This profile is no longer valid and remains purely for historical reasons. The fund has a new manager and a new strategy.

Objective

The fund seeks “maximum total return” through a combination of capital appreciation and income. The fund invests in undervalued securities, mostly mid- to large-cap dividend paying stocks. The manager has the option of investing in REITs, master limited partnerships, royalty trusts, preferred shares, convertibles, bonds and cash. The manager invests in companies “that it understands well.” The managers also generate income by selling covered calls on some of their stocks. The portfolio currently consists of about 30 holdings, 16 of which are stocks.

Adviser

Centaur Capital Partners, L.P., headquartered in Southlake, TX, has been the investment advisor for the fund since September 3, 2013. Before that, T2 Partners Management, LP advised the fund with Centaur serving as the sub-advisor. The first “T” of T2 was Whitney Tilson and this fund was named Tilson Dividend Fund. Centaur is a three person shop with about $90 million in AUM. It also advises the Centaur Value Fund LP, a hedge fund.

Manager

Zeke Ashton, founder, managing partner, and a portfolio manager of Centaur Capital Partners L.P., has managed the fund since inception. Before founding Centaur in 2002, he spent three years working for The Motley Fool where he developed and produced investing seminars, subscription investing newsletters and stock research reports in addition to writing online investing articles. He graduated from Austin College, a good liberal arts college, in 1995 with degrees in Economics and German.

Management’s Stake in the Fund

Mr. Ashton has somewhere between $500,000 and $1,000,000 invested in the fund. One of the fund’s two trustees has a modest investment in it.

Strategy capacity

That’s dependent on market conditions. Mr. Ashton speculates that he could have quickly and profitably deployed $25 billion in March, 2009. In early 2016, he saw more reason to hold cash in anticipation of a significant market reset. He’s managed a couple hundred million before but has no aspiration to take it to a billion.

Opening date

March 16, 2005

Minimum investment

$1,500 for regular and tax-advantaged accounts, reduced to $1000 for accounts with an automatic investing plan.

Expense ratio

1.95% after waivers on an asset base of $27 million.

Comments

You’d think that a fund that had squashed the S&P 500 over the course of the current market cycle, and had done so with vastly less risk, would be swamped with potential investors. Indeed, you’d even hope so. And you’d be disappointed.

Here’s how to read that chart: over the course of the full market cycle that began in October 2007, Centaur has outperformed its peers and the S&P 500 by 2.6 and 1.7 percent annually, respectively. In normal times, it’s about 20% less volatile while in bear market months it’s about 25% less volatile. In the worst-case – the 2007-09 meltdown – it lost 17% less than the S&P and recovered 30 months sooner.

$10,000 invested in October 2007 would have grown to $18,700 in Centaur against $16,300 in Vanguard’s 500 Index Fund.

Centaur Total Return presents itself as an income-oriented fund. The argument for that orientation is simple: income stabilizes returns in bad times and adds to them in good. The manager imagines two sources of income: (1) dividends paid by the companies whose stock they own and (2) fees generated by selling covered calls on portfolio investments. The latter, of late, have been pretty minimal.

The core of the portfolio is a limited number (currently about 16) of high quality stocks. In bad markets, such stocks benefit from the dividend income – which helps support their share price – and from a sort of “flight to quality” effect, where investors prefer (and, to an extent, bid up) steady firms in preference to volatile ones. Almost all of those are domestic firms, though he’s had significant direct foreign exposure when market conditions permit. Mr. Ashton reports becoming “a bit less dogmatic” on valuations over time, but he remains one of the industry’s most disciplined managers.

The manager also sells covered calls on a portion of the portfolio. At base, he’s offering to sell a stock to another investor at a guaranteed price. “If GM hits $40 a share within the next six months, we’ll sell it to you at that price.” Investors buying those options pay a small upfront price, which generates income for the fund. As long as the agreed-to price is approximately the manager’s estimate of fair value, the fund doesn’t lose much upside (since they’d sell anyway) and gains a bit of income. The profitability of that strategy depends on market conditions; in a calm market, the manager might place only 0.5% of his assets in covered calls but, in volatile markets, it might be ten times as much.

