Three Alarm nomenclature, best performing funds rate a “2” (highlighted in blue) and the worst rate a “-2” (red).

As expected, most of the reference funds rate mid range “0” or slightly better. None produce top or bottom tier returns across all evaluation periods. The same is true for all 60 plus category reference funds. Selecting reference funds in the other 30 categories remains difficult because of their diversity.

To “keep it simple” MFO will include funds on the Three Alarm list if they have the worst returns in their categories across all three evaluation periods. More precisely, Three Alarm Funds have absolute returns in the bottom quintile of their categories during the past 1, 3, and 5 years. Most likely, these funds have also under-performed their “benchmarks” over the same three periods.

There are currently 316 funds on the list, or fewer than 6% of all funds rated. Here are the Three Alarm Funds in the balanced category, sorted by 3 year annualized return:

Like in the original Three Alarm list, a fund’s Risk Rating is assigned based a “potential bad year” relative to other funds in the same category. A Risk Rating of “2” (highlighted in red) goes to the highest risk funds, while “-2” (blue) goes to the lowest risk funds. (Caution: This rating measures a fund’s risk relative to other funds in same category, so a fund in a high volatility category like energy can have high absolute risk relative to market, even if it has a low risk rating in its category.)

“Risk” in this case is based on the 3 year standard deviation and return values. Specifically, two standard deviations are subtracted from the return value. The result is then compared with other funds in the category to assign a rating. The rating is a little more sensitive to downside than the original measure as investors have experienced two 50% drawdowns since the Three Alarm system was first published.

While never quite as popular as the Three Alarm list, Mr. Weitz also published an Honor Roll list. In the redux system, Honor Roll funds have returns in the top quintile of their categories in the past 1, 3, and 5 years. There are currently 339 such funds.

The Three Alarm, Honor Roll, and Reference funds can all be found in a down-loadable *.pdf version.

06Nov2013/Charles

Funds that are hard to love

Not all regrettable funds are defined by incompetent management. Far from it. Some have records good enough that we really, really wish that they weren’t so hard to love (or easy to despise). High on our list:

Oceanstone Fund (OSFDX)

Why would we like to love it? Five-star rating from Morningstar. Small asset base. Flexible mandate. Same manager since launch. Top 1% returns over the past five years.

What makes it hard to love? The fund is entirely opaque and the manager entirely autocratic. Take, for example, this sentence from the Statement of Additional Information:

Ownership of Securities: As of June 30, 2013, the dollar range of shares in the Fund beneficially owned by James J. Wang and Yajun Zheng is $500,001-$1,000,000.

Mr. Wang manages the fund. Ms. Zheng does not. Nor is she a director or board member; she is listed nowhere else in the prospectus or the SAI as having a role in the fund. Except this: she’s married to Mr. Wang. Which is grand. But why is she appearing in the section of the manager’s share ownership?

Mr. Wang was the only manager to refuse to show up to receive a Lipper mutual fund award. He’s also refused all media attempts to arrange an interview and even the chairman of his board of trustees sounds modestly intimidated by him. His explanation of his investment strategy is nonsense. He keeps repeating the magic formula: IV = IV divided by E, times E. No more than a high school grasp of algebra tells you that this formula tells you nothing. I shared it with two professors of mathematics, who both gave it the technical term “vacuous.” It works for any two numbers (4 = 4 divided by 2, times 2) but it doesn’t allow you to derive one value from the other.

The fund’s portfolio turns over at triple the average rate, consists of just five stocks and a 70% cash stake.

Value Line Asset Allocation Fund (VLAAX)

Why would we like to love it? Five-star rating from Morningstar. Consistency below-average to low risk. Small asset base. Same manager for 20 years. Top tier returns over the past decade.

What makes it hard to love? Putting aside the fact that the advisory firm’s name is “value” spelled backward (“Eulav”? Really guys?), it’s this sentence:

Ownership of Securities. None of the portfolio managers of the Value Line Asset Allocation Fund own shares of the Fund. The portfolio manager of the Value Line Small Cap Opportunities Fund similarly does not own shares of that Fund.

It’s also the fact that I’ve tried, on three occasions, to reach out to the fund’s advisor to ask why no manager ever puts a penny alongside his shareholders but they’ve never responded to any of the queries.

But wait! There’s 

Four things strike us as quite good:

1. You probably aren’t invested in any of the really rotten funds!
2. Even if you are, you know they’re rotten and you can easily get out.
3. There are better funds – ones more appropriate to your needs and personality – available.
4. We can help you find them!

Accipiter, Charles and Chip have been working hard to make it easier for you to find funds you’ll be comfortable with. We’d like to share two and have a third almost ready, but we need to be sure that our server can handle the load (we might a tiny bit have precipitated a server crash in November and so we’re being cautious until we can arrange a server upgrade).

The Risk Profile Search is designed to help you understand the different measures of a fund’s risk profile. Most fund profiles reduce a fund’s risks to a single label (“above average”) or a single stat (standard deviation = 17.63). Unfortunately, no one measure of risk captures the full picture and most measures of risk are not self-explanatory (how would you do on a pop quiz over the Martin Ratio?). Our Risk Profile Reporter allows you to enter a single ticker symbol for any fund and it will generate a short, clear report, in simple, conversational English, that walks you through the various means of risk and returns and will provide you with the profiles for a whole range of possible benchmarks. Alternatively, entering multiple ticker symbols will return a tabular results page, making side-by-side comparisons more convenient.

The Great Owl Search Engine allows you to screen our Great Owl Funds – those which have top tier performance in every trailing period of three years or more – by category or profile. We know that past performance should never be the primary driver of your decision-making, but working from a pool of consistently superior performers and learning more about their risk-return profile strikes us as a sensible place to start.

Our Fund Dashboard. a snapshot of all of the funds we’ve profiled, is updated quarterly and is available both as a .pdf and searchable, sortable search.

Accipiter’s Miraculous Multi-Search will, God and server willing, launch by mid-December and we’ll highlight its functions for you in our New Year’s edition.

Touchstone Funds: Setting a high standard on analysis

On November 13, Morningstar published an essay entitled “A Measure of Active Management.” Authored by Touchstone Investments, it’s entirely worth your consideration as one of the most readable walk-throughs available of the literature on active management and portfolio outperformance.

We all know that most actively managed funds underperform their benchmarks, often by more than the amount of their expense ratios. That is, even accounting for an index fund’s low-expense advantage, the average manager seems to actively detract value. Literally, many investors would be better off if their managers were turned to stone (“calling Madam Medusa, fund manager in Aisle Four”), the portfolio frozen and the manager never replaced.

Some managers, however, do consistently earn their keep. While they might or might not produce raw returns greater than those in an index fund, they can fine-tune strategies, moderate risks and keep investors calm and focused.

Touchstone’s essay at Morningstar makes two powerful contributions. First, the Touchstone folks make the criteria for success – small funds, active and focused portfolios, aligned interests – really accessible. Second, they document the horrifying reality of the fund industry: that a greater and greater fraction of all investments are going into funds that profess active management but are barely distinguishable from their benchmarks.

Here’s a piece of their essay:

A surprising take away from the Active Share studies was the clear trend away from higher Active Share (Exhibit 5). The percentage of assets in U.S. equity funds with Active Share less than 60% went from 1.5% in 1980 to 50.2% in 2009. Clearly indexing has had an impact on these results.

Yet mutual funds with assets under management with an Active Share between 20% and 60% (the closet indexers) saw their assets grow from 1.1% in 1980 to 31% in 2009, meaning that closet index funds have seen the greatest proportion of asset growth. Assets in funds managed with a high Active Share, (over 80%), have dropped precipitously from 60% in 1980 to just 19% in 2009.

While the 2009 data is likely exaggerated — as Active Share tends to come down in periods of high market volatility —the longer term trend is away from high Active Share.

 

Cremers and Petajisto speculate that asset growth of many funds may be one of the reasons for the trend toward lower Active Share. They note that the data reveals an inverse relationship between assets in a fund and Active Share. As assets grow, managers may have a tougher time maintaining high Active Share. As the saying goes “nothing fails like success,” and quite often asset growth can lead to a more narrow opportunity set due to liquidity constraints that prevent managers from allocating new assets to their best ideas, they then add more liquid benchmark holdings. Cremers states in his study: “What I say is, if you have skill, why not apply that skill to your whole portfolio? And if your fund is too large to do that, why not close your portfolio?”

In an essentially unprecedented disclosure, Touchstone then published the concentration and Active Share statistics for their entire lineup of funds:

While it’s clear that Touchstone has some great funds and some modest ones, they really deserve attention and praise for sharing important, rarely-disclosed information with all of their investors and with the public at large. We’d be much better served if other fund companies had the same degree of confidence and transparency.

Touchstone is also consolidating four funds into two, effective March 2014. Steve Owen, one of their Managing Directors and head of International Business Development, explains:

With regard to small value, we are consolidating two funds, both subadvised by the same subadvisor, DePrince, Race & Zollo. Touchstone Small Cap Value Fund (TVOAX) was a legacy fund and that will be the receiving fund. Touchstone Small Company Value Fund (FTVAX), the one that is going away, is a fund that was adopted last year when we bought the Fifth Third Fund Family and we replaced the subadvisor at that time with DePrince Race & Zollo. Same investment mandate, same subadvisor, so it was time to consolidate the two funds.

The Mid Value Opportunities Fund (TMOAX)was adopted last year from the Old Mutual Fund Family and will be merged into Touchstone Mid Cap Value Fund (TCVAX). Consolidating the lineup, eliminating the adopted fund in favor of our incumbent from four years ago.

In preparation for the merger, Lee Munder Capital Group has been given manager responsibilities for both mid-cap funds. Neither of the surviving funds is a stand-out performer but bear watching.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Aegis Value (AVALX): There are a few funds that promise to pursue the most inefficient, potentially most profitable corner of the domestic equity mark, ultra-small deep value stocks. Of the handful that pursue it, only one other microcap value fund even comes close to Aegis’s long-term record.

T. Rowe Price Global Allocation (RPGAX): T. Rowe is getting bold, cautiously. Their newest and most innovative fund offers a changing mix of global assets, including structural exposure to a single hedge fund, is also broadly diversified, low-cost and run by the team responsible for their Spectrum and Personal Strategy Funds. So far, so good!

Elevator Talk

Elevator Talks are a short feature which offer the opportunity for the managers of interesting funds which we are not yet ready to profile, to speak directly to you. The basic strategy is for the Observer to lay out three paragraphs of introduction and then to give the manager 200 unedited words – about what he’d have time for in an elevator ride with a prospective investors – to lay out his case for the fund.

Our planned Elevator Talk for December didn’t come to fruition, but we’ll keep working with the managers to see if we can get things lined up for January.

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.
10. November 2013: Jeffrey Ringdahl of American Beacon Flexible Bond (AFXAX) gives teams from Brandywine Global, GAM and PIMCO incredible leeway wth which to pursue “positive total return regardless of market conditions.” Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

Conference Call Highlights: John Park and Greg Jackson, Oakseed Opportunity

If I had to suggest what characteristics gave an investor the greater prospects for success, I suggest looking for demonstrably successful managers who viscerally disliked the prospect of careless risk and whose interests were visibly, substantially and consistently aligned with yours.

The evidence increasingly suggests that Oakseed Opportunity matches those criteria. On November 18^th, Messrs Jackson and Park joined me and three dozen Observer readers for an hour-long conversation about the fund and their approach to it.

I was struck, particularly, that their singular focus in talking about the fund is “complete alignment of interests.” A few claims particularly stood out:

1. their every investable penny in is in the fund.
2. they intend their personal gains to be driven by the fund’s performance and not by the acquisition of assets and fees
3. they’ll never manage separate accounts or a second fund
4. they created an “Institutional” class as a way of giving shareholders a choice between buying the fund NTF with a marketing fee or paying a transaction fee but not having the ongoing expense; originally they had a $1 million institutional minimum because they thought institutional shares had to be that pricey. Having discovered that there’s no logical requirement for that, they dropped the institutional minimum by 99%.
5. they’ll close on the day they come across an idea they love but can’t invest in
6. they’ll close if the fund becomes big enough that they have to hire somebody to help with it (no analysts, no marketers, no administrators – just the two of them)

Highlights on the investing front were two-fold:

first, they don’t intend to be “active investors” in the sense of buying into companies with defective managements and then trying to force management to act responsibly. Their time in the private equity/venture capital world taught them that that’s neither their particular strength nor their passion.

second, they have the ability to short stocks but they’ll only do so for offensive – rather than defensive – purposes. They imagine shorting as an alpha-generating tool, rather than a beta-managing one. But it sounds a lot like they’ll not short, given the magnitude of the losses that a mistaken short might trigger, unless there’s evidence of near-criminal negligence (or near-Congressional idiocy) on the part of a firm’s management. They do maintain a small short position on the Russell 2000 because the Russell is trading at an unprecedented high relative to the S&P and attempts to justify its valuations require what is, to their minds, laughable contortions (e.g., that the growth rate of Russell stocks will rise 33% in 2014 relative to where they are now.

Their reflections of 2013 performance were both wry and relevant. The fund is up 21% YTD, which trails the S&P500 by about 6.5%. Greg started by imagining what John’s reaction might have been if Greg said, a year ago, “hey, JP, our fund will finish its first year up more than 20%.” His guess was “gleeful” because neither of them could imagine the S&P500 up 27%. While trailing their benchmark is substantially annoying, they made these points about performance:

• beating an index during a sharp market rally is not their goal, outperforming across a complete cycle is.
• the fund’s cash stake – about 16% – and the small short position on the Russell 2000 doubtless hurt returns.
• nonetheless, they’re very satisfied with the portfolio and its positioning – they believe they offer “substantial downside protection,” that they’ve crafted a “sleep well at night” portfolio, and that they’ve especially cognizant of the fact that they’ve put their friends’, families’ and former investors’ money at risk – and they want to be sure that they’re being well-rewarded for the risks they’re taking.

John described their approach as “inherently conservative” and Greg invoked advice given to him by a former employer and brilliant manager, Don Yacktman: “always practice defense, Greg.”

When, at the close, I asked them what one thing they thought a potential investor in the fund most needed to understand in order to know whether they were a good “fit” for the fund, Greg Jackson volunteered the observation “we’re the most competitive people alive, we want great returns but we want them in the most risk-responsible way we can generate them.” John Park allowed “we’re not easy to categorize, we don’t adhere to stylebox purity and so we’re not going to fit into the plans of investors who invest by type.”

They announced that they should be NTF at Fidelity within a week. Their contracts with distributors such as Schwab give those platforms latitude to set the minimums, and so some platforms reflect the $10,000 institutional minimum, some picked $100,000 and others maintain the original $1M. It’s beyond the guys’ control.

Finally, they anticipate a small distribution this year, perhaps $0.04-0.05/share. That reflects two factors. They manage their positions to minimize tax burdens whenever that’s possible and the steadily growing number of investors in the fund diminishes the taxable gain attributed to any of them.

If you’re interested in the fund, you might benefit from reviewing the vigorous debate on the discussion board that followed the call. Our colleague Charles, who joined in on the call, looked at the managers’ previous funds. He writes: “OK, quick look back at LTFAX and OAKGX from circa 2000 through 2004. Ted, even you should be impressed…mitigated drawdown, superior absolute returns, and high risk adjusted returns.”

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

The SEEDX Conference Call

As with all of these funds, we’ve created a new featured funds page for Oakseed Opportunity Fund, pulling together all of the best resources we have for the fund.

December Conference Call: David Sherman, RiverPark Strategic Income

David Sherman

We’d be delighted if you’d join us on Monday, December 9^th, for a conversation with David Sherman of Cohanzick Asset Management and Morty Schaja, president of the RiverPark funds. On September 30, 2013, Cohanzick and Riverpark collaborated on the launch of their second fund together, RiverPark Strategic Income (RSIVX). Two months later, the fund has drawn nearly $90 million into a limited capacity strategy that sort of straddles the short- to intermediate-term border.

David describes this as a conservatively managed fund that focuses on reasonable returns with maximum downside protection. With both this fund and RiverPark Short-Term High-Yield (RPHYX, closed to new investors), David was comfortable having his mom invest in the fund and is also comfortable that if he gets, say, abducted by aliens, the fund could simply and profitably hold all of its bonds to redemption without putting her security as risk. Indeed, one hallmark of his strategy is its willingness to buy and hold to redemption rather than trading on the secondary market.

President Schaja writes, “In terms of a teaser….

• Sherman and his team are hoping for returns in the 6-8% range while managing a portfolio of “Money Good” securities with an average duration of less than 5 years.  Thereby, getting paid handsomely for the risk of rising rates.
• By being small and nimble Sherman and his team believe they can purchase “Money Good” securities with above average market yields with limited risk if held to maturity.
• The fund will be able to take advantage of some of the same securities in the 1-3 year maturity range that are in the short term high yield fund.
• There are “dented Credits” where credit stress is likely, however because of the seniority of the security the Fund will purchase, capital loss is deemed unlikely.

David has the fund positioned as the next step out from RPHYX on the risk-return spectrum and he thinks the new fund will about double the returns on its sibling. So far, so good:

Since I’m not a fan of wild rivers in a fixed-income portfolio, I really appreciate the total return line for the two RiverPark funds. Here’s Strategic Income against its multisector bond peer group:

Well, yes, I know that’s just two months. By way of context, here’s the three year comparison of RPHYX with its wildly-inappropriate Morningstar peer group (high yield bonds, orange), its plausible peer group (short-term bonds, green) and its functional peer, Vanguard’s Prime Money Market (VMMXX, hmmm…goldenrod?):

Our conference call will be Monday, December 9, from 7:00 – 8:00 Eastern. It’s free. It’s a phone call.

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WOULD AN ADDITIONAL HEADS UP HELP?

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Launch Alert: Kopernik Global All-Cap Fund (KGGAX and KGGIX)

It’s rare that the departure of a manager triggers that collapse of an empire, but that’s pretty much what happened when David Iben left his Nuveen Tradewinds Global All-Cap Fund (NWGAX) in June 2012. From inception through his departure, a $10,000 investment in NWGAX would have grown by $3750. An investment made in his average peer would have grown by $90.

Iben was hired away from Tradewinds by Jeff Vinik, the former Fidelity Magellan manager who’d left that fund in 1996 to establish his hedge fund firm, Vinik Asset Management. Iben moved with four analysts to Vinik and became head of a 20-person value investing team.

In the six months following his announced intention to depart, Tradewinds lost nearly 75% of its total assets under management. Not 75% of his funds’ assets. 75% of the entire firm’s assets, about $28 billion between investor exits and market declines.

In May 2013, Vinik announced the closure of his firm “citing poor performance over a 10-month period” (Tampa Bay Business Journal, May 3 2013). You’ll have to give me a second to let my eyes return to normal; the thought of closing a firm because of a ten month bad stretch made them roll.  Mr. Iben promptly launched his own firm, backed by a $20 million investment (a/k/a pocket change) by Mr. Vinik.

On November 1, 2013, Kopernik Global Investors launched launched Kopernik Global All-Cap Fund (Class A: KGGAX; Class I: KGGIX) which they hope will become their flagship. By month’s end, the fund had nearly $120 million in assets.

If we base an estimate of Kopernik Global on the biases evident in Nuveen Tradewinds Global, you might expect:

A frequently out-of-step portfolio, which reflects Mr. Iben’s value orientation, disdain for most investors’ moves and affinity for market volatility. They describe the outcome this way:

This investment philosophy implies ongoing contrarian asset positioning, which in turn implies that the performance of Kopernik holdings are less reliant on the prevailing sentiment of market investors. As one would expect with such asset positioning, the performance of Kopernik strategies tend to have little correlation to common benchmarks.

A substantial overweight in energy and basic materials, which Mr. Iben overweighted almost 2:1 relative to his peers. He had a particular affinity for gold-miners.

The potential for a substantial overweight in emerging markets, which Mr. Iben overweighted almost 2:1 relative to his peers.

A slight overweight in international stocks, which were 60% of the Tradewinds’ portfolio but a bit more than 50% of its peers.

The themes of independence, lack of correlation with other investments, and the exploitation of market anomalies recur throughout Kopernik’s website. If you’re even vaguely interested in exploring this fund, you’d better take those disclosures very seriously. Mr. Iben had brilliant performance in his first four years at Tradewinds, and then badly trailed his peers in five of his last six quarters. While we do not know how his strategy performed at Vinik, we do know that 10 months after his arrival, the firm closed for poor performance.

Extended periods of poor performance are one of the hallmarks of independent, contrarian, visionary investors. It’s also one of the hallmarks of self-prepossessed monomaniacs.  Sometimes the latter look like the former. Often enough, the former are the latter.

The first month of Kopernik’s performance (in blue) looks like this:

Mr. Iben is clearly not following the pack. You’d want to be comfortable with where he is leading the caravan before joining.

“A” shares carry a 5.75% load, capped 1.35% expenses and $3000 minimum. Institutional shares are no-load with expenses of 1.10% and a $1 million minimum. The fund is not (yet) available for sale at Schwab or the other major platforms and a Schwab rep says he does not see any evidence of active negotiation with Kopernik but recommends that interested parties check in occasionally at the Kopernik Global All-Cap page at Schwab. The “availability” tab will let you know if it has become available.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Any fund that wanted to launch before the end of the year needed to be in registration by mid- to late October.

And there were a lot of funds targeting a year-end launch. Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves. This month he tracked down 15 no-load retail funds in registration, which represents our core interest. That number is down from what we’d normally see because these funds won’t launch until February 2014; whenever possible, firms prefer to launch by December 30^th and so force a lot of funds into the pipeline in October.

Interesting entries this month include:

American Beacon Global Evolution Frontier Markets Income Fund will be the first frontier market bond fund, focusing on sovereign debt. It will be managed by a team from Global Evolution USA, LLC, a subsidiary of Global Evolution Fondsmæglerselskab A/S. But you already knew that, right?

PIMCO Balanced Income Fund primarily pursues income and will invest globally, both very much unlike the average balanced fund. They’ll invest globally in dividend-paying common and preferred stocks and all flavors of fixed- and floating-rate instruments. The prospectus is still in the early stages of development, so there’s no named manager or expense ratio. This might be good news for Sextant Global High Income (SGHIX), which tries to pursue the same distinctive strategy but has had trouble explaining itself to investors.

SPDR Floating Rate Treasury ETF and WisdomTree Floating Rate Treasury Fund will track index of the as-yet unissued floating rate Treasury notes, the first small auction of which will occur January 29, 2014.

Manager Changes

On a related note, we also tracked down 58 fund manager changes.

Updates: the reorganization of Aegis Value, take two

Last month we noted, with unwarranted snarkiness, the reorganization of Aegis Value Fund (AVALX).  We have now had a chance to further review the preliminary prospectus and a 73-page proxy filing. The reorganization had two aspects, one of which would be immediately visible to investors and the other of which may be significant behind the scenes.

The visible change: before reorganization AVALX operates as a no-load retail fund with one share class and a $10,000 investment minimum.  According to the filings, after reorganization, Aegis is expected to have two share classes.  In the reorganization, a new, front-loaded, retail A-share class would be introduced with a maximum 3.75% sales load but also a series of breakpoint reductions.  There would also be a two-year, 1% redemption fee on some A-share purchases with value in excess of $1 million. There would also be a no-load institutional share class with a published $1,000,000 minimum.  However, current AVALX shareholders would become holders of grandfathered institutional shares not subject to the $1 million investment minimum.

Does this mean that new retail investors get stuck paying a sales load?  No, not necessarily. While the institutional class of Aegis High Yield has the same nominal million dollar minimum as Aegis Value will, it’s currently available through many fund supermarkets with the same $10,000 minimum investment as the retail shares of Aegis Value now have. We suspect that Aegis Value shareholders may benefit from the same sort of arrangement.

Does this mean that retail investors get stuck paying a 1% redemption fee on shares sold early? Again, not necessarily. As best I understand it, the redemption fee applies only to broker-sold A-shares sold in denominations greater than $1 million where the advisor pays a commission to the broker if the shares are then redeemed within two years of purchase.  So folks buying no-load institutional shares or buying “A” shares and actually paying the sales load are expected to be exempt.

The visible changes appear designed to make the fund more attractive in the market and especially to the advisor market, though it remains an open question whether “A” shares are the package most attractive to such folks.  Despite competitive returns over the past five years, the fund’s AUM remains far below its peak so we believe there’s room and management ability for substantially more assets.

The invisible change: two existing legal structures interfere with the advisor’s smooth and efficient organization.  They have two funds (Aegis High Yield AHYAX/AHYFX is the other) with different legal structures (one Delaware Trust, one Maryland Corporation) and different fiscal year ends. That means two sets of bookkeeping and two sets of reports; the reorganization is expected to consolidate the two and streamline the process.  We estimate the clean-up might save the advisor a little bit in administrative expenses.  In the reorganization, AVALX is also eliminating some legacy investment restrictions.  For example, AVALX is currently restricted from holding more than 10% of the publicly-available shares of any company.  The reorganization would lift these restrictions.  While the Fund has in the past only rarely held positions approaching the 10 percent ownership threshold, lifting these kinds of restrictions may provide management with more investment flexibility in the future.

Briefly Noted . . .

In a surprising announcement, Forward Funds removed a four-person team from Cedar Ridge Partners as the sub-advisers responsible for Forward Credit Analysis Long/Short Fund (FLSLX).  The fund was built around Cedar Ridge’s expertise in muni bond investing and the team had managed the fund from inception.  Considered as a “non-traditional bond” fund by Morningstar, FLSLX absolutely clubbed their peers in 2009, 2011, and 2012 while trailing a bit in 2010.  Then this in 2013:

Over the past six months, FLSLX dropped about 14% in value while its peers drifted down less than 2%.

We spoke with CEO Alan Reid in mid-November about the change.  While he praised the Cedar Ridge team for their work, he noted that their strategy seemed to work best when credit spreads were compressed and poorly when they widened.  Bernanke’s May 22 Congressional testimony concerning “tapering” roiled the credit markets, but appears to have gobsmacked the Cedar Ridge team: that’s the cliff you see them falling off.  Forward asked them to “de-risk” the portfolio and shortly afterward asked them to do it again.  As he monitored the fund’s evolution, Mr. Reid faced the question “would I put my money in this fund for the next three to five years?”   When he realized the answer was “no,” he moved to change management.

The new management team, Joseph Deane and David Hammer, comes from PIMCO.  Both are muni bond managers, though neither has run a fund or – so far as I can tell – a long/short portfolio.  Nonetheless they’re back by an enormous analyst corps.  That means they’re likely to have access to stronger research which would lead to better security selection.  Mr. Reid points to three other distinctions:

There is likely to be less exposure to low-quality issues, but more exposure to other parts of the fixed-income market.  The revised prospectus points to “municipal bonds, corporate bonds, notes and other debentures, U.S. Treasury and Agency securities, sovereign debt, emerging markets debt, variable rate demand notes, floating rate or zero coupon securities and nonconvertible preferred securities.”

There is likely to be a more conservative hedging strategy, focused on the use of credit default swaps and futures rather than shorting Treasury bonds.

The fund’s expenses have been materially reduced.  Cedar Ridge’s management fee had already been cut from 1.5% to 1.2% and the new PIMCO team is under contract for 1.0%.

It would be wise to approach with care, since the team is promising but untested and the strategy is new.  That said, Forward has been acting quickly and decisively in their shareholders’ interests and they have arranged an awfully attractive partnership with PIMCO.

Wow.  In mid-November T. Rowe Price’s board decided to merge the T. Rowe Price Global Infrastructure Fund (TRGFX) into T. Rowe Price Real Assets Fund (PRAFX).  Equity CIO John Linehan talked with us in late November about the move.  The short version is this: Global Infrastructure found very little market appeal because the vogue for infrastructure investing is in private equity rather than stocks.  That is, investors would rather own the lease on a toll road than own stock in a company which owns, among other things, the lease on a toll road. Since the fund’s investment rationale – providing a hedge against inflation – can be addressed well in the Real Assets funds, it made business sense to merge Infrastructure away.

Taken as a global stock fund, Infrastructure was small and mediocre. (We warned that “[t]he case for a dedicated infrastructure fund, and this fund in particular, is still unproven.”) Taken as a global stock fund, Real Assets is large and rotten. The key is that “real assets” funds are largely an inflation-hedge, investing in firms that control “stuff in the ground.”  With inflation dauntingly low, all funds with this focus (AllianceBernstein, Cohen & Steers, Cornerstone, Harford, Principal and others offer them) has looked somewhere between “punky” and “putrid.”  In the interim, Price has replaced Infrastructure’s manager (Kes Visuvalingam has replaced Susanta Mazumdar) and suspended its redemption fee, for the convenience of those who would like out early. 

Our Real Assets profile highlights the fact that this portfolio might be used as a small hedge in a diversified portfolio; perhaps 3-5%, which reflects its weight in Price’s asset allocation portfolios.  Mr. Lee warns that the fund, with its huge sector bets on energy and real estate, will underperform in a low-inflation environment and would have no structural advantage even in a moderate rate one. Investors should probably celebrate PRAFX’s underperformance as a sign that the chief scourge of their savings and investments – inflation – is so thoroughly suppressed.

FundX Tactical Total Return Fund (TOTLX) Effective January 31, 2014, the investment objective of the FundX Tactical Total Return Fund is revised to read:  “The Fund seeks long term capital appreciation with less volatility than the broad equity market; capital preservation is a secondary consideration.”

SMALL WINS FOR INVESTORS

CAN SLIM® Select Growth Fund (CANGX) On Monday, November 11, 2013, the Board of Trustees of Professionally Managed Portfolios approved the following change to the Fund’s Summary Prospectus, Prospectus and Statement of Additional Information: The Fund’s Expense Cap has been reduced from 1.70% to 1.39%.

The expense ratio on nine of Guggenheim’s S&P500 Equal Weight sector ETFS (Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Materials, Technology and Utilities) have dropped from 0.50% to 0.40%.

Effective November 15^th, REMS Real Estate Income 50/50 (RREFX) eliminated its sales load and reduced its 12(b)1 fee from 0.35% to 0.25%.  The new investment minimum is $2,500, up from its previous $1,000.  The 50/50 refers to the fund’s target allocation: 50% in the common stock of REITs, 50% in their preferred securities.

Effective mid-November, the Meridian Funds activated Advisor and Institutional share classes.

CLOSINGS (and related inconveniences)

Effective November 18, 2013, the Buffalo Emerging Opportunities Fund (BUFOX), a series of Buffalo Funds, will be closed to all new accounts, including new employer sponsored retirement plans (“ESRPs”).  The Fund will remain open to additional investments by all existing accounts

Invesco European Small Company Fund (ESMAX) will close to all investors effective the open of business on December 4, 2013. The fund has $560 million in AUM, a low turnover style and a splendid record. The long-time lead manager, Jason Holzer, manages 13 other funds, most for Invesco and most in the European and international small cap realms. That means he’s responsible for over $16 billion in assets.  He has over a million invested both here and in his International Small Company Fund (IEGAX).

