Category Archives: Stars in the shadows

Small funds of exceptional merit

Sunbridge Capital Emerging Markets (formerly Fiera Capital Emerging Markets Fund), (RIMIX, CNRYX), October 2016

By Dennis Baran

At the time of publication, this fund was named City National Rochdale Emerging Markets Fund.
This fund was formerly named Fiera Capital Emerging Markets Fund.

Objective and strategy

The fund seeks to provide long-term capital appreciation primarily by investing in locally listed large, medium, and small quality companies broadly accessible to U.S. investors within Asian Emerging Markets. The Adviser conducts on-the-ground research to provide direct insight into these companies using its domain expertise in the region, and while it may invest in companies from any emerging market country, it expects to focus its investments in Asia.

The fund is intended for long-term investors who have a time horizon of at least 5 years but preferably 7-10. It was first mentioned in the April 2015 edition of MFO as Continue reading →

Mairs and Power Small Cap Fund (MSCFX), September 2016

By David Snowball

Objective and strategy

The fund seeks “above-average” long-term capital appreciation by investing in 40-45 small cap stocks. For their purposes, “small caps” have a market capitalization under $3.4 billion at the time of purchase. The manager is authorized to invest up to 25% of the portfolio in foreign stocks and to invest, without limit, in convertible securities (but he plans to do neither). Across all their portfolios, Mairs & Power invests in “carefully selected, quality growth stocks” purchased “at reasonable valuation levels.” Continue reading →

Ariel Global (AGLOX), August 2016

By David Snowball

Objective and strategy

Ariel Global Fund’s fundamental objective is long-term capital appreciation. The manager pursues an all-cap global portfolio. The fund is, in general, currency hedged so that the returns you see are driven by stock selection rather than currency fluctuation. The manager pursues a “bottom up” discipline which starts by weeding out as much trash as humanly possible before proceeding to a meticulous investment in both the fundamentals of the remaining businesses and their intrinsic value. The fund is diversified and will generally hold 50-150 positions. As of July 2016, there are 84. Continue reading →

Catalyst/MAP Global Balanced (TRXAX, TRXIX), August 2016

By David Snowball

At the time of publication, this fund was named Catalyst/MAP Global Total Return Income.

Objective and strategy

The manager attempts to preserve capital while generating a combination of current income and moderate long-term capital gains. The portfolio has four sleeves:

  • 40-65 global equity positions constituting 30-70% of the portfolio depending on market conditions. Over the past five years, the range has been 54-62%.
  • Income-generating covered calls which might be sold on 0-30% of the portfolio. Of late option premiums have not justified writing.
  • Short/intermediate-term bonds, generally rated B+ or better and generally with an average maturity of approximately a year.
  • Cash, which has traditionally been 5-15% of the portfolio.

The portfolio is unconstrained by geography, credit quality or market cap. The manager is risk conscious, looking for securities that combine undervaluation with a definable catalyst which will lead the market to recognize its intrinsic value. Continue reading →

Intrepid Endurance (ICMAX), April 2016

By David Snowball

Objective and strategy

The fund pursues long-term capital appreciation by investing in high quality small cap equities, which they’ll only buy and hold when they’re undervalued. “Small stocks” are stocks comparable in size to those in common indexes like the Russell 2000; currently, that means a maximum cap of $6.5 billion. The fund can hold domestic and international common stocks, preferred stocks, convertible preferred stocks, warrants, and options. They typically hold 15-50 securities. High quality businesses, typically, are “internally financed companies generating cash in excess of their business needs, with predictable revenue streams, and in industries with high barriers to entry.” The managers calculate the intrinsic value of a lot of small companies, though very few are currently selling at an acceptable discount to those values. As a result, the fund has about two-thirds of its portfolio in cash (as of March 2016). When opportunities present themselves, though, the managers deploy their cash quickly; in 2011, the fund moved from 40% cash down to 20% in the space of two weeks.  


Intrepid Capital Management. Intrepid was founded in 1994 by the father and son team of Forrest and Mark Travis. It’s headquartered in Jacksonville, Florida; the location is part of a conscious strategy to distance themselves from Wall Street’s groupthink. Rather distinctively, their self-description stresses the importance of the fact that their managers have rich, active lives (“some of us surf … others spend weekends at kids’ football games”) outside of work. That focus “makes us a better company and better managers.” They are responsible for “approximately $800 million for individuals and institutional investors through a combination of separately managed accounts, no-load mutual funds, and a long/short hedge fund.” They advise six mutual funds.


Jayme Wiggins, Mark Travis and Greg Estes. Mr. Wiggins, whose first name is pronounced “Jay Mee,” is the lead manager and the guy responsible for the fund’s day-to-day operations. His career is just a bit complex: right after college, he joined Intrepid in 2002 where he worked as an analyst on the strategy before it even became a fund. In 2005 Jayme took over the high-yield bond strategy which, in 2007, was embodied in the new Intrepid Income Fund (ICMUX). In 2008, he left to pursue his MBA at Columbia. While he was away, Endurance’s lead manager Eric Cinnamond left to join River Road Asset Management. Upon his return in September 2010, Jayme became lead manager here. Mr. Travis is one of Intrepid’s founders and the lead manager on Intrepid Capital (ICMBX). Mr. Estes, who joined the firm in 2000, is lead manager of Intrepid Disciplined Value (ICMCX). Each member of the team contributes to each of the firm’s other funds.

Strategy capacity and closure

The managers would likely begin discussions about the fund’s assets when it approaches the $1 billion level, but there’s no firm trigger level. What they learned from the past was that too great a fraction of the fund’s assets represented “hot money,” people who got excited about the fund’s returns without ever becoming educated about the fund’s distinctive strategy. When the short-term returns didn’t thrill them, they fled. The managers are engaged now in discussions about how to attract more people who “get it.” Their assessment of the type of fund flows, as much as their amount, will influence their judgment of how and when to act.

Management’s stake in the fund

All of the fund’s managers have personal investments in it. Messrs. Travis and Wiggins have between $100,000 and $500,000 while Mr. Estes has between $10,000 and $50,000. The fund’s three independent directors also all have investments in the fund; it’s the only Intrepid fund where every director has a personal stake.

Opening date

The underlying small cap strategy launched in October, 1998; the mutual fund was opened on October 3, 2005.

Minimum investment

$2,500 for Investor shares, $250,000 for Institutional (ICMZX) shares.

Expense ratio

1.40% on assets of approximately $250 million (as of 3/30/16).


Start with two investing premises that seem uncontroversial:

  1. You should not buy businesses that you’ll regret owning. At base, you wouldn’t want to own a mismanaged, debt-ridden firm in a dying industry.
  2. You should not pay prices that you’ll regret paying. If a company is making a million dollars a year, no matter how attractive it is, it would be unwise to pay $100 million for it.

If those strike you as sensible premises, then two conclusions flow from them:

  1. You should not buy funds that invest in businesses regardless of their quality or price. Don’t buy trash, don’t pay ridiculous amounts even for quality goods.
  2. You should buy funds that act responsibly in allocating money based on the availability of quality businesses at low prices. Identify high quality goods that you’d like to own, but keep your money in your wallet until they’re on a reasonable sale.

The average investor, individual and professional, consistently disregards those two principles. Cap-weighted index funds, by their very nature, are designed to throw your money at whatever’s been working recently, regardless of price or quality. If Stock A has doubled in value, its weighting in the index doubles and the amount of money subsequently devoted to it by index investors doubles. Conversely, if Stock B halves in value, its weighting is cut in half and so is the money devoted to it by index funds.

Most professional investors, scared to death of losing their jobs because they underperformed an index, position their “actively managed” funds as close to their index as they think they can get away with. Both the indexes and the closet indexers are playing a dangerous game.

How dangerous? The folks at Intrepid offer this breakdown of some of the hot stocks in the S&P 500:

Four S&P tech stocks—Facebook, Amazon, Netflix, and Google (the “FANGs”)—accounted for $450 billion of growth in market cap in 2015, while the 496 other stocks in the S&P collectively lost $938 billion in capitalization. Amazon’s market capitalization is $317 billion, which is bigger than the combined market values of Walmart, Target, and Costco. These three old economy retailers reported trailing twelve month GAAP net income of nearly $17 billion, while Amazon’s net income was $328 million.

As of late March, 2016, Amazon trades at 474 times earnings. The other FANG stocks sell for multiples of 77, 330 and 32. Why are people buying such crazy expensive stocks? Because everyone else is buying them.

That’s not going to end well.

The situation among small cap stocks is worse. As of April 1, 2016, the aggregate price/earnings ratio for stocks in the small cap Russell 2000 index is “nil.” It means, taken as a whole, those 2000 stocks had no earnings over the past 12 months. A year ago, the p/e was 68.4. In late 2015, the p/e ratios for the pharma, biotech, software, internet and energy sectors of the Russell 2000 were incalculable because those sectors – four of five are very popular sectors – have negative earnings.

“Small cap valuations,” Mr. Wiggins notes, “are pretty obscene. In historical terms, valuations are in the upper tier of lunacy. When that corrects, it’s going to get really bad for everybody and small caps are going to be ground zero.”

