Category Archives: Old Profile

These profiles have been updated since the original publication, but remain here for permalinks. A link to the fully updated profile should be included at the top.

Aston/River Road Independent Value (ARIVX)

By David Snowball

Update: This fund has been liquidated.

This fund was previously profiled in September 2012. You can find that profile here.

Objective

The fund seeks to provide long-term total return by investing in common and preferred stocks, convertibles and REITs. The manager attempts to invest in high quality, small- to mid-cap firms (those with market caps between $100 million and $5 billion). He thinks of himself as having an “absolute return” mandate, which means an exceptional degree of risk-consciousness. He’ll pursue the same style of investing as in his previous charges, but has more flexibility than before because this fund does not include the “small cap” name.

Adviser

Aston Asset Management, LP. It’s an interesting setup. Aston oversees 24 funds with $9.3 billion in assets, and is a subsidiary of the Affiliated Managers Group. River Road Asset Management LLC subadvises six Aston funds; i.e., provides the management teams. River Road, founded in 2005, oversees $6.1 billion and was acquired by AMG in 2014. River Road also manages seven separate account strategies, including the Independent Value strategy used here.

Manager

Eric Cinnamond. Mr. Cinnamond is a Vice President and Portfolio Manager of River Road’s independent value investment strategy. Mr. Cinnamond has 23 years of investment industry experience. Mr. Cinnamond managed the Intrepid Small Cap (ICMAX) fund from 2005-2010 and Intrepid’s small cap separate accounts from 1998-2010. He co-managed, with Nola Falcone, Evergreen Small Cap Equity Income from 1996-1998.

Management’s Stake in the Fund

Mr. Cinnamond has invested between $500,000 – $1,000,000 in the fund.

Strategy capacity

Mr. Cinnamond anticipates a soft close at about a billion. The strategy has $450 million in assets, which hot money drove close to a billion during the last market crisis.

Opening date

December 30, 2010.

Minimum investment

$2,000 for regular accounts, $1000 for various sorts of tax-advantaged products (IRAs, Coverdells, UTMAs).

Expense ratio

1.42%, after waivers, on $410 million in assets.

Comments

If James Brown is the godfather of soul, then Eric Cinnamond might be thought the godfather of small cap, absolute value investing. He’s been at it since 1996 and he suspects that folks who own lots of small cap stocks today are going to want to sell them to him, for a lot less than they paid, sooner rather than later.

This fund’s first incarnation appeared in 1996, as the Evergreen Small Cap Equity Income fund. Mr. Cinnamond had been hired by First Union, Evergreen’s advisor, as an analyst and soon co-manager of their small cap separate account strategy and fund. The fund grew quickly, from $5 million in ’96 to $350 million in ’98. It earned a five-star designation from Morningstar and was twice recognized by Barron’s as a Top 100 mutual fund.

In 1998, Mr. Cinnamond became engaged to a Floridian, moved south and was hired by Intrepid (located in Jacksonville Beach, Florida) to replicate the Evergreen fund. For the next several years, he built and managed a successful separate accounts portfolio for Intrepid, which eventually aspired to a publicly available fund.

The fund’s second incarnation appeared in 2005, with the launch of Intrepid Small Cap (now called Intrepid Endurance, ICMAX). In his five years with the fund, Mr. Cinnamond built a remarkable record which attracted $700 million in assets and earned a five-star rating from Morningstar and a Lipper Leader for total returns and capital preservation. If you had invested $10,000 at inception, your account would have grown to $17,300 by the time he left. Over that same period, the average small cap value fund lost money.

The fund’s third incarnation appeared on the last day of 2010, with the launch of Aston / River Road Independent Value (ARIVX). While ARIVX is run using the same discipline as its predecessors, Mr. Cinnamond intentionally avoided the “small cap” name. While the new fund will maintain its historic small cap value focus, he wanted to avoid the SEC stricture which would have mandated him to keep 80% of assets in small caps.

Over an extended period, Mr. Cinnamond’s small cap composite (that is, the weighted average of the separately managed accounts under his charge over the past 20 years) has returned 10% per year to his investors. That figure understates his stock picking skills, since it includes the low returns he earned on his often-substantial cash holdings.

The key to Mr. Cinnamond’s performance (which, Morningstar observed, “trounced nearly all equity funds”) is achieved, in his words, “by not making mistakes.” He articulates a strong focus on absolute returns; that is, he’d rather position his portfolio to make some money, steadily, in all markets, rather than having it alternately soar and swoon. There seem to be three elements involved in investing without mistakes:

  • Buy the right firms.
  • At the right price.
  • Move decisively when circumstances demand.

All things being equal, his “right” firms are “steady-Eddy companies.” They’re firms with look for companies with strong cash flows and solid operating histories. Many of the firms in his portfolio are 50 or more years old, often market leaders, more mature firms with lower growth and little debt.

His judgment, as of early 2016, is that virtually any new investments in his universe – which requires both high business quality and low stock prices – would be a mistake. He writes:

As a result of extremely expensive small cap valuations, especially in higher quality small cap stocks, the Independent Value Portfolio maintains its very contrarian positioning. Cash is near record levels, while expensive, high quality small cap holdings have been sold. We expect our unique, but disciplined, positioning to cause the Portfolio to continue to look and perform very differently than the market and its peers.

… we do not believe the current market cycle will continue indefinitely. We feel we are positioned well for the end of the current cycle and the inevitable return to more rational and justifiable equity valuations. As disciplined value investors, we have not strayed from our valuation practices and investment discipline. We continue to require an adequate return for risk assumed on each stock we consider for purchase, and will not invest your (and our) capital simply for the sake of being invested.

He’s at 85% cash currently (late April 2016), but that does not mean he’s some sort of ultra-cautious perma-bear. He has moved decisively to pursue bargains when they arise. “I’m willing to be aggressive in undervalued markets,” he says. For example, his fund went from 0% energy and 20% cash in 2008 to 20% energy and no cash at the market trough in March, 2009. Similarly, his small cap composite moved from 40% cash to 5% in the same period. That quick move let the fund follow an excellent 2008 (when defense was the key) with an excellent 2009 (where he was paid for taking risks). The fund’s 40% return in 2009 beat his index by 20 percentage points for a second consecutive year. As the market began frothy in 2010 (“names you just can’t value are leading the market,” he noted), he began to let cash build. While he found a few pockets of value in 2015 (he surprised himself by buying gold miners, something he’d never done), prices rose so quickly that he needed to sell.

The argument against owning is captured in Cinnamond’s cheery declaration, “I like volatility.” Because he’s unwilling to overpay for a stock, or to expose his shareholders to risk in an overextended market, he sidelines more and more cash which means the fund lags in extended rallies. But when stocks begin cratering, he moves quickly in which means he increases his exposure as the market falls. Buying before the final bottom is, in the short term, painful and might be taken, by some, as a sign that the manager has lost his marbles. Again.

Bottom Line

Mr. Cinnamond’s view, informed by a quarter century of investing and a careful review of history, is that small cap stocks are in a bubble. More particularly, they might be in a historic bubble that exceeds those in 2000 and 2007. Each of those peaks was followed by 40% declines. The fragility of the small cap space is illustrated by the sudden decline in those stocks in the stock half of 2015. In eight months, from their peak in June 2015 to their bottom in February 2016, small cap indexes dropped 22%. Then, in 10 weeks, they shrugged it off, rose 19% and returned to historically high valuations. Investing in small cap stocks can be rational and rewarding. Reaping those rewards requires a manager who is willing to protect you from the market’s worst excesses and your own all-to-human impulses. You might check here if you’re in search of such a manager.

Fund website

Aston/River Road Independent Value

© Mutual Fund Observer, 2016. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Northern Global Tactical Asset Allocation (BBALX), March 2015

By David Snowball

This profile has been updated. Find the new profile here.

Objective

The fund seeks a combination of growth and income. Northern Trust’s Investment Policy Committee develops tactical asset allocation recommendations based on economic factors such as GDP and inflation; fixed-income market factors such as sovereign yields, credit spreads and currency trends; and stock market factors such as domestic and foreign earnings growth and valuations. The managers execute that allocation by investing in other Northern funds and ETFs. As of 12/30/2014, the fund held three Northern funds and eight ETFs.

Adviser

Northern Trust Investments is part of Northern Trust Corp., a bank founded in 1889. The parent company provides investment management, asset and fund administration, fiduciary and banking solutions for corporations, institutions and affluent individuals worldwide. As of June 30, 2014, Northern Trust had assets under custody of $6.0 trillion, and assets under investment management of $924.4 billion. The Northern funds account for about $52 billion in assets. When these folks say, “affluent individuals,” they really mean it. Access to Northern Institutional Funds is limited to retirement plans with at least $30 million in assets, corporations and similar institutions, and “personal financial services clients having at least $500 million in total assets at Northern Trust.” Yikes. There are 42 Northern funds, nine sub-advised by multiple institutional managers.

Managers

Daniel Phillips, Robert Browne and James McDonald. Mr. Phillips joined Northern in 2005 and became co-manager in April, 2011. He’s one of Northern’s lead asset-allocation specialists. Mr. Browne joined as chief investment officer of Northern Trust in 2009 after serving as ING’s chief investment officer for fixed income. Mr. McDonald, Northern Trust’s chief investment strategist, joined the firm in 2001. This is the only mutual fund they manage.

Management’s Stake in the Fund

Northern Trust representatives report that, “that the SAI update will show Bob Browne and Jim McDonald each own BBALX shares in the $100,001-$500,000 range, and Daniel Phillips owns shares in the $1-$10,000 range.” Only one of the fund’s nine trustees has invested in it, though most have substantial investments across the fund complex. 

Opening date

Northern Institutional Balanced, this fund’s initial incarnation, launched in July 1, 1993. On April 1, 2008, this became an institutional fund of funds with a new name, manager and mission and offered four share classes. On August 1, 2011, all four share classes were combined into a single no-load retail fund.

Minimum investment

$2500, reduced to $500 for IRAs and $250 for accounts with an automatic investing plan.

Expense ratio

0.64%, after waivers, on assets of $79 million.

Comments

When we reviewed BBALX in 2011 and 2012, Morningstar classified it as a five-star moderate allocation fund. We made two points:

  1. It’s a really intriguing fund
  2. But it’s not a moderate allocation fund; you’ll be misled if you judge it against that group.

Here we are in 2015, following up on BBALX. Morningstar now classifies it as a two star moderate allocation fund. We’d like to make two points:

  1. It’s a really intriguing fund.
  2. But it’s not a moderate allocation fund; you’ll be misled if you judge it against that group.

We’ll take those points in order.

It’s a really intriguing fund. As the ticker implies, BBALX began life is a bland, perfectly respectable balanced fund that invests in larger US firms and investment grade US bonds. Northern’s core clientele are very affluent people who’d like to remain affluent, so Northern tends toward “A conservative investment approach . . . strength and stability . . . disciplined, risk-managed investment . . .” which promises “peace of mind.” The fund was mild-mannered and respectable, but not particularly interesting, much less compelling.

In April 2008, the fund morphed from conservative balanced to a global tactical fund of funds. At a swoop, the fund underwent a series of useful changes.

The strategic or “neutral” asset allocation became more aggressive, with the shift to a global portfolio and the addition of a wide range of asset classes.

Tactical asset allocation shifts became possible, with an investment committee able to substantially shift asset class exposure as opportunities changed.

Execution of the portfolio plan was through index funds and, increasingly, factor-tilted ETFs, mostly Northern’s FlexShare products. For any given asset class, the FlexShare ETFs modestly overweight factors such as dividends, quality and size which predict long-term outperformance.

Both the broadened strategic allocation and the flexibility of the tactical shifts have increased shareholder returns and reduced their risk. Compared to a simple benchmark of 60% global stocks/40% bonds, the strategic allocation adds about 50 basis points of return (4.4% vs 3.9, since inception) while reducing volatility by about 70 bps (11.6% versus 12.3%). The tactical shifts have produced dramatic improvements, adding 110 bps of return while trimming 100 bps of volatility.

trailing

In short, Northern has managed since inception to produce about 40% more upside than a global balanced benchmark while suffering about 15% less volatility.

But it’s not a moderate allocation fund. Morningstar’s moderate allocation group is dominated by funds like the pre-2008 BBALX; lots of US large caps, lots of intermediate term, investment grade bonds and little prospect for distinction. That’s an honorable niche but it is not a fair benchmark for BBALX. A quick comparison of the portfolios highlights the difference:

 

BBALX

Moderate Allocation Group

U.S. equity

19%

47

Developed non U.S. equity

15

10

Emerging markets

5

1.5

Bonds

43

31

“Other” assets, which might include commodities, global real estate, gold, and other real asset plays

17

2

Cash

1

7

Average market cap

$15 billion

$46 billion

Dividend yield

3.3%

2.2%

When US markets dominate, as they have in four of the past five years, funds with a strong home bias will typically outperform those with a global portfolio.

With BBALX, you get a truly global asset allocation, disciplined management and remarkably low operating and trading expenses.

Over longer period, the larger opportunity set available to global investors – assuming that they’re not offset by higher expenses – gives them a distinct and systemic advantage. With BBALX, you get a truly global asset allocation, disciplined management and remarkably low operating and trading expenses. 

The strength of the fund is more evident when you make more valid comparisons. Morningstar purports to offer up “the best of the best of the best, sir!” in the form of the Gold-rated funds and its “best of the best of the rest” in its Silver funds. Using the Observer’s premium Multisearch Tool, we generated a comparison of BBALX against the only Gold fund (BlackRock Global Allocation) and the four Silver funds in Morningstar’s global allocation group.

Over both the full market cycle (November 2007-present) and the upmarket cycle (March 2009-present), BBALX is competitive with the best global allocation funds in existence. Here are the full-cycle risk-return metrics:

full cycle risk return

Here’s how to read the table: the three ratios at the end measure risk-adjusted returns. For them, higher is better. The Maximum Drawdown, Downside Deviation and Ulcer Indexes are measures of risk. For them, lower is better. APR is the annual percentage return. In general, your best investments over the period – the GMO funds – aren’t available to mere mortals, they require minimum investments of $10 million. Northern has been a better investment than either BlackRock or Capital Income Builder.

The pattern is similar if we look just at the rebound from the market bottom in 2009. Ivy, not available in 2007, gets added to the mix. GMO leads while BBALX remains one of the best options for retail global investors.

since 09

In short, the fund’s biggest detriment is that it’s misclassified, not that it’s underperforming.

Bottom Line

There is a very strong case to be made that BBALX might be a core holding for two groups of investors. Conservative equity investors will be well-served by its uncommonly broad diversification, risk-consciousness and team management. Young families or investors looking for their first equity fund would find it one of the most affordable options, no-load with low expenses and a $250 minimum initial investment for folks willing to establish an automatic investment plan. Frankly, we know of no comparable options. This remains a cautious fund, but one which offers exposure to a diverse array of asset classes. It has used its flexibility and low expenses to outperform some very distinguished competition. Folks looking for an interesting and affordable core fund owe it to themselves to add this one to their short-list.

Fund website

Northern Global Tactical Asset Allocation.  Northern has an exceptional commitment to transparency and education; they provide a lot of detailed, current information about what they’re up to in managing the fund. A pretty readable current introduction is 2015 Outlook: Watching our Overweights (12/2014).

Disclosure:

I have owned shares of BBALX in my personal portfolio for about three years. My intent is to continue making modest, automatic monthly additions.

© Mutual Fund Observer, 2015. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

RiverPark Structural Alpha Fund (RSAFX/RSAIX), December 2014

By David Snowball

This fund has been liquidated.

Objective and strategy

The RiverPark Structural Alpha Fund seeks long-term capital appreciation while exposing investors to less risk than broad stock market indices. The managers invest in a portfolio of listed and over-the-counter option spreads and short option positions that they believe structurally will generate exposure to equity markets with less volatility. They also maintain a short position against the broad stock market to hedge against a market decline and invest the majority of their assets in cash alternatives and high quality, short-term fixed income securities.

Adviser

RiverPark Advisors, LLC. RiverPark was formed in 2009 by former executives of Baron Asset Management. The firm is privately owned, with 84% of the company being owned by its employees. They advise, directly or through the selection of sub-advisers, the seven RiverPark funds. Overall assets under management at the RiverPark funds were over $3.5 billion as of September, 2014.

Manager

Jeremy Berman and Justin Frankel. The managers joined RiverPark in June 2013 when their Wavecrest Partners Fund was converted into the RiverPark Structural Alpha Fund. Prior to co-founding Wavecrest, Jeremy managed Morgan Stanley’s Structured Solutions group for eastern US; prior to that he held similar positions at Bank of America and JP Morgan. Before RiverPark and Wavecrest, Mr. Frankel managed the Structured Investments business at Morgan Stanley. He began his career on the floor of the NYSE, became a market maker for a NASDAQ, helped Merrill Lynch grow their structured products business and served as a Private Wealth Advisor at UBS. They also graduated from liberal arts colleges (hah!).

Strategy capacity and closure

Something on the order for $3-5 billion. The derivatives market is “incredibly liquid,” so that the managers could accommodate substantially more assets by simply holding larger positions. Currently they have about 35 positions; by their calculation, a 100-fold increase in assets could be accommodated with a doubling of the number of positions. The unique nature of this market means that “more positions would decrease volatility without impinging returns. Given our portfolio structure, there’s no downside to growth.”

Active share

Not calculable for this sort of fund.

Management’s stake in the fund

Each of the managers has between $100,000 – 500,000 in the fund, as of the January 2014 Statement of Additional Information. RiverPark’s president is the fund’s single biggest shareholder; both he and the managers have been adding to their holdings lately. Two of the fund’s three trustees have substantial investments in the fund, which is particularly striking since they receive modest compensation for their work as trustees. In broad terms, they’ve invested hundreds of thousands more than they’ve received.

We’d also like to compliment RiverPark for exemplary disclosure: the SEC allows funds to use “over $100,000” as the highest report for trustee ownership. RiverPark instead reports three higher bands: $100,000-500,000, $500,000-1 million, over $1 million. That’s really much more informative than the norm.

Opening date

June 28, 2013, though the preceding limited partnership launched on September 26, 2008.

Minimum investment

The minimum initial investment in the retail class is $1,000 and in the institutional class is $100,000.

Expense ratio

Retail class at 2.00% after waivers, institutional class at 1.75% after waivers, on total assets of $9.1 million. While that is high in comparison to traditional stock or bond funds, it’s competitive with other alt funds and cheap by hedge fund standards. If Wavecrest’s returns were recalculated assuming this expense structure, they’d be 2.0 – 2.5% higher than reported.

Comments

It’s time to get past having one five-word phrase, repeated out of context, define your understanding of an options-based strategy. In his 2002 letter, Warren Buffett described derivatives as (here are the five words): “financial weapons of mass destruction.” Set aside for the moment the fact that Buffett invests in derivatives and has made hundreds of millions of dollars from them and take time to read his original letter on the matter. His indictment was narrowly focused on uncollateralized positions and Buffett now has backed away from his earlier statement (“I don’t think they’re evil per se. It’s just, they, I mean there’s nothing wrong with having a futures contract or something of the sort”). His latest version of the warning is couched in terms of what happens to the derivatives market if there’s a nuclear strike or major biological weapons attack.

