Category Archives: Most intriguing new funds

American Beacon Continuous Capital Emerging Market Equity Fund (CCEYX)

By David Snowball

Objective and strategy

Continuous Capital pursues long-term capital appreciation through investing in a diversified portfolio of EM equities. The managers view their core competence as security selection. They try to keep the portfolio roughly sector- and country-neutral relative to their benchmark so that the portfolio’s performance will be driven primarily by their security selection. Security selection, in turn, is driven by the interplay of three factors: value, quality, and dividends. In consequence, the fund’s “style” might appear more growth-oriented in some markets and more value-oriented in others.

The portfolio is broadly diversified, with a commitment to including both mid- and small-cap stocks. The managers anticipate Continue reading →

Rondure Overseas Fund (ROSOX / ROSIX)

By David Snowball

Objective and strategy

Rondure Overseas invests, primarily, in the stocks of corporations located in developed markets outside of the US. The managers pursue a benchmark-agnostic, active style that allows them to invest in stocks of any size. In general, they aspire to invest in great companies at good prices. They have the freedom to invest in good companies at great prices, but the wisdom to play that game rarely.

The quantitative markers of being a great company include strong balance sheets, stable free cash flows, and high returns on capital. The qualitative markers are “compelling competitive advantages,” which might include elements of the business niche and strong, responsible leadership.

The portfolio currently holds Continue reading →

Harbor Global Leaders Investor HGGIX

By David Snowball

Objective and strategy

Harbor Global Leaders targets firms, worldwide, that are capable of generating sustainable, above-average, and relatively stable rates of earnings per share growth and strong free cash flows. The manager looks for companies that are leaders in their country, industry, or globally in terms of products, services, or execution. 

Their ideal business has six Continue reading →

Invenomic Fund (BIVRX/BIVIX/BIVSX)

By David Snowball

At the time of publication, this fund was named Balter Invenomic.

Objective and strategy

Balter Invenomic Fund is seeking long term capital appreciation. They pursue that through a widely diversified long-short portfolio comprised, primarily, of domestic stocks. The long and short portfolios each held about 150 positions, as of early 2019. The long portfolio is always fully invested in undervalued, timely stocks while the size of the short portfolio varies based on the opportunities available. The long portfolio is all-cap and might include equity securities other than just common stocks. The fund’s short portfolio is broadly diversified and targets stocks which are both overvalued and are likely to fall. The short portfolio is not designed merely as a defensive buffer; it is designed to deliver positive returns and reduce the overall risk of the portfolio through Continue reading →

Holbrook Income Fund (HOBIX)

By Dennis Baran

Objective and strategy

The fund seeks to provide current income with a secondary objective of capital preservation in a rising interest rate and inflationary environment.

The manager’s goal is to achieve a 2% return above inflation, generate income, and protect principal. By managing credit and interest rate risk, limiting duration, and minimizing drawdown to less than 2%, it’s designed to fend against frontal attacks that may ravage the bond market which reduce investor returns and suffocate Continue reading →

AlphaCentric Income Opportunities Fund (IOFIX), February 2018

By Charles Boccadoro

“Timing, perseverance, and ten years of trying

will eventually make you look like an overnight success.”

        Biz Stone

Objective and Strategy

The AlphaCentric Income Opportunities Fund seeks to provide current income. Presently, it invests in often overlooked (some call “pejorative”) segments of non‐agency (private label) residential mortgage-backed securities (RMBS), specifically in seasoned (2007 or earlier) subprime mortgages with floating rate coupons.

The irony is that 10 years after the housing collapse these bonds, once highly discounted if not feared worthless, represent one of the more sought after asset classes, as described nicely in Claire Boston’s Bloomberg Continue reading →

Centerstone Investors (CETAX/CENTX)

By David Snowball

Objective and strategy

Investors Fund seeks long-term growth by investing, primarily, in an all-cap global equity value portfolio though there’s no formal limit on its ability to hold fixed-income securities, including private placements. The manager’s value discipline leads him to higher-quality firms whose stocks are selling at a discount to his assessment of their intrinsic value. As the stresses on the firm rise, so does the size of the discount he demands. The goal is to also invest with a margin of safety, which might also lead the fund to hold substantial amounts of cash when attractive and attractively-priced opportunities are not available. As of June 30, 2017, cash and cash surrogates comprise 26% of the portfolio. The manager expects to keep at least Continue reading →

Moerus Worldwide Value (MOWNX / MOWIX)

By David Snowball

Objective and strategy

Moerus Worldwide Value pursues long term capital appreciation, primarily by investing in foreign and domestic common stocks that it believes are deeply undervalued. The portfolio is constructed from the bottom-up through fundamental analysis; which is to say the manager cares about finding 15-50 great stocks with no particular interest in paralleling some indexes sector, size or country weightings. As of May 31, 2017, the fund is invested in 37 stocks.


Moerus Capital Management, LLC. Moerus is a Continue reading →

Matthews Asia Credit Opportunities (MCRDX / MICPX)

By David Snowball

Objective and strategy

The managers seek total return over the long term. They invest in debt issued by Asian corporations, governments and supranatural institutions. The managers invest, primarily, in high-yield, dollar-denominated debt though they define that term broadly enough to incorporate both high-yield bonds and debt-related instruments such as convertible bonds, hybrids and derivatives with fixed income characteristics.  Around 20-25% of the portfolio has been in convertible bonds since inception, and that percentage is been pretty stable from year to year. 


Matthews International Capital Management, LLC, the Investment Advisor to the Matthews Asia Funds, was founded Continue reading →

Intrepid International Fund (ICMIX)

By Dennis Baran

Objective and strategy

The fund seeks long-term capital appreciation by investing in an international, all-cap portfolio. The fund is non-diversified and its primary focus is on developed markets. Its strategy is benchmark-agnostic, so its country, industry and sector weightings may differ substantially from those in its benchmark index or peer group. Its process capitalizes on market disruptions, fear, and volatility to generate bargains. The fund plans to hold between 15-50 different companies, may hold substantial cash and is typically hedges its currency exposure when cost effective.

The fund is intended for Continue reading →

Otter Creek Long Short Opportunity (OTCRX), April 2016

By David Snowball

Objective and strategy

The Otter Creek Long/Short Opportunity Fund seeks long-term capital appreciation. They take long positions in securities they believe to be undervalued and short positions in the overvalued. Their net market exposure will range between (-35%) and 80%. They can place up to 20% in MLPs, 30% in REITs, and 30% in fixed income securities, including junk bonds. They use a limited amount of leverage. The fund is unusually concentrated with about 30 long and 30 short positions.


Otter Creek Advisors. Otter Creek Advisors was formed for the special purpose of managing this mutual fund and giving Messrs. Walling and Winter, the two primary managers, a substantial equity stake in the operation. That arrangement is part of a “succession plan to provide equity ownership to the next generation of portfolio managers: Mike Winter and Tyler Walling.” Otter Creek Advisers has about $280 million in assets under management.


R. Keith Long, Tyler Walling and Michael Winter. Mr. Long has a long and distinguished career in the financial services industry, dating back to 1973. Mr. Walling joins Otter Creek in 2011 after a five-year stint as an equity analyst for Goldman Sachs. Mr. Winter joined Otter Creek in 2007. Prior to Otter Creek, he worked for a long/short equity hedge fund and, before that, for Putnam Investment Management.

Strategy capacity and closure

Somewhere “north of a billion” the team would consider a soft close. They were pretty emphatic that they didn’t want to become an asset sponge and that they were putting an enormous amount of care into attracting compatible investors.

Management’s stake in the fund

Mr. Long has invested more than $1,000,000 in the fund, Mr. Winter and Mr. Walling each have $500,000-$1,000,000. Those are substantial commitments for 30-something managers to make. Sadly, as of December 30, 2015, no member of the fund’s board of trustees had chosen to invest in it.

Opening date

December 30, 2013.

Minimum investment

$2,500, reduced to $1,000 for accounts established with an automatic investment plan.

Expense ratio

2.57% for the Investor class, on assets of $270 million (as of March 2016). The fund caps its fees at 1.95% but has to account for acquired fund fees and other expenses related to shorting. Those amount to 0.92%.


In its first two-plus years of operation, Otter Creek Opportunity has been a very, very good long/short fund. Three observations lie behind that judgment.

First, it has made much more money than its generally sad sack peer group. From inception from the end of February, 2016, OTCRX posted annual returns of 10.2%. Its average peer lost 1% annually in the same period. During that stretch, it bested the S&P 500 in 15 of 25 calendar months and beat its peers in 17 of 25 months.

Second, it has provided exceptional downside protection. It outperformed the S&P 500 in 10 of the 11 months in which the index declined and consistently stayed in the range of tiny losses to modest gains in periods when the S&P 500 was down 3% or more.


It also outperformed its long/short peers in nine of the 11 months in which the S&P 500 dropped. Since launch, the fund’s downside deviation has been only 40% of its peers and its maximum drawdown has been barely one-fourth as great as theirs.

Third, it has negligible correlation to the market. To date, its correlation to the S&P 500 is 0.05. In practical terms, that means that there’s no evidence that a decline in the stock market will be consistently associated with a decline in Otter Creek.

What accounts for their very distinctive performance?

At base, the managers believe it’s because they focus. They focus, for example, on picking exceptional stocks. They are Graham and Dodd sorts of investors, looking for sustainably high return-on-equity, growing dividends, limited financial leverage and dominant market positions.  They use a “forensic accounting approach to financial statement analysis” to help identify not only attractive firms but also the places within the firm’s capital structure that holds the best opportunities. They tend to construct a focused portfolio around 30 or so long and short positions. On the flip side, they short firms that use aggressive accounting, weak balance sheets, wretched leadership and low quality earnings.

Which is to say, yes, they were shorting Valeant in 2015.

Their top ten long and short positions, taken together, account for about 70% of the portfolio. They’re both more concentrated and more patient, measured by turnover, than their peers.

They also focus on the portfolio, rather than just on individual names for the portfolio. They’ve created a series of rules, drawing on their prior work with their firm’s hedge fund, to limit mishaps in their short portfolio. If, for example, a short position begins to get “crowded,” that is, if other investors start shorting the same names they do, they’ll reduce their position size to avoid the risk of a short squeeze. Likewise they substantially reduce or eliminate any short that moves against the portfolio by 25% or more over the course of six months.

Bottom Line

Messrs. Walling and Winter bear watching. They’ve got a healthy attitude and have done a lot right in a short period. As of mid-February, they had a vast performance advantage over the S&P 500 and their peers. Even after the S&P’s furious six-week rally, they are still ahead – and vastly ahead if you take the effects of volatility into account. It’s clear that they see this fund as a long-term project, they’re excited by it and they’re looking for the right kind of investors to join in with them. If you’re looking to partner with investors who don’t like volatility and detest losing their shareholders money, you might reasonably add OTCRX to your short-list of funds to investigate.

Fund website

Otter Creek Long/Short

© 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.