At the moment, just 50 of 2050 active U.S. equity mutual funds are holding significant cash (that is, 20% or more of total assets). Only nine small cap funds are holding out. That includes Intrepid Endurance whose portfolio is 67% cash.

Endurance looks for 30-40 high-quality companies, typically small cap names, whose prices are low enough to create a reasonable margin of safety. Mr. Wiggins is not willing to lower his standards – for example, he doesn’t want to buy debt-ridden companies just because they’re dirt cheap – just for the sake of buying something. You’ll see the challenge he faces as you consider the Observer’s diagram of the market’s current state and Endurance’s place in it.


It wasn’t always that way. By his standards, “that small cap market was really cheap in ‘09 to fairly-priced in 2011 but since then it’s just become ridiculously expensive.”

For now, Mr. Wiggins is doing what he needs to do to protect his investors in the short term and enrich them in the longer term. He’s got 12 securities in the portfolio, in addition to the large cash reserve. He’s been looking further afield than usual because he’d prefer being invested to the alternative. Among his recent purchases are the common stock of Corus Entertainment, a small Canadian firm that’s Canada’s largest owner of women’s and children’s television networks, and convertible shares in EZcorp, an oddly-structured (hence mispriced) pawn shop operator in the US and Mexico.

While you might be skeptical of a fund that’s holding so much cash, it’s indisputable that Intrepid Endurance has been the single best steward of its shareholders’ money over the full market cycle that began in the fall of 2007. We track three sophisticated measures of a fund’s risk-return tradeoff: its Sharpe ratio, Sortino ratio and Martin ratio.

Endurance has the highest score on all three risk-return ratios among all small cap funds – domestic, global, and international, value, core and growth.  

We track short-term pain by looking at a fund’s maximum drawdown, its Ulcer index which measures the depth and duration of a drawdown, its standard deviation and downside deviation.

Endurance has the best or second best record, among all small cap funds, on all of those risk measures. It also has the best performance during bear market months.

And it has substantially outperformed its peers. Over the full cycle, Endurance has returned 3.6% more annually than the average small-value fund. Morningstar’s Katie Reichart, writing in December 2010, reported that “the fund’s annualized 12% gain during [the past five years] trounced nearly all equity funds, thanks to the fund’s stellar relative performance during the market downturn.”

Bottom Line

Endurance is not a fund for the impatient or impetuous. It’s not a fund for folks who love the thrill of a rushing, roaring bull market. It is a fund for people who know their limits, control their greed and ask questions like “if I wanted to find a fund that I could trust to handle the next seven to ten years while I’m trying to enjoy my life, which would it be?” Indeed, if your preferred holding period for a fund is measured in weeks or months, the Intrepid folks would suggest you go find some nice ETF to speculate with. If you’re looking for a way to get ahead of the inevitable crash and profit from the following rebound, you owe it to yourself to spend some time reading Mr. Wiggins’ essays and doing your due diligence on his fund.

Fund website

Intrepid Endurance Fund

© 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.

Royce Global Financial Services (RYFSX), March 2016

By David Snowball

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.


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.


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.


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.

ryfsx since inception

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

ryfsx current cycle

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.

© 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.

AXS Market Neutral (formerly Cognios Market Neutral), (COGMX), February 2016

By David Snowball

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

Objective and strategy

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


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.


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.


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

© 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.

Leuthold Core Investment (LCORX), February 2016

By David Snowball

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%.


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.


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.


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: check check check check check check check check check check

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

© 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.

Fidelity Total Emerging Markets (FTEMX), December 2015

By David Snowball

Objective and strategy

FTEMX seeks income and capital growth by investing in both emerging markets equities and emerging markets debt. White their neutral weighting is 60/40 between stocks/bonds, the managers adjust the balance between equity and debt based on which universe is most attractively positioned. In practice, that has ranged between 55% – 75% in equities. Within equities, sector and regional exposure are driven by security selection; they go where they find the best opportunities. The debt portfolio is distinctive; it tends to hold US dollar-denominated debt (a conservative move) but overweight frontier and smaller emerging markets (an aggressive one).


Fidelity Investments. Fidelity has a bewildering slug of subsidiaries spread across the globe. Collectively they manage 575 mutual funds, over half of those institutional, and $2.1 trillion in assets.


John Carlson and a five person team of EM equity folks. Mr. Carlson has managed Fidelity’s EM bond fund, New Markets Income (FNMIX), since 1995. He added Global High Income (FGHIX) in 2011. He was Morningstar’s Fixed-Income Manager of the Year in 2011. He manages $7.8 billion and is supported by a 15 person team. The equity managers are Timothy Gannon, Jim Hayes, Sam Polyak, Greg Lee and Xiaoting Zhao. Gannon, Hayes and Polyak have been with the fund since inception, Lee was added in 2012 and Zhao in 2015. These folks have been responsible since 2014 for Emerging Markets Discovery (FEDDX), a four star fund with a small- to mid-cap bias. They also help manage Fidelity Series Emerging Markets (FEMSX), a four star fund that is only available to the managers of Fidelity funds-of-funds. The equity managers are each responsible for investing in a set of industries: Hayes (financials, telecom, utilities), Polyak (consumer and materials), Lee (industrials), Gannon (health care) and Zhao (tech). They help manage between $2 – 12 billion each.

Management’s stake in the fund

Messrs. Carlson, Gannon and Hayes have each invested between $100,000 and $500,000. Mr. Lee and Mr. Polyak have no investment in the fund. None of the fund’s 10 trustees have an investment in it. While they oversee Fidelity’s entire suite of EM funds, five of the 10 have no investment in any of the EM funds.

Opening date

November 1, 2011

Minimum investment


Expense ratio

1.40% on assets of $62 million (as of 11/01/2015). There’s also a 1.5% redemption fee on shares held fewer than 90 days.


Simple, simple, simple.

The argument for considering an emerging markets fund is simple: they offer the prospect of being the world’s best performing asset class over the next 5 or 10 years. In October 2015, GMO estimated that EM stocks (4.0% real return) would be the highest returning asset class over the next 5-7 years, EM bonds (2.2%) would be second. Most other asset classes were projected to have negative real returns. At the same moment, Rob Arnott’s Research Affiliates was more optimistic, suggesting that EM stocks are priced to return 7.9% a year with high volatility compared with 1.1% in the US and 5.3% in the other developed markets. Given global demographics, it wouldn’t be surprising, give or take the wildcard effects of global warming, for them to be the best asset class over the next 50 or 100 years as well.

The argument against considering an emerging markets fund is simple: emerging markets are a mess. Their markets tend to be volatile. 30-60% drawdowns are not uncommon. National economies are overleveraged to commodity prices and their capital markets (banks, bond auctions, stock markets) can’t be relied upon; Andrew Foster, my favorite emerging markets manager and head of the Seafarer fund, argues that broken capital markets are almost a defining characteristic of the emerging markets. Investors yanked over a trillion dollars from emerging markets over the past 12 months.

The argument for investing in emerging markets through a balanced fund is simple: they combine higher returns and lower volatility than you can achieve through 100% equity exposure. The evidence here is a bit fragmentary (because the “e.m. balanced” approach is new and neither Morningstar nor Lipper have either a peer group or a benchmark) but consistent. The oldest EM balanced fund, the closed-end First Trust Aberdeen Emerging Opportunities Fund (FEO), reports that from 2006-2014 a blended benchmark returned 6.9% annually while the FTSE All World Emerging Market Equity Index returned 5.9%. From late 2011 to early 2015, Fidelity calculates that a balanced index returned 5.6% while the MSCI Emerging Markets Index returns 5.1%. Both funds have lower standard deviations and higher since-inception returns than an equity index. Simply rebalancing each year between Fidelity’s EM stock and bond funds so that you end up with a 60/40 weighting in a hypothetical balanced portfolio yields the same result for the past 10- and 15-year periods.

If balanced makes sense, does Fidelity make special sense?


Two things stand out. First, the lead manager John Carlson is exceptionally talented and experienced. He’s been running Fidelity New Market Income (FNMIX), an emerging markets bond fund, since 1995. He’s the third longest-tenured EM bond manager and has navigated his fund through a series of crises initiated in Mexico, Asia and Russia. He earned Morningstar’s Fixed-Income Fund Manager of the Year in 2011. $10,000 entrusted to him when I took over FNMIX would have grown to $100,000 now while his average peer would be about $30,000 behind.

Second, it’s a sensible portfolio. Equity exposure has ranged from 55 – 73%. Currently it’s at the lowest in the fund’s history. Mr. Carlson says that “From an asset-allocation perspective, we believe shareholders can expect the sort of downside protection typically afforded by a balanced fund comprising both fixed-income and equity exposure.” He invests in dollar-denominated (so-called “hard currency”) EM bonds, which shields his investors from the effects of currency fluctuations. That makes the portfolio’s bond safety net extra safe. At the same time, he doesn’t hedge his stock exposure and is willing to venture into smaller emerging markets and frontier markets. At least in theory those are more likely to be mispriced than issues in larger markets, and they offer a bit more portfolio diversification. The manager says that “Based on about two decades of research, we found that frontier-markets debt performs much like EM equity.” In general the equity sub-portfolio’s returns are driven by individual security selection. It shows no unusual bias to any region, sector or market cap. “On the equity side, we take a sector-neutral approach that targets high active share, a measure of the percentage of holdings that differ from the index, which historically has offered greater potential for outperformance.”