I suspect that Messrs. Berman and Frankel would agree that, in the case of a nuclear attack, the derivatives market would be in trouble. As would the stock markets. And my local farmer’s market. Indeed, all of us would be in trouble.

Structural Alpha is designed to address a far more immediate challenge: where should investors who are horrified by the prospects of the bond market but are already sufficiently exposed to the stock market turn for stable, credible returns?

The managers believe that have found an answer which is grounded in one of the enduring characteristics of investor (read: “human”) psychology. We hate losing and we have an almost overwhelming fear of huge losses. That fear underlies our willingness to overpay for car, life, homeowners or health insurance for decades (the average US house suffers one serious fire every 300 years, does that make you want to drop your fire coverage?) and is reflected in the huge compensation packages received by top insurance company executives (the average insurance CEO pockets $8 million/year, the CEO of Aetna took in $30 million). They make that money because risk is overpriced.

Berman and Frankel found the same is true for volatility. Investors are willing to systematically overpay to manage the risks that make them most anxious. A carefully structured portfolio has allowed Structural Alpha and its predecessor limited partnership to benefit from that risk aversion, and to offer several distinctive advantages to their investors.

Unlike an ETF or other passive product, this is not simply a mechanical collection of options. The portfolio has four complementary components whose weighting varies based on market conditions.

  1. Long-dated options which rise as the stock market does. The amount of the rise is capped, so that the fund trades away the prospect of capturing all of a bull market run in exchange for consistent returns in markets that are rising more normally.
  2. Short-dated options (called “straddles and strangles,” for reasons that are beyond me) which are essentially market neutral; they generate income and contribute to alpha in stable or range-bound markets.
  3. A short position against the stock market, designed to offset the portfolio’s exposure to market declines.
  4. A lot of high-quality, short-term fixed income products. Most of the fund’s portfolio is in cash, which serves as collateral on its options. Investing that cash carefully generates a modest, consistent stream of income.

Over the better part of a full market cycle, the Structural Alpha strategy captured 80% of the stock index’s returns – the strategy gained about 70% while the S&P rose 87% – while largely sidestepping any sustained losses. On average, it captures about 20% of the market’s down market performance and 40% of its up market. The magic of compounding then works in their favor – by minimizing their losses in falling markets, they have little ground to make up when markets rally and so, little by little, they catch up with a pure equity portfolio.

Here’s what that looks like:

riverpark

The blue line is Structural Alpha (you’ll notice it largely ignoring the 2008 crash) and the green line is the S&P 500. The dotted line is the point that Wavecrest became RiverPark. From inception, this strategy turned $10,000 into $16,700 with very low volatility while the S&P reached $19,600.

The chart offers a pretty clear illustration of the managers’ goal: providing equity-like returns (around 9% annually) with fixed income-like volatility (around 30% of the stock market’s).

There are two other claims worth considering:

  1. The fund benefits from market volatility, since the tendency to overpay rises as anxiety does.
  2. The fund benefits from rising interest rates, since its core strategies are uncorrelated with the bond market and its cash stash benefits from rising rates.

Mr. Frankel notes that “if volatility and interest rates return to their historic means, it’s going to be a significant tailwind for us. That’s part of the reason we’re absolutely buying more shares for our own accounts.” That’s a rare combination.

Bottom Line

Fear causes us to act poorly. This is one of the few funds designed to allow you to use other’s fears to address your own. It seems to offer a plausible third path to reasonable returns, away from and independent of traditional but historically overpriced asset classes. Investors looking to lighten their bond exposure or dampen their equity portfolio owe it to consider Buffett’s actions rather than just his words. They should look closely here.

Fund website

RiverPark Structural Alpha. The managers lay out the research behind the strategy in The Benefits of Systematically Selling Volatility (2014), which is readable and well worth reading. If you’d like to listen to a précis of the strategy, they have a cute homemade video on the fund’s webpage. Start listening at about the 4:00 minute mark through to about 6:50. They make a complex strategy about as clear as anyone I’ve yet heard. The stuff before 4:00 is biography and the stuff afterward is legalese.

Fact Sheet

© Mutual Fund Observer, 2014. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Martin Focused Value (MFVRX)

By David Snowball

Update: This fund has been liquidated.

Objective and strategy

The Fund seeks to achieve long-term capital growth of capital by investing in an all-cap portfolio of undervalued stocks.  The managers look for three qualities in their portfolio companies:

  • High quality business, those companies that have a competitive advantage, high profit margins and returns on capital, sustainable results and/or low-cost operations,
  • High quality management, an assessment grounded in the management’s record for ethical action, inside ownership and responsible allocation of capital
  • Undervalued stock, which factors in future cash flow as well as conventional measures such as price/earnings and price/sales.

Mr. Martin summarizes his discipline this way: “When companies we favor reach what our analysis concludes are economically compelling prices, we will buy them.  Period.” If there are no compelling bargains in the securities markets, the Fund may have a substantial portion of its assets in cash or cash equivalents such as short-term Treasuries. The fund is non-diversified and has not yet had more than 9% in equities, although that would certainly rise if stock prices fell dramatically.

Adviser

Martin Capital Management (MCM), headquartered in Elkhart, IN.  Established in 1987, MCM has stated an ongoing commitment to a “rational, disciplined, concentrated, value-oriented investment philosophy.”  Their first priority is preservation of capital, but seek opportunities for growth when they find underpriced, but well-run companies. They manage about $160 million, roughly 10% of which is in their mutual fund.

Manager

Frank Martin is portfolio manager, as well as the founder and CIO of the adviser. A 1964 graduate of Northwestern University’s investment management program, Mr. Martin went on to obtain an MBA from Indiana University. He does a lot of charitable work, including his role as founder and chairman of the board of DreamsWork, a mentoring and scholarship program for inner-city children. Mr. Martin has published two books on investing, Speculative Contagion and A Decade of Delusions.  He’s assisted by a four person research team.

Strategy capacity and closure

Mr. Martin allows that the theoretical capacity is “pretty darn large,” but that having a fund that was big is “too distracting” from the work on investing so he’d look for a manageable portfolio size.

Active share

Not formally calculated but undoubtedly near 100, given a portfolio with just four stocks.

Management’s stake in the fund

Mr. Martin has invested over $1 million in the fund and, as of the early 2014, is the fund’s largest shareholder. No member of the board of directors has invested in the fund but then four of the six directors haven’t invested in any of the 18 funds they oversee. The firm’s employees invest in this strategy largely through separately managed accounts, which reflects the fact that the fund did not exist when his folks began investing. The portfolio is small enough that Mr. Martin knows many of his shareholders, five of whom own 35% of the retail shares between them.

Opening date

May 03, 2012

Minimum investment

$2,500 for an initial investment for retail shares. $100 minimum for subsequent investments.

Expense ratio

1.39%, after waivers, on about $15 million in assets (as of April 2014). There’s also an institutional share class (MFVIX) with an e.r. of 0.99% and a $100,000 minimum.

Comments

Absolute value investors are different.  These are guys who don’t want to live at the edge.  They take the phrase “margin of safety” very seriously.  For them, “risk” is about “permanent losses,” not “foregone gains.” They don’t BASE jump. They don’t order fugu. They don’t answer the question “I wonder if this will hold my weight?” by hopping on it.  They do drive, often in Volvos and generally within five MPH of the posted speed limit, to Omaha every May to hear The Word from Warren and fellowship with like-minded investors.

Unlike relative value and growth guys, they don’t believe that you hired them to pick the best stocks available.  They do believe you hired them to compose the best equity portfolio available.  The difference is that “the best equity portfolio” might well be one that, potentially for long periods, holds few stocks and huge amounts of cash.  Why? Because markets are neither efficient nor rational; they are the aggregated decisions of millions of humans who often move as herds and sometimes as stampeding herds.  Those stampedes – sometimes called manias or bubbles, sometimes simply frothy markets or periods of irrational exuberance – are a lot of fun while they last and catastrophic when they end.  We don’t know when they will end, but we do know that every market that overshoots on the upside is followed by one that overshoots on the downside.

In general, absolute value investors try to protect you from those entirely predictable risks.  Rather than relying on you to judge the state of the market and its level of riskiness, they act on your behalf by leaving early, sacrificing part of the gain in order to spare you as much of the pain as possible.

In general, that translates to stockpiling cash (or implementing some sort of hedging position) when stocks with absolutely attractive valuations are unavailable, in anticipation of being able to strike quickly on the day when attractively-priced stocks are again available.

Mr. Martin takes that caution one step further.  In addition to protecting you from predictable risks (“known unknowns,” in Mr. Rumsfeld’s parlance), he has attempted to create a portfolio that offers some protection against risks that are impossible to anticipate (“unknown unknowns” for Mr. Rumsfeld, “black swans” if you prefer Mr. Taleb’s term).  His strategy, also drawing from Mr. Taleb’s research, is to create an “antifragile” portfolio; that is, one which grows stronger as the stress on it rises.

Mr. Martin, a value investor with 40 years of experience, has won praise from the likes of Jack Bogle, Jim Grant and Edward Studzinski.  Earlier in his career, he ran fully-invested portfolios.  In the past 20 years, he’s become less willing to buy marginally-priced stocks and has rarely been more than 70% invested in the market.  With the launch of Martin Focused Value Fund in 2011, he moved more decisively into pursuing a barbell strategy in his portfolio, which he believes to be decidedly anti-fragile.  The bulk of the portfolio is now invested in short-term Treasuries while under 10% is in undervalued, high-quality equities.  In normal markets, the equities will provide much of the fund’s upside while the bonds contribute modest returns.  The portfolio’s advantage is that in market crises, panicked investors are prone to bid up the price of the ultra-safe bonds in his portfolio, giving him both downside protection and “dry powder” to deploy when stocks tank.

The result is a low volatility portfolio which has produced consistent results.  While his mutual fund is new, he’s been using the same discipline in private accounts and those investments have decisively outperformed the S&P this century. The following chart reflects the performance of those private accounts:

mcm

Those returns include the effects of some outstanding stock picking.  The equity portion of Mr. Martin’s portfolio returned 13.1% annually from 2000 – 2014Q1, while the S&P banked just 3.7% for the same period.  He and his analysts are, in short, really talented at picking stocks.  Over this same period, the composite had a standard deviation (a measure of volatility) of 3.4% while the S&P 500 bounced 12.3%, a difference of 350%.

Why might you want to consider a low-equity, antifragile portfolio?  Like many absolute value investors, Mr. Martin believes that we’re now seeing “a market that seems increasingly detached from its fundamental moorings.”  That’s a “known unknown.”  He goes further than most and posits the worrisome presence of an unknown unknown.  Here’s the argument: corporations can do one of four things with their income (technically, their free cash flow):

  1. They can invest in the business through new capital expenditures or by hiring new workers.
  2. They can give money back to their investors in the form of dividends.
  3. They can buy back shares of the corporation’s stock on the open market.
  4. They can acquire someone else’s company to add to the corporate empire.

Of these four activities, one and only one – re-investment – is consistently beneficial to a corporation’s long-term prospects.  It is also the one that least interests corporate leaders who are being pushed to maximize immediate stock returns; focusing on the long-term now poses a palpable risk of being dismissed if it causes short-term performance to lag.

Amazon’s chief and founder, Jeff Bezos, and Amazon’s stock are both being pounded in mid-2014 because Bezos stubbornly insists on pouring money into research and development and capital projects.  Amazon’s stock has fallen 25% YTD through May 1, an event that Bezos can survive when most other CEOs would fall.

“Since 2008, the proportion of cash flow invested in capital assets is the lowest on record” while both the debt to GDP ratio and the amount of margin debt (that is, money borrowed to speculate in the market) are at their highest levels ever. At the same time, the 100 largest companies in the U.S. have spent a trillion dollars buying back stock since 2008 while dividend payments in 2013 were 40% above their 10-year average; by Mr. Martin’s calculation, “90% of cash flow is being expended for purposes that don’t increase the value of most companies over the longer-term.”  In short, stock prices are rising steadily for firms whose futures are increasingly at risk.

His aim, then, is to build a portfolio which will, first, preserve investors’ wealth and then grow it over the course of a life.

Potential investors should note two cautions:

  1. They need to understand that double-digit returns will be relatively rare; his separate account composition had returns above 10% in four of 14 years from 2000-13.
  2. Succession planning at the firm has not yet born fruit.  At 71, Mr. Martin is actively, but so far unsuccessfully, engaged in a search for a successor.  He wants someone who shares his passion for long-term success and his willingness to sacrifice short-term gains when need be.  One simple test that he’s subjected candidates to is to look at whether their portfolios outperformed the S&P during the 2007-09 meltdown.  So far, the answer has mostly been “no.”

Bottom Line

There are some investors for whom this strategy is a very good fit, though few have yet found their way to the fund.  Folks who share Mr. Martin’s concern about the effects of perverse financial incentives (or even the growing risks of global technology that’s outracing our ability to comprehend, much less control, its consequences) should consider the fund.  Likewise investors who are trying to preserve wealth against the effects of inflation over decades would find a comfortable home here.  Folks who are convinced that they can outsmart the market, who are banking on double-digit rights and expect to out-time its gyrations are apt to be disappointed.

Fund website

www.martinfocusedvaluefund.com.  He’s got a remarkable body of writings at the fund website, but rather more at the main Martin Capital Management site.  His essays are well-written, both substantial and wide-ranging, sort of the antithesis of the usual marketing stuff that passes for mutual fund white papers.

Evermore Global Value (EVGBX), April 2014

By David Snowball

 

This profile has been updated. Find the new profile here.
This is an update of our profile from April 2011.  The original profile is still available.

Objective and Strategy

Evermore Global Value Fund seeks capital appreciation by investing in a global portfolio of 30-40 securities. Their focus is on micro to mid-cap. They’re willing “to dabble” in larger cap names, but it’s not their core. Similarly they may invest beyond the equity market in “less liquid” investments such as distressed debt. They’ve frequently held short positions to hedge market risk and are willing to hold a lot of cash.

Adviser

Evermore Global Advisors, LLC. Evermore was founded by Mutual Series alumni David Marcus and Eric LeGoff in June 2009. David Marcus manages the portfolios. While they manage several products, including their US mutual fund, all of them follow the same “special situations” strategy. They have about $400 million in AUM.

Manager

David Marcus. Mr. Marcus co-founded the adviser. He was hired in the late 1980s by Michael Price at the Mutual Series Funds, started there as an intern and describes himself as “a believer” in the discipline pursued by Max Heine and Michael Price. He managed Mutual European (MEURX) and co-managed Mutual Discovery (MDISX) and Mutual Shares (MUTHX), but left in 2000 to establish a Europe-domiciled hedge fund with a Swedish billionaire partner. Marcus liquidated this fund after his partner’s passing and spent several years helping manage his partner’s family fortune and restructure a number of the public and private companies they controlled. He then went back to investing and started another European-focused hedge fund. In that role he was an activist investor, ending up on corporate boards and gaining additional operational experience. That operational experience “added tools to my tool belt,” but did not change the underlying discipline.

Strategy capacity and closure

$2 – 3 billion, which is large for a fund with a strong focus on small firms. Mr. Marcus explains that he’s previously managed far larger sums in this style, that he’s willing to take “controlling” positions in small firms which raises the size of his potential position in his smallest holdings and raises the manageable cap. He currently manages about $400 million, including some separate accounts which rely on the same discipline. He’ll close if he’s ever forced into style drift.

Active share

100. “Active share” measures the degree to which a fund’s portfolio differs from the holdings of its benchmark portfolio.  High active share indicates management which is providing a portfolio that is substantially different from, and independent of, the index.  An active share of zero indicates perfect overlap with the index, 100 indicates perfect independence. The active share for Evermore is 100.6, which reflects extreme independence plus the effect of several hedged positions.

Management’s stake in the fund

Substantial. The fund provides all of Mr. Marcus’s equity exposure except for long-held legacy positions that predate the launch of Evermore. He’s slowly “migrating assets” from those positions to greater investments in the fund and anticipates that his holdings will grow substantially. His family, business partner and all of his employees are invested. In addition, he co-owns the firm to which he and his partner have committed millions of their personal wealth. It’s striking that one of his two outside board members, the guy who helped build the Oppenheimer Funds group, has invested more than a million in the fund (despite receiving just a few thousand dollars a year for his work with the fund). That’s incredibly rare.

Opening date

December 31, 2009.

Minimum investment

$5000, reduced to $2000 for tax-advantaged accounts. The institutional share class (EVGIX) has a $1 million minimum, no load and a 1.37% expense ratio.

Expense ratio

1.62%, on assets of $235 million. There’s a 5% sales load which, because of agreements with advisers and financial intermediaries, is almost never paid.

Comments

Kermit the Frog famously crooned (or croaked) the song “It’s Not Easy Being Green” (“it seems you blend in with so many other ordinary things, And people tend to pass you over”). I suspect that if Mr. Marcus were the lyricist, the song would have been “It’s Not Easy Being Independent.” By any measure, Evermore Global is one of the most independent funds around.

Everyone else wants to be Warren Buffett. They’re all about buying “a wonderful company at a fair price.”  Mr. Marcus is not looking for “great companies selling at a modest price.” There are, he notes, a million guys already out there chasing those companies. That sort of growth-at-a-reasonable price focus isn’t in his genes and isn’t where he can distinguish himself. He does, faithfully and well, what Michael Price taught him to do: find and exploit special situations, often in uncovered or under-covered smaller stocks. That predisposition is reflected in his fund’s active share: 100.6 on a scale that normally tops-out at 100.

An active share of 100 means that it has essentially no overlap with its benchmark. The same applies to its peer group: Evermore has seven-times the exposure to small- and micro-cap stocks as does its peers. It has half of the US exposure and twice the European exposure of the average global fund.  And it has zero exposure to three defensive sectors (consumer defensive, healthcare, utilities) that make up a quarter of the average global fund.

The fund focuses on a small number of positions – rarely more than 40 – that fall into one of two categories:

  1. Cheap with a catalyst: he describes this as a private-equity mentality where “cheap” is attractive only if there’s good reason to believe it’s not going to remain cheap. The goal is to find businesses that merely have to stop being awful in order to recruit a profit to their investors, rather than requiring earnings growth to do so. This helps explain why the fund is lightly invested in both Japan (cheap, few catalysts) and the U.S. (lot of catalysts, broadly overpriced).
  2. Compounders: a term that means different things to different investors. Here he means family owned or controlled firms that have activist internal management. Some of these folks are “ruthless value creators.”  The key is to get to know personally the patriarch or matriarch who’s behind it all; establish whether they’re “on the same side” as their investors, have a record of value creation and are good people.

