January 1, 2014

Dear friends,

Welcome to the New Year. At least as we calculate it. The Year of the Horse begins January 31, a date the Vietnamese share. The Iranians, like the ancient Romans, sensibly celebrate the New Year at the beginning of spring. A bunch of cultures in South Asia pick mid-April. Rosh Hashanah (“head of the year”) rolls around in September. My Celtic ancestors (and a bunch of modern Druidic wannabees) preferred Samhain, at the start of November.

Whatever your culture, the New Year is bittersweet. We seem obsessed with looking back in regret at all the stuff we didn’t do, as much as we look forward to all of the stuff we might yet do.

My suggestion: can the regrets, get off yer butt, and do the stuff now that you know you need to do. One small start: get rid of that mutual fund. You know the one. You’ve been regretting it for years. You keep thinking “maybe I’ll wait to let it come back a bit.” The one that you tend to forget to mention whenever you talk about investments.

Good gravy. Dump it! It takes about 30 seconds on the phone and no one is going to hassle you about it; it’s not like the manager is going to grab the line and begin pleading for a bit more time. Pick up a lower cost replacement. Maybe look into a nice ETF or index fund. Track down a really good fund whose manager is willing to put his own fortune and honor at risk along with yours.

You’ll feel a lot better once you do.

We can talk about your gym membership later.

Voices from the bottom of the well

THESE are the times that try men’s souls. The summer soldier and the sunshine patriot will, in this crisis, shrink from the service of their country; but he that stands by it now, deserves the love and thanks of man and woman. Tyranny, like hell, is not easily conquered; yet we have this consolation with us, that the harder the conflict, the more glorious the triumph. What we obtain too cheap, we esteem too lightly: it is dearness only that gives every thing its value. Heaven knows how to put a proper price upon its goods; and it would be strange indeed if so celestial an article as FREEDOM should not be highly rated.

Thos. Paine, The Crisis, 23 December 1776

Investors highly value managers who are principled, decisive, independent, active and contrarian. Right up to the moment that they have one.

Then they’re appalled.

There are two honorable approaches to investing: relative value and absolute value. Relative value investors tend to buy the best-priced securities available, even if the price quoted isn’t very good. They tend to remain fully invested even when the market is pricey and have, as their mantra, “there’s always a bull market in something.” They’re optimistic by nature, enjoy fruity wines and rarely wear bowties.

Absolute value investors tend to buy equities only when they’re selling for cheap. Schooled in the works of Graham and Dodd, they’re adamant about having “a margin of safety” when investing in an inherently risk asset class like stocks. They tend to calculate the fair value of a company and they tend to use cautious assumptions in making those calculations. They tend to look for investments selling at a 30% discount to fair value, or to firms likely to produce 10% internal returns of return even if things turn ugly. They’re often found sniffing around the piles that trendier investors have fled. And when they find no compelling values, they raise cash. Sometimes lots of cash, sometimes for quite a while. Their mantra is, “it’s not ‘different this time’.” They’re slightly-mournful by nature, contemplate Scotch, and rather enjoyed Andy Rooney’s commentaries on “60 Minutes.”

If you’re looking for a shortcut to finding absolute value investors today, it’s a safe bet you’ll find them atop the “%age portfolio cash” list. And at the bottom of the “YTD relative return” list. They are, in short, the guys you’re now railing against.

But should you be?

I spent a chunk of December talking with guys who’ve managed five-star funds and who were loved by the crowds but who are now suspected of having doubled-up on their intake of Stupid Pills. They are, on whole, stoic.

Take-aways from those conversations:

They hate cash. As a matter of fact, it’s second on their most-hated list behind only “risking permanent impairment of capital”.
They’re not perma-bears. They love owning stocks. These are, by and large, guys who sat around reading The Intelligent Investor during recess and get tingly at the thought of visiting Omaha. But they love them for the prospect of the substantial, compounded returns they might generate. The price of those outsized returns, though, is waiting for one of the market’s periodic mad sales.
They bought stocks like mad in early 2009, around the time that the rest of us were becoming nauseated at the thought of opening our 401(k) statements. Richard Cook and Dowe Bynum, for example, were at 2% cash in March 2009. Eric Cinnamond was, likewise, fully invested then.
They’ve been through this before though, as Mr. Cinnamond notes, “it isn’t very fun.” The market moves in multi-year cycles, generally five years long more or less. While each cycle is different in composition, they all have similar features: the macro environment turns accommodative, stocks rise, the fearful finally rush in, stocks overshoot fair value by a lot, there’s an “oops” and a mass exit for the door. Typically, the folks who arrived late inherit the bulk of the pain.
And they know you’re disgusted with them. Mr. Cinnamond, whose fund has compounded at 12% annually for the past 15 years, allows “we get those long-term returns by looking very stupid.” Richard Cook agrees, “we’re going to look silly, sometimes for three to five years at a stretch.” Zac Wydra admits that he sometimes looks at himself in the mirror and asks “how can you be so stupid?”

And to those investors who declare, “but the market is reasonably priced,” they reply: “we don’t buy ‘the market.’ We buy stocks. Find the individual stocks that meet the criteria that you hired us to apply, and we’ll buy them.”

What do they think you should do now? In general, be patient. Mr. Cook points to Charlie Munger’s observation:

I think the [Berkshire Hathaway’s] record shows the advantage of a peculiar mind-set – not seeking action for its own sake, but instead combining extreme patience with extreme decisiveness. It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.

Which is hard. Several of the guys pointed to Seth Klarman’s decision to return $4 billion in capital to his hedge fund investors this month. Klarman made the decision in principle back in September, arguing that if there were no compelling investment opportunities, he’d start mailing out checks. Two things are worth noting about Klarman: (1) his hedge funds have posted returns in the high teens for over 30 years and (2) he’s willing to sit at 33-50% cash for a long time if that’s what it takes to generate big long-term returns.

Few managers have Klarman’s record or ability to wait out markets. Mr. Cinnamond noted, “there aren’t many fund managers with a long track record doing this because you’re so apt to get fired.” Jeremy Grantham of GMO nods, declaring that “career risk” is often a greater driver of a manager’s decisions than market risk is.

In general, the absolute value guys suggest you think differently about their funds than you think about fully-invested relative value ones. Cook and Bynum’s institutional partners think of them as “alternative asset managers,” rather than equity guys and they regard value-leaning hedge funds as their natural peer group. John Deysher, manager of Pinnacle Value (PVFIX), recommends considering “cash-adjusted returns” as a viable measure, though Mr. Cinnamond disagrees since a manager investing in unpopular, undervalued sectors in a momentum driven market is still going to look inept.

Our bottom line: investors need to take a lot more responsibility if they’re going to thrive. That means we’ve got to look beyond simple return numbers and ask, instead, about what decisions led to those returns. That means actually reading your managers’ commentaries, contacting the fund reps with specific questions (if your questions are thoughtful rather more than knee-jerk, you’d be surprised at the quality of answers you receive) and asking the all-important question, “is my manager doing precisely what I hired him to do: to be stubbornly independent, fearful when others are greedy and greedy when others are fearful?”

Alternately: buy a suite of broadly diversified, low-cost index funds. There are several really solid funds-of-index-funds that give you broad exposure to market risk with no exposure to manager risk. The only thing that you need to avoid at all costs is the herd: do not pay active management prices for the services of managers whose only goal is to be no different than every other timid soul out there.

The Absolute Value Guys

	Cash	Absolute 2013 return	Relative 2013 return
ASTON River Road Independent Value ARIVX	67%	7%	bottom 1%
Beck, Mack & Oliver Partners BMPEX	18	20	bottom 3%
Cook & Bynum COBYX	44	11	bottom 1%
FPA Crescent FPACX *	35	22	top 5%
FPA International Value FPIVX	40	18	bottom 20%
Longleaf Partners Small-Cap LLSCX	45	30	bottom 23%
Oakseed SEEDX	21	24	bottom 8%
Pinnacle Value PVFIX	44	17	bottom 2%
Yacktman YACKX	22	28	bottom 17%

* FPACX’s “moderate allocation” competitors were caught holding bonds this year, dumber even than holding cash.

Don’t worry, relative value guys. Morningstar’s got your back.

Earnings at S&P500 companies grew by 11% in 2013, through late December, and they paid out a couple percent in dividends. Arguably, then, stocks are worth about 13% more than they were in January. Unfortunately, the prices paid for those stocks rose by more than twice that amount. Stocks rose by 32.4% in 2013, with the Dow setting 50 all-time record highs in the process. One might imagine that if prices started at around fair value and then rose 2.5 times as much as earnings did, valuations would be getting stretched. Perhaps overvalued by 19% (simple subtraction of the earnings + dividend rise from the price + dividend rise)?

Not to worry, Morningstar’s got you covered. By their estimation, valuations are up only 5% on the year – from fully valued in January to 5% high at year’s end. They concluded that it’s certainly not time to reconsider your mad rush into US equities. (Our outlook for the stock market, 12/27/2013.) While the author, Matthew Coffina, did approvingly quote Warren Buffett on market timing:

Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.

He didn’t, however, invoke what Warren Buffett terms “the three most important words in all of investing,” margin of safety. Because you can’t be sure of a firm’s exact value, you always need to pay less than you think it’s worth – ideally 30 or 40% less – in order to protect your investors against your own fallible judgment.

Quo Vadis Japan

I go out of the darkness

Onto a road of darkness

Lit only by the far off

Moon on the edge of the mountains.

Izumi

One of the benefits of having had multiple careers and a plethora of interests is that friends and associates always stand ready with suggestions for you to occupy your time. In January of 2012, a former colleague and good friend from my days with the Navy’s long-range strategic planning group suggested that I might find it interesting to attend the Second China Defense and Security Conference at the Jamestown Foundation. That is how I found myself seated in a conference room in February with roughly a hundred other people. My fellow attendees were primarily from the various alphabet soup governmental agencies and mid-level military officers.

The morning’s presentations might best be summed up as grudging praise about the transformation of the Chinese military, especially their navy, from a regional force to one increasingly able to project power throughout Asia and beyond to carry out China’s national interests. When I finally could not stand it any longer, after a presentation during Q&A, I stuck my hand up and asked why there was absolutely no mention of the 600 pound gorilla in the corner of the room, namely Japan and the Japanese Maritime Self-Defense Force. The JMSDF was and is either the second or third largest navy in the world. It is considered by many professional observers to be extraordinarily capable. The silence that greeted my question was akin to what one would observe if I had brought in a dog that had peed on the floor. The moderator muttered a few comments about the JMSDF having fine capabilities. We then went on with no mention of Japan again. At that point I realized I had just learned the most important thing that I was going to take from the conference, that Japan (and its military) had become the invisible country of Asia.