Since inception in 2011, the strategy has worked. The fund has returned 2.9% a year in very rocky times while its all-equity peers lost money. Both measures of volatility, standard deviation and downside deviation, are noticeably lower than an EM equity fund’s.


Bottom Line

I am biased in favor of EM investing. Despite substantial turmoil, it makes sense to me but only if you have a strategy for coping with volatility. Mr. Carlson has done a good job of it, making this the most attractive of the EM balanced funds on the market. There are other risk-conscious EM funds (most notable Seafarer Overseas Growth & Income SFGIX and the hedged Driehaus Emerging Markets Small Cap DRESX) but folks wanting even more of a buffer might reasonably start by looking here.

Fund website

Fidelity Total Emerging Markets

Disclosure: I own shares of FTEMX through my college’s 403b retirement plan and shares of SFGIX in my non-retirement portfolio.

RiverNorth Core Opportunity (RNCOX/RNCIX), November 2015

By David Snowball


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.


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.


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.


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.

rivernorth vs 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.

© 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.

Manning & Napier Pro-Blend Conservative (EXDAX), September 2015

By David Snowball

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.


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.


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.


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.

© 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 STAR (VGSTX), August 2015

By David Snowball

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.”


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.


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.


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:

  Which invests primarily in …
Windsor II Large U.S. companies whose stock is temporarily out of favor
Windsor The same sorts of stocks as Windsor II, but somewhat more aggressively
U.S. Growth well-known blue-chip stocks
Morgan Growth large- and mid-sized U.S. companies
PRIMECAP large- and mid-sized fast growing U.S. companies
International Growth non-U.S. companies with high growth potential
International Value non-U.S. companies from developed and emerging markets around the world that are temporarily undervalued
Explorer small U.S. companies with growth potential
Long-Term Investment-Grade medium-and high-quality investment-grade corporate bonds
GNMA GNMA is a government-owned corporation that backs mortgage loans made by the Veterans Administration and Federal Housing Authority; this fund invests in government mortgage-backed securities issued by GNMA.
Short-Term Investment-Grade Bond high- and medium-quality, investment-grade bonds with short-term maturities.

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:

vanguard account

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.

© 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.

TIAA-CREF Lifestyle Conservative (TSCLX), August 2015

By David Snowball

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.


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.


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.


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:

  Which invests in
Large-Cap Growth   large companies in new and emerging areas of the economy that appear poised for growth
Large-Cap Value   Large companies, mostly in the US, whose stock is undervalued based on an evaluation of their potential worth
Enhanced Large-Cap Growth Index   Quantitative models try to help it put extra money into the most attractive stocks in the US Large Cap Growth index; it tries to sort of “tilt” a traditional index
Enhanced Large-Cap Value Index   Quantitative models try to help it put extra money into the most attractive stocks in the US Large Cap Value index
Mid-Cap Growth   Medium-sized US companies with strong earnings growth
Mid-Cap Value   Temporarily undervalued mid-sized companies
Growth & Income   Large US companies which are paying healthy dividends or buying back their stock
Small-Cap Equity   smaller domestic companies across a wide range of sectors, growth rates and valuations
International Equity   Stocks of stable and growing non-US companies
International Opportunities   Stocks of foreign firms that might have great potential but a limited track record
Emerging Markets Equity   Stocks of firms located in emerging markets such as India and China
Enhanced International Equity Index Quantitative models try to help it put extra money into the most attractive stocks in the International Equity index
Global Natural Resources   Firms around the world involved in energy, metals, agriculture and other commodities
Bond   High quality US bonds
Bond Plus   70% investment grade bonds and 30% spicier fare, such as emerging markets bonds or high-yield debt
High-Yield   Mostly somewhat riskier, higher-yielding bonds for US and foreign corporations
Short-Term Bond   Short-term, investment grade US government and corporate bonds
Money Market   Ultra-safe, lower-returning CDs and such

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.

© 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.

James Balanced Golden Rainbow Fund (GLRBX/GLRIX), August 2015

By Charles Boccadoro

Objective and Strategy

The James Balanced Golden Rainbow Fund (GLRBX/GLRIX) seeks to provide total return through a combination of growth and income and preservation of capital in declining markets.

Under normal circumstances, the diversified James Balanced Golden Rainbow Fund invests primarily in undervalued domestic equities of companies with various market capitalizations and in high-quality (S&P’s rating of BBB or better) fixed income securities of various durations. At end of June 2015, the fund was 55% equity, 42% fixed income, and 3% cash equivalent. Median market cap was $7.6B (mid-cap, but with average about $15B) and average bond duration was 4.3 years.

The fund will normally hold both equity securities and fixed income securities, with at least 25% of its assets in equity and at least 25% of its assets in fixed income. Its broad, go-anywhere (if long only) charter enables it to go to 100% cash equivalents for short periods or even 50% for longer periods, although the adviser usually finds better opportunities than cash. It will hold foreign equities, currently just a couple percent, but probably never more than 10% and usually in form of ETFs or ADRs. Similarly, it can hold sovereign debt.

GLRBX’s allocation closely echoes the simple philosophy championed by Ben Graham in the Intelligent Investor and similarly touted by famed investors Harry Markowitz and John Bogle. Nominally 50/50 equity/fixed allocation, but then tailored based on investor temperament and/or market assessment, but never less than 25% in either. GLRBX targets defensively minded long-term investors.

Here’s a look back at the fund’s allocation since inception, which rarely deviates more than about 10% from the 50/50 split:


The fund attempts to provide total return in excess of the rate of inflation over the long term (3 to 5 years).


James Investment Research (JIR), Inc. is the fund’s adviser. Dr. Francis E. James is the controlling share-holder. In 1972, he and his wife, Iris, started JIR in the bedroom of their son, David, with only $20K AUM. Their lofty goal was to garner $10M from family, friends and business relationships, which they considered the threshold AUM to enable purchasing a computer.

A spokesman for the firm explains that marketing has never been the main focus: “It has always been doing research, taking care of our clients and managing their funds wisely.” Fortunately, performance of the early fund (a precursor to GLRBX that was a comingled trust fund managed by Dr. James for Citizen’s Federal Savings and Loan) was satisfactory and the conservative nature of the investments attracted investors. It grew to about $100 million in size in 1983. The name “Golden Rainbow” comes from the original S&L’s logo.

Today the firm manages $6.5B for individuals, businesses, and endowments, as shown below. The preponderance is in GLRBX. It is a conservative allocation fund with $4.2B AUM, established formally in 1991. It is the firm’s oldest fund and flagship. JIR advises five other mutual funds “to provide diversification in our James Advantage Funds (aka James Funds) family.” These other funds appear to be offered to more aggressive investors for at least part of their portfolios, as capital preservation in declining markets is a secondary goal.


The firm has 19 full-time employees and two part-time. Since 1978, JIR practices profit sharing with its employees. “Cash profits shared last year were in excess of 45%, not including pension contributions.”

James maintains a PO Box in Alpha, Ohio, but is actually located in nearby Xenia, which is about 10 miles east of Dayton, near Wright Patterson Air Force Base, Wright Brother’s Memorial, and Wright State University. “It is a quiet place to do research and it is far from Wall Street. We don’t tend to follow the herd and we can keep our independent approach a little easier than in a big city. We operate on 35 acres in the woods, and it helps to keep stress levels lower and hopefully helps us make wiser decisions for our clients.”


GLRBX is managed by a 9 member investment committee. Average tenure is over 20 years with the firm. Three are James’ family members: founder Dr. Frank James, CEO Barry James, and Head of Research David James. The committee makes the determination of allocation, stocks approved for purchase or sale, and bond duration. Day to day, any member handles implementation of the committee’s guidance. Normal work flow for the Golden Rainbow fund has Dr. James, Brian Culpepper, and Brian Shepardson placing the bulk of the trades.

Dr. James is 83 years old. He served in the Air Force for 23 years, achieving the rank of Colonel and headed the Department of Quantitative Studies at the Air Force Institute of Technology. He received his Ph.D. from RPI where his thesis was “The Implications of Trend Persistency in Portfolio Management,” which challenged the idea that stocks move at random and formed the basis for technical analysis still employed by the firm today. Basically, he observed that stock price movements are not random and trends persist. He remains engaged with the firm, does research, and provides mentoring to the team on a regular basis.

Barry James also served as a pilot in the Air Force, receiving degrees from both Air Force Academy and Boston University, returning full time to James in 1986. All other members of the investment team have at least one degree from colleges or universities located in Ohio, except David James who holds no formal degree, but is a CFA.