AQR Equity Market Neutral (QMNIX), AQR Long-Short Equity (QLEIX), April 2016

By Samuel Lee

Objective and strategy

AQR offers its absolute return equity strategy in two mutual fund flavors: AQR Equity Market Neutral and AQR Long-Short Equity. Equity Market Neutral, or EMN, goes long global stocks that score well on proprietary composite measures and shorts global stocks that score poorly. AQR groups these measures into six broad “themes”:

  • Value is the strategy of buying stocks that are cheap on fundamental measures such as book value, earnings, dividends and cash flow.
  • Momentum is the strategy of buying stocks with strong recent relative performance according to measures such as price returns, abnormal returns after earnings announcements (earnings surprises), abnormal risk-adjusted returns (residual momentum), and returns of economically linked firms (indirect momentum).
  • Earnings quality is the strategy of buying stocks with reported earnings that are more reliable indicators of future earnings, according to measures such as accruals.
  • Stability is the strategy of buying stocks with defensive characteristics, such as low volatility, low beta, and low leverage.
  • Investor sentiment is the strategy of buying stocks with wide agreement by “smart money”, according to measures such as low short interest as a percentage of market capitalization and high commonality of holdings by elite hedge funds.
  • Management signaling is the strategy of buying stocks where management engages in actions that indicate financial strength or cheapness, such as debt retirement and share repurchases.

Stocks are ranked by these measures within each industry. The stocks with the highest composite scores are bought and the stocks with the lowest composite scores are shorted. Industry neutrality improves risk-adjusted returns on a wide variety of stock selection signals, perhaps because it removes persistent industry bets.

In addition, the strategy engages in country-industry pairs selection using the same six sets of signals and industry selection using only value and momentum. Because AQR dislikes concentrated bets, the country-industry pairs and industry selection strategies are allotted a smaller portion of the strategy’s overall risk than the stock-selection strategy.

The balance of the long and short sleeves is managed to produce returns uncorrelated with the MSCI World Index, a market-weighted benchmark of developed market stocks. This does not mean each sleeve has the same notional size. The long sleeve tends to exhibit lower volatility for each unit of notional exposure than the short sleeve. In order to balance them, the strategy must own more dollars of the long sleeve, creating the impression that it has net long equity exposure. The gross exposure for each sleeve has a floor of 100% NAV and a cap of 250% NAV, meaning the strategy’s gross exposure can range from 2x to 5x the net asset value of the fund. As of February end, AQR Equity Market Neutral had 190% notional long exposure and 173% notional short exposure, for a total gross notional exposure of 363%.

AQR takes steps to mitigate the risks of leverage. First, the strategy is well diversified, with over 1700 stock positions, most of them under 0.5% notional exposure and the biggest at a little under 1.7%. Single-stock concentration goes against every bone in AQR. Like most quant investors, AQR goes for seconds and thirds when it comes to the “free lunch” of diversification.

Second, AQR has a 6% annualized volatility target for the strategy, which means AQR will likely reduce gross leverage if its positions behave erratically. This is a trend-following strategy as periods of high volatility usually coincide with bad returns. For reference, the volatility target is about a third of the historical volatility of the U.S. stock market and roughly the same as the historical volatility of the Barclays Aggregate Bond Index (though in recent years the bond index’s volatility has dropped to about 3%).

Finally, the strategy applies what AQR calls a “drawdown control system”, a methodology for cutting risk when the strategy loses money and adding it back as it recoups its losses (or enough time lapses since a drawdown). The drawdown control system can cut the fund’s target volatility by up to half in the worst circumstances. AQR’s use of volatility targeting and drawdown control are common practices among quantitative investors. As a group these investors tend to cut and add risks at the same time. It is unclear whether they are influential enough to alter the nature of markets and perhaps render these methods obsolete or even harmful (think of portfolio insurance and its contribution to Black Monday in 1987, when the Dow Jones Industrial Average fell 22.6%). My guess is quantitative investors aren’t yet big enough because many more investors are counter-cyclical rebalancers over the short-run, particularly institutions. This is speculation, of course. The market is a big and wild herd that will sometimes stampede in a direction it had never gone before—a lesson AQR itself learned at least twice: during the madness of the dot-com bubble and during the great quant meltdown of 2007.

Long-Short Equity, or LSE, takes the EMN strategy (though they’re not exact clones if we’re to judge by their holdings and position sizes) and overlays a tactical equity strategy that targets an average 50% exposure to the MSCI World Index, with the ability to adjust its exposure by +/- 20% based largely on valuation and momentum. The equity exposure is obtained through futures.

In a back-test of a simplified version of the strategy, the market-timing component did not add much to the strategy’s performance while it worsened the drawdown during the financial crisis.


AQR Capital Management, LLC, was founded in 1998 by a team of ex-Goldman Sachs quant investors led by Clifford S. Asness, David G. Kabiller, Robert J. Krail, and John M. Liew. (Krail is no longer with the firm.) AQR stands for Applied Quantitative Research. Asness, Krail and Liew met each other at the University of Chicago’s finance PhD program. The firm’s bread and butter has long been trading value and momentum together, an idea Asness studied in his dissertation under Eugene Fama, father of modern finance and one of the co-formulators of the efficient market hypothesis.

AQR is mostly owned by AQR Group LP, which in turn is owned by employees of the firm. AMG, a publicly traded asset manager, has owned a stake in AQR since 2004 and in 2014 it increased it, but remains a minority shareholder (terms of both transactions have not been disclosed). AMG largely leaves its investees to run themselves, so I am not concerned about the firm pushing AQR to do stupid things to meet or beat a quarterly target. Though the implosion of Third Avenue, an investee, may spur AMG to more actively monitor its portfolio companies, I doubt Asness and his partners gave AMG much power to meddle in AQR’s affairs.

AQR’s mutual fund business has grown rapidly in size and sophistication since 2009, when it launched arbitrage and equity momentum funds. It competes with DFA for the mantle of academic “thought leadership” among advisors, its main clients. This has put Asness in the awkward position of competing with his former mentor Fama, who is a significant shareholder in DFA and the chief intellectual architect of its approach. Like DFA, AQR emphasizes the primacy of factors in managing portfolios.

When AQR started up, it was hot. It had one of the biggest launches of any hedge-fund up to that point. Then the dot-com bubble inflated. The widening gap in valuations between value and growth stocks almost sunk AQR. According to Asness, had the bubble lasted six more months, he would have been out of business. When the bubble burst, the firm’s returns soared and so did its assets. The good times rolled on and the firm was on the verge of an IPO by late 2007. According to the New York Post, AQR had to shelve it as the subprime crisis began roiling the markets. The financial crisis shredded its returns, with its flagship Absolute Return fund falling more than 50 percent from the start of 2007 to the end of 2008. Firm-wide assets from peak-to-trough went from $39.1 billion to $17.2 billion. The good times are back: As of December-end, AQR had $142.2 billion in net assets under management.

The two near-death experiences have instilled in AQR a fear of concentrated business risks. In 2009, AQR began to diversify away from its flighty institutional clientele by launching mutual funds to entice stickier retail investors. The firm has also launched new strategies at a steady clip, including managed futures, risk parity, and global macro.

AQR has a strong academic bent. Its leadership is sprinkled with economics and finance PhDs from top universities, particularly the University of Chicago. The firm has poached academics with strong publishing records, including Andrea Frazzini, Lasse Pedersen, and Tobias Moskowitz. Its researchers and leaders are still active in publishing papers.

The firm’s principals are critical of hedge funds that charge high fees on strategies that are largely replicable. AQR’s business model is to offer up simplified quant versions of these strategies and charge relatively low fees.


Both the Equity Market Neutral and Long-Short Equity strategies are run by Jacques A. Friedman, Andrea Frazzini, and Michele L. Aghassi. Ronen Israel helps manage EMN. Hoon Kim helps manage LSE. All five are principals, or partners, in the firm.

Friedman heads AQR’s Global Stock Selection team. Prior to joining AQR at its inception in 1998, he developed quantitative stock selection strategies at Goldman Sachs. He is the principal portfolio manager and supervises Frazzini, Aghassi and Kim.

Israel heads AQR’s Global Alternative Premia Group. Prior to joining AQR in 1999, he was a senior analyst at Quantitative Financial Strategies, Inc.

Frazzini researches global stock-selection strategies. Prior to joining AQR in 2008 he was a star finance professor at the University of Chicago.

Aghassi is co-head of research of AQR’s Global Stock Selection team. Prior to joining AQR in 2005, she obtained her PhD in operations research at MIT.

Kim is the head of equity portfolio management in AQR’s Global Stock Selection team. Prior to joining AQR in 2005, he was head of quantitative equity research at Mellon Capital Management.

Israel and Friedman have master’s degrees in mathematics. Frazzini, Aghassi and Kim have PhDs.

Strategy capacity and closure

The EMN and LSE funds together have over $1.6 billion in assets. However, AQR runs hedge funds, institutional separate accounts, and foreign funds, and re-uses the same signals in different formats, such as long-only funds. The effective dollars dedicated to the signals use by the funds are almost certainly much higher than reported by the aggregate net asset values of the mutual funds.

Fortunately, AQR has a history of closing funds and ensuring its assets don’t overwhelm the capacity of its strategies. When the firm launched in 1998, it could have started with $2 billion but chose to manage only half that, according to founding partner David Kabiller. Of its mutual funds, AQR has already closed its Multi-Strategy Alternative, Diversified Arbitrage and Risk Parity mutual funds. Soon after I wrote about AQR Style Premia Alternative QSPIX and AQR Style Premia LV QSLIX in the September 2015 edition of MFO, AQR announced a soft close of the funds. It went into effect on March 31, 2016. AQR will meet additional demand by launching funds that are tweaked to have more capacity. 

Management’s stake in the funds

As of December 31, 2014, the funds’ managers had relatively low investments in the mutual funds.

  • Friedman had $50,001 to $100,000 in the EMN fund and $100,001 to $500,000 in the LSE fund.
  • Israel had no investment in the EMN fund.
  • Frazzini had $10,001 to $50,000 in both funds.
  • Aghassi had no investments in either fund.
  • Kim had no investment in the LSE fund.

The low levels of investment should not be held against the managers. It is cheaper and more tax efficient for them to invest in the strategies through AQR’s hedge funds. They also have a direct interest in the success of the firm. Unlike many other hedge funds, AQR does not compensate partners and employees largely based on the profits attributable to them. The team-based nature of AQR’s quantitative process means profits cannot be cleanly attributable to a given employee. Moreover, there is a huge element of luck in the performance of a given strategy and AQR rightly does not want to overwhelmingly tie compensation to it. All the portfolio managers of the funds are partners and so earn a payout based on the firm’s earnings and their relative ownership stakes. AQR grants ownership stakes based on “cumulative research, leadership and other contributions.”

I expect that over time the managers’ stakes will rise as a matter of window-dressing for consultants who take a check-the-box approach to due diligence (most of them). There is evidence that window-dressing has occurred: Some of AQR’s principals own both the low- and high-volatility versions of the same strategy, which is strange because it is costlier to own the low-volatility version per unit of exposure.