Mr. Marcus thinks of himself as an absolute value investor and follows Seth Klarman’s adage, “invest when you have the edge; when you don’t have the edge, don’t invest.”

There are two real downsides to being independent: you’re sometimes disastrously out-of-step with the herd and it’s devilishly hard to find an appropriate benchmark for the fund’s risk-return profile.

Evermore was substantially out-of-step for its first three years. It posted mid-single digit returns in 2010 and 2012, and crashed in 2011.  2011 was a turbulent year in the markets and Evermore’s loss of nearly 20% was among the worst suffered by global stock funds. Mr. Marcus would ask you to keep two considerations in mind before placing too much weight on those returns:

  1. Special situations stocks are, almost by definition, poorly understood, feared or loathed. These are often battered or untested companies with little or no analyst coverage. When markets correct, these stocks often fall fastest and furthest. 
  2. Special situations portfolios take time to mature. By definition, these are firms with unusual challenges. Mr. Marcus invests when there’s evidence that the firm is able to overcome their challenges and is moving to do so (i.e., there’s a catalyst), but that process might take years to unfold. In consequence, it takes time for the underlying value to be unlocked. He argues that the stocks he purchased in 2010-11 were beginning to pay off in 2012 and, especially, 2013. In baseball terms, he believes he now has a solid line-up of mid- to late-inning names.

The upside of special situations investing is two-fold. First, mispricing in their securities can be severe. There are few corners of the market further from efficient pricing than this. These stocks can’t be found or analyzed using standard quantitative measures and there are fewer and fewer seasoned analysts out there capable of understanding them. Second, a lot of the stocks’ returns are independent of the market. That is, these firms don’t need to grow revenue in order to see sharp share-price gains. If you have a firm that’s struggling because its CEO is a dolt and its board is in revolt, you’re likely to see the firm’s stock rebound once the dolt is removed. If you have a firm that used to be a solidly profitable division of a conglomerate but has been spun-off, you should expect an abnormally low stock price relatively to its value until it has a documented operating history. Investors like Mr. Marcus buy them cheap and early, then wait for what are essentially arbitrage gains.

Bottom Line

There’s no question that Evermore Global Value is a hard fund to love. It sports a one-star Morningstar rating and bottom-tier three year returns. The question is, does that say more about the fund or more about our ability to understand really independent, distinctive funds? The discipline that Max Heine taught to Michael Price, that Michael Price (who consulted on the launch of this fund) taught to David Marcus, and that David Marcus is teaching to his analysts, is highly-specialized, rarely practiced and – over long cycles – very profitable. Mr. Marcus, who has been described as the best and brightest of Price’s protégés, has attracted serious money from professional investors. That suggests that looking beyond the stars might well be in order here.

Fund website

Evermore Global Value Fund. In general, when a fund is presented as one manifestation of a strategy, it’s informative to wander around the site to learn what you can. With Evermore, there’s a nice discussion under “Active Value” of Mr. Marcus’s experience as an operating officer and its relevance for his work as an investor.

© Mutual Fund Observer, 2014. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

RiverNorth Equity Opportunity (RNEOX), February 2014

By David Snowball

This fund has been liquidated.

Objective and Strategy

The Fund’s investment objective is overall total return consisting of long-term capital appreciation and income. They pursue their objective by investing in equities. The managers start with a tactical asset allocation plan that lets them know what sectors they’d like to have exposure to. They can gain that exposure directly, by purchasing common or preferred shares, but their core strategy is to gain the exposure through owning shares of closed-end funds and ETFs. Their specialty is in trading CEFs when those funds’ are selling at historically unsustainable discounts. The inevitable closure of those discounts provides a market-neutral arbitrage gain on top of any market gains the fund posts.

Adviser

RiverNorth Capital Management, LLC. RiverNorth, founded in 2000, specializes in quantitative and qualitative closed-end fund trading strategies and advises the RiverNorth Core Opportunity (RNCOX), RiverNorth/DoubleLine Strategic Income (RNDLX), RiverNorth Managed Volatility (RNBWX), and RiverNorth/OakTree High Income (RNHIX). As of January 2014, they managed $1.9 billion through limited partnerships, mutual funds and employee benefit plans.

Manager

Patrick W. Galley and Stephen O’Neill. Mr. Galley is RiverNorth’s President, Chairman and Chief Investment Officer. He also manages all or parts of four RiverNorth funds. Before joining RiverNorth Capital in 2004, he was a Vice President at Bank of America in the Global Investment Bank’s Portfolio Management group. Mr. O’Neill specializes in qualitative and quantitative analysis of closed-end funds and their respective asset classes. Prior to joining RiverNorth in 2007, he was an Assistant Vice President at Bank of America in the Global Investment Bank’s Portfolio Management group. Messrs Galley and O’Neill manage about $2 billion in other pooled assets.

Strategy capacity and closure

Not yet determined, but the broader RiverNorth Core Opportunity (RNCOX) fund using the same strategy closed at under $500 million.

Management’s Stake in the Fund

Mr. Galley has over $100,000 invested in the fund and owns 25% of the parent, RiverNorth Holdings Company. Mr. O’Neill has invested between $10,000 – $50,000 in the fund. One of the four independent directors has a small investment (under $10,000) in the fund.

Opening date

The original fund opened on July 18, 2012. The rechristened version opened on January 1, 2014.

Minimum investment

$5000

Expense ratio

Operating expenses are capped at1.60%, on assets of $13 million, as of January 2014. Like RiverNorth Core Opportunity, the fund also incurs additional expenses in the form of the operating costs of the funds it buys for the portfolio. Those expenses vary based on the managers’ ability to find attractively discounted closed-end funds; as the number of CEFs in the portfolio goes up, so does the expense ratio. RiverNorth estimates the all-in expense ratio to be about 2.17%.

Comments

Polonius, in his death scene, famously puts it this way:

Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
This above all- to thine own self be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.

Gramma Snowball reduced it to, “stick to your knitting, boy.”

It’s good advice. RiverNorth is following it.

RiverNorth’s distinctive strength is their ability to exploit the pricing dislocations caused by short-term irrationality and panic in the market. Their investment process has two basic elements:

  1. Determine where to invest
  2. Determine how to invest.

RiverNorth uses a number of quantitative models to determine what asset allocation to pursue. In the case of RNEOX, that comes down to determining things like size and sector.

They implement that allocation by investing either through low cost ETFs or through closed-end funds. Closed-end funds can trade at a discount or premium to the value of their holdings. Most funds trade consistently within a narrow band (Adams Express ADX, for example, pretty consistently trades at a discount of 14 – 15.5% so you pay $86 to buy $100 worth of stock). In times of panic, investors anxious to get out of the market have foolishly sold shares of the CEFs for discounts of greater than 40%. RiverNorth has better data on the trading patterns of CEFs than anyone else so they know that ADX at a 14.5% discount is nothing to write home about but ADX at a 22% discount might be a major opportunity because that discount will revert back to its normal range. So, whether the market goes up or down, the ADX discount will narrow.

If RiverNorth gets it right, investors have two sources of gain: investing in rising sectors because of the asset allocation and in CEFs whose returns are super-charged by the contracting discount. They are, for all practical purposes, the sole experienced player in this game.

In December 2012, RiverNorth launched RiverNorth/Manning & Napier Dividend Income Fund. The fund struck us as a curious hybrid: one half of the portfolio with RiverNorth’s opportunistic, higher-turnover closed-end fund strategy while the other half was Manning & Napier’s low-key, enhanced index strategy which rebalances its holdings just once a year. It was a sort of attempt to marry spumoni and vanilla. While we have great respect for each of the managers, the fund didn’t strike us as offering a compelling option and so we chose not to profile it.

Three things became clear in the succeeding twelve months:

The fund’s performance was not outstanding. The fund posted very respectable absolute returns in 2013 (25.6%) but managed to trail 90% of its peers. Manning and Napier Dividend Focus (MNDFX) whose strategy was replicated here, trailed 90% of its peers in 2013 and in three of the past four years.

Investors were not intrigued. At the end of November, 2013, the fund’s assets stood at $14 million.

RiverNorth noticed. In November, RiverNorth’s Board of Trustees voted not to renew the sub-advisory contract with Manning & Napier.

The reborn fund will stick to RiverNorth’s knitting: a tactical asset allocation plan implemented through CEFs when possible. It’s a strategy that they’ve put to good use in their (closed) RiverNorth Core Opportunity Fund (RNCOX), a stock/bond hybrid fund that uses this same discipline. 

Here’s the story of RiverNorth Core in two pictures.

rneox chart

From inception, Core Opportunity turned $10,000 into $17,700. Its average balanced competitor generated $13,500. You might note that Core made two supercharged moves upward in late 2008 and early 2009, which strongly affected the cumulative return.

rneox risk return

From inception, Core Opportunity has had noticeably greater short-term volatility than has its average competitor, but also noticeably higher returns. And, in comparison to the S&P 500, it has offered both higher returns and lower volatility.

Investors do need to be aware of some of the implications of RiverNorth’s approach.  Three things will happen when market volatility rises sharply:

The opportunities for excess returns rise. When people panic, mispricing becomes abundant and the managers have the opportunity to deploy cash in a rich collection of funds.

The fund’s short-term volatility rises. Moving into a market panic is profitable in the long-term, but can be hair-raising in the short term. 30% discounts can go to 40% before returning to 5%. The managers know that and are accustomed to sharp, short-term moves. The standard deviation, above, both reflects and misrepresents that volatility. It correctly notes the fund’s greater price movement, but fails to note that some of the volatility is to the upside as the discounts contract.

The fund’s expense ratio rises. The managers have the option of using inexpensive ETFs to implement their asset allocation, which they do when they are not compelling opportunities in the CEF arena. CEFs are noticeably costlier than ETFs, so as the move toward the prospect of excess return, they also incur higher expenses.

And, subsequently, portfolio turnover rises. An arbitrage strategy dictates selling the CEF when its discount has closed, which can happen quite suddenly. That may make the fund less tax-efficient than some of its vanilla peers.

Bottom Line

RiverNorth has a distinctive strategy that has served its investors well. The rechristened fund deserves serious consideration from investors who understand its unique characteristics and are willing to ride out short-term bumps in pursuit of the funds extra layer of long-term returns.

Fund website

RiverNorth Equity Opportunity

Fact Sheet

© Mutual Fund Observer, 2014. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

FPA Paramount (FPRAX), September 2013

By David Snowball

Objective and Strategy

The FPA Global Value Strategy will seek to provide above-average capital appreciation over the long term while attempting to minimize the risk of capital losses by investing in well-run, financially robust, high-quality businesses around the world, in both developed and emerging markets.

Adviser

FPA, formerly First Pacific Advisors, which is located in Los Angeles.  The firm is entirely owned by its management which, in a singularly cool move, bought FPA from its parent company in 2006 and became independent for the first time in its 50 year history.  The firm has 28 investment professionals and 72 employees in total.  Currently, FPA manages about $25 billion across four equity strategies and one fixed income strategy.  Each strategy is manifested in a mutual fund and in separately managed accounts; for example, the Contrarian Value strategy is manifested in FPA Crescent (FPACX), in nine separate accounts and a half dozen hedge funds.  On April 1, 2013, all FPA funds became no-loads.

Managers

Pierre O. Py and Greg Herr.  Mr. Py joined FPA in September 2011. Prior to that, he was an International Research Analyst for Harris Associates, adviser to the Oakmark funds, from 2004 to 2010.  Mr. Py has managed FPA International Value (FPIVX) since launch. Mr. Herr joined the firm in 2007, after stints at Vontobel Asset Management, Sanford Bernstein and Bankers Trust.  He received a BA in Art History at Colgate University.  Mr. Herr co-manages FPA Perennial (FPPFX) and the closed-end Source Capital (SOR) funds with the team that used to co-manage FPA Paramount.  Py and Herr will be supported by the two research analysts, Jason Dempsey and Victor Liu, who also contribute to FPIVX.

Management’s Stake in the Fund

As of the last SAI (September 30, 2012), Mr. Herr had invested between $1 and $10,000 in the fund and Mr. Py had no investment in it.  Mr. Py did have a very large investment in his other charge, FPA International Value.

Opening date

September 8, 1958.

Minimum investment

$1,500, reduced to $100 for IRAs or accounts with automatic investing plans.

Expense ratio

0.94% on $323 million in assets, as of August 2013.

Comments

We’ve never before designated a 55-year-old fund as a “most intriguing new fund,” but the leadership and focus changes at FPRAX warrant the label.

I’ve written elsewhere that “Few fund companies get it consistently right.  By “right” I don’t mean “in step with current market passions” or “at the top of the charts every year.”  By “right” I mean two things: they have an excellent investment discipline and they treat their shareholders with profound respect.

FPA gets it consistently right.

FPA has been getting it right with the two funds overseen by Eric Ende and Stephen Geist: FPA Paramount (since March 2000) and FPA Perennial (since 1995 and 1999, respectively).   Morningstar designates Paramount as a five-star world stock fund and Perennial as a three-star domestic mid-cap growth fund (both as of August, 2013).  That despite the fact that there’s a negligible difference in the fund’s asset allocation (cash/US stock/international stock) and no difference in their long-term performance.  The chart below shows the two funds’ returns and volatility since Geist and Ende inherited Paramount.

fpa paramount

To put it bluntly, both have consistently clubbed every plausible peer group (mid-cap growth, global stock) and benchmark (S&P 500, Total Stock Market, Morningstar US Growth composite) that I compared them to.  By way of illustration, $10,000 invested in either of these funds in March 2000 would have grown to $35,000 by August 2013.  The same amount in the Total Stock Market index would have hit $16,000 – and that’s the best of any of the comparison groups.

To be equally blunt, the funds mostly post distinctions without a difference.  In theory Paramount has been more global than Perennial but, in practice, both remained mostly focused on high-quality U.S. stocks. 

FPA has decided to change that.  Geist and Ende will now focus on Perennial, while Py and Herr reshape Paramount.  There are two immediately evident differences:

  1. The new team is likely to transition toward a more global portfolio.  We spoke with Mr. Py after the announcement and he downplayed the magnitude of any immediate shifts.  He does believe that the most attractive valuations globally lie overseas and the most attractive ones domestically lie among large cap stocks.  That said, it’s unlikely the case that FPA brought over a young and promising international fund manager with the expectation that he’ll continue to skipper a portfolio with only 10-15% international exposure.
  2. The new team is certain to transition toward a more absolute value portfolio.  Mr. Py’s investment approach, reflected in the FPIVX prospectus, stresses “Low Absolute Valuation. The Adviser only purchases shares when the Adviser believes they offer a significant margin of safety (i.e. when they trade at a significant discount to the Adviser’s estimate of their intrinsic value).”  In consequence of that, “the limited number of holdings in the portfolio and the ability to hold cash are key aspects of the portfolio.”  At the last portfolio report, International Value held 24 stocks and 38% cash while Paramount held 31 and 10%.  Given that the investment universe here is broader than International’s, it’s unlikely to hold huge cash stakes but likely that it might drift well north of its current level at times.

Bottom Line

Paramount is apt to become a very solid, but very different fund under its new leadership.  There will certainly be a portfolio restructuring and there will likely be some movement of assets as investors committed to Ende and Geist’s style migrate to Perennial.  The pace of those changes will dictate the magnitude of the short-term tax burden that shareholders will bear. 

Fund website

FPA Paramount Fund

2013 Q3 Report and Commentary

Fact Sheet

© Mutual Fund Observer, 2013. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

LS Opportunity Fund (LSOFX), August 2013

By David Snowball

Objective and Strategy

The Fund aims to preserve capital while delivering above-market returns and managing volatility.  They invest, long and short, in a domestic equity portfolio.  The portfolio is driven by intensive company research and risk management protocols. The long portfolio is typically 30-50 names, though as of mid-2013 it was closer to 70.  The short portfolio is also 30-50 names.  The average long position persists for 12-24 months while the average short position is closed after 3-6.  The fund averages about 50% net long, though at any given point it might be 20-70% long.  The fund’s target standard deviation is eight.

Adviser

Long Short Advisors, LLC.   LSA launched the LS Opportunity Fund to offer access to Independence Capital Asset Partners’ long/short equity strategy. ICAP is a Denver-based long/short equity manager with approximately $500 million in assets under management.

Manager

James A. Hillary, Chief Executive Officer, Chief Investment Officer, and Portfolio Manager at ICAP.  Mr. Hillary founded Independence Capital Asset Partners (ICAP) in 2004. From 1997-2004, Mr. Hillary was a founding partner and portfolio manager at Marsico Capital Management.  While there he managed the 21st Century Fund (MXXIX) and co-managed several other products. Morningstar noted that during Mr. Hillary’s tenure “the fund [MXXIX] has sailed past the peer-group norm by a huge margin.” Bank of America bought Marsico in 2000, at which time Mr. Hillary received a substantial payout.  Before Marsico, he managed a long/short equity fund for W.H. Reaves. Effective June 1, 2013, Mr. Chris Hillary was added as a co-portfolio manager of the Fund. Messrs Hillary are supported by seven other investment professionals.

Strategy capacity and closure

The strategy, which is manifested in the mutual fund, a hedge fund (ICAP QP Absolute Return Fund), a European investment vehicle (Prosper Stars and Stripes, no less) and separate accounts, might accommodate as much as $2 billion in assets but the advisor will begin at about $1 billion to look at the prospect of soft closing the strategy.

Management’s Stake in the Fund

The senior Mr. Hillary has between $100,000 and 500,000 in the fund.  Most of his investable net wealth is invested here and in other vehicles using this strategy.  The firm’s principals and employees account for about 14% of ICAP’s AUM, though the fund’s trustees have no investment in the fund.

Opening date

September 9, 2010, though the hedge fund which runs side-by-side with it was launched in 2004.

Minimum investment

$5,000

Expense ratio

1.95% on fund assets of $40 million.  The limit was reduced in early 2013 from 2.50%.

Comments

In 2004, Jim Hillary had a serious though delightful problem.  As one of the co-founders of MCM, he had received a rich payout from the Bank of America when they purchased the firm.  The problem was what to do with that payout.

He had, of course, several options.  He might have allowed someone else to manage the money, though I suspect he would have found that option to be laughable.  In managing it himself, he might reasonably have chosen a long-only equity portfolio, a long-short equity portfolio or a long equity portfolio supplemented by some sort of fixed-income position.  He had success in managing both of the first two approaches and might easily have pursued the third.

The decision that Mr. Hillary made was to pursue a long-short equity strategy as the most prudent and sustainable way to manage his own and his family’s wealth.  That strategy achieved substantial success, measured both by its ability to achieve sustainable long-term returns (about 9% annually from 2004) and to manage volatility (a standard deviation of about 12, both better than the Total Stock Market’s performance). 