Strategy capacity and closure

GLRBX has never closed. The firm believes capacity is $10-15B, based on its studies of expected performance and trading limitations. So, plenty of capacity remaining. That said: “We think having controlled growth is the key to being able to sustain performance. We aren’t trying to become the biggest because we don’t want to sacrifice the current client and their results just to add another dollar to the fund. At the same time, we believe we have something that many folks want and need and we don’t want to turn them away if we can help them.”

James admits that it focuses on advisers versus retail investors because it wants long-term relationships and it wants to avoid maintaining a large marketing staff.

To put GLRBX in perspective, its AUM is just 1% of Vanguard Wellington Wellesley (VWINX) fund, which maintains an average market cap of about $90B in its equity portfolio.

Active share

GLRBX reports against a blended index comprising 25% S&P 500, 25% Russell 2000, and 50% Barclays Capital Intermediate Government/Credit Bond indices. In practice, however, it does not follow a benchmark and does not compute the “active share” metric, which measures the degree to which a fund’s portfolio differs from the holdings of its benchmark portfolio. So, the metric is not particularly applicable here.

JIR’s David James, Director of Research, explains: “The fund deviates greatly and on purpose from the sector weightings of both these indexes. Typically this leads us to be better diversified than the benchmark which often overweights technology and finance sectors. Similarly, the fund would show up with a high “active share” as we presently have 141 individual equity holdings compared to close to 2,500 for the combined S&P 500 / Russell 2000 Indexes.”

We asked our friends at Alpha Architect to assess the GLRBX portfolio with their on-line Active Share Calculator (coming soon) and sure enough, they calculated 94.2%.

Management’s Stake in the Fund

GLRBX represents the model for how fund management should maintain significant “skin in the game” and align its interests with those of shareholders. All long-time trustees and the entire team of 9 portfolio managers (the fund’s investment committee) are invested in the fund, plus the adviser’s retirement plan is invested in the fund. Per the latest SAI, dated November 14, 2014, the four trustees have more the $100K in the fund (two others just elected are expected to hold similar amounts). The table below represents holdings by the investment committee members:


Opening date

July 1, 1991 for investor share class (GLRBX) and March 2, 2009 for institutional share class (GLRIX).

Minimum investment

When investing directly with James, just $2K for a GLRBX individual account, just $500 for a retirement account, and just $50 with an automatic investment plan. Institutional shares also have a friendly $50K minimum by industry standards.

Just as a sample, Schwab offers GLRBX as a No Load/No Fee fund, with slightly higher minimums ($2.5K individual/$1K retirement) but imposes a short-term redemption fee. Similarly, Schwab offers GLRIX but with transaction fee and $100K minimum, but no short-term redemption fee.

Expense ratio

GLRBX charges a 1.01% expense fee annually, per its latest prospectus dated 11/01/2014, which is about 0.25% below industry average for the conservative allocation category. Its fee for active management is 0.66%.

Unfortunately like most of the industry, James still imposes 0.25% 12b-1 distribution and/or shareholder servicing fee and still maintains two share classes. Most of the 12b-1 fees are paid to the broker-dealers, like Schwab, who sell fund shares. Multiple share classes mean shareholders pay different expenses for the same fund, typically due to initial investment amount, transaction fee, or association of some form.

Institution shares (GLRIX) do not include the 12b-1 fee, resulting in a low 0.76% expense fee annually.

James imposes no loads.

On practice of soft dollars, which is essentially a hidden fee that allows advisers to pay higher commissions to broker-dealers to execute trades in exchange for things like research databases, James’ SAI allows it. Its Chief Compliance Officer, Lesley Ott, explains: “The language in our SAI permits soft dollars; however, it is our policy to not use them.  Per advice from counsel, the language in the SAI is intended to be broad in nature even though we may not engage in specific practices.”

On page 19 of the firm’s public disclosure of qualifications and practices (the so-called Part 2A of Form ADV: Firm Brochure) it states: “JIR does not have any soft-dollar arrangements and does not receive any soft-dollar benefits.” In fact, it is James’ practice to not pay for outside research; rather it conducts most of its research in-house.


The track record since inception for GLRBX is enviable by any measure and across any time frame.

Through June 2015, it is an MFO 20-year Great Owl, which means its shareholders have enjoyed top quintile risk adjusted returns based on Martin Ratio for the past 20, 10, 5, and 3 year periods. It is the only 20-year Great Owl in the conservative allocation category. It is also on the MFO Honor Roll, which means that it has delivered top quintile absolute returns in its category over the past 5, 3, and 1 year periods.

Though it is a Morningstar 5 star fund based on quantitative past performance, the fund is not covered by Morningstar analysts.

Here are its risk/return metrics across various evaluation periods through June 2015:




Here’s how it compares with notable peers during the current market cycle (Cycle 5 in table above), beginning November 2007, which includes the housing bubble:


Here’s how it compares with during the market in cycle from September 2000 through October 2007 (Cycle 4 in table above), which includes the tech bubble:


True to its objective across all these evaluation periods, the fund has delivered very satisfactory total returns while minimizing volatility and drawdown.

How does it do it?

James believes it is better to try and anticipate rather than react to the market. In doing so, it has developed a set of risk indicators and stock selection factors to set allocation and portfolio construction. James has quantified these indicators every week since 1972 in disciplined fashion to help reduce 1) emotional moves, and 2) base actions on facts and current data.

When change to the portfolio does occur, it is done gradually. “We don’t jump from one extreme to the other in terms of allocation, we use the salami approach, taking a slice into or out of the market and then watching our indicators and continuing the process if they keep the same level of bullishness or bearishness.”

The risk measures and stock selection factors include a combination of macro-economic, sector analysis, company fundamental, and even market and stock technical analysis, like moving averages, as depicted below.


Once the investment committee establishes allocation, capitalization, and sector weightings, the universe of about 8500 stocks tracked in Zack’s database, including those on Russell 2000 and S&P 500, are ranked based on three categories: relative valuation/sentiment (50%), positive and growing earnings (35%), and relative price strength (15%). The top ranked stocks then get reviewed more qualitatively by a team of 3 before being debated and voted on for inclusion by the investment committee. “A simple majority rules, with committee members voting in reverse order of seniority, to avoid undue influence by senior management.”

The disciplined risk management process is further depicted here:


In his book, 7 Timeless Principles of Investing, Barry James discusses how the decision to sell is more important than the decision to buy. James never enters a position without having the conviction to hold a stock a minimum of six month. But, more importantly and distinct than say deep-value investors, like Bruce Berkowitz or even Dodge & Cox, James will exit a position based on technical analysis alone. Not drawdown limits per se but technicals none the less.

Barry James explains: “We will sell a stock when it no longer offers good risk/reward return, which could be a change in fundamentals, but also weak price strength. While individual investors may often hang-on to poor performing stocks in hopes of a come-back, we see hanging-on to losers as an opportunity cost … we’ve developed the discipline to simply not do that.” Basically, fundamentals being equal, James would rather dump the losing stock for a stock with stronger price strength.

On share-holder friendliness, the company does a lot right: skin-in-the-game through substantial investment in the fund by all managing principals and directors of the trust, the firm’s employee retirement plan is in the fund, weekly email with updates on allocation decisions, quarterly commentary newsletters, frequent special reports including an annual financial outlook, no loads, relatively low fees, and a published Guiding Principles document.

The Guiding Principles document covers the firm’s mission, ethical standards, focus, and the importance of following the “Golden Rule” of treating others as one would like others to treat oneself. But the firm goes a step further by aligning these principles as “God Honoring” and applies the biblical reference of “Seek First the Kingdom of God.”

The firm’s vision articulated by James Barry, in fact, is “…best investment firm in US by striving to follow God Honoring Principles…we will spearhead a dramatic improvement in reputation of our industry.”

Mr. James’s religious faith clearly informs his investment practice. When asked if the association ever caused potential investors to feel awkward or even alienated, he states, “People will tell me that I don’t believe what you believe but I’m glad you do.”

Unlike socially responsible or so-called ESG funds, James applies no screen to restrict investments to firms practicing similar principles or of any religious association.

(James does act as a sub-adviser for the Timothy Plan Growth & Income Fund TGIAX, which is part of The Timothy Plan family of mutual funds for “biblically responsible investing”. These funds avoid “investing in companies that are involved in practices contrary to Judeo-Christian principles.” This family ranks in the bottom quintile on MFO’s Fund Family Score Card due in part at least to indefensible front-loads and high expense ratios.)

James is a family business and succession planning is clear and present from Dr. James to Barry and David. Beyond that, a grandson-in-law and a grandson are getting experience at the firm and in the brokerage business. A spokesman explains: “Our intent is for the firm to remain independent in the years ahead and estate planning has been done to keep the business in the family’s hands.”

Bottom Line

At some level, all actively managed funds try to anticipate the future and position accordingly. By studying past results and identifying persistent premiums, like value or small cap stocks. By studying company fundamentals to find under-appreciated stocks of high quality companies. By finding pricing displacements or inefficiencies in the market and attempting to capitalize with say value arbitrage trades. By anticipating macro-economic events or recognizing trends in the market.