Effective December 31, 2013, T. Rowe Price New Horizons Fund (PRHNX) will be closed to new investors.  This used to be one of Price’s best small cap growth funds until the weight of $14 billion in assets moved it up the scale.  Morningstar still categorizes it as “small growth” and it still has a fair chunk of its assets in small cap names, but a majority of its holdings are now mid- to large-cap stocks.

Also on December 31, 2013, the T. Rowe Price Small-Cap Stock Fund (OTCFX) will be closed to new investors.  Small Cap is smaller than New Horizons – $9 billion versus $14 billion – and maintains a far higher exposure to small cap stocks (about 70% of the portfolio).  Nonetheless it faces serious headwinds from the inevitable pressure of a rising asset base – up by $2 billion in 12 months.  There’s an interesting hint buried in the fund’s ticker symbol: it was once the Over the Counter Securities Fund.

Too late: Vulcan Value Partners Small Cap Fund (VVPSX), which we profiled as “a solid, sensible, profitable vehicle” shortly after launch, vindicated our judgment when it closed to new investors at the end of November.  The closure came with about one week’s notice, which strikes me as a responsible decision if you’re actually looking to close off new flows rather than trigger a last minute rush for the door.  The fund’s current AUM, $750 million, still gives it plenty of room to maneuver in the small cap realm. 

Effective December 31, 2013, Wells Fargo Advantage Emerging Markets Equity Fund (EMGAX) will be closed to most new investors.  Curious timing: four years in a row (2009-2012) of top decile returns, and it stayed open.  Utterly mediocre returns in 2013 (50^th percentile, slightly underwater) and it closes.

OLD WINE, NEW BOTTLES

BlackRock Emerging Market Local Debt Portfolio (BAEDX) is changing its name and oh so much more.  On New Year’s 2014, shareholders will find themselves invested in BlackRock Emerging Markets Flexible Dynamic Bond Portfolio which certainly sounds a lot more … uhh, flexible.  And dynamic!  I sometimes wonder if fund marketers have an app on their iPhones, rather like UrbanSpoon, where you hit “shake” and slot machine-like wheels start spinning.  When they stop you get some combination of Flexible, Strategic, Multi-, Asset, Manager, Strategy, Dynamic, Flexible and Tactical.

Oh, right.  Back to the fund.  The Flexible Dynamic fund will flexibly and dynamically invest in what it invests in now except they are no longer bound to keep 65% or more in local-currency bonds.

Effective March 1, 2014, BMO Government Income Fund (MRGIX) beomes BMO Mortgage Income Fund. There will be no change in strategy reflecting the fact that the government gets its income from . . . uh, mortgages?

Effective December 11, 2013 Columbia Large Cap Core Fund (NSGAX) will change to Columbia Select Large Cap Equity Fund.  The prospectus for the new version of the fund warns that it might concentrate on a single sector (they name technology) and will likely hold 45-65 stocks, which is about where they already are.  At that same time, Columbia Active Portfolios® – Diversified Equity Income Fund (INDZX) becomes Active Portfolios® Multi-Manager Value Fund and Columbia Recovery and Infrastructure (RRIAX) becomes Columbia Global Infrastructure Fund.  Morningstar rates it as a one-star fund despite high relative returns since inception, which suggests that the fund’s volatility is higher still.

Dreyfus will ask shareholders to approve a set of as-yet undescribed strategy changes which, if approved, will cause them to change the Dreyfus/Standish Intermediate Tax Exempt Bond Fund to Dreyfus Tax Sensitive Total Return Bond Fund

On February 21, 20414, Dreyfus/The Boston Company Emerging Markets Core Equity Fund will change its name to Dreyfus Diversified Emerging Markets Fund.

Effective December 23, 2013, Forward Select Income Opportunity Fund (FSONX) becomes Forward Select Opportunity Fund.  The fact that neither the fund’s webpage nor its fact sheet report any income (i.e., there’s not even a spot for 30-day SEC yield or anything like it) might be telling us why “income” is leaving the name.

Ivy Pacific Opportunities Fund (IPOAX) seems to have become Ivy Emerging Markets Equity Fund. The new fund’s prospectus shifts it from a mid-to-large cap fund to an all-cap portfolio, adds the proviso that up to 20% of the portfolio might be invested in precious metals. There’s an unclear provision about investing in a Cayman Islands subsidiary to gain commodities exposure but it’s not clear whether that’s in addition to the gold.  And, finally, Ivy Asset Strategy New Opportunities Fund (INOAX) will merge into the new fund in early 2014.  That might come as a surprise to INOAX shareholders, since their current fund is not primarily an emerging markets vehicle.

OFF TO THE DUSTBIN OF HISTORY

Corporate America CU Short Duration Fund (CASDX) liquidated at the end of November.  That’s apparently more evidence of Corporate America’s shortened time horizon.  The fund was open a bit more than a year and pulled in a bit more than $60 million in assets before the advisor thought … what?  “Oh, we’re not very good at this”?  “Oh, we’re not apt to get very good at this”?  “Oh, look!  There’s a butterfly”?

Delaware International Bond Fund (DPIFX) will be liquidated and dissolved on New Year’s Eve.  I knew several grad students who suffered a similar fate that evening.

The Equinox funds plan a wholesale liquidation: Equinox Abraham Strategy Fund (EABIX), Absolute Return Plus Strategy (EMEIX), Eclipse Strategy (EECIX), John Locke Strategy (EJILX), QCM Strategy (EQQCX) and Tiverton Strategy (EQTVX) all meet their maker on December 9^th.  The smallest of these funds has about $8500 in AUM.  Right: not enough to buy a used 2010 Toyota Corolla.  The largest has about $600,000 and, in total, they don’t reach $750,000.  All are classified as “managed futures” funds and no, I have no earthly idea why Equinox has seven such funds: the six dead funds walking and the surviving Equinox Crabel Strategy (EQCRX) which has about $15,000 in AUM.

Given that these funds have $25,000 minimums and half of them have under $25,000 in assets, the clear implications is that several of these funds have one shareholder. In no instance, however, is that one shareholder a manager of the fund since none of the five managers was silly enough to invest.

FundX ETF Upgrader Fund (REMIX) is merging into the FundX Upgrader Fund (FUNDX) and the FundX ETF Aggressive Upgrader Fund (UNBOX) goes into the FundX Aggressive Upgrader Fund (HOTFX), effective January 24, 2014.   My colleague Charles’s thoughtful and extensive analysis of their flagship FundX Upgrader Fund offers them as “a cautionary tale” for folks whose strategy is to churn their portfolios, always seeking hot funds.

An ING fund disappears: ING has designated ING Bond Portfolio (IABPX) as a “disappearing portfolio.”  They craftily plan to ask shareholders in late February to authorize the disappearance.  The largely-inoffensive ING Intermediate Bond Portfolio (IIABX) has been designated as “the Surviving Portfolio.”

But nothing will survive of ING American Funds International Growth and Income Portfolio (IAIPX) or ING American Funds Global Growth and Income Portfolio (IAGPX), both of which will be liquidated on February 7, 2014.

ING PIMCO High Yield Portfolio (IPHYX) disappears on February 14 and is replaced by ING High Yield Portfolio.  See ING decided to replace the world’s most renowned fixed income shop, which was running a four-star $900 million portfolio for them, with themselves with Rick Cumberledge and team, nice people who haven’t previously managed a mutual fund.  The investors get to celebrate a two (count ‘em: 2!) basis point fee reduction as a result.

The Board of Trustees of the JPMorgan India Fund (JIDAX) has approved the liquidation and dissolution of the Fund on or about January 10, 2014.  The fund has a six-year record that’s a bit above average but that comes out as a 17% loss since inception.  The $9.5 million there would have been, and would still be, better used in Matthews India (MINDX).  

We’d already announced the closure and impending liquidation of BlackRock India Fund (BAINX).  The closure occurred October 28 and the liquidation occurs on December 10, 2013.  BAINX – the bane of your portfolio?  due to be bain-ished from it? – is down 14% since launch, its peers are down 21% from the same date. 

The Board of Trustees of the JPMorgan U.S. Real Estate Fund (SUSIX) has approved the liquidation and dissolution of the Fund on or about December 20, 2013.  Color me clueless: it’s an unimpressive fund, but it’s not wretched and it does have $380 million dollars.

Litman Gregory Masters Focused Opportunities Fund (MSFOX) is merging into Litman Gregory Masters Equity Fund (MSENX) because, they explain, MSFOX

… has had net shareholder redemptions over the past five years, causing the asset level of the Focused Opportunities Fund to decline almost 50% over that time period.  The decline in assets has resulted in a corresponding increase in the Focused Opportunities Fund’s expense ratio, and … it is unlikely that the Focused Opportunities Fund will increase in size significantly in the foreseeable future.

The first part of that statement is a bit disingenuous.  MSFOX has $67 million at the moment.  The only time it exceeded that level was in 2007 when, at year end, it had $118 million.  It lost 60% between October 2007 and March 2009 (much more than its peers) and has never regained its place in the market. The Observer has a favorable opinion of the fund, which has earned four stars from Morningstar and five for Returns, Consistency and Preservation from Lipper but its fall does point to the fragility of survival once investors have been burned. This is the second fund to merge into MSENX, Litman Gregory Masters Value was the first, in May 2013.

The Lord hath left the building: the shareholders of Lord Abbett Classic Stock Fund (LRLCX) convened on November 7^th to ponder the future of their fund.  Fifteen days later it was gone, absorbed by Lord Abbett Calibrated Dividend Growth Fund (LAMAX).  Not to suggest that Lord Abbett was going through the motions, but they did put the LAMAX managers in charge of LRLCX back on June 11^th. 

Mercer Investment Management decided to liquidate the Mercer US Short Maturity Fixed Income Fund (MUSMX) on or about December 16, 2013

Monetta has decided to liquidate Monetta Mid-Cap Equity Fund (MMCEX), effective as of the close of business on December 20, 2013.  Robert Baccarella has been running the fund for 20 years, the last four with his son, Robert.  Despite a couple good years, the fund has resided in the 98^th or 99^th percentiles for performance for long ago.

Effective December 9, 2013, the name of the MutualHedge Frontier Legends Fund (MHFAX) changes to Equinox MutualHedge Futures Strategy Fund.  Morningstar has a Neutral rating on the fund and describes it as “good but not great yet” because of some management instability and high expenses.

Paladin Long Short Fund (PALFX) will discontinue operations on December 20, 2013.  Given the fund’s wild churning, this closure might well threaten the profitability of three or four systemically important institutions:

Why, yes, the liquidation is a taxable event for you.  Not so much for the fund’s manager, who has under $50,000 invested.  Given that the fund has, from inception in 2011 to mid-November 2013 lost money for its investors, taxes generated by churn will be particularly galling.

As noted above, T. Rowe Price Global Infrastructure Fund (TRGFX) is slated to merge into T. Rowe Price Real Assets Fund (PRAFX) in the spring of 2014.

Quaker Funds closed Quaker Akros Absolute Return Fund (AARFX) and the Quaker Small-Cap Growth Tactical Allocation Fund (QGASX) on November 5^th in anticipation of liquidating them (an action which requires shareholder approval).  I have no idea of why they’re ditching AARFX.  The fund promises “absolute returns.”  $10,000 invested at inception in 2005 would be worth $10,040 today.  Mission accomplished!

Roosevelt Strategic Income Fund (RSTIX) was liquidated on November 27, 2013.  That’s presumably a low-assets/bad marketing sort of call since the fund had top tier returns compared to its global bond peers over the two-plus years of its existence.  The manager, Arthur Sheer, continues managing Roosevelt Multi-Cap (BULLX).

The Royce Fund’s Board of Trustees approved a plan of liquidation for Royce Global Select Long/Short Fund (RSTFX), to be effective on December 2, 2013. The Fund is being liquidated primarily because it has not attracted and maintained assets at a sufficient level for it to be viable.  The decision elicited several disgusted comments on the board, directed at Royce Funds.  The tenor of the comments was this: “Royce, a Legg Mason subsidiary, has morphed from an investment manager to an asset gatherer.  It’s the Legg Mason mantra: “assets (hence revenues) über alles.”  It’s indisputably the case that Royce rolled out a bunch of funds once it became part of Mason; they ran 11 funds when they were independent, 29 today plus some Legg Mason branded funds (such as Legg Mason Royce Smaller Companies Premier, £ denominated “A” shares in Ireland) and some sub-advised ones.  And the senior Royce managers presume to oversee more funds than almost any serious peer: Charles Royce – 13 funds, Whitney George – 10 funds, David Nadel – 10 funds.

Then, too, it’s not very good. At least over the past three years, it’s badly trailed a whole variety of benchmarks.

Symetra funds has decided, for no immediately evident reason, to liquidate several successful funds (Symetra DoubleLine Total Return, Symetra DoubleLine Emerging Markets Income and Symetra Yacktman Focused).

TEAM Asset Strategy Fund (TEAMX) is liquidating, but it’s doing so with refreshing honesty: it’s “because of a decline in assets due to continued poor performance and significant redemptions.” 

Yep.  You’re reading it right: $10,000 becomes $1904.  75% YTD loss.  To which I can only response: “Go, TEAM, go!  Quickly!  Go now!”

The Board of Directors of Tributary Funds has approved liquidation of Tributary Large Cap Growth Fund (FOLCX) on or about January 29, 2014.  Since David Jordan, manager of the five-star Tributary Balanced (FOBAX) and flagship four-star Growth Opportunities (FOGRX) funds, took over in 2011, the fund has had very competitive returns but not enough to draw serious assets and move the fund toward economic viability.

Vanguard Tax-Managed International Fund (VTMGX) merges into the Vanguard Developed Markets Index Fund, which is expected to occur on or about April 4, 2014.  Finally, a $20 billion closet index fund (the r-squared against the MSCI EAFE Index was nearly 99) that just surrenders to being an index!  In a final dose of irony, VTMGX tracked its index better than does the index fund into which it’s merging.  Indeed, there are seven international large-blend index funds which track their indexes less faithfully than the supposedly-active VTMGX did. 

In Closing . . .

Thanks to all of the folks who join us each month, and thanks especially to those who support the Observer by joining our remarkably thoughtful discussion board, by sharing tips and leads with me by email, and by contributing through PayPal or via our Amazon partnership.  Your interest and engagements helps make up for a lot of late nights and the occasional withering glare as we duck away from family gatherings to write a bit more.

Our partnership with Amazon provides our steadiest income stream: if you buy a $14 book, we get about a buck. If you buy a Cuisinart Brew Central coffeemaker at $78, we get five or six.  Buy an iPad and we get bumpkus (Apple refuses to play along), but that’s okay, they’re cool anyway. There are, nonetheless, way cool smaller retailers that we’ve come across but that you might not have heard of. The Observer has no financial stake in any of this stuff but I like sharing word of things that strike me as really first-rate.

Some guys wear ties rarely enough that they need to keep that little “how to tie a tie” diagram taped to their bathroom mirrors.  Other guys really wish that they had a job where they wore ties rarely enough that they needed to keep that little “how to tie a tie” diagram taped up.

Duluth sells clothes, and accessories, for them.  I own rather a lot of it.  Their stuff is remarkably well-made if moderately pricey.  Their sweatshirts, by way of example, are $45-50 when they’re not on sale.  JCPenney claims that their sweatshirts are $48 but on perma-sale for $20 or so.  The difference is that Duluth’s are substantially better: thicker fabric, longer cut, with thoughtful touches like expandable/stretchy side panels.

VoiceBase offers cools, affordable transcription services.  We’re working with the folks at Beck, Mack & Oliver to generate a FINRA-compliant transcript of our October conference call with Zac Wydra.  Step One was to generate a raw transcript with which the compliance folks at Beck, Mack might work. Chip, our estimable technical director, sorted through a variety of sites before settling on VoiceBase.

It strikes us that their service is cool, reliable and affordable.  Here’s the process.  Set up a free account.  Upload an audio file to their site.  About 24 hours later, they’ve generate a free machine-based transcription for you.  If you need greater accuracy than the machine produces – having multiple speakers and variable audio quality wreaks havoc with the poor beastie’s circuits – they provide human transcription within two or three days.

The cool part is that they host the audio on their website in a searchable format.  Go to the audio, type “emerging markets” and the system automatically flags any uses of that phrase and allows you to listen directly to them. If you’d like to play, here is the MFO Conference Call with Zac Wydra.

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

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

We hope it’s a joyful holiday season for you all, and we look forward to seeing you in the New Year.

Dear friends,

Occasionally Facebook produces finds that I’m at a loss to explain.  Ecce:

(Thanks to Nina K., a really first-rate writer and first-rate property/insurance lawyer in the Bay State for sharing Mr. Takei’s post with us. Now if I could just get her to restrain the impulse to blurt out, incredulous, “you really find this stuff interesting?”)

Let’s see.  Should I be more curious about the fact that Mr. Takei (iconically Ensign Sulu on Star Trek) manages just a basso profundo “oh myyy” on his post or the fact that he was recently lounging in a waiting room at the University of Iowa Hospitals, a bit west of here?  Perhaps it would be better to let his friends weigh in?

Chip’s vote was to simply swipe her favorite image from the thread, one labeled “a real hedge fund.”

Which is to say, a market that tacks on 29% in a year makes it easy to think of investing as fun and funny again. 

Now if only that popular sentiment could be reconciled with the fact that a bunch of very disciplined, very successful managers are quietly selling down their stocks and building their cash reserves again.

Here’s today’s “know your Morningstar!” quiz.  

Here are the total return charts for two short-term bond funds.  One is the sole Morningstar Gold Medalist in the group, representing “one of the industry’s best managers, and one of the category’s best funds.”  The other is a lowly one-star fund unworthy of Morningstar’s notice 

Question: do you …know your Morningstar!?  Which is the golden child?  Is it blue or orange?

Would it help to know that one of these funds is managed by a multi-trillion dollar titan and the other by a small, distinctive boutique?  Or that one of the funds invests quite conventionally and fits neatly into a style-box while the other is one-of-a-kind?

If you know your Morningstar, you’ll know that “small, distinctive and hard to pigeonhole” is pretty much the kiss of death.  The orange (or gold) line represents PIMCO Low Duration, “D” shares (PLDDX).  It’s a $24 billion “juggernaut” (Morningstar’s term) that’s earned four stars and a Gold designation.  It tends to be in the top quarter of the short-term bond group, though not at its top, and is a bit riskier than average.

The blue line represents RiverPark Short Term High Yield (RPHYX), an absolutely first-rate cash management fund about which we’ve written a lot. And which Morningstar just designated as a one-star fund. Why so?  Because Morningstar classifies it as a “high yield bond” fund and benchmarks it against an investment class that has outperformed the stock market over the past 15 years but with the highest volatility in the fixed-income universe. To be clear: there is essentially no overlap between RiverPark’s portfolio and the average high-yield bond funds and they have entirely different strategies, objectives and risk profiles. Which is to say, Morningstar has managed a classic “walnuts to lug nuts” comparison.

Here’s the defense Morningstar might reasonably make: “we had to put it somewhere.  It says ‘high yield.’  We put it there.”

Here’s our response: “that’s a sad and self-damning answer.  Yes, you had to put it somewhere.  But having put it in a place that you know is wildly inappropriate, you also need to accept the responsibility – to your readers, to RiverPark’s investors and to yourselves – to address your decision.  You’ve got the world’s biggest and best supported corps of analysts in the world. Use them! Don’t ignore the funds that do well outside of the comfortable framework of style boxes, categories and corporate investing! If the algorithms produce palpably misleading ratings, speak up.”

But, of course, they didn’t.

The problem is straightforward: Morningstar’s ratings are most reliable when you least need them. For funds with conventional, straightforward, style-pure disciplines – index funds and closet index funds – the star ratings probably produce a fair snapshot across the funds. But really, how hard is it – even absent Morningstar’s imprimatur – to find the most solid offering among a gaggle of long-only, domestic large cap, growth-at-a-reasonable price funds? You’ll get 90% of the way there with three numbers: five year returns, five year volatility and expense ratio. Look for ones where the first is higher and the second two are lower.

When funds try not to follow the herd, when the manager appears to have a brain and to be using it to pursue different possibilities, is when the ratings system is most prone to misleading readers. That’s when you need to hear an expert’s analysis. 

So why, then, deploy your analysts to write endless prose about domestic large cap funds? Because that’s where the money is.

Morningstar ETF Invest: Rather less useful content than I’d imagined

Morningstar hosted their ETF-focused conference in Chicago at the beginning of October.  The folks report that the gathering has tripled in size over the last couple years, turned away potential registrants and will soon need to move to a new space.  After three days there, though, I came away with few strong reactions.  I was struck by the decision of one keynote speaker to refer to active fixed-income managers as “the enemy” (no, dude, check the mirror) and the apparent anxiety around Fidelity’s decision to enter the ETF market (“Fidelity is coming.  We know they’re coming.  It’s only a matter of time,” warned one).

My greatest bewilderment was at the industry’s apparent insistence on damaging themselves as quickly and thoroughly as possible.  ETFs really have, at most, three advantages: they’re cheap, transparent and liquid.  The vogue seems to be for frittering that away.  More and more advisors are being persuaded to purchase the services of managed portfolio advisors who, for a fee, promise to custom-package (and trade) dozens of ETFs.  I spoke with representatives of a couple index providers, including FTSE, who corroborated Morningstar’s assertion that there are likely two million separate security indexes in operation with more being created daily. And many of the exchange-traded products rely in derivatives to try to capture the movements of those 2,000,000.  On whole, it feels like a systematic attempt to capture the most troubling features of the mutual fund industry – all while preening about your Olympian superiority to the mutual fund industry.

Odd.

The most interesting presentation at the conference was made by Austan Goolsbee, a University of Chicago economist and former chief of the President’s Council of Economic Advisers, who addressed a luncheon crowd. It was a thoroughly unexpected performance: there’s a strong overtone of Jon Stewart from The Daily Show, an almost antic energy. The presentation was one-third Goolsbee family anecdotes (“when I’d complain about a problem, gramma would say ‘80% of us don’t care. . . and the other 20% are glad about it'”), one-third White House anecdotes and one-third economic arguments.

The short version:

• The next 12-18 months will be tough because the old drivers of recovery aren’t available this time. Over the last century, house prices appreciated by 40 basis points annually for the first 90 years. From 2000-08, it appreciated 1350 bps annually. In the future, 40 bps is likely about right which means that a recovery in the housing industry won’t be lifting all boats any time soon.
• We’ll know the economy is recovering when 25 year olds start moving out of their parents’ basements, renting little apartments, buying futons and cheap pots and pans. (Technically, an uptick in household formation. Since the beginning of the recession, the US population has grown by 10 million but the number of households has remained flat.) One optimistic measure that Goolsbee did not mention but which seems comparable: the number of Americans choosing to quit their jobs (presumably for something better) is rising.
• The shutdown is probably a good thing, since it will derail efforts to create an unnecessary crisis around the debt ceiling.
• In the longer term, the US will recover and grow at 3.5% annually, driven by a population that’s growing (we’ll likely peak around 400 million while Japan, Western Europe and Russia contract), the world’s most productive workforce and relatively light taxation. While Social Security faces challenges, they’re manageable. Given the slow rolling crisis in higher education and the near collapse of new business launches over the past decade, I’m actually somewhere between skeptical and queasy on this one.
• The Chinese economic numbers can’t be trusted at all. The US reports quarterly economic data after a 30 day lag and frequently revises the numbers 30 days after that. China reports their quarterly numbers one day after the end of the quarter and has never revised any of the numbers. A better measure of Chinese activity is derivable from FedEx volume (it’s way down) since China is so export driven.

One highlight was his report of a headline from The Onion: “recession-plagued nation demands a new bubble to invest in … so we can get the economy going again. We need a concrete way to create illusory wealth in the near future.”

One of the great things about having Messrs Studzinski and Boccadoro contributing to the Observer is that they’re keen, experienced observers and very good writers.  The other great thing about it is that I no longer have to bear the label, “the cranky one.” In the following essay, Ed Studzinkski takes on one of the beloved touchstones of shareholder-friendly management: “skin in the game.”  Further down, Charles Boccadoro casts a skeptical eye, in a data-rich piece, on the likelihood that an investor’s going to avoid permanent loss of capital.

Skin in the Game, Part Two

The trouble with our times is that the future is not what it used to be.

Paul Valery

Nassim Nicholas Taleb, the author of The Black Swan as well as Antifragile: Things That Gain from Disorder, has recently been giving a series of interviews in which he argues that current investment industry compensation practices lead to subtle conflicts of interest, that end up inuring to the disadvantage of individual investors. Nowhere is this more apparent than when one looks at the mutual fund complexes that have become asset gatherers rather than investment managers.

By way of full disclosure I have to tell you that I am an admirer of Mr. Taleb’s. I was not always the most popular boy in the classroom as I was always worrying about the need to consider the potential for “Black Swan” or outlier events. Unfortunately all one has to have is one investment massacre like the 2008-2009 period. This gave investors a lost decade of investment returns and a potentially permanent loss of capital if they panicked and liquidated their investments. To have a more in-depth appreciation of the concept and its implications, I commend those of you with the time to a careful study of the data that the Mutual Fund Observer has compiled and begun releasing regularly. You should pay particular attention to a number called the “Maximum Drawdown.” There you will see that as a result of that dark period, looking back five years it is a rarity to find a domestic fund manager who did not lose 35-50% of his or her investors’ money. The same is to be said for global and international fund managers who likewise did not distinguish themselves, losing 50-65% of investors’ capital, assuming the investors panicked and liquidated their investments, and many did.

A number of investment managers that I know are not fans of Mr. Taleb’s work, primarily because he has a habit of bringing attention to inconvenient truths. In Fooled by Randomness, he made the case that given the large number of people who had come into the investment management business in recent years, there were a number who had to have generated good records randomly. They were what he calls “spurious winners.” I would argue that the maximum drawdown numbers referred to above confirm that thesis.

How then to avoid the spurious winner? Taleb argues that the hedge fund industry serves as a model, by truly having managers with “skin in the game.” In his experience a hedge fund manager typically has twenty to fifty times the exposure of his next biggest client. That of necessity makes them both more careful and as well as aware of the consequences if they have underinvested in the necessary talent to remain competitive. Taleb quite definitively states, “You don’t get that with fund managers.”

I suspect the counterargument I am going to hear is that fund managers are now required to disclose, by means of reporting within various ranges, the amount of money they have invested in the fund they are managing. Just go to the Statement of Additional Information, which is usually found on a fund website. And if the SAI shows that the manager has more than $1 million invested in his or her fund, then that is supposed to be a good sign concerning alignment of interests. Like the old Hertz commercial, the real rather than apparent answer is “not exactly.”

The gold standard in this regard has been set by Longleaf Partners with their funds. Their employees are required to limit their publicly offered equity investments to funds advised by Southeastern Asset Management, Longleaf’s advisor, unless granted a compliance exception. Their trustees also must obtain permission before making a publicly offered equity investment. That is rather unique in the fund industry, since what you usually see in the marketing brochures or periodic fund reports is something like “the employees and families of blah-blah have more than $X million invested in our funds.” If you are lucky this may work out to be one percent of assets under management in the firm, hardly hedge-fund like metrics. At the same time, you often find trustees of the fund with de minimis investments.

The comparison becomes worse when you look at a fund with $9 billion in assets and the “normal” one percent investment management fee, which generates $90 million in revenue. The fund manager may tell you that his largest equity investment is in the fund and is more than $1 million. But if his annual compensation runs somewhere between $1million and $10 million, and this is Taleb’s strongest point, the fund manager does not have a true disincentive for losing money. The situation becomes even more blurred where compliance policy allows investment in ETF’s or open-ended mutual funds, which in today’s world will often allow a fund manager to construct his own personal market neutral or hedged portfolio, to offset his investment in the fund he is managing.

Is there a solution? Yes, a fairly easy one – adopt as an industry standard through government regulation the requirement that all employees in the investment firm are required to limit their publicly offered equity investments to the funds in the complex. To give credit where credit is due, just as we have a Volcker rule, we can call it the “Southeastern Asset Management” rule. If that should prove too restrictive, I would suggest as an alternative that the SEC add another band of investment ranges above the current $1 million limit, at perhaps $5 million. That at least would give a truer picture for the investor, especially given the money flows now gushing into a number of firms, which often make a $1 million investment not material to the fund manager. Such disclosure will do a better job of attuning investment professionals to what should be their real concern – managing risk with a view towards the potential downside, rather than ignoring risk with other people’s money.

Postscript:

What does it say when such well known value managers as Tweedy, Browne and First Pacific Advisors are letting cash positions rise in their portfolios as they sell and don’t replace securities that have reached their target valuations? Probably the same thing as when one of the people I consider to be one of the outstanding money managers of our time, Seth Klarman at Baupost Partners, announces that he will be returning some capital to his partnership investors at year end. Stay tuned.

So, if it’s “the best,” why can’t people just agree on what it is?

Last month David pointed out how little overlap he found between three popular mutual fund lists: Kiplinger 25, Money 70, and Morningstar’s Fantastic 51. David mused: “You’d think that if all of these publications shared the same sensible goal – good risk-adjusted returns and shareholder-friendly practices – they’d also be stumbling across the same funds. You’d be wrong.”

He found only one fund, Dodge & Cox International Fund DODFX, on all three lists. Just one! Although just one is a statistically better outcome than randomly picking three such lists from the 6600 or so mutual funds and 1000 ETFs, it does seem surprisingly small. 

Opening up the field a little, by replacing the Fantastic 51 with a list of 232 funds formed from Morningstar’s current “Gold-Rated Funds” and “Favorite ETFs,” the overlap does not improve much. Just two funds appear in all three publications: DODFX and Habor Bond Institutional HABDX. Just two!

While perhaps not directly comparable, the table below provides a quick summary of the criteria used by each publication. Money 70 criteria actually include Morningstar’s so-called stewardship grade, which must be one of the least maintained measures. For example, Morningstar awarded Bruce Berkowitz Fund Manager of the Decade, but it never published a stewardship grade for Fairholme.

Overall, however, the criteria seem quite similar, or as David described “good risk-adjusted returns and shareholder-friendly practices.”  Add in experienced managers for good measure and one would expect the lists to overlap pretty well. But again, they don’t.

How do the “forward-looking” recommendations in each of these lists fare against Morningstar’s purely quantitative “backward-looking” performance rating system? Not as well as you might think. There are just seven 5-star funds on Money’s list, or 1-in-10. Kiplinger does the best with six, from a percentage perspective, or almost 1-in-4. (They must have peeked.) Morningstar’s own list includes 44 5-star funds, or about 1-in-5. So, as well intentioned and “forward looking” as these analysts certainly try to be, only a small minority of their “best funds” have delivered top-tier returns.