Mr. Hillary’s success became better known and he chose, bit by bit, to make the strategy available to others.  One manifestation of the strategy is that ICAP QP Absolute Return L.P. hedge fund, a second is the European SICAV Prosper Star & Stripes, and a third are separately managed accounts.  The fourth and newest manifestation, and the only one available to retail investors, is LS Opportunity Fund.  Regardless of which vehicle you invest in, you are relying on the same strategy and the portfolio in which Mr. Hillary’s own fortune resides.

Mr. Hillary’s approach combines intensive fundamental research in individual equities, both long and short. 

There are two questions for potential investors:

  • Does a long-short position make sense for me?
  • Does this particular long-short vehicle make the most sense for me?

The argument for long-short investing is complicated by the fact that there are multiple types of long-short funds which, despite having similar names or the same peer group assigned by a rating agency, have strikingly different portfolios and risk/return profiles.  A fund which combines an ETF-based long portfolio and covered calls might, for example, offer far more income but far fewer opportunities for gain than a “pure” long/short strategy such as this one.

The argument for pure long/short is straightforward: investors cannot stomach the volatility generated by unhedged exposure to the stock market.  That volatility has traditionally been high (the standard deviation for large cap stocks this century has been over 16 while the mean return has been 4; the translation is that you’ve been averaging a measly 4% per year while routinely encountering returns in the range of minus-12 to plus-20 with the occasional quarterly loss of 17% and annual loss of 40% thrown in) and there’s no reason to expect it to decline.   The traditional hedge has been to hold a large bond position, which worked well during the 30-year bond bull market just ended.  Going forward, asset allocation specialists expect the bond market to post negative real returns for years.  Cash, which is also posting negative real returns, is hardly an attractive option.

The alternative is a portfolio which offsets exposure to the market’s most attractive stocks with bets against its least attractive ones.  Research provided by Long Short Advisors makes two important points:

  • since 1998, an index of long/short equity hedge funds has outperformed a simple 60/40 allocation with no material change in risk and
  • when the market moves out of its panic mode, which are periods in which all stocks move in abnormal unison, both the upside and downside advantages of a hedged strategy rises in comparison to a long-only portfolio.

In short, a skilled long-short manager can offer more upside and less downside than either a pure stock portfolio or a stock/bond hybrid one.

The argument for LS Opportunity is simpler.  Most long/short managers have limited experience either with shorting stocks or with mutual funds as an investment vehicle.  More and more long/short funds are entering the market with managers whose ability is undocumented and whose prospects are speculative.  Given the complexity and cost of the strategy, I’d avoid managers-with-training-wheels.

Mr. Hillary, in contrast, has a record worth noticing.  He’s managed separate accounts and hedge funds, but also has a fine record as a mutual fund manager.  He’s been working with long/short portfolios since his days at W.H. Reaves in the early 1990s.  The hedge fund on which LS Opportunity is based has survived two jarring periods, including the most traumatic market since the Great Depression.  The mutual fund itself has outperformed its peers since launch and has functioned with about half of the market’s volatility.

Bottom Line

This is not a risk-free strategy.  The fund has posted losses in 15 of its first 34 months of operation.  Eight of those losses have come in months when the S&P500 rose.  The fund’s annualized return from inception through the end of June 2013 is 6.32% while the S&P moved relentlessly and, many fear, irrationally higher.  In the longer term, the strategy has worked to both boost returns and mute volatility.  And, with his personal fortune and professional reputation invested in the strategy, you’d be working with an experienced team which has committed “our lives, our fortunes, and our sacred honor” to making it work.  It’s worth further investigation.

Fund website

LS Opportunity Fund

3Q 2013 Fact Sheet

© Mutual Fund Observer, 2013. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Scout Low Duration Bond Fund (SCLDX), June 2013

By David Snowball

This fund is now the Carillon Reams Low Duration Bond Fund.

Objective and Strategy

The fund seeks a high level of total return consistent with the preservation of capital.  The managers may invest in a wide variety of income-producing securities, including bonds, debt securities, derivatives and mortgage- and asset-based securities.  They may invest in U.S. and non-U.S. securities and in securities issued by both public and private entities.  Up to 25% of the portfolio may be invested in high yield debt.  The investment process combines top-down interest rate management (determining the likely course of interest rates and identifying the types of securities most likely to thrive in various environments) and bottom-up fixed income security selection, focusing on undervalued issues in the fixed income market. 

Adviser

Scout Investments, Inc. Scout is a wholly-owned subsidiary of UMB Financial, both are located in Kansas City, Missouri. Scout advises the nine Scout funds. As of January 2013, they managed about $25 billion.  Scout’s four fixed-income funds are managed by its Reams Asset Management division, including Low-Duration Bond (SCLDX), Unconstrained Bond (SUBYX), Core Bond (SCCYX, four stars) and Core Plus Bond (SCPZX, retail shares were rated four star and institutional shares five star/Silver by Morningstar, as of May, 2013).

Manager

Mark M. Egan is the lead portfolio manager for all their fixed income funds. His co-managers are Thomas Fink, Todd Thompson and Stephen Vincent.  From 1990 to 2010, Mr. Egan was a portfolio manager for Reams Asset Management.  In 2010, Reams became the fixed-income arm of Scout.  His team worked together at Reams.  In 2012, they were finalists for Morningstar’s Fixed-Income Manager of the Year honors.   

Management’s Stake in the Fund

None yet reported.  Messrs. Egan, Fink and Thompson have each invested over $1,000,000 in their Unconstrained Bond fund while Mr. Vincent has between $10,000 – 50,000 in it.  

Opening date

August 29, 2012.

Minimum investment

$1,000 for regular accounts, reduced to $100 for IRAs or accounts with AIPs.

Expense ratio

0.40%, after waivers, on assets of $32 million (as of May 2013).  The fund’s assets are growing briskly.  The Low Duration Strategy on which this fund operates was launched July 1, 2002 and has $2.9 billion in it.

Comments

The simple act of saving money is not supposed to be a risky activity.  Recent Federal Reserve policy has made it so.  By driving interest rates relentlessly down in support of a feeble economy, the Fed has turned all forms of saving into a money losing proposition.  Inflation in the past couple years has average 1.5%.  That’s low but it’s also 35-times higher than the rate of return on the Vanguard Prime Money Market fund, which paid 0.04% in each of the past two years.  The average bank interest rate sits at 0.21%.  In effect, every dollar you place in a “safe” place loses value year after year.

Savers are understandable irate and have pushed their advisers to find alternate investments (called “funky bonds” by The Wall Street Journal) which will offer returns in excess of the rate of inflation.  Technically, those are called “positive real returns.”  Combining a willingness to consider unconventional fixed-income securities with a low duration portfolio offers the prospect of maintaining such returns in both low and rising interest rate environments.

That impulse makes sense and investors have poured hundreds of billions into such funds over the past three years.  The problem is that the demand for flexible fixed-income management exceeds the supply of managers who have demonstrated an ability to execute the strategy well, across a variety of markets.

In short, a lot of people are handing money over to managers whose credentials in this field are paper thin.   That is unwise.

We believe, contrarily, that investing with Mr. Egan and his team from Reams is exceptionally wise.  There are four arguments to consider:

  1. This strategy is quite flexible.

    The fund can invest globally, in both public and private debt, in investment grade and non-investment grade, and in various derivatives.  All of the Scout/Reams funds, according to Mr. Egan, use “the same proven philosophy and process.”  While he concedes that “due to the duration restrictions the opportunity set is slightly smaller for a low duration fund …  the ability to react to value when it is created in the capital markets is absolutely available in the low duration fund.  This includes sector decisions, individual security selection, and duration/yield curve management.”

  2. The managers are first-rate.

    Reams was nominated as one of Morningstar’s fixed-income managers of the year in 2012.  They were, at base, recognized as one of the five best teams in existence In explaining their nomination of Reams as fixed-asset manager of the year, Morningstar explained:

    Mark Egan and crew [have delivered] excellent long-term returns here. Reams isn’t a penny-ante player, either: The firm has managed close to $10 billion in fixed-income assets, mainly for institutions, for much of the past decade.

    Like some of its fellow nominees, the team followed up a stellar showing in 2011 with a strong 2012, owing much of the fund’s success this year to decisions made amid late 2011’s stormy climate, including adding exposure to battered U.S. bank bonds and high-yield. Unlike the other nominees, however, the managers have pulled in the fund’s horns substantially as credit has rallied this year. That’s emblematic of what they’ve done for more than a decade. When volatility rises, they pounce. When it falls, they protect. That approach has taken a few hits along the way, but the end result has been outstanding.

  3. They’ve succeeded over time.

    While the Low Duration fund is new, the Low Duration strategy has been used in separately managed accounts for 11 years.  They currently manage nearly $3 billion in low duration investments for high net-worth individuals and institutions.  For every trailing time period, Mr. Egan has beaten both his peer group.  His ten year returns have been 51% higher than his peers:

     

    1 Yr.

    3 Yrs.

    5 Yrs.

    10 Yrs.

    Low Duration Composite (net of fees)

    3.76%

    3.72%

    5.22%

    4.73%

    Vanguard Short-Term Bond Index fund (VBISX)

    1.70

    2.62

    3.12

    3.51

    Average short-term bond fund

    2.67

    2.81

    3.22

    3.13

    Reams performance advantage over peers

    41%

    32%

    62%

    51%

    Annualized Performance as of March 31, 2013.  The Low Duration Fixed Income Composite was created July 1, 2003.

    The pattern repeats if you look year by year: he has outperformed his peers in six of the past six years and is doing so again in 2013, through May.  While he trails the Vanguard fund above half the time, the magnitude of his “wins” over the index fund is far greater than the size of his losses.

     

    2007

    2008

    2009

    2010

    2011

    2012

    Low Duration Composite (net of fees)

    7.02

    1.48

    13.93

    5.02

    2.62

    5.06

    Vanguard Short-Term Bond Index fund (VBISX)

    7.22

    5.43

    4.28

    3.92

    2.96

    1.95

    Average short-term bond fund

    4.29

    (4.23)

    9.30

    4.11

    1.66

    3.67

    Annualized Performance as of March 31, 2013.  The Low Duration Fixed Income Composite was created July 1, 2003.

  4. They’ve succeeded when you most needed them.

    The fund made money during the market meltdown that devastated so many investors.  Supposedly ultra-safe ultra-short bond funds imploded and the mild-mannered short-term bond group lost about 4.2% in 2008.  When we asked Mr. Egan about why he managed to make money when so many others were losing it, his answer came down to a deep-seated aversion to suffering a loss of principle.

    One primary reason we outperformed relative to many peers in 2008 was due to our investment philosophy that focuses on downside risk protection.  Many short-term bond funds experienced negative returns in 2008 because they were willing to take on what we view as unacceptable risks in the quest for incremental yield or income.  This manifested itself in many forms: a junior position in the capital structure, leveraged derivative credit instruments, or securities backed by loans of questionable underwriting and payer quality.   Specifically, many were willing to purchase and hold subprime securities because the higher current yield was more important to them then downside protection.  When the credit crisis occurred, the higher risks they were willing to accept produced significant losses, including permanent impairment.  We were able to side-step this damage due to our focus on downside risk protection.  We believe that true risk in fixed income should be defined as a permanent loss of principle.  Focusing on securities that are designed to avoid this type of risk has served us well through the years.

Bottom Line

Mr. Egan’s team has been at this for a long time.  Their discipline is clear, has worked under a wide variety of conditions, and has worked with great consistency.  For investors who need to take one step out on the risk spectrum in order to escape the trap of virtually guaranteed real losses in money markets and savings accounts, there are few more compelling options.

Fund website

Scout Low Duration Bond

Commentary

Fact Sheet

© Mutual Fund Observer, 2013. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Oakseed Opportunity Fund (SEEDX), May 2013

By David Snowball

This fund has been liquidated.

Objective and Strategy

The fund will seek long term capital appreciation.  While the prospectus notes that “the Fund will invest primarily in U.S. equity securities,” the managers view it as more of a go-anywhere operation, akin to the Oakmark Global and Acorn funds.  They can invest in common and preferred stocks, warrants, ETFs and ADRs.  The managers are looking for investments with three characteristics:

  • High quality businesses in healthy industries
  • Compelling valuations
  • Evidence that management’s interests are aligned with shareholders

They are hopeful of holding their investments for three to five years on average, and are intent on exploiting short-term market turbulence.  The managers do have the option to using derivatives, primarily put options, to reduce volatility and strengthen returns.

Adviser

Jackson Park Capital, LLC was founded in late 2012 by Greg Jackson and John Park. The firm is based in Park City, Utah.  The founders claim over 40 years of combined investment experience in managing mutual funds, hedge funds, and private equity funds.

Managers

Gregory L. Jackson and John H. Park.  Mr. Jackson was a Partner at Harris Associates and co-manager of Oakmark Global (OAKGX) from 1999 – 2003.  Prior to that, he works at Yacktman Asset Management and afterward he and Mr. Park were co-heads of the investment committee at the private equity firm Blum Capital.  Mr. Park was Director of Research at Columbia Wanger Asset Management, portfolio manager of the Columbia Acorn Select Fund (LTFAX) from inception until 2004 and co-manager of the Columbia Acorn Fund (LACAX) from 2003 to 2004.  Like Mr. Jackson, he subsequently joined Blum Capital.  The Oakmark/Acorn nexus gave rise to the Oakseed moniker.

Management’s Stake in the Fund

Mr. Park estimates that the managers have $8-9 million in the fund, with plans to add more when they’re able to redeem their stake in Blum Capital.  Much of the rest of the money comes from their friends, family, and long-time investors.  In addition, Messrs. Jackson and Park own 100% of Jackson Park. 

Opening date

December 31, 2012.

Minimum investment

$2500 for regular accounts, $1000 for various tax-deferred accounts and $100 for accounts set up with an AIP.

Expense ratio

1.41% after waivers on assets of $40 million (as of March, 2013).  Morningstar inexplicably assigns the fund an expense ratio of 0.00%, which they correctly describe as “low.”

Comments

If you’re fairly sure that creeping corporatism – that is, the increasing power of marketers and folks more concerned with asset-gathering than with excellence – is a really bad thing, then you’re going to discover that Oakseed is a really good one.

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.”

It’s entirely plausible that Messrs. Park and Jackson will be able to accomplish that goal. 

Why does that seem likely?  Two reasons.  First, they’ve done it before.  Mr. Park managed Columbia Acorn Select from its inception through 2004. Morningstar analyst Emily Hall’s 2003 profile of the fund was effusive about the fund’s ability to thrive in hard times:

This fund proved its mettle in the bear market. On a relative basis (and often on an absolute basis), it was a stellar performer. Over the trailing three years through July 22 [2003], its 7.6% annualized gain ranks at the top of the mid-growth category.

Like all managers and analysts at Liberty Acorn, this fund’s skipper, John Park, is a stickler for reasonably priced stocks. As a result, Park eschews expensive, speculative fare in favor of steadier growth names. That practical strategy was a huge boon in the rough, turn-of-the-century environment, when investors abandoned racier technology and health-care stocks. 

They were openly mournful of the fund’s prospects after his departure.  Their 2004 analysis began, “Camel, meet straw.”  Greg Jackson’s work with Oakmark Global was equally distinguished, but there Morningstar saw enough depth in the management ranks for the fund to continue to prosper.  (In both cases they were right.)  The strength of their performance led to an extended recruiting campaign, which took them from the mutual fund work and into the world of private equity funds, where they (and their investors) also prospered.

Second, they’re not all that concerned about attracting more money.  They started this fund because they didn’t want to do marketing, which was an integral and time consuming element of working with a private equity fund.  Private equity funds are cyclical: you raise money from investors, you put it to work for a set period, you liquidate the fund and return all the money, then begin again.  The “then begin again” part held no attraction to them.  “We love investing and we could be perfectly happy just managing the resources we have now for ourselves, our families and our friends – including folks like THOR Investment who have been investing with us for a really long time.”  And so, they’ve structured their lives and their firm to allow them to do what they love and excel at.  Mr. Park described it as “a virtual firm” where they’ve outsourced everything except the actual work of investing.  And while they like the idea of engaging with prospective investors (perhaps through a summer conference call with the Observer’s readers), they won’t be making road trips to the East Coast to rub elbows and make pitches.  They’ll allow for organic growth of the portfolio – a combination of capital appreciation and word-of-mouth marketing – until the fund reaches capacity, then they’ll close it to new investors and continue serving the old.

A quirk of timing makes the fund’s 2013 returns look tepid: my Morningstar’s calculation (as of April 30), they trail 95% of their peers.  Look closer, friends.  The entire performance deficit occurred on the first day of the year and the fund’s first day of existence.  The market melted up that day but because the fund’s very first NAV was determined after the close of business, they didn’t benefit from the run-up.  If you look at returns from Day Two – present, they’re very solid and exceptional if you account for the fund’s high cash stake and the managers’ slow, deliberate pace in deploying that cash.

Bottom Line

This is going to be good.  Quite possibly really good.  And, in all cases, focused on the needs of its investors and strengths of its managers.  That’s a rare combination and one which surely warrants your attention.

Fund website

Oakseed Funds.  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.   

Update: In our original article, we noted that the Oakseed website was distressingly Spartan. After a round of good-natured sparring, the guys launched a highly functional, visually striking new site. Nicely done

Fact Sheet

© Mutual Fund Observer, 2013. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Whitebox Market Neutral Equity Fund, Investor Class (WBLSX), April 2013

By David Snowball

Update: This fund has been liquidated.

Objective and Strategy

The fund seeks to provide investors with a positive return regardless of the direction and fluctuations of the U.S. equity markets by creating a market neutral portfolio designed to exploit inefficiencies in the markets. While they can invest in stocks of any size, they anticipate a small- to mid-cap bias. The managers advertising three reasons to consider the fund:

Downside Management: they seek to limit exposure to downside risk by running a beta neutral portfolio (one with a target beta of 0.2 to minus 0.2 which implies a net equity exposure of 20% to minus 20%) designed to capitalize on arbitrage opportunities in the equity markets.

Portfolio Diversification: they seek to generate total return that is not correlated to traditional asset classes and offers portfolio diversification benefits.

Experienced, Talented Investment Team: The team possess[es] decades of experience investing in long short equity strategies for institutional investors.

Morningstar analysis of their portfolio bears no resemblance to the team’s description of it (one short position or 198? 65% cash or 5%?), so you’ll need to proceed with care and vigilance.  Unlike many of its competitors, this is not a quant fund.

Adviser

Whitebox Advisors LLC, a multi-billion dollar alternative asset manager founded in 2000.  Whitebox manages private investment funds (including Credit Arbitrage, Small Cap L/S Equity, Liquid L/S Equity, Special Opportunities and Asymmetric Opportunities), separately managed accounts and the two (soon to be three) Whitebox funds. As of January 2012, they had $2.3 billion in assets under management (though some advisor-search sites have undated $5.5 billion figures).