James combines several of these approaches with its flagship fund for setting allocations, sector weightings, bond duration targets, equity selection, and portfolio construction in a way that mitigates risk, protects against downside, while still delivering very satisfactory returns. Given its track record, relatively small size, and disciplined implementation, there is no reason to believe it will not keep meeting its investment objective. It definitely deserves to be on the short list of easy mutual funds to own for defensive minded investors.

Fund website

James Advantage Funds maintains a decent website, which includes fund regulatory documentation, past performance, market outlooks, quarterly and special reports. Similarly, more information about the adviser can be found at James Investment Research.

JOHCM International Select II Fund (formerly JOHCM International Select Fund), (JOHAX/JOHIX), June 2015

By David Snowball

At the time of publication, this fund was named JOHCM International Select Fund,

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.”


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.


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.


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:

1 year

Top 1% (rank #1 of 339 funds)

3 year

Top 1% (rank #1 of 293 funds)

5 year

Top 1% (rank #1 of 277 funds)

(Morningstar rankings for Class I shares)

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.

johaxHere’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.

© 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.

Towle Deep Value Fund (TDVFX), May 2015

By David Snowball

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.


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.


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.


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:


Annualized return

$10,000 invested in ’82 would now be worth:

Towle Deep Value (net of fees)



Russell 2000 Value



S&P 500



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.




Standard Deviation,






Towle Deep Value Fund









Small Cap Value Group









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

© 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.

Seafarer Overseas Growth & Income (SFGIX/SIGIX), May 2015

By David Snowball

This fund profile was previously updated on March 1, 2013. You can find an archive of that profile here.

Download a .pdf of this profile here.

Objective and Strategy

Seafarer seeks to provide long-term capital appreciation along with some current income; it also seeks to mitigate volatility. The portfolio has two distinctive features. First, the fund invests a significant amount – 20-50% of its portfolio – in the securities of companies which are domiciled in developed countries but whose earnings are driven by emerging markets. The remainder is invested directly in developing and frontier markets. Second, the fund generally invests in dividend-paying common stocks but the portfolio might contain preferred stocks, convertible bonds, closed-end funds, ADRs and fixed-income securities. The fund typically has much more exposure to small- and mid-cap stocks than does its peers. On average, 80% of the portfolio is invested in common stock but that has ranged from 71% – 86%.


Seafarer Capital Partners of San Francisco. Seafarer is a small, employee-owned firm that advises the Seafarer fund in the US and a €45 million French SICAV, Essor Asie Opportunités. The firm has about $190 million in assets under management, as of March 2015.


Andrew Foster is the manager, as well as Seafarer’s cofounder, CEO and CIO. Mr. Foster formerly was manager or co-manager of Matthews Asia Growth & Income (MACSX), Matthews’ research director and acting chief investment officer. He began his career in emerging markets in 1996, when he worked as a management consultant with A.T. Kearney, based in Singapore, then joined Matthews in 1998. Andrew was named Director of Research in 2003 and served as the firm’s Acting Chief Investment Officer during the height of the global financial crisis, from 2008 through 2009. Andrew is assisted by Kate Jacquet, Paul Espinosa and Sameer Agrawal. Ms. Jacquet has been with Seafarer since 2011; Messrs. Espinosa and Agrawal joined in 2014.

Management’s Stake in the Fund

Mr. Foster has over $1 million in the fund. None of the fund’s trustees have an investment in any of the 32 funds they oversee.

Opening date

February 15, 2012

Minimum investment

$100,000 for institutional share class accounts, $2,500 for regular retail accounts and $1000 for retirement accounts. The minimum subsequent investment is $500. In a spectacularly thoughtful gesture, individuals who invest directly with the fund and who establish an automatic investment plan on their accounts are eligible for a waiver of the institutional share class’s minimum investment requirement. The folks at Seafarer argue that they would like as many shareholders as possible to benefit from lower expenses, so they’re trying to manage an arrangement by which their institutional share class might actually be considered the “universal” share class.

Expense ratio

1.25% after waivers for retail shares and 1.05% for institutional shares, on assets of $177 million (as of May 2015). The fund does not charge a 12(b)1 marketing fee but does have a 2% redemption fee on shares held fewer than 90 days.


Our contention has always been that Seafarer represents one of the best possible options for investors interested in approaching the emerging markets. It’s not a question of whether we’re right but, rather, of why we are.

Seafarer has three attributes that set it apart:

  1. Its approach is distinctive. Mr. Foster’s hope is to outperform his benchmark (the MSCI EM index) “slowly but steadily over time.” He describes the approach as a “relative return strategy” which pursues growth that’s more sustainable than what’s typical in developing markets while remaining value conscious. It’s grounded in the structural realities of the emerging markets.

    A defining characteristic of emerging markets is that their capital markets (including banks, brokerages and bond and stock exchanges) cannot be counted on to operate. In consequence, you’re best off with firms who won’t need to turn to those markets for capital needs. Seafarer targets (1) firms that can grow their top line steadily in the 7-15% per annum range and (2) those that can finance their growth internally. The focus on the top line means looking for firms that can increase revenues by 7-15% without obsessing about similar growth in the bottom line. It’s almost inevitable that EM firms will have “stumbles” that might diminish earnings for one to three years; while you can’t ignore them, you also can’t let them drive your investing decisions. “If the top line grows,” Mr. Foster argues, “the bottom line will follow.” The focus on internal financing means that the firms will be capable of funding their operations and plans without needing recourse to the unreliable external sources of capital.

    Seafarer tries to marry that focus on sustainable moderate growth “with some current income, which is a key tool to understanding quality and valuation of growth.” His preference is to buy dividend-paying stocks, but he often has 20% or more of the portfolio invested in other sorts of securities. The dividends are not themselves magical, but serve as “crude but useful” tools for identifying firms most likely to preserve value and navigate rough markets.

  2. Its performance is first rate. That judgment was substantiated in early March 2015 when Seafarer received its inaugural five-star rating from Morningstar. They’re also a Great Owl fund (as of May, 2015), a designation which recognizes funds whose risk-adjusted returns have finished in the top 20% of their peers for all trailing periods. Our greater sensitivity to risk, based on the evidence that investors are far less risk-tolerant than they imagine, leads to some divergence between our results and Morningstar’s: five of their five-star EM funds are not Great Owls, for instance, while some one-star funds are.

    Of 219 diversified EM funds currently tracked by Morningstar, 18 have a five-star rating (as of mid-March, 2015). 13 are Great Owls. Seafarer is one of only 10 EM funds (representing less than 5% of the peer group) that are both five-star and Great Owls.

  3. Its commitment to its shareholders is unmatched. Mr. Foster has produced consistently first-rate shareholder communications that are equally clear and honest about the fund’s successes and occasional lapses. And he’s been near-evangelical about reducing the fund’s expenses, often posting voluntary mid-year fee reductions as assets permit. Seafarer is one of the least expensive actively-managed EM funds available to retail investors.

In the three years through April 30, 2015, the fund’s annualized return was 10.8% which placed it in the top 2% of all EM equity funds. Rather than trumpet the fund’s success, Mr. Foster warned, both in letters to his shareholders and on the Observer’s conference call that investors should not expect such dominant returns in the future. “Our strategy ideally matches the anemic growth conditions that emerging markets have experienced lately,” he says. As growth returns, other strategies will have their day in the sun. Seafarer, meanwhile, will continue pursuing firms with sustainable rather than maximum growth.

Bottom Line

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

Fund website

Seafarer Overseas Growth and Income. The website is remarkably rich, both with analyses of the fund’s portfolio and performance, and with commentary on broader issues. One emblem of Mr. Foster’s commitment to having you understand what the fund is up to is a remarkably complete spreadsheet that provides month-by-month and year-by-year data on the portfolio, dating all the way back to the fund’s launch. Whether you’d like to know what percentage of the portfolio was invested in convertible shares in April 2014 or how the fund’s regional exposure affected its performance relative to its benchmark in 2013, the data’s there for you.


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

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

FPA Queens Road Small Cap Value (formerly Queens Road Small Cap Value), (QRSVX), April 2015

By David Snowball

At the time of publication, this fund was named Queens Road Small Cap Value.

Objective and strategy

The fund pursues long-term capital growth by investing, primarily, in a diversified portfolio of US small cap stocks. The advisor defines small cap in relation to the Russell 2000 Value Index; currently that means stocks with capitalizations under $3.3 billion. The portfolio is assembled by looking at stocks with low P/E and P/CF ratios, whose underlying firms have strong balance sheets and good management. The fund, which holds 39 common stocks and shares in one closed-end fund, is nominally non-diversified. The fund’s cash position is a residue of market opportunities. In times when the market is rich with opportunities, they deploy cash decisively. In 2009, for instance, they moved to under 3% cash. As markets have increasingly become richly-priced, the cash stake has grown. Over the past five years it has averaged 24% which is also where it stands in early 2015.


Bragg Financial Advisors, headquartered in Charlotte, NC, just across from the Dowd YMCA. They used to be located on Queens Road. Bragg is a family firm with four Braggs (founder Frank as well as sons Benton, John and Phillips) and one son-in-law (manager Steven Scruggs) leading the firm. It has been around since the early 1970s, and manages approximately $850 million in assets. A lot of that is for 300 families in the Charlotte region.