On the other hand, they each do better than picking funds arbitrarily, if not unwittingly, since Morningstar assigns 5 stars to only about 1-in-17 funds. Neither of the two over-lapping funds that appear on all three lists, DODFX and HABDX, have 5 stars. But both have a commendable 4 stars, and certainly, that’s good enough.

Lowering expectations a bit, how many funds appear on at least two of these lists? The answer: 38, excluding the two trifectas. Vanguard dominates with 14. T. Rowe Price and American Funds each have 4. Fidelity has just one. Most have 4 stars, a few have 3, like SLASX, probably the scariest.

But there is no Artisan. There is no Tweedy. There is no Matthews. There is no TCW or Doubleline. There are no PIMCO bond funds. (Can you believe?) There is no Yacktman. Or Arke. Or Sequoia. There are no funds less than five years old. In short, there’s a lot missing.

There are, however, nine 5-star funds among the 38, or just about 1-in-4. That’s not bad. Interestingly, not one is a fixed income fund, which is probably a sign of the times. Here’s how they stack-up in MFO’s own “backward looking” ratings system, updated through September:

Four are moderate allocation funds: FPACX, PRWCX, VWELX, and TRRBX. Three are Vanguard funds: VWELX, VDIGX, and VASVX. One FMI fund FMIHX and one Oakmark fund OAKIX. Hard to argue with any of these funds, especially the three Great Owls: PRWCX, VWELX, and OAKIX.

These lists of “best funds” are probably not a bad place to start, especially for those new to mutual funds. They tend to expose investors to many perfectly acceptable, if more mainstream, funds with desirable characteristics: lower fees, experienced teams, defensible, if not superior, past performance.

They probably do not stress downside potential enough, so any selection needs to also take risk tolerance and investment time-frame into account. And, incredulously, Morningstar continues to give Gold ratings to loaded funds, about 1-in-7 actually.

The lists produce surprisingly little overlap, perhaps simply because there are a lot of funds available that satisfy the broad screening criteria. But within the little bit of overlap, one can find some very satisfying funds.

Money 70 and Kiplinger 25 are free and online. Morningstar’s rated funds are available for a premium subscription. (Cheapest path may be to subscribe for just one month each year at $22 while performing an annual portfolio review.)

As for a list of smaller, less well known mutual funds with great managers and intriguing strategies? Well, of course, that’s the niche MFO aspires to cover.

23Oct2013/Charles

The Great Owl search engine has arrived

Great Owls are the designation that my colleague Charles Boccadoro gives to those funds which are first in the top 20% of their peer group for every trailing period of three years or more. Because we know that “risk” is often more durable and a better predictor of investor actions than “return” is, we’ve compiled a wide variety of risk measures for each of the Great Owl funds.

Up until now, we’ve been limited to publishing the Great Owls as a .pdf while working on a search engine for them. We’re pleased to announce the launch of the Great Owl Search, 1.0. We expect in the months ahead to widen the engine’s function and to better integrate it into the site. We hope you like it.

For JJ and other fans of FundAlarm’s Three-Alarm and Most Alarming fund lists, we’re working to create a predefined search that will allow you to quickly and reliable identify the most gruesome investments in the fund world. More soon!

Who do you trust for fund information?

The short answer is: not fund companies.  On October 22, the WSJ’s Karen Damato hosted an online poll entitled Poll: The Best Source of Mutual-Fund Information? 

Representing, as I do, Column Three, I should be cheered.  Teaching, as I do, Journalism 215: News Literacy, I felt compelled to admit that the results were somewhere between empty (the margin of error is 10.89, so it’s “somewhere between 16% and 38% think it’s the fund company’s website and marketing materials”) and discouraging (the country’s leading financial newspaper managed to engage the interest of precisely 81 of its readers on this question).

Nina Eisenman, President of Eisenman Associates which oversees strategic communications for corporations, and sometime contributor to the Observer

Asking which of the 3 choices individual investors find “most useful” generates data that creates an impression that they don’t use the other two at all when, in fact, they may use all 3 to varying degrees. It’s also a broad question. Are investors responding based on what’s most useful to them in conducting their initial research or due diligence? For example, I may read about a fund in the Mutual Fund Observer (“other website”) and decide to check it out but I would (hopefully) look at the fund’s website, read the manager’s letters and the fund prospectus before I actually put money in.

When I surveyed financial advisors and RIAs on the same topic, but gave them an option to rate the importance of various sources of information they use, the vast majority used mutual funds’ own websites to some extent as part of their due diligence research. [especially for] fund-specific information (including the fund prospectus which is generally available on the website) that can help investors make educated investment decisions.

Both Nina’s own research and the results of a comparable Advisor Perspectives poll can be found at FundSites, her portal for addressing the challenges and practices of small- to medium sizes fund company websites.

The difference between “departures” and “succession planning”

Three firms this month announced the decisions of superb managers to move on. Happily for their investors, the departures are long-dated and seem to be surrounded by a careful succession planning process.

Mitch Milias will be retiring at the end of 2013

Primecap Management was founded by three American Funds veterans. That generation is passing. Howard Schow has passed away at age 84 in April 2012. Vanguard observer Dan Weiner wrote at the time that “To say that he was one of the best, and least-known investors would be a vast understatement.”  The second of the triumvirate, Mitch Milias, retires in two months at 71.  That leaves Theo Kolokotrones who, at 68, is likely in the latter half of his investing career.  Milias has served as comanager of four Gold-rated funds: Vanguard Primecap  (VPMCX) Vanguard Primecap Core (VPCCX), Primecap Odyssey Growth (POGRX), and  Primecap Odyssey Stock (POSKX).

Neil Woodford will depart Invesco in April, 2014

British fund manager Neil Woodford is leaving after 25 years of managing Invesco Perpetual High Income Fund and the Invesco Perpetual Income Fund. Mr. Woodford apparently is the best known manager in England and described as a “hero” in the media for his resolute style.  He’s decided to set up his own English fund company.  In making the move he reports:

My decision to leave is a personal one based on my views about where I see long-term opportunities in the fund management industry.  My intention is to establish a new fund management business serving institutional and retail clients as soon as possible after 29th April 2014.

His investors seem somehow less sanguine: they pulled over £1 billion in the two weeks after his announcement.  Invesco’s British president describes that reaction as “calm.”

Given Mr. Woodford’s reputation and the global nature of the securities market, I would surely flag 1 May 2014 as a day to peer across the Atlantic to see what “long-term opportunities” he’s pursuing.

Scott Satterwhite will be retiring at the end of September, 2016

Scott Satterwhite joined Artisan from Wachovia Securities in 1997 and was the sole manager of Artisan Small Cap Value (ARTVX) from its launch. ARTVX is also the longest-tenured fund in my non-retirement portfolio; I moved my Artisan Small Cap (ARTSX) investment into Satterwhite’s fund almost as soon as it launched and I’ve never had reason to question that decision.  Mr. Satterwhite then extended his discipline into Artisan Mid Cap Value (ARTQX) and the large cap Artisan Value (ARTLX).  All are, as is typical of Artisan, superb.

Artisan has a really strong internal culture and focus on creating coherent, self-sustaining investment teams.  Three years after launch, Satterwhite’s long-time analyst Jim Kieffer became a co-manager.  George Sertl was added six years after that and Dan Kane six years later.  Mr. Kane is now described as “the informal lead manager” with Satterwhite on ARTVX.  This is probably one of the two most significant manager changes in Artisan’s history (the retirement of its founder was the other) but the firm seems exceptionally well-positioned both to attract additional talent and to manage the required three year transition.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds.  Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds.  “Stars in the Shadows” are older funds that have attracted far less attention than they deserve. 

T. Rowe Price Global Allocation (RPGAX): T. Rowe is getting bold, cautiously.  Their newest and most innovative fund offers a changing mix of global assets, including structural exposure to a single hedge fund, is also broadly diversified, low-cost and run by the team responsible for their Spectrum and Personal Strategy Funds.  So far, so good!

Oops! The fund profile is slightly delayed. Please check back tomorrow.

Elevator Talk: Jeffrey K. Ringdahl of American Beacon Flexible Bond (AFXAX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

In a fundamentally hostile environment, investors need to have a flexible approach to income investing. Some funds express that flexibility by investing in emerging market bonds, financial derivatives such as options, or illiquid securities (think: “lease payments from the apartment complex we just bought”).

American Beacon’s decision was to target “positive total return regardless of market conditions” in their version.  Beacon, like Harbor, positions itself as “a manager of managers” and assembles teams of institutional sub-advisors to manage the actual portfolio.  In this case, they’ve paired Brandywine Global, GAM and PIMCO and have given the managers extraordinarily leeway in pursuing the fund’s objective.  One measure of that flexibility is the fund’s duration, a measure of interest rate sensitivity.  They project a duration of anything from negative five years (effectively shorting the market) to plus eight years (generally the preferred spot for long-term owners of bond funds).  Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

Jeff Ringdahl is American Beacon’s Chief Operating Officer and one of the primary architects of the Flexible Bond Strategy. He’s worked with a bunch of “A” tier management firms including Touchstone Investments, Fidelity and State Street Global Advisors.   Here are his 245 words (I know, he overshot) on why you should consider a flexible bond strategy:

In building an alternative to a traditional bond fund, our goal was to stay true to what we consider the three tenets of traditional bond investing: current income, principal preservation and equity diversification.  However, we also sought to protect against unstable interest rates and credit spreads.

The word “unconstrained” is often used to describe similar strategies, but we believe “flexible” is a better descriptor for our approach. Many investors associate the word “unconstrained” with higher risk.  We implemented important risk constraints which help to create a lower risk profile. Our multi-manager structure is a key distinguishing characteristic because of its built-in risk management. Unconstrained or flexible bond funds feature a great degree of investment flexibility. While investment managers may deliver compelling risk-adjusted performance by using this enhanced flexibility, there may be an increased possibility of underperformance because there are fewer risk controls imposed by many of our peer funds. In our opinion, if you would ever want to diversify your managers you would do so where the manager had the greatest latitude. We think that this product style is uniquely designed for multi-manager diversification.

Flexible bond investing allows asset managers the ability to invest long and short across the global bond and currency markets to capitalize on opportunities in the broad areas of credit, currencies and yield curve strategies. We think focusing on the three Cs: Credit, Currency and Curve gives us an advantage in seeking to deliver positive returns over a complete market cycle.

The fund has five share classes. The minimum initial investment for the no-load Investor class is $2,500.   Expenses are 1.27% on about $300 million in assets.

The fund’s website is functional but spare.  You get the essential information, but there’s no particular wealth of insight or commentary on this strategy (and there is one odd picture of a bunch of sailboats barely able to get out of one another’s way).

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.

Conference Call Highlights: Zac Wydra of Beck, Mack & Oliver Partners

We looked for a picture of Zac Wydra on the web but found Wydra the Otter instead. We decided that Zac is cute but Wydra is cuter, so… If we can find a t-shirt with Wydra’s picture on it, we might send it along to Zac with our best wishes.

In mid-October we spoke for about an hour with Zac Wydra of Beck, Mack & Oliver Partners Fund (BMPEX). There were about 30 other participants on the call. I’ve elsewhere analogized Beck, Mack to Dodge & Cox: an old money, white shoe firm whose core business is helping the rich stay rich. In general, you need a $3 million minimum investment to engage with them. Partners was created in 1991 as a limited partnership to accommodate the grandkids or staff of their clients, folks who might only have a few hundred thousand to commit. (Insert about here: “Snowball gulps”) The “limited” in limited partnership signals a maximum number of investors, 100. The partnership filled up and prospered. When the managing partner retired, Zac made a pitch to convert the partnership to a ’40 fund and make it more widely available. He argued that he thought there was a wider audience for a disciplined, concentrated fund.

He was made the fund’s inaugural manager. He’s 41 and anticipates running BMPEX for about the next quarter century, at which point he’ll be required – as all partners are – to move into retirement and undertake a phased five year divestment of his economic stake in the firm. His then-former ownership stake will be available to help attract and retain the best cadre of younger professionals that they can find. Between now and retirement he will (1) not run any other pooled investment vehicle, (2) not allow BMPEX to get noticeably bigger than $1.5 billion – he’ll return capital to investors first – and (3) will, over a period of years, train and oversee a potential successor.

In the interim, the discipline is simple:

1. never hold more than 30 securities – he can hold bonds but hasn’t found any that offer a better risk/return profile than the stocks he’s found.
2. only invest in firms with great management teams, a criterion that’s met when the team demonstrates superior capital allocation decisions over a period of years
3. invest only in firms whose cash flows are consistent and predictable. Some fine firms come with high variable flows and some are in industries whose drivers are particularly hard to decipher; he avoids those altogether.
4. only buy when stocks sell at a sufficient discount to fair value that you’ve got a margin of safety, a patience that was illustrated by his decision to watch Bed, Bath & Beyond for over two and a half years before a short-term stumble triggered a panicky price drop and he could move in. In general, he is targeting stocks which have the prospect of gaining at least 50% over the next three years and which will not lose value over that time.
5. ignore the question of whether it’s a “high turnover” or “low turnover” strategy. His argument is that the market determines the turnover rate. If his holdings become overpriced, he’ll sell them quickly. If the market collapses, he’ll look for stocks with even better risk/return profiles than those currently in the portfolio. In general, it would be common for him to turn over three to five names in the portfolio each year, though occasionally that’s just recycling: he’ll sell a good firm whose stock becomes overvalued then buy it back again once it becomes undervalued.

Two listener questions, in particular, stood out:

Kevin asked what Zac’s “edge” was. A focus on cash, rather than earnings, seemed to be the core of it. Businesses exist to generate cash, not earnings, and so BM&O’s valuations were driven by discounted cash flow models. Those models were meaningful only if it were possible to calculate the durability of cash flows over 5 years. In industries where cash flows have volatile, it’s hard to assign a meaningful multiple and so he avoids them.

Seth asked what mistakes have you made and what did you learn from them? Zac hearkened back to the days when the fund was still a private partnership. They’d invested in AIG which subsequently turned into a bloody mess. Ummm, “not an enjoyable experience” was his phrase. He learned from that that “independent” was not always the same as “contrary.” AIG was selling at what appeared to be a lunatic discount, so BM&O bought in a contrarian move. Out of the resulting debacle, Zac learned a bit more respect for the market’s occasionally unexplainable pricings of an asset. At base, if the market says a stock is worth twenty cents a share, you’d better than remarkably strong evidence in order to act on an internal valuation of twenty dollars a share.

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

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

The BMPEX Conference Call

As with all of these funds, we’ve created a new featured funds page for Beck, Mack & Oliver Partners Fund, pulling together all of the best resources we have for the fund, including a brand new audio profile in .mp3 format.

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

As promised, my colleague Charles Boccadoro weighs in on your almost-magical ability to turn a temporary loss of principal into a …

Permanent Loss of Capital

The father of value investing, Benjamin Graham, employed the concept of “Margin of Safety” to minimize risk of permanent loss. His great student, Warren Buffett, puts it like this: “Rule No. 1: never lose money; rule No. 2: don’t forget rule No. 1.”

Zachary Wydra, portfolio manager of the 5-star Beck Mack & Oliver Partners (BMPEX) fund, actually cited Mr. Buffett’s quote during the recent MFO conference call.

But a look at Berkshire Hathaway, one of the great stocks of all time, shows it dropped 46% between December 2007 and February of 2009. And, further back, it dropped about the same between June 1998 and February 2002. So, is Mr. Buffett not following his own rule? Similarly, a look at BMPEX shows an even steeper decline in 2009 at -54%, slightly worse than the SP500.

The distinction, of course, is that drawdown does not necessarily mean loss, unless one sells at what is only a temporary loss in valuation – as opposed to an unrecoverable loss, like experienced by Enron shareholders. Since its 2009 drawdown, BMPEX is in fact up an enviable 161%, beating the SP500 by 9%.

Robert Arnott, founder of Research Associates, summarizes as follows: “Temporary losses of value are frequent; at times they can become so frightening that they become permanent—for those that sell.” Distinguishing between temporary drawdown and permanent loss of capital (aka “the ultimate risk”) is singularly the most important, if unnerving, aspect of successful value investing.

Mr. Wydra explains his strategy is to target stocks that have an upside potential over the next three years of at least 50% and will not lose value over that time. Translation: “loss,” as far as BMPEX is concerned, equates to no drawdown over a three year period. A very practical goal indeed, since any longer period would likely not be tolerated by risk averse investors.

And yet, it is very, very hard to do, perhaps even impossible for any fund that is primarily long equities.

Here is downside SP500 total return performance looking back about 52 years:

It says that 3-year returns fall below zero over nearly 30% of the time and the SP500 shows a loss of 20% or more in 15% of 3-year returns. If we compare returns against consumer price index (CPI), the result is even worse. But for simplicity (and Pete’s) sake, we will not. Fact is, over this time frame, one would need to have invested in the SP500 for nearly 12 years continuously to guarantee a positive return. 12 years!

How many equity or asset allocation funds have not experienced a drawdown over any three year period? Very few. In the last 20 years, only four, or about 1-in-1000. Gabelli ABC (GABCX) and Merger (MERFX), both in the market neutral category and both focused on merger arbitrage strategies. Along with Permanent Portfolio (PRPFX) and Midas Perpetual Portfolio (MPREX), both in the conservative allocation category and both with large a percentage of their portfolios in gold. None of these four beat the SP500. (Although three beat bonds and GABCX did so with especially low volatility.)

So, while delivering equity-like returns without incurring a “loss” over a three year period may simply prove too high a goal to come true, it is what we wish was true.

29Oct2013/Charles

Conference Call Upcoming: John Park and Greg Jackson, Oakseed Opportunity, November 18, 7:00 – 8:00 Eastern

On November 18, Observer readers will have the opportunity to hear from, and speak to John Park and Greg Jackson, co-managers of Oakseed Opportunity Fund (SEEDX and SEDEX). John managed Columbia Acorn Select for five and a half years and, at his 2004 departure, Morningstar announced “we are troubled by his departure: Park had run this fund since its inception and was a big driver behind its great long-term record. He was also the firm’s primary health-care analyst.” Greg co-managed Oakmark Global (OAKGX) for over four years and his departure in 2003 prompted an Eeyore-ish, “It’s never good news when a talented manager leaves.”

The guys moved to Blum Capital, a venture capital firm.  They did well, made money but had less fun than they’d like so they decided to return to managing a distinctly low-profile mutual fund.

Oakseed is designed to be an opportunistic equity fund.  Its managers are expected to be able to look broadly and go boldly, wherever the greatest opportunities present themselves.  It’s limited by neither geography, market cap nor stylebox.   John Park laid out its mission succinctly: “we pursue the maximum returns in the safest way possible.”

I asked John where he thought they’d focus their opening comments.  Here’s his reply:

We would like to talk about the structure of our firm and how it relates to the fund at the outset of the call.  I think people should know we’re not the usual fund management company most people think of when investing in a fund. We discussed this in our first letter to shareholders, but I think it’s worthwhile for our prospective and current investors to know that Oakseed is the only client we have, primarily because we want complete alignment with our clients from not only a mutual investment perspective (“skin in the game”), but also that all of our time is spent on this one entity. In addition, being founders of our firm and this fund, with no intentions of ever starting and managing a new fund, there is much less risk to our investors that one or both of us would ever leave. I think having that assurance is important.

Our conference call will be Monday, November 18, from 7:00 – 8:00 Eastern.  It’s free.  It’s a phone call.

How can you join in?

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

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

WOULD AN ADDITIONAL HEADS UP HELP?

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

Conference Call Queue: David Sherman, RiverPark Strategic Income, December 9, 7:00 – 8:00 Eastern

On Monday, December 9, from 7:00 – 8:00 Eastern, you’ll have a chance to meet David Sherman, manager of RiverPark Short Term High Yield (RPHYX) and the newly-launched RiverPark Strategic Income Fund (RSIVX). David positions RSIVX as the next step out on the risk-return ladder from RPHYX: capable of doubling its sibling’s returns with entirely manageable risk.  If you’d like to get ahead of the curve, you can register for the call with David though I will highlight his call in next month’s issue.

Launch Alert: DoubleLine Shiller Enhanced CAPE

On October 29, DoubleLine Shiller Enhanced CAPE (DSEEX and DSENX) launched. The fund will use derivatives to try to outperform the Shiller Barclays CAPE US Sector Total Return Index.  CAPE is an acronym for “cyclically-adjusted price/earnings.”  The measure was propounded by Nobel Prize winning economist Robert Shiller as a way of taking some of the hocus-pocus out of the calculation of price/earnings ratios.  At base, it divides today’s stock price by the average, inflation-adjusted earnings from the past decade.  Shiller argues that current earnings are often deceptive since profit margins tend over time to regress to the mean and many firms earnings run on three to five year cycles.  As a result, the market might look dirt cheap (high profit margins plus high cyclical earnings = low conventional P/E) when it’s actually poised for a fall.  Looking at prices relative to longer-term earnings gives you a better chance of getting sucked into a value trap.

The fund will be managed by The Gundlach and Jeffrey Sherman. Messrs Gundlach and Sherman also work together on the distinctly disappointing Multi-Asset Growth fund (DMLAX), so the combination of these guys and an interesting idea doesn’t translate immediately into a desirable product.  The fact that it, like many PIMCO funds, is complicated and derivatives-driven counsels for due caution in one’s due diligence. The “N” share class has a $2000 minimum initial investment and 0.91% expense ratio.  The institutional shares are about one-third cheaper.

Those interested in a nice introduction to the CAPE research might look at Samuel Lee’s 2012 CAPE Crusader essay at Morningstar. There’s a fact sheet and a little other information on the fund’s homepage.

Funds in Registration (The New Year’s Edition)

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Any fund that wanted to launch before the end of the year needed to be in registration by mid- to late October.

And there were a lot of funds targeting a year-end launch. Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves.  This month he tracked down 24 no-load retail funds in registration, which represents our core interest.  But if you expand that to include ETFs, institutional funds, reorganized funds and load-bearing funds, you find nearly 120 new vehicles scheduled for Christmas delivery.

Close readers might find the answers to four funds in reg quiz questions:

1. Which manager of a newly-registered fund had the schmanciest high society wedding this year?
2. Which fund in registration gave Snowball, by far, the biggest headache as he tried to translate their prose to English?
3. Which hedge fund manager decided that the perfect time to launch a mutual fund was after getting bludgeoned on returns for two consecutive years?
4. Which managers seem most attuned to young investors, skippering craft that might be described as Clifford the Big Red Mutual Fund and the Spongebob Fund?

Manager Changes

On a related note, we also tracked down 51 fund manager changes.

Updates

One of the characteristics of good managers is their ability to think clearly and one of the best clues to the existence of clear thinking is clear writing. Here’s a decent rule: if they can’t write a grocery list without babbling, you should avoid them. Contrarily, clear, graceful writing often reflects clear thinking.

Many managers update their commentaries and fund materials quarterly and we want to guide you to the most recent discussions and data possible for the funds we’ve written about. The indefatigable Mr. Welsch has checked (and updated) every link and linked document for every fund we’ve profiled in 2013 and for most of 2012. Here’s David’s summary table, which will allow you to click through to a variety of updated documents.

Briefly Noted 

A big ol’ “uhhh” to Advisory Research Emerging Markets All Cap Value Fund (the “Fund”) which has changed both manager (“Effective immediately, Brien M. O’Brien is no longer a portfolio manager of the Fund”) and name (it will be Advisory Research Emerging Markets Opportunities Fund), both before the fund even launched.  A few days after that announcement, AR also decided that Matthew Dougherty would be removed as a manager of the still-unlaunched fund.  On the bright side, it didn’t close to new investors before launch, so that’s good.  Launch date is November 1, 2013.

In a singularly dark day, Mr. O’Brien was also removed as manager of Advisory Research Small Micro Cap Value Fund, which has also not launched and has changed its name: Advisory Research Small Company Opportunities Fund.”

A Centaur arises!  The Tilson funds used to be a two-fund family: the one that Mr. Tilson ran and the one that was really good. After years of returns that never quite matched the hype, Mr. Tilson liquidated his Tilson Focus (TILFX) fund in June 2013.  That left behind the Tilson-less Tilson Dividend Fund (TILDX) which we described as “an awfully compelling little fund.”

Effective November 1, Tilson Dividend became Centaur Total Return Fund (TILDX), named after its long-time sub-adviser, Centaur Capital Partners.  Rick Schumacher, the operations guy at the Centaur funds, elaborates:

Since Tilson is no longer involved in the mutual fund whatsoever, and since the Dividend Fund has historically generated as much (if not more) income from covered call premiums rather than pure dividends, we felt that it was a good time to rebrand the fund.  So, effective today, our fund is now named the Centaur Total Return Fund.  We have kept the ticker (TILDX), as nothing’s really changed as far as the investment objective or strategy of the fund, and besides, we like our track record.  But, we’re very excited about our new Centaur Mutual Funds brand, as it will provide us with potential opportunities to launch other strategies under this platform in the future.

They’ve just launched a clean and appropriate dignified website that both represents the new fund and archives the analytic materials relevant to its old designation.  The fund sits at $65 million in assets with cash occupying about a quarter of its portfolio.  All cap, four stars, low risk. It’s worth considering, which we’ll do again in our December issue.

Laudus Growth Investors U.S. Large Cap Growth Fund is having almost as much fun.  On September 24, its Board booted UBS Global Asset Management as the managers of the fund in favor of BlackRock.  They then changed the name (to Laudus U.S. Large Cap Growth Fund) and, generously, slashed the fund’s expense ratio by an entire basis point from 0.78% to 0.77%.

But no joy in Mudville: the shareholder meeting being held to vote on the merger of  Lord Abbett Classic Stock Fund (LRLCX) into Lord Abbett Calibrated Dividend Growth Fund (LAMAX) has been adjourned until November 7, 2013 for lack of a quorum.

Scout Funds are sporting a redesigned website. Despite the fact that our profiles of Scout Unconstrained Bond and Scout Low Duration don’t qualify as “news” for the purposes of their media list (sniffles), I agree with reader Dennis Green’s celebration of the fact the new site is “thoughtful, with a classy layout, and—are you sitting down?— their data are no longer stale and are readily accessible!”  Thanks to Dennis for the heads-up.

Snowball’s portfolio: in September, I noted that two funds were on the watchlist for my own, non-retirement portfolio.  They were Aston River Road Long Short (ARLSX) and RiverPark Strategic Income (RSIVX). I’ve now opened a small exploratory position in Aston (I pay much more attention to a fund when I have actual money at risk) as I continue to explore the possibility of transferring my Northern Global Tactical Asset Allocation (BBALX) investment there.  The Strategic Income position is small but permanent and linked to a monthly automatic investment plan.

For those interested, John Waggoner of USA Today talked with me for a long while about the industry and interesting new funds.  Part of that conversation contributed to his October 17 article, “New Funds Worth Mentioning.”

SMALL WINS FOR INVESTORS

Eaton Vance Asian Small Companies Fund (EVASX) will eliminate its danged annoying “B” share class on November 4, 2013. It’s still trying to catch up from having lost 70% in the 2007-09 meltdown. 

Green Owl Intrinsic Value Fund (GOWLX) substantially reduced its expense cap from 1.40% to 1.10%. It’s been a very solid little large cap fund since its launch in early 2012.

Invesco Balanced-Risk Commodity Strategy Fund (BRCAX) will reopen to new investors on November 8, 2013. The fund has three quarters of a billion in assets despite trailing its peers and losing money in two of its first three years of existence.

As of December, Vanguard Dividend Appreciation Index (VDAIX) will have new Admiral shares with a 0.10% expense ratio and a $10,000 minimum investment. That’s a welcome savings on a fund currently charging 0.20% for the Investor share class.

At eight funds, Vanguard will rename Signal shares as Admiral shares and will lower the minimum investment to $10,000 from $100,000.

Zeo Strategic Income Fund (ZEOIX) dropped its “institutional” minimum to $5,000.  I will say this for Zeo: it’s very steady.

CLOSINGS (and related inconveniences)

The Brown Capital Management Small Company Fund (BCSIX) closed to new investors on October 18, 2013.

Buffalo Emerging Opportunities Fund (BUFOX) formally announced its intention to close to new investors when the fund’s assets under management reach $475 million. At last check, they’re at $420 million.  Five star fund with consistently top 1% returns.  If you’re curious, check quick!

GW&K Small Cap Equity Fund (GWETX) is slated to close to new investors on November 1, 2013.

Matthews Pacific Tiger Fund (MAPTX) closed to new investors on October 25, 2013.

Oakmark International (OAKIX) closed to most new investors as of the close of business on October 4, 2013

Templeton Foreign Smaller Companies (FINEX) will close to new investors on December 10^th.  I have no idea of why: it’s a small fund with an undistinguished but not awful record. Liquidation seems unlikely but I can’t imagine that much hot money has been burning a hole in the managers’ pockets.

Touchstone Merger Arbitrage Fund (TMGAX), already mostly closed, will limit access a bit more on November 11, 2013.  That means closing the fund to new financial advisors.

OLD WINE, NEW BOTTLES

Advisory Research Emerging Markets All Cap Value Fund has renamed itself, before launch, as Advisory Research Emerging Markets Opportunities Fund.

Aegis Value Fund (AVALX) has been reorganized as … Aegis Value Fund (AVALX), except with a sales load (see story above).

DundeeWealth US, LP (the “Adviser”) has also changed its name to “Scotia Institutional Investments US, LP” effective November 1, 2013.

The Hatteras suite of alternative strategy funds (Hatteras Alpha Hedged Strategies, Hedged Strategies Fund, Long/Short Debt Fund, Long/Short Equity Fund and Managed Futures Strategies Fund) have been sold to RCS Capital Corporation and Scotland Acquisition, LLC.  We know this because the SEC filing avers the “Purchaser will purchase from the Sellers and the Sellers will sell to the Purchaser, substantially all the assets related to the business and operations of the Sellers and … the “Hatteras Funds Group.” Morningstar has a “negative” analyst rating on the group but I cannot find a discussion of that judgment.

Ladenburg Thalmann Alternative Strategies Fund (LTAFX) have been boldly renamed (wait for it) Alternative Strategies Fund.  It appears to be another in the expanding array of “interval” funds, whose shares are illiquid and partially redeemable just once a quarter. Its performance since October 2010 launch has been substantially better than its open-ended peers.

Effective October 7, 2013, the WisdomTree Global ex-US Growth Fund (DNL) became WisdomTree Global ex-US Dividend Growth Fund.

U.S. Global Investors MegaTrends Fund (MEGAX) will, on December 20, become Holmes Growth Fund

OFF TO THE DUSTBIN OF HISTORY

On-going thanks to The Shadow for help in tracking the consequences of “the perennial gale of creative destruction” blowing through the industry.  Shadow, a member of the Observer’s discussion community, has an uncanny talent for identifying and posting fund liquidations (and occasionally) launches to our discussion board about, oh, 30 seconds after the SEC first learns of the change.  Rather more than three dozen of the changes noted here and elsewhere in Briefly Noted were flagged by The Shadow.  While my daily reading of SEC 497 filings identified most of the them, his work really does contribute a lot. 