Manager

Andrew Redleaf, Jason E. Cross, Paul Karos and Kurt Winters.  Mr. Redleaf founded the advisor, has deep hedge fund experience and also manages Whitebox Tactical Opportunities.  Dr. Cross has a Ph.D. in Statistics, had a Nobel Laureate as an academic adviser and published his dissertation in the Journal of Mathematical Finance. Together they also manage a piece of Collins Alternative Solutions (CLLIX).  Messrs. Karos and Winters are relative newcomers, but both have substantial portfolio management experience.

Management’s Stake in the Fund

Not yet reported but, as of 12/31/12, Whitebox and the managers owned 42% of fund shares and the Redleaf Family Foundation owned 6.5%  Mr. Redleaf also owns 85% of the advisor.

Opening date

November 01, 2012 but The Fund is the successor to Whitebox Long Short Equity Partners, L.P., a private investment company managed by the Adviser from June, 2004 through October, 2012.

Minimum investment

$5000, reduced to $1000 for IRAs.

Expense ratio

1.95% after waivers on assets of $17 million (as of March, 2013).  The “Investor” shares carry a 4.5% front-end sales load, the “Advisor” shares do not.

Comments

Here’s the story of the Whitebox Long Short Equity fund, in two pictures.

Picture One, what you see if you include the fund’s performance when it was a hedge fund:

whitebox1

Picture Two, what you see if you look only at its performance as a mutual fund:

whitebox2

The divergence between those two graphs is striking and common.  There are lots of hedge funds – the progenitors of Nakoma Absolute Return, Baron Partners, RiverPark Long Short Opportunities – which offered mountainous chart performance as hedge funds but whose performance as a mutual fund was somewhere between “okay” and “time to turn out the lights and go home.”  The same has been true of some funds – for example, Auer Growth and Utopia Core – whose credentials derive from the performance of privately-managed accounts.  Similarly, as the Whitebox managers note, there are lots of markets in which their strategy will be undistinguished.

So, what do they do?  They operate with an extremely high level of quantitative expertise, but they are not a quant fund (that’s the Whitebox versus “black box” distinction).  We know that there are predictable patterns of investor irrationality (that’s the basis of behavioral finance) and that those investor preferences can shift substantially (for example, between obsessions with greed and fear).  Whitebox believes that those irrationalities continually generate exploitable mispricings (some healthy firms or sound sectors priced as if bankruptcy is imminent, others priced as if consumers are locked into an insane spending binge).  Whitebox’s models attempt to identify which factors are currently driving prices and they assign a factor score to stocks and sectors.

Whitebox does not, however, immediately act on those scores.  Instead, they subject the stocks to extensive, fundamental analysis.  They’re especially sensitive to the fact that quant outputs become unreliable in suddenly unstable markets, and so they’re especially vigilant in such markets are cast a skeptical eye on seemingly objective, once-reliable outputs.

They believe that the strengths of each approach (quant and fundamental, machine and human) can be complementary: they discount the models in times of instability but use it to force their attention on overlooked possibilities otherwise. 

They tend assemble a “beta neutral” portfolio, one that acts as if it has no exposure to the stock market’s volatility.  They argue that “risk management … is inseparable from position selection.”  They believe that many investors mistakenly seek out risky assets, expecting that higher risk correlates with higher returns.  They disagree, arguing that they generate alpha by limiting beta; that is, by not losing your money in the first place.  They’re looking for investments with asymmetric risks: downside that’s “relatively contained” but “a potentially fat tailed” upside.  Part of that risk management comes from limits on position size, sector exposure and leverage.  Part from daily liquidity and performance monitoring.

Whitebox will, the managers believe, excel in two sorts of markets.  Their discipline works well in “calm, stable markets” and in the recovery phase after “pronounced market turmoil,” where prices have gotten seriously out-of-whack.  The experience of their hedge fund suggests that they have the ability to add serious alpha: from inception, the fund returned about 14% per year while the stock market managed 2.5%.

Are there reasons to be cautious?  Yep.  Two come to mind:

  1. The fund is expensive.  After waivers, retail investors are still paying nearly 2% plus a front load of 4.5%.  While that was more than offset by the fund’s past returns, current investors can’t buy past returns.
  2. Some hedge funds manage the transition well, others don’t.  As I noted above, success as a hedge fund – even sustained success as a hedge fund – has not proven to be a fool-proof predictor of mutual fund success.  The fund’s slightly older sibling, Whitebox Tactical Opportunities (WBMAX) has provided perfectly ordinary returns since inception (12/2011) and weak ones over the past 12 months.  That’s not a criticism, it’s a caution.

Bottom Line

There’s no question that the managers are smart, successful and experienced hedge fund investors.  Their writing is thoughtful and their arguments are well-made.  They’ve been entrusted with billions of other people’s money and they’ve got a huge personal stake – financial and otherwise – in this strategy.  Lacking a more sophisticated understanding of what they’re about and a bit concerned about expenses, I’m at best cautiously optimistic about the fund’s prospects.

Fund website

Whitebox Market Neutral Equity Fund.  (The Whitebox homepage is just a bit grandiose, so it seems better to go straight to the fund’s page.)

Fact Sheet

© Mutual Fund Observer, 2013. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Seafarer Overseas Growth & Income (SFGIX)

By David Snowball

THIS IS AN UPDATE OF THE FUND PROFILE ORIGINALLY PUBLISHED IN July 2012. YOU CAN FIND THAT PROFILE HERE

Objective and Strategy

Seafarer seeks to provide long-term capital appreciation along with some current income; it also seeks to mitigate volatility. The Fund invests a significant amount – 20-50% of its portfolio – in the securities of companies located in developed countries. The remainder is investing in developing and frontier markets.  The Fund can invest in dividend-paying common stocks, preferred stocks, convertible bonds, and fixed-income securities. 

Adviser

Seafarer Capital Partners of San Francisco.  Seafarer is a small, employee-owned firm whose only focus is the Seafarer fund.

Managers

Andrew Foster is the lead manager.  Mr. Foster is Seafarer’s founder and Chief Investment Officer.  Mr. Foster formerly was manager or co-manager of Matthews Asia Growth & Income (MACSX), Matthews’ research director and acting chief investment officer.  He began his career in emerging markets in 1996, when he worked as a management consultant with A.T. Kearney, based in Singapore, then joined Matthews in 1998.  Andrew was named Director of Research in 2003 and served as the firm’s Acting Chief Investment Officer during the height of the global financial crisis, from 2008 through 2009.  Andrew is assisted by William Maeck and Kate Jaquet.  Mr. Maeck is the associate portfolio manager and head trader for Seafarer.  He’s had a long career as an investment adviser, equity analyst and management consultant.  Ms. Jaquet spent the first part of her career with Credit Suisse First Boston as an investment banking analyst within their Latin America group. In 2000, she joined Seneca Capital Management in San Francisco as a senior research analyst in their high yield group. Her responsibilities included the metals & mining, oil & gas, and utilities industries as well as emerging market sovereigns and select emerging market corporate issuers.

Management’s Stake in the Fund

Mr. Foster has over $1 million in the fund.  Both Maeck and Jaquet have between $100,000 and $500,000 invested.

Opening date

February 15, 2012

Minimum investment

$2,500 for regular accounts and $1000 for retirement accounts. The minimum subsequent investment is $500.

Expense ratio

1.40% after waivers on assets of $35 million (as of February 2013).  The fund has two fee waivers in place, a contractual waiver which is reflected in standard reports (such as those at Morningstar) but also a voluntary one which is not reflected elsewhere. The fund does not charge a 12(b)1 marketing fee but does have a 2% redemption fee on shares held fewer than 90 days.

Comments

Investors have latched on, perhaps too tightly, to the need for emerging markets exposure.  As of March 2013, e.m. funds had seen 21 consecutive weeks of asset inflows after years of languishing.  Any time there is that much enthusiasm for an asset class, prudent investors should pause.  But we also believe that prudent investors who want emerging markets exposure should start at Seafarer.  The case for Seafarer is straightforward: it’s going to be one of your best options for sustaining exposure to an important but challenging asset class.

There are four reasons to believe this is true.

First, Andrew Foster has been getting it right for a long time.  This is the quintessential case of “a seasoned manager at a nimble new fund.”  In addition to managing or co-managing Matthews Asian Growth & Income for eight years (2003-2011), he was a portfolio manager on Asia Dividend for six years and India Fund for five.  His hallmark piece, prior to Seafarer, indisputably was MACSX.  The fund’s careful risk management helped investors control the impulse to panic.  Volatility is the bane of most emerging markets funds (the group’s standard deviation is about 25, while developed markets average 15). The average emerging markets stock investor captured a mere 25 – 35% of their funds’ nominal gains. MACSX’s captured 90% over the decade that ended with Andrew’s departure and virtually 100% over the preceding 15 years.  The great debate surrounding MACSX during his tenure was whether it was the best Asia-centered fund in existence or merely one of the two or three best funds in existence. 

Second, Seafarer is independent.  Based on his earlier research, Mr. Foster believes that perhaps two-thirds of MACSX’s out-performance was driven by having “a more sensible” approach (for example, recognizing the strategic errors embedded in the index benchmarks which drive most “active” managers) and one-third by better security selection (driven by intensive research and over 1500 field visits).  Seafarer and its benchmarks focus on about 24 markets.  In 14 of them, Seafarer has dramatically different weightings than do the indexes (MSCI or FTSE) or his peers.  It’s striking, on a country-by-country level, how closely the average e.m. fund hugs its benchmark.  Seafarer dramatically underweights the BRICs and Korea, which represent 58% of the MSCI index but only 25% of Seafarer’s portfolio.  That’s made up for by substantially greater positions in Chile, Hong Kong, Japan, Poland, Singapore, Thailand and Turkey.  While the average e.m. fund seems to hold 100-250 names and index funds hold 1000, Seafarer focuses on 40.

Third, Seafarer is cautious. Andrew targets firms which are well-managed and capable of sustained growth.  He’s willing to sacrifice dramatic upside potential for the prospect of steady, long-term growth and income.  The stocks in his portfolio receive far high financial health and slightly lower growth scores from Morningstar than either indexed or actively managed e.m. funds as a group. Concern about stretched valuations led him to halve his small cap stake in 2012 and move into larger, steadier firms including those domiciled in developed markets. 

Combined with a greater interest in income in the portfolio, that’s given Seafarer noticeable downside protection.  E.M. funds as a group have posted losses in five of the past 12 months.  In those down months, their average loss is 2.9% per month.  In those same months, Seafarer posted an average loss of 1.3% (about 45% of the market’s).  In three of those five months, Seafarer made money.  That’s consistent with his long-term record.  During the global meltdown (10/07 – 03/09), his previous charge lost 34% but the average Asia fund dropped 58% and the average emerging markets fund dropped 59%.

Fourth Seafarer is rewarding.  In its first year, Seafarer returned 18% versus the MSCI emerging market index’s 3.8%.   It outperformed the only e.m. fund to receive Morningstar’s “Gold” designation, American Funds New World (NEWFX), the offerings from Vanguard, Price, Fidelity and PIMCO, its emerging markets peer group and First Trust/Aberdeen Emerging Opportunities (FEO), the best of the EM balanced funds.

Bottom Line

Mr. Foster is remarkably bright, thoughtful, experienced and concerned about the welfare of his shareholders.  He thinks more broadly than most and has more experience than the vast majority of his peers. The fund offers him more flexibility than he’s ever had and he’s using it well.  There are few more-attractive emerging markets options available.

Fund website

Seafarer Overseas Growth and Income.  The website is remarkably rich, both with analyses of the fund’s portfolio and performance, and with commentary on broader issues.

Disclosure: the Observer has no financial ties with Seafarer Funds.  I do own shares of Seafarer and Matthews Asian Growth & Income (purchased during Andrew’s managership there) in my personal account.

© Mutual Fund Observer, 2013. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Matthews Asia Strategic Income (MAINX), February 2013

By David Snowball

 

This is an update of the fund profile originally published in February 2012, and updated in March 2012. You can find that profile here

Objective and Strategy

MAINX seeks total return over the long term with an emphasis on income. The fund invests in income-producing securities including, but not limited to, debt and debt-related instruments issued by government, quasi-governmental and corporate bonds, dividend-paying stocks and convertible securities (a sort of stock/bond hybrid).  The fund may hedge its currency exposure, but does not intend to do so routinely.  In general, at least half of the portfolio will be in investment-grade bonds.  Equities, both common stocks and convertibles, will not exceed 20% of the portfolio.

Adviser

Matthews International Capital Management. Matthews was founded in 1991 and advises the 13 Matthews Asia funds.   As of December 31, 2012, Matthews had $20.9 billion in assets under management.  On whole, the Matthews Asia funds offer below average expenses.  They also publish an interesting and well-written newsletter on Asian investing, Asia Insight.

Manager(s)

Teresa Kong is the lead manager.  Before joining Matthews in 2010, she was Head of Emerging Market Investments at Barclays Global Investors (now BlackRock) and responsible for managing the firm’s investment strategies in Emerging Asia, Eastern Europe, Africa and Latin America. In addition to founding the Fixed Income Emerging Markets Group at BlackRock, she was also Senior Portfolio Manager and Credit Strategist on the Fixed Income credit team.  She’s also served as an analyst for Oppenheimer Funds and JP Morgan Securities, where she worked in the Structured Products Group and Latin America Capital Markets Group.  Kong has two co-managers, Gerald Hwang, who for three years managed foreign exchange and fixed income assets for some of Vanguard’s exchange-traded funds and mutual funds before joining Matthews in 2011, and Robert Horrocks, Matthews’ chief investment officer.

Management’s Stake in the Fund

As of the April 2012 Statement of Additional Information, Ms. Kong and Mr. Horrocks each had between $100,000 and 500,000 invested in the fund.  About one-third of the fund’s Investor class shares were held by Matthews.

Opening date

November 30, 2011.

Minimum investment

$2500 for regular accounts, $500 for IRAs for the retail shares.  The fund’s available, NTF, through Fidelity, Scottrade, TD Ameritrade, TIAA-CREF and Vanguard and a few others.

Expense ratio

1.40%, after waivers, on $50 million in assets (as of January, 2013).  There’s also a 2% redemption fee for shares held fewer than 90 days.  The Institutional share class (MINCX) charges 1.0% and has a $3 million minimum.

Comments

The events of 2012 only make the case for Matthews Asia Strategic Income more intriguing.  Our original case for MAINX had two premises:

  1. Traditional fixed-income investments are failing. The combination of microscopic domestic interest rates with the slow depreciation of the U.S. dollar and the corrosive effects of inflation means that more and more “risk-free” fixed-income portfolios simply won’t meet their owners’ needs.  Surmounting that risk requires looking beyond the traditional.  For many investors, Asia is a logical destination for two reasons: the fundamentals of their fixed-income market is stronger than those in Europe or the U.S. and most investors are systematically underexposed to the Asian market.
  2.  Matthews Asia is probably the best tool you have for gaining that exposure.  They have the largest array of Asia investment products in the U.S. market, the deepest analytic core and the broadest array of experience.  They also have a long history of fixed-income investing in the service of funds such as Matthews Asian Growth & Income (MACSX).   Their culture and policies are shareholder-friendly and their success has been consistent. 

Three developments in 2012 made the case for looking at MAINX more compelling.

  1. Alarm about the state of developed credit markets is rising.  As of February 2013, Bill Gross anticipates “negative real interest rates approaching minus 2%” and warns “our credit-based financial markets and the economy it supports are levered, fragile and increasingly entropic – it is running out of energy and time.”  Templeton’s Dan Hasentab, “the man who made some of the boldest contrarian bets in the bond market last year has,” The Financial Times reported on January 30, “a new message for investors: get out of supposedly safe government debt now, before it is too late.” The 79 year old maestro behind Loomis Sayles Bond and Strategic Income, Dan Fuss, declares “This is the most overbought market I have ever seen in my life . . . What I tell my clients is, ‘It’s not the end of the world, but . . .”   

    Ms. Kong points to Asia as a powerful counterbalance to these concerns.  Its beta relative to US Treasuries bonds is among the lowest around: If, for example, the 5-year Treasury declines 1% in value, U.S. investment grade debt will decline 0.7%, the global aggregate index 0.5% and Asia fixed-income around 0.25%.

  2. Strategic Income performed beautifully in its first full year.  The fund returned 13.62% in 2012, placing it in the top 10% of Morningstar’s “world bond” peer group.  A more telling comparison was provided by our collaborator, Charles Boccadoro, who notes that the fund’s absolute and risk-adjusted returns far exceeded those of its few Asia-centered competitors.

  3. Strategic Income’s equity exposure may be rising in significance.  The inclusion of an equity stake adds upside, allows the fund to range across a firm’s capital structure and allows it to pursue opportunities in markets where the fixed-income segment is closed or fundamentally unattractive.  Increasingly, the top tier of strategists are pointing to income-producing equities as an essential component of a fixed-income portfolio.

Bottom Line

MAINX offers rare and sensible access to an important, under-followed asset class.  The long track record of Matthews Asia funds suggests that this is going to be a solid, risk-conscious and rewarding vehicle for gaining access to that class.  By design, MAINX will likely offer the highest Sharpe ratio (a measure of risk-adjusted returns) of any of the Matthews Asia funds. You really want to consider the possibility before the issue becomes pressing.

Fund website

Matthews Asia Strategic Income

Commentary

2013 Q3 Report

© Mutual Fund Observer, 2013. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Artisan Global Equity Fund (ARTHX) – December 2012

By David Snowball

Objective and Strategy

The fund seeks to maximize long-term capital growth.  They invest in a global, all-cap equity portfolio which may include common and preferred stocks, convertible securities and, to a limited extent, derivatives.  They’re looking for high-quality growth companies with sustainable growth characteristics.  Their preference is to invest in firms that benefit from long-term growth trends and in stocks which are selling at a reasonable price.  Typically they hold 60-100 stocks. No more than 30% of the portfolio may be invested in emerging markets.  In general they do not hedge their currency exposure but could choose to do so if they owned a security denominated in an overvalued currency.

Adviser

Artisan Partners of Milwaukee, Wisconsin with Artisan Partners UK LLP as a subadvisor.   Artisan has five autonomous investment teams that oversee twelve distinct U.S., non-U.S. and global investment strategies. Artisan has been around since 1994.  As of 9/30/2012, Artisan Partners had approximately $70 billion in assets under management.  That’s up from $10 billion in 2000. They advise the 12 Artisan funds, but only 5% of their assets come from retail investors.

Manager

Barry P. Dargan is lead portfolio manager and Mark L. Yockey is portfolio manager.  Dargan and Yockey are jointly responsible for management of the fund, they work together to develop investment strategies but Mr. Dargan generally exercises final decision-making authority.  Previously, Mr. Dargan worked for MFS, as an investment analyst from 1996 to 2001 and as a manager of MFS International Growth (MGRAX) from 2001 to 2010.  Mr. Yockey joined Artisan in 1995 and is the lead manager for Artisan International (ARTIX) and Artisan International Small Cap (ARTJX).  The fact that Mr. Dargan’s main charge handily outperformed ARTIX over nearly a decade might have helped convince Artisan to bring him on-board.