Opening date

AQR Long-Short Equity started on July 16, 2013. AQR Equity Market Neutral started on October 7, 2014. AQR has been running long-short stock-selection strategies since its 1998 founding.

Minimum investment

$1 million for the N shares, $5 million for the I shares. The minimums are waived at certain brokerages. Fidelity, for example, allows investments as small as $2500 in IRAs. Fee-only financial advisors have no investment minimums.

Expense ratio

1.55% for the N shares, 1.3% for the I shares. The fees are high compared to long-only funds, but low for long-short mutual funds. Note that EMN and LSE both charge the same fee, but the LSE fund throws on equity market exposure and tactical timing for free.


Since its October 2014 inception, AQR Equity Market Neutral Fund I QMNIX has returned 18.6% annualized with a standard deviation of 7.0%, for a Sharpe ratio of 2.66. Since its July 2013 inception, AQR Long-Short Equity Fund I QLEIX has returned 14.4% above its benchmark (a 50-50 blend of the MSCI World Index and cash) with a standard deviation of 5.8%, for a Sharpe ratio of 2.46. Almost all of the abnormal returns were driven by the market-neutral equity stock selection sleeve; AQR’s tactical market timing in the LSE strategy contributed zilch to the fund’s returns from inception to the end of 2015.

These are not sustainable numbers. A more reasonable, conservative long-run Sharpe ratio is 0.5. Translated to a raw return, that’s 3% above cash for a market-neutral strategy that runs at a 6% volatility.

While AQR’s absolute return global stock selection strategy has done well, its long-only funds have not. Since the LSE fund launched in 2013, its active returns (that is, returns above its benchmark) have far outstripped the active returns of the AQR Multi-Style funds. In the chart below I plotted the cumulative active returns of AQR Long-Short Equity (which has a longer live track record than AQR Equity Market Neutral) against a sum of the active returns of AQR Large Cap Multi-Style I QCELX and AQR International Multi-Style I QICLX. The long-only funds have stagnated, while the long-short fund has consistently made lots of money. While I doubt this divergence will remain big and persistent, I’m confident that it’s well worth paying up for AQR’s long-short strategy. 


Bottom line

AQR’s long-short global stock-selection strategy is well worth the money and a better deal than its long-only stock funds.

Fund Website

AQR Equity Market Neutral

AQR Long-Short Equity

SamLeeSam Lee and Severian Asset Management

Sam is the founder of Severian Asset Management, Chicago. He is also former Morningstar analyst and editor of their ETF Investor newsletter. Sam has been celebrated as one of the country’s best financial writers (Morgan Housel: “Really smart takes on ETFs, with an occasional killer piece about general investment wisdom”) and as Morningstar’s best analyst and one of their best writers (John Coumarianos: “ Lee has written two excellent pieces [in the span of a month], and his showing himself to be Morningstar’s finest analyst”). He has been quoted by The Wall Street Journal, Financial Times, Financial Advisor, MarketWatch, Barron’s, and other financial publications.  

Severian works with high net-worth partners, but very selectively. “We are organized to minimize conflicts of interest; our only business is providing investment advice and our only source of income is our client fees. We deal with a select clientele we like and admire. Because of our unusual mode of operation, we work hard to figure out whether a potential client, like you, is a mutual fit. The adviser-client relationship we want demands a high level of mutual admiration and trust. We would never want to go into business with someone just for his money, just as we would never marry someone for money—the heartache isn’t worth it.” Sam works from an understanding of his partners’ needs to craft a series of recommendations that might range from the need for better cybersecurity or lower-rate credit cards to portfolio reconstruction. 

© 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.

LS Opportunity Fund (LSOFX), March 2016

By David Snowball

Objective and strategy

LS Opportunity Fund pursues three goals: preserving capital, delivering above-market returns and managing volatility. “The secret,” says manager John Gillespie, “is to avoid large losses.” They invest, both long and short, in individual stocks; they do not short “the market,” they don’t use esoteric options and they don’t typically use ETFs. They normally will have 20-40 short positions and 50-70 long ones. The long portfolio is both all-cap and value-oriented, both of which are fairly rare. The short portfolio targets firms with weak or deteriorating fundamentals and unattractive valuations. They use pair-traded investments to reduce volatility and sector risk.


Long Short Advisors, which was founded in 2010 as a way of making the ICAP hedge fund strategy available to retail investors. ICAP sub-advised this fund from 2010 until May, 2015. Prospector Partners LLC became the sub-advisor at the end of May, 2015. Prospector employs nine investment professionals and manages about $600 million through private partnerships, three funds and a couple of separately-managed accounts.


John Gillespie, Kevin O’Brien and Jason Kish. Mr. Gillespie worked for T. Rowe Price from 1986 – 1997, beginning as an analyst then managing Growth Stock (PRGFX) from 1994-1996 and New Age Media (a closed-end fund that morphed into Media & Telecommunications (PRMTX) from 1994-1997, after which he left to found Prospector Partners. Mr. Kish joined Prospector in 1997. Mr. O’Brien joined Prospector in 2003; prior to that he was an analyst and co-manager for Neuberger Berman Genesis Fund (NBGNX) and White Mountain Advisors. The team co-manages the Prospector Partners funds.

Strategy capacity and closure

$2 billion. The strategy currently holds $300 million.

Management’s stake in the fund

The managers just assumed responsibility for the fund in May 2015, shortly before the date of the Statement of Additional Information. At that point, two of the three managers had been $100,000 – $500,000 invested in the fund. Collectively they have “significant personal investments” in the strategy, beyond those in the mutual fund.

Opening date

The fund launched in September 2010, but with a different sub-adviser and strategy. The Prospector Partners took over on May 28, 2015; as a practical matter, this became a new fund on that date. Prospector has been managing the underlying strategy since 1997.

Minimum investment


Expense ratio

1.95% after waivers on assets of $25 million, as of February 2016.


In May 2015, circumstances forced Long-Short Advisors (LSA) to hit the reset button on their only mutual fund. The fund had been managed since inception by Independence Capital Asset Partners (ICAP), side by side with ICAP QP Absolute Return L.P., ICAP’s hedge fund. Unexpectedly, Jim Hillary, ICAP’s founder decided to retire from asset management, shutter the firm and liquidate his hedge fund. That left LSA with a hard decision: close the fund that was an extension of Mr. Hillary’s vision or find a new team to manage it.

They chose the latter and seem to have chosen well.

The phrase “long-short portfolio” covers a bunch of very diverse strategies. The purest form is this: find the most attractive stocks and reward them by buying them, then find the least attractive and punish them by shorting them. The hope is that, if the market falls, the attractive stocks will fall by a lot less than the whole market while the rotten ones fall by a lot more. If that happens, you might make more money on your short positions than you lose on your long ones and the portfolio prospers. Many funds labeled as “long-short” by Morningstar do not follow that script: some use ETFs to invest in or short entire market segments, some use futures contracts to achieve their short position, many hedge using buy-write options while some are simply misplaced “liquid alternatives” funds that get labeled “long short” for the lack of a better option. Here’s the takeaway: few funds in the “long-short” category actually invest, long and short, in individual stocks. By LSA’s estimation, there are about 30.

The argument for a long-short fund is simple. Most investors who want to reduce their portfolio’s volatility add bonds, in hopes that they’re lightly correlated to stocks and less volatile than them. The simplest manifestation of that strategy is a 60/40 balanced funds; 60% large cap stocks, 40% investment grade bonds. Such strategies are simple, cheap and have paid off historically.

Why complicate matters by introducing shorting? Research provided by Long Short Advisors and others makes two important points:

  • The bond market is a potential nightmare. Over the past 30 years, steadily falling interest rates have made bonds look like a risk-free option. They are not. Domestic interest rates have bottomed near zero; rising rates drive bond prices down. Structural changes in the bond markets, the side effect of well-intentioned government reforms, have made the bond market more fragile, less liquid and more subject to disruption than it’s been in any point in living memory. In early 2016, both GMO and Vanguard projected that the real returns from investment-grade bonds over the next five to ten years will be somewhere between zero and negative 1.5% annually.
  • Even assuming “normal” markets, long-short strategies are a better option than 60/40 ones. Between 1998 and 2014, an index of long/short equity hedge funds has outperformed a simple 60/40 allocation with no material change in risk.

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.

Prospector Partners, in contrast, has a long and excellent record of long-short investing. The firm was founded in 1997 by professionals who had first-rate experience as mutual fund managers. They have a clear, clearly-articulated investment discipline; they work from the bottom up, starting with measures of free cash flow yield. FCF is like earnings, in that it measures a firm’s economic health. It is unlike earnings in that it’s hard to rig; that is, the “earnings” that go into a stock’s P/E ratio are subject to an awful lot of gaming by management while the simpler free cash flow remains much cleaner. So, start with healthy firms, assess the health of their industries, look for evidence of management that uses capital wisely, then create a relatively concentrated portfolio of 50-70 stocks with the majority of the assets typically in the top 20 names. The fact that they’ve been developing deeper understanding of specific industries for 20 years while many competitors sort of fly-by using quant screens and quick trades, allows Prospector “to capitalize on informational vacuums in Insurance, Consumer, Utilities, and Banks.” They seem to have particular strength in property and casualty insurance, an arena “that’s consistently seen disruption and opportunity over time.”

The short portfolio is a smaller number of weak companies in crumbling industries. The fact that the management team is stable, risk-conscious and deeply invested in the strategy, helps strengthen the argument for their ability to repeat their accomplishments.

The LSOFX portfolio is built to parallel Prospector Partners’ hedge fund, whose historical returns are treated as prior related performance and disclosed in the prospectus of LSOFX. Here are the highlights:

  • From inception through mid-2015, a $1,000 investment in the Partner’s strategy grew to $5000 while an investing in the S&P 500 would have grown to $3000 and in the average long-short hedge fund (HFRI Equity Hedge), to $4000.
  • During the dot-com crash from 2000-02, their hedge fund made money each year while the S&P 500 lost 9, 12, and 22%. That reflects, in part, the managers’ preference for a value-oriented investment style during a period when anything linked with tech got eviscerated.
  • During the market panic from 2007-09, the S&P 500 fell by 3% or more in nine (of 18) months. The fund outperformed the market in every one of those months, by an average of 476 basis points per month.

Since taking responsibility for LSOFX, the managers have provided solid performance and consistent protection. The market has been flat or down in six of the eight months since the changeover. LSOFX has outperformed the market in five of those six months. And it has handily outperformed both the S&P 500 and its nominal long-short peers. From June 1, 2015 to the middle of February 2016, LSOFX lost 2.1% in value while the S&P 500 dropped 7.4% and the average long-short fund lost 9.0%.

Bottom Line

Even the best long-short funds aren’t magic. They don’t pretend to be market-neutral, so they’ll often decline as the stock market does. And they’re not designed to keep up with a rampaging bull, so they’ll lag when long-only investors are pocketing 20 or 30% a year. And that’s okay. At their best, these are funds designed to mute the market’s gyrations, making them bearable for you. That, in turn, allows you to become a better, more committed long-term investor. The evidence available to us suggests that LSA has found a good partner for you: value-oriented, time-tested, and consistently successful. As you imagine a post-60/40 world, this is a group you should learn more about.