Mr. Ashton brings a hedge fund manager’s ethos to this fund. That’s natural since he also runs a hedge fund in parallel to this. Long before he launched Centaur, he became convinced that a good hedge fund manager needs to have “an absolute value mentality,” in part because a fund’s decline hits the manager’s finances personally. The goal is to “avoid significant drawdowns which bring the prospect of catastrophic or permanent capital loss. That made so much sense. I asked myself, what if somebody tried to help the average investor out – took away the moments of deep fear and wild exuberance? They could engineer a relatively easy ride. And so I designed a fund for folks like my parents. Dad’s in his 70s, he can’t live on no-risk bonds but he’d be badly tempted to pull out of his stock investments at the bottom. And so I decided to try to create a home for those people.”

And he’s done precisely that: a big part of his assets are from family and friends, people who know him and whose fates are visible to him almost daily. He’s served them well.

This profile is no longer valid and remains purely for historical reasons. The fund has a new manager and a new strategy.

Bottom Line

You’re certain to least want funds like Centaur just when you most need them. As the US market reaches historic highs that might be today. For folks looking to maintain their stock exposure cautiously, and be ready when richer opportunities present themselves, this is an awfully compelling little fund.

Fund website

Centaur Total Return Fund

Objective and strategy

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

Adviser

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

Managers

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

Strategy capacity and closure

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

Management’s stake in the fund

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

Opening date

December 31, 2003

Minimum investment

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

Expense ratio

1.49% on an asset base of $52 million, with a 1% redemption fee on shares held less than 30 days.

Comments

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

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

On investing in the financial services sector.

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

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

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

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

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

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

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

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

On investing with Royce

There are two things to note here.

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

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

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

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

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

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

Bottom Line

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

Fund website

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

Objective and strategy

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

Adviser

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

Manager

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

Strategy capacity and closure

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

Management’s stake in the fund

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

Opening date

31 December 2012

Minimum investment

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

Expense ratio

Excluding dividend expenses, borrowing costs and brokerage expenses on securities sold short, the expense ratio is 1.95% on assets of $31 million, as of January 2016. Once the “excluded” expenses are factored-in, the expense ratio bounces to 3.96% on the retail shares and 3.71% for the institutional ones.

Comments

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

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

Why bother?

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

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

What has Cognios gotten right?

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

Bottom Line

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

Fund website

Cognios Funds

Objective and strategy

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

Adviser

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

Manager

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

Strategy capacity and closure

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

Management’s stake in the fund

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

Opening date

November 20, 1995.

Minimum investment

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

Expense ratio

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

Comments

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

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

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

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

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

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

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

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

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

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

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

Bottom Line

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

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

Fund website

Leuthold Core Investment Fund

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

Objective and strategy

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

Adviser

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

Managers

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

Strategy capacity and closure

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

Active share

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

Management’s stake in the fund

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

Opening date

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

Minimum investment

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

Expense ratio

2.41% on assets of $727 million (as of September 2015). That’s a notoriously unreliable figure since it’s heavily influenced by the pass-through expense from the closed-end funds in which it invests. The fund has a 2% redemption fee on shares held fewer than 90 days.

Comments

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

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

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

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

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

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

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

Bottom Line

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

Fund website

RiverNorth Core Opportunity.

Objective and strategy

TCW/Gargoyle Hedged Value seeks long-term capital appreciation while exposing investors to less risk than broad stock market indices. The strategy is to hold a diversified portfolio mid- to large-cap value stocks, mostly domestic, and to hedge part of the stock market risk by selling a blend of index call options. In theory, the mix will allow investors to enjoy most of the market’s upside while being buffered for a fair chunk of its downside.

Adviser

TCW. TCW, based in Los Angeles, was founded in 1971 as Trust Company of the West. About $140 billion of that are in fixed income assets. The Carlyle Group owns about 60% of the adviser while TCW’s employees own the remainder. They advise 22 TCW funds, as well as nine Metropolitan West funds with a new series of TCW Alternative funds in registration. As of June 30, 2015, the firm had about $180 billion in AUM; of that, $18 billion resides in TCW funds and $76 billion in the mostly fixed-income MetWest funds.