The New Year is when as an investor you reflect back on successes and mistakes. And if one is especially introspective, one can ponder why. For most of 2013, I was banging the drum on two investment themes that made sense to me: (a) the Japanese equity market and (b) the Japanese currency – the yen – hedged back into U.S. dollars. The broad Japanese market touched highs this month not seen before this century. The dollar – yen exchange rate moved from 89.5 at the beginning of the year to 105.5. In tandem, the themes have proven to be quite profitable. Had an investment been made solely in the Wisdom Tree: Japan Hedged Equity ETF, a total return of 41.8% would have been achieved by the U.S. dollar investor. So, is this another false start for both the Japanese stock market and economy? Or is Japan on the cusp of an economic and political transformation?

merry men When I mention to institutional investors that I think the change in Japan is real, the most common response I get is a concern about “Abenomics.” This is usually expressed as “They are printing an awful lot of money.” Give me a break. Ben Bernanke and his little band of merry Fed governors have effectively been printing money with their various QE efforts. Who thinks that money will be repaid or the devaluation of the U.S. dollar will be reversed? The same can be said of the EU central bankers. If anything, the U.S. has been pursuing a policy of beggar thy creditor, since much of our debt is owed to others. At least in Japan, they owe the money to themselves. They have also gone through years of deflation without the social order and fabric of society breaking down. One wonders how the U.S. would fare in a similar long-term deflationary environment.

I think the more important distinction is to emphasize what “Abenomics” is not. It is not a one-off program of purchasing government bonds with a view towards going from a multi-year deflationary spiral to generating a few points of inflation. It is a comprehensive program aimed at reversing Japan’s economic, political, and strategic slide of the past twenty years. Subsumed under the rubric of “Abenomics” are efforts to increase and widen the acceptance of child care facilities to enable more of Japan’s female talent pool to actively participate in the workforce, a shift in policy for the investments permitted in pension funds to dramatically increase domestic equity exposure, and incentives to transform the Japanese universities into research and resource engines. Similarly, the Japanese economy is beginning to open from a closed economy to one of free trade, especially in agriculture, as Japan has joined the Trans Pacific Partnership. Finally, public opinion has shifted dramatically to a willingness to contemplate revision of Japan’s American-drafted post-war Constitution. This would permit a standing military and a more active military posture. It would normalize Japan as a global nation, and restore a balance of interests and power in East Asia. The ultimate goal then is to restore the self-confidence of the Japanese nation. So, what awakened Japan and the Japanese?

Strangely enough, the Chinese did it. I have been in Japan four times in the last twenty-two months, which does not make me an expert on anything. But it has allowed me to discern a shift in the mood of the country. Long-time Japan hands had told me that when public opinion in Japan shifts, it shifts all at once and moves together in the same direction. Several months ago, I asked a friend and investment manager who is a long-time resident of Tokyo what had caused that shift in opinion. His response was that most individuals, he as well, traced it to the arrest and detention by the Japanese Coast Guard, of a Chinese fishing vessel and its captain who had strayed into Japanese waters. China responded aggressively, embargoing rare earth materials that the Japanese electronics and automobile industries needed, and made other public bellicose noises. Riots and torching of Japanese plants in China followed, with what seemed to be the tacit approval of the Chinese government. Japan released the ship and its captain, and in Asian parlance, lost face. As my friend explained it, the Japanese public came to the conclusion that the Chinese government was composed of bad people whose behavior was unacceptable. Concurrently, Japan Inc. began to relocate its overseas investment away from China and into countries such as Vietnam, Indonesia, Thailand, and Singapore.

From an investment point of view, what does it all mean? First, one should not look at Prime Minister Abe, Act II (remember that he was briefly in office for 12 months in 2006-2007) in a vacuum. Like Reagan and Churchill, he used his time in the “wilderness years” to rethink what he wanted to achieve for Japan and how he would set about doing it. Second, one of the things one learns about Japan and the Japanese is that they believe in their country and generally trust their government, and are prepared to invest in Japan. This is in stark contrast to China, where if the rumors of capital flows are to be believed, vast sums of money are flowing out of the country through Hong Kong and Singapore. So, after the above events involving China, Abe’s timing in return to office was timely.

While Japanese equities have surged this year, that surge has been primarily in the large cap liquid issues that are easily studied and invested in by global firms. Most U.S. firms follow the fly-by approach. Go to Tokyo for a week of company meetings, and invest accordingly. Few firms make the commitment of having resources on the ground. That is why if you look at most U.S.-based Japan specialist mutual funds, they all own pretty much the same large cap liquid names, with only the percentages and sector weightings varying. There are tiers of small and mid-cap companies that are under-researched and under-invested in. If this is the beginning of a secular bull market, as we saw start in the U.S. in 1982, Japan will just be at the beginnings of eliminating the value gap between intrinsic value and the market price of securities, especially in the more inefficiently-traded and under-researched companies.

So, as Lenin once famously asked, “What is to be done?” For most individuals, individual stock investments are out of the question, given the currency, custody, language, trading, and tax issues. For exposure to the asset class, there is a lot to be said for a passive approach through an index fund or exchange-traded fund, of which there are a number with relatively low expense ratios. Finally, there are the fifteen or so Japan-only mutual funds. I am only aware of three that are small-cap vehicles – DFA, Fidelity, and Hennessy. There are also two actively-managed closed end funds. I will look to others to put together performance numbers and information that will allow you to research the area and draw your own conclusions.

Finally, it should be obvious that Japan does not lend itself to simple explanations. As Americans, we are often in a time-warp, thinking that with the atomic bombs, American Occupation and force-fed Constitution, we successfully transformed Japan into a pacifist democratically-styled Asian theme park. My conclusion is rather that what you see in Japan is not reality (whatever that is) but what they are comfortable with you seeing. I think for instance of the cultural differences with China in a business sense. With the Chinese businessman, a signed contract is in effect the beginning of the negotiation. For the Japanese businessman, a signed contract is a commitment to be honored to the letter.

I will leave you with one thing to ponder shared with me by a Japanese friend. She told me that the samurai have been gone for a long time in Japan. But, everyone in Japan still knows who the samurai families are and everyone knows who is of those families and who is not. And she said, everyone from those families still tends to marry into other samurai families. So I thought, perhaps they are not gone after all.

Edward Studzinski

From Day One …

… the Observer’s readers were anxious to have us publish lists of Great Funds, as FundAlarm did with its Honor Roll funds. For a long time I demurred because I was afraid folks would take such a list too seriously. That is, rather than viewing it as a collection of historical observations, they’d see it as a shopping list.

After two years and unrelenting inquires, I prevailed upon my colleague Charles to look at whether we could produce a list of funds that had great track records but, at the same time, highlight the often-hidden data concerning those funds’ risks. With that request and Charles’s initiative, the Great Owl Funds were launched.

And now Charles returns to that troubling original question: what can we actually learn about the future from a fund’s past?

In Search of Persistence

It’s 1993. Ten moderate allocation funds are available that have existed for 20 years or more. A diligent, well intended investor wants to purchase one of them based on persistent superior performance. The investor examines rolling 3-year risk-adjusted returns every month during the preceding 20 years, which amounts to 205 evaluation periods, and delightfully discovers Virtus Tactical Allocation (NAINX).

It outperformed nearly 3/4ths of the time, while it under-performed only 5%. NAINX essentially equaled or beat its peers 194 out of 205 periods. Encouraged, the investor purchases the fund making a long-term commitment to buy-and-hold.

It’s now 2013, twenty years later. How has NAINX performed? To the investor’s horror, Virtus Tactical Allocation underperformed 3/4ths of the time since purchased! And the fund that outperformed most persistently? Mairs & Power Balanced (MAPOX), of course.

Back to 1993. This time a more aggressive investor applies the same methodology to the large growth category and finds an extraordinary fund, named Fidelity Magellan (FMAGX). This fund outperformed nearly 100% of the time across 205 rolling 3-year periods over 20 years versus 31 other long-time peers. But during the next 20 years…? Not well, unfortunately. This investor would have done better choosing Fidelity Contrafund (FCNTX). How can this be? Most industry experts would attribute the colossal shift in FMAGX performance to the resignation of legendary fund manager Peter Lynch in 1990.

virtus fidelity

MJG, one of the heavy contributors to MFO’s discussion board, posts regularly about the difficulty of staying on top of one’s peer group, often citing results from Standard & Poor’s Index Versus Active Indexing (SPIVA) reports. Here is the top lesson-learned from ten years of these reports:

“Over a five-year horizon…a majority of active funds in most categories fail to outperform indexes. If an investing horizon is five years or longer, a passive approach may be preferable.”

The December 2013 SPIVA “Persistence Scorecard” has just been published, which Joshua Brown writes insightfully about in “Persistence is a Killer.” The scorecard once again shows that only a small fraction of top performing domestic equity mutual funds remain on top across any 2, 3, or 5 year period.

What does mutual fund non-persistence look like across 40 years? Here’s one depiction:

The image (or “mural”) represents monthly rank by color-coded quintiles of risk-adjusted returns, specifically Martin Ratio, for 101 funds across five categories. The funds have existed for 40 years through September 2013. The calculations use total monthly returns of oldest share class only, ignoring any load, survivor bias, and category drift. Within each category, the funds are listed alphabetically.

There are no long blue/green horizontal streaks. If anything, there seem to be more extended orange/red streaks, suggesting that if mutual fund persistence does exist, it’s in the wrong quintiles! (SPIVA actually finds similar result and such bottom funds tend to end-up merged or liquated.)

Looking across the 40 years of 3-year rolling risk-adjusted returns, some observations:

98% of funds spent some periods in every rank level…top, bottom, and all in-between
35% landed in the bottom two quintiles most of the time…that’s more than 1/3^rd of all funds
13% were in the top two bottom quintiles…apparently harder to be persistently good than bad
Sequoia (SEQUX) was the most persistent top performer…one of greatest mutual funds ever
Wall Street (WALLX) was the most persistent cellar dweller…how can it still exist?

sequoia v wall street

The difference in overall return between the most persistent winner and loser is breathtaking: SEQUX delivered 5.5 times more than SP500 and 16 times more than WALLX. Put another way, $10K invested in SEQUX in October 1973 is worth nearly $3M today. Here’s how the comparison looks:

So, while attaining persistence may be elusive, the motivation to achieve it is clear and present.

The implication of a lack of persistence strikes at the core of all fund rating methodologies that investors try to use to predict future returns, at least those based only on historical returns. It is, of course, why Kiplinger, Money, and Morningstar all try to incorporate additional factors, like shareholder friendliness, experience, and strategy, when compiling their Best Funds lists. An attempt, as Morningstar well states, to identify “funds with the highest potential of success.”

The MFO rating system was introduced in June 2013. The current 20-year Great Owls, shown below for moderate allocation and large growth categories, include funds that have achieved top performance rank over the past 20, 10, 5, and 3 year evaluation periods. (See Rating Definitions.)