Steven Scruggs, CFA. Mr. Scruggs has worked for BFA since 2000 and manages this fund and Queens Road Value (QRVLX). That’s about it. No separate accounts, hedge funds or other distractions. He does not have research analysts but the firm’s investment committee oversees the progress of the portfolio as a whole.

Strategy capacity and closure

Based on the liquidity of their holdings, that is their ability to get into and out of positions without disrupting the market, they anticipate about $800 million in capacity. They’d likely soft close the fund at $800 million and hard close it “not far north of that.”

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. The advisor does not calculate active share for their funds. Mr. Scruggs argues that, “By the nature of our process, we’re not going to look like the index. Whether that’s a good thing or a bad thing, I can’t say.” Indeed, measured by sector weightings, the fund is demonstrably independent: the fund’s portfolio weights differ dramatically from its peer group in 10 of 11 industry sectors that Morningstar tracks.

Management’s stake in the fund

Mr. Scruggs has invested between $100,000 and $500,000 in the fund. Though modest in absolute terms, he explains that he has “the overwhelming bulk – 90-95% – of my liquid investments” in the two funds he manages. In addition, all of the fund’s independent trustees have invested in it; three of the four have investments in excess of $100,000. Especially given their modest compensation, that level of commitment is admirable, rare and helpful.

Opening date

June 13, 2002

Minimum investment

$2500 for regular accounts, $1000 for tax-sheltered accounts.

Expense ratio

1.24% on assets of $77 million.


Sometimes our greatest, and least understood, advantages, come from all of the things we don’t have. Like distractions. Second-guessers. Friends who talk us into trying hot new fashions. Or the fear of being canned if we make a mistake.

It’s sometimes dubbed “addition by subtraction.” Thomas Gray famously celebrated the virtue of being far from the temptation of the “in” crowd in his poem “Elegy Written in a Country Churchyard” (1751):

Far from the madding crowd’s ignoble strife
Their sober wishes never learn’d to stray;
Along the cool sequester’d vale of life
They kept the noiseless tenor of their way

How madding might the investment crowd be? Mr. Scruggs commends for your consideration a classic essay by Jeremy Grantham,  My Sister’s Pension Assets and Agency Problems. Mr. Grantham has been managing the pension investments for one of his sisters since 1968. She’s, in many ways, the ideal client: she’s not even vaguely interested in what the market has or has not been doing, she doesn’t meddle and isn’t going to fire him. That’s a far cry from the fate of most professional investors.

The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples’ money. The prime directive, as Keynes knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To prevent this calamity, professional investors pay ruthless attention to what other investors in general are doing. The great majority “go with the flow,” either completely or partially. This creates herding, or momentum, which drives prices far above or far below fair price.

There are many other inefficiencies in market pricing, but this is by far the largest. It explains the discrepancy between a remarkably volatile stock market and a remarkably stable GDP growth, together with an equally stable growth in “fair value” for the stock market. This difference is massive – two-thirds of the time annual GDP growth and annual change in the fair value of the market is within plus or minus a tiny 1% of its long-term trend. The market’s actual price – brought to us by the workings of wild and wooly individuals – is within plus or minus 19% two-thirds of the time. Thus, the market moves 19 times more than is justified by the underlying engines!

Investors’ fears and fads feed off each other, they do what’s “hot” rather than what’s right, they chase the same assets and prices rise briskly. Until they don’t.

The success of the two small funds managed by Mr. Scruggs for Queens Road is remarkable. He has no fancy strategies or sophisticated portfolio tools. He measures a firm’s earnings and cash flow against normal, rather than abnormal, earnings. He tries to determine whether the management is likely able to continue growing earnings. If he sees a good margin of safety in the price, he buys. His preference is to be broadly diversified across sectors and industries to reduce the impact of sector-specific risks (such as oil price or interest rate changes). He won’t buy overpriced stocks just for the sake of obtaining sector exposure (he has no investments at all in five of Morningstar’s 11 sectors while his average peer has 24% of their portfolio in those sectors) but, on whole, he thinks broader exposure is more prudent than not. In the past year, his portfolio turnover has been zero. In short, he’s not trying to outsmart the market, he’s just trying to do his job: prudently compound his investors’ capital over time.

Mr. Scruggs believes that his fund will be competitive in healthy rising markets and superior in declining ones but will likely trail noticeably in frothy markets, those driven by investor frenzy rather than fundamentals. He anticipates that, across the entirety of a five-to-seven year market cycle, he’ll offer his investors somewhat better than average returns with much less heartburn.

So far he’s been true to his word. QRSVX has returned a solid 10.25% per year run inception through the end of 2014 while its benchmark made just 9% which greater volatility. A $10,000 investment at inception would have grown to $34,400 by April 2015 – about $4,000 more than his peers would have earned.

The question is: how does Queens Road stand up to the best funds, not just to the average ones. The short answer is: really quite well. The table below compares the performance of Queens Road to the three SCV funds that Morningstar designates as “the best of the best” and the low-cost default, Vanguard’s index. This data all reflects performance over the current market cycle, from the last peak in November 2007 to March 2015. For the sake of clarity, we’ve highlighted in blue the best performer in each category.


What do we see?

  • All of the funds have been above-average performers, besting their SCV peer group by 0.2 – 1.7% per year.
  • Queens Road has strong absolute returns but the lowest absolute returns of the group.
  • Once risk is taken into account, however, Queens Road posts the best performance in every category. Its loss during the 2007-09 crash was smaller (Max Draw), its tendency to lose in falling markets (Downside Deviation) was smaller, and its risk-adjusted returns (Sharpe, Sortino, Martin and Return group) were all the best in class.

The advisor illustrates the same point by looking the fund’s performance during all of the quarters in which the Russell 2000 Value index fell:


For those counting, the fund outperformed its benchmark in nine of 10 down quarters.

When they don’t find stocks that are unreasonably cheap given their companies’ prospects, they let cash accumulate. As of the last portfolio disclosure, cash about 24% of the portfolio. That doesn’t reflect a market call, it simply reflects a shortage of stocks that offer a sufficient margin of safety:

[H]istory says we’re due for a pullback and we think it makes sense to be prepared. How do we prepare? As we’ve often said, by not making a drastic move in the portfolio. As esteemed money manager, Peter Lynch once said, “Far more money has been lost by investors trying to anticipate corrections than has ever been lost in corrections themselves.”

So why hasn’t he fallen into the trap that Mr. Grantham describes? That is, does he actually have a sustainable advantage as an investor? The fund’s 2014 Annual Report suggests three:

This is where we think we have an advantage …. First, we live in Charlotte, North Carolina, far away from the investment swirl and noise of New York, Boston or Chicago. Second, we are not a huge fund shop with a massive sales force/marketing division. Fall behind your peers for a few quarters, or heaven forbid, you lag for a couple of years at a big fund shop, and you’ve got the marketing guys in your office asking you, “What are you doing wrong? You gotta change something.” Third, we believe in our process. Collectively, our fund manager, investment committee, Board of Directors, and family have over $3 million of our own money invested in our Queens Road Funds … We understand the investment process. We are comfortable under-performing during certain periods. And we have the patience to stay the course.

Bottom Line

Most of us are best served by funds whose managers speak clearly, buy cautiously, sell rarely, and keep out of the limelight. It’s clear that thrilling funds are a disastrous move for most of us. The funds that dot the top of last year’s performance list have a real risk of landing on next year’s fund liquidation list. Investors who understand the significance of “for the long-term” in the phrase “stocks for the long-term” come to have patience with their portfolios; that patience willingness to let an investment play out over six years rather than six months distinguishes successful investors from the herd. Based on his record over the past 13 years, Mr. Scruggs has earned the designations patient, disciplined, successful. If you aspire to the same, the two Queens Road funds should surely be on your due-diligence list.

Fund website

Queens Road Small Cap Value fund

© 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.

Pinnacle Value (PVFIX), March 2015

By David Snowball


Pinnacle Value seeks long-term capital appreciation by investing in small- and micro-cap stocks that it believes trade at a discount to underlying earnings power or asset values. It might also invest in companies undergoing unpleasant corporate events (companies beginning a turnaround, spin-offs, reorganizations, broken IPOs) as well as illiquid investments. It also buys convertible bonds and preferred stocks which provide current income plus upside potential embedded in their convertibility. The manager writes that “while our structure is a mutual fund, our attitude is partnership and we built in maximum flexibility to manage the portfolios in good markets and bad.”


Bertolet Capital of New York. Bertolet has $83 million in assets under management, including this fund and one separate account.


John Deysher, Bertolet’s founder and president. From 1990 to 2002 Mr. Deysher was a research analyst and portfolio manager for Royce & Associates. Before that he managed equity and income portfolios at Kidder Peabody for individuals and small institutions. The fund added an equities analyst, Mike Walters, in January 2011 who is also serving as a sort of business development officer.