Fund website

Long Short Advisors. The site remains pretty Spartan. Happily, the advisor is quite approachable so it’s easy to get information to help complete your due diligence.

© 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.

RiverNorth Opportunities Fund, Inc. (RIV), February 2016

By David Snowball

Objective and strategy

The Fund’s investment objective is total return consisting of capital appreciation and current income. Like the open-end RiverNorth Core Opportunity Fund (RNCOX), this fund invests opportunistically in a changing mix of closed-end funds including business development companies and ETFs. In the normal course of events, at least 65% of the fund’s assets will be in CEFs.  RiverNorth will implement an opportunistic strategy designed to capitalize on the inefficiencies in the CEF space while simultaneously providing diversified exposure to several asset classes. The prospectus articulates a long series of investment guidelines:

  • Up to 80% of the fund might be invested in equity funds
  • No more than 30% will be invested in global equity funds
  • No more than 15% will be in emerging markets equities
  • Up to 60% might be invested in fixed income funds
  • No more than 30% in high yield bonds or senior loans
  • No more than 15% in emerging market income
  • No more than 15% in real estate
  • No more than 15% in energy MLPs
  • No more than 10% in new CEFs
  • No investments in leveraged or inverse CEFs
  • Up to 30% of the portfolio can be short positions in ETFs, a strategy that will be used defensively.
  • Fund leverage is limited to 15% with look-through leverage (that is, factoring in leverage that might be use in the funds they invest in) limited to 33%.


ALPS Advisors, Inc.


RiverNorth Capital Management, LLC. RiverNorth is an investment managementfirm founded in 2000 that specializes in opportunistic strategies in niche markets where the potential to exploit inefficiencies is greatest. RiverNorth is the sub-adviser to RiverNorth Opportunities Fund, Inc. RiverNorth also advises three limited partnerships and the four RiverNorth Funds: RiverNorth Core Opportunity (RNCOX), RiverNorth/Oaktree High Income (RNOTX), Equity Opportunity (RNEOX), RiverNorth/DoubleLine Strategic Income (RNDLX) and this one. As of December 31, 2015, they managed $3.3 billion.


Patrick Galley and Stephen O’Neill. Mr. Galley is RiverNorth’s Chief Investment Officer and President and Chairman of RiverNorth Funds. He also manages all or parts of seven strategies with Mr. O’Neill. Before joining RiverNorth in 2004, he was a Vice President at Bank of America in the Global Investment Bank’s Portfolio Management group. Mr. O’Neill co-manages the firm’s closed-end fund strategies and helps to oversee the closed-end fund investment team. 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.

Strategy capacity and closure

The Fund is a fixed pool of assets now that the IPO is complete, which means there are no issues with capacity going forward.

Management’s stake in the fund

Messrs. Galley and O’Neill each have between $100,000 – 500,000 in the fund. Three of the four independent trustees have relatively modest ($10,000-100,000) investments in the open-end version of the fund while one has no investments with RiverNorth. RiverNorth, “its affiliates and employees anticipate beneficially owning, as a group, approximately $10 million in shares of the Fund.” Mr. Galley also owns more than 25% of RiverNorth Holding Company, the adviser’s parent company.

Opening date

December 23, 2015

Minimum investment

Like stocks and ETFs, there is no minimum purchase established by the fund though you will need to pay a brokerage fee.

Expense ratio

Total Expense Ratio: 2.98%


The pricing of closed-end fund shares is famously irrational. Like a “normal” mutual fund, closed-end funds calculate daily net asset values by taking the value of all of the securities they own – an unambiguous figure based on the publicly-quoted prices for stocks – and divide it by the number of shares they’ve issued, another unambiguous figure. At the end of each day, a fund can say, with considerable confidence, “one share of our fund is worth $10.”

So, why can you buy that share for $9.60? Or $9.00 or $8.37? Or, as in the case of Boulder Growth & Income (BIF), $7.56?

The short answer is: people are nuts. CEFs trade like stocks throughout the day and, at any given moment, one share is worth precisely what you convince somebody to pay for that one share. When investors get panicked, people want to dump their shares. If they’re sufficiently panicked they’ll sell at a loss, accepting dimes on the dollar just to be free again. To be clear: during a panic, you can often buy $10 worth of securities for $8. If you simply hold those shares until the panic subsidies, you might reasonably expect to sell them for $9 or $9.50. Even if the market is falling, when the panic selling passes, the discounts contract and you might pocket market-neutral arbitrage gains of 10 or 20%.

It’s a fascinating game, but one which very few of us can successfully play. There are two reasons for that:

  1. You need to know a ridiculous lot about every potential CEF investment: not just current discount but its typical discount, its price movement history, its maximum discount but also the structural factors that might make its current discount continue or deepen.
  2. You need to know when to move and you need to be ready to: remember, these discounts are at their greatest during panics. Just as the market collapses and it appears the world really is ending this time, you need to reach for your checkbook. The discounts are evidence that normal investors do the exact opposite: the desire to escape leads us to sell for the sake of selling.

RiverNorth’s primary expertise is CEF investing; in particular, in investing opportunistically when things look their worst. That strategy is primarily manifested in RiverNorth Core Opportunity (RNCOX), an open-ended tactical allocation fund that uses this strategy. This long-awaited fund embodies the same strategy with a couple twists: it can make modest use of leverage and it’s more devoted to CEFs than is RNCOX. RIV will have at least 65% in CEFs while RNCOX might average 50-70%.

And, too, RIV itself can sell at a discount. A sophisticated investor might monitor the fund and find herself able to buy RIV at a 10% discount at the very moment that RIV is buying other funds at a 20% discount. That would translate to the opportunity to buy $10 worth of stock for $7.20.

Investing in RIV carries clearly demonstrable risks:

  1. It costs a lot. The fund invests in, and passes costs through from, an expensive asset class. The aforementioned Boulder Growth & Income fund charges 1.83%, if RiverNorth buys it, that expense gets passed through to its shareholders as a normal cost of the strategy. The adviser estimates that the fund’s current expenses, assuming they’re using the leverage available to them and including the acquired fund fees and expenses, is 3.72%.
  2. It’s apt to be extremely volatile at times. Put bluntly, the strategy here is to catch falling knives. Ideally you catch them when they don’t have much farther to fall but there’s no guarantee of that.
  3. Its Morningstar rating will periodically suck. If CEF discounts widen after the fund acquires shares, those widened discounts reduce RiverNorth’s return and increase its volatility. Persistently high discounts will make for persistently low Morningstar ratings, which is what we see with RNCOX right now.

That said, this fund is apt to deliver on its promises. The CEF structure, which frees the managers from needing to worry about redemptions or hot money flows, seems well-suited for the mission.

Bottom Line

CEF discounts are now the greatest they’ve been since the depth of the 2008 market meltdown. By RiverNorth’s calculation, discounts are greater now than they’ve been 99% of the time. If panic subsidies, that will provide a substantial tailwind to boost returns for RiverNorth’s shareholders. If the panic persists just long enough for investors to buy RIV at a discount, as the managers are apt to, then the potential gains are multiplied. Investors interested in a more-complete picture of the strategy might want to read our November 2015 profile of RiverNorth Core Opportunity.

Fund website

© 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.

AQR Style Premia Alternative I (QSPIX), AQR Style Premia Alternative LV I (QSLIX), September 2015

By Samuel Lee

Objective and strategy

AQR’s Style Premia Alternative, or SPA, strategy offers leveraged, market-neutral exposure to the four major investing “styles” AQR has identified:

Value, the tendency for fundamentally cheap assets to beat expensive assets.

Momentum, the tendency for relative performance in assets to persist over the short run (about one to twelve months).

Carry, the tendency for high-yield assets to beat low-yield assets.

Defensive, the tendency for low-volatility assets to offer higher volatility-adjusted returns than high-volatility assets.

To make the cut as a bona fide style, a strategy has to be persistent, pervasive, dynamic, liquid, transparent and systematic.

SPA offers pure exposure to these styles across virtually all major markets, including stocks, bonds, currencies, and commodities. It removes big, intentional directional bets by going long and short and hedging residual market exposure. As with all alternative investments, the goal is to create returns uncorrelated with conventional portfolio returns.

SPA sizes its positions by volatility, not nominal dollars. In quant-speak, risk is often used as short-hand for volatility, a convention I will adopt. Of course, volatility is not risk (though they are awfully correlated in many situations).

SPA’s strategic risk allocations to each style are as follows: 34% each to value and momentum, 18% to defensive, and 14% to carry. Its strategic risk allocations to each asset class are as follows: 30% to global stock selection, 20% each to equity markets and fixed income, and 15% each to currencies and commodities. There is a bias to the value and momentum styles, perhaps reflecting AQR’s greater confidence in and longer history with them.

Risk allocations drift based on momentum and “style agreement,” where high-conviction positions are leveraged up relative to low-conviction positions. The strategy’s overall risk target falls in steps in the event of a drawdown and rises as losses are recouped. These overlays embody some of the hard-knock knowledge speculators have acquired over the decades: bet on your best ideas, cut losers and ride winners, and cut capital at risk when one is trading poorly.

SPA targets a Sharpe ratio of 0.7 over a market cycle. AQR offers two flavors to the public: the 10% volatility-targeted QSPIX and the 5%-vol QSLIX.


AQR Capital Management, LLC, was founded in 1998 by a team of ex-Goldman Sachs quant investors led by Clifford S. Asness, David G. Kabiller, Robert J. Krail, and John M. Liew. AQR stands for Applied Quantitative Research. The firm’s bread and butter has long been trading value and momentum together, an idea Asness studied in his PhD dissertation at the University of Chicago. (Asness’s PhD advisor was none other than Eugene Fama, father of modern finance and one of the co-formulators of the efficient market hypothesis.)

When the firm started up, it was hot. It had one of the biggest launches of any hedge-fund up to that point. Then the dot-com bubble inflated. The widening gap in valuations between value and growth stocks almost sunk AQR. According to Asness, the firm was six months away from going out of business. When the bubble burst, the firm’s returns soared and so did its assets. The good times rolled until the financial crisis shredded its returns. Firm-wide assets from peak-to-trough went from $39.1 billion to $17.2 billion. The good times are back: As of June-end, AQR has $136.2 billion under management.

The two near-death experiences have instilled in AQR a fear of concentrated business risks. In 2009, AQR began to diversify away from its flighty institutional clientele by launching mutual funds to entice stickier retail investors. The firm has also launched new strategies at a steady clip, including managed futures, risk parity, and global macro.

AQR has a strong academic bent. Its leadership is sprinkled with economics and finance PhDs from top universities, particularly the University of Chicago. The firm has poached academics with strong publishing records, including Andrea Frazzini, Lasse Pedersen, and Tobias Moskowitz. Its researchers and leaders are still active in publishing papers.

The firm’s principals are critical of hedge funds that charge high fees on strategies that are largely replicable. AQR’s business model is to offer up simplified quant versions of these strategies and charge relatively low fees.