But will they be Great Owls next year? The system is strictly quantitative based on past returns, which means, alas, a gentle and all too ubiquitous reminder that past performance is not a guarantee of future results. (More qualitative assessments of fund strategy, stewardship, and promise are provided monthly in David’s fund profiles.) In any case and in the spirit of SPIVA, we will plan to publish periodically a Great Owl “Persistence Scorecard.”

31Dec2013/Charles

It’s not exciting just because the marketers say it is

Most mutual funds don’t really have any investment reason to exist: they’re mostly asset gathering tools that some advisor created in support of its business model. Even the funds that do have a compelling case to make often have trouble receiving a fair hearing, so I’m sympathetic to the need to find new angles and new pitches to try to get journalists’ and investors’ attention.

But the fact that a marketer announces it doesn’t mean that journalists need to validate it through repetition. And it doesn’t mean that you should just take in what we’ve written.

Case in point: BlackRock Emerging Markets Long/Short Fund (BLSAX). Here’s the combination of reasonable and silly statements offered in a BlackRock article justifying long/short investing:

For example, our access to information relies on cutting edge infrastructure to compile vast amounts of obvious and less-obvious sources of publicly available information. In fact, we consume a massive amount of data from more than 25 countries, with a storage capacity 4 times the Library of Congress and 8 times the size of Wikipedia. We take that vast quantity of publicly available information and filter and identify relevant pieces.

Reasonable statement: we do lots of research. Silly statement: we have a really big hard drive on our computer (“a storage capacity of…”). Why on earth would we care? And what on earth does it mean? “4 times the Library of Congress”? The LoC digital collection – a small fraction of its total collection – holds three petabytes of data, a statement that folks immediately recognize as nonsensical. 3,000,000 gigabytes. So the BlackRock team has a 12 petabyte hard drive? 12 petabytes of data? How’s it used? How much is reliable, consistent, contradictory or outdated? How much value do you get from data so vast that you’ll never comprehend it?

NSA’s biggest “data farm” consumes 65 megawatts of power, has melted down 10 times, and – by the fed’s own reckoning – still hasn’t produced demonstrable security gains. Data ≠ knowledge.

The Google, by the way, processes 20 petabytes of user-generated content per day.

Nonetheless, Investment News promptly and uncritically gloms onto the factoid, and then gets it twice wrong:

The Scientific Active Equity team takes quantitative investing to a whole new level. In fact, the team has amassed so much data on publicly traded companies that its database is now four times the size of Wikipedia and eight times the size of the Library of Congress (Jason Kephart, Beyond black box investing: Fund uses database four times the size of Wikipedia, 12/26/13).

Error 1: reversing the LoC and the Wikipedia. Error 2: conflating “storage capacity” with “data.” (And, of course, confusing “pile o’ data” with “something meaningful.”)

MFWire promptly grabs the bullhorn to share the errors and the credulity:

This Fund Uses the Data of Eight Libraries of Congress (12/26/13, Boxing Day for our British friends)

The team managing the fund uses gigantic amounts of data — four times the size of Wikipedia and eight times the size of the Library of Congress — on public company earnings, analyst calls, news releases, what have you, to gain on insights into different stocks, according to Kephart.

Our second, perhaps larger, point of disagreement with Jason (who, in fairness, generally does exceptionally solid work) comes in his enthusiasm for one particular statistic:

That brings us to perhaps the fund’s most impressive stat, and the one advisers really need to keep their eyes on: its correlation to global equities.

Based on weekly returns through the third quarter, the most recent data available, the fund has a correlation of just 0.38 to the MSCI World Index and a correlation of 0.36 to the S&P 500. Correlations lower than 0.5 lead to better diversification and can lead to better risk-adjusted returns for the entire portfolio.

Uhhh. No?

Why, exactly, is correlation The Golden Number? And why is BlackRock’s correlation enough to make you tingle? The BlackRock fund has been around just one year, so we don’t know its long-term correlation. In December, it had a net market exposure of just 9% which actually makes a .36 correlation seem oddly high. BlackRock’s correlation is not distinctively low (Whitebox Long/Short WBLSX has a three-year correlation of 0.33, for instance).

Nor is low correlation the hallmark of the best long-term funds in the group. By almost any measure, the best long/short fund in existence is the closed Robeco Boston Partners L/S Equity Fund (BPLEX). BPLEX is a five-star fund, a Lipper Leader, a Great Owl fund, with returns in the top 4% of its peer group over the past decade. And its long term correlation to the market: 75. Wasatch Long/Short (FMLSX), another great fund with a long track record: 90. Marketfield (MFLDX), four-star, Great Owl: 67.

The case for BlackRock EM L/S is it’s open. It’s got a good record, though a short one. In comparison to other, more-established funds, it substantially trails Long-Short Opportunity (LSOFX) since inception, is comparable to ASTON River Road (ARLSX) and Wasatch Long Short (FMLSX), while it leads Whitebox Long-Short (WBLSX), Robeco Boston Partners (BPLEX) and RiverPark Long/Short Opportunity (RLSFX). The fund has nearly $400 million in assets after one year and charges 2% expenses plus a 5.25% front load. That’s more than ARLSX, WBLSX or FMLSX, though cheaper than LSOFX.

Bottom Line: as writers, we need to guard against the pressures created by deadlines and the desire for “clicks.” As readers, you need to realize we have good days and bad and you need to keep asking the questions we should be asking: what’s the context of this number? What does it mean? Why am I being given it? How does it compare? And, as investors, we all need to remember that magic is more common in the world of Harry Potter than in the world we’re stuck with.

Wells Fargo and the Roll Call of the Wretched

Our Annual Roll Call of the Wretched highlights those funds which consistently, over a period of many years, trail their benchmark. We noted that inclusion on the list signaled one of two problems:

Bad fund or
Bad benchmark.

The former problem is obvious. The latter takes a word of explanation. There are 7055 distinct mutual funds, each claiming – more or less legitimately – to be different from all of the others. For the purpose of comparison, Morningstar and Lipper assign them to one of 108 categories. Some funds fit easily and well, others are laughably misfit. One example is RiverPark Short-Term High Yield Fund (RPHYX), which is a splendid cash management fund whose performance is being compared to the High-Yield group which is dominated by longer-duration bonds that carry equity-like risks and returns.

You get a sense of the mismatch – and of the reason that RPHYX was assigned one-star – when you compare the movements of the fund to the high-yield group.

rphyx

That same problem afflicts Wells Fargo Advantage Short-Term High Yield Bond (SSTHX), an entirely admirable fund that returns around 4% per year over the long term in a category that delivers 50% greater returns with 150% greater volatility. In Morningstar’s eyes, one star.

Joel Talish, one of the managing directors at Wells Fargo Advisors, raised the entirely reasonable objection that SSTHX isn’t wretched – it’s misclassified – and it shouldn’t be in the Roll Call at all. He might well be right. Our strategy has been to report all of the funds that pass the statistical screen, then to highlight those whose performance is better than the peer data suggest. We don’t tend to remove funds from the list just because we believe that the ratings agencies are wrong. We’ve made that decision consciously: investors need to read these ubiquitous statistical screens more closely and more skeptically. A pattern of results arises from a series of actions, and they’re meaningful only if you take the time to understand what’s going on. By highlighting solid funds that look bad because of a rater’s unexplained assignments, we’re trying to help folks learn how to look past the stars.

It might well be the case that highlighting and explaining SSTHX’s consistently one-star performance did a substantial disservice to the management team. It was a judgment call on our part and we’ll revisit it as we prepare future features. For now, we’re hopeful that the point we highlighted at the start of the list:

Use lists like the Roll Call of the Wretched or the Three Alarm Funds as a first step, not a final answer. If you see a fund of yours on either list, find out why. Call the adviser, read the prospectus, try the manager’s letter, post a question on our board. There might be a perfectly good reason for their performance, there might be a perfectly awful one. In either case, you need to know.

Observer Fund Profile

Each month the Observer provides in-depth profiles of notable funds that you’d otherwise not hear of. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

RiverPark Strategic Income (RSIVX): RSIVX sits at the core of Cohanzick’s competence, a conservative yet opportunistic strategy that they’ve pursued for two decades and that offers the prospect of doubling the returns of its very fine Short-Term High Yield Fund.

Elevator Talk: Oliver Pursche, GMG Defensive Beta Fund (MPDAX)

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

The traditional approach to buffering the stock market’s volatility without entirely surrendering the prospect of adequate returns was to divide the portfolio between (domestic, large cap) stocks and (domestic, investment grade) bonds, at a ratio of roughly 60/40. That strategy worked passably well as long as stocks could be counted on to produce robust returns and bonds could be counted on to post solid though smaller gains without fail. As the wheels began falling off that strategy, advisors began casting about for alternative strategies.

Some, like the folks at Montebello Partners, began drawing lessons from the experience of hedge funds and institutional alternatives managers. Their conclusion was that each asset class had one or two vital contributions to make to the health of the portfolio, but that exposure to those assets had to be actively managed if they were going to have a chance of producing equity-like (perhaps “equity-lite”) returns with substantial downside protection.

Their strategy is manifested in GMG Defensive Beta, which launched in the summer of 2009. Its returns have generally overwhelmed those of its multi-alternative peers (top 3% over the past three years, substantially higher returns since inception) though at the cost of substantially higher volatility. Morningstar rates it as a five-star fund, while Lipper gives it four stars for both Total Return and Consistency of Return and five stars for Capital Preservation.

Oliver Pursche is the president of Gary M Goldberg Financial Services (hence GMG) one of the four founding co-managers of MPDAX. Here are his 218 words (on whole, durn close to target) on why you should consider a multi alternative strategy:

Markets are up, and as a result, so are the risks of a correction. I don’t think that a 2008-like crash is in the cards, but we could certainly see a 20% correction at some point. If you agree with me, protecting your hard fought gains makes all the sense in the world, which is why I believe low-volatility and multi-alternative funds like our GMG Defensive Beta Fund will continue to gain favor with investors. The problem is that most of these new funds have no, or only a short track-record, so it’s difficult to know how they will actually perform in a prolonged downturn. One thing is certain, in the absence of a longer-term track record, low fees and low turnover tend to be advantageous to investors. This is why our fund is a no-load fund and we cap our fees at 1.49%, well below most of our peers, and our cap gain distributions have been minimal.

From my perspective, if you’re looking to continue to have market exposure, but don’t want all of the risks associated with investing in the S&P 500, our fund is ideally suited. We’re strategic and tactical at the same time and have demonstrated our ability to remain disciplined, which is (I think) why Morningstar has awarded us a 5 Star ranking.

MPDAX is a no-load fund with a single share class. The minimum initial investment is $1,000. Expenses are 1.49% on about $27 million in assets.

The fund’s website is functional but spare. You get the essential information, but there’s no particular wealth of insight or commentary on this strategy. There’s a Morningstar reprint available but you should be aware that the file contains one page of data reporting and five pages of definitions and disclaimers.