And so, thanks, big guy!

On October 16, 2013, the Board of Trustees of the Trust approved a Plan of Liquidation, which authorizes the termination, liquidation and dissolution of the 361 Absolute Alpha Fund. In order to effect such liquidation, the Fund is closed to all new investment. Shareholders may redeem their shares until the date of liquidation. The Fund will be liquidated on or about October 30, 2013.

City National Rochdale Diversified Equity Fund (the “Diversified Fund”) has merged into City National Rochdale U.S. Core Equity Fund while City National Rochdale Full Maturity Fixed Income Fund was absorbed by City National Rochdale Intermediate Fixed Income Fund

Great-West Ariel Small Cap Value Fund (MXSCX) will merge into Great-West Ariel Mid Cap Value Fund (MXMCX) around Christmas, 2013.  That’s probably a win for shareholders, since SCV has been mired in the muck while MCV has posted top 1% returns over the past five years.

As we suspected, Fidelity Europe Capital Appreciation Fund (FECAX) is merging into Fidelity Europe Fund (FIEUX). FECAX was supposed to be the aggressive growth version of FIEUX but the funds have operated as virtually clones for the past five years.  And neither has particularly justified its existence: average risk, average return, high r-squared despite the advantages of low expenses and a large analyst pool.

The Board of the Hansberger funds seems concerned that you don’t quite understand the implications of having a fund liquidated.  And so, in the announcement of the October 18 liquidation of Hansberger International Fund they helpfully explain: “The Fund no longer exists, and as a result, shares of the Fund are no longer available for purchase.”

Highland Alpha Trend Strategies Fund (HATAX), formerly Pyxis Alpha Trend Strategies Fund, will close on November 20, 2013.  With assets not much greater than my retirement account (and performance vastly below it), I’m not sure that even the manager will notice the disappearance.

Huntington Income Equity (HUINX) will merge into Huntington Dividend Capture Fund (HDCAX) at the end of the first week of December.  It’s never a good sign when the winning fund – the more attractive of the two – trails 80% of its peers.

The JPMorgan Global Opportunities Fund was liquidated and dissolved on or about October 25, 2013. Given that they’re speaking in the past tense, don’t you think that they’d know whether it was “on” or “about”?

Update on the JPMorgan Value Opportunities Fund: an attempt to merge the fund out of existence in September failed because the Board couldn’t get enough shareholders to vote one way or the other.  On October 10, though, they reached a critical mass and folded the fund into JPMorgan Large Cap Value Fund (OLVAX) on October 18^th.

So long to LONGX! Longview Tactical Allocation Fund (LONGX) has closed and will liquidate on November 15, 2013.  700% turnover which might well have led to a joke about their ability to take the long view except for the fact that they’ve joined the zombie legion of walking dead funds.

In a determinedly “WTF?” move, the Mitchell Capital’s Board of Trustees has determined to liquidate the Mitchell Capital All-Cap Growth Fund (MCAEX) “due to the adviser’s business decision that it no longer is economically viable to continue managing the Fund because of the Fund’s small size, the increasing costs associated with managing the Fund, and the difficulty encountered in distributing the Fund’s shares.”  Huh?  “No longer economically viable”?  They only launched this sucker on March 1, 2013.  Seven months, guys?  You hung on seven months and that’s it?  What sort of analytic abilities are on display here, do you suppose?

On October 15, Nomura Partners Funds closed all of its remaining five mutual funds to purchases and exchanges.  They are The Japan Fund (NPJAX), Nomura Partners High Yield (NPHAX), Nomura Partners Asia Pacific Ex Japan (NPAAX), Nomura Partners Global Equity Income (NPWAX), and Nomura Partners Global Emerging Markets (NPEAX).  Here’s a sentence you should take seriously: “The Board will consider the best interests of the investors in each of the Funds and may decide to liquidate, merge, assign the advisory contract or to take another course of action for one or more of the Funds.”  The NPJAX board has acted boldly in the past.  In 2002, it fired the fund’s long-standing adviser, Scudder,Stevens, and turned the fund over to Fidelity to manage.  Then, in 2008, they moved it again from Fidelity to Nomura.  No telling what they might do next.

The firm also announced that it, like DundeeWealth, is planning to get out of the US retail fund business.

The liquidations of Nuveen Tradewinds Global Resources Fund and Nuveen Tradewinds Small-Cap Opportunities Fund are complete.  It’s an ill wind that blows …

Oppenheimer SteelPath MLP and Infrastructure Debt Fund went the way of the wild goose on October 4.

Transamerica is bumping off two sub-advised funds in mid-December: Transamerica International Bond (TABAX), subadvised by J.P. Morgan, and Transamerica International Value Opportunities Fund, subadvised by Thornburg but only available to other Transamerica fund managers.

UBS Global Frontier Fund became UBS Asset Growth Fund (BGFAX) on October 28.  Uhhh … doesn’t “Asset Growth” strike you as pretty much “Asset Gathering”?  Under the assumption that “incredibly complicated” is the magic strategy, the fund will adopt a managed volatility objective that tries to capture all of the upside of the MSCI World Free Index with a standard deviation of no more than 15.  On the portfolio’s horizon: indirect real estate securities, index funds, options and derivatives with leverage of up to 75%. They lose a couple managers and gain a couple in the process.

U.S. Global Investors Global Emerging Markets Fund closed on October 1 and liquidated on Halloween.  If you were an investor in the fund, I’m hopeful that you’d already noticed.  And considered Seafarer as an alternative.

Vanguard plans to merge two of its tax-managed funds into very similar index funds.  Vanguard Tax-Managed International (VTMNX) is merging into Vanguard Developed Markets Index (VDMIX) and Vanguard Tax-Managed Growth & Income (VTMIX) will merge into Vanguard 500 Index (VFINX). Since these were closet index funds to begin with – they have R-squared values of 98.5 and 100(!) – the merger mostly serves to raise the expenses borne by VTMNX investors from 10 basis points to 20 for the index fund.

Vanguard Growth Equity (VGEQX) is being absorbed by Vanguard US Growth (VWUSX). Baillie Gifford, managers of Growth Equity, will be added as another team for US Growth.

Vanguard Managed Payout Distribution Focus (VPDFX) and Vanguard Managed Payout Growth Focus (VPGFX) are slated to merge to create a new fund, Vanguard Managed Payout Fund. At that time, the payout in question will decrease to 4% from 5%.

WHV Emerging Markets Equity Fund (WHEAX) is suffering “final liquidation”  on or about December 20, 2013.  Okay returns, $5 million in assets.

In Closing . . .

As Chip reviewed how folks use our email notification (do they open it?  Do they click through to MFO?), she discovered 33 clicks from folks in Toyko (youkoso!), 21 in the U.K. (uhhh … pip pip?), 13 in the United Arab Emirates (keep cool, guys!) and 10 scattered about India (Namaste!).  Welcome to all.

Thanks to the kind folks who contributed to the Observer this month.  I never second guess folks’ decision to contribute, directly or through PayPal, but I am sometimes humbled by their generosity and years of support.  And so thanks, especially, to the Right Reverend Rick – a friend of many years – and to Andrew, Bradford, Matt, James (uhh… Jimmy?) and you all.  You make it all possible.

Thanks to all of the folks who bookmarked or clicked on our Amazon link.   Here’s the reminder of the easiest way to support the Observer: just use our Amazon link whenever you’d normally be doing your shopping, holiday or other, on Amazon anyway.  They contribute an amount equal to about 7% of the value of all stuff purchased through the link.  It costs you nothing (the cost is already built into their marketing budget) and is invisible.  If you’re interested in the details, feel free to look at the Amazon section under “Support.”  

Remember to join us, if you can, for our upcoming conversations with John, Greg and David.  Regardless, enjoy the quiet descent of fall and its seasonal reminder to slow down a bit and remember all the things you have to be grateful for rather than fretting about the ones you don’t have (and, really, likely don’t need and wouldn’t enjoy).

Cheers!

Welcome to October, the time of pumpkins.

October’s a month of surprises, from the first morning that you see frost on the grass to the appearance of ghosts and ghouls at month’s end.  It’s a month famous of market crashes – 1929, 1987, 2008 – and for being the least hospitable to stocks. And now it promises to be a month famous for government showdowns and shutdowns, when the sales of scary Halloween masks (Barackula, anyone?) take off.

It’s the month of golden leaves, apple cider, backyard fires and weekend football.  (Except possibly back home in Pittsburgh, where some suspect a zombie takeover of the beloved Steelers backfield.)  It’s the month that the danged lawnmower gets put away but the snowblower doesn’t need to be dragged out.

It’s the month where we discover the Octoberfest actually takes place in September, and we’ve missed it. 

In short, it’s a good month to be alive and to share with you.

Better make that “The Fantastic 48,” Russ

Russel Kinnel, Morningstar’s chief fund guy, sent out an email on September 16^th, touting his “Fantastic 51,” described as “51 Funds You Should Know About.”  And if you’ll just pony up the $125 for a Fund Investor subscription, it’s yours!

 Uhhh … might have to pare that back to the Fantastic 48, Russ.  It turns out that a couple of the funds hyped in the email underwent critical changes between the time Mr. Kinnel published that article in May and the time Morningstar’s marketers began pushing it in September.

Let’s start by looking at Mr. K’s criteria, then talking about the flubbed funds and finish by figuring out what we might learn from the list as a whole.

Here are the criteria for being Fantastic this year:

Last year I shared the “Fantastic 46” with you. This year I raised the bar on my tests and still reached 51 funds. Here’s what I want:

1. A fund with expenses in the cheapest quintile
2. Returns that beat the benchmark over the course of the manager’s tenure (minimum five years)
3. Manager investment of at least $500,000
4. A Positive Parent rating
5. A medalist Morningstar Analyst Rating

Sub-text: Fantastic funds are large or come from large fund complexes.  Of the 1150 medalist funds, only 53 have assets under $100 million.  Of those 53, only five or six are the products of independent or boutique firms.  The others are from Fido, MFS, PIMCO or another large firm.  Typically an entire target-date series gets medalized, including the Retirement 2075 fund with $500,003 in it.  By way of comparison, there are 2433 funds with under $100 million in assets.

And it’s certainly the case that the Fantastic 51 is The Corporate Collection: 10 American Funds, 10 Price and nine Vanguard.  Russel holds out the LKCM funds as examples of off-the-radar families, which would be more credible if LKCM Small Cap Equity (LKSCX) didn’t already have $1.1 billion in assets.

And what about the funds touted in the promotional email.  Two stand out: FPA Paramount and Janus Triton.

Morningstar’s take on FPA Paramount

The Mutual Fund Observer’s reply:

Great recommendation, except that the managers you’re touting left the fund and its strategy has substantially changed.  Eric and Steve’s unnamed and unrecognized co-managers are now in charge of the fund and are working to transition it from a quality-growth to an absolute-value portfolio.  Both of those took place in August 2013. 

The MFO recommendation: if you like Eric and Steve’s work, invest in FPA Perennial (FPPFX) which is a fund they actually run, using the strategy that Mr. Kinnel celebrates.

Morningstar’s take on Janus Triton

The Observer’s reply:

Uhhh … a bigger worry here is that Chad and Brian left in early May, 2013. The new manager’s tenure is 14 weeks.  Morningstar’s analysts promptly downgraded the fund to “neutral.” And Greg Carlson fretted that the “manager change leaves Janus Triton with uncertain prospects” because Mr. Coleman has not done a consistently excellent job in his other charges. That would be four months before the distribution of this email promo.

The MFO recommendation: if you’re impressed by Chad and Brian’s work (an entirely reasonable conclusion) check Meridian Growth Legacy Fund (MERDX), or wait until November and invest in their new Meridian Small Cap Growth Fund.

The email did not highlight, but the Fantastic 51 does include, T. Rowe Price New America Growth (PRWAX), whose manager resigned in May 2013.   Presumably these funds ended up in the letter because, contrary to appearances, Mr. Kinnel neither wrote, read nor approved its content (his smiling face and first-personal singular style notwithstanding).  That work was likely all done by a marketer who wouldn’t know Triton from Trident.

The bigger picture should give you pause about the value of such lists.   Twenty-six percent of the funds that were “fantastic” last year are absent this year, including the entire contingent of Fidelity funds.  Thirty-three percent of the currently fantastic funds were not so distinguished twelve months ago.  If you systematically exclude large chunks of the fund universe from consideration (those not medalized) and have a list that’s both prosaic (“tape the names of all of the Price funds to the wall, throw a dart, find your fantasy fund!”) and unstable, you wonder how much insight you’re being offered.

Interested parties might choose to compare last year’s Fantastic 46 list with 2013’s new and improved Fantastic 51. 

About the lack of index funds in the Fantastic 51

Good index funds – ones with little tracking error – can’t beat their benchmarks over time because their return is the benchmark minus expenses.  A few bad index funds – ones with high tracking error, so they’re sometimes out of step with their benchmark – might beat it from time to time, and Gus Sauter was pretty sure that microscopic expenses and canny trade execution might allow him to eke out the occasional win.  But the current 51 has no passive funds.

The authors of S&P Indices Versus Active Funds (SPIVA®) Scorecard would argue that’s a foolish bias.  They track the percentage of funds in each equity category which manage to outperform their benchmark, controlling for survivorship bias.  The results aren’t pretty.  In 17 of 17 domestic equity categories they analyzed, active funds trailed passive.  Not just “most active funds.”  No, no.  The vast majority of active funds.  Over the past five years, 64.08% of large value funds trailed their benchmark and that’s the best performance by any of the 17 groups.  Overall, 72.01% trailed.  Your poorest odds came in the large cap growth, midcap growth and multicap growth categories, where 88% of funds lagged. 

In general, active funds lag passive ones by 150-200 basis points year.  That’s a problem, since that loss is greater than what the fund’s expense ratios could explain.  Put another way: even if actively managed funds had an expense ratio of zero, they’d still modestly trail their passive peers.

There is one and only one bright spot in the picture for active managers: international small cap funds, nearly 90% of which outperform a comparable index. Which international small caps qualify as Fantastic you might ask? That would be, none.

If you were looking for great prospects in the international small cap arena, the Observer recommends that you check Grandeur Peak Global Reach (GPROX) or wait for the launch of one of their next generation of purely international funds. Oberweis International Opportunities (OBIOX), profiled this month, would surely be on the list. Fans of thrill rides might consider Driehaus International Small Cap Growth (DRIOX). Those more interested in restrained, high-probability bets might look at the new Artisan Global Small Cap Fund (ARTWX), a profile of which is forthcoming.

How much can you actually gain by picking a good manager?

It’s hard to find a good manager. It takes time and effort and it would be nice to believe that you might receive a reward commensurate with all your hard work. That is, spending dozens of hours in research makes a lot more sense if a good pick actually has a noticeably pay-off. One way of measuring that pay-off is by looking at the performance difference between purely average managers and those who are well above average. 

The chart below, derived from data in the S&P 2013 SPIVA analysis shows how much additional reward a manager in the top 25% of funds provides compared to a purely average manager.

What might this suggest about where to put your energy?  First and foremost, a good emerging markets manager makes a real difference – the average manager lost money for you, the top tier of guys kept you in the black. Likewise with diversified international funds.  The poorest investment of your time might be in looking for a large cap and especially large cap value manager. Not only do they rarely beat an index fund when they do, the margin of victory is slim. 

The group where good active manager appears to have the biggest payoff – small caps across the board –  is muddied a bit by the fact that the average return was so high to begin with. The seemingly huge 231 bps advantage held by top managers represents just a 28% premium over the work of mediocre managers. In international small caps, the good-manager premium is far higher at 41%.  Likewise, top global managers returned about 42% more than average ones.

The bottom line: invest your intellectual resources where your likeliest to see the greatest reward.  In particular, managers who invest largely or exclusively overseas seem to have the prospect of making a substantial difference in your returns and probably warrant the most careful selection.  Managers in what’s traditionally the safest corner of the equity style box – large core, large  value, midcap value – don’t have a huge capacity to outperform either indexes or peers.  In those areas, cheap and simple might be your mantra.

The one consensus pick: Dodge & Cox International (DODFX)

There are three lists of “best funds” in wide circulation now: the Kiplinger 25, the Fantastic 51, and the Money 70.  You’d think that if all of these publications shared the same sensible goal – good risk-adjusted returns and shareholder-friendly practices – they’d also be stumbling across the same funds.

You’d be wrong. There’s actually just one fund that they all agree on: Dodge & Cox International (DODFX). The fund is managed by the same team that handles all of Dodge & Cox. It’s dragging around $45 billion in assets but, despite consistently elevated volatility, it’s done beautifully. It has trailed its peers only twice in the past decade, including 2008 when all of the D&C funds made a mistimed bet that the market couldn’t get much cheaper.  They were wrong, by about six months and 25% of their assets.

The fund has 94% of its assets in large cap stocks, but a surprisingly high exposure to the emerging markets – 17% to its peers 7%.

My colleague Charles is, even as you read this, analyzing the overlap – and lack of overlap – between such “best funds” lists.  He’ll share his findings with us in November.

Tealeaf Long/Short Deep Value Fund?

Really guys?

Really?

You’ve got a business model that’s predicated upon being ridiculed before you even launch?

The fate of the Palantir (“mystical far-seeing eye”) Fund (PALIX) didn’t raise a red flag?  Nor the Oracle Fund (ORGAX – the jokes there were too dangerous), or the Eye of Zohar Fund (okay, I made that one up)?  It’s hard to imagine investment advisors wanting to deal with their clients’ incredulity at being placed in a fund that sounds like a parody, and it’s harder to imagine that folks like Chuck Jaffe (and, well, me) won’t be waiting for you to do something ridiculous.

In any case, the fund’s in registration now and will eventually ask you for 2.62 – 3.62% of your money each year.

The art of reading tea leaves is referred to as tasseography.  Thought you’d like to know.

A new Fidelity fund is doing okay!

Yeah, I’m surprised to hear me saying that, too.  It’s a rarity.  Still FidelityTotal Emerging Markets (FTEMX) has made a really solid start.  FTEMX is one of the new generation of emerging markets balanced or hybrid funds.  It launched on November 1, 2011 and is managed by a seven-person team.  The team is led by John Carlson, who has been running Fidelity New Markets Income (FNMIX), an emerging markets bond fund, since 1995.  Mr. Carlson’s co-managers in general are young managers with only one other fund responsibility (for most, Fidelity Series Emerging Markets, a fund open only to other Fidelity funds).

The fund has allocated between 60-73% of its portfolio to equities and its equity allocation is currently at a historic high.

Since there’s no “emerging markets balanced” peer group or benchmark, the best we can do is compare it to the handful of other comparable funds we could find.  Below we report the fund’s expense ratios and the amount of money you’d have in September 2013 if you’d invested $10,000 in each on the day that FTEMX launched.

The only fund with even modestly better returns is the closed-end First Trust Aberdeen Emerging Opportunities, about which we wrote a short, positive profile.  That fund’s shares are selling, as of October 1, at a 9.2% discount to its actual net asset value which is a bit more than its 8.9% average discount over the past five years and substantially more than its 7.4% discount over the past three.

Microscopic by Fidelity standard, the fund has just $80 million in assets.  The minimum initial investment is $2500, reduced to $500 for IRAs.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds.  Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds.  “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Frank Value Fund (FRNKX) is not “that other Frank Fund” (John Buckingham’s Al Frank fund VALUX). It’s a concentrated, all-cap value fund that’s approaching its 10^th anniversary. It’s entirely plausible that it will celebrate its 10^thanniversary with returns in the top 10% of its peer group.

Oberweis International Opportunities (OBIOX) brings a unique strategy grounded in the tenets of behavioral finance to the world of international small- and mid-cap growth investing.  The results (top decile returns in three of the past four years) and the firm’s increasingly sophisticated approach to risk management are both striking.

Elevator Talk #9: Bashar Qasem of Wise Capital (WISEX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

Wise Capital (WISEX) provides investors with an opportunity for diversification in a fund category (short term bonds) mostly distinguished by bland uniformity: 10% cash, one equity security thrown in for its thrill-value, about 90% of the bond portfolio would be US with a dribble of Canadian and British issues, 90% A-AAA rated and little distance between the fund and its peers. 

We began searching, late last year, from short-term income funds that offered some prospect of offering atypical returns in a bad environment: negative real short-term rates for now and the prospect of a market overreaction when US rates finally began to rise.  Our touchstones were stable management, a distinctive strategy, and a record of success.  A tiny handful of funds survived the cull.  Among them, PIMCO Short Asset (PAUIX ), Payden Global Low Duration (PYGSX), RiverPark Short Term High Yield (RPHYX), Scout Low Duration (SCLDX) … and Azzad Wise Capital.

WISEX draws on a fundamentally different asset set than any other US fixed-income fund.  Much of the fund’s portfolio is invested in the Islamic world, in a special class of bank deposits and bond-equivalents called Sukuks.  The fund is not constrained to invest solely in either asset class, but its investments are ethically-screened, Shariah-compliant and offers ethical exposure to emerging markets such as Turkey, Indonesia, Malaysia and the Gulf.

Azzad was founded in 1997 by Bashar Qasem, a computer engineer who immigrated to the United States from Jordan at the age of 23.  Here’s Mr. Qasem’s 200 words making his case:

I started Azzad Asset Management back 1997 because I was disappointed with the lack of investment options that aligned with my socially responsible worldview. For similar reasons, I traveled across the globe to consult with scholars and earned licenses to teach and consult on compliance with Islamic finance. I later trained and became licensed to work in the investment industry.

We launched the Azzad Wise Capital Fund in 2010 as a response to calls from clients asking for a fund that respects the Islamic prohibition on interest but still offers a revenue stream and risk/return profile similar to a short-term bond fund. WISEX invests in a variety of Sukuk (Islamic bonds) and Islamic bank deposits involved in overseas development projects. Of course, it’s SEC-registered and governed by the Investment Company Act of 1940. Although it doesn’t deal with debt instruments created from interest-based lending, WISEX shares in the profits from its ventures.

And I’m particularly pleased that it appeals to conservative, income-oriented investors of all backgrounds, Muslim or not. We hear from financial advisors and individual shareholders of all stripes who own WISEX for exposure to countries like Turkey, Malaysia, and Indonesia, as well as access to an alternative asset class like Sukuk.

The fund has a single share class. The minimum initial investment is $4,000, reduced to $300 for accounts established with an automatic investing plan (always a good idea with cash management accounts). Expenses are capped at 1.49% through December, 2018.

For those unfamiliar with the risk/return profile of these sorts of investments, Azzad offers two resources.  First, on the Azzad Funds website, they’ve got an okay (not but great) white paper on Sukuks.  It’s under Investor Education, then White Papers.  Second, on October 23^rd, Mr. Quesam and portfolio manager Jamal Elbarmil will host a free webinar on Fed Tapering and Sukuk Investing.  Azzad shared the announcement with us but I can’t, for the life of me, find it on either of their websites so here’s a .pdf explaining the call.

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility

During the summer hiatus on Observer conference calls, my colleague Charles Boccadoro and I have been listening-in on calls sponsored by some of the more interesting fund companies.  We report this month on the highlights of the calls concerning the reopening of RiverNorth/DoubleLine Strategic Income (David) and the evolution of the intriguing Whitebox Tactical Opportunities (Charles) funds.

Conference Call Highlights: RiverNorth/DoubleLine Strategic Income (RNDLX)

Strategic Income was launched on December 30, 2010 and our profile of the fund described it as “compelling.”  We speculated that if an investor were planning to hold only three funds over the long haul, “given its reasonable expenses, the managers’ sustained successes, innovative design and risk-consciousness, this might well be one of those three.”  Both popular ($1.1 billion in the portfolio) and successful (it has outperformed its “multisector bond” peers since inception and in seven of 10 quarters), the fund closed to new investors at the end of March. 2012.  Faced with a substantial expansion in their opportunity set, RiverNorth decided to reopen the fund to new investors 17 months later, at the end of August 2013, with the understanding that it was subject to re-closure if there was a pressing mismatch between the fund’s resources and the opportunities available.

On September 18, 2013, co-managers Jeffrey Gundlach of DoubleLine and Patrick Galley of RiverNorth spoke with interested parties about their decision to re-open the fund and its likely evolution.

By happenstance, the call coincided with the fed’s announcement that they’d put plans to reduce stimulus on hold, an event which led Mr. Gundlach to describe it as “a pivotal day for investor attitudes.” The call addressed three issues:

• The fund’s strategy and positioning.  The fund was launched as an answer to the question, how do income-oriented investors manage in a zero-rate environment?  The answer was, by taking an eclectic and opportunistic approach to exploiting income-producing investments.  The portfolio has three sleeves: core income, modeled after Doubleline’s Core Income Fund, opportunistic income, a mortgage-backed securities strategy which is Doubleline’s signature strength, and RiverNorth’s tactical closed-end income sleeve which seeks to profit from both tactical asset choices and the opportunities for arbitrage gains when the discounts on CEFs become unsustainably large.

  The original allocation was 50% core, 25% opportunistic and 25% tactical CEF.  RiverNorth’s strategy is to change weightings between the sleeves to help the portfolio manage changes in interest rates and volatility; in a highly volatile market, they might reallocate toward the more conservative core strategy while a rising interest rate regime might move them toward their opportunistic and tactical sleeves.  Before closing, much of the tactical CEF money was held in cash because opportunities were so few. 

• The rationale for reopening. Asset prices often bear some vague relation to reality.  But not always.  Opportunistic investors look to exploit other investors’ irrationality.  In 2009, people loathed many asset classes and in 2010 they loathed them more selectively.  As the memory of the crash faded, greed began to supplant fear and CEFs began selling at historic premiums to their NAVs.  That is, investors were willing to pay $110 for the privilege of owning $100 in equities.  Mr. Galley reported that 60% of CEFs sold at a premium to their NAVs in 2012.  2013 brought renewed anxiety, an anxious departure from the bond market by many and the replacement of historic premiums on CEFs with substantial discounts.  As of mid-September, 60% of CEFs were selling at discounts of 5% or more.  That is, investors were willing to sell $100 worth of securities for $95.

  As a whole, CEFs were selling at a 6.5% discount to NAV.  That compared to a premium the year before, an average 1% discount over the preceding three years and an average 3% discount over the preceding decade.

  

  The lack of opportunities in the fixed-income CEF space, a relatively small place, forced the fund’s closure.  The dramatic expansion of those opportunities justified its reopening.  The strategy might be able to accommodate as much as $1.5 billion in assets, but the question of re-closing the fund would arise well before then.

• Listener concerns.  Listeners were able to submit questions electronically to a RiverNorth moderator, an approach rather more cautious than the Observer’s strategy of having callers speak directly to the managers.  Some of the questions submitted were categorized as “repetitive or not worth answering” (yikes), but three issues did make it through. CEFs are traded using an algorithmic trading system developed by RiverNorth. It is not a black box, but rather a proprietary execution system used to efficiently trade closed-end funds based off of discount, instead of price. The size of the fund’s investable CEF universe is about 300 funds, out of 400 extant closed-end fixed-income funds. The extent of leverage in the portfolio’s CEFs was about 20%.

Bottom Line: the record of the managers and the fund deserves considerable respect, as does the advisor’s clear commitment to closing funds when doing so is in their investors’ best interest. The available data clearly supports the conclusion that, even with dislocations in the CEF space in 2013, active management has added considerable value here. 

The data-rich slides are already available by contacting RiverNorth. A transcript of the broadcast will be available on the RiverNorthFunds.com website sometime in October. 

Update: The webcast is now available at https://event.webcasts.com/viewer/event.jsp?ei=1021309 You will be required to register, but you’ll gain access immediately.

Conference Call Highlights: Whitebox Tactical Opportunities Fund (WBMAX and WBMIX)

Portfolio managers Andrew Redleaf and Dr. Jason Cross, along with Whitebox Funds’ President Bruce Nordin, hosted the 2^nd quarter conference call for their Tactical Opportunities Fund (WBMIX) on September 10. Robert Vogel, the fund’s third manager, did not participate. The call provided an opportunity to take a closer look at the fund, which is becoming hard to ignore.

Background

WBMIX is the more directionally oriented sibling of Whitebox’s market-neutral Long Short Equity Fund (WBLFX), which David profiled in April. Whitebox is preparing to launch a third mutual fund, named Enhanced Convertible Fund (WBNIX), although no target date has been established.

Whitebox Advisors, founded by Mr. Redleaf in 1999, manages its mutual funds with similar staff and strategies as its hedge funds. Mr. Redleaf is a deep contrarian of efficient market theory. He works to exploit market irrationalities and inefficiencies, like “mispriced securities that have a relationship to each other.” He received considerable attention for successfully betting against mortgages in 2008.

The Tactical Opportunities Fund seeks to provide “a combination of capital appreciation and income that is consistent with prudent investment management.” It employs the full spectrum of security classes, including stocks, bonds, and options. Its managers reject the notion that investors are rewarded for accepting more risk. “We believe risk does not create wealth, it destroys wealth.” Instead, they identify salient risks and adjust their portfolio “to perform at least tolerably well in multiple likely scenarios.”

The fund has attracted $205M AUM since its inception in December 2011 ­– on the day of the conference call, Morningstar showed AUM at $171M, an increase of $34M in less than three weeks. All three managers are also partners and owners in the firm, which manages about $2.4B in various types of investment accounts, but the SAI filed February 2013 showed none invested in the fund proper. Since this filing, Whitebox reports Mr. Redleaf has become a “significant owner” and that most of its partners and employees are invested in its funds through the company’s 401k program.

Morningstar recently re-categorized WBMIX from aggressive allocation to long-short after Whitebox management successfully appealed to the editorial board. While long-short is currently more appropriate, the fund’s versatility makes it an awkward fit in any category. It maintains two disparate benchmarks, S&P 500 Price Index SPX (excludes dividends) and Barclay’s Aggregate U.S. Bond Total Return Index. Going forward, Whitebox reports it will add S&P 500 Total Return Index as a benchmark.

Ideally, Mr. Redleaf would prefer the fund’s performance be measured against the nation’s best endowment funds, like Yale’s or Havard’s. He received multiple degrees from Yale in 1978. Dr. Cross holds an MBA from University of Chicago and a Ph.D. in Statistics from Yale.

Call Highlights

Most of its portfolio themes were positive or flat for the quarter, resulting in a 1.3% gain versus 2.9% for SP500 Total Return, 2.4% SP500 Price Return, 0.7% for Vanguard’s Balanced Index , and -2.3% for US Aggregate Bonds. In short, WBMIX had a good quarter.

Short Bonds. Whitebox has been sounding warning bells for sometime about overbought fixed income markets. Consequently, it has been shorting 20+ year Treasuries and high-yield bond ETFs, while being long blue-chip equities. If 1Q was “status quo” for investors, 2Q saw more of an orderly rotation out of low yielding bonds and into quality stocks. WBMIX was positioned to take advantage.