Andrea Frazzini, Jacques A. Friedman, Ronen Israel, and Michael Katz. Frazzini was a finance professor at University of Chicago and rising star before he joined AQR. He is now a principal on AQR’s Global Stock Selection team. Friedman is head of the Global Stock Selection team and worked at Goldman Sachs with the original founders prior to joining AQR. Israel is head of Global Alternative Premia and prior to AQR was a senior analyst at Quantitative Financial Strategies Inc. Katz leads AQR’s macro and fixed-income team.

Frazzini is the most recognizable, as he has the fortune of having a last name that’s first in alphabetical order and publishing several influential studies in top finance journals, including “Betting Against Beta” with his colleague Lasse Pedersen.

Unlisted is the intellectual godfather of SPA, Antti Ilmanen, a University of Chicago finance PhD who authored Expected Returns, an imposing but plainly-written tome that synthesizes the academic literature as it relates to money management. Though written years before SPA was conceived, Expected Returns can be read as an extended argument for an SPA-like strategy.

Strategy capacity and closure

AQR has a history of closing funds and ensuring its assets don’t overwhelm the capacity of its strategies. When the firm launched in 1998, it could have started with $2 billion but chose to manage only half that, according to founding partner David Kabiller.

Of its mutual funds, AQR has already closed its Multi-Strategy Alternative, Diversified Arbitrage and Risk Parity mutual funds. However, AQR will meet additional demand by launching additional funds that are tweaked to have more capacity. As of the end of 2014, AQR reported a little over $3 billion in its SPA composite return record. Given the strategy’s strong recent returns, assets have almost certainly grown through capital appreciation and inflows.

Because AQR uses many of the same models or signals in different formats and even in different strategies, the effective amount of capital dedicated to at least some components of SPA’s strategy is higher than the amount reported by AQR.

Management’s stake in the fund

As of Dec. 31, 2014, the strategy’s managers had no assets in the low-volatility SPA fund and little in the standard-volatility SPA fund. One trustee had less than $50,000 in QSPIX. Collectively, the managers had $170,004 to $700,000 in the SPA mutual funds.

Although these are piddling amounts compared to the millions the managers make every year, the SPA strategy is tax-inefficient. If the managers wanted significant exposure to the strategies, they would probably do so through the partnerships AQR offers to high-net-worth investors. But would they do that? AQR, like most quant shops, attempts to scarf down as much as possible the “free lunch” of diversification. The managers are well aware that their human capital is tied to AQR’s success and so they would probably not want to concentrate too heavily in its potent leveraged strategies.

Opening date

QSPIX opened on October 30, 2013. QSLIX opened on September 17, 2014. The live performance composite began on September 1, 2012.

Minimum investment

The minimum investment varies depending share class, broker-dealer and channel. For individual investors, a Fidelity IRA offers the lowest hurdle: a mere $2,500 for the I share class of the normal and low-volatility flavors of SPA. Or you can get access through an advisor. Otherwise, the hurdles are steep: $5 million for the I class, $1 million for the N class, and $50 million for the R6 class.

Expense ratio

The I class for the normal and low-volatility versions cost 1.50% and 0.85%, respectively. The N classes costs 0.25% more and the R6 classes costs 0.10% less.

The per-unit price of exposure to SPA is lower the higher the volatility of the strategy. QSPIX targets 10% vol and costs 1.5%. QSLIX targets 5% vol and costs 0.85%. Anyone can replicate a position in QSLIX by simply halving the amount invested in QSPIX and putting the rest in cash. The effective expense ratio of a half QSPIX, half cash clone strategy is 0.75%.


Among right-thinking passive investors who count fees by the basis point, AQR’s SPA strategy elicits revulsion. It’s expensive, leveraged, complicated, hard to understand, and did I mention expensive?

To make the strategy easier to swallow, some passive-investing advocates argue SPA is “passive” because it’s a transparent, systematic, and involves no discretionary stock-selection or market forecasting. This definition is not universally accepted by academics, or even by AQR. The purer, technical definition of passive investing is a strategy that replicates market weightings, and indeed this definition is used by the venerable William Sharpe in his famous essay, “The Arithmetic of Active Management.”

I do not think SPA is passive in any widely understood sense of the word. In fact, I think it’s about as active as you can get within a mutual fund. And I also happen to think SPA is a great fund. Regardless of my warm feelings for the strategy, I consider SPA suitable only for a rare kind of nerd, not the investing public.

Though SPA is aggressively active, its intellectual roots dig deep into the foundations of financial theory that underpin what are commonly thought to be “passive” strategies, particularly value- and size-tilted stock portfolios (DFA has made a big business selling them).

The nerds among you will have quickly caught on that what AQR calls a style is nothing more than a factor, a decades-old idea that sprung from academic finance.

For the non-nerds: A factor, loosely speaking, is a fundamental building block that explains asset returns. Most stocks move together, as if their crescendos and diminuendos were orchestrated by the hand of some invisible conductor. This co-movement is attributed to the equity market factor. According to factor theory, a factor generates a positive excess return called a premium as reward for the distinct risk it represents.

It is now widely agreed that two factors pervade virtually all markets: value and momentum (size has long been criticized as weak). AQR’s researchers—including some of the leading lights in finance—argue there are two more: carry and defensive. They’ve marshalled data and theoretical arguments that share an uncanny family resemblance with the data and arguments marshalled to justify the size and value factors.

The SPA strategy is a potent distillation of the factor-theoretical approach to investing. If you believe the methods that produced the research demonstrating the value and size effects are sound, then you have to admit that those same tools applied to different data sets may yield more factors that can be harvested.

OK, I’ve blasted you with theory. On to more practical matters.

Who should invest in this fund?

Investors who believe active management can produce market-beating results and are willing to run some unusual but controllable risks.

How much capital should one dedicate to it?

Depends on how much you trust the strategy, the managers, and so on. I personally would invest up to 30% of my personal money in the fund (and may do so soon!), but that’s only because I have a high taste for unconventionality, decades of earnings ahead of me, high conviction in the strategy and people, and a pessimistic view of competing options (other alternatives as well as conventional stocks and bonds). Swedroe, on the other hand, says he has 3% of his portfolio in it.

How should it be assessed?

At a minimum, an alternative has to produce positive excess returns that are uncorrelated to the returns of conventional portfolios to be worthwhile.

However, AQR is making a rather bold claim: It has identified four distinct strategies that produce decent returns on a standalone basis and are both largely uncorrelated with each other and conventional portfolios. When combined and leveraged, the resulting portfolio is expected to produce a much steadier stream of positive returns, also uncorrelated with conventional portfolios.

So far, the strategy is working as advertised. Returns have been good and uncorrelated. In back-tests, the strategy only really suffered during the dot-com bubble and the financial crisis. Even then, returns weren’t horrendous.

Is AQR’s 0.7 Sharpe ratio target reasonable?

I think so, but I would be ecstatic with 0.5.

What are its major risks?

Aside from leverage, counterparty, operational, credit, etc., I worry about a repeat of the quant meltdown of August 2007. It’s thought that a long-short hedge fund suddenly liquidated its positions then. Because many hedge funds dynamically adjust their positions based on recent volatility and returns, the sudden price movements induced by the liquidation set off a self-reinforcing cycle where more and more hedge funds cut the same positions. The stampede to the exits resulted in huge and sudden losses. However, the terror was short-lived. The funds that sold out lost a lot of money; the funds that held onto their positions looked fine by month-end.

AQR is cognizant of this risk and so keeps its holdings liquid and doesn’t go overboard with the leverage. However, it is hard for outsiders to assess whether AQR is doing enough to mitigate this risk. I think they are, because I trust AQR’s people, but I’m well aware that I could be wrong.

Bottom line

One of the best alternative funds available to mutual-fund investors.

Fund website

© 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.

Eventide Healthcare & Life Sciences Fund (ETNHX)

By David Snowball

Objective and strategy

The Eventide Healthcare & Life Sciences Fund seeks to provide long-term capital appreciation. The manager selects equity and equity-related securities of firms in the healthcare and life sciences sectors. The manager’s valuation standards aren’t spelled out, except to say that he’s looking for “attractively valued securities.” The advisor imposes a set of ESG screens so that it limits itself to firms that “operate with integrity and create value for customers, employees, and other stakeholders,” which includes its immediate community and the broader society. Some of the firms in which it invests, especially in the biotech sector, are “development stage companies,” which implies that their stock is illiquid and potentially very volatile. Up to 15% of the portfolio might be invested in such securities. At the same time, up to 10% can be invested in derivatives that help hedge the portfolio.


Eventide Asset Management, LLC. Founded in 2008, Eventide is a Boston-based adviser that specializes in faith-based and socially responsible investing. They manage more than $2 billion in assets through their two (and soon to be three) mutual funds.


Finny Kuruvilla. Dr. Kuruvilla has been a busy bee. In addition to managing the Eventide funds, he’s a Principal with Clarus Ventures, a health care venture capital firm with $1.7 billion in assets. In that role, he sits on several corporate boards. He has earned an MD from Harvard Medical School, a PhD in Chemistry and Chemical Biology from Harvard, a master’s in Electrical Engineering and Computer Science from MIT, and a bachelor’s degree from Caltech in Chemistry. Somewhere in there he completed medical residencies at two major Boston hospitals and served as a research fellow at MIT. He completed his residency and fellowship at the Brigham & Women’s Hospital and Children’s Hospital Boston where he cared for adult and pediatric patients suffering from a variety of hematologic, oncologic, and autoimmune disorders. Subsequently, he was a research fellow at MIT where he did incredibly complicated statistical stuff. He’s coauthored 15 peer-reviewed articles in science journals and also manages Eventide Gilead Fund.

Strategy capacity and closure

“Strategy capacity” refers to the amount of money that a manager believes he or she can handle without compromising the strategy’s prospects. Sometimes the limitation is imposed by the nature of the strategy (microcap strategies can handle less money than megacap ones) and sometimes by the limits of the investment team’s time and attention. In general, managers who can articulate the limits of their strategy and have thought through how they’ll handle excess inflows do better in the long run than those you make it up as they go. The Eventide managers report that “Eventide has not discussed closing the fund and is not expecting capacity issues until the fund gets to about $2 billion in AUM.”

Active share

Unknown.  “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 fund’s active share hasn’t been calculated, though its low correlation with its benchmark suggests a fairly active approach.

Management’s stake in the fund

Dr. Kuruvilla has invested under $100,000 in this fund and between $100,001-$500,000 across his two funds. None of the fund’s independent trustees have any investment in the Eventide funds. As of October 1, 2014, the officers and Trustees collectively owned less than 1% of the fund shares; that translates to less than $200,000.

Opening date

December 27, 2012

Minimum investment

$1,000 for a regular account, $1,000 for an IRA account, or $100 for an automatic investment plan account.

Expense ratio

1.63% on assets of $360 million. There is a 1% redemption fee for shares held fewer than 180 days.