Our earlier Elevator Talks were:

Conference Call Highlights

On December 9^th, about 50 of us spent a rollicking hour with David Sherman of Cohanzick Asset Management, discussing his new fund: RiverPark Strategic Income Fund (RSIVX). I’m always amazed at how excited folks can get about short-term bonds and dented credits. It’s sort of contagious.

David’s first fund with RiverPark, the now-closed Short Term High Yield (RPHYX), was built around Cohanzick’s strategy for managing its excess cash. Strategic Income represents their seminal, and core, strategy to fixed-income investing. Before launching Cohanzick in 1996, David was a Vice President of Leucadia National Corporation, a holding company that might be thought of as a mini-Berkshire Hathaway. His responsibilities there included helping to manage a $3 billion investment portfolio which had an opportunistic distressed securities flair. When he founded Cohanzick, Leucadia was his first client. They entrusted him with $150 million, this was the strategy he used to invest it.

Rather than review the fund’s portfolio, which we cover in this month’s profile of it (below), we’ll highlight strategy and his response to listener questions.

The fund focuses on “money good” securities. Those are securities where, if held to maturity, he’s confident that he’ll get his entire principal and all of the interest due to him. They’re the sorts of securities where, if the issuer files for bankruptcy, he still anticipates eventually receiving his principal and interest plus interest on his interest. Because he expects to be able to hold securities to maturity, he doesn’t care about “the taper” and its effects – he’ll simply hold on through any kerfuffle and benefit from regular payments that flow in much like an annuity stream. These are, he says, bonds that he’d have his mother hold.

Given that David’s mother was one of the early investors in the fund, these are bonds his mother holds. He joked that he serves as a sort of financial guarantor for her standard of living (if her portfolio doesn’t produce sufficient returns to cover her expenses, he has to reach for his checkbook), he’s very motivated to get this right.

While the fund might hold a variety of securities, they hold little international exposure and no emerging markets debt. They’re primarily invested in North American (77%) and European(14%) corporate debt, in firms where the accounting is clear and nations where the laws are. The fund’s investment mandate is very flexible, so they can actively hedge portfolio positions (and might) and they can buy income-producing equities (but won’t).

The portfolio focuses on non-investment grade securities, mostly in the B – BB range, but that’s consistent with his intention not to lose his investors’ money. He values liquidity in his investments; that is to say, he doesn’t get into investments that he can’t quickly get out of. The fund has been letting cash build, and it’s now about 30% of the portfolio. David’s general preference is to get out too early and lose some potential returns, rather than linger too long and suffer the risk of permanent impairment.

There were rather more questions from callers than we had time to field. Some of the points we did get to talk about:

David is not impressed with the values available in one- to three-year bonds, they’ve been subject to too much buying by the anxious herd. He’s currently finding better values in three- to five-year bonds, especially those which are not included in the major bond indexes. There is, he says, “a lot of high yield value outside of indexed issues.”

About 50% of the corporate bond market qualifies as “high yield,” which gives him lots of opportunities.

This could function as one’s core bond portfolio. While there will be more NAV volatility because of mark-to-market rules (that is, you have to ask “what would I get if I stupidly decided to sell my entire portfolio in the midst of a particular day’s market panic”), the risk of permanent impairment of capital occurs only if he’s made a mistake.

Munis are a possibility, but they’re not currently cheap enough to be attractive.

If there’s a limited supply of a security that would be appropriate for both Short-Term and here, Short-Term gets dibs.

Cohanzick is really good at pricing their portfolio securities. At one level, they use an independent pricing service. At another, getting the price right has been a central discipline since the firm’s founding and he’s comfortable with his ability to do so even with relatively illiquid names.

At base, David believes the fund can generate returns in the 7-8% range with minimal risk of capital loss. Given his record with Cohanzick and RPHYX, we are confident that he’s capable of delivering on that promise. By way of full disclosure: In aligning our mouths and our money, both Chip and I added RSIVX to our personal portfolios this fall. Once we work out all of the Observer’s year-end finances, we also intend to transfer a portion of the money now in MFO’s credit union savings account into an investment in this fund.

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

The RSIVX conference call

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

January Conference Call: Matt Moran, ASTON River Road Long/Short

Last winter we spent time talking with the managers of really promising hedged funds, including a couple who joined us on conference calls. The fund that best matched my own predilections was ASTON River Road Long/Short (ARLSX), extensive details on which appear on our ARLSX Featured Fund Page. In our December 2012 call, manager Matt Moran argued that:

The fund might outperform the stock market by 200 bps/year over a full, 3-5 year market cycle.
The fund can maintain a beta at 0.3 to 0.5, in part because of their systematic Drawdown Plan.
Risk management is more important than return management, so all three of their disciplines are risk-tuned.

I was sufficiently impressed that I chose to invest in the fund. That does not say that we believe this is “the best” long/short fund (an entirely pointless designation), just that it’s the fund that best matched my own concerns and interests. The fund returned 18% in 2013, placing it in the top third of all long/short funds.

Matt and co-manager Dan Johnson have agreed to join us for a second conversation. That call is scheduled for Wednesday, January 15, from 7:00 – 8:00 Eastern. Please note that this is one day later than our original announcement. Matt has been kicking around ideas for what he’d like to talk about. His short-list includes:

How we think about our performance in 2013 and, in particular, why we’re satisfied with it given our three mandates (equity-like returns, reduced volatility, capital preservation)
Where we are finding value on the long side. It’s a struggle…
How we’re surviving on the short side. It’s a huge challenge. Really, how many marginal businesses can keep hanging on because of the Fed’s historic generosity? Stocks must ultimately earn what underlying business earns and a slug of these firms are earning …
But, too, our desire not to be carried out in body bags on short side.
The fact that we sleep better at night with Drawdown Plan in place.

HOW CAN YOU JOIN IN?

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

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

For those of you new to our conference calls, here’s the short version: we set up an audio-only phone conversation, you register and receive an 800-number and a PIN, our guest talks for about 20 minutes on his fund’s genesis and strategy, I ask questions for about 20, and then our listeners get to chime in with questions of their own. A couple days later we post an .mp3 of the call and highlights of the conversation.

WOULD AN ADDITIONAL HEADS UP HELP?

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

February Conference Call: Joshua B. Parker and Alan Salzbank, RiverPark / Gargoyle Hedged Value

We extend our conversation with hedged fund managers in a conversation with Messrs. Parker and Salzbank, whose RiverPark / Gargoyle Hedged Value (RGHVX) we profiled last June, but with whom we’ve never spoken.

insight

Gargoyle is a converted hedge fund. The hedge fund launched in 1999 and the strategy was converted to a mutual fund on April 30, 2012. Rather than shorting stocks, the strategy is to hold a diversified portfolio mid- to large-cap value stocks, mostly domestic, and to hedge part of the stock market risk by selling a blend of index call options. That value focus is both distinctive and sensible; the strategy’s stock portfolio has outperformed the S&P500 by 4.5% per year over the past 23 years. The options overlay generates 1.5 – 2% in premium income per month. The fund ended 2013 with a 29% gain, which beat 88% of its long/short peers.

That call is scheduled for Wednesday, February 12, from 7:00 – 8:00 Eastern. We’ll provide additional details in our February issue.

HOW CAN YOU JOIN IN?

Launch Alert: Vanguard Global Minimum Volatility Fund (VMVFX)

Vanguard Global Minimum Volatility Fund (VMVFX) launched on December 12, 2013. It’s Vanguard’s answer to the craze for “smart beta,” a strategy that seemingly promises both higher returns and lower risk over time. Vanguard dismisses the possibility with terms like “new-age investment alchemy,” and promise instead to provide reasonable returns with lower risk than an equity investor would otherwise be subject to. They are, they say, “trying to deliver broadly diversified exposure to the equity asset class, with lower average volatility over time than the market. We will use quantitative models to assess the expected volatility of stocks and correlation to one another.” They also intend to hedge currency risk in order to further dampen volatility.

Most portfolios are constructed with an eye to maximizing returns within a set of secondary constraints (for example, market cap). Volatility is then a sort of fallout from the system. Vanguard reverses the process here by working to minimize the volatility of an all-equity portfolio within a set of secondary constraints dealing with diversification and liquidity. Returns are then a sort of fallout from the design. Vanguard recently explained the fund’s distinctiveness in Our new fund offering: What it is and what it isn’t.

The fund will be managed by James D. Troyer, James P. Stetler, and Michael R. Roach. They are members of the management teams for about a dozen other Vanguard funds.

The Investor share class has a $3,000 minimum initial investment. The opening expense ratio is 0.30%.

MFS made its first foray into low-volatility investing this month, launching MFS Low Volatility Equity (MLVAX) and MFS Low Volatility Global Equity (MVGAX) just one week before Vanguard. The former will target a volatility level that is 20% lower than that of the S&P 500 Index over a full market cycle, while the latter will target 30% less volatility than the MSCI All Country World Index. The MFS funds charge about four times what Vanguard does.

Launch Alert II: Meridian Small Cap Growth Advisor (MSGAX)

Meridian Small Cap Growth Fund launched on December 16^th. The prospectus says very little about what the managers will be doing: “The portfolio managers apply a ‘bottom up’ fundamental research process in selecting investments. In other words, the portfolio managers analyze individual companies to determine if a company presents an attractive investment opportunity and if it is consistent with the Fund’s investment strategies and policies.”

Nevertheless, the fund warrants – and will receive – considerable attention because of the pedigree of its managers. Chad Meade and Brian Schaub managed Janus Triton (JATTX) together from 2006 – May 2013. During their tenure, they managed to turn an initial $10,000 investment into $21,400 by the time they departed; their peers would have parlayed $10,000 into just over $14,000. The more remarkable fact is that the managed it with a low turnover (39%, half the group average), relatively low risk (beta = .80, S.D. about 3 points below their peers) strategy. Understandably, the fund’s assets soared to $6 billion and it morphed from focused on small caps to slightly larger names. Regrettably, Janus decided that wasn’t grounds for closing the fund.

Messrs Meade and Schaub joined Arrowpoint Partners in May 2013. Arrowpoint famously is the home of a cadre of Janus alumni (or escapees, depending): David Corkins, Karen Reidy, Tony Yao, Minyoung Sohn and Rick Grove. Together they managed over $2 billion. In June, they purchased Aster Investment Management, advisor to the Meridian funds, adding nearly $3 billion more in assets. We’ll reach out to the Arrowpoint folks early in the new year.

The Advisor share class is available no-load and NTF through brokerages like Scottrade, with a $2,500 minimum initial investment. The opening expense ratio is 1.60%.

Funds in Registration

Funds in registration this month are eligible to launch in March, 2014 and some of the prospectuses do highlight that date.

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

Interesting entries this month include:

Artisan High Income Fund will invest in high yield corporate bonds and debt. There are two major distinctions here. First, it is Artisan’s first fixed-income fund. Second, Artisan has always claimed that they’re only willing to hire managers who will be “category-killers.” If you look at Artisan’s returns, you’ll get a sense of how very good they are at that task. Their new high-yield manager, and eventual head of a new, autonomous high-yield team, is Bryan C. Krug who ran the $10 billion, five star Ivy High Income Fund (WHIYX) for the past seven years. The minimum initial investment will be $1000 for Investor shares and $250,000 for Advisor shares. The initial expense ratio will be 1.25% for both Investor and Advisor shares.