Management’s Stake in the Fund

Mr. Dargan has over $1 million invested with the fund, and Mr. Yockey has between $500,000 and $1 million invested.  As of December 31, 2011, the officers and directors of Artisan Funds owned 16.94% of Artisan Global Equity Fund.

Opening date

March 29, 2010

Minimum investment

$1,000, which Artisan will waive if you establish an account with an automatic investment plan.

Expense ratio

1.50%, after waivers, on assets of $16.7 million. There is a 2% redemption fee for shares held less than 90 days.

Comments

Q:   What do you get when you combine the talents of two supremely successful international stock managers, a healthy corporate culture and a small, flexible fund?

A:   Artisan Global Equity.

The argument for considering ARTHX is really straightforward.  First, both managers have records that are both sustained and excellent.  Mr. Dargan managed, or co-managed, six funds, including two global funds, while at MFS.  Those included funds targeting both U.S. and non-U.S. investors.  While I don’t have a precise calculation, it’s clear he was managing more than $3 billion.  Mr. Yockey has famously managed two Artisan international funds since their inception, was once recognized as Morningstar’s International Fund Manager of the Year (1998).  For most trailing time periods, his funds have top 10% returns.  International Small Cap received Morningstar’s highest accolade when it was designated as the only “Gold” fund in its peer group while International was recognized as a “Silver” fund.  Based on head-to-head comparisons from 2001-2010, Mr. Yockey is really first rate and Mr. Dargan might be better.  (Being British, it’s almost certain that he has a cooler accent.)

Second, Artisan is a good steward.  The firm’s managers are divided into five teams, each with a distinctive philosophy and portfolio strategy.  The Global Equity team has four members (including Associate Portfolio Managers Charles Hamker and Andrew Euretig who also co-manage International Small Cap) and their discipline grows from the strategies first employed in ARTIX then extended to ARTJX.  Artisan has a very good record for lowering expenses, being risk conscious, opening funds only when they believe they have the capacity to be category-leaders (and almost all are) and closing funds before they’re bloated.

Third, ARTHX is nimble.  Its mandate is flexible: all sizes, all countries, any industry.  The fund’s direct investment in emerging markets is limited to 30% of the portfolio, but their pursuit of the world’s best companies leads them to firms whose income streams are more diverse than would be suggested by the names of the countries where they’re headquartered.  The managers note:

Though we have outsized exposure to Europe and undersized exposure to the U.S., we believe our relative country weights are of less significance since the companies we own in these developed economies continually expand their revenue bases across the globe.

Our portfolio remains centered around global industry leading companies with attractive valuations. This has led to a significant overweight position in the consumer sectors where many of our holdings benefit from significant exposure to the faster growth in emerging economies.

Since much of the world’s secular (enduring, long-term) growth is in the emerging markets, the portfolio is positioned to give them substantial exposure to it through their Europe and US-domiciled firms.  While the managers are experienced in handling billions, here they’re dealing with only $17 million.

The results are not surprising.  Morningstar believes that their analysts can identify those funds likely to serve their shareholders best; they do this by looking at a series of qualitative factors on top of pure performance.  When they find a fund that they believe has the potential to be consistently strong in the future, they can name it as a “Gold” fund.   Here are ARTHX’s returns since inception (the blue line) against all of Morningstar’s global Gold funds:

Artisan Global Equity versus gold funds

Not to say that the gap between Artisan and the other top funds is large and growing, but it is.

Bottom Line

Artisan Global Equity is an outstanding small fund for investors looking for exposure to many of the best firms from around the global.  The expenses are reasonable, the investment minimum is low and the manager is first-rate.  Which should be no surprise since two of the few funds keeping pace with Artisan Global Equity have names beginning with the same two words: Artisan Global Opportunities (ARTRX) and Artisan Global Value (ARTGX).

Fund website

Artisan Global Equity

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Scout Unconstrained Bond Fund (SUBFX), November 2012

By David Snowball

This fund is now the Carillon Reams Unconstrained Bond Fund.

Objective and Strategy

The fund seeks to maximize total return consistent with the preservation of capital.  The fund can invest in almost any sort of fixed-income instrument, though as a practical matter their international investments are quite limited.  The fund’s maturity will not normally exceed eight years, but they maintain the option of going longer in some markets and even achieving a negative duration (effectively shorting the bond market) in others.  They can use derivative instruments, such as options, futures contracts (including interest rate futures contracts), currency forwards or swap agreements (including credit default swaps) to enhance returns, increase liquidity and/or gain exposure to particular areas of the market.  Because they sell a security when it approaches fair market value, this may be a relatively high turnover fund.

Adviser

Scout Investments, Inc. Scout is a wholly-owned subsidiary of UMB Financial, both are located in Kansas City, Missouri. Scout advises the eleven Scout funds. As of June 30, 2012, assets under the management of the Advisor were approximately $22.37 billion.  Scout’s four fixed-income funds are managed by its Reams Asset Management division, including Low-Duration Bond (SCLDX), Core Bond (SCCYX, four stars) and Core Plus Bond (SCPZX, rated five star/Silver by Morningstar, as of October 2012).

Manager

Mark M. Egan is the lead portfolio manager of the Fixed Income Funds. Thomas M. Fink, Todd C. Thompson and Stephen T. Vincent are co-portfolio managers of the Fixed Income Funds. Mr. Egan joined the Advisor on November 30, 2010. He oversees the entire fixed income division of the Advisor, Reams Asset Management, and retains oversight over all investment decisions. Mr. Egan was a portfolio manager of Reams Asset Management Company, LLC (“Reams”) from April 1994 until November 2010 and was a portfolio manager of Reams Asset Management Company, Inc. from June 1990 until March 1994. Mr. Egan was a portfolio manager of National Investment Services until May 1990.

Management’s Stake in the Fund

Messrs. Egan, Fink and Thompson have each invested over $1,000,000 in the fund.  Mr. Vincent has between $10,000 – 50,000 in it.

Opening date

September 29, 2011.

Minimum investment

$1,000 for regular accounts, reduced to $100 for IRAs or accounts with AIPs.

Expense ratio

0.99%, after waivers, on assets of $45 million (as of October 2012).

Comments

There are 6850 funds of all kinds in Morningstar’s database.  Of those, precisely 117 have a better one-year record than Scout Unconstrained Bond.

There are 1134 fixed-income funds in Morningstar’s database.  Of those, precisely five have a better one-year record.

98.3% of all funds trail Scout Unconstrained between November 1, 2011 and October 30, 2012.  99.6% of all fixed-income funds trailed Scout for the same period.

Surprised?  You might not be if you knew the record of the management team that runs Scout Unconstrained.  Mark Egan and his team from Reams Asset Management have been investing money using this strategy since 1998.  Their audited performance for the private accounts (about $231 million worth of them) is stunningly better than the records of the most renowned bond fund managers.  The funds below represent the work of the three best-known bond managers (Jeff Gundlach at DoubleLine, Bill Gross at PIMCO, Dan Fuss at Loomis) plus the performance of the Gold-rated funds in Morningstar’s two most-flexible categories: multi-sector and world.

 

1 Yr.

3 Yrs.

5 Yrs.

10 Yrs.

Unconstrained Composite

33.98%

20.78

17.45

15.67

SUBFX

25.37

DoubleLine Core Fixed Income

8.62

Loomis Sayles Bond

14.25

10.83

7.08

10.41

Loomis Sayles Strategic Income

14.02

10.63

6.89

11.14

PIMCO Total Return

9.08

11.51

8.92

6.95

Templeton Global Bond

12.92

8.03

9.47

10.95

ML 3 Month LIBOR

0.48

0.37

1.44

2.26

Annualized Performance Ending September 30, 2012

You’ll notice that the performance of Scout Unconstrained does not equal the performance of the Unconstrained Composite.  The difference is that the team bought, in the private accounts, deeply distressed securities in the 2008 panic and they’re now harvesting the rewards of those purchases.  Since the fund didn’t exist, its investors don’t have the benefit of that exposure. Clark Holland, a Portfolio Analyst on the Fund, reports that, “We strive to invest the separate accounts and the mutual fund as closely as possible so returns should be similar going forward.”

Just because I’m a cautious person, I also screened all bond funds against the trailing record of the Unconstrained Bond composite, looking for close competitors.  There were none.

But I’m not sure why.  The team’s strategy is deceptively simple.  Find where the best values are, then buy them.  The Reams website posits this process:

STEP 1: Determine whether the bond market is cheap or expensive by comparing the current real interest rate to historical rates.

STEP 2: Focus on sectors offering relative value and select securities offering the highest risk‐adjusted return.

STEP 3: Continually measure and control exposure to security‐ and portfolio‐level risks.

It looks like the fund benefits from the combination of two factors: boldness and caution.

It’s clear that the managers have sufficient confidence in their judgment to act when other hesitate.  Their 2012 Annual Report cites one such instance:

A contribution to performance in the asset-backed securities (ABS) sector can be traced to our second lien or home equity holdings, which strongly outperformed.  We purchased these securities at an extreme discount after the 2008-2009 financial crisis, when defaults on home equity loans were high. Since then, default rates declined, the perceived risk of owning these securities lessened, and the prices of the securities have risen sharply.

As you comb through the fund’s reports, you find discussions of “airline enhanced equipment trust certificates” and the successful exploitation of mispricing in the derivatives market:

High-yield index swaps (CDX) such as those we own, which represent groups of credit default swaps (CDS), usually are priced similarly to high-yield cash bonds. Due to somewhat technical reasons, a price gap opened, in the second quarter of this year, between the price of high-yield CDX index swaps and high-yield cash bonds .We took advantage of the price gap to buy the CDX index swap at an attractive price and captured a nice return when pricing trended back toward a more normal level.

One simple and bold decision was to have zero long exposure to Treasuries; their peers average 35%.   As with RiverPark Short Term High Yield, the fact that their strategy (separate accounts plus the fund) has attracted a relatively small amount of investment, they’re able to drive performance with a series of relatively small, profitable trades that larger funds might need to skip over.

At the same time, you get a sense of intense risk-consciousness.  Cautious about rising interest rates, the managers expect to maintain a shorter average duration as they look for potential investments. In his October 3, 2012 letter to investors, Mr. Egan lays out his sense of how the market is evolving and how his team will respond:

What to do? Recognize the reality of a challenging environment, focus on your realistic goals as an investor, and be ready to seize opportunities as they arise.  A well-known investor recently opined as to the death of equity as an asset class.  Our take is the death of static risk allocations, or even what constitutes risk, along with buy and hold investing.  The successful investor will be aware of the challenges we face as a society, understand the efficacy or lack of it in the various (mostly political) solutions prescribed, and allow volatility, and the inevitable mispricing that will result, to be your guide. Flexibility and nimbleness will be required.  For our part, we have positioned accounts in a cautious, conservative stance as the cost of doing so has rapidly declined. We may be early and we may forgo some modest gains in risk assets, but it is both appropriate and in keeping with the style that has generated returns well in excess of our peers over most time periods.

Bottom Line

You need to approach any “too good to be true” investment with care and diligence.  The track record behind SUBFX, which is splendid and carefully documented, was earned in a different sort of investment vehicle.  As assets grow, the fund’s opportunity set will change and, possibly, narrow.  That said, the managers have successfully invested substantial sums via this strategy for nearly 15 years; the fact that they’ve placed millions of their own dollars at risk represents a very serious endorsement.

Fund website

Scout Unconstrained Bond.  Mr. Egan also wrote a very good white paper entitled “Fixed Income: The Search for Total Returns in Volatile Markets” (March 2012).  If you’re intrigued by the fund, you’ll get a better sense of the managers’ approach.  Even if you’re not, you might well benefit from their discussion of “the growing risks of not taking risks.”

Fact Sheet

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Stewart Capital Mid Cap Fund (SCMFX), November 2012

By David Snowball

This fund has been liquidated.

Objective and Strategy

Stewart Capital Mid Cap Fund seeks long-term capital appreciation.  It invests, primarily, in domestic midcap stocks.  While it is technically a “diversified” fund, the managers warn that they prefer to invest in “a relatively small number of intensively researched companies.”  They operationalize “relatively small” as 30-60.  They target firms that don’t need “large amounts of leverage to execute their business plan” and firms with sustainable business advantages (favorable demographics and long-term trends, high barriers to entry, good management teams, and high returns on invested capital).

Adviser

Stewart Capital Advisors, LLC, was founded in August 2005.  It is a wholly-owned subsidiary of S&T Bank, headquartered in Indiana, PA.  As of December 31, 2011, Stewart had $965 million in assets under management.

Managers

Matthew A. Di Filippo, Charles G. Frank, Jonathan V. Pavlik, Malcolm E. Polley, Helena Rados-Derr and Nicholas Westric.  Mr. Di Filippo is the senior manager and the adviser’s investment strategist.  Mr. Polley is president and CIO.  His investing career started on Black Monday, 1987 and includes 25 years of primarily-midcap investing.  Except for Ms. Rados-Derr and Mr. Westric, the managers have all been with the fund since inception.  Each of the managers also handles something like 100-300 private accounts.

Management’s Stake in the Fund

Modest.  Three of the managers have invested between $10,001-50,000 in the fund: Polley, Di Filippo and Pavlik.  The others have invested under $10,000.  I expressed my concern about such modest commitments to President Polley.  He writes:

I could require that staff invest solely in the fund, but realize that a portfolio that is solely mid-cap oriented for some folks does not meet their risk parameters.  Also, I want staff to invest in the fund on its merits. That said, I have exactly two investments: S&T Bank stock and the Stewart Capital Mid Cap Fund.  I also have two children in college and have been using some of my investment in that fund to pay for that expense.  So, I believe I put my money where my mouth is.

Opening date

December 29, 2006. The fund converted to no-load on April 1, 2012.

Minimum investment

$1,000 or $100 for accounts with an automatic investment plan.

Expense ratio

1.50%, after waivers, on assets of $37.0 million.

Comments

I wandered by the Stewart Capital booth at Morningstar Investment Conference in June, picked up the fund’s factsheet and reports, and then stood there for a long time.  Have you ever had one of those “how on earth did I manage to miss this?” moments? As I looked at the fund’s record, that’s precisely what went through my mind: small, no-load, independent fund, great returns, low risk, low minimum investments.  Heck, they’re even in Steeler Country.  How on earth did I manage to miss this?

Part of the answer is that Stewart was not always a no-load fund, so they weren’t traditionally in my coverage universe, and their marketing efforts are very low-key.

There’s a lot to like here. The two reliable fund rating services, Morningstar and Lipper, agree that SCMFX is at the top of the midcap pack in both risk management and returns.  Here’s the Morningstar snapshot:

 

Returns

Risk

Rating

3-year

High

Below Average

Five Stars

5-year

High

Below Average

Five Stars

Overall

High

Below Average

Five Stars

(Morningstar ratings, as of 10/30/12)

Morningstar’s estimate of tax-adjusted returns places Stewart in the top 1% of mid-cap funds over the past five years.

Lipper supports a similar conclusion:

 

Total Return

Consistent Return

Preservation

Tax Efficiency

3-year

5

5

5

4

5-year

5

5

5

5

Overall

5

5

5

5

(Lipper Leaders ratings, as of 10/30/12)

The fund has a striking pattern of performance over time. Normally good funds make their money either on the upside or the downside; that is, they consistently outperform in either rising or falling markets. Stewart seems to do both.  It has outperformed its peer group in eight of eight down quarters in the past five years (2008 – Q3 2012) but in only four of 11 rising quarters. But it still wins in rising markets. In quarters when the market has been rising, SCMFX gains an average of 10.65% versus 10.58% for its peer group, reflecting the fact that its “up” quarters rarely trail the market by much and sometimes lead it by a lot.

When I asked the simple question, “which mid-cap funds have been as successful? And screened for folks who could match or better Stewart over the past one, three and five year periods, I could find only four funds in a universe of 300 midcaps. Of those, only one fund, the $1.6 billion Nicholas Fund (NICSX), was less volatile.

That’s a distinguished record in a notably volatile market: 10 of the past 23 quarters have seen double-digit gains (six) or losses (four) for midcap stocks.

The fund is distinguished by effective active management. They buy the stocks they expect to outperform, regardless of the broader market’s preferences. They target stocks where they anticipate a 15% annual rate of return and which are selling at a discount to fair-value of at least 15%. Their question seems to be, “would we want to own this whole company?”  That leads them to buy businesses where the industry is favorably positioned (they mostly avoid financials, for example, because the industry only thrives when assets are growing and Stewart suspects that growth is going to be limited for years and years) and the individual firm has exceptional management. An analysis of the portfolio shows the result. They own high quality companies, ones which are growing much more quickly (whether measured by long-term earnings, cash flow, or book value) than their peers.  And they are buying those companies at a good price; their high-quality portfolio is selling at a slight discount (in price/earnings, price/sales, price/cash flow) to their peers.

Bottom Line

This is arguably one of the top two midcap funds on the market, based on its ability to perform in volatile rising and falling markets. Their strategy seems disciplined, sensible and repeatable. Management has an entirely-admirable urge “to guard against … making foolish decisions” based on any desire to buy what’s popular at the moment.  They deserve a spot on the due diligence list for anyone looking to add actively-managed, risk-conscious equity exposure.

Fund website

Stewart Capital

Fact Sheet

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

RiverPark Short Term High Yield Fund (RPHYX), July 2011, updated October 2012

By David Snowball

This profile has been updated. Find the new profile here.

Objective

The fund seeks high current income and capital appreciation consistent with the preservation of capital, and is looking for yields that are better than those available via traditional money market and short term bond funds.  They invest primarily in high yield bonds with an effective maturity of less than three years but can also have money in short term debt, preferred stock, convertible bonds, and fixed- or floating-rate bank loans.

Adviser

RiverPark Advisors, LLC. Executives from Baron Asset Management, including president Morty Schaja, formed RiverPark in July 2009.  RiverPark oversees the six RiverPark funds, though other firms manage three of them.  RiverPark Capital Management runs separate accounts and partnerships.  Collectively, they have $567 million in assets under management, as of July 31, 2012.

Manager

David Sherman, founder and owner of Cohanzick Management of Pleasantville (think Reader’s Digest), NY.  Cohanzick manages separate accounts and partnerships.  The firm has more than $320 million in assets under management.  Since 1997, Cohanzick has managed accounts for a variety of clients using substantially the same process that they’ll use with this fund. He currently invests about $100 million in this style, between the fund and his separate accounts.  Before founding Cohanzick, Mr. Sherman worked for Leucadia National Corporation and its subsidiaries.  From 1992 – 1996, he oversaw Leucadia’s insurance companies’ investment portfolios.  All told, he has over 23 years of experience investing in high yield and distressed securities.  He’s assisted by three other investment professionals.

Management’s Stake in the Fund

Mr. Sherman has over $1 million invested in the fund.  At the time of our first profile (September 2011), folks associated with RiverPark or Cohanzick had nearly $10 million in the fund.  In addition, 75% of Cohanzick is owned by its employees.