Manager

Joshua B. Parker and Alan Salzbank. Messrs. Parker and Salzbank are the Managing Partners of Gargoyle Investment Advisor, LLC. They were the architects of the combined strategy and managed the hedge fund which became RiverPark/Gargoyle, and now TCW/Gargoyle, and also oversee about a half billion in separate accounts. Mr. Parker, a securities lawyer by training is also an internationally competitive bridge player (Gates, Buffett, Parker…) and there’s some reason to believe that the habits of mind that make for successful bridge play also makes for successful options trading. They both have over three decades of experience and all of the investment folks who support them at Gargoyle have at least 20 years of experience in the industry.

Strategy capacity and closure

The managers estimate that they could manage about $2 billion in the stock portion of the portfolio and a vastly greater sum in the large, liquid options market. TCW appears not to have any clear standards controlling fund closures.

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. Gargoyle has calculated the active share of the equity portion of the portfolio but is legally constrained from making that information public. Given the portfolio’s distinctive construction, it’s apt to be reasonably high.

Management’s stake in the fund

As of January 2014, the managers had $5 million invested in the strategy (including $500,000 in this fund). Gargoyle Partners and employees have over $10 million invested in the strategy.

Opening date

The strategy was originally embodied in a hedge fund which launched December 31, 1999. The hedge fund converted to a mutual fund on April 30, 2012. TCW adopted the RiverPark fund on June 26, 2015.

Minimum investment

$5000, reduced to $1000 for retirement accounts. There’s also an institutional share class (TFHIX) with a $1 million minimum and 1.25% expense ratio.

Expense ratio

1.50%, after waivers, on assets of $74.5 million, as of July, 2015.

Comments

Shakespeare was right. Juliet, the world’s most famously confused 13-year-old, decries the harm that a name can do:

‘Tis but thy name that is my enemy;
Thou art thyself, though not a Montague.
What’s Montague? it is nor hand, nor foot,
Nor arm, nor face, nor any other part
Belonging to a man. O, be some other name!
What’s in a name? that which we call a rose
By any other name would smell as sweet;
So Romeo would, were he not Romeo call’d,
Retain that dear perfection which he owes
Without that title.

Her point is clear: people react to the name, no matter how little sense that makes. In many ways, they make the same mistake with this fund. The word “hedged” as the first significant term of the name leads many people to think “low volatility,” “mild-mannered,” “market neutral” or something comparable. Those who understand the fund’s strategy recognize that it isn’t any of those things.

The Gargoyle fund has two components. The fund combines an unleveraged long portfolio and a 50% short portfolio, for a steady market exposure of 50%. The portfolio rebalances between those strategies monthly, but monitors and trades its options portfolio “in real time” throughout the month.

The long portfolio is 80-120 stocks, and stock selection is algorithmic. They screen the 1000 largest US stocks on four valuation criteria (price to book, earnings, cash flow and sales) and then assign a “J score” to each stock based on how its current valuation compares with (1) its historic valuation and (2) its industry peers’ valuation. They then buy the hundred most undervalued stocks, but maintain sector weightings that are close to the S&P 500’s.

The options portfolio is index call options. At base, they’re selling insurance policies to nervous investors. Those policies pay an average premium of 2% per month and rise in value as the market falls. That 2% is a long-term average, during the market panic in the fall of 2008, their options were generating 8% per month in premiums.

Why index calls? Two reasons: (1) they are systematically mispriced, and so they generate more profit (or suffer less of a loss) than they theoretically should. Apparently anxious investors are not as price-sensitive as they should be. In particular, these options are overpriced by about 35 basis points per month 88% of the time. For sellers such as Gargoyle, that means something like a 35 bps free lunch. Moreover, (2) selling calls on their individual stocks – that is, betting that the stocks in their long portfolio will fall – would reduce returns. They believe that their long portfolio is a collection of stocks superior to any index and so they don’t want to hedge away any of their stock-specific upside. By managing their options overlay, the team can react to changes in the extent to which their investors are exposed to the stock markets movements. At base, as they sell more index options, they reduce the degree to which the fund is exposed to the market. Their plan is to keep net market exposure somewhere in the range of 35-65%, with a 50% average and a healthy amount of income.