Worst-Case Hedge. It continues to hold out-of-money option straddles, which hedge against sudden moves up or down, in addition to its bond shorts. Both plays help in the less probable scenario that “credit markets crack” due to total loss of confidence in bonds, rapid rate increase and mass exodus, taking equities down with them.

Bullish Industrials. Dr. Cross explained that in 2Q they remained bullish on industrials and automakers. After healthy appreciation, they pared back on airlines and large financials, focusing instead on smaller banks, life insurers, and specialty financials. They’ve also been shorting lower yielding apartment REITS, but are beginning to see dislocations in higher yielding REITs and CEFs.

Gold Miner Value. Their one misstep was gold miners, at just under 5% of portfolio; it detracted 150 basis points from 2Q returns. Long a proxy for gold, miners have been displaced by gold ETFs and will no longer be able to mask poor business performance with commodity pricing. Mr. Redleaf believes increased scrutiny on these miners will lead to improved operations and a closure in the spread, reaping significant upside. He cited that six CEOs have retired or been replaced recently. This play is signature Whitebox. The portfolio managers do not see similar inefficiencies in base metal miners.

Large vs Small. Like its miss with gold miners, its large cap versus small cap play has yet to pan-out. It believes small caps are systematically overpriced, so they have been long on large caps while short on small caps. Again, “value arbitrage” Whitebox. The market agreed last quarter, but this theme has worked against the fund since 2Q12.

Heading into 3Q, Whitebox believes equities are becoming overbought, if temporarily, given their extended ascent since 2009. Consequently, WBMIX beta was cut to 0.35 from 0.70. This move appears more tactical than strategic, as they remain bullish on industrials longer term. Mr. Redleaf explains that this is a “game with no called strikes…you never have to swing.” Better instead to wait for your pitch, like winners of baseball’s Home Run Derby invariably do.

Whitebox has been considering an increase to European exposure, if it can find special situations, but during the call Mr. Redleaf stated that “emerging markets is a bit out of our comfort zone.”

Performance To-Date

The table below summaries WBMIX’s return/risk metrics over its 20-month lifetime. The comparative funds were suggested by MFO reader and prolific board contributor “Scott.” (He also brought WBMIX to community attention with his post back in August 2012, entitled “Somewhat Interesting Tiny Fund.”) Most if not all of the funds listed here, at some point and level (except VBINX), tout the ability to deliver balanced-like returns with less risk than the 60/40 fixed balanced portfolio.

While Whitebox has delivered superior returns (besting VBINX, Mr. Aronstein’s Marketfield and Mr. Romick’s Crescent, while trouncing Mr. Arnott’s All Asset and AQR’s Risk Parity), it’s generally done so with higher volatility. But the S&P 500 has had few drawdowns and low downside over this period, so it’s difficult to conclude if the fund is managing risk more effectively. That said, it has certainly played bonds correctly.

Other Considerations

When asked about the fund’s quickly increasing AUM, Dr. Cross stated that their portfolio contains large sector plays, so liquidity is not an issue. He believes that the fund’s capacity is “immense.”

Whitebox provides timely and thoughtful quarterly commentaries, both macro and security specific, both qualitative and quantitative. These commentaries reflect well on the firm, whose very name was selected to highlight a “culture of transparency and integrity.” Whitebox also sponsors an annual award for best financial research. The $25K prize this year went to authors of the paper “Time Series Momentum,” published in the Journal of Financial Economics.

Whitebox Mutual Funds offers Tactical Opportunities in three share classes. (This unfortunate practice is embraced by some houses, like American Funds and PIMCO, but not others, like Dodge & Cox and FPA.) Investor shares carry an indefensible front-load for purchases below $1M. Both Investor and Advisor shares carry a 12b-1 fee. Some brokerages, like Fidelity and Schwab, offer Advisor shares with No Transaction Fee. (As is common in the fund industry, but not well publicized, Whitebox pays these brokerages to do so – an expensive borne by the Advisor and not fund shareholders.) Its Institutional shares WBMIX are competitive currently at 1.35 ER, if not inexpensive, and are available at some brokerages for accounts with $100,000 minimum.

During the call, Mr. Redleaf stated that its mutual funds are cheaper than its hedge funds, but the latter “can hold illiquid and obscure securities, so it kind of balances out.” Perhaps so, but as Whitebox Mutual Funds continues to grow through thoughtful risk and portfolio management, it should adopt a simpler and less expensive fee structure: single share class, no loads or 12b-1 fees, reasonable minimums, and lowest ER possible. That would make this already promising fund impossible to ignore.

Bottom Line

At the end of the day, continued success with the fund will depend on whether investors believe its portfolio managers “have behaved reasonably in preparing for the good and bad possibilities in the current environment.” The fund proper is still young and yet to be truly tested, but it has the potential to be one of an elite group of funds that moderate investors could consider holding singularly – on the short list, if you will, for those who simply want to hold one all-weather fund.

A transcript of the 2Q call should be posted shortly at Whitebox Tactical Opportunities Fund.

27Sept2013/Charles

Conference Call Upcoming: Zachary Wydra, Beck, Mack & Oliver Partners (BMPEX), October 16, 7:00 – 8:00 Eastern

On October 16, Observer readers will have the opportunity to hear from, and speak to Zachary Wydra, manager of Beck, Mack & Oliver Partners (BMPEX).  After review of a lot of written materials on the fund and its investment discipline, we were impressed and intrigued.  After a long conversation with Zac, we were delighted.  Not to put pressure on the poor guy, but he came across as smart, insightful, reflective, animated and funny, often in a self-deprecating way.  We were more delighted when he agreed to spend an hour talking with our readers and other folks interested in the fund.

Mr. Wydra will celebrate having survived both the sojourn to Nebraska and participation in The Last Blast Triathlon by opening with a discussion of the  structure, portfolio management approach and stock selection criteria that distinguish BMPEX from the run-of-the-mill large cap fund, and then we’ll settle in to questions (yours and mine).

Our conference call will be Wednesday, October 16, from 7:00 – 8:00 Eastern.  It’s free.  It’s a phone call.

How can you join in?

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

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

WOULD AN ADDITIONAL HEADS UP HELP?

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

The Conference Call Queue

We have two other calls on tap.  On Monday, November 18, from 7:00 – 8:00 Eastern, you’ll have a chance to meet John Park and Greg Jackson, co-managers of Oakseed Opportunity (SEEDX and SEDEX).  John and Greg have really first-rate experience as mutual fund managers and in private equity, as well.  Oakseed is a focused equity fund that invests in high quality businesses whose managers interests are aligned with their shareholders.  As we note in the Updates section below, they’re beginning to draw both high-quality investors and a greater range of media attention.  If you’d like to get ahead of the curve, you can register for the call with John and Greg though I will highlight their call in next month’s issue.

In early December we’ll give you a chance to speak with the inimitable duo of Sherman and Schaja on the genesis and early performance of RiverPark Strategic Income, the focus of this month’s Launch Alert.

Launch Alert: RiverPark Strategic Income (RSIVX, RSIIX)

There are two things particularly worth knowing about RiverPark Short-Term High Yield (RPHYX): (1) it’s splendid and (2) it’s closed.  Tragically mischaracterized as a high-yield bond fund by Morningstar, it’s actually a cash management fund that has posted 3-4% annual returns and negligible volatility, which eventually drew almost a billion to the fund and triggered its soft close in June.  Two weeks later, RiverPark placed its sibling in registration. That fund went live on September 30, 2013.

Strategic Income will be managed by David Sherman of Cohanzick Management, LLC.  David spent ten years at Leucadia National Corporation where he was actively involved high yield and distressed securities and rose to the rank of vice president.  He founded Cohanzick in 1996 and Leucadia became his first client.  Cohanzick is now a $1.3 billion dollar investment adviser to high net worth individuals and corporations.   

Ed Studzinski and I had a chance to talk with Mr. Sherman and Morty Schaja, RiverPark’s president, for an hour on September 18^th.  We wanted to pursue three topics: the relation of the new fund to the older one, his portfolio strategy, and how much risk he was willing to court. 

RPHYX represented the strategies that Cohanzick uses for dealing with in-house cash.  It targets returns of 3-4% with negligible volatility.  RSIVX represents the next step out on the risk-return continuum.  David believes that this strategy might be reasonably expected to double the returns of RPHYX.  While volatility will be higher, David is absolutely adamant about risk-management.  He intends this to be a “sleep well at night” fund in which his mother will be invested.  He refuses to be driven by the temptation to shoot for “the best” total returns; he would far rather sacrifice returns to protect against loss of principal.  Morty Schaja affirms the commitment to “a very conservative credit posture.”

The strategy snapshot is this.  He will use the same security selection discipline here that he uses at RPHYX, but will apply that discipline to a wider opportunity set.  Broadly speaking, the fund’s investments fall into a half dozen categories:

1. RPHYX overlap holdings – some of the longer-dated securities (1-3 year maturities) in the RPHYX portfolio will appear here and might make up 20-40% of the portfolio.
2. Buy and hold securities – money good bonds that he’s prepared to hold to maturity. 
3. Priority-based debt – which he describes as “above the fray securities of [firms with] dented credit.”  These are firms that “have issue” but are unlikely to file for bankruptcy any time soon.  David will buy higher-order debt “if it’s cheap enough,” confident that even in bankruptcy or reorganization the margin of safety provided by buying debt at the right price at the peak of the creditor priority pyramid should be money good.
4. Off-the-beaten-path debt – issues with limited markets and limited liquidity, possibly small issues of high quality credits or the debt of firms that has solid business prospects but only modestly-talented management teams.  As raters like S&P contract their coverage universe, it’s likely that more folks are off the major firm’s radar.
5. Interest rate resets – uhhh … my ears started ringing during this part of the interview; I had one of those “Charlie Brown’s teacher” moments.  I’m confident that the “cushion bonds” of the RPHYX portfolio, where the coupon rate is greater than the yield-to maturity, would fall into this category.  Beyond that, you’re going to need to call and see if you’re better at following the explanation than I was.
6. And other stuff – always my favorite category.  He’s found some interesting asset-backed securities, fixed income issues with equity-like characteristics and distressed securities, which end up in the “miscellaneous” basket.

Mr. Sherman reiterates that he’s not looking for the highest possible return here; he wants a reasonable, safe return.  As such, he anticipates underperforming in silly markets and outperforming in normal ones.

The minimum initial investment in the retail class is $1,000.  The expense ratio is capped at 1.25%.  The fund is available today at TD and Fidelity and is expected to be available within the next few days at Schwab. More information is available at RiverPark’s website.  As I noted in September’s review of my portfolio, this is one of two funds that I’m almost certain to purchase before year’s end.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details.

Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves.  This month he tracked down 10 no-load funds in registration, one of the lowest levels in a year (compare it to 26 last month), but it does contain three offerings from first-rate, veteran teams:

361 Multi-Strategy Fund, 361’s fourth alternatives fund, guided by Brian Cunningham (a hedge fund guy), Thomas Florence (ex-Morningstar Investment Management), Blaine Rollins (ex-Janus) and Jeremy Frank.

Croft Focus, which transplants the discipline that’s guided Croft Value for 18 years into a far more concentrated global portfolio.

RSQ International Equity, which marks the re-emergence of Rudolph Riad-Younes and Richard Pell from the ashes of the Artio International crash.

In addition, two first-tier firms (Brookfield and First Eagle) have new funds managed by experienced teams.

Funds in registration this month won’t be available for sale until, typically, the end of November or early December 2013.

Manager Changes

On a related note, we also tracked down 39 fund manager changes.

Updates

The good folks at Oakseed Opportunity (SEEDX and SEDEX) are getting their share of favorable notice.  The folks at Bloomberg featured them in A Fund’s Value: Having Skin in the Game (Sept 6, 2013) while, something called Institutional Imperative made them one of Two Funds on which to Build a Portfolio (Sept 10, 2013).  At last report, they were holding more cash, more international exposure and smaller firms than their peers, none of which has been positive in this year’s market. Somehow the fact that the managers have $10 million of their own money in the fund, and that two phenomenally talented international investors (David Herro of Oakmark and David Samra of Artisan) are also invested in the fund does rather make “weak relative returns in 2013” sound rather like background noise.  Thanks to the indefatigable Denny Baran for sharing both of those links and do consider the opportunity to speak with the Oakseed managers during our November conference call.

Morningstar declared Poplar Forest Partners Fund (PFPFX and IPFPX) to be an Undiscovered Manager (uhhh … okay) and featured them in a Morningstar Advisor Magazine article, “Greener Pastures” (August/September, 2013).  Rob Wherry makes the argument that manager Dale Harvey walked away from managing a $20 billion fund because it was – for reasons he couldn’t control – a $20 billion fund.  “I had to put the money to work. I was managing $20 billion, but I didn’t have $20 billion [worth of] good ideas . . . I had 80 investments, but I only wanted 30.”  It’s a good piece.

Briefly Noted . . .

Since DundeeWealth US, LP, has opted to get out of the US mutual fund business they’re looking for a buyer for their Dynamic Energy Income Fund (DWEIX/DWEJX/DWEKX), Dynamic U.S. Growth Fund (DWUGX/DWUHX/DWUIX) and Mount Lucas U.S. Focused Equity Fund (BMLEX) funds. Failing that, they’re likely to liquidate them. My suggestion for eBaying them was not received warmly (hey, it worked for William Shatner’s $25,000 kidney stone!). If you’re looking for a handful of $50 million funds – one of which, US Growth, is remarkably good – you might give them a call.

Fidelity Global Balanced Fund (FGBLX) manager Ruben Calderon has taken a leave of absence for an unspecified reason.  His co-manager, Geoff Stein, will take sole control.   A chunk of my retirement accounts are, and have for a long time been, invested in the fund and I wish Mr. Calderon all the best with whatever has called him away.

JPMorgan Value Opportunities Fund (JVOAX) isn’t dead yet.  The Board is appalled.  The Board convened a meeting on September 10, 2013, for the purpose of merged Value Opps into JPMorgan Large Cap Value.  Unfortunately, they have not received enough ballots to meet their quorum requirement and the meeting dissolved.  They’ve resolved to try again with the following stern warning to non-voting shareholders:

However, recognizing that it is neither feasible nor legally permitted for the Value Opportunities Fund to conduct a proxy solicitation indefinitely, the Board approved in principle the liquidation of the Value Opportunities Fund if shareholders do not approve the merger when the Meeting is reconvened on October 10, 2013. If the Value Opportunities Fund is liquidated, the Fund’s liquidation may be taxable to a shareholder depending on the shareholder’s tax situation; as a result, the tax-free nature of the merger may be more beneficial to shareholders.

Translation: (a) vote (b) the way we want you to, or we’ll liquidate your fund and jack up your taxes.

Litman Gregory giveth and Litman Gregory taketh away.  The firm has eliminated the redemption fee on its Institutional Class shares, but then increased the minimum investment for Institutional shares of their Equity (MSEFX) and International (MSILX) funds from $10,000 to $100,000.

Vanguard 500 Index Fund ETF Shares (VOO) has announced an odd reverse share split.  As of October 24, 2013, the fund will issue one new share for every two current ones.  Good news: Vanguard expects somewhat lower transaction costs as a result, savings which they’ll pass along to investors.  Bad news: “As a result of the split, VOO shareholders could potentially hold fractional shares. These will be redeemed for cash and sent to the broker of record, which may result in the realization of modest taxable gains or deductible losses for some shareholders.”

Virtus Dynamic AlphaSector Fund (EMNAX), on the other hand, mostly taketh away.  Virtus discontinued the voluntary limit on “Other Expenses” of the fund.  The fund, categorized as a long/short fund though it currently has no reported short positions, charges a lot for modest achievement: Class A Shares, 2.56%; Class B Shares, 3.31%; Class C Shares, 3.31%; and Class I Shares, 2.31%.   Virtus may also recapture fees previously waived. 

SMALL WINS FOR INVESTORS

The Board for Altegris Equity Long Short Fund (ELSAX) voted to reduce Altegris’s management fee from 2.75% to 2.25% of assets.   This qualifies as a small win since that’s still about 50% higher than reasonable.  Aston River Road Long/Short (ARLSX) investors, for example, pays a management fee of 1.20% for considerably stronger performance.  Wasatch Long/Short (FMLSX) investors pay 1.10%.

Altegris Futures Evolution Strategy Fund  (EVOAX) has capped its management fee at 1.50%.

Calamos Convertible Fund (CCVIX) reopened to new investors on September 6^th.

CSC Small Cap Value Fund (CSCSX) has been renamed Cove Street Capital Small Cap Value Fund.  They’ve eliminated their sales loads and reduced the minimum initial investment to $1,000 for Investor class shares and $10,000 for Institutional class shares.   The manager here was part of the team that had fair success at the former CNI Charter RCB Small Cap Value Fund.

CLOSINGS (and related inconveniences)

ASTON/Fairpointe Mid Cap Fund (ABMIX) is set to close on October 18, 2013.  About $5 billion in assets.  Consistently solid performance.  I’m still not a fan of announcing a closing four weeks ahead of the actual event, as happened here.

BMO Small-Cap Growth Fund (MRSCX) is closing effective November 1, 2013.  The closure represents an interesting reminder of the role of invisible assets in capacity limits.  The fund has $795 million in it, but the advisor reports that assets in the small-cap growth strategy as a whole are approaching approximately $1.5 billion.

Invesco European Small Company Fund (ESMAX) closes to new investors on October 4, 2013.  Invesco’s to be complimented on their decision to close the fund while it was still small, under a half billion in assets.

Touchstone Sands Capital Select Growth Fund (TSNAX) instituted a soft-close on April 8, 2013.  That barely slowed the inrush of money and the fund is now up to $5.5 billion in assets.  In response, the advisor will institute additional restrictions on October 21, 2013. In particular, existing RIA’s already using the fund can continue to use the fund for both new and existing clients.  They will not be able to accept any new RIA’s after that date.

Virtus Emerging Markets Opportunities Fund (HEMZX), a four-star medalist run by Morningstar’s International Stock Fund Manager of the Year Rajiv Jain, has closed to new investors.

OLD WINE, NEW BOTTLES

FMI Focus (FMIOX) will reorganize itself into Broadview Opportunity Fund in November.  It’s an exceedingly solid small-cap fund (four stars, “silver” rated, nearly a billion in assets) that’s being sold to its managers.

Invesco Disciplined Equity Fund (AWEIX) will, pending shareholder approval on October 17, become AT Disciplined Equity Fund.

Meridian Value (MVALX) is Meridian Contrarian Fund.  Same investment objective, policies, strategies and team. 

Oppenheimer Capital Income Fund (OPPEX) has gained a little flexibility; it can now invest 40% in junk bonds rather than 25%.  The fund was crushed during the meltdown in 2007-09.  Immediately thereafter its managers were discharged and it has been pretty solid since then.

Effective October 1, 2013, Reaves Select Research Fund (RSRAX) became Reaves Utilities and Energy Infrastructure Fund, with all of the predictable fallout in its listed investment strategies and risks.

Smith Group Large Cap Core Growth Fund (BSLGX) will, pending shareholder approval, be reorganized into an identical fund of the same name in early 2014. 

Tilson Dividend Fund (TILDX) has been sold to its long-time subadviser, Centaur Capital Partners, LP, presumably as part of the unwinding of the other Tilson fund.

U.S. Global Investors Government Securities Savings Fund (UGSCX) is being converted from a money market fund to an ultra-short bond fund, right around Christmas.

OFF TO THE DUSTBIN OF HISTORY

American Century announced that it will merge American Century Vista Fund (TWVAX) into American Century Heritage (ATHAX).  Both are multibillion dollar midcap growth funds, with Heritage being far the stronger. The merger will take place Dec. 6, 2013.

EGA Emerging Global ordered the liquidation of a dozen of emerging markets sector funds, all effective October 4, 2013.  The dearly departed:

• EGShares GEMS Composite ETF (AGEM)
• EGShares Basic Materials GEMS ETF (LGEM)
• EGShares Consumer Goods GEMS ETF (GGEM)
• EGShares Consumer Services GEMS ETF (VGEM)
• EGShares Energy GEMS ETF (OGEM)
• EGShares Financials GEMS ETF (FGEM)
• EGShares Health Care GEMS ETF (HGEM)
• EGShares Industrials GEMS ETF (IGEM)
• EGShares Technology GEMS ETF (QGEM)
• EGShares Telecom GEMS ETF (TGEM)
• EGShares Utilities GEMS ETF (UGEM)
• EGShares Emerging Markets Metals & Mining ETF (EMT)

FCI Value Equity Fund (FCIEX) closed September 27, on its way to liquidation.  The Board cited “the Fund’s small size and the increasing costs associated with advising a registered investment company” but might have cited, too, the fact that it trails 97% of its peers over the past five years and tended to post two awful years for every decent one.

Natixis Hansberger International Fund (NEFDX) will liquidate on October 18, 2013, a victim of bad returns, high risk, high expenses, wretched tax efficiency … all your basic causes.

Loomis Sayles Multi-Asset Real Return Fund (MARAX) liquidates at the end of October, 2013.  The fund drew about  $25 million in assets and was in existence for fewer than three years.  “Real return” funds are designed to thrive in a relatively high or rising inflation rate environment.  Pretty much any fund bearing the name has been thwarted by the consistent economic weakness that’s been suppressing prices.

I really like Manning & Napier.  They are killing off three funds that were never a good match for the firm’s core strengths.  Manning & Napier Small Cap (MNSMX), Life Sciences (EXLSX), and Technology (EXTCX) will all cease to exist on or about January 24, 2014.  My affection for them comes to mind because these funds, unlike the vast majority that end up in the trash heap, were all economically viable.  Between them they have over $600 million in assets and were producing $7 million/year in revenue for M&N.  The firm’s great strength is risk-conscious, low-cost, team-managed diversified funds.  Other than a real estate fund, they offer almost no niche products really.  Heck, the tech fund even had a great 10-year record and was no worse than mediocre in shorter time periods.  But, it seems, they didn’t make sense given M&N’s focus. 

Metzler/Payden European Emerging Markets Fund (MPYMX) closed on September 30, 2013.  It actually outperformed the average European equity fund over the past decade but suffered two cataclysm losses – 74% from June 2008 to March 2009 and 33% in 2011 – that surely sealed its fate.  We reviewed the fund favorably as a fascinating Eurozone play about seven years ago. 

Nuveen International (FAIAX) is slated to merge into Nuveen International Select (ISACX), which is a case of a poor fund with few assets joining an almost-as-poor fund with more assets (and, not coincidentally, the same managers). 

PIA Moderate Duration Bond Fund (PIATX) “will be liquidating its assets on October 31, 2013.  You are welcome, however, to redeem your shares before that date.”  As $30 million in assets, it appears that most investors didn’t require the board’s urging before getting out.

U.S. Global Investors Tax Free Fund (USUTX) will merge with a far better fund, Near-Term Tax Free (NEARX) on or about December 13, 2013.

U.S. Global Investors Treasury Securities Cash (USTXX) vanishes on December 27, 2013.

Victoria 1522 Fund (VMDAX) has closed and will liquidate on October 10, 2013.  Nice people, high fees, weak performance, no assets. 

Westcore Small-Cap Opportunity Fund (WTSCX) merges into the Westcore Small-Cap Value Dividend Fund (WTSVX) on or about November 14, 2013.  It’s hard to make a case for the surviving fund (it pays almost no dividend and trails 90% of its peers) except to say it’s better than WTSCX.  Vanguard has an undistinguished SCV index fund that would be a better choice than either.

In Closing . . .

At the beginning of October, we’ll be attending Morningstar’s ETF Invest Conference in Chicago, our first tentative inquiry, made in hopes of understanding better the prospects of actively-managed ETFs.  I don’t tweet (I will never tweet) but I will try to share daily updates and insights on our discussion board.  We’ll offer highlights of the conference presentations in our November issue.

Thanks to all of the folks who bookmarked or clicked on our Amazon link.  There was a gratifyingly sustained uptick in credit from Amazon, on the order of a 7-8% rise from our 2013 average.  Thanks especially to those who’ve supported the Observer directly (Hi, Joe!  It’s a tough balance each month: we try to be enjoyable without being fluffy, informative without being plodding.  Glad you think we make it.) or via our PayPal link (Thanks, Ken!  Thanks, Michelle.  Sorry I didn’t extend thanks sooner.  And thanks, especially, to Deb.  You make a difference).  It does make a difference.

We’ll see you just after Halloween.  If you have little kids who enjoy playing on line, one of Chip’s staff made a little free website that lets kids decorate jack-o-lanterns.  It’s been very popular with the seven-and-under set. 

Take care!

David

Dear friends,

My colleagues in the English department are forever yammering on about this Shakespeare guy.I’m skeptical. First, he didn’t even know how to spell his own name (“Wm Shakspē”? Really?). Second, he clearly didn’t understand seasonality of the markets. If you listen to Gloucester’s famous declamation in Richard III, you’ll see what I mean:

Now is the winter of our discontent
Made glorious summer by this sun of York;
And all the clouds that lour’d upon our house
In the deep bosom of the ocean buried.
Now are our brows bound with victorious wreaths;
Our bruised arms hung up for monuments;
Our stern alarums changed to merry meetings,
Our dreadful marches to delightful measures.

It’s pretty danged clear that we haven’t had anything “made glorious summer by the sun of [New] York.” By Morningstar’s report, every single category of bond and hybrid fund has lost money over the course of the allegedly “glorious summer.” Seven of the nine domestic equity boxes have flopped around, neither noticeably rising nor falling.

And now, the glorious summer passed, we enter what historically are the two worst months for the stock market. To which I can only reply with three observations (The Pirates are on the verge of their first winning season since 1992! The Steelers have no serious injuries looming over them. And Will’s fall baseball practices are upon us.) and one question:

Is it time to loathe the emerging markets? Again?

Yuh, apparently. A quick search in Google News for “emerging markets panic” turns up 3300 stories during the month of August. They look pretty much like this:

With our preeminent journalists contributing:

Many investors have responded as they usually do, by applying a short-term perspective to a long-term decision. Which is to say, they’re fleeing. Emerging market bond funds saw a $2 billion outflow in the last week of August and $24 billion since late May (Emerging Markets Fund Flows Investors Are Dumping Emerging Markets at an Accelerating Pace, Business Insider, 8/30/13). The withdrawals were indiscriminate, affecting all regions and both local currency and hard currency securities. Equity funds saw $4 billion outflows for the week, with ETFs leading the way down (Emerging markets rout has investors saying one word: sell, Marketwatch, 8/30/13).

In a peculiar counterpoint, Jason Kepler of Investment News claims – using slightly older data – that Mom and pop can’t quit emerging-market stocks. And that’s good (8/27/13). He finds “uncharacteristic resiliency” in retail investors’ behavior. I’d like to believe him. (The News allows a limited number of free article views; if you’d exceeded your limit and hit a paywall, you might try Googling the article title. Or subscribing, I guess.)

We’d like to make three points.

• Emerging markets securities are deeply undervalued
• Those securities certainly could become much more deeply undervalued.
• It’s not the time to be running away.

Emerging markets securities are deeply undervalued

Wall Street Ranter, an anonymous blogger from the financial services industry and sometime contributor to the Observer’s discussion board, shared two really striking bits of valuation data from his blog.

The first, “Valuations of Emerging Markets vs US Stocks” (7/20/13) looks at a PIMCO presentation of the Shiller PE for the emerging markets and U.S., then at how such p/e ratios have correlated to future returns. Shiller adjusts the market’s price/earnings ratio to eliminate the effect of atypical profit margins, since those margins relentlessly regress to the mean over time. There’s a fair amount of research that suggests that the Shiller PE has fair predictive validity; that is, abnormally low Shiller PEs are followed by abnormally high market returns and vice versa.

Here, with Ranter’s kind permission, is one of the graphics from that piece:

At June 30, 2013 valuations, this suggests that US equities were priced for 4% nominal returns (2-3% real), on average, over the next five years while e.m. equities were priced to return 19% nominal (17% or so real) over the same period. GMO, at month’s end, reached about the same figure for high quality US equities (3.1% real) but a much lower estimate (6.8%) for emerging equities. By GMO’s calculation, emerging equities were priced to return more than twice as much as any other publicly traded asset class.

Based on recent conversations with the folks at GMO, Ranter concludes that GMO suspects that changes in the structure of the Chinese economy might be leading them to overstate likely emerging equity returns. Even accounting for those changes, they remain the world’s most attractive asset class:

While emerging markets are the highest on their 7 year forecast (approx. 7%/year) they are treating it more like 4%/year in their allocations . . . because they believe they need to account for a longer-term shift in the pace of China’s growth. They believe the last 10 years or so have skewed the mean too far upwards. While this reduces slightly their allocation, it still leaves Emerging Markets has one of their highest forecasts (but very close to International Value … which includes a lot of developed European companies).

Ranter offered a second, equally striking graphic in “Emerging Markets Price-to-Book Ratio and Forward Returns (8/9/13).”

At these levels, he reports, you’d typically expect returns over the following year of around 55%. That data is available in his original article. 

In a singularly unpopular observation, Andrew Foster, manager of Seafarer Overseas Growth & Income (SFGIX/SIGIX), one of the most successful and risk-alert e.m. managers (those two attributes are intimately connected), notes that the most-loathed emerging markets are also the most compelling values:

The BRICs have underperformed to such an extent that their aggregate valuation, when compared to the emerging markets as a whole, is as low as it has been in eight years. In other words, based on a variety of valuation metrics (price-to-book value, price-to-prospective-earnings, and dividend yield), the BRICs are as cheap relative to the rest of the emerging markets as they have been in a long time. I find this interesting. . . for the (rare?) subset of investors contemplating a long-term (10-year) allocation to EM, just as they were better off to avoid the BRICs over the past 5 years when they were “hot,” they are likely to be better off over the next 10 years emphasizing the BRICs now they are “not.”

Those securities certainly could become much more deeply undervalued.

The graphic above illustrates the ugly reality that sometimes (late ’98, all of ’08), but not always (’02, ’03, mid ’11), very cheap markets become sickeningly cheap markets before rebounding. Likewise, Shiller PE for the emerging markets occasionally slip from cheap (10-15PE) to “I don’t want to talk about it” (7 PE). GMO mildly notes, “economic reality and investor behavior cause securities and markets to overshoot their fair value.”

Andrew Foster gently dismisses his own predictive powers (“my record on predicting short-term outcomes is very poor”). At the same time, he finds additional cause for short-term concern:

[M]y thinking on the big picture has changed since [early July] because currencies have gotten into the act. I have been worried about this for two years now — and yet even with some sense it could get ugly, it has been hard to avoid mistakes. In my opinion, currency movements are impossible to predict over the short or long term. The only thing that is predictable is that when currency volatility picks up, is likely to overshoot (to the downside) in the short run.

It’s not the time to be running away.