Brown Advisory Japan Alpha Opportunities Fund will pursue total return by investing principally in Japanese stocks. The fund will be constructed around a series of distinct “sleeves,” each with its own distinct risk profile but they don’t explain what they might be. They may invest in common and preferred stock, futures, convertibles, options, ADRs and GDR, REITs and ETFs. While they advertise an all-cap portfolio, they do flag small cap and EM risks. The fund will be managed by a team from Wellington Management. The minimum initial investment will be $5000. The initial expense ratio will be 1.36%.

Perritt Low Priced Stock Fund will pursue long-term capital appreciation by investing in small cap stocks priced at $15 or less. I’m a bit ambivalent but could be talked into liking it. The lead manager also runs Perritt Microcap (PRCGX) and Ultra MicroCap (PREOX), both of which are very solid funds with good risk profiles. Doubtless he can do it here. That said, the whole “under $15” thing strikes me as a marketing ploy and a modestly regrettable one. What benefit does that stipulation really offer the investors? The minimum initial investment will be $1000, reduced to $250 for all sorts of good reasons, and the initial expense ratio will be 1.5%.

Manager Changes

On a related note, we also tracked down 40 fund manager changes. The most intriguing of those include what appears to be the abrupt dismissal of Ken Feinberg, one of the longest-serving managers in the Davis/Selected Funds, and PIMCO’s decision to add to Bill Gross’s workload by having him fill in for a manager on sabbatical.

Updates

There are really very few emerging markets investors which whom I’d trust my money. Robert Gardiner and Andrew Foster are at the top of the list. There are notable updates on both this month.

Grandeur Peak Emerging Opportunities (GPEOX) launched two weeks ago, hasn’t released a word about its portfolio, has earned one half of one percent for its investors . . . and has drawn nearly $100 million in assets. Mr. Gardiner and company have a long-established plan to close the fund at $200 million. I’d encourage interested parties to (quickly!) read our review of Grandeur Peak’s flagship Global Reach fund. If you’re interested in a reasonably assertive, small- to mid-cap fund, you may have just a few weeks to establish your account before the fund closes. The advisor does not intend to market the fund to the general public until February 1, by which time it might well be at capacity.

Investors understandably assume that an e.m. small cap fund is necessarily, and probably substantially, riskier than a more-diversified e.m. fund. That assumption might be faulty. By most measures (standard deviation and beta, for example) it’s about 15% more volatile than the average e.m. fund, but part of that volatility is on the upside. In the past five years, emerging markets equities have fallen in six of 20 quarters. We can look at the performance of DFA’s semi-passive Emerging Markets Small Cap Fund (DEMSX) to gauge the downside of these funds.

DFA E.M. Small Cap …	No. of quarters
Falls more	2
Fall equally (+/- 25 bps)	1
Falls less	2
Rises	1

The same pattern is demonstrated by Templeton E.M. Small Cap (TEMMX): higher beta but surprising resilience in declining quarters. For aggressive investors, a $2,000 foot-in-the-door position might well represent a rational balance between the need for more information and the desire to maintain their options.

Happily, there’s an entirely-excellent alternative to GPEOX and it’s not (yet) near closing to new investors.

Seafarer Overseas Growth & Income (SFGIX and SIGIX) is beginning to draw well-earned attention. Seafarer offers a particularly risk-conscious approach to emerging markets investing. It offers a compact (40 names), all-cap portfolio (20% in small- and microcap names and 28% in mid-caps, both vastly higher than its peers) that includes both firms domiciled in the emerging markets (about 70%) and those headquartered in the developing world but profiting from the emerging one (30%). It finished 2013 up 5.5%, which puts it in the top tier of all emerging markets funds.

That’s consistent with both manager Andrew Foster’s record at his former charge (Matthews Asian Growth & Income MACSX which was one of the two top Asian funds in existence through his time there) and Seafarer’s record since launch (it has returned 20% since February 2012 while its average peer made less than 4%). Assets had been growing briskly through the fund’s first full year, plateaued for much of 2013 then popped in December: the fund moved from about $40 million in AUM to $55 million in a very short period. That presumably signals a rising recognition of Seafarer’s strength among larger investors, which strikes me as a very good thing for both Seafarer and the investors.

On an unrelated note, Oakseed Opportunity (SEEDX) has added master limited partnerships to its list of investable securities. The guys continue negotiating distribution arrangements; the fund became available on the Fidelity platform in the second week of December, 2013. They were already available through Schwab, Scottrade, TDAmeritrade and Vanguard.

Briefly Noted . . .

The Gold Bullion Strategy Fund (QGLDX) has added a redemption fee of 2.00% for shares sold within seven days of purchase because, really, how could you consider yourself a long-term investor if you’re not willing to hold for at least eight days?

Legg Mason Capital Management Special Investment Trust (LMSAX) will transition from being a small- and mid-cap fund to a small cap and special situations fund. The advisor warns that this will involve an abnormal turnover in the portfolio and higher-than-usual capital gains distributions. The fund has beaten its peers precisely twice in the past decade, cratered in 2007-09, got a new manager in 2011 and has ascended to … uh, mediocrity since then. Apparently “unstable” and “mediocre” is sufficient to justify someone’s decision to keep $750 million in the fund.

PIMCO’s RealRetirement funds just got a bit more aggressive. In an SEC filing on December 30, PIMCO shifted the target asset allocations to increase equity exposure and decrease real estate, commodities and fixed income. Here’s the allocation for an individual with 40 years until retirement

	New allocation	Old allocation
Stocks	62.5%, with a range of 40-70%	55%, same range
Commodities & real estate	20, range 10-40%	25, same range
Fixed income	17.5, range 10-60%	20, same range

Real estate and commodities are an inflation hedge (that’s the “real” part of RealRetirement) and PIMCO’s commitment to them has been (1) unusually high and (2) unusually detrimental to performance.

SMALL WINS FOR INVESTORS

Effective January 2, 2014, BlackRock U.S. Opportunities Portfolio (BMEAX) reopened to new investors. Skeptics might note that the fund is large ($1.6 billion), overpriced (1.47%) and under-performing (having trailed its peers in four of the past five years), which makes its renewed availability a distinctly small win.

Speaking of “small wins,” the Board of Trustees of Buffalo Funds has approved a series of management fees breakpoints for the very solid Buffalo Small Cap Fund (BUFSX). The fund, with remains open to new investors despite having nearly $4 billion in assets, currently pays a 1.0% management fee to its advisor. Under the new arrangement, the fee drops by five basis points for assets from $6 to $7 billion, another five for assets from $7-8 and $8-9 then it levels out at 80 bps for assets over $9 billion. Those gains are fairly minor (the net fee on the fund at $7 billion is $69.5 million under the new arrangement versus $70 million under the old) and the implication that the fund might remain open as it swells is worrisome.

Effective January 1, 2014, Polaris Global Value Fund (PGVFX) has agreed to cap operating expenses at 0.99%. Polaris, a four-star fund with a quarter billion in assets, currently charges 1.39% so the drop will be substantial.

The investment minimum for Institutional Class shares of Yacktman Focused Fund (YAFFX) has dropped from $1,000,000 to $100,000.

Vanguard High-Yield Corporate Fund (VWEHX) has reopened to new investors. Wellington Management, the fund’s advisor, reports that “Cash flow to the fund has subsided, which, along with a change in market conditions, has enabled us to reopen the fund.”

CLOSINGS (and related inconveniences)

Driehaus Select Credit Fund (DRSLX) will close to most new investors on January 31, 2014. The strategy capacity is about $1.5 billion and the fund already holds $1 billion, with more flowing in, so they decided to close it just as they closed its sibling, Driehaus Active Income (LCMAX). You might think of it as a high-conviction, high-volatility fixed income hedge fund.

Hotchkis & Wiley Mid-Cap Value (HWMIX) is slated to close to new investors on March 1, 2014. Ted, our board’s most senior member, opines “Top notch MCV fund, 2.8 Billion in assets, and superior returns.” I nod.

Sequoia (SEQUX) closed to new investors on December 10^th. Their last closure lasted 25 years.

Vanguard Capital Opportunity Fund (VHCOX), managed by PRIMECAP Management Company, has closed again. It closed in 2004, opened the door a crack in 2007 and fully reopened in 2009. Apparently the $2 billion in new assets generated a sense of concern, prompting the reclosure.

OLD WINE, NEW BOTTLES

Aberdeen Diversified Income Fund (GMAAX), a tiny fund distinguished more for volatility than for great returns, can now invest in closed-end funds. Two other Aberdeen funds, Dynamic Allocation (GMMAX) and Diversified Alternatives (GASAX), are also now permitted to invest, to a limited extent, in “certain direct investments” and so if you’ve always wanted exposure to certain direct investments (as opposed to uncertain ones), they’ve got the funds for you.

American Independence Core Plus Fund (IBFSX) has changed its name to the American Independence Boyd Watterson Core Plus Fund, presumably in the hope that the Boyd Watterson name will work marketing magic. Not entirely sure why that would be the case, but there it is.

Effective December 31, 2013, FAMCO MLP & Energy Income Fund became Advisory Research MLP & Energy Income Fund. Oddly, the announcement lists two separate “A” shares with two separate ticker symbols (INFIX and INFRX).

In February Compass EMP Long/Short Fixed Income Fund (CBHAX) gets rechristened Compass EMP Market Neutral Income Fund and it will no longer be required to invest at least 80% in fixed income securities. The change likely reflects the fact that the fund is underwater since its November 2013 inception (its late December NAV was $9.67) and no one cares (AUM is $28 million).

In yet another test of my assertion that giving yourself an obscure and nonsensical name is a bad way to build a following (think “Artio”), ING reiterated its plan to rebrand itself as Voya Financial. The name change will roll out over the first half of 2014.

As of early December, Gabelli Value Fund became Gabelli Value 25 Fund (GABVX). And no, it does not hold 25 stocks (the portfolio has nearly 200 names). Here’s their explanation: “The name change highlights the Fund’s overweighting of its core 25 equity positions and underscores the upcoming 25^th anniversary of the Fund’s inception.” And yes, that does strike me as something that The Mario came up with and no one dared contradict.

GMO, as part of a far larger fund shakeup (see below), has renamed and repurposed four of its institutional funds. GMO International Core Equity Fund becomes GMO International Large/Mid Cap Equity Fund, GMO International Intrinsic Value Fund becomes GMO International Equity Fund, GMO International Opportunities Equity Allocation Fund becomes GMO International Developed Equity Allocation Fund, and GMO World Opportunities Equity Allocation Fund morphs (slightly) into GMO Global Developed Equity Allocation Fund, all on February 12, 2014. Most of the funds tweaked their investment strategy statements to comply with the SEC’s naming rules which say that if you have a distinct asset class in your name (large/midcap equity), you need to have at least 80% of your portfolio in that class.