Opening date

September 30, 2010.

Minimum investment

$1,000.

Expense ratio

1.25% after waivers on $197 million in assets (as of September 2012).  The prospectus reports that the actual cost of operation is 2.65% with RiverPark underwriting everything above 1.25%.  Mr. Schaja, RiverPark’s president, says that the fund is very near the break-even point.

There’s also a 2% redemption fee on shares held under one month.

Update

Our original analysis, posted September, 2011, appears just below this update.  Depending on your familiarity with the fund’s strategy and its relationship to other cash management vehicles, you might choose to read or review that analysis first.

October, 2012

2011 returns: 3.86%2012 returns, through 9/28: 3.34%  
Asset growth: about $180 million in 12 months, from $20 million  
People are starting to catch on to RPHYX’s discrete and substantial charms.  Both the fund’s name and Morningstar’s assignment of it to the “high yield” peer group threw off some potential investors.  To be clear: this is nota high yield bond fund in any sense that you’d recognize.  As I explain below in our original commentary, this is a conservative cash-management fund which is able to exploit pieces of the high yield market to generate substantial returns with minimal volatility.In a September 2012 conference call with Observer readers, Mr. Sherman made it clear that it’s “absolutely possible” for the fund to lose money in the very short term, but for folks with an investment time horizon of more than three months, the risks are very small.Beyond that, it’s worth noting that:

  1. they expect to be able to return 300 – 400 basis points more than a money market fund – there are times when that might drop to 250 basis points for a short period, but 300-400 is, they believe, a sustainable advantage.  And that’s almost exactly what they’re doing.  Through 9/28/2012, Vanguard Prime Money Market (VMMXX) returned 3 basis points while RPHYX earned 334 basis points.
  2. they manage to minimize risk, not maximize return – if market conditions are sufficiently iffy, Mr. Sherman would rather move entirely to short-term Treasuries than expose his investors to permanent loss of capital.  This also explains why Mr. Sherman strictly limits position sizes and refuses to buy securities which would expose his investors to the substantial short-term gyrations of the financial sector.
  3. they’ve done a pretty good job at risk minimization – neither the fund nor the strategy operated in 2008, so we don’t have a direct measure of their performance in a market freeze. Since the majority of the portfolio rolls to cash every 30 days or so, even there the impairment would be limited. The best stress test to date was the third quarter of 2011, one of the worst ever for the high-yield market. In 3Q2011, the high yield market dropped 600 basis points. RPHYX dropped 7 basis points.  In its worst single month, August 2011, the fund dropped 24 basis points (that is, less than one-quarter of one percent) while the average high yield fund dropped 438 basis points.
  4. they do not anticipate significant competition for these assets – at least not from another mutual fund. There are three reasons. (1) The niche is too small to interest a major player like PIMCO (I actually asked PIMCO about this) or Fidelity. (2) The work is incredibly labor-intense. Over the past 12 months, the portfolio averaged something like $120 million in assets. Because their issues are redeemed so often, they had to make $442 million in purchases and involved the services of 46 brokers. (3) There’s a significant “first mover” advantage. As they’ve grown in size, they can now handle larger purchases which make them much more attractive as partners in deals. A year ago, they had to beat the bushes to find potential purchases; now, brokers seek them out.
  5. expenses are unlikely to move much – the caps are 1.0% (RPHIX) and 1.25% (RPHYX). As the fund grows, they move closer to the point where the waivers won’t be necessary but (1) it’s an expensive strategy to execute and (2) they’re likely to close the fund when it’s still small ($600M – $1B, depending on market conditions) which will limit their ability to capture and share huge efficiencies of scale. In any case, RiverPark intends to maintain the caps indefinitely.
  6. NAV volatility is more apparent than real – by any measure other than a money market, it’s a very steady NAV. Because the fund’s share price movement is typically no more than $0.01/share people notice changes that would be essentially invisible in a normal fund. Three sources of the movement are (1) monthly income distributions, which are responsible for the majority of all change, (2) rounding effects – they price to three decimal points, and changes of well below $0.01 often trigger a rounding up or down, and (3) bad pricing on late trades. Because their portfolio is “marked to market,” other people’s poor end-of-day trading can create pricing goofs that last until the market reopens the following morning.  President Morty Schaja and the folks at RiverPark are working with accountants and such to see how “artificial” pricing errors can be eliminated.

Bottom Line

This continues to strike me as a compelling opportunity for conservative investors or those with short time horizons to earn returns well in excess of the rate of inflation with, so far as we can determine, minimal downside.  I bought shares of RPHYX two weeks after publishing my original review of them in September 2011 and continue adding to that account.

Comments

The good folks at Cohanzick are looking to construct a profitable alternative to traditional money management funds.  The case for seeking an alternative is compelling.  Money market funds have negative real returns, and will continue to have them for years ahead.  As of June 28 2011, Vanguard Prime Money Market Fund (VMMXX) has an annualized yield of 0.04%.  Fidelity Money Market Fund (SPRXX) yields 0.01%.  TIAA-CREF Money Market (TIRXX) yields 0.00%.  If you had put $1 million in Vanguard a year ago, you’d have made $400 before taxes.  You might be tempted to say “that’s better than nothing,” but it isn’t.  The most recent estimate of year over year inflation (released by the Bureau of Labor Statistics, June 15 2011) is 3.6%, which means that your ultra-safe million dollar account lost $35,600 in purchasing power.  The “rush to safety” has kept the yield on short term T-bills at (or, egads, below) zero.  Unless the U.S. economy strengths enough to embolden the Fed to raise interest rates (likely by a quarter point at a time), those negative returns may last through the next presidential election.

That’s compounded by rising, largely undisclosed risks that those money market funds are taking.  The problem for money market managers is that their expense ratios often exceed the available yield from their portfolios; that is, they’re charging more in fees than they can make for investors – at least when they rely on safe, predictable, boring investments.  In consequence, money market managers are reaching (some say “groping”) for yield by buying unconventional debt.  In 2007 they were buying weird asset-backed derivatives, which turned poisonous very quickly.  In 2011 they’re buying the debt of European banks, banks which are often exposed to the risk of sovereign defaults from nations such as Portugal, Greece, Ireland and Spain.  On whole, European banks outside of those four countries have over $2 trillion of exposure to their debt. James Grant observed in the June 3 2011 edition of Grant’s Interest Rate Observer, that the nation’s five largest money market funds (three Fidelity funds, Vanguard and BlackRock) hold an average of 41% of their assets in European debt securities.

Enter Cohanzick and the RiverPark Short Term High Yield fund.  Cohanzick generally does not buy conventional short term, high yield bonds.  They do something far more interesting.  They buy several different types of orphaned securities; exceedingly short-term (think 30-90 day maturity) securities for which there are few other buyers.

One type of investment is redeemed debt, or called bonds.  A firm or government might have issued a high yielding ten-year bond.  Now, after seven years, they’d like to buy those bonds back in order to escape the high interest payments they’ve had to make.  That’s “calling” the bond, but the issuer must wait 30 days between announcing the call and actually buying back the bonds.  Let’s say you’re a mutual fund manager holding a million dollars worth of a called bond that’s been yielding 5%.  You’ve got a decision to make: hold on to the bond for the next 30 days – during which time it will earn you a whoppin’ $4166 – or try to sell the bond fast so you have the $1 million to redeploy.  The $4166 feels like chump change, so you’d like to sell but to whom?

In general, bond fund managers won’t buy such short-lived remnants and money market managers can’t buy them: these are still nominally “junk” and forbidden to them.  According to RiverPark’s president, Morty Schaja, these are “orphaned credit opportunities with no logical or active buyers.”  The buyers are a handful of hedge funds and this fund.  If Cohanzick’s research convinces them that the entity making the call will be able to survive for another 30 days, they can afford to negotiate purchase of the bond, hold it for a month, redeem it, and buy another.  The effect is that the fund has junk bond like yields (better than 4% currently) with negligible share price volatility.

Redeemed debt (which represents 33% of the June 2011 portfolio) is one of five sorts of investments typical of the fund.  The others include

  • Corporate event driven (18% of the portfolio) purchases, the vast majority of which mature in under 60 days. This might be where an already-public corporate event will trigger an imminent call, but hasn’t yet.  If, for example, one company is purchased by another, the acquired company’s bonds will all be called at the moment of the merger.
  • Strategic recapitalization (10% of the portfolio), which describes a situation in which there’s the announced intention to call, but the firm has not yet undertaken the legal formalities.  By way of example, Virgin Media has repeatedly announced its intention to call certain bonds in August 2011.  Buying before call means that the fund has to post the original maturities (7 years) despite knowing the bond will cash out in (say) 90 days.  This means that the portfolio will show some intermediate duration bonds.
  • Cushion bonds (14%), a type of callable bond that sells at a premium because the issued coupon payments are above market interest rates.
  • Short term maturities (25%), fixed and floating rate debt that the manager believes are “money good.”

What are the arguments in favor of RPHYX?

  • It’s currently yielding 100-400 times more than a money market.  While the disparity won’t always be that great, the manager believes that these sorts of assets might typically generate returns of 3.5 – 4.5% per year, which is exceedingly good.
  • It features low share price volatility.  The NAV is $10.01 (as of 6/29/11).  It’s never been high than $10.03 or lower than $9.97.  Their five separately managed accounts have almost never shown a monthly decline in value.  The key risk in high-yield investing is the ability of the issuer to make payments for, say, the next decade.  Do you really want to bet on Eastman Kodak’s ability to survive to 2021?  With these securities, Mr. Sherman just needs to be sure that they’ll survive to next month.  If he’s not sure, he doesn’t bite.  And the odds are in his favor.  In the case of redeemed debt, for instance, there’s been only one bankruptcy among such firms since 1985 and even then the bondholders are secured creditors in the bankruptcy proceedings.
  • It offers protection against rising interest rates.  Because most of the fund’s securities mature within 30-60 days, a rise in the Fed funds rate will have a negligible effect on the value of the portfolio.
  • It offers experienced, shareholder-friendly management.  The Cohanzick folks are deeply invested in the fund.  They run $100 million in this style currently and estimate that they could run up to $1 billion. Because they’re one of the few large purchasers, they’re “a logical first call for sellers.  We … know how to negotiate purchase terms.”  They’ve committed to closing both their separate accounts and the fund to new investors before they reach their capacity limit.

Bottom Line

This strikes me as a fascinating fund.  It is, in the mutual fund world, utterly unique.  It has competitive advantages (including “first mover” status) that later entrants won’t easily match.  And it makes sense.  That’s a rare and wonderful combination.  Conservative investors – folks saving up for a house or girding for upcoming tuition payments – need to put this on their short list of best cash management options.

Financial disclosure

Several of us own shares in RPHYX, though the Observer has no financial stake in the fund or relationship with RiverPark.  My investment in the fund, made after I read an awful lot and interviewed the manager, might well color my assessment.  Caveat emptor.

Fund website

RiverPark Short Term High Yield

Fact Sheet

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Northern Global Tactical Asset Allocation Fund (BBALX), September 2011, Updated September 2012

By David Snowball

Objective

The fund seeks a combination of growth and income. Northern’s Investment Policy Committee develops tactical asset allocation recommendations based on economic factors such as GDP and inflation; fixed-income market factors such as sovereign yields, credit spreads and currency trends; and stock market factors such as domestic and foreign earnings growth and valuations.  The managers execute that allocation by investing in other Northern funds and outside ETFs.  As of 6/30/2011, the fund holds 10 Northern funds and 3 ETFs.

Adviser

Northern Trust Investments.  Northern’s parent was founded in 1889 and provides investment management, asset and fund administration, fiduciary and banking solutions for corporations, institutions and affluent individuals worldwide.  As of June 30, 2011, Northern Trust Corporation had $97 billion in banking assets, $4.4 trillion in assets under custody and $680 billion in assets under management.  The Northern funds account for about $37 billion in assets.  When these folks say, “affluent individuals,” they really mean it.  Access to Northern Institutional Funds is limited to retirement plans with at least $30 million in assets, corporations and similar institutions, and “personal financial services clients having at least $500 million in total assets at Northern Trust.”  Yikes.  There are 51 Northern funds, seven sub-advised by multiple institutional managers.

Managers

Peter Flood and Daniel Phillips.  Mr. Flood has been managing the fund since April, 2008.  He is the head of Northern’s Fixed Income Risk Management and Fixed Income Strategy teams and has been with Northern since 1979.  Mr. Phillips joined Northern in 2005 and became co-manager in April, 2011.  He’s one of Northern’s lead asset-allocation specialists.

Management’s Stake in the Fund

None, zero, zip.   The research is pretty clear, that substantial manager ownership of a fund is associated with more prudent risk taking and modestly higher returns.  I checked 15 Northern managers listed in the 2010 Statement of Additional Information.  Not a single manager had a single dollar invested.  For both practical and symbolic reasons, that strikes me as regrettable.

Opening date

Northern Institutional Balanced, this fund’s initial incarnation, launched on July 1, 1993.  On April 1, 2008, this became an institutional fund of funds with a new name, manager and mission and offered four share classes.  On August 1, 2011, all four share classes were combined into a single no-load retail fund but is otherwise identical to its institutional predecessor.

Minimum investment

$2500, reduced to $500 for IRAs and $250 for accounts with an automatic investing plan.

Expense ratio

0.68%, after waivers, on assets of $18 million. While there’s no guarantee that the waiver will be renewed next year, Peter Jacob, a vice president for Northern Trust Global Investments, says that the board has never failed to renew a requested waiver. Since the new fund inherited the original fund’s shareholders, Northern and the board concluded that they could not in good conscience impose a fee increase on those folks. That decision that benefits all investors in the fund. Update – 0.68%, after waivers, on assets of nearly $28 million (as of 12/31/2012.)

UpdateOur original analysis, posted September, 2011, appears just below this update.  Depending on your familiarity with the research on behavioral finance, you might choose to read or review that analysis first. September, 2012
2011 returns: -0.01%.  Depending on which peer group you choose, that’s either a bit better (in the case of “moderate allocation” funds) or vastly better (in the case of “world allocation” funds).  2012 returns, through 8/29: 8.9%, top half of moderate allocation fund group and much better than world allocation funds.  
Asset growth: about $25 million in twelve months, from $18 – $45 million.  
This is a rare instance in which a close reading of a fund’s numbers are as likely to deceive as to inform.  As our original commentary notes:The fund’s mandate changed in April 2008, from a traditional stock/bond hybrid to a far more eclectic, flexible portfolio.  As a result, performance numbers prior to early 2008 are misleading.The fund’s Morningstar peer arguably should have changed as well (possibly to world allocation) but did not.  As a result, relative performance numbers are suspect.The fund’s strategic allocation includes US and international stocks (including international small caps and emerging markets), US bonds (including high yield and TIPs), gold, natural resources stocks, global real estate and cash.  Tactical allocation moves so far in 2012 include shifting 2% from investment grade to global real estate and 2% from investment grade to high-yield.Since its conversion, BBALX has had lower volatility by a variety of measures than either the world allocation or moderate allocation peer groups or than its closest counterpart, Vanguard’s $14 billion STAR (VGSTX) fund-of-funds.  It has, at the same time, produced strong absolute returns.  Here’s the comparison between $10,000 invested in BBALX at conversion versus the same amount on the same day in a number of benchmarks and first-rate balanced funds:

Northern GTAA

$12,050

PIMCO All-Asset “D” (PASDX)

12,950

Vanguard Balanced Index (VBINX)

12,400

Vanguard STAR (VGSTX)

12,050

T. Rowe Price Balanced (RPBAX)

11,950

Fidelity Global Balanced (FGBLX)

11,450

Dodge & Cox Balanced (DODBX)

11,300

Moderate Allocation peer group

11,300

World Allocation peer group

10,300

Leuthold Core (LCORX)

9,750

BBALX holds a lot more international exposure, both developed and developing, than its peers.   Its record of strong returns and muted volatility in the face of instability in many non-U.S. markets is very impressive.

BBALX has developed in a very strong alternative to Vanguard STAR (VGSTX).  If its greater exposure to hard assets and emerging markets pays off, it has the potential to be stronger still.

Comments

The case for this fund can be summarized easily.  It was a perfectly respectable institutional balanced fund which has become dramatically better as a result of two sets of recent changes.

Northern Institutional Balanced invested conservatively and conventionally.  It held about two-thirds in stocks (mostly mid- to large-sized US companies plus a few large foreign firms) and one-third in bonds (mostly investment grade domestic bonds).   Northern’s ethos is very risk sensitive which makes a world of sense given their traditional client base: the exceedingly affluent.  Those folks didn’t need Northern to make a ton of money for them (they already had that), they needed Northern to steward it carefully and not take silly risks.  Even today, Northern trumpets “active risk management and well-defined buy-sell criteria” and celebrates their ability to provide clients with “peace of mind.”  Northern continues to highlight “A conservative investment approach . . . strength and stability . . .  disciplined, risk-managed investment . . . “

As a reflection of that, Balanced tended to capture only 65-85% of its benchmark’s gains in years when the market was rising but much less of the loss when the market was falling.  In the long-term, the fund returned about 85% of its 65% stock – 35% bond benchmark’s gains but did so with low volatility.

That was perfectly respectable.

Since then, two sets of changes have made it dramatically better.  In April 2008, the fund morphed from conservative balanced to a global tactical fund of funds.  At a swoop, the fund underwent a series of useful changes.

The asset allocation became fluid, with an investment committee able to substantially shift asset class exposure as opportunities changed.

The basic asset allocation became more aggressive, with the addition of a high-yield bond fund and emerging markets equities.

The fund added exposure to alternative investments, including gold, commodities, global real estate and currencies.

Those changes resulted in a markedly stronger performer.  In the three years since the change, the fund has handily outperformed both its Morningstar benchmark and its peer group.  Its returns place it in the top 7% of balanced funds in the past three years (through 8/25/11).  Morningstar has awarded it five stars for the past three years, even as the fund maintained its “low risk” rating.  Over the same period, it’s been designated a Lipper Leader (5 out of 5 score) for Total Returns and Expenses, and 4 out of 5 for Consistency and Capital Preservation.

In the same period (04/01/2008 – 08/26/2011), it has outperformed its peer group and a host of first-rate balanced funds including Vanguard STAR (VGSTX), Vanguard Balanced Index (VBINX), Fidelity Global Balanced (FGBLX), Leuthold Core (LCORX), T. Rowe Price Balanced (RPBAX) and Dodge & Cox Balanced (DODBX).

In August 2011, the fund morphed again from an institutional fund to a retail one.   The investment minimum dropped from $5,000,000 to as low as $250.  The expense ratio, however, remained extremely low, thanks to an ongoing expense waiver from Northern.  The average for other retail funds advertising themselves as “tactical asset” or “tactical allocation” funds is about 1.80%.