There are two reasons driving that conclusion. First, you’ve already gotten the timing wrong and you’re apt to double your error. The broad emerging markets index has been bumping along without material gain for five years now. If you were actually good at actively allocating your portfolio, you’d have gotten out in the summer of 2007 instead of thinking that five consecutive years of 25%+ gains would go on forever. And you, like the guys at Cook and Bynum, would have foregone Christmas presents in 2008 in order to plow every penny you had into an irrationally, shockingly cheap market. If you didn’t pull it off then, you’re not going to pull it off this time, either.

Second, there are better options here than elsewhere. These remain, even after you adjust down their earnings and adjust them down again, about the best values you’ll find. Ranter grumbles about the thoughtless domestic dash:

Bottom line is I fail to see, on a relative basis, how the US is more tempting looking 5 years out. People can be scared all they want of catching a falling knife…but it’s a lot easier to catch something which is only 5 feet in the air than something that is 10 feet in the air.

If you’re thinking of your emerging markets stake as something that you’ll be holding or building over the next 10-15 years (as I do), it doesn’t matter whether you buy now or in three months, at this level or 7% up or down from here. It will matter if you panic, leave and then refuse to return until the emerging markets feel “safe” to you – typically around the top of the next market cycle.

It’s certainly possible that you’re systemically over-allocated to equities or emerging equities. The current turbulence might well provide an opportunity to revisit your long-term plan, and I’d salute you for it. My argument here is against actions driven by your gut.

Happily, there are a number of first rate options available for folks seeking risk-conscious exposure to the emerging markets. My own choice, discussed more fully below, is Seafarer. I’ve added to my (small investor-sized) account twice since the market began turning south in late spring. I have no idea of whether those dollars with be worth a dollar or eighty cents or a plugged nickel six months from now. My suspicion is that those dollars will be worth more a decade from now having been invested with a smart manager in the emerging markets than they would have been had I invested them in domestic equities (or hidden them away in a 0.01% bank account). But Seafarer isn’t the only “A” level choice. There are some managers sitting on large war chests (Amana Developing World AMDWX), others with the freedom to invest across asset classes (First Trust/Aberdeen Emerging Opportunities FEO) and even some with both (Lazard Emerging Markets Multi-Strategy EMMOX).

To which Morningstar says, “If you’ve got $50 million to spend, we’ve got a fund for you!”

On August 22^nd, Morningstar’s Fund Spy trumpeted “Medalist Emerging-Markets Funds Open for Business,” in which they reviewed their list of the crème de la crème emerging markets funds. It is, from the average investor’s perspective, a curious list studded with funds you couldn’t get into or wouldn’t want to pay for. Here’s the Big Picture:

Our take on those funds follows.

Our recommendations differ from theirs, given our preference for smaller funds that are actually available to the public. Our shortlist:

Amana Developing World (AMDWX): offers an exceedingly cautious take on an exceedingly risky slice of the world. Readers were openly derisive of Amana’s refusal to buy at any cost, which led the managers to sit on a 50% cash stake while the market’s roared ahead. As those markets began their swoon in 2011, Amana began moving in and disposing of more than half of its cash reserves. Still cash-rich, the fund’s relative performance is picking up and its risks remain very muted.

First Trust/Aberdeen Emerging Opportunity (FEO): one of the first emerging markets balanced funds, it’s performed very well over the long-term and is currently selling at a substantial discount to NAV: 12.6%, about 50% greater than its long-term average. That implies that investors might see something like a 5% arbitrage gain once the current panic abates, above and beyond whatever the market provides.

Grandeur Peak Emerging Markets Opportunities (GPEOX): the Grandeur Peak team has been brilliantly successful both here and at Wasatch. Their intention is to create a single master fund (Global Reach) and six subsidiary funds whose portfolios represent slices of the master profile. Emerging Markets has already cleared the SEC registration procedures but hasn’t launched. The Grandeur Peak folks say two factors are driving the delay. First, the managers want to be able to invest directly in Indian equities which requires registration with that country’s equity regulators. They couldn’t begin the registration until the fund itself was registered in the US. So they’re working through the process. Second, they wanted to be comfortable with the launch of Global Reach before adding another set of tasks. Give or take the market’s current tantrum (one manager describes it as “a taper tantrum”), that’s going well. With luck, but without any guarantees, the fund might be live sometime in Q4.

Seafarer Overseas Growth & Income (SFGIX): hugely talented manager, global portfolio, risk conscious, shareholder-centered and successful.

Wasatch Frontier Emerging Small Countries (WAFMX): one of the very few no-load, retail funds that targets the smaller, more dynamic markets rather than markets with billions of people (India and China) or plausible claim to be developed markets (e.g., Korea). The manager, Laura Geritz, has been exceedingly successful. Frontier markets effectively diversify emerging markets portfolios and the fund has drawn nearly $700 million. The key is that Wasatch is apt to close the fund sooner rather than later.

Snowball’s portfolio

Some number of folks have, reasonably enough, asked whether I invest in all of the funds I profile (uhhh … there have been over 150 of them, so no) or whether I have found The Secret Formula (presumably whatever Nicholas Cage has been looking for in all those movies). The answer is less interesting than the question.

I guess my portfolio construction is driven by three dictums:

1. Don’t pretend to be smarter than you are
2. Don’t pretend to be braver than you are
3. There’s a lot of virtue in doing nothing

Don’t pretend to be smarter than you are. If I knew which asset classes were going to soar and which were going to tank in the next six months or year or two, two things would happen. First, I’d invest in the winners. Second, I’d sell my services to ridiculously rich people and sock them with huge and abusive fees that they’d happily pay. But, I don’t.

As a result, I tend to invest in funds whose managers have a reasonable degree of autonomy about investing across asset classes, rather than ones pigeonholed into a small (style) box. That’s a problem: it makes benchmarking hard, it makes maintaining an asset allocation plan hard and it requires abnormally skilled managers. My focus has been on establishing a strategic objective (“increasing exposure to fast growing economies”) and then spending a lot of time trying to find managers whose strategies I trust, respect and understand.

Don’t pretend to be braver than you are. Stocks have a lot in common with chili peppers. In each case, you get a surprising amount of benefit from a relatively small amount of exposure. In each case, increasing exposure quickly shifts the pleasure/pain balance from pleasantly piquant to moronically painful. Some readers think of my non-retirement asset allocation is surprisingly timid: about 50% stocks, 30% bonds, 20% cash equivalents. They’re not much happier about my 70% equity stake in retirement funds. But, they’re wrong.

T. Rowe Price is one of my favorite fund companies, in part because they treat their investors with unusual respect. I found two Price studies, in 2004 and again in 2010, particularly provocative. Price constructed a series of portfolios representing different levels of stock exposure and looked at how the various portfolios would have played out over the past 50-60 years.

The original study looked at portfolios with 20/40/60/80/100% stocks. The update dropped the 20% portfolio and looked at 0/40/60/80/100%. Below I’ve reproduced partial results for three portfolios. The original 2004 and 2010 studies are available at the T. Rowe Price website.

 Over a 10 year period – reasonable for a non-retirement account – a portfolio that’s 20% stocks would grow from $10,000 to $21,000. A 100% stock portfolio would grow to $28,000. Roughly speaking, the conservative portfolio ends up at 75% of the size of the aggressive one but a pure stock portfolio increases the probability of losing money by 400% (from a 6% chance to 23%), increases the size of your average loss by 2500% (from 0.5% to 12.5%) and triples your volatility. Somewhere in there, it will face the real prospect of a 51% loss, which is the average maximum drawdown for large core stock funds that have been around 20 years or more. Sadly, there’s no way of knowing whether the 51% loss will occur in Year One (where you might have some recovery time) or Year Ten (where you’d be toast).

At 50% equities, I might capture 80% of the market’s gain with 50% of its volatility. If domestic bonds weren’t in such dismal straits, a smaller stock exposure might be justifiable. But they suck so I’m stuck.

There’s a lot of virtue in doing nothing. Our action tends to be a lot more costly than our inaction, so I change my target allocation slowly and change my fund line-up slowly. I’ve held a few retirement plan funds (e.g., Fidelity Low Priced Stock FLPSX) for decades and a number of non-retirement funds since their inception. In general, I’ll only add a fund if it represents an entirely new opportunity set or if it’s replacing an existing fund. On average, I might change out one fund every year or two.

My retirement portfolio is dominated by the providers in Augustana’s 403(b) plan: Fidelity, T. Rowe Price and TIAA-CREF. The college contribution to retirement goes exclusively into TIAA-CREF. CREF Stock accounts for 68%, TIAA Real Estate holds 22% and the rest is in a target-date fund. The Fidelity and Price allocations mirror one another: 33% domestic stock (with a value bias), 33% international stock (with an emerging markets bias) and 33% income (of the eclectic Spectrum Income/Global High Income sort).

My non-retirement portfolio is nine funds and some cash waiting to be deployed.

Is anyone likely to make it into my portfolio in 2013-14? There are two candidates:

ASTON/River Road Long-Short (ARLSX). We’ve both profiled the fund and had a conference call with its manager, both of which are available on the Observer’s ARLSX page. I’m very impressed with the quality and clarity of their risk-management disciplines; they’ve left little to chance and have created a system that forces them to act when it’s time. They’ve performed well since inception and have the prospect of outperforming the stock market with a fraction of its risk. If this enters the portfolio, it would likely be as a substitute for Northern Global Tactical since the two serve the same risk-dampening function.

RiverPark Strategic Income (not yet launched). This fund will come to market in October and represents the next step out on the risk-return spectrum from the very successful RiverPark Short Term High Yield (RPHYX). I’ve been impressed with David Sherman’s intelligence and judgment and with RPHYX’s ability to deliver on its promises. We’ll be doing fairly serious inquiries in the next couple months, but the new fund might become a success to T. Rowe Price Spectrum Income.

Sterling Capital hits Ctrl+Alt+Delete

Sterling Capital Select Equity (BBTGX) has been a determinedly bad fund for years. It’s had three managers since 1993 and it has badly trailed its benchmark under each of them. The strategy is determinedly nondescript. They’ve managed to return 3.2% annually over the past 15 years. That’s better – by about 50 bps – than Vanguard’s money market fund, but not by much. Effective September 3, 2013, they’re hitting “reformat.”

The fund’s name changes, to Sterling Capital Large Cap Value Diversified Fund.

The strategy changes, to a “behavioral financed” based system targeting large cap value stocks.

The benchmark changes, to the Russell 1000 Value

And the management team changes, to Robert W. Bridges and Robert O. Weller. Bridges joined the firm in 2008 and runs the Sterling Behavioral Finance Small Cap Diversified Alpha. Mr. Weller joined in 2012 after 15 years at JPMorgan, much of it with their behavioral finance team.

None of which required shareholders’ agreement since, presumably, all aspects of the fund are “non-fundamental.” 

One change that they should pursue but haven’t: get the manager to put his own money at risk. The departing manager was responsible for five funds since 2009 and managed to find nary a penny to invest in any of them. As a group, Sterling’s bond and asset allocation team seems utterly uninterested in risking their own money in a lineup of mostly one- and two-star funds. Here’s the snapshot of those managers’ holdings in their own funds:

You’ll notice the word “none” appears 32 times. Let’s agree that it would be silly to expect a manager to own tax-free bonds anywhere but in his home jurisdiction. That leaves 26 decisions to avoid their own funds out of a total of 27 opportunities. Most of the equity managers, by contrast, have made substantial personal investments.

Warren Buffett thinks you’ve come to the right place

Fortune recently published a short article which highlighted a letter that Warren Buffett wrote to the publisher of the Washington Post in 1975. Buffett’s an investor in the Post and was concerned about the long-term consequences of the Post’s defined-benefit pension. The letter covers two topics: the economics of pension obligations in general and the challenge of finding competent investment management. There’s also a nice swipe at the financial services industry, which most folks should keep posted somewhere near their phone or monitor to review as you reflect on the inevitable marketing pitch for the next great financial product.

I particularly enjoy the “initially.” Large money managers, whose performance records were generally parlous, “felt obliged to seek improvement or at least the approach of improvement” by hiring groups “with impressive organizational charts, lots of young talent … and a record of recent performance (pg 8).” Unfortunately, he notes, they found it.

The pressure to look like you were earning your keep led to high portfolio turnover (Buffett warns against what would now be laughably low turnover: 25% per annum). By definition, most professionals cannot be above average but “a few will succeed – in a modest way – because of skill” (pg 10). If you’re going to find them, it won’t be by picking past winners though it might be by understanding what they’re doing and why:

The key: abandon all hope ye who invest in behemoths:

For those interested in Buffett’s entire reflection, Chip’s embedded the following:

Warren Buffett Katharine Graham Letter

And now for something completely different …

We can be certain of some things about Ed Studzinski. As an investor and co-manager of Oakmark Equity & Income (OAKBX), he was consistently successful in caring for other people’s money (as much as $17 billion of it), in part because he remained keenly aware that he was also caring for their futures. $10,000 entrusted to Ed and co-manager Clyde McGregor on the day Ed joined the fund (01 March 2000) would have grown to $27,750 on the day of his departure (31 December 2011). His average competitor (I’m purposefully avoiding “peer” as a misnomer) would have managed $13,900.

As a writer and thinker, he minced no words.

The Equity and Income Fund’s managers have both worked in the investment industry for many decades, so we both should be at the point in our careers where dubious financial-industry innovations no longer surprise us. Such an assumption, however, would be incorrect.

For the past few quarters we have repeatedly read that the daily outcomes in the securities markets are the result of the “Risk On/Risk Off” trade, wherein investors (sic?) react to the most recent news by buying equities/selling bonds (Risk On) or the reverse (Risk Off). As value investors we think this is pure nonsense. 

Over the past two years, Ed and I have engaged in monthly conversations that I’ve found consistently provocative and information-rich. It’s clear that he’s been paying active attention for many years to contortions of his industry which he views with equal measures of disdain and alarm. 

I’ve prevailed upon Ed to share a manager’s fuss and fulminations with us, as whim, wife and other obligations permit. His first installment, which might also be phrased as the question “Whose skin in the game?” follows.

“Skin in the Game, Part One”

One of the more favored sayings of fund managers is that they like to invest with managements with “skin in the game.” This is another instance where the early Buffett (as opposed to the later Buffett) had it right. Managements can and should own stock in their firms. But they should purchase it with their own money. That, like the prospect of hanging as Dr. Johnson said, would truly clarify the mind. In hind sight a major error in judgment was made by investment professionals who bought into the argument that awarding stock options would beneficially serve to align the interests of managements and shareholders. Never mind that the corporate officers should have already understood their fiduciary obligations. What resulted, not in all instances but often enough in the largest capitalization companies, was a class of condottieri such as one saw in Renaissance Italy, heading armies that spent their days marching around avoiding each other, all the while being lavishly paid for the risks they were NOT facing. This sub-set of managers became a new entitled class that achieved great personal wealth, often just by being present and fitting in to the culture. Rather than thinking about truly long-term strategic implications and questions raised in running a business, they acted with a short-duration focus, and an ever-present image of the current share price in the background. Creating sustainable long-term business value rarely entered into the equation, often because they had never seen it practiced.

I understood how much of a Frankenstein’s monster had been created when executive compensation proposals ended up often being the greater part of a proxy filing. A particularly bothersome practice was “reloading” options annually. Over time, with much dilution, these programs transferred significant share ownership to management. You knew you were on to something when these compensation proposals started attracting negative vote recommendations. The calls would initially start with the investor relations person inquiring about the proxy voting process. Once it was obvious that best practices governance indicated a “no” vote, the CFO would call and ask for reconsideration.

How do you determine whether a CEO or CFO actually walks the walk of good capital allocation, which is really what this is all about? One tip-off usually comes from discussions about business strategy and what the company will look like in five to ten years. You will have covered metrics and standards for acquisitions, dividends, debt, share repurchase, and other corporate action. Following that, if the CEO or CFO says, “Why do you think our share price is so low?” I would know I was in the wrong place. My usual response was, “Why do you care if you know what the business value of the company is per share? You wouldn’t sell the company for that price. You aren’t going to liquidate the business. If you did, you know it is worth substantially more than the current share price.” Another “tell” is when you see management taking actions that don’t make sense if building long-term value is the goal. Other hints also raise questions – a CFO leaves “because he wants to enjoy more time with his family.” Selling a position contemporaneously with the departure of a CFO that you respected would usually leave your investors better off than doing nothing. And if you see the CEO or CFO selling stock – “our investment bankers have suggested that I need to diversify my portfolio, since all my wealth is tied up in the company.” That usually should raise red flags that indicate something is going on not obvious to the non-insider.

Are things improving? Options have gone out of favor as a compensation vehicle for executives, increasingly replaced by the use of restricted stock. More investors are aware of the potential conflicts that options awards can create and have a greater appreciation of governance. That said, one simple law or regulation would eliminate many of the potential abuses caused by stock options. “All stock acquired by reason of stock option awards to senior corporate officers as part of their compensation MAY NOT BE SOLD OR OTHERWISE DISPOSED OF UNTIL AFTER THE EXPIRATION OF A PERIOD OF THREE YEARS FROM THE INDIVIDUAL’S LAST DATE OF SERVICE.” Then you might actually see the investors having a better chance of getting their own yachts.

Edward A. Studzinski

If you’d like to reach Ed, click here. An artist’s rendering of Messrs. Boccadoro and Studzinski appears below.

Introducing Charles’ Balcony

Since his debut in February 2012, my colleague Charles Boccadoro has produced some exceedingly solid, data-rich analyses for us, including this month’s review of the risk/return profiles of the FundX family of funds. One of his signature contributions was “Timing Method Performance Over Ten Decades,” which was widely reproduced and debated around the web.

We’re pleased to announce that we’ve collected his essays in a single, easy-to-access location. We’ve dubbed it “Charles’ Balcony” and we even stumbled upon this striking likeness of Charles and the shadowy Ed Studzinski in situ. I’m deeply hopeful that from their airy (aerie or eery) perch, they’ll share their sharp-eyed insights with us for years to come.

Observer fund profiles

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve. 

Advisory Research Strategic Income (ADVNX): you’ve got to love a 10 month old fund with a 10 year track record and a portfolio that Morningstar can only describe as 60% “other.” AR converted a successful limited partnership into the only no-load mutual fund offering investors substantial access to preferred securities.

Beck, Mack and Oliver Partners (BMPEX): we think of it as “Dodge and Cox without the $50 billion in baggage.” This is an admirably disciplined, focused equity fund with a remarkable array of safeguards against self-inflicted injuries.

FPA Paramount (FPRAX): some see Paramount as a 60-year-old fund that seeks out only the highest-quality mid-cap growth stocks. With a just-announced change of management and philosophy, it might be moving to become a first-rate global value fund (with enough assets under management to start life as one of the group’s most affordable entries).

FundX Upgrader (FUNDX): all investors struggle with the need to refine their portfolios, dumping losers and adding winners. In a follow-up to his data-rich analysis on the possibility of using a simple moving average as a portfolio signal, associate editor Charles Boccadoro investigated the flagship fund of the Upgrader fleet.

Tributary Balanced (FOBAX): it’s remarkable that a fund this consistently good – in the top tier of all balanced funds over the past five-, ten-, and fifteen-year periods and a Great Owl by my colleague Charles’ risk/return calculations – hasn’t drawn more attention. It will be more remarkable if that neglect continues despite the recent return of the long-time manager who beat pretty much everyone in sight.

Elevator Talk #8: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

Steven Vannelli, Manager

GaveKal Knowledge Leaders (GAVAX) believes in investing only in firms that are committed to being smart, so where did the dumb name come from? GaveKal is a portmanteau formed from the names of the firm’s founders: Charles Gave, Anatole Kaletsky and Louis-Vincent Gave. Happily it changed the fund’s original name from GaveKal Platform Company Fund (named after its European counterpart) to Knowledge Leaders. 

GaveKal, headquartered in Hong Kong, started in 2001 as a global economics and asset allocation research firm. Their other investment products (the Asian Balanced Fund – a cool idea which was rechristened Asian Absolute Return – and Greater China Fund) are available to non-U.S. investors as, originally, was Knowledge Leaders. They opened a U.S. office in 2006. In 2010 they deepened their Asia expertise by acquiring Dragonomics, a China-focused research and advisory firm.

Knowledge Leaders has generated a remarkable record in its two-plus years of U.S. operation. They look to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility. Currently, approximately 30% of the portfolio is in cash, down from 40% earlier in summer.

Manager Steven Vannelli researches intangible capital and corporate performance and leads the fund’s investment team. Before joining GaveKal, he spent a decade at Alexander Capital, a Denver-based investment advisor. Here’s Mr. Vannelli’s 200 words making his case:

We invest in the world’s most innovative companies. Decades of academic research show that companies that invest heavily in innovation are structurally undervalued due to lack of information on innovative activities. Our strategy capitalizes on this market inefficiency.

To find investment opportunities, we identify Knowledge Leaders, or companies with large stores of intangible assets. These companies often operate globally across an array of industries from health care to technology, from consumer to capital goods. We have developed a proprietary method to capitalize a company’s intangible investments, revealing an important, invisible layer of value inherent to intangible-rich companies. 

The Knowledge Leaders Strategy employs an active strategy that offers equity-like returns with bond-like risk. Superior risk-adjusted returns with low correlation to market indices make the GaveKal Knowledge Leaders Strategy a good vehicle for investors who seek to maximize their risk and return objectives.

The genesis of the strategy has its origin in the 2005 book, Our Brave New World, by GaveKal Research, which highlights knowledge as a scare asset.

As a validation of our intellectual foundation, in July, the US Bureau of Economic Analysis began to capitalize R&D to measure the contribution of innovation spending on growth of the US economy.

The minimum initial investment on the fund’s retail shares is $2,500. There are also institutional shares (GAVIX) with a $100,000 minimum (though they do let financial advisors aggregate accounts in order to reach that threshold). The fund’s website is clean and easily navigated. It would make a fair amount of sense for you to visit to “Fund Documents” page, which hosts the fund’s factsheet and a thoughtful presentation on intangible capital. 

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.

Upcoming conference call: A discussion of the reopening of RiverNorth Strategy Income (RNDLX)

The folks at RiverNorth will host a conference call between the fund’s two lead managers, Patrick Galley of RiverNorth and Jeffrey Gundlach of DoubleLine, to discuss their decision to reopen the fund to new investors at the end of August and what they see going forward (the phrase “fear and loathing” keeps coming up). 

The call will be: Wednesday, September 18, 3:15pm – 4:15pm CDT

To register, go to www.rivernorthfunds.com/events/

The webcast will feature a Q&A with Messrs. Galley and Gundlach.

RNDLX (RNSIX for the institutional class), which the Observer profiled shortly after launch, has been a very solid fund with a distinctive strategy. Mr. Gundlach manages part of his sleeve of the portfolio in a manner akin to DoubleLine Core Fixed Income (DLFNX) and part with a more opportunistic income strategy. Mr. Galley pursues a tactical fixed-income allocation and an utterly unique closed-end fund arbitrage strategy in his slice. The lack of attractive opportunities in the CEF universe prompted the fund’s initial closure. Emily Deter of RiverNorth reports that the opening “is primarily driven by the current market opportunity in the closed-end fund space. Fixed-income closed-end funds are trading at attractive discounts to their NAVs, which is an opportunity we have not seen in years.” Investment News reported that fixed-income CEFs moved quickly from selling at a 2% premium to selling at a 7% discount. 

That’s led Mr. Galley’s move from CEFs from occupying 17% of the portfolio a year ago to 30% today and, it seems, he believes he could pursue more opportunities if he had more cash on hand.

Given RiverNorth’s ongoing success and clear commitment to closing funds well before they become unmanageable, it’s apt to be a good use of your time.

The Observer’s own series of conference calls with managers who’ve proven to be interesting, sharp, occasionally wry and successful, will resume in October. We’ll share details in our October issue.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details.

Every day David Welsch, an exceedingly diligent research assistant at the Observer, scours new SEC filings to see what opportunities might be about to present themselves. David tracked down nearly 100 new funds and ETFs. Many of the proposed funds offer nothing new, distinctive or interesting. Some were downright mystifying. (Puerto Rico Shares? Colombia Capped ETF? The Target Duration 2-month ETF?) There were 26 no-load funds or actively-managed ETFs in registration with the SEC this month. 

Funds in registration this month won’t be available for sale until, typically, the end of October or early November 2013.

There are probably more interesting products in registration this month than at any time in the seven years we’ve been tracking them. Among the standouts:

Brown Advisory Strategic European Equity Fund which will be managed by Dirk Enderlein of Wellington Management. Wellington is indisputably an “A-team” shop (they’ve got about three-quarters of a trillion in assets under management). Mr. Enderlein joined them in 2010 after serving as a manager for RCM – Allianz Global Investors in Frankfurt, Germany (1999-2009). Media reports described him as “one of Europe’s most highly regarded European growth managers.”

DoubleLine Shiller Enhanced CAPE will attempt to beat an index, Shiller Barclays CAPE® US Sector TR USD Index, which was designed based on decades of research by the renowned Robert Shiller. The fund will be managed by Jeffrey Gundlach and Jeffrey Sherman.

Driehaus Micro Cap Growth Fund, a converted 15 year old hedge fund

Harbor Emerging Markets Equity Fund, which will be sub-advised by the emerging markets team at Oaktree Capital Management. Oaktree’s a first-tier institutional manager with a very limited number of advisory relationships (primarily with Vanguard and RiverNorth) in the mutual fund world. 

Meridian Small Cap Growth, which will be the star vehicle for Chad Meade and Brian Schaub, who Meridian’s new owner hired away from Janus. Morningstar’s Greg Carlson described them as “superb managers” who were “consistently successful during their nearly seven years at the helm” of Janus Triton.

Plus some innovative offerings from Northern, PIMCO and T. Rowe Price. Details and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes

On a related note, we also tracked down a record 85 fund manager changes. Investors should take particular note of Eric Ende and Stephen Geist’s exit from FPA Paramount after a 13 year run. The change is big enough that we’ve got a profile of Paramount as one of the month’s Most Intriguing New Funds.

Updates

Bretton Fund (BRTNX) is now available through Vanguard. Manager Stephen Dodson writes that after our conference call, several listeners asked about the fund’s availability and Stephen encouraged them to speak directly with Vanguard. Mirabile dictu, the Big V was receptive to the idea.

Stephen recently posted his most recent letter to his shareholders. He does a nice job of walking folks through the core of his investing discipline with some current illustrations. The short version is that he’s looking for firms with durable competitive advantages in healthy industries whose stocks are selling at a substantial discount. He writes:

There are a number of relevant and defensible companies out there that are easily identifiable; the hard part is finding the rare ones that are undervalued. The sweet spot for us continues to be relevant, defensible businesses at low prices (“cheap compounders”). I continue to spend my waking hours looking for them.

Q2 2013 presented slim pickin’s for absolute value investors (Bretton “neither initiated nor eliminated any investments during the quarter”). For all of the market’s disconcerting gyrations this summer, Morningstar calculates that valuations for its Wide Moat and Low Business Uncertainty groups (surrogates for “high quality stocks”) remains just about where they were in June: undervalued by about 4% while junkier stocks remain modestly overvalued.

Patience is hard.

Briefly Noted . . .

Calamos loses another president

James Boyne is resigning as president and chief operating officer of Calamos Investments effective Sept. 30, just eight months after being promoted to president. The firm has decided that they need neither a president nor a chief operating officer. Those responsibilities will be assumed “by other senior leaders” at the firm (see: Black, Gary, below). The preceding president, Nick P. Calamos, decided to “step back” from his responsibilities in August 2012 when, by coincidence, Calamos hired former Janus CEO Gary Black. To describe Black as controversial is a bit like described Rush Limbaugh as opinionated.

They’re not dead yet!

Back in July, the Board of Caritas All-Cap Growth (CTSAX): “our fund is tiny, expensive, bad, and pursues a flawed investment strategy (long stocks, short ETFs).” Thereupon they reached a sensible conclusion: euthanasia. Shortly after the fund had liquidated all of its securities, “the Board was presented with and reviewed possible alternatives to the liquidation of the Fund that had arisen since the meeting on July 25, 2013.”

The alternative? Hire Brenda A. Smith, founder of CV Investment Advisors, LLC, to manage the fund. A quick scan of SEC ADV filings shows that Ms. Smith is the principal in a two person firm with 10 or fewer clients and $5,000 in regulated AUM. 

(I don’t know more about the firm because they have a one page website.)

At almost the same moment, the same Board gave Ms. Smith charge of the failing Presidio Multi-Strategy Fund (PMSFX), an overpriced long/short fund that executes its strategy through ETFs. 

I wish Ms. Smith and her new investors all the luck in the world, but it’s hard to see how a Board of Trustees could, with a straight face, decide to hand over one fund and resuscitate another with huge structural impediments on the promise of handing it off to a rookie manager and declare that both moves are in the best interests of long-suffering shareholders.

Diamond Hill goes overseas, a bit

Effective September 1, 2013, Diamond Hill Research Opportunities Fund (DHROX) gains the flexibility to invest internationally (the new prospectus allows that it “may also invest in non-U.S. equity securities, including equity securities in emerging market countries”) and the SEC filing avers that they “will commence investing in foreign securities.” The fund has 15 managers; I’m guessing they got bored. As a hedge fund (2009-2011), it had a reasonably mediocre record which might have spurred the conversion to a ’40 fund. Which has also had a reasonably mediocre lesson, so points to the management for consistency!

Janus gets more bad news

Janus investors pulled $2.2 billion from the firm’s funds in July, the worst outflows in more than three years. A single investor accounted for $1.3 billion of the leakage. The star managers of Triton and Venture left in May. And now this: they’re losing business to Legg Mason.

The Board of Trustees of Met Investors Series Trust has approved a change of subadviser for the Janus Forty Portfolio from Janus Capital Management to ClearBridge Investments to be effective November 1, 2013 . . . Effective November 1, 2013, the name of the Portfolio will change to ClearBridge Aggressive Growth Portfolio II.

Matthews chucks Taiwan

Matthews Asia China (MCHFX), China Dividend (MCDFX) and Matthews and China Small Companies (MCSMX) have changed their Principal Investment Strategy to delete Taiwan. The text for China Dividend shows the template:

Under normal market conditions, the Matthews China Dividend Fund seeks to achieve its investment objective by investing at least 80% of its net assets, which include borrowings for investment purposes, in dividend-paying equity securities of companies located in China and Taiwan.

To:

Under normal market conditions, the Matthews China Dividend Fund seeks to achieve its investment objective by investing at least 80% of its nets assets, which include borrowings for investment purposes, in dividend-paying equity securities of companies located in China.