Effective February 28, MainStay Intermediate Term Bond Fund (MTMAX) becomes MainStay Total Return Bond Fund.

Nuveen NWQ Flexible Income Fund (NWQIX), formerly Nuveen NWQ Equity Income Fund has been rechristened as Nuveen NWQ Global Equity Income Fund, with James Stephenson serving as its sole manager. If you’d like to get a sense of what “survivorship bias” looks like, you might check out Nuveen’s SEC distributions filing and count the number of funds with lines through their names.

Old Westbury Global Small & Mid Cap Fund (OWSMX) has been rechristened as Old Westbury Small & Mid Cap Fund. It’s no longer required to have a global portfolio, but might. It’s been very solid, with about 20% of its portfolio in ETFs and the rest in individual securities.

At the meeting on December 3, 2013, the Board approved a change in Old Westbury Global Opportunities Fund’s (OWGOX) name to Old Westbury Strategic Opportunities Fund. Let’s see: 13 managers, $6 billion in assets, and a long-term record that trails 70% of its peers. Yep, a name change is just what’s needed!

OFF TO THE DUSTBIN OF HISTORY

Jeez, The Shadow is just a wild man here.

On December 6, 2013, the Board of the Conestoga Funds decided to close and liquidate the Conestoga Mid Cap Fund (CCMGX), effective February 28, 2014. At the same time, they’re launched a SMid cap fund with the same management team. I wrote the advisor to ask why this isn’t just a scam to bury a bad track record and get a re-do; they could, more easily, just have amended Mid Cap’s principal investment strategy to encompass small caps and called it SMid Cap. They volunteered to talk then reconsidered, suggesting that they’d be freer to walk me through their decision once the new fund is up and running. I’m looking forward to the opportunity.

Dynamic Energy Income Fund (DWEIS), one of the suite of former DundeeWealth funds, was liquidated on December 31, 2013.

Fidelity has finalized plans for the merger of Fidelity Europe Capital Appreciation Fund (FECAX) into Fidelity Europe Fund (FIEUX), which occurs on March 21.

The institutional firm Grantham, Mayo, van Otterloo (GMO) is not known for precipitous action, so their December announcement of a dozen fund closures is striking. One set of funds is simply slated to disappear:

Liquidating Fund	Liquidation Date
GMO Real Estate Fund	January 17, 2014
GMO U.S. Growth Fund	January 17, 2014
GMO U.S. Intrinsic Value Fund	January 17, 2014
GMO U.S. Small/Mid Cap Fund	January 17, 2014
GMO U.S. Equity Allocation Fund	January 28, 2014
GMO International Growth Equity Fund	February 3, 2014
GMO Short-Duration Collateral Share Fund	February 10, 2014
GMO Domestic Bond Fund	February 10, 2014

In addition, the Board has approved the termination of GMO Asset Allocation International Small Companies Fund and GMO International Large/Mid Cap Value Fund, neither of which had commenced operations.

They then added two sets of fund mergers: GMO Debt Opportunities Fund into GMO Short-Duration Collateral Fund (with the freakish coda that “GMO Short-Duration Collateral Fund is not pursuing an active investment program and is gradually liquidating its portfolio” but absorbing Debt Opportunities gives it reason to live) and GMO U.S. Flexible Equities Fund into GMO U.S. Core Equity Fund, which is expected to occur on or about January 24, 2014.

Not to be outdone, The Hartford Mutual Funds announced ten fund mergers and closures themselves. Hartford Growth Fund (HGWAX) is merging with Hartford Growth Opportunities Fund (HGOAX), Hartford Global Growth (HALAX) merges with Hartford Capital Appreciation II (HCTAX) and Hartford Value (HVFAX) goes into Hartford Value Opportunities (HV)AX), all effective April 7, 2014. None of which, they note, requires shareholder approval. I have real trouble seeing any upside for the funds’ investors, since most going from one sub-par fund into another and will see expenses drop by just a few basis points. The exceptions are the value funds, both of which are solid and economically viable on their own. In addition, Hartford is pulling the plug on its entire target-date retirement line-up. The funds slated for liquidation are Hartford Target Retirement 2010 through 2050. That dirty deed will be done on June 30, 2014.

Highbridge Dynamic Commodities Strategy Fund (HDSAX) is slated to be liquidated and dissolved (an interesting visual image) on February 7, 2014. In the interim, it’s going to cash.

John Hancock Sovereign Investors Fund (SOVIX) will merge into John Hancock Large Cap Equity Fund (TAGRX), on or about April 30, 2014.

Principal SmallCap Growth Fund II (PPMIX) will be absorbed by SmallCap Growth Fund I (PGRTX) on or about April 25, 2014.

It’s with some sadness that we bid adieu to Tom Kerr and his Rocky Peak Small Cap Value Fund (RPCSX), which liquidated on December 30. The fund sagged from “tiny” to “microscopic” by the end of its run, with under a million in assets. Its performance in 2013 was pretty much calamitous, which was both curious and fatal. Tom was an experienced manager and sensible guy who will, we hope, find a satisfying path forward.

In a sort of three-for-one swap, Pax World International Fund (PXIRX) and Pax MSCI EAFE ESG Index ETF (EAPS) are merging to form the Pax World International ESG Index Fund.

On October 21, 2013, the Board of Directors of the T. Rowe Price Summit GNMA Fund (PRSUX) approved a proposed merger with, and into, T. Rowe Price GNMA Fund (PRGMX).

The Vanguard Managed Payout Growth Focus Fund (VPGFX) and Vanguard Managed Payout Distribution Focus Fund (VPDFX) are each to be reorganized into the Vanguard Managed Payout Growth and Distribution Fund (VPGDX) on or about January 17, 2014.

W.P. Stewart & Co. Growth Fund (WPSGX) is merging into the AllianceBernstein Concentrated Growth Fund (WPCSX), which has the same manager, investment discipline and expenses of the WPS fund. Alliance acquired WPS in December, so the merger was a sort of foregone conclusion.

Wegener Adaptive Growth Fund (WAGFX) decided, on about three days’ notice, to close and liquidate at the end of December, 2013. It had a couple very solid years (2008 and 2009) then went into the dumper, ending with a portfolio smaller than my retirement account.

A small change

Our navigation menu is growing. If you look along the top of our page, you’ll likely notice that “Featured Funds” is no longer a top-level menu item. Instead the “Featured Funds” category can now be found under the “Fund” or “The Best” menus. Replacing it as a new top-level menu is “Search Tools”, which is the easiest way to directly access new search functionality that Accipiter, Charles, and Chip have been working on for the past few months.

Under Search Tools, you’ll find:

Risk Profile – designed to help you understand the different measures of a fund’s risk profile. No one measure of risk captures the full picture and most measures of risk are not self-explanatory. Our Risk Profile reporter allows you to enter a single ticker symbol for any fund and it will generate a short, clear report, in simple, conversational English, that walks you through the various means of risk and returns and will provide you with the profiles for a whole range of possible benchmarks. Alternatively, entering multiple ticker symbols will return a tabular results page, making side-by-side comparisons more convenient.
Great Owls – allows you to screen our Great Owl Funds – those which have top tier performance in every trailing period of three years or more – by category or profile. We know that past performance should never be the primary driver of your decision-making, but working from a pool of consistently superior performers and learning more about their risk-return profile strikes us as a sensible place to start.
Fund Dashboard – a snapshot of all of the funds we’ve profiled, is updated monthly and is available both as a .pdf and as a searchable and sortable search.
Miraculous Multi-Search – Accipiter’s newest screening tool helps us search Charles’ database of risk elements. Searches are available by fund name, category, risk group and age group. There’s even an option to restrict the results to GreatOwl funds. Better yet, you can search on multiple criteria and further refine your results list by choosing to hide certain results.

In Closing . . .

Thank you, dear friends. It’s been a remarkable year. In December of 2012, we served 9000 readers. A year later, 24,500 readers made 57,000 visits to the Observer in December – a gain of 150%. The amount of time readers spend on site is up, too, by about 50% over last year. The percentage of new visitors is up 57%. But almost 70% of visits are by returning readers.

It’s all the more striking because we’re the antithesis of a modern news site: our pieces tend to be long, appear once a month and try to be reflective and intelligent. NPR had a nice piece that lamented the pressure to be “first, loud and sensational” (This is (not) the most important story of the year, 12/29/2013). The “reflective and intelligent” part sort of reflects our mental image of who you are.

We’ve often reminded folks of their ability to help the Observer financially, either through our partnership with Amazon (they rebate us about 7% of the value of items purchased through our link) or direct contributions. Those are both essential and we’re deeply grateful to the dozens of folks who’ve acted on our behalf. This month we’d like to ask for a different sort of support, one which might help us make the Observer better in the months ahead.

Would you tell us a bit about who you are and why you’re here? We do not collect any information about you when you visit. The cosmically-talented Chip found a way to embed an anonymous survey directly in this essay, so that you could answer a few questions without ever leaving the comfort of your chair. What follows are six quick questions. We’re setting aside questions about our discussion board for now, since it’s been pretty easy to keep in touch with the folks there. Complete as many as you’re comfortable with.

Create your free online surveys with SurveyMonkey , the world’s leading questionnaire tool.

We’ll share as soon as we hear back from you.

Thanks to Deb (the first person ever to set up an automatic monthly contribution to the site, which was really startling when we found out), to David and the other contributors scattered (mostly) in warm states (and Indianapolis), and to friends who’ve shared books, cookies, well-wishes and holiday cheer.

Finally, thanks to the folks whose constant presence makes the Observer happen: the folks who’ve spent this entire century supporting the discussion board (BobC, glampig, rono, Slick, the indefatigable Ted, and Whakamole among them) and the hundred or so folks regularly on the board; The Shadow, who can sense the presence of interesting SEC filings from a mile away; Accipiter, whose programming skills – generally self-taught – lie behind our fund searches; Ed, who puzzles and grumbles; Charles, who makes data sing; and the irreplaceable Chip, friend, partner and magician. I’m grateful to you all and look forward to the adventures of the year ahead.

As ever,

David

November 1, 2013

Dear friends,

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

hedge-fund-myth

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

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

comments

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

hedge-fund

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

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

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

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

golden-child

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

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

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

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

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

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

But, of course, they didn’t.

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

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

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

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

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

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

Odd.

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

The short version:

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

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

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

Skin in the Game, Part Two

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

Paul Valery

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

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

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

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

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

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

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

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

Postscript:

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

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

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

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

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

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

comparison

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

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

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

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

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

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

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

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

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

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

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

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

23Oct2013/Charles

The Great Owl search engine has arrived

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

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

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

Who do you trust for fund information?