Bottom Line

Northern GTA offers an intriguing opportunity for conservative investors.  This remains a cautious fund, but one which offers exposure to a diverse array of asset classes and a price unavailable in other retail offerings.  It has used its newfound flexibility and low expenses to outperform some very distinguished competition.  Folks looking for an interesting and affordable core fund owe it to themselves to add this one to their short-list.

Fund website

Northern Global Tactical Asset Allocation

Update – 3Q2011 Fact Sheet

Fund Profile, 2nd quarter, 2012

2013 Q3 Report

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Aston/River Road Independent Value Fund (ARIVX), updated September 2012

By David Snowball

Update: This fund has been liquidated.

Objective and strategy

The fund seeks to provide long-term total return by investing in common and preferred stocks, convertibles and REITs. The manager attempts to invest in high quality, small- to mid-cap firms (those with market caps between $100 million and $5 billion). He thinks of himself as having an “absolute return” mandate, which means an exceptional degree of risk-consciousness. He’ll pursue the same style of investing as in his previous charges, but has more flexibility than before because this fund does not include the “small cap” name.

Adviser

Aston Asset Management, LP. It’s an interesting setup. As of June 30, 2012, Aston is the adviser to twenty-seven mutual funds with total net assets of approximately $10.5 billion and is a subsidiary of the Affiliated Managers Group. River Road Asset Management LLC subadvises six Aston funds; i.e., provides the management teams. River Road, founded in 2005, oversees $7 billion and is a subsidiary of the European insurance firm, Aviva, which manages $430 billion in assets. River Road also manages five separate account strategies, including the Independent Value strategy used here.

Manager

Eric Cinnamond. Mr. Cinnamond is a Vice President and Portfolio Manager of River Road’s independent value investment strategy. Mr. Cinnamond has 19 years of investment industry experience. Mr. Cinnamond managed the Intrepid Small Cap (ICMAX) fund from 2005-2010 and Intrepid’s small cap separate accounts from 1998-2010. He co-managed, with Nola Falcone, Evergreen Small Cap Equity Income from 1996-1998.  In addition to this fund, he manages six smallish (collectively, about $50 million) separate accounts using the same strategy.

Management’s Stake in the Fund

As of October 2011, Mr. Cinnamond has between $100,000 and $500,000 invested in his fund.  Two of Aston’s 10 trustees have invested in the fund.  In general, a high degree of insider ownership – including trustee ownership – tends to predict strong performance.  Given that River Road is a sub-advisor and Aston’s trustees oversee 27 funds each, I’m not predisposed to be terribly worried.

Opening date

December 30, 2010.

Minimum investment

$2,500 for regular accounts, $500 for various sorts of tax-advantaged products (IRAs, Coverdells, UTMAs).

Expense ratio

1.42%, after waivers, on $616 million in assets.

Update

Our original analysis, posted February, 2011, appears just below this update.  It describes the fund’s strategy, Mr. Cinnamond’s rationale for it and his track record over the past 16 years.

September, 2012

2011 returns: 7.8%, while his peers lost 4.5%, which placed ARIVX in the top 1% of comparable funds.  2012 returns, through 8/30: 5.3%, which places ARIVX in the bottom 13% of small value funds.  
Asset growth: about $600 million in 18 months, from $16 million.  The fund’s expense ratio did not change.  
What are the very best small-value funds?  Morningstar has designated three as the best of the best: their analysts assigned Gold designations to DFA US Small Value (DFSVX), Diamond Hill Small Cap (DHSCX) and Perkins Small Cap Value (JDSAX).  For my money (literally: I own it), the answer has been Artisan Small Cap(ARTVX).And where can you find these unquestionably excellent funds?  In the chart below (click to enlarge), you can find them where you usually find them.  Well below Eric Cinnamond’s fund.

fund comparison chart

That chart measures only the performance of his newest fund since launch, but if you added his previous funds’ performance you get the same picture over a longer time line.  Good in rising markets, great in falling ones, far steadier than you might reasonably hope for.

Why?  His explanation is that he’s an “absolute return” investor.  He buys only very good companies and only when they’re selling at very good prices.  “Very good prices” does not mean either “less than last year” or “the best currently available.”  Those are relative measures which, he says, make no sense to him.

His insistence on buying only at the right price has two notable implications.

He’s willing to hold cash when there are few compelling values.  That’s often 20-40% of the portfolio and, as of mid-summer 2012, is over 50%.  Folks who own fully invested small cap funds are betting that Mr. Cinnamond’s caution is misplaced.  They have rarely won that bet.

He’s willing to spend cash very aggressively when there are many compelling values.  From late 2008 to the market bottom in March 2009, his separate accounts went from 40% cash to almost fully-invested.  That led him to beat his peers by 20% in both the down market in 2008 and the up market in 2009.

This does not mean that he looks for low risk investments per se.  It does mean that he looks for investments where he is richly compensated for the risks he takes on behalf of his investors.  His July 2012 shareholder letter notes that he sold some consumer-related holdings at a nice profit and invested in several energy holdings.  The energy firms are exceptionally strong players offering exceptional value (natural gas costs $2.50 per mcf to produce, he’s buying reserves at $1.50 per mcf) in a volatile business, which may “increase the volatility of [our] equity holdings overall.”  If the market as a whole becomes more volatile, “turnover in the portfolio may increase” as he repositions toward the most compelling values.

The fund is apt to remain open for a relatively brief time.  You really should use some of that time to learn more about this remarkable fund.

Comments

While some might see a three-month old fund, others see the third incarnation of a splendid 16 year old fund.

The fund’s first incarnation appeared in 1996, as the Evergreen Small Cap Equity Income fund. Mr. Cinnamond had been hired by First Union, Evergreen’s advisor, as an analyst and soon co-manager of their small cap separate account strategy and fund. The fund grew quickly, from $5 million in ’96 to $350 million in ’98. It earned a five-star designation from Morningstar and was twice recognized by Barron’s as a Top 100 mutual fund.

In 1998, Mr. Cinnamond became engaged to a Floridian, moved south and was hired by Intrepid (located in Jacksonville Beach, Florida) to replicate the Evergreen fund. For the next several years, he built and managed a successful separate accounts portfolio for Intrepid, which eventually aspired to a publicly available fund.

The fund’s second incarnation appeared in 2005, with the launch of Intrepid Small Cap (ICMAX). In his five years with the fund, Mr. Cinnamond built a remarkable record which attracted $700 million in assets and earned a five-star rating from Morningstar. If you had invested $10,000 at inception, your account would have grown to $17,300 by the time he left. Over that same period, the average small cap value fund lost money. In addition to a five star rating from Morningstar (as of 2/25/11), the fund was also designated a Lipper Leader for both total returns and preservation of capital.

In 2010, Mr. Cinnamond concluded that it was time to move on. In part he was drawn to family and his home state of Kentucky. In part, he seems to have reassessed his growth prospects with the firm.

The fund’s third incarnation appeared on the last day of 2010, with the launch of Aston / River Road Independent Value (ARIVX). While ARIVX is run using the same discipline as its predecessors, Mr. Cinnamond intentionally avoided the “small cap” name. While the new fund will maintain its historic small cap value focus, he wanted to avoid the SEC stricture which would have mandated him to keep 80% of assets in small caps.

Over an extended period, Mr. Cinnamond’s small cap composite (that is, the weighted average of the separately managed accounts under his charge over the past 15 years) has returned 12% per year to his investors. That figure understates his stock picking skills, since it includes the low returns he earned on his often-substantial cash holdings. The equities, by themselves, earned 15.6% a year.

The key to Mr. Cinnamond’s performance (which, Morningstar observes, “trounced nearly all equity funds”) is achieved, in his words, “by not making mistakes.” He articulates a strong focus on absolute returns; that is, he’d rather position his portfolio to make some money, steadily, in all markets, rather than having it alternately soar and swoon. There seem to be three elements involved in investing without mistakes:

  • Buy the right firms.
  • At the right price.
  • Move decisively when circumstances demand.

All things being equal, his “right” firms are “steady-Eddy companies.” They’re firms with look for companies with strong cash flows and solid operating histories. Many of the firms in his portfolio are 50 or more years old, often market leaders, more mature firms with lower growth and little debt.

Like many successful managers, Mr. Cinnamond pursues a rigorous value discipline. Put simply, there are times that owning stocks simply aren’t worth the risk. Like, well, now. He says that he “will take risks if I’m paid for it; currently I’m not being paid for taking risk.” In those sorts of markets, he has two options. First, he’ll hold cash, often 20-30% of the portfolio. Second, he moves to the highest quality companies in “stretched markets.” That caution is reflected in his 2008 returns, when the fund dropped 7% while his benchmark dropped 29%.

But he’ll also move decisively to pursue bargains when they arise. “I’m willing to be aggressive in undervalued markets,” he says. For example, ICMAX’s portfolio went from 0% energy and 20% cash in 2008 to 20% energy and no cash at the market trough in March, 2009. Similarly, his small cap composite moved from 40% cash to 5% in the same period. That quick move let the fund follow an excellent 2008 (when defense was the key) with an excellent 2009 (where he was paid for taking risks). The fund’s 40% return in 2009 beat his index by 20 percentage points for a second consecutive year. As the market began frothy in 2010 (“names you just can’t value are leading the market,” he noted), he let cash build to nearly 30% of the portfolio. That meant that his relative returns sucked (bottom 10%), but he posted solid absolute returns (up 20% for the year) and left ICMAX well-positioned to deal with volatility in 2011.

Unfortunately for ICMAX shareholders, he’s moved on and their fund trailed 95% of its peers for the first couple months of 2011. Fortunately for ARIVX shareholders, his new fund is leading both ICMAX and its small value peers by a comfortable early margin.

The sole argument against owning is captured in Cinnamond’s cheery declaration, “I like volatility.” Because he’s unwilling to overpay for a stock, or to expose his shareholders to risk in an overextended market, he sidelines more and more cash which means the fund might lag in extended rallies. But when stocks begin cratering, he moves quickly in which means he increases his exposure as the market falls. Buying before the final bottom is, in the short term, painful and might be taken, by some, as a sign that the manager has lost his marbles. He’s currently at 40% cash, effectively his max, because he hasn’t found enough opportunities to fill a portfolio. He’ll buy more as prices on individual stocks because attractive, and could imagine a veritable buying spree when the Russell 2000 is at 350. At the end of February 2011, the index was close to 700.

Bottom Line

Aston / River Road Independent Value is the classic case of getting something for nothing. Investors impressed with Mr. Cinnamond’s 15 year record – high returns with low risk investing in smaller companies – have the opportunity to access his skills with no higher expenses and no higher minimum than they’d pay at Intrepid Small Cap. The far smaller asset base and lack of legacy positions makes ARIVX the more attractive of the two options. And attractive, period.

Fund website

Aston/River Road Independent Value

2013 Q3 Report

2013 Q3 Commentary

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

The Cook and Bynum Fund (COBYX), August 2012

By David Snowball

Objective and Strategy

COBYX pursues the long-term growth of capital.  They do that by assembling an exceedingly concentrated global stock portfolio.  The stocks in the portfolio must meet four criteria.

    • Circle of Competence: they only invest in businesses “whose economics and future prospects” they can understand.
    • Business: they only invest in “wide moat” firms, those with sustainable competitive advantages.
    • People: they only invest when they believe the management team is highly competent and trustworthy.
    • Price: they only buy shares priced at a substantial discount – preferably 50% – to their estimate of the share’s true value.

Within those confines, they can invest pretty much anywhere and in any amount.

Adviser

Cook & Bynum Capital Management, LLC, an independent, employee-owned money management firm established in 2001.  The firm is headquartered in Birmingham, Alabama.  It manages COBYX and two other “pooled investment vehicles.”  As of June 30, 2012, the adviser had approximately $220 million in assets under management.

Managers

Richard P. Cook and J. Dowe Bynum.  Messrs Cook and Bynum are the principals and founding partners of Cook & Bynum (are you surprised?) and have managed the fund since its inception. They have a combined 23 years of investment management experience. Mr. Cook previously managed individual accounts for Cook & Bynum Capital Management, which also served as a subadviser to Gullane Capital Partners. Prior to that, he worked for Tudor Investment Corp. in Greenwich, CT. Mr. Bynum also managed individual accounts for Cook & Bynum. Previously, he’d worked as an equity analyst at Goldman Sachs & Co. in New York.   They work alone and also manage around $140 million in two other accounts.

Management’s Stake in the Fund

As of September 30, 2011, Mr. Cook had between $100,000 and $500,000 invested in the fund, and Mr. Bynum had over $500,000 invested.  Between these investments and their investments in the firm’s private accounts, they have “substantially all of our investable net worth” in the firm’s investment vehicles.

Opening date

July 1, 2009.  The fund is modeled on a private accounts which the team has run since August 2001.

Minimum investment

$5,000 for regular accounts and $1,000 for IRA accounts.

Expense ratio

1.88%, after waivers, on assets of $82 million.  There’s also a 2% redemption fee for shares held less than 60 days.

Comments

I can explain what Cook and Bynum do.

I can explain how they’ve done.

But I have no comfortable explanation for how they’ve done it.

Messrs. Cook and Bynum are concentrated value investors in the tradition of Buffett and Munger.  They’ve been investing since before they were teens and even tried to start a mutual fund with $200,000 in seed money while they were in college.  Within a few years after graduating college, they began managing money professionally.  Now in their mid 30s, they’re on the verge of their first Morningstar rating which might well be five stars.

Their investment discipline seems straightforward: do what Warren would do.  Focus on businesses and industries that you understand, invest only with world-class management teams, research intensely, wait for a good price, don’t over-diversify, and be willing to admit your mistakes.

They are, on face, very much like dozens of other Buffett devotees in the fund world.

Their discipline led to the construction of a very distinctive portfolio.  They’ve invested in just eight stocks (as of 3/31/12) and hold about 30% in cash.  There are simply no surprises in the list:

Company Ticker Sector

% of Total Portfolio

Wal-Mart Stores WMT General Merchandise Stores

19.0

Microsoft MSFT Software Publishers

10.8

Berkshire Hathaway BRK/B Diversified Companies

10.3

Arca Continental SAB AC* MM Soft Drink Bottling & Distribution

8.8

Coca-Cola KO Soft Drink Manufacturing

5.2

Procter & Gamble PG Household/Cosmetic Products Manufacturing

5.0

Kraft Foods KFT Snack Food Manufacturing

4.9

Tesco TSCO Supermarkets & Other Grocery Stores

4.9

American investors might be a bit unfamiliar with the fund’s two international holdings (Arca is a large Coca-Cola bottler serving Latin America and Tesco is the world’s third-largest retailer) but neither is “an undiscovered gem.”  With so few stocks, there’s little diversification by sector (70% of the fund is “consumer defensive” stocks) or size (85% are mega-caps).  Both are residues of bottom-up stock picking (that is, the stocks which best met C&B’s criteria were consumer-oriented multinationals) and are of no concern to the managers who remain agnostic about such external benchmarks. The fund’s turnover ratio is 25%, which is quite, if not stunningly, low.

Their performance has, however, been excellent.  Kiplinger’s (11/29/2011) reported on their long-term record: “Over the past ten years through October 31, 2011, a private account the duo have managed in the same way they manage the fund returned 8.7% annualized” which beat the S&P 500 by 6.4% per year.  COBYX just passed its third anniversary with a bang: its returns are in the top 1-5% of its large blend peer group for the past month, quarter, YTD, year and three years.  While the mutual fund trailed the vast majority of its peers in 2010, returning 11.8% versus 14.0% for its peers, that’s both very respectable and not unusual for a cash-heavy fund in a rallying market.  In 2011 the fund finished in the top 1% of its peer group and it was in the top 3% through the first seven months of 2012.

More to the point, the fund has (since inception) substantially outperformed Mr. Buffett’s Berkshire-Hathaway (BRK.A).  It is well ahead of other focus Buffettesque funds such as Tilson Focus (TILFX) and FAM Value (FAMVX) and while it has returns in the neighborhood of Tilson Dividend (TILDX), Yacktman (YACKX) and Yacktman Focused (YAFFX), it’s less volatile.

Having read about everything written by or about the fund and having spoken at length with David Hobbs, Cook & Bynum’s president, I’m still not sure why they do so well.  What stands out from that conversation is the insane amount of fieldwork the managers do before initiating and while monitoring a position.  By way of example, the fund invested in Wal-Mart de Mexico (Walmex) from 2007-2012.  Their interest began while they were investigating another firm (Soriana), whose management idolized Walmex.  “We visited Walmex’s management the following week in Mexico City and were blown away … Since then we have made hundreds of store visits to Walmex’s various formats as well as to Soriana’s and to those of other competitors…”  They concluded that Walmex was “perhaps the finest large company in the world” and its stock was deeply discounted.  They bought.   The Walmex position “significantly outperformed our most optimistic expectation over the last six years,” with the stock rising high enough that it no longer trades at an adequate discount so they sold it.

In talking with Mr. Hobbs, it seems that a comparable research push is taking place in emerging Europe.  While the team suspects that the Eurozone might collapse, such macro calls don’t drive their stock selection and so they’re pursuing a number of leads within the zone.  Given their belief in a focused portfolio, Hobbs concluded “if we can find two or three good ideas, it’s been a good year.”

Potential investors need to cope with three concerns.  First, a 1.88% expense ratio is high and is going to be an ongoing drag on returns.  Second, their incessant travel carries risks.  In psychology, the problem is summed up in the adage, “seek and ye shall find, whether it’s there or not.”  In acoustical engineering, it’s addressed as the “signal-to-noise ratio.”  If you were to spend three weeks of your life schlepping around central Europe, perusing every mini-mart from Bratislava to Bucharest, you’d experience tremendous internal pressure to conclude that you’d gained A Great Insight from all that effort. Third, it’s not always going to work.  For all their care and skill, someone will slip Stupid Pills into their coffee one morning.  It happened to Donald Yacktman, a phenomenally talented guy who trailed his peers badly for three consecutive years (2004-06).  It happened to Bill Nygren whose Oakmark Select (OAKLX) crushed for a decade then trailed the pack, sometimes dramatically, for five consecutive years (2003-07).  Over 30 years it happens repeatedly to Marty Whitman at Third Avenue Value (TAVFX). And it happened to a bunch of once-untouchable managers (Jim Oelschlager at White Oak Growth WOGSX, Auriana and Utsch at Kaufmann KAUFX, Ron Muhlenkamp at Muhlenkamp Fund MUHLX) whose former brilliance is now largely eclipsed.  The best managers stumble and recover.  The best focused portfolio managers stumble harder, and recover.  The best shareholders stick with them.

Bottom Line

It’s working.  Cook and Bynum might well be among the best.  They’re young.  The fund is small and nimble.  Their discipline makes great sense.  It’s not magic, but it has been very, very good and offers an intriguing alternative for investors concerned by lockstep correlations and watered-down portfolios.

Fund website

The Cook & Bynum Fund.  The C&B website was recently recognized as one of the two best small fund websites as part of the Observer’s “Best of the Web” feature.

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.