On whole, the strategy works.

The entire strategy has outperformed the S&P. Since inception, its returns have roughly doubled those of the S&P 500. It’s done so with modestly less volatility.

Throughout, it has sort of clubbed its actively-managed long-short peers. More significantly, it has substantially outperformed the gargantuan Gateway Fund (GATEX). At $7.8 billion, Gateway is – for many institutions and advisors – the automatic go-to fund for an options-hedged portfolio. It’s not clear to me that it should be. Here’s the long-term performance of Gateway (green) versus Gargoyle (blue):

Two things stand out: an initial investment in Gargoyle fifteen years ago would have returned more than twice as much as the same investment at the same time in Gateway (or the S&P 500). That outperformance is neither a fluke nor a one-time occurrence: Gargoyle leads Gateway over the past one, three, five, seven and ten-year periods as well.

The second thing that stands out is Gargoyle’s weak performance in the 2008 crash. The fund’s maximum drawdown was 48%, between 10/07 and 03/09. The managers attribute that loss to the nature of the fund’s long portfolio: it buys stocks in badly dented companies when the price of the stock is even lower than the company’s dents would warrant. Unfortunately in the meltdown, those were the stocks people least wanted to own so they got killed. The fund’s discipline kept them from wavering: they stayed 100% invested and rebalanced monthly to buy more of the stocks that were cratering. The payback come in 2009 when they posted a 42% return against the S&P’s 26% and again in 2010 when they made 18% to the index’s 15%.

The managers believe that ’08 was exceptional, and note that the strategy actually made money from 2000-02 when the market suffered from the bursting of the dot-com bubble. Morty Schaja, president of River Park Funds, notes that “We are going to have meltdowns in the future, but it is unlikely that they will play out the same way as it did 2008 . . . a market decline that is substantial but lasts a long time, would play better for Gargoyle that sells 1-2% option premium and therefore has that as a cushion every month as compared to a sudden drop in one quarter where they are more exposed. Similarly, a market decline that experiences movement from growth stocks to value stocks would benefit a Gargoyle, as compared to a 2008.” I concur. Just as the French obsession with avoiding a repeat of WW1 led to the disastrous decision to build the Maginot Line in the 1930s, so an investor’s obsession with avoiding “another ‘08” will lead him badly astray.

What about the ETF option? Josh and Alan anticipate clubbing the emerging bevy of buy-write ETFs. The guys identify two structural advantages they have over an ETF: (1) they buy stocks superior to those in broad indexes, and (2) they manage their options portfolio moment by moment, while the ETF just sits and takes hits for 29 out of 30 days each month.

There’s evidence that they’re right. The ETFs are largely based on the CBOE S&P Buy-Write Index (BXM). Between 2000 and 2012, the S&P 500 returned 24% and the BXM returned 52%; the options portion of the Gargoyle portfolio returned 110% while the long portfolio crushed the S&P.

Nonetheless, investors need to know that returns are lumpy; it’s quite capable of beating the S&P 500 for three or four years in a row, and then trailing it for the next three or four. The fund’s returns are not highly correlated with the returns of the S&P 500; the fund may lose money when the index makes money, and vice versa. That’s true in the short term – it beat the S&P 500 during August’s turbulence but substantially trailed during the quieter July – as well as the long-term. All of that is driven by the fact that this is a fairly aggressive value portfolio. In years when value investing is out of favor and momentum rules the day, the fund will lag.

Bottom line

On average and over time, a value-oriented portfolio works. It outperforms growth-oriented portfolios and generally does so with lower volatility. On average and over time, an options overlay works and an actively-managed one works better. It generates substantial income and effectively buffers market volatility with modest loss of upside potential. There will always be periods, such as the rapidly rising market of the past several years, where their performance is merely solid rather than spectacular. That said, Messrs. Parker and Salzbank have been doing this and doing this well for decades. What’s the role of the fund in a portfolio? For the guys, it’s virtually 100% of their US equity exposure. In talking with investors, they discuss it as a substitute for a large-cap value investment; so if your asset allocation plan is 20% LCV, then you could profitably invest up to 20% of your portfolio in Gargoyle. Indeed, the record suggests “very profitably.”