The argument for Eventide Healthcare is pretty straightforward: it’s the hottest fund in the hottest sector of the U.S. economy and it’s led by a manager with an unparalleled breadth of training and experience.

The Wall Street Journal’s mid-year report on the mutual funds with the best 10-year performance offered the following list of specialties:

  1. Biotech
  2. Biotech
  3. Health sciences
  4. Pharmaceuticals
  5. Biotech
  6. Biotech
  7. Biotech
  8. Health sciences
  9. Biotech
  10. 2x leveraged NASDAQ

Those funds earned an average of 19% per year. At the same time, the Total Stock Market Index clocked in at 8% per year.

And so far in its short life, Eventide Healthcare is among the field’s strongest performers. It has, since inception, handily beaten both the field and the field’s two most-respected funds, Vanguard Health Care (VGHCX, the only fund endorsed by Morningstar analysts) and T. Rowe Price Health Sciences (PRHSX).  Here are the returns on a hypothetical $10,000 investment made on the day Eventide launched in December 2012:

Eventide HealthCare 26,990
T. Rowe Price Health Sciences 24,750
Health care peer group 22,750
Vanguard Health Care 21,440

In 2015, through the end of July, Eventide has returned 28.6% – 9% better than the average healthcare fund and 25% above the broad stock market. Despite those soaring returns, Mr. Kuruvilla concludes that the key biotech “sector is significantly less overvalued than the S&P 500 as a whole. While individual biotech companies may indeed be overvalued, we see no reason to believe that overvaluation is endemic in the sector.”

Much of the credit belongs to its manager, Finny Kuruvilla. His academic accomplishments are formidable. As I note above, Dr. Kuruvilla has an MD and a PhD in chemical biology (both from Harvard) and a master’s degree in engineering and computer science (from MIT). His professional investing career includes both the Eventide fund and a venture capital fund. That second tier of experience is important, since VC funds tend both to be far more activist – that is, far more intimately involved in the development of their charges – than mutual funds and to focus on a distinct set of early stage firms whose prospects might explode. About 70% of the Eventide fund is invested in biotech stocks and 40% in microcaps; most of the remainder are small cap firms.

The other investor with a similar range of expertise was Kris Jenner, the now-departed manager of T. Rowe Price Health Sciences. Mr. Jenner managed to leverage his deep academic and professional knowledge of the growing edge of the healthcare universe – biotech firms, among others – into the third best 10-year record among the 7000 funds that Morningstar tracks.

That said, prospective investors need to attend to four red flags:

  1. The manager has two masters. Mr. Kuruvilla is a principal at Clarus Ventures, a healthcare venture capital firm with $1.7 billion in assets. He’s managed investments for both firms since 2008. That might raise two concerns. The first is whether he’s able to juggle both sets of obligations, especially as assets grow. The second is how he handles potential conflicts of interest between his two charges. If, for example, he discovers a fascinating illiquid security, he might need to choose whether to invest for the benefit of his Clarus shareholders or his Eventide ones.

    Eventide’s conflict-of-interest policy addresses his role at Clarus, but mostly concerning how he will deal with non-public information and trading in his personal accouts, not how he would deal with potential conflicts between the needs of the two funds.

  2. Asset growth might impair the strategy. The fund is attracting steadily inflows. It has grown from $40 million at the end of 2013 to $150 million at the end of 2014 to $300 million at the start of July, 2015. By the end of July, they’d reached $350 million. For a fund whose success is driven by its ability to find and fund firms in “the smallcap biotech space,” 40% of which are microcaps and some of whom are privately traded and illiquid, sustained asset growth is a real concern. Sadly that growth has not yet translated into low expenses; it is the third most-expensive of the 31 health care funds.

  3. The question of volatility needs to be addressed. Despite its ability to hedge volatility, the fund declined by almost 20% in the late spring and early summer, 2014. Its peers dropped 7.4% in the same period. Since inception, its downside deviation and Ulcer Index, a measure that combines the magnitude and duration of a drawdown, are two to three times higher than its peers.

    The managers are aware of the issue, but consider it to be part of the price of admission. David Barksdale, co-portfolio manager on the Gilead fund and managing partner of Eventide, writes:  

    A draw-down like that in early 2014 for the Healthcare fund should be considered normal for the fund. There was a pullback in biotech stocks at that time and these are a regular feature of the industry. Although individual biotech companies tend to be uncorrelated on their fundamentals, investors tend to trade their stocks as a group via ETF’s or otherwise and investor sentiment changes can precipitate these kinds of draw-downs.

    He reports that “we generally see these drawdowns at least once a year.” The ability to exploit the market’s excessive reactions are an essential part of generating outsized gains (“We tend to keep some cash on hand in the fund to be able to take advantage of these pullbacks as buying opportunities.”) but they may prove difficult for some investors to ride through.

  4. The quality of shareholder communications is surprisingly low. Communication between the manager and retail shareholders is limited to a three page letter, covering both funds, in the Annual Report. The semi-annual report contains no text and there are no shareholder letters. There are quarterly conference calls but those are limited to financial advisers; copies are password protected. The adviser does maintain a rich archive of the managers’ media appearances.

Bottom Line

Eventide Healthcare and Life Sciences has a fascinating pedigree and a outstanding early record. Mr. Kuruvilla has the breadth of experience at training – both academic and professional – to give him a distinct and sustained competitive advantage over his peers. That said, enough questions persist that investors need to approach the fund cautiously, if at all.

Fund website

Eventide Healthcare and Life Sciences

© 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.

Vanguard Global Minimum Volatility Fund (VMVFX), April 2015

By David Snowball

Objective and strategy

The fund seeks to provide long-term capital appreciation with low volatility relative to the global equity market. The managers use quantitative models to “construct a global equity portfolio that seeks to achieve the lowest amount of expected volatility subject to a set of reasonable constraints designed to foster portfolio diversification and liquidity.” It’s broadly diversified, with 340 stocks across all capitalizations and industry groups, with about 50% outside the U.S. The fund generally hedges most of its currency exposure to further reduce overall portfolio volatility.


The Vanguard Group, Inc. Vanguard was founded by Jack Bogle in 1975 as a sort of crazed evangelical investing hobby. It now controls between $2.2 trillion and $2.7 trillion in assets and advises 170 mutual funds. Struck by Vanguard’s quarter trillion dollars of inflows in 2014, Morningstar’s John Rekenthaler recently mused about “what will happen when Vanguard owns everything.”


James D. Troyer, James P. Stetler, and Michael R. Roach co-manage the fund. Mr. Troyer and Mr. Stetler are Principals at Vanguard and all three have been with the fund since launch. Messrs. Troyer, Stetler, and Roach also co-manage all or a portion of 14 funds with total assets of $121 billion.

Strategy capacity and closure


Active share

“Active share” measures the degree to which a fund’s portfolio differs from the holdings of its benchmark portfolio. High active share indicates management which is providing a portfolio that is substantially different from, and independent of, the index. An active share of zero indicates perfect overlap with the index, 100 indicates perfect independence. Vanguard does not, however, make active share calculations public.

Management’s stake in the fund

As of October 31, 2014, Mr. Troyer had invested between $500,001–$1,000,000 in the fund while Mr. Roach had a minimal investment and Mr. Stetler had none at all. None of Vanguard’s trustees, each of whom oversees 178 funds, has invested in this fund. Oddly, the fund’s largest investor is Vanguard Managed Payout Fund (VPGDX) which owns 52% of it. Overall, Vanguard employees have invested more than $4.7 billion in their funds.

Opening date

December 12, 2013.

Minimum investment


Expense ratio

0.30% on Investor class shares, on assets of about $700 million.


The case for owning a consciously low-volatility stock fund comes down to two observations:

  1. Most options for reducing portfolio volatility are complicated, expensive and ineffective.

    Investors loathe equity managers who hold cash (“I’m not paying you 1.0% a year to buy CDs,” they howl), which is why there are so few managers willing to take the risk: of 2260 US equity funds, well under 100 have 15% or more in cash as of April 2015. Bonds are priced for long-term disappointment, which reduces the appeal of traditional 60/40 portfolios. Folks are much more prone to invest in “liquid alts” despite the fact that most combine untested teams, untested strategies, high expenses (the “multi-alternative” group averages 1.7-1.8%) and low returns (over most trailing periods, the multi-alt group returns between 3-4%).

    While we’ve tried to identify the few most-promising options in these areas, there’s an argument that for many investors simply investing in the right types of stocks makes a lot of sense, which brings us to …

  2. Low volatility stock portfolios substantially raise returns and reduce risk.

    The evidence here is remarkable. You’re taught in financial class that high risk assets have higher returns than low risk assets, simply because no one in their right mind would invest in a high risk game without the prospect of commensurately high returns. While that’s true between asset classes (stocks tend to return more than bonds which tend to return more than cash), it’s not true within the stock class. There’s a mass of research that shows that low volatility stocks are a free lunch, worldwide.

    There are different ways to constructing such a portfolio. The folks at Research Associates tested four different techniques against a standard market cap weighted index and found the same results everywhere, pretty much regardless of how you chose to choose your portfolio. In the US market, low vol stocks returned 156 basis points higher (134-182, depending) than did the market. In a global sample, the returns were 56 basis points higher (8-143, depending) but the risk was 30% lower. And in the emerging markets, the returns gain was huge – 203 basis points (97-407, depending) – and the volatility reduction was stunning, about a 50% lower volatility was achievable. “In all cases,” they concluded, “the risk reduction is economically and statistically significant.”

    Researchers at Standard & Poor’s found that the effect holds across all sizes of stocks, as well. Oddly, the record for large and small cap low volatility stocks is far more consistently positive than for mid-caps. Got no explanation for that.

    If the reduction in volatility keeps investors from fleeing the stock market at exactly the wrong moment, then the actual gains to investor portfolios might well be greater than the raw returns suggest.

Why is there a low volatility anomaly? That is, why are less risky stocks more profitable? The best guess is that it’s because they’re boring. No one is excited by them, no one writes excitedly about Church & Dwight (the maker of Arm & Hammer baking soda, Orajel and … well, Trojan condoms) or The Clorox Company. As a result, the stocks aren’t subject to getting bid frantically up and crashing down.

The case for using Vanguard Global Minimum is similarly straightforward:

  1. It’s Vanguard.

    That brings three advantages: it’s going to be run at-cost (30 bps, less than one-quarter of what their peers charge). It’s going to be disciplined. They argue that the “minimum” volatility moniker signals a more sophisticated approach than the simple, more-common “low volatility” strategy. Low-vol, they argue, is simply a collection of the lowest volatility stocks in a screening process; minimum volatility approaches the problem of managing the entire portfolio by accounting for factors such as correlations between the stocks, sector weights and over-exposure to less obvious risk factors such as currency or interest rate fluctuations. And it’s not going to be subject to “Great Man” risk since it’s team-managed by Vanguard’s Quantitative Equity Group.

  2. It’s global and broadly diversified.

    The managers work with a universe of 50 developed and emerging markets. Their expectation is that about half of the money, on average, will be in the US and half elsewhere. The portfolio is spread widely across various market caps (20% small- to micro-cap and 20% mega-cap) and valuations (30% value, 32% growth) and industries (though noticeably light on basic materials, tech and financials).