Strategy capacity and closure

The strategy’s maximum capacity has not been formally determined. It’s largely dependent on market conditions and the availability of reasonably priced merchandise. Mr. Deysher reports “if we ever reach the point where Fund inflows threaten to dilute the quality of investment ideas, we’ll close the Fund.” Given his steadfast and enduring commitment to his investment discipline, I have no doubt that he will.

Active share

99%. “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. Pinnacle’s active share is typically between 98.5-99%, indicating an exceedingly high level of independence.

Management’s stake in the fund

Mr. Deysher has in excess of $1,000,000 in the fund, making him the fund’s largest shareholder. He also owns the fund’s advisor. Two of the fund’s three independent directors have invested over $100,000 in the fund while one has only a nominal investment, as of the May 2014 Statement of Additional Information.

Opening date

April Fool’s Day, 2003.

Minimum investment

$2500 for regular accounts and $1500 for IRAs. The fund is available through TD Ameritrade, Fidelity, Schwab, Vanguard and other platforms.

Expense ratio

1.49%, after waivers, on assets of $67 million. There is a 1% redemption fee for shares held less than a year.


By any rational measure, for long-term investors Pinnacle Value is the best small cap value fund in existence.

There are two assumptions behind that statement:

  1. Returns matter.
  2. Risk matters more.

The first is self-evident; the second requires just a word of explanation. Part of the explanation is simple math: an investment that falls by 50% must subsequently rise by 100% just to break even. Another part of the explanation comes from behavioral psychology. Investors are psychologically ill-equipped to deal with risk: we hate huge losses and we react irrationally in the face of them but we refuse to believe that they’re going to happen to us, so we rarely act appropriately to mitigate them. In good times we delude ourselves into thinking that we’re not taking on unmanageable risks, then they blow up and we sit for years in cash. The more volatile the asset class, the greater the magnitude of our misbehavior.

If you’re thinking “uh-uh, not me,” you need to go buy Dan Kahneman’s Thinking, Fast and Slow (2013) or James Montier’s The Little Book of Behavioral Investing (2010). Kahneman won the Nobel Prize for his work on the topic, Montier is an asset allocation strategist with GMO and used to be head of Global Strategy at Société Générale.

John Deysher does a better job of managing risks in pursuit of reasonable returns than any other small cap manager. Since inception, Pinnacle Value has returned about 9.9% annually. 

Using the Observer’s premium MultiSearch tool, we were able to assess the ten-year risk adjusted performance of every small cap value fund. Here’s what we found:



Coming in second

Maximum Drawdown, i.e. greatest decline

25%, best in class

Heartland Value Plus, 38.9%

Standard deviation

8%, best in class

Queens Road SCV, 15.6%

Downside deviation

5.2%, best in class

Queens Road SCV, 10.4%

Ulcer Index, which combines the magnitude of the greatest loss with the amount of time needed to recover from it

6.0, best in class

Perkins Small Cap Value, 9.2

Sharpe ratio, the most famous calculation which balances returns against volatility

0.75, best in class

0.49, AllianzGI NFJ Small-Cap Value

Sortino ratio, a refinement of the Sharpe ratio that targets downside volatility

1.15, best in class

0.71, Perkins Small Cap Value

Martin ratio, a refinement that targets returns against the size of a fund’s drawdowns

1.01, best in class

0.81, Perkins Small Cap Value

Those rankings are essentially unchanged even if we look only at results for the powerful Upmarket cycle that began in March 2009: Pinnacle returned an average of 11.4% annually during the cycle, with the group’s best performance in six of the seven measures above. It’s fourth of 94 on the Martin ratio.

We reach the same conclusion when we compare Pinnacle just against Morningstar’s “Gold” rated small cap value funds and Vanguard’s SCV index. Again, these are the 10-year numbers:

pinnacle 10yr

So what does he actually do?

The short version: he buys very good, very small companies when their stocks are selling at historic lows. Pinnacle looks for firms with strong balance sheets since small firms have fewer buffers in a downturn than large ones do, management teams that do an outstanding job of allocating capital including their own, and understandable businesses which tends to keep him out of tech, bio-tech and other high obsolescence industries.

For each of the firms they track, they know what qualifies as the “fire sale” price of the stock, typically the lowest p/e or lowest price/book ratios at which the stock has sold. When impatient investors offer quality companies at fire sale prices, Mr. Deysher buys. When they demand higher prices, he waits.

There’s an old saying, Wall Street is the place where the patient take from the impatient. Impatient investors tend to make mistakes. We are there to exploit those mistakes. We are very patient. When we find a compelling value, we step up quickly. That reflects the fact that we’re very risk adverse, not action adverse. John Deysher

His aspiration is to be competitive in rising markets and to substantially outperform in falling ones. That’s pretty much was his ten-year performance chart shows. Pinnacle is the blue line levitating over the 2008 crash; his peer group is in orange.

pinnacle chart

Pinnacle’s portfolio is compact, at 37 names.  Since fire sales are relatively rare, the fund generally sits between 40-60% in cash though he’s been willing to invest substantial amounts of that cash in a relatively short period. Many of his holdings are incredibly small; of 202 small cap value funds, only five have smaller average market caps. And many of the holdings are unusual, even by the standard of microcap value funds. Some trade over-the-counter and for some he’s virtually the only mutual fund holding them. He also owns seven closed-end funds as arbitrage plays: he bought them at vast discounts to their NAVs, those discounts will eventually revert to normal and provide Pinnacle with a source of market-neutral gain.

Bottom line

The small cap Russell 2000 index closed February 2015 at an all-time high. An investment made six years ago – March 2009 – in Vanguard’s small cap index has almost quadrupled in value. GMO calculates that U.S. small caps are the most overvalued equity class they track. If investors are incredibly lucky, prices might drift up or stage a slow, orderly decline. If they’re less lucky, small cap prices might reset themselves 40% below their current level. No one knows what path they’ll take. So Dirty Harry brings us to the nub of the matter:

You’ve gotta ask yourself one question: “Do you feel lucky?” Well, do ya, punk?

Mr. Deysher would prefer to give his investors the opportunity to earn prudent returns, sleep well at night and, eventually, profit richly from the irrational behavior of the mass of investors. Over the past decade, he’s pulled that off better than any of his peers.

Fund website

Pinnacle Value Fund. Yuh … really, John’s not much into marketing, so the amount of information available on the site is pretty limited. Jeez, we’ve profiled the fund twice before and never even made it to his “In the News” list. And while I’m pretty sure that the factsheet was done on a typewriter…. After two or three hours’ worth of conversations over the years, it’s clear that he’s a very smart and approachable guy. He provides his direct phone number on the factsheet. If I were an advisor worried about how long the good times will last and how to get ahead of events, I’d likely call him.

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.

Osterweis Growth & Income Fund (formerly Osterweis Strategic Investment), (OSTVX), February 2015      

By David Snowball

At the time of publication, this fund was named Osterweis Strategic Investment.

Objective and strategy

The fund pursues the reassuring objective of long-term total returns and capital preservation. The plan is to shift allocation between equity and debt based on management’s judgment of the asset class which offers the best risk-return balance. Equity can range from 25 – 75% of the portfolio, likewise debt. Both equity and debt are largely unconstrained, that is, the managers can buy pretty much anything, anywhere. That means that the fixed-income portfolio might at one point contain a large exposure to high-yield securities and, at another, to Treasuries. The two notable restrictions are minor: no more than 50% of the total portfolio can be invested outside the U.S. and no more than 15% may be invested in Master Limited Partnerships, which are generally energy and natural resources investments.


Osterweis Capital Management. Osterweis Capital Management was founded in 1983 by John Osterweis to manage money for high net worth individuals, foundations and endowments. They’ve got $10 billion in assets under management (as of December 31, 2015), and run both individually managed portfolios and four mutual funds. Osterweis once managed hedge funds but concluded that such vehicles served their investors poorly and so wound them down in 2012. (Their argument is recapped in the “Better Mousetrap” article, linked below.) The firm is privately-held, mostly by its employees. Mr. Osterweis is in his early 70s and, as part of the firm’s transition plan, has been transferring his ownership stake to a cadre of key employees. At least six of the eight co-managers listed below own 5% of more of the adviser.


John Osterweis, Matt Berler and Carl Kaufman lead a team that includes the folks (John Osterweis, Matthew Berler, Alexander “Sasha” Kovriga, Gregory Hermanski, and Nael Fakhry) who manage Osterweis Fund (OSTFX) and those at the Osterweis Strategic Income Fund (Carl Kaufman, Simon Lee and Bradley Kane). The equity team manages over 300 separate accounts; the fixed-income team handles “a small number” of them. The team members have all held senior positions with distinguished firms (Robertson Stephens, Morgan Stanley, and Merrill Lynch).

Strategy capacity and closure

Mr. Kaufman was reluctant to estimate capacity since it’s more determined by market conditions (“in 2008 we could have put $50 billion to work with no problem”) than by limits on the asset classes or team. Conservatively estimated, the fixed-income team could handle at least an additional $4 billion given current conditions.