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

poll

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

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

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

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

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

The difference between “departures” and “succession planning”

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

Mitch Milias will be retiring at the end of 2013

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

Neil Woodford will depart Invesco in April, 2014

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

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

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

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

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

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

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

Observer Fund Profiles:

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

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

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

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

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

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

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

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

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

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

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

Our earlier Elevator Talks were:

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

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

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

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

In the interim, the discipline is simple:

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

Two listener questions, in particular, stood out:

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

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

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

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

The BMPEX Conference Call

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

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

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

Permanent Loss of Capital

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

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

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

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

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

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

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

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

sp5003yr

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

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

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

29Oct2013/Charles

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

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

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

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

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

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

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

How can you join in?

WOULD AN ADDITIONAL HEADS UP HELP?

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

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

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

Launch Alert: DoubleLine Shiller Enhanced CAPE

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

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

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

Funds in Registration (The New Year’s Edition)

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

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

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

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

Manager Changes

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

Updates

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

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

Advisory Research Strategic Income	Q3 Report Manager Commentary Fact Sheet
Artisan Global Equity Fund	Q3 Report
Artisan Global Value Fund	Q3 Report
Beck, Mack & Oliver Partners Fund	Fact Sheet
Bretton Fund	Q3 Report Fund Fact Page
Bridgeway Managed Volatility	Q3 Report Fact Sheet
FPA International Value	Q3 Report and Commentary Fact Sheet
FPA Paramount	Q3 Report and Commentary Fact Sheet
Frank Value	Fact Sheet Q3 Report and Commentary
FundX Upgrader Fund	Fact Sheet
Grandeur Peak Global Opportunities	Q3 Report Commentary
Grandeur Peak Global Reach	Q3 Report Commentary
LS Opportunity Fund	Q3 Report
Matthews Asia Strategic Income	Commentary Q3 Report
Oakseed Opportunity Fund	Fact Sheet
Oberweis International Opportunities	Q3 Report
Payden Global Low Duration Fund	Q3 Report Commentary
PIMCO Short Asset Investment Fund “D” shares	Q3 Report
RiverPark/Gargoyle Hedge Value	Q3 Report
Scout Low Duration Bond Fund	Q3 Report Commentary
Sextant Global High Income	Q3 Report
Smead Value Fund	Q3 Report Fact Sheet
The Cook and Bynum Fund	Fact Sheet
Tributary Balanced	Q3 Report Fact Sheet
Whitebox Long Short Equity Investor Class	Fact Sheet

Briefly Noted

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

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

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

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

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

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

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

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

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

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

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

SMALL WINS FOR INVESTORS

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

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

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

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

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

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

CLOSINGS (and related inconveniences)

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

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

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

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

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

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

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

OLD WINE, NEW BOTTLES

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

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

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

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

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

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

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

OFF TO THE DUSTBIN OF HISTORY

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

And so, thanks, big guy!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

In Closing . . .

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

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

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

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

Cheers!

David

July 1, 2013

Dear friends,

Welcome to summer, a time of year when heat records are rather more common than market records.

temp_map

What’s in your long/short fund?

viking Everybody’s talking about long/short funds. Google chronicles 273,000 pages that use the phrase. Bloomberg promises “a comprehensive list of long/short funds worldwide.” Morningstar, Lipper and U.S. News plunk nearly a hundred funds into a box with that label. (Not the same hundred funds, by the way. Not nearly.) Seeking Alpha offers up the “best and less long/short funds 2013.”

Here’s the Observer’s position: Talking about “long/short funds” is dangerous and delusional because it leads you to believe that there are such things. Using the phrase validates the existence of a category, that is, a group of things where we perceive shared characteristics. As soon as we announce a category, we start judging things in the category based on how well they conform to our expectations of the category. If we assign a piece of fruit (or a hard-boiled egg) to the category “upscale dessert,” we start judging it based on how upscale-dessert-y it seems. The fact that the assignment is random, silly and unfair doesn’t stop us from making judgments anyway. The renowned linguist George Lakoff writes, “there is nothing more basic than categorization to our thought, perception, action and speech.”

Do categories automatically make sense? Try this one out: Dyirbal, an Australian aboriginal language, has a category balan which contains women, fire, dangerous things, non-threatening birds and platypuses.

When Morningstar groups 83 funds together in the category “long/short equity,” they’re telling us “hey, all of these things have essential similarities. Feel free to judge them against each other.” We sympathize with the analysts’ need to organize funds. Nonetheless, this particular category is seriously misleading. It contains funds that have only superficial – not essential – similarities with each other. In extended conversations with managers and executives representing a half dozen long/short funds, it’s become clear that investors need to give up entirely on this simple category if they want to make meaningful comparisons and choices.

Each of the folks we spoke to have their own preferred way of organizing these sorts of “alternative investment” funds. After two weeks of conversation, though, useful commonalities began to emerge. Here’s a manager-inspired schema:

Start with the role of the short portfolio. What are the managers attempting to do with their short book and how are they doing it? The RiverNorth folks, and most of the others, agree that this should be “the first and perhaps most important” criterion. Alan Salzbank of the Gargoyle Group warns that “the character of the short positions varies from fund to fund, and is not necessarily designed to hedge market exposure as the category title would suggest.” Based on our discussions, we think there are three distinct roles that short books play and three ways those strategies get reflected in the fund.

Role	Portfolio tool	Translation
Add alpha	Individual stock shorts	These funds want to increase returns by identifying the market’s least attractive stocks and betting against them
Reduce beta	Shorting indexes or sectors, generally by using ETFs	These funds want to tamp market volatility by placing larger or smaller bets against the entire market, or large subsets of it, with no concern for the value of individual issues
Structural	Various option strategies such as selling calls	These funds believe they can generate considerable income – as much as 1.5-2% per month – by selling options. Those options become more valuable as the market becomes more volatile, so they serve as a cushion for the portfolio; they are “by their very nature negatively correlated to the market” (AS).

Determine the degree of market exposure. Net exposure (% long minus % short) varies dramatically, from 100% (from what ARLSX manager Matt Moran laments as “the faddish 130/30 funds from a few years ago”) to under 25%. An analysis by the Gargoyle Group showed three-year betas for funds in Morningstar’s long/short category ranging from 1.40 to (-0.43), which gives you an idea of how dramatically market exposure varies. For some funds the net market exposure is held in a tight band (40-60% with a target of 50% is pretty common). Some of the more aggressive funds will shift exposure dramatically, based on their market experience and projections. It doesn’t make sense to compare a fund that’s consistently 60% exposure to the market with one that swings from 25% – 100%.

Ideally, that information should be prominently displayed on a fund’s fact sheet, especially if the manager has the freedom to move by more than a few percent. A nice example comes from Aberdeen Equity Long/Short Fund’s (GLSRX) factsheet:

Greg Parcella of Long/Short Advisors maintains an internal database of all of long/short funds and expressed some considerable frustration in discovering that many don’t make that information available or require investors to do their own portfolio analyses to discover it. Even with the help of Morningstar, such self-generated calculations can be a bit daunting. Here, for example, is how Morningstar reports the portfolio of Robeco Boston Partners Long/Short Equity BPLEX in comparison to its (entirely-irrelevant) long-short benchmark and (wildly incomparable) long/short equity peers:

So, look for managers who offer this information in a clear way and who keep it current. Morty Schaja, president of RiverPark Advisors which offers two very distinctive long/short funds (RiverPark Long/Short Opportunity RLSFX and RiverPark/Gargoyle Hedged Value RGHVX) suggest that such a lack of transparency would immediately raise concerns for him as an investor; he did not offer a flat “avoid them” but was surely leaning in that direction.
Look at the risk/return metrics for the fund over time. Once you’ve completed the first two steps, you’ve stopped comparing apples to rutabagas and mopeds (step one) or even cooking apples to snacking apples (step two). Now that you’ve got a stack of closely comparable funds, many of the managers call for you to look at specific risk measures. Matt Moran suggests that “the best measure to employ are … the Sharpe, the Sortino and the Ulcer Index [which help you determine] how much return an investor is getting for the risk that they are taking.”

As part of the Observer’s new risk profiles of 7600 funds, we’ve pulled all of the funds that Morningstar categorizes as “long/short equity” into a single table for you. It will measure both returns and seven different flavors of risk. If you’re unfamiliar with the varied risk metrics, check our definitions page. Remember that each bit of data must be read carefully since the fund’s longevity can dramatically affect their profile. Funds that were around in the 2008 will have much greater maximum drawdowns than funds launched since then. Those numbers do not immediately make a fund “bad,” it means that something happened that you want to understand before trusting these folks with your money.

As a preview, we’d like to share the profiles for five of the six funds whose advisors have been helping us understand these issues. The sixth, RiverNorth Dynamic Buy-Write (RNBWX), is too new to appear. These are all funds that we’ve profiled as among their categories’ best and that we’ll be profiling in August.

long-short-table

Long/short managers aren’t the only folks concerned with managing risk. For the sake of perspective, we calculated the returns on a bunch of the risk-conscious funds that we’ve profiled. We looked, in particular, at the recent turmoil since it affected both global and domestic, equity and bond markets.

Downside protection in one ugly stretch, 05/28/2013 – 06/24/2013

Strategy	Represented by	Returned
Traditional balanced	Vanguard Balanced Index Fund (VBINX)	(3.97)
Global equity	Vanguard Total World Stock Index (VTWSX)	(6.99)
Absolute value equity a/k/a cash-heavy funds	ASTON/River Road Independent Value (ARIVX) Bretton (BRTNX) Cook and Bynum (COBYX) FPA International Value (FPIVX) Pinnacle Value (PVFIX)	(1.71) (2.51) (3.20) (3.30) (1.75)
Pure long-short	ASTON/River Road Long-Short (ARLSX) Long/Short Opportunity (LSOFX) RiverPark Long Short Opportunity (RLSFX) Wasatch Long/Short (FMLSX)	(3.34) (4.93) (5.08) (3.84)
Long with covered calls	Bridgeway Managed Volatility (BRBPX) RiverNorth Dynamic Buy-Write (RNBWX) RiverPark Gargoyle Hedged Value (RGHVX)	(1.18) (2.64) (4.39)
Market neutral	Whitebox Long/Short Equity (WBLSX)	(1.75)
Multi-alternative	MainStay Marketfield (MFLDX)	(1.11)

Charles, widely-read and occasionally whimsical, thought it useful to share two stories and a bit of data that lead him to suspect that successful long/short investments are, like Babe Ruth’s “called home run,” more legend than history.

Notes from the Morningstar Conference

If you ever wonder what we do with contributions to the Observer or with income from our Amazon partnership, the short answer is, we try to get better. Three ongoing projects reflect those efforts. One is our ongoing visual upgrade, the results of which will be evident online during July. More than window-dressing, we think of a more graphically sophisticated image as a tool for getting more folks to notice and benefit from our content. A second our own risk profiles for more than 7500 funds. We’ll discuss those more below. The third was our recent presence at the Morningstar Investment Conference. None of them would be possible without your support, and so thanks!