A reader in the financial services industry, Anonymous Dude, checked with Matthews about the decision. AD reports

T. Rowe tweaks

Long ago, as a college administrator, I was worried about whether the text in a proposed policy statement might one day get us in trouble. I still remember college counsel shaking his head confidently, smiling and saying “Not to worry. We’re going to fuzz it up real good.” One wonders if he works for T. Rowe Price now? Up until now, many of Price’s funds have had relatively detailed and descriptive investment objectives. No more! At least five of Price’s funds propose new language that reduces the statement of investment objectives to an indistinct mumble. T. Rowe Price Growth Stock Fund (PRGFX) goes from

The fund seeks to provide long-term capital growth and, secondarily, increasing dividend income through investments in the common stocks of well-established growth companies.

To

The fund seeks long-term capital growth through investments in stocks.

Similar blandifications are proposed for Dividend Growth, Equity Income, Growth & Income and International Growth & Income.

Wasatch redefines “small cap”

A series of Wasatch funds, Small Growth, Small Value and Emerging Markets Small Cap are upping the size of stocks in their universe from $2.5 billion or less to $3.0 billion or less. The change is effective in November.

Can you say whoa!? Or WOA?

The Board of Trustees of an admittedly obscure little institutional fund, WOA All Asset (WOAIX), has decided that the best way to solve what ails the yearling fund is to get it more aggressive.

The Board approved certain changes to the Fund’s principal investment strategies. The changes will be effective on or about September 3, 2013. . . the changes in the Fund’s strategy will alter the Fund’s risk level from balanced strategy with a moderate risk level to an aggressive risk level.

Here’s the chart of the fund’s performance since inception against conservative and moderate benchmarks. While that might show that the managers just need to fire up the risk machine, I’d also imagine that addressing the ridiculously high expenses (1.75% for an institutional balanced fund) and consistent ability to lag in both up and down months (11 of 16 and counting) might actually be a better move. 

WOA’s Trustees, by the way, are charged with overseeing 24 funds. No Trustee has a dollar invested in any of those funds.

SMALL WINS FOR INVESTORS

The Board of Trustees of the Direxion Funds and Rafferty Asset Management have decided to make it cheaper for you to own a bunch of funds that you really shouldn’t own. They’re removed the 25 bps Shareholder Servicing Fee from

• Direxion Monthly S&P 500® Bull 2X Fund
• Direxion Monthly S&P 500® Bear 2X Fund
• Direxion Monthly NASDAQ-100® Bull 2X Fund
• Direxion Monthly Small Cap Bull 2X Fund
• Direxion Monthly Small Cap Bear 2X Fund
• Direxion Monthly Emerging Markets Bull 2X Fund
• Direxion Monthly Latin America Bull 2X Fund
• Direxion Monthly China Bull 2X Fund
• Direxion Monthly Commodity Bull 2X Fund
• Direxion Monthly 7-10 Year Treasury Bull 2X Fund
• Direxion Monthly 7-10 Year Treasury Bear 2X Fund
• Dynamic HY Bond Fund and
• U.S. Government Money Market Fund.

Because Eaton Vance loves you, they’ve decided to create the opportunity for investors to buy high expense “C” class shares of Eaton Vance Bond (EVBCX). The new shares will add a 1.00% back load for sales held less than a year and a 1.70% expense ratio (compared to 0.7 and 0.95 for Institutional and A, respectively). 

The Fairholme Fund (FAIRX) reopened to new investors on August 19, 2013. The other Fairholme family funds, not so much.

The Advisor Class shares of Forward Select Income Fund (FSIMX) reopened to new investors at the end of August.

The Board of Directors of the Leuthold Global Industries Fund (LGINX) has agreed to reduce the Fund’s expense cap from 1.85% to 1.60%.

JacksonPark Capital reduced the minimum initial investment on Oakseed Opportunity Institutional shares (SEDEX) from $1 million to $10,000. Given the 18% lower fees on the institutional class (capped at 1.15% versus 1.40% for retail shares), reasonably affluent retail investors ought to seriously consider pursuing the institutional share class. That said, Oakseed’s minimum investment for the retail shares, as low as $100 for accounts set up with an AIP, are awfully reasonable.

RiverNorth DoubleLine Strategic Income (RNDLX/RNSIX) reopened to new investors at the end of August. Check the “upcoming conference calls” feature, above, for more details.

Westcore Blue Chip Dividend Fund (WTMVX ) lowered the expense ratio on its no-load retail shares from 1.15% to 0.99%, effective September 1. They also changed from paying distributions annually to paying them quarterly. It’s a perfectly agreeable, mild-mannered little fund: stable management, global diversified, reasonable expenses and very consistently muted volatility. You do give up a fair amount of upside for the opportunity to sleep a bit more quietly at night.

CLOSINGS (and related inconveniences)

American Beacon Stephens Small Cap Growth Fund (STSGX) will close to new investors, effective as of September 16, 2013. The no-class share class has returned 11.8% while its peers made 9.3% and it did so with lower volatility. The fund is closing at a still small $500 million.

Neither high fees nor mediocre performance can dim the appeal of AQR Multi-Strategy Alternative Fund (ASANX/ASAIX). The fund has drawn $1.5 billion and has advertised the opportunity for rich investors (the minimum runs between $1 million and $5 million) to rush in before the doors swing shut at the end of September. It’s almost always a bad sign that a fund feels the need to close and the need to put up a flashing neon sign six weeks ahead.

Morgan Stanley Institutional Global Franchise (MSFAX) will close to new investors on Nov. 29, 2013. The current management team came on board four years ago (June 2009) and have posted very good risk-adjusted returns since then. Investors might wonder why a large cap global fund with a small asset base needs to close. The answer is that the mutual fund represents just the tip of the iceberg; this team actually manages almost $17 billion in this strategy, so the size of the separate accounts is what’s driving the decision.

OLD WINE, NEW BOTTLES

At the end of September Ariel International Equity Fund (AINTX) becomes Ariel International Fund and will no longer be required to invest at least 80% of its assets in equities. At the same time, Ariel Global Equity Fund (AGLOX) becomes Ariel Global Fund. The advisor avers that it’s not planning on changing the funds’ investment strategies, just that it would be nice to have the option to move into other asset classes if conditions dictate.

Effective October 30, Guggenheim U.S. Long Short Momentum Fund (RYAMX) will become plain ol’ Guggenheim Long-Short Fund. In one of those “why bother” changes, the prospectus adds a new first sentence to the Strategy section (“invest, under normal circumstances, at least 80% of its assets in long and short equity or equity-like securities”) but maintains the old “momentum” language in the second and third sentences. They’ll still “respond to the dynamically changing economy by moving its investments among different industries and styles” and “allocates investments to industries and styles according to several measures of momentum. “ Over the past five years, the fund has been modestly more volatile and less profitable than its peers. As a result, they’ve attracted few assets and might have decided, as a marketing matter, that highlighting a momentum approach isn’t winning them friends.

As of October 28, the SCA Absolute Return Fund (SCARX) will become the Granite Harbor Alternative Fund and it will no longer aim to provide “positive absolute returns with less volatility than traditional equity markets.” Instead, it’s going for the wimpier “long-term capital appreciation and income with low correlation” to the markets. SCA Directional Fund (SCADX) will become Granite Harbor Tactical Fund but will no longer seek “returns similar to equities with less volatility.” Instead, it will aspire to “long term capital appreciation with moderate correlation to traditional equity markets.” 

Have you ever heard someone say, “You know, what I’m really looking for is a change for a moderate correlation to the equity markets”? No, me neither.

Thomas Rowe Price, Jr. (the man, 1898-1983) has been called “the father of growth investing.” It’s perhaps then fitting that T. Rowe Price (the company) has decided to graft the word “Growth” into the names of many of its funds effective November 1.

T. Rowe Price Institutional Global Equity Fund becomes T. Rowe Price Institutional Global Focused Growth Equity Fund. Institutional Global Large-Cap Equity Fund will change its name to the T. Rowe Price Institutional Global Growth Equity Fund. T. Rowe Price Global Large-Cap Stock Fund will change its name to the T. Rowe Price Global Growth Stock Fund.

Effective October 28, 2013, USB International Equity Fund (BNIEX) gets a new name (UBS Global Sustainable Equity Fund), new mandate (invest globally in firms that pass a series of ESG screens) and new managers (Bruno Bertocci and Shari Gilfillan). The fund’s been a bit better under the five years of Nick Irish’s leadership than its two-star rating suggests, but not by a lot.

Off to the dustbin of history

There were an exceptionally large number of funds giving up the ghost this month. We’ve tracked 26, the same as the number of new no-load funds in registration and well below the hundred or so new portfolios of all sorts being launched. I’m deeply grateful to The Shadow, one of the longest-tenured members of our discussion board, for helping me to keep ahead of the flood.

American Independence Dynamic Conservative Plus Fund (TBBIX, AABBX) will liquidate on or about September 27, 2012.

Dynamic Canadian Equity Income Fund (DWGIX) and Dynamic Gold & Precious Metals Fund (DWGOX), both series of the DundeeWealth Funds, are slated for liquidation on September 23, 2013. Dundee bumped off Dynamic Contrarian Advantage Fund (DWGVX) and announced that it was divesting itself of three other funds (JOHCM Emerging Markets Opportunities Fund JOEIX, JOHCM International Select Fund JOHIX and JOHCM Global Equity Fund JOGEX), which are being transferred to new owners.

Equinox Commodity Strategy Fund (EQCAX) closed to new investors in mid-August and will liquidate on September 27^th.

The Evolution Funds face extinction! Oh, the cruel irony of it.

Evolution Managed Bond (PEMVX) Evolution All-Cap Equity (PEVEX), Evolution Market Leaders (PEVSX) and Evolution Alternative Investment (PETRX) have closed to all new investment and were scheduled to liquidate by the end of September. Given their disappearance from Morningstar, one suspects the end came more quickly than we knew.

Frontegra HEXAM Emerging Markets Fund (FHEMX) liquidates at the end of September.

The Northern Lights Board of Trustees has concluded that “based on, among other factors, the current and projected level of assets in the Fund and the belief that it would be in the best interests of the Fund and its shareholders to discontinue the Hundredfold Select Global Fund (SFGPX).”

Perhaps the “other factors” would be the fact that Hundredfold trailed 100% of its peers over the past three- and five-year periods? The manager was unpaid and quite possibly the fund’s largest shareholder ($50-100k in a $2M fund). His Hundredfold Select Equity (SFEOX) is almost as woeful as the decedent, but Hundredfold Select Alternative (SFHYX) is in the top 1% of its peer group for the same period that the others are bottom 1%. That raises the spectre that luck, rather than skill, might be involved.

JPMorgan is cleaning house: JPMorgan Credit Opportunities Fund (JOCAX), JPMorgan Global Opportunities Fund (JGFAX) and JPMorgan Russia Fund (JRUAX) are all gone as of October 4.

John Hancock intends to merge John Hancock High Income (JHAQX) into John Hancock High Yield (JHHBX). I’m guessing at the fund tickers because the names in the SEC filing don’t quite line up with the Morningstar ones.

Legg Mason Esemplia Emerging Markets Long-Short Fund (SMKAX) will be terminated on October 1, 2013. Let’s see: hard-to-manage strategy, high risk, high expenses, high front load, no assets . . . sounds like Legg.

Leuthold Asset Allocation Fund (LAALX) is merging into Leuthold Core Investment Fund (LCORX). The Board of Directors approved a proposal for the Leuthold Asset Allocation to be acquired by the Leuthold Core, sometime in October 2013. Curious. LAALX, with a quarter billion in assets, modestly lags LCORX which has about $600 million. Both lag more mild-mannered funds such as Northern Global Tactical Asset Allocation (BBALX) and Vanguard STAR (VGSTX) over the course of LAALX’s lifetime. This might be less a story about LAALX than about the once-legendary Leuthold Core. Leuthold’s funds are all quant-driven, based on an unparalleled dataset. For years Core seemed unstoppable: between 2003 and 2008, it finished in the top 5% of its peer group four times. But for 2009 to now, it has trailed its peers every year and has bled $1 billion in assets. In merging the two, LAALX investors get a modestly less expensive fund with modestly better performance. Leuthold gets a simpler administrative structure. 

I halfway admire the willingness of Leuthold to close products that can’t distinguish themselves in the market. Clean Tech, Hedged Equity, Undervalued & Unloved, Select Equities and now Asset Allocation have been liquidated.

MassMutual Premier Capital Appreciation Fund (MCALX) will be liquidated, but not until January 24, 2014. Why? 

New Frontiers KC India Fund (NFIFX) has closed and began the process of liquidating their portfolio on August 26^th. They point to “difficult market conditions in India.” The fund’s returns were comparable to its India-focused peers, which is to say it lost about 30% in 18 months.

Nomura Partners India Fund (NPIAX), Greater China Fund (NPCAX) and International Equity Fund (NPQAX) will all be liquidated by month’s end.

Nuveen Quantitative Enhanced Core Equity (FQCAX) is slated, pending inevitable shareholder approval, to disappear into Nuveen Symphony Low Volatility Equity Fund (NOPAX, formerly Nuveen Symphony Optimized Alpha Fund)

Oracle Mutual Fund (ORGAX) has “due to the relatively small size of the fund” underwent the process of “orderly dissolution.” Due to the relatively small size? How about, “due to losing 49.5% of our investors’ money over the past 30 months, despite an ongoing bull market in our investment universe”? To his credit, the advisor’s president and portfolio manager went down with the ship: he had something between $500,000 – $1,000,000 left in the fund as of the last SAI.

Quantitative Managed Futures Strategy Fund (QMFAX) will “in the best interests of the Fund and its shareholders” redeem all outstanding shares on September 15^th.

The directors of the United Association S&P 500 Index Fund (UASPX/UAIIX) have determined that it’s in their shareholders’ best interest to liquidate. Uhhh … I don’t know why. $140 million in assets, low expenses, four-star rating …

Okay, so the Oracle Fund didn’t seem particularly oracular but what about the Steadfast Fund? Let’s see: “steadfast: firmly loyal or constant, unswerving, not subject to change.” VFM Steadfast Fund (VFMSX) launched less than one year ago and gone before its first birthday.

In Closing . . .

Interesting stuff’s afoot. We’ve spoken with the folks behind the surprising Oberweis International Opportunities Fund (OBIOX), which was much different and much more interesting that we’d anticipated. Thanks to “Investor” for poking us about a profile. In October we’ll have one. RiverPark Strategic Income is set to launch at the end of the month, which is exciting both because of the success of the other fund (the now-closed RiverPark Short Term High Yield Fund RPHYX) managed by David Sherman and Cohanzick Asset Management and because Sherman comes across as such a consistently sharp and engaging guy. With luck, I’ll lure him into an extended interview with me and a co-conspirator (the gruff but lovable Ed Studzinski, cast in the role of a gruff but lovable curmudgeon who formerly managed a really first-rate mutual fund, which he did).

MFO returns to Morningstar! Morningstar is hosting their annual ETF Invest Conference in Chicago, from October 2 – 4. While, on whole, we’d rather drop by their November conference in Milan, Italy it was a bit pricey and I couldn’t get a dinner reservation at D’O before early February 2014 so we decided to pass it up. While the ETF industry seems to be home to more loony ideas and regrettable business practices than most, it’s clear that the industry’s maturing and a number of ETF products offer low cost access to sensible strategies, some in areas where there are no tested active managers. The slow emergence of active ETFs blurs the distinction with funds and Morningstar does seem do have arranged both interesting panels (skeptical though I am, I’ll go listen to some gold-talk on your behalf) and flashy speakers (Austan Goolsbee among them). With luck, I’ll be able to arrange a couple of face-to-face meetings with Chicago-based fund management teams while I’m in town. If you’re going to be at the conference, feel free to wave. If you’d like to chat, let me know.

If you shop Amazon, please do remember to click on the Observer’s link and use it. If you click on it right now, you can bookmark it or set it as a homepage and then you won’t forget. The partnership with Amazon generates about $20/day which, while modest, allows us to reliably cover all of our “hard” expenses and underwrites the occasional conference coverage. If you’d prefer to consider other support options, that’s great. Just click on “support us” on the top menu bar. But the Amazon thing is utterly painless for you.

The Sufi poet Attar records the fable of a powerful king who asks assembled wise men to create a ring that will make him happy when he is sad, and vice versa. After deliberation the sages hand him a simple ring with the words “This too will pass.” That’s also true of whatever happens to the market and your portfolio in September and October.

Be brave and we’ll be with you in a month!

Dear friends,

Welcome to the Vacation 2013 issue of the Observer. I’ve spent the past two weeks of July and the first days of August enjoying myself in Door County, the Cape Cod-like peninsula above Green Bay. I’ve done substantial damage to two Four Berry pies from Bea’s Ho-made Pies (jokes about the makers of the pie have been deleted), enjoyed rather more Leinies than usual, sailed on a tall ship, ziplined (ending in a singularly undignified position), putt-putted, worked with my son on his pitching, hiked miles and learned rather more than I cared to about alewives, gobies and lake levels.

I did not think (much) about mutual funds, Mr. Market, my portfolio, or the Dow’s closing level.  Indeed, I have no idea of what the market’s been doing.

Life is good.

Risk spectrum for Observer funds

We have published some dozens of profiles of new, distinguished and distinctive funds in the past couple years (click on the Funds tab if you’re curious).  Charles Boccadoro, our Associate Editor, has been working on ways to make those profiles more organized and accessible.  Here’s his take on one way of thinking about the collection.

Dashboard of MFO Profiled Funds

Each month, David provides in-depth analysis of two to four funds, continuing a FundAlarm tradition. Today, more than 75 profiles are available on MFO Funds index page. Most are quite current, but a few date back, under “Archives of FundAlarm,” so reference appropriately.

This month we roll out a new summary or “dashboard” of the many profiled funds. It’s intended to help identify funds of interest, so that readers can better scroll the index to retrieve in-depth profiles.

The dashboard presents funds by broad investment type, consistent with MFO Rating System. The three types are: fixed income, asset allocation, and equity. (See also Definitions page.)

Here is dashboard of profiled fixed income and asset allocation funds:

For each fund, the dashboard identifies current investment style or category as defined by Morningstar, date (month/year) of latest profile published, fund inception date (from first whole month), and latest 12-month yield percentage, as applicable.

Risk group is also identified, consistent with latest MFO rating. In the dashboard, funds with lowest risk will generally be at top of list, while those with highest risk will be at bottom, agnostic of M* category. Probably good to insert a gentle reminder here that risk ratings can get elevated, temporarily at least, when funds hit a rough patch, like recently with some bond and all-asset funds.

The dashboard also depicts fund absolute return relative to cash (90-day T-Bill), bonds (US Aggregate TR), and stocks (S&P 500 TR), again agnostic of M* category. If a fund’s return from inception through the latest quarter exceeds any of these indices, “Return Beats…” column will be shaded appropriately.

The Enhanced Strategy column alerts readers of a fund’s use of leverage or hedge via short positions, or if a fund holds any derivatives, like swaps or futures. If so, regardless of how small, the column will show “Yes.” It’s what David calls a kind of complexity flag. This assessment is strictly numerical using latest portfolio allocations from Morningstar’s database in Steele Mutual Fund Expert.

Finally, the column entitled “David’s Take” is a one-word summary of how each fund was characterized in its profile. Since David tends to only profile funds that have promising or at least intriguing strategies, most of these are positive. But every now and then, the review is skeptical (negative) or neutral (mixed).

We will update the dashboard monthly and, as always, improve and tailor based on your feedback. Normally the dashboard will be published atop the Funds index page, but for completeness this month, here’s dashboard of remaining equity funds profiled by MFO:

Charles/28Jul13

Would you ever need more than one long-short fund?

By bits, investors have come to understand that long-short (and possible other alternative) funds may have a place in their portfolios.  That’s a justifiable conclusion.  The question is, would you ever want need more than one long-short fund?

The lead story in our July issue made the argument, based on interviews with executives and managers are a half dozen firms, that there are at least three very distinct types of long-short funds (pure long/short on individual stocks, long on individual stocks/short on sectors or markets, long on individual stocks plus covered called exposure) .  They have different strategies and different risk-return profiles.  They are not interchangeable in a portfolio.

The folks at Long-Short Advisors gave permission to share some fascinating data with you.  They calculated the correlation matrix for their fund, the stock market and ten of their largest competitors, not all of which are pure long/short funds.  By way of context, the three-year correlation between the movement of Vanguard’s Small Cap Index Fund (NAESX) and their S&P 500 Index Fund (VFINX) is .93; that is, when you buy a small cap index as a way to diversify your large cap-heavy portfolio, you’re settling for an investment with a 93% correlation to your original portfolio.

Here are the correlations between various long/short funds:

This does not automatically justify inclusion of a second or third long-short fund in your portfolio, but it does demonstrate two things.  First, that long-short funds really are vastly different from one another, which is why their correlations are so low.  Second, a single long-short fund offers considerable diversification in a long-only portfolio and a carefully selected second fund might add a further layer of independence.

Royce Value Trust plans on exporting its investors

Royce Value Trust (RVT) is a very fine closed-end fund managed by a team led by Chuck Royce.  Morningstar rates it as a “Gold” CEF despite the fact that it has modestly trailed its peers for more than a decade.  The fund has attracted rather more than a billion in assets.

Apparently the managers aren’t happy with that development and so have propsoed exporting some of their investors’ money to a new fund.  Here’s the SEC filing:

I invite you to a special stockholder meeting of Royce Value Trust Inc. to be held on September 5, 2013. At the meeting, stockholders will be asked to approve a proposal to contribute a portion of Value Trust’s assets to a newly-organized, closed-end management investment company, Royce Global Value Trust, Inc. and to distribute to common stockholders of Value Trust shares of common stock of Global Trust.

And why would they “contribute” a portion of your RVT portfolio to their global fund?

Although Value Trust and Global Trust have the exact same investment objective of long-term growth of capital, Value Trust invests primarily in U.S. domiciled small-cap companies while Global Trust will invest primarily in companies located outside the U.S. and may invest up to 35% of its assets in the securities of companies headquartered in “developing countries.” For some time, we have been attracted to the opportunities for long-term capital growth presented in the international markets, particularly in small-cap stocks. To enable Value Trust’s stockholders to participate more directly in these opportunities, we are proposing to contribute approximately $100 million of Value Trust’s assets to Global Trust.

I see.  RVT shareholders, by decree, need more international and emerging markets exposure.  Rather than risking the prospect that they might do something foolish (for example, refuse to buy an untested new fund on their own), Royce proposes simply diversifying your portfolio into their favorite new area.  By the same logic, they might conclude that you could also use some emerging markets bonds.  Were you silly enough to think that you needed domestic small cap exposure and, hence, bought a domestic small cap fund?  “No problem!  We’ll launch and move you into …”

And why $100 million exactly?  “The $100 million target size (approximately 8% of Value Trust’s current net assets) was established to satisfy New York Stock Exchange listing standards and to seek to ensure that Global Trust has sufficient assets to conduct its investment program while maintaining an expense ratio that is competitive with those of other global small-cap value funds.”  So, as a portfolio move, RVT shareholders gain perhaps 4% exposure to small caps in developed foreign markets and 2% in emerging markets.

In one of Morningstar’s odder tables, they classified RVT as having the worst performance ever, anywhere, by anything:

You might notice the frequency with which RVT trails 100% of its peers.  Odd in a “Gold” fund?  Not so much as you might think.  When I asked Morningstar’s peerless Alexa Auerbach to check, she reported that RVT’s category contains only two funds.  The other, slightly better one is also from Royce and so the 100^th percentile ranking translates to “finished second in a two-person race.”

Experienced managers launching their own firms: Barron’s gets it (mostly) right

Barron’s featured a nice story on the challenge of launching a new fund firm and highlighted four star managers who choose to strike out on their own (“Introducing the New Guard,” July 8, p.p. L17-19). (We can’t link directly to this article, but if you Google the title you should be able to gain complimentary access to it.) They focus on four firms about which, you might have noticed, I have considerable enthusiasm:

Vulcan Value Partners, whose Vulcan Value Small Cap Fund we profiled.

Highlights: C.T. Fitzpatrick – one of the few managers whose funds I’ve profiled but with whom I’ve never spoken – distinguishes Vulcan’s approach from the Longleaf (his former employer) approach because “we place as much emphasis on business quality as we do on the discount.” He also thinks that his location in Birmingham is a plus since it’s easier to stand back from the Wall Street consensus if you’re 960 (point eight!) miles away from it. He also thinks that it makes recruiting staff easier since, delightful as New York City is, a livable, affordable smaller city with good schools is a remarkable draw.

Seafarer Capital Partners, whose Seafarer Overseas Growth & Income is in my own portfolio and to which I recently added shares.

Highlight: Andrew Foster spends about a third of this time running the business. Rather than a distraction, he thinks it’s making him a better investor by giving him a perspective he never before had. He frets about investors headlong rush into the more volatile pieces of an intrinsically volatile sector. He argues in this piece for slow-and-steady growers and notes that “People often forget that when you invest in emerging markets, you’re investing in something that is flawed but that you believe can eventually improve.”

Grandeur Peak Global Advisors, whose Grandeur Peak Global Opportunities was profiled in February 2012 and about whom we offer a short feature article and two fund profiles, all below.

Highlight: Lead manager Robert Gardiner and president Eric Huefner both began working for Wasatch as teenagers? (Nuts. I worked at a public library for $1.60/hour and was doing landscaping for less.) They reject the domestic/international split when it comes to doing security analysis and allow Mr. Gardiner to focus entirely on investing while Mr. Huefner obsesses about running a great firm. 

Okay, Barrons’ got it mostly right. They got the newest name of the fund wrong (it’s Reach, not Research), the photo caption wrong and a provocative quote wrong. Barron’s claimed that Gardiner is “intent on keeping Grandeur Peak, which is now on the small side, just shy of $1 billion under management.” Apparently Mr. Huefner said Grandeur Peak currently had a bit under a billion, that their strategies’ collective capacity was $3 billion but they’re apt to close once they hit $2 billion to give them room for growth.

RiverPark Advisors, five of whose funds we’ve profiled, two more of which we’ve pointed to and one of which is in my personal portfolio (and Chip’s). 

Highlight: Mitch Rubin’s reflection on the failure of their first venture, a hedge fund “Our mistake, we realized, was trying to create strategies we thought investors wanted to buy rather than structuring the portfolios around how we wanted to invest” and Mitch Rubin’s vitally important note, “Managers often think of themselves as the talent. But the ability to run these businesses well takes real talent.” Ding, ding, ding, ding! Exactly. There are only a handful of firms, including Artisan, RiverPark and Seafarer, where I think the quality of the business operation is consistently outstanding. (It’s a topic we return, briefly, to below in the discussion of “Two questions for potential fund entrepreneurs.”)  Lots of small firms handicap themselves by making the operations part of the business an afterthought. Half of the failure of Marx’s thought was his inability to grasp the vital and difficult role of organizing and managing your resources.

Will casting off at Anderson’s Pier in Ephraim, WI.

Two questions for potential fund entrepreneurs

Where will you find your first $100 million?  And who’s got the 263 hours to spend on the paperwork?

I’d expressed some skepticism about the claim in Barron’s (see above) that mutual funds need between $100 – 200 million in AUM in order to be self-sustaining.  That is, to cover both their external expenses such as legal fees, to pay for staff beyond a single manager and to – here’s a wild thought – pay the manager a salary. 

In conversations over the past month with Andrew Foster at Seafarer and Greg Parcella at Long/Short Advisors, it became clear that the figure quoted in Barron’s was pretty reasonable.  Mr. Foster points out that the break-even is lower for a second or third fund, since a viable first fund might cover most of the firm’s overhead expenses, but for a firm with a single product (and most especially an international or global one), $100 million is a pretty reasonable target. 

Sadly, many of the managers I’ve spoken with – even guys with enormous investment management skill – have a pretty limited plan for getting there beyond the “build a better mousetrap” fiction.  In truth, lots of “better mousetraps” languish.  There are 2400 funds with fewer than $100 million in the portfolio, 10% of which are current four- or five-star funds, according to Morningstar.  (Many of the rest are too new to have a Morningstar rating.)

What I didn’t realize was how long the danged paperwork for a fund takes.  One recent prospectus on file with the SEC contained the following disclosure that’s required under a federal paperwork reduction act:

Which is to say, writing a prospectus is estimated to take six weeks.  I’m gobsmacked.

The big picture at Grandeur Peak

In the course of launching their new Global Reach fund, profiled below, Grandeur Peak decided to share a bit of their firm’s long-term planning with the public. Grandeur Peak’s investment focus is small- to micro-cap stocks.  The firm estimates that they will be able to manage about $3 billion in assets before their size becomes an impediment to their performance.  From that estimate, they backed out the point at which they might need to soft close their products in order to allow room for capital growth (about $2 billion) and then allocated resource levels for each of their seven envisioned strategies.

Those strategies are:

• Global Reach, their 300-500 stock flagship fund
• Global Opportunities, a more concentrated version of Global Reach
• International Opportunities, the non-U.S. sub-set of Global Reach
• Emerging Markets Opportunities, the emerging and frontier markets subset of International Opportunities
• US Opportunities, the U.S.-only subset of Global Opportunities
• Global Value, the “Fallen Angels” sub-set of Global Reach
• Global Microcap, the micro-cap subset of Global Reach

President Eric Huefner remarks that “Remaining nimble is critical for a small/micro cap manager to be world-class,” hence “we are terribly passionate about asset capping across the firm.”  With two strategies already closed and another gaining traction, it might be prudent to look into the opportunity.

Observer fund profiles

Each month the Observer provides in-depth profiles of between two and four funds.  Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds.  “Stars in the Shadows” are older funds that have attracted far less attention than they deserve. 

Grandeur Peak Global Opportunity (GPGOX): this now-closed star goes where few others dare, into the realm of global and emerging markets small to micro-caps.  With the launch of its sibling, Global Reach, its portfolio is about to tighten and focus.

Grandeur Peak Global Reach (GPGRX): this is the fund that Grandeur Peak wanted to offer you two years ago.  It will be their most broadly-diversified, lowest-cost portfolio and will serve as the flagship for the Grandeur Peak fleet. 

LS Opportunity (LSOFX): Jim Hillary left Marsico in 2004 with a lot of money and the burning question, “what’s the best way to sustainably grow my wealth?”  His answer was a pure long/short portfolio that’s served him, his hedge fund investors, his European investors, and his high net worth investors really well.  LSOFX gives retail investors a chance to join the party.

Sextant Global High Income (SGHIX): what do income-oriented investors do when The Old Reliables fail?  Saturna Capital, which has a long and distinguished record of bond-free income investing at Amana Income (AMANX), offers this highly adaptable, benchmark-free fund as one intriguing option.

Elevator Talk #6: Brian Frank of Frank Value Fund (FRNKX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

Frank Value Fund (FRNKX) is not “that other Frank Fund” (John Buckingham’s Al Frank fund VALUX). It’s a concentrated, all-cap value fund that’s approaching its 10^th anniversary. It’s entirely plausible that it will celebrate its 10^th anniversary with returns in the top 10% of its peer group.