Fund website

TCW/Gargoyle Hedged Value homepage. If you’re a fan of web video, there’s even a sort of infomercial for Gargoyle on Vimeo but relatively little additional information on the Gargoyle Group website.

Fact Sheet

Objective and strategy

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

Adviser

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

Manager

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

Management’s stake in the fund

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

Opening date

November 1, 1995.

Minimum investment

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

Expense ratio

0.87% on $1.5 billion in assets, as of August 2015. That’s about average for funds of this type.

Comments

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

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

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

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

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

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

Bottom Line

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

Fund website

Manning & Napier Pro-Blend Conservative homepage. From there you can download the fund’s fact sheet, a two page .pdf document which gives you updated information on what the fund has been investing in and how it’s doing. From there it’s easy to open a mutual fund account and set up your AIP.

Objective and strategy

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

Adviser

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

Managers

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

Management’s stake in the fund

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

Opening date

March 29, 1985

Minimum investment

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

Expense ratio

0.34% on assets of $19.1 billion.

Comments

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

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

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

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

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

Bottom Line

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

Fund website

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

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

Objective and strategy

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

Adviser

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

Manager

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

Management’s stake in the fund

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

Opening date

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

Minimum investment

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

Expense ratio

0.87% on $115 million in assets, as of July 2015. That’s about average for funds of this type.

Comments

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

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

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

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

Bottom Line

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

Fund website

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

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

Objective and strategy

The fund seeks long-term capital appreciation by investing in a compact portfolio of developed and developing markets stocks. The strategy combines fundamental analysis of individual equities with a top-down overlay which shapes country and sector weights. At the level of individual securities, the managers use a growth-at-a-reasonable-price; they characterize it as “a core investment style with a modest growth tilt.” They target firms with three characteristics:

• positive earnings surprises
• sustainably high or increasing return on equity, and
• attractive valuations.

At the country and sector level, they look for “green lights” in four areas:

• fundamentals
• valuations,
• beta, and
• price trend.

Those inquiries include questions about currency trends. They do not hedge their currency exposure. The portfolio holds around 30 equally-weighted positions. They are not hesitant “to weed out the losers.”

Adviser

J O Hambro Capital Management (JOHCM) is an investment boutique headquartered in London, but with offices in Singapore, New York and Boston. They were founded in 2001 and entered the U.S. market in 2009. As of March 2015, they managed $27.3 billion of assets for clients worldwide. Their US operations had $6.4 billion in AUM, with $3.1 billion in seven mutual funds.

Manager

Christopher Lees and Nudgem Richyal. Mr. Lees joined JOHCM in 2008 after 20 years with Barings Asset Management where he was, among other things, Lead Global High Alpha Manager. Mr. Richyal also joined JOHCM in 2008 from Barings where he ran large global resources and Latin American equity portfolios. Lees and Richyal have been working together for more than 12 years.  They manage about $15 billion in assets together, including the much younger, smaller and less accessible Global Equity Fund (JOGEX/JOGIX).

Strategy capacity and closure

$8 billion. As of May, 2015, the fund had about $2.8 billion in assets but the strategy, which is also manifested in separate accounts, was about twice that. In response, the advisor slated a “soft close” for July 2015. They would prefer to avoid a “hard close” but haven’t foreclosed that option. They anticipate reopening only if “we experienced significant redemptions, or if market conditions changed dramatically.”

Active share

94.2. “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. An active share of 94.2 is extremely high for a fund with a large cap portfolio.

Management’s stake in the fund

None, which is understandable since the managers are British and the fund’s only open to U.S. investors. The managers do invest in the strategy through a separate vehicle but we do not know the extent of that investment.

Opening date

July 29, 2009 for the institutional class, March 31, 2010 for the retail class.

Minimum investment

$2,000 for Class II retail shares, $25,000 for Class I institutional shares.

Expense ratio

1.34% for retail shares, 1.09% for institutional ones on assets of $2.8 billion.

Comments

It’s hard to find fault with JOHCM Select International. As of 31 March 2015, the five-year-old fund has the best performance of any international large growth portfolio:

Remarkably, those returns have not come at the expense of heightened volatility. Here’s the Observer’s risk-return profile for JOHAX’s performance against its international large-growth peers since inception.