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. Typically active share is calculated only for equity funds, so we do not have a calculation for OSTVX. The equity sleeve of this fund is the same as the flagship Osterweis Fund (OSTFX), whose active share is 94 which reflects a very high level of independence from its benchmark.

Management’s stake in the fund

Four of the eight team members had investments in excess of $1 million in the fund, a substantial increase since our last profile of the fund. The four younger members of the team generally have substantial holdings. As of December 31, 2013, none of the fund’s independent trustees (who are very modestly compensated for their work) had an investment in the fund. Two of the five had no investment in any of the Osterweis funds they oversee.

Opening date

August 31, 2010

Minimum investment

$5000 for regular accounts, $1500 for IRAs and other tax-advantaged accounts.

Expense ratio

1.15% on assets of $304 million (as of December 31, 2014).


Explanations exist; they have existed for all time; there is always a well-known solution to every human problem — neat, plausible, and wrong. H.L. Mencken, “The Divine Afflatus,” New York Evening Mail, 16 Nov 1917.

If you had to invest in a portfolio that held a lot of fixed-income securities which of the following would you prefer, a fund that’s “more conservative than the portfolio’s credit profile suggests,” which “shines when volatility is considered” and its “lowest 10-year Morningstar Risk score” or one that suffers from “a lack of balance,” is “one-sided,” “doubles down on related risks” and “is vulnerable to contractions”?

Good news! You don’t have to choose since those excerpts, all from Morningstar analyst Kevin McDevitt’s latest analyses, describe the exact same portfolio: Osterweis Strategic Income (OSTIX), which serves as the fixed-income portion of the Osterweis Strategic Investment Fund’s portfolio.

How does the same collection of fixed-income securities end up being praised for their excellent low risk score and being pilloried for their riskiness? Start with the dogmatic belief that “investment grade” is always safe and good and that “high yield” is always dangerous and bad. Add in the assumption that the role of fixed-income in a stock/bond hybrid “is to provide ballast” and you’ve got a recipe for dismissing funds that don’t conform to the cookie-cutter.

Neither assumption is universally true which is to say, neither should be used as an assumption when you’re judging your investments.

Is high-yield always riskier than investment grade?


There are two sources of risk to consider: interest-rate risk and credit risk. Investment grade bond investors thrive when interest rates are falling; they suffer loss of principal when interest rates rise. The risk is systemic: all sorts of intermediate-term bonds are going to suffer about equally when the Feds raise rates. Fed funds rate futures are currently forecasting a 50% prospect of a 0.25% rate hike in April and an equal chance of a 0.50% hike by October. Credit risk, the prospect that a bond issuer won’t be able to repay his debt, is idiosyncratic. That is, it’s particular to individual issuers and it’s within the power of fund managers to dodge it. In a strengthening economy, interest rate risks rise and credit risk falls. Because ratings agencies under-react to changing conditions, companies and entire sectors of the economy might have substantially lower credit risk than their “non-investment grade” ratings imply. Mr. Kaufman, one of the managers, reports on the case of “one firm in the portfolio which cut its outstanding debt in half, has lots of free cash flow and was still belatedly downgraded.” Likewise, the debt of energy companies was rated as investment grade while the sector was imploding; now that it has likely bottomed, it’s being reclassified as junk.

The Osterweis team argues that it’s possible to find lots of opportunities in shorter term high yield debt, in particular of companies that are fundamentally stronger than outdated ratings reports recognize. Such firms, Mr. Kaufman argues, offer the best risk-return tradeoff of any fixed income option today:

We invest in fixed-income for absolute return. We’re playing chicken right now, betting that interest rates won’t rise just yet. When the music stops, people are going to get hurt. I don’t like to make bets. I want to control what I can control. Investment grade investors win only if interest rates go lower. Look at what’s going to happen if nothing happens. The yield on the 10-year Treasury is 1.673%. That’s what you would get for returns if nothing happens.

Is fixed-income always the portfolio’s ballast?


There are, broadly speaking, two sorts of funds which mix both stocks and bonds in their portfolios. One sort, often simply called a “balanced” fund, sticks with a mix that changes very little over time: 60% stocks (mostly domestic large caps) plus 40% bonds (mostly investment grade), and we’re done. They tend to be inexpensive, predictable and reassuringly dull. An excellent anchor for a portfolio, at least if interest rates don’t rise.

The second sort, sometimes called an “allocation” fund, allows its manager to shift assets between and within categories, sometimes dramatically. These funds are designed to allow the management team to back away from a badly overvalued asset class and redeploy into an undervalued one. Such funds tend to be far more troubled than simple balanced funds for two reasons. First, the manager has to be right twice rather than once. A balanced manager has to be right in his or her security selection. An allocation manager has to be right both on the weighting to give an asset class (and when to give it) and on the selection of stocks or bonds within that portion of the portfolio. Second, these funds can carry large visible and invisible expenses. The visible expenses are reflected in the sector’s high expense ratios, generally 1.5 – 2%. The funds’ trading, within and between sectors, invisibly adds another couple percent in drag though trading expenses are not included in the expense ratio and are frequently not disclosed.

Why consider these funds at all?

If you believe that the market, like the global climate, seems to be increasingly unstable and inhospitable, it might make sense to pay for an insurance policy against an implosion in one asset class or one sector. One is to seek a fund designed to dodge and weave through the hard times. If the manager is good (see, for example, Rob Arnott’s PIMCO All Asset PASDX, Steve Romick’s FPA Crescent FPACX or Leuthold Core LCORX) you’ll receive your money’s worth and more. Another option would be to use the services of a good fee-only financial planner who specializes in asset allocation. In either case, you’re going to pay for access to the additional “dynamic allocation” expertise.

Why consider Osterweis Strategic Investment?

There are two reasons. First, Osterweis makes sense in an uncertain world. Osterweis Strategic Investment is essentially the marriage of the flagship Osterweis Fund (OSTFX) and Osterweis Strategic Income (OSTIX). OSTFX is primarily a stock fund, but the managers have the freedom to move decisively into bonds and cash if need be. In the last 10 years, the fund’s lowest stock allocation was 60% and highest was 96%, but it tends to have a neutral position in the upper-80s. Management has used that flexibility to deliver solid long-term returns (7.3% over the past 15 years, as of 1/21/2015) with a third less volatility than the stock market’s. Osterweis Strategic Income (OSTIX) plays the same game within the bond universe, moving between bonds, convertibles and loans, investment grade and junk, domestic and foreign. This plays hob with its long-term rankings at Morningstar, which has placed it in three very different categories (convertibles, multi-sector income and high-yield bonds) over the past 10 years but now benchmarks all of its trailing returns as if it had been a high-yield bond fund all along.

For now, the fund is dialing back on its stock exposure. Mr. Kaufman reports:

We can invest 75%/25% in either direction. Our decision to lighten up on stocks now – we’ve dropped near 60% – determined by opportunity set. We’re adding fixed income now because we’re finding lots of great value in the short-term side of the market. Equities might return 6% this year and we think we can get equity-like returns, without equity-like risk, in fixed-income portfolio.

In his recent communication with shareholders, he writes:

We prefer to add risk only when we see a “fat pitch,” of which there are precious few at this time … at current yields there is no investment grade “fat pitch.” Our focus remains on keeping duration short and layering-in higher yielding paper, especially on sharp corrections in the market like we have seen recently. We believe that the appropriate time to take a swing at investment grade bonds will be when yields are much higher and the economy is teetering towards recession.

Second, Osterweis’s expenses, direct and indirect, are more reasonable than most. The 1.15% ratio (as of the most recent prospectus) has been dropping steadily and is at the lower end for an active allocation fund, strikingly so for a tiny one. And the other two Osterweis funds each started around 1.5% and then steadily lowered their expense ratios, year after year, as assets grew. In addition, both funds tend to have lower-than-normal portfolio turnover, which decreases the drag created by trading costs.

Bottom Line

It is easy to dismiss OSTVX because it refuses to play by other people’s rules; it rejects the formulaic 60/40 split, it refuses to maintain a blind commitment to investment grade bonds, its stock sector-, size- and country-weightings are all uncommon. Because rating systems value herd-like behavior and stolid consistency, these funds may often look bad. The question is, are such complaints “neat, plausible and wrong”? The fund’s fixed income portfolio have managed a negative down-market capture over the past 12 years; that is, it rises when the bond market falls, then rises some more when the bond market rises. Osterweis closed down their hedge fund business, concluding that many investors would derive much more benefit, more economically, from using a balanced fund as a significant part of their portfolio. Given reasonable expenses, outstanding management and a long, solid track record, Osterweis Strategic Investment warrants a place on any investor’s due-diligence short list.

Fund website

Osterweis Strategic Investment. There’s a link to a really nicely-reasoned, well-written piece on why, to be blunt, hedge funds are stupid investments. Osterweis used to run one and concluded that they could actually serve their investors better (better risk/return balance, less complexity, lower expenses) by moving them to a balanced fund. The story “A Better Mousetrap” ran in the Inside Information newsletter, September 2014. It gives good insight into how the Osterweis folks think.

© 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.