Most funds that claim to be “all cap” are sorting of spoofing you; most mean “all lot of easily-researched large companies with the occasional SMID-cap tossed in.”  To get an idea of how seriously Brian Frank means “go anywhere” when he says “go anywhere,” here’s his Morningstar portfolio map in comparison to that of the Vanguard Total Stock Market Index (VTSMX):

Vanguard Total Stock Market	Frank Value

Brian Frank is Frank Capital Partners’ co-founder, president and chief investment officer.  He’s been interested in stock investing since he was a teenager and, like many entrepreneurial managers, was a voracious reader.  At 19, his grandfather gave him $100,000 with the injunction, “buy me the best stocks.”  In pursuit of that goal, he founded a family office in 2002, an investment adviser in 2003 and a mutual fund in 2004. He earned degrees in accounting and finance from NYU.  Here’s Mr. Frank’s 200 words making his case:

What does the large-cap growth or small-cap value manager do when there are no good opportunities in their style box? They hold cash, which lowers your exposure to the equity markets and acts as a lead-weight in bull markets, or they invest in companies that do not fit their criteria and end up taking excess risk in bear markets. Neither one of these options made any sense when I was managing family-only money, and neither one made sense as we opened the strategy to the public through The Frank Value Fund. Our strategy is quantitative, meaning we go where we can numerically prove to ourselves there is opportunity. If there is no opportunity, we leave the space. It sounds simple, and it’s probably what you would do with your own money if you were an investment professional, but it is not how the fund industry is structured. If you believe in buying low-valuation, high-quality companies, and you allow your principles, not the Morningstar style-box to be your guide, I believe our fund has the structure and discipline to maintain this strategy, and I also believe because of this, we will continue to generate significant outperformance over the long-term.

The fund’s minimum initial investment is $1,500.  The fund’s website is clean and well-organized.  Brian’s most-recent discussion of the fund appears in his Second Quarter 2013 shareholder letter, though you might also enjoy his rant about the perils of passive investing.

Elevator Talk #7: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX)

Guinness Atkinson Inflation-Managed Dividend (GAINX) is about the most “normal” fund in GA’s Asia/energy/innovation-dominated line-up.  Its global equity portfolio targets “moderate current income and consistent dividend growth that outpace inflation.”  The centerpiece of their portfolio construction is what they call the “10 over 10” methodology: in order to qualify for consideration, a corporation must have demonstrated at least 10% cash flow return on investment for 10 years.  By their estimation, only 3% of corporations clear this first hurdle.

They then work their way down from a 400 stock universe to a roughly equally-weighted portfolio of 35 names, representing firms with the potential for sustained dividend growth rather than just high current yields.  Morningstar reports that their trailing twelve-month yield is 3.02% while the 10-year U.S. Treasury sits at 2.55% (both as of July 17, 2013).

Managers Ian Mortimer and Matthew Page have a curious distinction: they are British, London-based managers of a largely-U.S. equity portfolio.  While that shouldn’t be remarkable, virtually every other domestic or global fund manager of a U.S. retail fund is American and domiciled here.  Dr. Mortimer earned a Master’s degree from University College London (2003) and a doctorate from Christ College, Oxford, both in physics.  He joined GA in 2006.  Mr. Page earned a Master’s degree in physics from New College, Oxford, worked at Goldman Sachs for a year and joined GA in 2005.  The duo co-manages GA Global Innovators (IWIRX) together.  Each also co-manages an energy fund.  Here are Ian and Matt, sharing 211 words on their strategy:

In the environment of historically low bond yields, investors looking for income are concerned with the possibility of rising inflation and rising yields. We believe a rising dividend strategy that seeks either a rising dividend stream over time or the accumulation of shares through dividend reinvestment offers a systematic method of investing, where dividends provide a consistent, growing income stream through market fluctuations.

Our investment process screens for sustainable dividend paying companies.  For a company to pay a sustainable and potentially rising dividend in the future, it needs to generate consistently high return on capital, creating value each year, and distribute it in the form of a dividend.  We therefore do not seek to maximize the yield of our portfolio by screening for high yield companies, but rather focus on companies that have robust business models and settle for a moderate yield.

Companies generating consistent high return on capital exist all around the world, with 50% based in US. We also find a growing number of them in emerging markets.  They also exist across industries and market capitalisations. Given their high returns on capital 90% of these companies pay dividends.

Further, employing a bottom up value driven approach, we seek to buy these good companies when they are out of favour.

The fund’s minimum initial investment is $10,000, reduced to $5,000 for tax-advantaged accounts.  It’s available for $2500 at Fidelity and Schwab. GA is providing GAINX at 0.68%, which represents a massive subsidy for a $2 million fund.  The fund fact sheet and its homepage include some helpful and concise information about fund strategy, holdings, and performance, as well as biographies of the managers.  Given the importance of the “10 over 10” strategy to the fund’s operation, potential investors really should review their “10 over 10 Dividend Investment Strategy” white paper piece.

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund, a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies.  We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”

Pre-Launch Alert: Sarofim and Robeco

This is normally the space where we flag really interested funds which had become available to the public within the past 30 days.   Oddly, two intriguing funds became legal in July but have not yet launched.  This means that the fund companies might open the fund any day now, but might also mean that they’ll sit on the option for months or years.  I’ve been trying, with limited success to uncover the back story.

Robeco Boston Partners Global Long/Short Fund could have launched July 12.  It will be a global version of their Long/Short Research Fund (BPRRX).  When queries, a representative of the fund simply reported “they have yet [to] decide when they will actually launch the fund.” About the worst you can say about Long/Short Research is that it’s not as great as their flagship Robeco Boston Partners L/S Equity Fund (BPLEX).  Since launch, BPRRX has modestly trailed BPLEX but has clubbed most of its competitors.  With $1.5 billion already in the portfolio, it’s likely to close by year’s end.  The global version will be managed by Jay Feeney, Chief Investment Officer-Equities and co-manager of Long/Short Research, and Christopher K. Hart.  $2500 minimum investment.3.77%, the only redeeming feature of which is that institutional investors are getting charged almost as much (3.52%). The recent (July 1) acquisition of 90.1% of Robeco by ORIX might be contributing to the delay since ORIX has their own strategic priorities for Robeco – mostly expanding in Asia and the Middle East – but that’s not been confirmed.

Sarofim Equity (SRFMX) didn’t launch on July 1, though it might have. Sarofim sub-advises the huge Dreyfus Appreciation Fund (DGAGX) whose “principal investment strategies” bear to striking resemblance to this fund’s. (In truth, there appears to be a two word difference between the two.) DGAGX is distinguished by its negligible turnover (typically under 1%), consistently low risk and mega-cap portfolio (the average market cap is north of $100 billion). It typically captures about 80% of the market’s movements, both up and down. Over periods of three years and longer, that translates to trailing the average large cap fund by less than a percent a year while courting a bit under 90% of the short-term volatility. So why launch a direct competitor to DGAGX, especially one that’s priced below what Dreyfus investors are charged for their shares of a $6 billion fund? Good question! Dan Crumrine, Sarofim’s CFO, explained that Sarofim would like to migrate lots of their smaller separately managed accounts (say, those with just a few hundred thousand) into the mutual fund. That would save money for both Sarofim and their clients, since the separate accounts offer a level of portfolio tuning that many of these folks don’t want and that costs money to provide. Dan expects a launch sometime this fall. The fund will have a $2500 minimum and 0.71% expense ratio after waivers (and only 0.87% – still below DGAGX – before waivers).

Sarofim will not market the fund nor will they place it on the major platforms since they aren’t seeking to compete with Dreyfus; they mostly need a “friends and family” fund to help out some of their clients. This has, with other firms, been a recipe for success since the funds don’t need to charge exorbitant amounts, are grounded in a well-tested discipline, and the managers are under no pressure to grow assets.

I’ll keep you posted.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting.

Funds in registration this month won’t be available for sale until, typically, the end of September 2013. There were 12 funds in registration with the SEC this month, through July 15th.  We’ll catch up on the last two weeks of July and all of August in our September issue; we had an early cut-off date this month to accommodate my vacation.

This month’s registrations reveal two particularly interesting developments:

The re-emergence of Stein Roe.  Stein, Roe&Farnham, founded in 1932, had a very well-respected family of no-load funds, most notably Stein Roe Young Investor. There was much drama surrounding the firm. Terrible performance in 1999 led to management shake-ups and botched mergers. Columbia (formerly FleetBoston Financial, then an arm of the Bank of America, later bought by Ameriprise which itself used to be American Express Financial Advisers – jeez, are you keeping a scorecard?) bought the Stein Roe funds in 2001, first renaming them and then merging them out of existence (2007).Somewhere in there, Columbia execs took the funds hip deep in a timing scandal. In 2004, Stein Roe Investment Council – which had been doing separate accounts after the departure of its mutual funds – was purchased by Invesco and became part of their Atlantic Trust private investment group.  In the last two months, Stein Roe has begun creeping back into the retail, no-load fund world as adviser to the new family of AT funds.  Last month it announced the rebranding of Invesco Disciplined Equity (AWIEX) as AT Disciplined Equity.  This month it’s added two entirely new funds to the line-up: AT Mid Cap Equity Fundand AT Income Opportunities Fund.  The former invests in mid-cap stocks while the latter pursues income and growth through a mix of common and preferred stocks and bonds.  The minimum initial investment is $3000 for either and the expense ratios are 1.39% and 1.25%, respectively. 

The first fund to advertise training wheels. Baron is launching Baron Discovery Fund, whose market cap target is low enough to qualify it as a micro-cap fund.  It will be co-managed by two guys who have been working as Baron analysts for more than a decade.  Apparently someone at Baron was a bit ambivalent about the promotion and so they’ve created an entirely new position at the fund: “Portfolio Manager Adviser.”   They’ve appointed the manager of Baron Small Cap, Cliff Greenberg, to make sure that the kids don’t get in over their heads.  His responsibility is to “advise the co-managers of the Fund on stock selection and buy and sell decisions” and, more critically, he’s responsible “for ensuring the execution of the Fund’s investment strategy.”  Uhh … what does it tell you when the nominal managers of the fund aren’t trusted to execute the fund’s investment strategy? Perhaps that they shouldn’t be the managers of the fund?  Make no mistake: many funds have “lead” managers and “co-managers,” who presumably enact the same sort of mentorship role and oversight that Baron is building here. The difference is that, in all of the other cases that come to mind, the guy in charge is the manager.  The minimum initial investment is $2000, reduced to $500 for accounts set up with an AIP. Expenses not yet announced.

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

Manager Changes

On a related note, we also tracked down a near-record 64 fund manager changes.  Freakishly, that’s the exact number of changes we identified last month.  Investors should take particular note of Bill Frels’ year-end departure from Mairs and Power and Jesper Madsen’s impended exit from Matthews and from the finance industry.  Both firms have handled past transitions very smoothly, but these are both lead managers with outstanding records.

Update #1: Celebrating three years for the ASTON/River Road Long-Short strategy

ASTON/River Road Long/Short Fund (ARLSX) launched on May 4, 2011.  It will have to wait until May 2014 to celebrate its third anniversary and June 2014 to receive its first Morningstar rating.  The strategy behind the fund, though, began operating in a series of separate accounts in June 2010.  As a result, the strategy just completed its third year and we asked manager Matt Moran about the highlights of his first three years.  He points to two in particular:

We are thrilled to have just completed our third year for the composite.  The mutual fund track record is now just a bit over two years.

[Co-manager] Daniel [Johnson] and I think there are two important points about our strategy now that we’ve hit three years:

1. Based on the Sharpe ratio, our composite ranks as the #1 strategy (attached with disclosures) of all 129 funds in the Morningstar Long-Short category over the past three years.

   We like what legendary investor Howard Marks wrote about the Sharpe ratio on page 39-40 of his 2011 masterpiece The Most Important Thing, “…investors who want some objective measure of risk-adjusted return…can only look to the so-called Sharpe ratio…this calculation seems serviceable for public market securities that trade and price often…and it truly is the best we have (my emphasis)”.

2. We’ve grown our AUM from $8 MM at the beginning of 2013 to $81.7 MM as of [mid-July, 2013].

   We are very pleased to have returned +14.1% annualized (gross) versus the Russell 3000 at +18.6% over the past three years with just [about] 45% of the volatility, a beta of 0.36, and a maximum drawdown of [about] 7.65% (vs. 20.4% for the Russell 3000).

Their long/short strategy has a nicely asymmetrical profile: it has captured 59% of the market’s upside but only 33% of the downside since inception.  ARLSX, the mutual fund which is one embodiment of the strategy, strikes us as one of three really promising “pure” long/short funds.  Folks anxious about abnormal market highs and considerable sensitivity to risk might want to poke around ARLSX’s homepage. There’s a separate and modestly more-detailed discussion on the River Road Asset Management Long-Short Equity Strategy homepage, including a nicely-done factsheet.

Update #2: Celebrating the new website for Oakseed Opportunity Fund

Okay, I suppose it’s possible that, at the end of our profile of Oakseed Opportunity Fund (SEEDX), I might have harshed on the guys just a little bit about the quality of their website:

Mr. Park mentioned that neither of them much liked marketing.  Uhhh … it shows.  I know the guys are just starting out and pinching pennies, but really these folks need to talk with Anya and Nina about a site that supports their operations and informs their (prospective) investors.  

One of the great things about the managers of small funds is that they’re still open to listening and reacting to what they’ve heard.  And so with some great delight (and a promise to edit the snarky comment at the end of their profile), we note the appearance of an attractive and far more useful Oakseed website: 

Welcome, indeed.  Nicely done, guys!

Briefly Noted . . .

DWS Enhanced Emerging Markets Fixed Income Fund (SZEAX), an emerging markets junk bond fund (and don’t you really need more exposure to the riskiest of e.m. bonds?) changed its principal investment strategy from investing in emerging markets junk to strike the proviso “the fund invests at least 50% of its total assets in sovereign debt securities issued or guaranteed by governments, government-related entities, supranational organizations and central banks based in emerging markets.”

ING International Growth Fundbecame ING Multi-Manager International Equity Fund (IIGIX) on July 1, 2013. More Marsico fallout: the nice folks from Marsico Capital Management were shown the door by Harbor International Growth (HIIGX) in May.  Baillie Gifford pulled two managers from the ING fund to help manage the Harbor one.  ING then decided to add Lazard and J.P. Morgan as sub-advisers to the fund, in addition to Baillie Gifford and T. Rowe Price.

As of August 1, TIAA-CREF LIFECYCLE FUNDS added TIAA-CREF International Opportunities Fund to their investable universe and increased their exposure to international stocks.

As set forth more fully below, effective as of August 1, 2013, Teachers Advisors, Inc. has increased the maximum exposure of the Funds to the international sector. In addition, the Advisor has begun investing in the and, effective August 1, 2013, the international component of each Fund’s composite benchmark has been changed from the MSCI EAFE® + EM Index to the MSCI ACWI ex-USA® Index.

SMALL WINS FOR INVESTORS

Hmmm … a bit thin this month.

The folks at Fleishman/Hillard report that Cognios Market Neutral Large Cap (COGMX) has been added to the Charles Schwab, Fidelity and Pershing platforms. It’s a new no-load that’s had a bit of a shaky start.

Melissa Mitchell of CWR & Partners reports some success on the part of the Praxis funds (socially responsible, faith-based, front loaded and institutional classes) in getting Hershey’s to commit to eliminating the use of child slaves in the cocoa plantations that serve it:

The chocolate industry’s history is riddled with problems related to child slavery on African cocoa bean farms. Everence, through its Praxis Mutual Funds, is actively working with chocolate companies to address the conditions that lead to forced child labor. For the last three years, Praxis has co-led shareholders in working with Hershey – one of the world’s largest chocolatiers – to shape new solutions to this long-standing problem.

Their Intermediate Income Fund (MIIAX) has purchased $2 million in International Finance Facility for Immunisation (IFFIm) bonds, funding a program which will help save millions of children from preventable diseases. Okay, those aren’t wins for investors per se but they’re danged admirable pursuits regardless and deserve some recognition.

CLOSINGS (and related inconveniences)

Fidelity will close Fidelity Ultra-Short Bond (FUSFX) to most investors on Aug. 2, 2013. It’s one of the ultra-short funds that went off a cliff in last 2007 and never quite regained its stride. Given that the fund’s assets are far below their peak, the closure might be a sign of some larger change on the way.

Artisan is closing Artisan Small Cap (ARTSX), the flagship fund, on August 2nd. This is the second closure in the fund’s history. In October 2009, Artisan rotated a new management team in: Andrew Stephens and the folks responsible for Artisan Midcap.  Since that time, the fund’s performance has improved dramatically and assets have steadily accumulated to $1.2 billion now.  Artisan has a long tradition of closing their funds in order to keep them manageable, so the move is entirely laudable.

OLD WINE, NEW BOTTLES

Marsico has gotten the boot so often that they’re thinking of opening a shoe store. The latest round includes their dismissal from the AST Marsico Capital Growth Portfolio, which became the AST Loomis Sayles Large-Cap Growth Portfolio on July 15, 2013.  This is the second portfolio that AST pulled from Marsico in recent weeks.  The firm’s assets are now down by $90 billion from their peak.  At the same time, The New York Times celebrated Marsico Global (MGLBX) as one of three “Mutual Funds that Made Sense of a Confusing Market” (July 6, 2013).

Invesco Global Quantitative Core (GTNDX) changed its name to Invesco Global Low Volatility Equity Yield on July 31, 2013.

OFF TO THE DUSTBIN OF HISTORY

Compak Dynamic Asset Allocation Fund (CMPKX) will be liquidated on or about September 13, 2013.  It closed to all new investment on July 31, 2013.  It’s a little fund-of-funds run by Moe and Faroz Ansari, both of whom appear to be interesting and distinguished guys.  High expenses, front load, undistinguished – but not bad – performance.

Invesco Dynamics (IDYAX) merged into Invesco Mid Cap Growth (VGRAX) and Invesco Municipal Bond (AMBDX) merged into Invesco Municipal Income (VKMMX).

John Hancock Funds liquidated two tiny funds on July 30: the $1.9 million JHancock Leveraged Companies (JVCAX) and the $3.5 million JHancock Small Cap Opportunities (JCPAX).  Do you suppose it’s a coincidence that JHancock Leveraged Companies was launched at the very peak of Fidelity Leverage Company’s performance?  From inception to April 28, 2008, FLVCX turned $10,000 into $41,000 while its midcap peers reached only $16,000. Sadly, and typically, Fidelity trailed its peers and benchmark noticeably from that day to this. JHancock did better but with its hopes of riding Fidelity’s coattails smashed …

Lord Abbett Small Cap Blend Fund melted into the Lord Abbett Value Opportunities Fund (LVOAX) on July 19, 2013. The fact that Value Opps doesn’t particularly invest in small cap stocks and has struggled to transcend “mediocre” in the last several years makes this a less-than-ideal merger.

My favorite liquidation notice, quoted in its entirety: “On July 31,2013, the ASG Growth Markets Fund (AGMAX) was liquidated. The Fund no longer exists, and as a result, shares of the Fund are no longer available for purchase or exchange.” It appears mostly to have bet on emerging markets currencies. Over its short life, it managed to transform $10,000 into $9,400.

COUNTRY Bond Fund (CTLAX) and COUNTRY Growth Fund (CGRAX) will be liquidated “on or before October 31, 2013, and in any event no later than December 31, 2013.” I have no idea (1) why the word “Country” is supposed to appear in all caps (same with ASTON) or (2) why you’d liquidate a reasonably solid fund with over $300 million in assets or a mediocre one with $250 million. No word of explanation in the filing.

The King is Dead: Fountainhead Special Value Fund (KINGX) has closed to new investors in anticipation of an October liquidation. Twas a $7 million midcap growth fund that had a promising start, cratered in the 2007-09 crisis and never recovered.

In Closing . . .

That’s about it from Door County.  I’ll soon be back at my desk as we pull together the September issue.  We’ll have a look inside your target-date funds and will share four more fund profiles (including one that we’ve dubbed “Dodge and Cox without all the excess baggage”).  It’s work, but joyful.

It wouldn’t be worthwhile without your readership and your thoughtful feedback.  And it wouldn’t be possible without your support, either directly or by using our Amazon link.   Our readership, curiously enough, has spiked to 15,014 “unique visitors” this month, though our revenue through Amazon is flat.  So, we thought we’d mention the system for the benefit of the new folks.  The Amazon system is amazingly simple and painless.  If you set our link as your default bookmark for Amazon (or, as I do, use Amazon as your homepage), the Observer receives a rebate from Amazon equivalent to 6% or more of the amount of your purchase.  It doesn’t change your cost by a penny since the money comes from Amazon’s marketing budget.  While 6% of the $11 you’ll pay for Bill Bernstein’s The Investor’s Manifesto (or 6% of a pound of coffee beans, back-to-school loot or an Easton S1 composite big barrel bat) seems trivial, it adds up to about 75% of our income.  Thanks for both!

We’ll look for you.

Dear friends,

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

What’s in your long/short fund?

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

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

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

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

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

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

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

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

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

   

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

   

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

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

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

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

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

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

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

Notes from the Morningstar Conference

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

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

Day One: Northern Trust on emerging and frontier investing

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

Day One: Smead Value (SMVLX)

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

Day One: Morningstar’s expert recommendations on emerging managers

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

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

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

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

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

Or

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

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

Day One: Michael Mauboussin on luck and skill in investing

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

This spurred a particularly rich discussion on the board.

Day Two: Matt Eagan on where to run now

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

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

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

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

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

In the end:

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

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

Day Two: David Herro on emerging markets and systemic risk

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

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

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

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

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

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

Day Two: Jack Bogle ‘s inconvenient truths

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

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

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

Day Three: Sextant Global High Income

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

Day Three: Off-the-record worries

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

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

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

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

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

Day Three: Reflecting on tchotchkes

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

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

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

It’s Charles in Charge! 

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

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

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

Timing method performance over ten decades

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

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

Read the full story here.

Announcing Mutual Fund Contacts, our new sister-site

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

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

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

Everyone loves a crisis

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

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

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

Many actively managed bond funds have loaded up?

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

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

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

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

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

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

Fidelity cries out: Run away!

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

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

I can only imagine three possibilities:

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

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

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

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

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

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

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds.  Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds.  “Stars in the Shadows” are older funds that have attracted far less attention than they deserve. 

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

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

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

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

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

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

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

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

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

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

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

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

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

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

How can you join in?  Just click

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

Launch Alert

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

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

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting.

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

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

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

Manager Changes

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

Briefly Noted . . .

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

SMALL WINS FOR INVESTORS

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

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

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

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

CLOSINGS (and related inconveniences)

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

OLD WINE, NEW BOTTLES

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

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

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

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

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

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

OFF TO THE DUSTBIN OF HISTORY

Geez, the dustbin is filling quickly.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

In Closing . . .

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

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

Dear friends,

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

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

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

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

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

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

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

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

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

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

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

Introducing MFO Fund Ratings

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

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

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

Dear Mom and Pop,

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

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

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

Love, your son,

Dave

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

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

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

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

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

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

Some qualifications:

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

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

31 May 2013/Charles

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

The Implosion of Professional Journalism will make you Poorer

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

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

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

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

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

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

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

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

Step Two: Investment News mindlessly reproduces the flawed information.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Step Seven: Word spreads like cockroaches.

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

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

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

Then Morningstar makes it All Worse

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

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

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

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

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

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

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

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

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

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

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

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

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

We Made the Cover!

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

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

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

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

Observer Fund Profiles

Each month the Observer provides in-depth profiles of between two and four funds.  Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds.  “Stars in the Shadows” are older funds that have attracted far less attention than they deserve. 

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

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

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

Conference Call Highlights: Stephen Dodson and Bretton Fund

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

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

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

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

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

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

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

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

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

Launch Alert: T. Rowe and Vanguard

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

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

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

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

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

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

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

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

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

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

The new funds’ glidepath	The old fund’s glidepath

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

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

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

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

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

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

MANAGER CHANGES

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

Updates …

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

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

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

15.8% of the fund is in cash

2.8% is in three short positions, mostly short ETF

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

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

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

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

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

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

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

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

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

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

Security Alert: A Word from our IT Folks

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

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

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

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

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

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

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

Good luck!  Chip and the MFO IT crowd

Meanwhile, in Footloose Famous Guys Land …

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

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

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

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

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

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

Briefly Noted . . .

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

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

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

SMALL WINS FOR INVESTORS

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

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

CLOSINGS (and related inconveniences)

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

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

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

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

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

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

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

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

OLD WINE, NEW BOTTLES

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

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

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

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

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

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

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

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

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

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

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

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

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

OFF TO THE DUSTBIN OF HISTORY

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

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

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

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

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

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

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

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

In Closing . . .

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

We’ll look for you.

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

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

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

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

 

Dear friends,

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

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

My set of questions is a bit different:

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

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

Of Acorns and Oaks

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

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

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

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

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

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

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

Three Messages from Rob Arnott

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Are they at least greasy high-yield bonds?

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

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

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

Introducing the Owl

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

Cool, eh?

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

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

The Observer resources that you’ve likely missed!

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

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

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

There are, so far, seven Featured Funds:

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

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

Valley Forge Fund staggers about

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

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

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

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

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

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

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

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds.  Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. 

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

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

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

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

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

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

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

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

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

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

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

RiverPark/Wedgewood Fund: Conference Call Highlights

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

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

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

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

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

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

The RWGFX Conference Call

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

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

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

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

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

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

How can you join in?  Just click

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

Launch Alert: ASTON/LMCG Emerging Markets (ALEMX)

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

Launch Alert II: Matthews Asia Focus and Matthews Emerging Asia

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

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

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

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

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

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

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

Manager Changes

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

Briefly Noted . . .

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

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

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

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

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

Small Wins for Investors

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

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

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

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

Closings

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

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

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

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

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

Old Wine, New Bottles

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

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

Off to the Dustbin of History

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

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

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

In Closing …

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

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

That’s all for now, folks!

Dear friends,

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Triumph of the optimists: Financial “journalists” and you

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

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

Case in point: Mellody Hobson, CBS Financial Analyst

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

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

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

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

Journalists should:

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

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

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

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

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

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

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

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

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

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

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

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

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

Who says mutual funds can’t make you rich?

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

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

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

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

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

Two new and noteworthy resources: InvestingNerd and Fundfox

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

InvestingNerd (a little slice of NerdWallet)

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

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

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

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

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

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

Fundfox

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

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

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

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

Introducing: The Elevator Talk

The Elevator Talk is a new feature which began in February. Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

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

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

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

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

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

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

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

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

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

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

The Cook and Bynum Fund, Conference Call Highlights

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

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

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

Among the highlights of the call for me:

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

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

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

The COBYX conference call

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

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

Inoculated By Value

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

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

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

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

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

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

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

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

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

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

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

(Thank you, sir! David)

Conference Call Upcoming: RiverPark Wedgewood Growth, April 17

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

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

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

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

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

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

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

How can you join in?

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

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

Observer Fund Profiles

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve. This month’s lineup features:

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

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

Launch Alert: BBH Global Core Select (BBGRX)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

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

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

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

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

Manager Changes: Two giants begin to step back

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

Snowball on the transformative power of standing around, doing little

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

Don’t Just Do Something. Stand There.

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

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

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

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

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

Be a winner: stand there.

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

Briefly Noted ….

Vanguard is shifting

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

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

PIMCO retargets

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

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

Capital Group / American Funds is bleeding

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

Matthews and the power of those three little words.

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

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

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

Good news and bad for AllianzGI Opportunity Fund shareholders

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

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

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

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

Direxion splits

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

Small Wins for Investors

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

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

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

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

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

Closings

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

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

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

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

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

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

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

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

Old Wine in New Bottles

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

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

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

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

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

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

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

Off to the Dustbin of History

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

600,000 visits later . . .

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

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

Four quick closing notes for the months ahead:

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

Take great care!

Dear friends,

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

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

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

Longleaf Global and its brethren

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Artisan goes public.  Now what?

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

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

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

What happens now with the Artisan funds?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

USA Today launches a new portfolio tracker

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

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

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

So, that’s sensible. 

Second bit of good news, the outputs are pretty:

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

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

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

Fidelity spirals (and not upward)

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

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

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

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

One more slap at Morningstar’s new ratings

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

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

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

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

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

Introducing: The Elevator Talk

The Elevator Talk is a new feature which began in February.  Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you.  That’s about the number of words a slightly-manic elevator companion could share in a minute and a half.   In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site.  Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share.  These aren’t endorsements; they’re opportunities to learn more.

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

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

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

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

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

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

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

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

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

Conference Call Highlights

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

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

The SFGIX conference call

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

Among the highlights of the call, for me:

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

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

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

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

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

Our conference call will be Tuesday, March 5, from 7:00 – 8:00 Eastern. 

How can you join in?

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

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

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

Observer Fund Profiles

Each month the Observer provides in-depth profiles of between two and four funds.  Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds.  “Stars in the Shadows” are older funds that have attracted far less attention than they deserve. This month’s lineup features:

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

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public.  The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details.  Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting.  Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

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

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

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

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

Manager Changes

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

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

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

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

Snowball and the fine art of Jaffe-casting

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

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

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

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

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

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

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

Briefly Noted ….

Kris Jenner’s curious departure

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

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

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

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

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

FPA announces conversion to a pure no-load fund family

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

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

Morningstar tracks down experienced managers in new funds

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

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

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

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

Rebalancing matters. 

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

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

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

Small Wins for Investors

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

Not much else to celebrate this month.

Closings

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

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

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

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

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

Old Wine in New Bottles

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

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

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

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

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

Off to the Dustbin of History

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

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

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

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

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

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

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

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

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

In Closing . . .

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

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

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

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

See you then!

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

American Funds: The Past Ten Years

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

Here are our findings so far:

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

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

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

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

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

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

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

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

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

It’s The Firm that Time Forgot 

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

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

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

Morningstar, Part One: Rating the Rater

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

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

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

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

2390 funds with under $100 million in assets.

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

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

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

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

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

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

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

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

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

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

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

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

Huber Small Cap Value (HUSIX)

Marathon Value (MVPFX)

Pinnacle Value (PVFIX)

Stewart Capital Mid Cap (SCMFX)

The Cook and Bynum Fund (COBYX)

Tilson Dividend (TILDX)

Tributary Balanced (FOBAX)

Introducing: The Elevator Talk

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

Dang.

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

Frustration gave rise to an experimental new feature: The Elevator Talk.  We’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you.  That’s about the number of words a slightly-manic elevator companion could share in a minute and a half.   In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site.  Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share.  These aren’t endorsements; they’re opportunities to learn more.

Elevator Talk #1: Tom Kerr, Rocky Peak Small Cap Value (RPCSX)

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

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

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

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

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

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

Morningstar, Part Two: “Speaking of Old Softies”

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

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

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

Morningstar’s Good Work

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

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

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

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

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

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

Matthews Asia Strategic Income Conference Call

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

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