Here’s the interpretation:

• JOHAX has made rather more than twice as much as its peers; 98% total since inception, which comes to 14.4% per year.
• Raw volatility is in-line with its peers; the maximum drawdown, peak-back-to-peak recovery time, the Ulcer Index (which measures a combination of the depth and length of a drawdown) and downside deviation are not noticeably higher than its peers.
• Measures of the risk-return trade-off (the Sharpe, Sortino and Martin ratios) are all uniformly positive.

What about that “bear decile”? On face, it’s bad: the fund has been among the worst 20% of performers during “bear market months.” In reality, it’s somewhere between inconsequential and positive. “Bear markets months” are measured by the movement of the S&P 500, which isn’t the benchmark here, and there have been only eight such months in the fund’s 60 months of existence. So, arguably inconsequential. And it’s potentially positive: JOHAX has such a high degree of independence that it sometimes falls when its benchmark is rising (three months) and rises when its benchmark is falling (3X) and it sometimes falls substantially more (3X) or substantially less (7X) than its benchmark.

JOHAX has thereby earned the highest possible ratings from Morningstar (Five Stars, but no analyst rating because they’re off Morningstar’s radar), Lipper (Lipper Leader, not that anyone really notices, for Total Return and Consistent Returns) and the Observer (it’s a Great Owl, which means it has top-tier risk-adjusted returns than its peers in every trailing measurement period).

How do they do it?

Good question. The portfolio is very distinctive. It currently holds about 30 names, which makes it the most compact international large-growth portfolio on the market and one of the 10 most compact international large cap portfolios overall. The shares are all equally-weighted, which is both rare and useful.

They claim to be benchmark agnostic, and that’s reflected in their sector and country weights. The fund’s most recent portfolio report shows huge divergences from its benchmark in most industry sectors.

Similarly, their regional allocations are distinctive. The average international large cap fund has twice as much in Europe as in Asia; JOHCM weights them equally, at about 42% each. That Asian overweight is likely to become much more pronounced in the near term. When they close out existing positions, they sometimes just add the proceeds to their existing names. As of mid-2015, however, they’re reallocating toward Japan and emerging Asia, where all of their top-down indicators are turning positive.

They describe Japan as “one of the cheapest developed markets in the world, [which] has finally embarked upon significant Western-style corporate restructuring, which is driving some of the fastest-growing earnings revisions and returns on equity in the world.” One spur for the change was the creation of a Nikkei 400 ROE index, which tracks companies “with high appeal for investors, which meet requirements of global investment standards, such as efficient use of capital and investor-focused management perspectives.” They point to tool-maker Amada as emblematic of the dramatic changes, and substantial price appreciation, possible once Japanese corporate leaders decide to reorient their capital policies in ways (the issuance of dividends and stock buybacks) that are shareholder-friendly. Amada failed to be included in the initial index, which led management to rethink and reorient.

They are unwilling to stick with stocks which are deteriorating; they repeated invoke the phrase “weeding out the losers,” which they describe as “selling stocks that were broken fundamentally and technically.” Their process seems to find a fair number of losers, with turnover running between 50-80%. That’s about in-line with comparable funds.

The managers believe they have “an idiosyncratic approach to stock picking that means [they] tend to look in parts of the market largely ignored by more traditional growth investors.” All of the available statistical evidence seems to validate that claim.

Bottom Line

Before you rush to join the party, consider three caveats:

• Independence comes with a price: when you’re structurally out-of-step with the herd, there are going to be periods when your performance diverges sharply from theirs. There will be periods when the managers look like idiots and when you’ll feel (poorly-timed) pressure to cut and run.
• Trees don’t grow to the sky: as both Morningstar’s research and ours has demonstrated, it’s exceedingly rare for managers to decisively outperform their peers for extended periods and impossible for them to do so for much more than three consecutive years. Even Buffett’s longest win streak is just three years, which matches his longest losing streak and perpetually fuels the “has Buffett lost it?” debate.
• Closing is not a panacea: the advisor has determined that it’s in the best interests of current shareholders for the fund to restrict inflows. They’ve made that decision relatively early; they’re closing at about two-thirds of strategy capacity, which is good. Nonetheless, academic and professional research both show that performance at closed funds tends to sag. It’s not universal, but it’s a common pattern.