So far, at least in the fund’s first 15 months, it’s working. Our colleague Charles generated a quick calculation of the fund’s performance since inception (December, 2013) against its global peers. Here’s the summary:


Bottom Line

Minimum volatility portfolios allow you to harness the power of other investor’s stupidly: you get to profit from their refusal to bid up boring stocks as they choose, instead, to become involved in the feeding frenzy surrounding sexy biotechs. For investors interested in maintaining their exposure to stocks for the long run, using a global minimum volatility portfolio makes a lot of sense. Using a cheap, discipline one such as Vanguard Global Minimum Volatility makes the most sense for folks who want to pursue that course.

Fund website

Vanguard Global Minimum Volatility. The Vanguard site covers the basics, but doesn’t occur any particularly striking insights into the dynamics of low- or minimum-volatility investing. Happily there are a number of reasonably good reviews, mostly readable, of what you might expect from such a portfolio.

Feifei Li, Ph.D. and Philip Lawton, Ph.D., both of Research Associates, wrote True Grit: The Durable Low Volatility Effect (September 2014). The essay spends as much time on the question of whether the effect is sustainable as on the nature of the effect itself. They draw, in part, on a study of fund manager behavior: fund managers love to tell a dramatic story to clients and associates, which leads them to invest in stocks that … well, have drama. As a result, they subconsciously prefer risky stocks to safe ones. Li and Lawton conclude:

… it is reasonable to expect low volatility investing to persist in producing excess returns. The intensity of investors’ preferences may vary, but chasing outlier returns from stocks that are in vogue seems to be a steady habit … many people find it very hard to change their mindset, and they just don’t seem to learn from experience.

For those who really revel in the statistics, a larger Research Associates team, including the firm’s co-founder Jason Hsu, published a more detailed study of the findings in 2014. Because the web is weird, you can access a pdf of the published study by Googling the title but I can’t embed the link for you. However the pre-publication draft, dated December 2013, is available from the Social Sciences Research Network. Tzee-man Chow, Jason Hsu, Li-lan Kuo, and Feifei Li, A Study of Low-Volatility Portfolio Construction Methods, Journal of Portfolio Management (Summer 2014)

Aye Soe, director of index research and design, Standard & Poor’s, The Low-Volatility Effect: A Comprehensive Look (2012) is not particularly readable, but it delivers what it promises: a comprehensive presentation of the statistical research.

© 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.

Touchstone Sands Capital Emerging Markets Growth Fund (TSEMX/TSEGX)

By David Snowball

Objective and strategy

The Fund seeks long-term capital appreciation by investing in a compact portfolio of “truly exceptional businesses” linked to the emerging markets, and occasionally to frontier markets. The managers look for companies that have strong financials, sustainable above-average earnings growth, a leadership position in a strong industry, durable competitive advantages, an understandable business model and a rational valuation. They typically hold 30-50 stocks which are “conviction weighted” in the portfolio. Currently three of those are located in frontier markets.


Touchstone Advisors. Touchstone is a Cincinnati-based firm with $21.0 billion in assets, as of December 2014. Touchstone selects and monitors the sub-advisors for their 39 funds. The sub-advisor here is Sands Capital Management of Arlington, VA. As of December 31, 2014, Sands Capital had approximately $47.7 billion in assets under management. Sands also manages two closed funds for Touchstone: Touchstone Sands Capital Select Growth (TSNAX) and Touchstone Sands Capital Institutional Growth (CISGX).


Brian Christiansen, Ashraf Haque and Neil Kansari. The managers have experience as research analysts at Sands and elsewhere. They also have M.B.A.s from first-tier universities (Yale 2009, Harvard 2007 and Darden 2008, respectively). They have not previously managed a mutual fund. In December 2014, the team was designated to run MMI New Stock Market – Sands, a billion dollar emerging markets fund located in Denmark but which trades in London. They are supported by a 38 person research team; the research teams are organized around six global sectors rather than region or asset class.

Strategy capacity and closure

$5 billion estimated capacity for the strategy, based on current market conditions. That might increase as markets evolve.

Active share

93. “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. TSEMX has an active share of 93 which reflects a very high level of independence from its benchmark MSCI Emerging Markets Index.

Management’s stake in the fund

All three managers are invested in the fund but the extent of the investment won’t be public until publication of the new Statement of Additional Information in May, 2015.

Opening date

May 12, 2014.

Minimum investment

$2,500, reduced to $1,000 for tax-advantaged accounts and $100 for accounts established with an automatic investing plan.  Institutional share class has a $500,000 minimum.

Expense ratio

1.49%, after waivers, on assets of $65 million (as of January 2015). Institutional shares have an expense ratio of 1.39%.


Touchstone Sands Capital Emerging Markets Growth is a young fund that’s worth watching. It has more going for it than its fine performance in its first ten months on the market.

The fund is managed by Sands Capital Management, using a tested formula. They invest over $47 billion using the same investment discipline. They look for:

  1. Sustainable above-average earnings growth
  2. Leaders in growing industries
  3. The presence of significant competitive advantages
  4. A clear mission and understandable model
  5. Financial strength
  6. Rational valuation

Collectively, they describe this as taking a “business owner’s perspective.” That is, they believe that great businesses will eventually and inevitably see great stock price performance. While a company’s stock price might be unstable, its business operations are likely to be much more stable. As a result, they don’t obsess about short-term price targets or price volatility; they keep focused on whether the underlying company will move ahead for years to come.

And they believe in concentrated and conviction-weighted portfolio. That is, they hold few stocks and put the most money where they have the greatest conviction. They believe that magnifies their returns while helping them to control risk, since they have much less to monitor and adjust than does some guy with a 300 stock portfolio.

The strategy seems to work:

Their Select Growth strategy has returned 12.3% annually since its 1992 launch, while its Russell 1000 Growth benchmark returned 8.9%. The strategy has led its benchmark in every trailing period longer than one year.

Their Global Growth strategy has returned 25% annually since launch in 2008, while its MSCI All Country benchmark has made 13%. The strategy has led its benchmark in every trailing period.

Finally, the Emerging Markets Growth strategy has returned 10.5% annually since launch in late 2012, while the MSCI Emerging Markets Index was actually underwater by 2.4% annually.

Bottom Line

Being independent is a risky business. It often means embracing, for its long-term potential, the sorts of investments that others despise for their short-term dislocations. The well-documented travails of Asian gaming and resort firms illustrate the problem: these firms stand to benefit enormously in moving from a focus on tens of thousands of ultra-rich gamblers to a focus on hundreds of millions of middle-class Chinese vacationers who love to shop and gamble. The Chinese government has committed a half trillion dollars to infrastructure projects in support of that aim but, in the short term, their anti-corruption campaign has panicked the rich and sent revenues falling. By worrying more about the business than about the stock price, Sands is moving in as many rush out. Prospective investors need to ask whether they share Sands’ faith in businesses as long-term drivers of stock performance and share their willingness to ride out the storms. If so, they might want to pay a fair amount of attention to this latest extension of a consistently successful investment discipline.

Fund website

Touchstone Sands Capital Emerging Markets Growth

Fact Sheet

© 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.

Alpha Architect US Quantitative Value (QVAL), December 2014

By Charles Boccadoro

At the time of publication, this fund was named ValueShares US Quantitative Value.

Objective and Strategy

The ValueShares US Quantitative Value (QVAL) strategy seeks long-term capital appreciation by investing in a concentrated portfolio of 40 or so US exchange traded stocks of larger capitalizations, which the adviser determines to be undervalued but possess strong economic moats and financial strength. In a nutshell: QVAL buys “the cheapest, highest quality value stocks.”

The fund attempts to actively capture returns in excess of the so-called “value anomaly” or premium, first identified in 1992 by Professors Fama and French. Basically, stocks with lower valuation (and smaller size) deliver greater than excess returns than the overall market. Using valuation and quality metrics based on empirically vetted academic research, the adviser believes QVAL will deliver positive alpha – higher returns than can be explained by the high-book-to-market value factor.

The adviser implements the QVAL strategy in strictly systematic and quant fashion, because it believes that stock picking based on fundamentals, where value managers try to exploit qualitative signals (e.g., Ben Graham’s cigar butts), is fraught with behavioral biases that “lead to predictable underperformance.”


Alpha Architect, LLC maintains the QVAL ETF Trust. Empowered Funds, LLC, which does business as Alpha Architect, is the statutory adviser. Alpha Architect is an SEC-registered investment advisor and asset management firm based in Broomall, Pennsylvania. It offers separately managed accounts (SMAs) for high net worth individuals, family offices, and exchange-traded funds (ETFs). It does not manage hedge funds. There are eight full-time employees, all owner/operators. A ninth employee begins 1 January.

Why Broomall, Pennsylvania? The adviser explains it “is the best value in the area–lowest tax, best prices, good access…the entire team lives 5-10 minutes away and we all hate commuting and have a disdain for flash.” It helps too that it’s close to Drexel University Lebow School of Business and University of Pennsylvania Wharton School of Business, since just about everyone on the team has ties to one or both of these schools. But the real reason, according to two of the managing members: “We both have roots in Colorado, but our wives are both from Philadelphia. We each decided to ‘compromise’ with our wives and settled on Philadelphia.”

Currently, the firm manages about $200M. Based on client needs, the firm employs various strategies, including “quantitative value,” which is the basis for QVAL, and robust asset allocation, which employs uncorrelated (or at least less correlated) asset allocation and trend following like that described in The Ivy Portfolio.

QVAL is the firm’s first ETF.  It is a pure-play, long-only, valued-based strategy. Three other ETFs are pending. IVAL, an international complement to QVAL, expected to launch in the next few weeks.  QMOM will be a pure-play, long-only, momentum-based strategy, launching middle of next year. Finally, IMOM, international complement to QMOM.

ValueShares is the brand name of Alpha Architect’s two value-based ETFs. MomentumShares will be the brand name for its two momentum-based ETFs. The adviser thoroughly appreciates the benefits and pitfalls of each strategy, but mutual appreciation is not shared by each investor camp, hence the separate brand names.

With their active ETF offerings, Alpha Architect is challenging the investment industry as detailed in the recent post “The Alpha Architect Proposition.” The adviser believes that:

  • The investment industry today thrives “on complexity and opaqueness to promote high-priced, low-value add products to confuse investors who are overwhelmed by financial decisions.”
  • “…active managers often overcharge for the expected alpha they deliver. Net of fees/costs/taxes, investors are usually better served via low-cost passive allocations.”
  • “Is it essentially impossible to generate genuine alpha in closet-indexing, low-tracking error strategies that will never get an institutional manager fired.”

Its goal is “to disrupt this calculus…to deliver Affordable Active Alpha for those investors who believe that markets aren’t perfectly efficient.”