There are no evident red flags in the fund’s construction, management or performance. There’s an indisputably fine record at hand. Folks interested in an idiosyncratic portfolio of high growth international names should review their options quickly. Investors who are hesitant to act quickly here but can afford a high minimum might consider the team’s other U.S. fund, JOHCM Global Equity (JOGEX). It’s small, comparable to their European global fund and off to a fine start; the downside is that the minimum investment is $25,000.

Fund website

JOHCM International Select. Be patient, the navigation takes a while to get used to. If you click on the “+” in the lower right of each box, new content appears for you. There’s parallel, but slightly different, content on the webpage for the fund’s European version, JOHCM Global Select, which has a bunch US stocks since, for their perspective we are a “foreign” investment.

Objective and strategy

The fund pursues long-term capital appreciation. They look to invest in a compact portfolio of 30-50 undervalued stocks. The fund is nominally all-cap but the managers have traditionally had the greatest success in identifying and investing in small cap stocks. The fund looks for “well-seasoned companies with strong market positions, identifiable catalysts for earnings improvement and [exceptional] management.” They have strong sector biases based on valuations but will not invest in tobacco, liquor, or gaming companies based on principle. For a small cap value fund, with predominantly domestic based holdings, it has unusually high exposure to international markets. They systematically track macro conditions and have the ability to move largely to cash as a defensive measure but have not done so.

Adviser

Towle & Co. Towle was founded in 1981 and is headquartered in St. Louis. They provide investment advice to institutional and private investors through the fund, partnerships and separately managed accounts. The firm had approximately $560 million in assets under management as of December 31, 2014.

Manager

The Fund’s portfolio is managed by an investment team comprised of J. Ellwood Towle, CEO, Christopher Towle, Peter Lewis, James Shields and Wesley Tibbetts. Together, they share responsibility for all day-to-day management, analytical and research duties. Other than Mr. Shields, the team has been in place since the fund’s inception. The team also manages two partnerships and about 75 separate accounts, all of which use the same strategy.

Strategy capacity and closure

The strategy’s capacity, in all vehicles, is viewed to be approximately $1 billion, but highly dependent on market conditions and opportunities. They have previously closed when they did not feel comfortable taking on new money.

Active share

98.6 “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. An active share of 98.6 reflects a very high level of independence from its benchmark, the Russell 2000 Value index.

Management’s stake in the fund

The elder Mr. Towle has over $1 million in the fund and owns 6.5% of its shares, as of January 2015. The Towle family is the largest investor in the fund and in the strategy. The family has over 90% of their wealth invested in the strategy. All of the managers have invested in the fund. The younger Mr. Towle has between $50,000 and $100,000. Mr. Lewis has between $100,000 and $500,000.  Messr. Tibbetts and the newest manager, Messr. Shield, have modest investments. None of the trustees have invested in the fund, but then they oversee 76 funds and have virtually no investment in any of them.

Opening date

October 31, 2011. The underlying strategy has been in operation since January 1, 1982.

Minimum investment

$5,000, which is reduced to $2,500 for various tax-advantaged accounts.

Expense ratio

1.20% on assets of $75 million, as of May 2015. There’s also a 2% redemption fee on shares held fewer than 90 days.

Comments

There are two persistent investing anomalies worth noting. The first is “the value premium.” Value has persistently outperformed growth over the long-term in every size of stock. One 2013 essay claims that every Russell value index, everywhere in the world, in every sector, has outperformed its growth counterpart since inception. It’s true for the Russell 1000, 2000, 2500, Global 3000 ex-US, EMEA, Global ex-US ex-Japan, Global ex-US Large Cap, Greater China, Microcap, the whole shebang. In many instances, the long-term return from value investing is two or three times greater than in growth investing. Value investing is, in short, a free lunch in a business that swears that there are no free lunches.

The second anomaly is the almost no actively-managed value fund captures the value premium. That is, investors who bill themselves as dyed in the wool value guys have far wimpier performance than the theory says they should. Value funds tend to prevail over long periods but by less than you’d expect. That reflects the fact that very few of these guys invest in the sorts of deeply undervalued stocks that create the value premium. Instead, they’re sort of value-lite investors who liberally hedge their exposure to really cheap stocks with a lot of cheap relative to the rest of the market stocks. The reason’s simple: these stocks are cheap for a reason, they’re often fragile companies in out-of-favor industries and they have the potential to make investors in them look incredibly stupid for a painfully long stretch.

Few investors are willing to risk that sort of pain in pursuit of the full potential of deeply undervalued stocks. Towle & Co. is one of those few. They’ve managed to stick with their convictions because they haven’t had to worry a lot about skittish investors fleeing. In part that’s because they work really hard, mostly with separate account clients, to partner with investors who buy into the strategy. And, in part, it’s because they are their own biggest client: The Towle family has over 90% of their wealth invested in the strategy.  Happily, their convictions have reaped enormous gains for long-term investors.

While Towle assesses a wide variety of valuation metrics, a primary measure is price-to-sales. They focus on sales rather than earnings for two reasons. Topline measures like sales directly measure a firm’s vitality (are they able to sell more stuff at better prices each year?) which is important for a discipline that relies on buying robust growth at value prices. And topline measures like sales are harder to fudge than bottom line measures like earnings; a lot of financial engineering goes into “managing” earnings which makes them a less reliable measure.

Towle’s portfolio sports a price-to-sale ratio of 0.26 while its benchmark is four times pricier: 1.03. The Total Stock Market Index sells at 1.61, a 600% higher price. By that measure, only one other stock fund (out of 2300 domestic equity funds) has such a deeply undervalued portfolio. By measures such as price-to-book, Towle’s stocks sell at a 30% discount (0.91 versus 1.45) to its benchmark and a 65% discount (0.91 versus 2.52) to the broader stock market.

In the long term, this strategy has performed well. There are about two dozen small cap value funds with 20 year track records. Precisely one of those, the long-closed Bridgeway Ultra-Small Company Fund (BRUSX), has managed to outperform the Towle strategy. In the very long term, Towle has performed astonishingly well. Here are the stats for performance since the strategy’s inception in 1982:

That said, a free lunch is still not a free ride. Over shorter periods, and sometimes over quite lengthy periods, deep value stocks can remain stubbornly undervalued and unrewarding. While the strategy has a three decade track record, the mutual fund has been in operation for about four years and has married substantially above average returns with even more substantially above average volatility.

The fund’s sector concentration – lots of consumer cyclicals, energy and industrials but very little tech, pharma or utilities – contributes to the potential for short-term volatility. In addition, the managers occasionally make mistakes. Joe Bradley, one of the folks at Towle, says of the strategy’s 2011 performance, “we made some bad choices and we stunk it up.” Indeed the strategy posted three disastrous years this century in which they trailed their benchmark by double digits: 2000 (-1 versus +22.8), 2008 (-49.9 versus -28.9) and 2011 (-17.4 versus -5.5). Two of those three lagging years was then followed by phenomenal outperformance: 2001 (42.8% vs 14.0) and 2009 (101% vs 20.5). The portfolio, Mr. Bradley reports, became like a too-tightly compressed spring; when the rebound occurred, it was incredibly powerful.

Bottom Line

Towle Deep Value positions itself a “an absolute value fund with a strong preference for staying fully invested.” While most absolute value funds often pile up cash, Towle chooses to turn over more rocks – in under covered small caps and international markets alike – in order to find enough deeply undervalued stocks to populate the portfolio. The fund has the potential to play a valuable role in a long-term investor’s portfolio. Its focus is on a volatile and sometimes-despised corner of the market means that it’s not appropriate as a core holding but its distinctive strategy, sensible structure, steady discipline and outstanding long-term record makes it a serious contender for diversifying a portfolio heavily weighted in large cap stocks.

Fund website

Towle Deep Value Fund. It’s a pretty Spartan site. Folks seriously interested in understanding the strategy and its performance over the past 34 years would be better served by checking out the Towle & Co. website.

Fact Sheet