The table below depicts how the adviser sees current asset management landscape and the opportunity for its new ETFs. Notice that Active Share, Antti Petajisto’s measure of active portfolio management (ref. “How Active Is Your Fund Manager? A New Measure That Predicts Performance”) is a key tenant. David Snowball started including this metric in MFO fund profiles last March.



Wesley Gray is the executive managing member of Alpha Architect and lead portfolio manager for QVAL. We first wrote about him in the September commentary (see Morningstar ETF Conference Notes and Beware of Geeks Bearing Formulas). To say we were late to his story would be a colossal understatement.

NPR’s Neil Simon interviewed him for Weekend Edition in 2009 when Wesley was in his final year at University of Chicago Booth School of Business completing his PhD and MBA. The interview wasn’t about quant research or behavioral economics, but Wesley’s time in Iraq where is served as a Marine lieutenant on the Military Transition Team, embedded as an adviser inside the Iraqi Army. The National Review describes Wesley’s 2003 book Embedded as “…brutally honest…no attempts at equivocation…raw yet thoughtful…intelligent…a perspective we have lacked for too long.”

Aside from Wesley’s four years in the military, which fulfilled his long-held desire to engage in public service, he’s been pursuing an investing career since childhood. At age 12, he earned $3K at the 4-H fair from selling a steer he raised. His grandmother, “an obsessed Buffett fan,” sent him a copy of The Intelligent Investor. He started trading stocks seriously the minute he opened a brokerage account at age 18 while an undergrad at Wharton, even starting a little LP called ValueBull Investment Partnership with $250K raised from friends and family.

In 2010, he formed the investment adviser Empiritrage, LLC, which was short for “Empirical-Based Arbitrage.” He was an assistant professor of finance at Drexel and had just after completed his doctoral thesis on information exchange and the limits of arbitrage (ref.  “Facebook for Finance: Why do Investors Share Ideas via Their Social Networks?”). During that time, he also formed Turnkey Analyst, LLC, a firm dedicated to the educating investors and sharing quantitative techniques to the general public.

In early 2013, Wiley published the book Quantitative Value, A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, which Wesley co-authored with Tobias Carlisle. It’s quickly become a must-read for value investors and quants alike. (I burned through its 274 pages in two sittings.)

The book’s success increased interest in the firm, which is part of the firm’s business development strategy. “Through our educational efforts, we hope that investors learn about us and eventually reach out for our services. So far, the strategy is working wonderfully.”

The only problem was nobody could pronounce Empiritrage and “nobody got it.” So, the firm pulled together Empiritrage, Turnkey, and other entities under one roof to form Alpha Architect, its trademark. It required swallowing a massive pain pill (redirecting blogs, Twitter feeds, etc.), but “we are all happier now that we have one name to operate.” Wesley gave up his professorship at Drexel. He and his team are now entirely focused on making their clients and their (now one) firm successful.

The other portfolio managers responsible for the day-to-day QVAL management of the are Patrick Cleary, David Foulke, Carl Kanner, Jack Vogel, Tao Wang and Yang Xu. “Portfolio management at a quant team is … truly a team effort.” Jack, Yang, and Tao work the research, trading, and execution side. All former students of and all handpicked by Wesley. Jack holds a PhD in Finance and an MS in Mathematics. Yang and Tao hold MS degrees in Finance.

Patrick, David, and Carl work the operations side. Patrick, like Wesley, a former Marine Corps Captain, with an MBA from Harvard is the firm’s COO. While David, the firm’s compliance officer, holds an MBA from Wharton. Carl holds a BS in Business from Babson. They are all assisted behind the scenes by Tian “Get ‘er done” Yao, several consultants (mostly from academia), and a compliance lawyer.

Strategy capacity and closure

As structured currently, QVAL has the capacity for about $1B. The adviser has done a lot of research that shows, from a quant perspective, larger scale would come with attendant drop in expected annualized return “~100-150bps, but gives us capacity to $5-10B.”

Active share

74.5. “Active share” measures the degree to which a fund’s portfolio differs from the holdings of its benchmark portfolio, which for QVAL is S&P500 Total Return index.

In response to our inquiry, the adviser provided an Active Share spread-sheet for several value funds. It shows, for example, Dodge & Cox Fund has an Active Share of 68.7.

MFO has tried to collect and maintain this metric for various funds on our Active Share webpage. Antti Petajisto’s website only provides data through 2009. Morningstar holds the current values close. Only a few fund houses (e.g., FPA) publish them on their fact sheets.

So, we were excited to learn that Alpha Architect is building a tool to compute Active Share for all funds using the most current 13F filings.  The tool will be part of its 100% free (but registration required) DIY Investing webpage.

Management’s Stake in the Fund

As of October 20, 2014, the SAI filing did not indicate any stake by the portfolio managers or trustees in the new fund. But the adviser’s executive managing member Wesley Gray indicates that he and two other partners have 100% of their personal savings in QVAL, while a fourth is 100% across the firm’s strategies. A fifth member has a 100% of discretionary savings in QVAL with non-discretionary tied-up in a long established trust.

The full team investment in QVAL amounts to $1.2M with an additional $5M from member families.

The SAI did show that its three Independent Trustees are each paid an annual retainer of $4K for attendance at meetings of the Board. Wesley reports that two of trustees have $10K+ invested.

Opening date

October 22, 2014. In its very short history through November 28, 2014, it has quickly amassed $18.4M in AUM.

Minimum investment

QVAL is an ETF, which means it trades like a stock. At market close on November 28, 2014, the share price was $26.13.

Expense ratio

0.79%. There is no 12b-1 fee.

As of October 2014, a review of US long-only, open-ended mutual funds (OEFs) and ETFs across the nine Morningstar domestic categories (small value to large growth) shows just over 2500 unique offerings, including 269 ETFs, but only 19 ETFs not following an index. Average er of these ETFs not following an index is 0.81%. Average er for index-following ETFs is 0.39%. Average er of the OEFs is 1.13%, with sadly about one third of these charging front-loads of nominally 5.5%. (This continuing practice never ceases to disappoint me.) Average er of OEFs across all share classes in this group is 1.25%.

QVAL appears to be just under the average of its “active” ETF peers, in between a couple other notables: Cambria Shareholder Yield ETF (SYLD) at 0.59% and AdvisorShares TrimTabs Float Shrink ETF (TTFS) at 0.99%.

But there is more…

The adviser informs us that there are “NO SOFT DOLLARS” in the QVAL fee structure.

What’s that mean? The SEC defines soft dollars in its 1998 document “Inspection Report on the Soft Dollar Practices of Broker-Dealers, Investment Advisers and Mutual Funds.”

Advisers that use soft dollars agree to pay higher commissions to broker-dealers to execute its trades in exchange for things like Bloomberg terminals and research databases, things that the adviser could choose to pay out of its own pocket, but rarely does. The higher commissions translate to higher transactions fees that are passed onto investors, effectively increasing er through a “hidden” fee.

“Hidden” outside the er, but disclosed in the fine print. To assess whether your fund’s adviser imposes a “soft dollar” fee, look in its SAI under the section typically entitled “Brokerage Selection” or “Portfolio Transactions and Brokerage.” Here’s how the disclosure reads, something like:

To the extent Adviser obtains brokerage and research services from a broker-dealer that it otherwise would acquire at its own expense, Adviser may have an incentive pay higher commissions than would otherwise be the case.

Here’s how the QVAL SAI reads:

Adviser does not currently use soft dollars.


Among the many great ideas and anecdotes conveyed in the book Quantitative Value, one is about the crash of the B-17 Flying Fortress during a test flight at Wright Air Field in Dayton, Ohio. The year was 1935. The incident took the life of Army Air Corps’ chief test pilot Major Ployer Hill, a very experienced pilot. Initially, people blamed the plane. That must have failed mechanically, or it was simply too difficult to fly. But the investigation concluded “pilot error” caused the accident. “It turned out the Flying Fortress was not ‘too much airplane for one man to fly,’ it was simply too much airplane for one man to fly from memory.”

In response to the incident, the Army Air Corps successfully instituted checklists, which remain intrinsic to all pilot and test pilot procedures today. The authors of Quantitative Value and the adviser of QVAL believe that the strategy becomes the checklist.

The following diagram depicts the five principal steps in the strategy “checklist” the adviser employs to systematically invest in “the cheapest, highest quality value stocks.” A more detailed description of each step is offered in the post “Our Quantitative Value Philosophy,” which is a much abbreviated version of the book.


The book culminates with results showing the qualitative value strategy beating S&P500 handily between 1974 through 2011, delivering much higher annualized returns with lower drawdown and volatility. Over the same period, it also bested Joel Greenblatt’s similar Magic Formula strategy made popular in The Little Book That Beats The Market. Finally, between 1991 and 2011, it outperformed three of the top activity managed funds of the period – Sequoia, Legg Mason Value, and Third Avenue Value. Sequoia, one of the greatest funds ever, is the only one that closely competed based on basic risk/reward metrics.

The quantitative value strategy has evolved over the past 12 years. Wesley states that, “barring some miraculous change in human psychology or a ‘eureka’ moment on the R&D side,” it is pretty much set for the foreseeable future.

Before including QVAL in your portfolio, which is based on the strategy outlined in the book, a couple precautions to consider…

First, it is long only, always fully invested, and does not impose an absolute value constraint.  It takes the “cheapest 10%,” so there will always be stocks in its portfolio even if the overall market is rocketing higher, perhaps irrationally higher. It applies no draw down control. It never moves to cash.

While it may use Ben Graham’s distillation of sound investing, known as “margin of safety,” to good effect, if the overall market tanks, QVAL will likely tank too. An investor should therefore allocate to QVAL based on investment timeline and risk tolerance.

More conservative investors could also use the strategy to create a more market neutral portfolio by going long QVAL and dynamically shorting S&P 500 futures – a DIY hedge fund for a lot less than 2/20 and a lot more tax-efficient. “In this structure you get to spread bet between deep value and the market, which has been a good bet historically,” Wesley explains.

Second, it has no sector diversification constraint. So, if an entire sector heads south, like energy has done lately, the QVAL portfolio will likely be heavy the beaten-down sector. Wesley defends this aspect of the strategy: “Sector diversification simply prevents good ideas (i.e., true value investing) from working. We’ve examined this and this is also what everyone else does. And just because everyone else is doing it, doesn’t mean it is a good idea.”

Bottom Line

The just launched ValueShares US Quantitative Value (QVAL) ETF appears to be an efficient, transparent, well formulated, and systematic vehicle to capture the value premium historically delivered by the US market…and maybe more. Its start-up adviser, Alpha Architect, is a well-capitalized firm with minimalist needs, a research-oriented academic culture, and passionate leadership. It is actually encouraging its many SMA customers to move to ETFs, which have inherently lower cost and no minimums.

If the concept of value investing appeals to you (and it should), if you believe that markets are not always efficient and offer opportunities for active strategies to exploit them, and if you are tired of scratching your head trying to understand ad hoc actions of your current portfolio manager while paying high expenses (you really should be), then QVAL should be on your very short list.

Fund website

The team at Alpha Architect pumps a ton of educational content on its website, which includes white papers, DIY investing tools, and its blog.

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