I spent about 48 hours at Morningstar and was listening to folks for about 30 hours. I posted my impressions to our discussion board and several stirred vigorous discussions. For your benefit, here’s a sort of Top Ten list of things I learned at Morningstar and links to the ensuing debates on our discussion board.

Day One: Northern Trust on emerging and frontier investing

Attended a small lunch with Northern managers. Northern primarily caters to the rich but has retail share class funds, FlexShare ETFs and multi-manager funds for the rest of us. They are the world’s 5th largest investor in frontier markets. Frontier markets are currently 1% of global market cap, emerging markets are 12% and both have GDP growth 350% greater than the developed world’s. EM/F stocks sell at a 20% discount to developed stocks. Northern’s research shows that the same factors that increase equity returns in the developed world (small, value, wide moat, dividend paying) also predict excess returns in emerging and frontier markets. In September 2012 they launched the FlexShares Emerging Markets Factor Tilt Index Fund (TLTE) that tilts toward Fama-French factors, which is to say it holds more small and more value than a standard e.m. index.

Day One: Smead Value (SMVLX)

Interviewed Bill Smead, an interesting guy, who positions himself against the “brilliant pessimists” like Grantham and Hussman. Smead argues their clients have now missed four years of phenomenal gains. Their thesis is correct (as were most of the tech investor theses in 1999) but optimism has been in such short supply that it became valuable. He launched Smead Value in 2007 with a simple strategy: buy and hold (for 10 to, say, 100 years) excellent companies. Pretty radical, eh? He argues that the fund universe is 35% passive, 5% active and 60% overly active. Turns out that he’s managed it to top 1-2% returns over most trailing periods. Much the top performing LCB fund around. There’s a complete profile of the fund below.

Day One: Morningstar’s expert recommendations on emerging managers

Consuelo Mack ran a panel discussion with Russ Kinnel, Laura Lallos, Scott Burns and John Rekenthaler. One question: “What are your recommendations for boutique firms that investors should know about, but don’t? Who are the smaller, emerging managers who are really standing out?”

Dead silence. Glances back and forth. After a long silence: FPA, Primecap and TFS.

There are two possible explanations: (1) Morningstar really has lost touch with anyone other than the top 20 (or 40 or whatever) fund complexes or (2) Morningstar charged dozens of smaller fund companies to be exhibitors at their conference and was afraid to offend any of them by naming someone else.

Since we notice small funds and fund boutiques, we’d like to offer the following answers that folks could have given:

Well, Consuelo, a number of advisors are searching for management teams that have outstanding records with private accounts and/or hedge funds, and are making those teams and their strategies available to the retail fund world. First rate examples include ASTON, RiverNorth and RiverPark.

Or

That’s a great question, Consuelo. Individual investors aren’t the only folks tired of dealing with oversized, underperforming funds. A number of first-tier investors have walked away from large fund complexes to launch their own boutiques and to pursue a focused investing vision. Some great places to start would be with the funds from Grandeur Peak, Oakseed, and Seafarer.

Mr. Mansueto did mention, in his opening remarks, an upcoming Morningstar initiative to identify and track “emerging managers.” If so, that’s a really good sign for all involved.

Day One: Michael Mauboussin on luck and skill in investing

Mauboussin works for Credit Suisse, Legg Mason before that and has written The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing (2012). Here’s his Paradox of Skill: as the aggregate level of skill rises, luck becomes a more important factor in separating average from way above average. Since you can’t count on luck, it becomes harder for anyone to remain way above average. Ted Williams hit .406 in 1941. No one has been over .400 since. Why? Because everyone has gotten better: pitchers, fielders and hitters. In 1941, Williams’ average was four standard deviations above the norm. In 2012, a hitter up by four s.d. would be hitting “just” .380. The same thing in investing: the dispersion of returns (the gap between 50th percentile funds and 90th percentile funds) has been falling for 50 years. Any outsized performance is now likely luck and unlikely to persist.

This spurred a particularly rich discussion on the board.

Day Two: Matt Eagan on where to run now

Day Two started with a 7:00 a.m. breakfast sponsored by Litman Gregory. (I’ll spare you the culinary commentary.) Litman runs the Masters series funds and bills itself as “a manager of managers.” The presenters were two of the guys who subadvise for them, Matt Eagan of Loomis Sayles and David Herro of Oakmark. Eagan helps manage the strategic income, strategic alpha, multi-sector bond, corporate bond and high-yield funds for LS. He’s part of a team named as Morningstar’s Fixed-Income Managers of the Year in 2009.

Eagan argues that fixed income is influenced by multiple cyclical risks, including market, interest rate and reinvestment risk. He’s concerned with a rising need to protect principal, which leads him to a neutral duration, selective shorting and some currency hedges (about 8% of his portfolios).

He’s concerned that the Fed has underwritten a hot-money move into the emerging markets. The fundamentals there “are very, very good and we see their currencies strengthening” but he’s made a tactical withdrawal because of some technical reasons (I have “because of a fund-out window” but have no idea of what that means) which might foretell a drop “which might be violent; when those come, you’ve just got to get out of the way.”

He finds Mexico to be “compelling long-term story.” It’s near the US, it’s capturing market share from China because of the “inshoring” phenomenon and, if they manage to break up Pemex, “you’re going to see a lot of growth there.”

Europe, contrarily, “is moribund at best. Our big hope is that it’s less bad than most people expect.” He suspects that the Europeans have more reason to stay together than to disappear, so they likely will, and an investor’s challenge is “to find good corporations in bad Zip codes.”

In the end:

avoid indexing – almost all of the fixed income indexes are configured to produce “negative real yields for the foreseeable future” and most passive products are useful mostly as “just liquidity vehicles.”
you can make money in the face of rising rates, something like a 3-4% yield with no correlation to the markets.
avoid Treasuries and agencies
build a yield advantage by broadening your opportunity set
look at convertible securities and be willing to move within a firm’s capital structure
invest overseas, in particular try to get away from the three reserve currencies.

Eagan manages a sleeve of Litman Gregory Masters Alternative Strategies (MASNX), which we’ve profiled and which has had pretty solid performance.

Day Two: David Herro on emerging markets and systemic risk

The other breakfast speaker was David Herro of Oakmark International. He was celebrated in our May 2013 essay, “Of Oaks and Acorns,” that looked at the success of Oakmark international analysts as fund managers.

Herro was asked about frothy markets and high valuations. He argues that “the #1 risk to protect against is the inability of companies to generate profits – macro-level events impact price but rarely impact long-term value. These macro-disturbances allow long-term investors to take advantage of the market’s short-termism.” The ’08-early ’09 events were “dismal but temporary.”

Herro notes that he had 20% of his flagship in the emerging markets in the late 90s, then backed down to zero as those markets were hit by “a wave of indiscriminate inflows.” He agrees that emerging markets will “be the propellant of global economic growth for the next 20 years” but, being a bright guy, warns that you still need to find “good businesses at good prices.” He hasn’t seen any in several years but, at this rate, “maybe in a year we’ll be back in.”

His current stance is that a stock needs to have 40-50% upside to get into his portfolio today and “some of the better quality e.m. firms are within 10-15% of getting in.” (Since then the e.m. indexes briefly dropped 7% but had regained most of that decline by June 30.) He seemed impressed, in particular, with the quality of management teams in Latin America (“those guys are really experienced with handling adversity”) but skeptical of the Chinese newbies (“they’re still a little dodgy”).

He also announced a bias “against reserve currencies.” That is, he thinks you’re better off buying earnings which are not denominated in dollars, Euros or … perhaps, yen. His co-presenter, Matt Eagan of Loomis Sayles, has the same bias. He’s been short the yen but long the Nikkei.

In terms of asset allocation, he thinks that global stocks, especially blue chips “are pretty attractively priced” since values have been rising faster than prices have. Global equities, he says, “haven’t come out of their funk.” There’s not much of a valuation difference between the US and the rest of the developed world (the US “is a little richer” but might deserve it), so he doesn’t see overweighting one over the other.

Day Two: Jack Bogle ‘s inconvenient truths

Don Phillips had a conversation with Bogle in a huge auditorium that, frankly, should dang well have had more people in it. I think the general excuse is, “we know what Bogle’s going to say, so why listen?” Uhhh … because Bogle’s still thinking clearly, which distinguishes him from a fair number of his industry brethren? He weighed in on why money market funds cost more than indexed stock funds (the cost of check cashing) and argued that our retirement system is facing three train wrecks: (1) underfunding of the Social Security system – which is manageable if politicians chose to manage it, (2) “grotesquely underfunded” defined benefit plans (a/k/a pension plans) whose managers still plan to earn 8% with a balanced portfolio – Bogle thinks they’ll be lucky to get 5% before expenses – and who are planning “to bring in some hedge fund guys” to magically solve their problem, and (3) defined contribution plans (401k’s and such) which allow folks to wreck their long-term prospects by cashing out for very little cause.

Bogle thinks that most target-date funds are ill-designed because they ignore Social Security, described by Bogle as “the best fixed-income position you’ll ever have.” The average lifetime SS benefit is something like $300,000. If your 401(k) contains $300,000 in stocks, you’ll have a 50/50 hybrid at retirement. If your 401(k) target-date fund is 40% in bonds, you’ll retire with a portfolio that’s 70% bonds (SS + target date fund) and 30% stocks. He’s skeptical of the bond market to begin with (he recommends that you look for a serious part of your income stream from dividend growth) and more skeptical of a product that buries you in bonds.

Finally, he has a strained relationship with his successors at Vanguard. On the one hand he exults that Vanguard’s structural advantage on expenses is so great “that nobody can match us – too bad for them, good for us.” And the other, he disagrees with most industry executives, including Vanguard’s, on regulations of the money market industry and the fund industry’s unwillingness – as owners of 35% of all stock – to stand up to cultures in which corporations have become “the private fiefdom of their chief executives.” (An issue addressed by The New York Times on June 29, “The Unstoppable Climb in CEO Pay.”) At base, “I don’t disagree with Vanguard. They disagree with me.”

Day Three: Sextant Global High Income

This is an interesting one and we’ll have a full profile of the fund in August. The managers target a portfolio yield of 8% (currently they manage 6.5% – the lower reported trailing 12 month yield reflects the fact that the fund launched 12 months ago and took six months to become fully invested). There are six other “global high income” funds – Aberdeen, DWS, Fidelity, JohnHancock, Mainstay, Western Asset. Here’s the key distinction: Sextant pursues high income through a combination of high dividend stocks (European utilities among them), preferred shares and high yield bonds. Right now about 50% of the portfolio is in stocks, 30% bonds, 10% preferreds and 10% cash. No other “high income” fund seems to hold more than 3% equities. That gives them both the potential for capital appreciation and interest rate insulation. They could imagine 8% from income and 2% from cap app. They made about 9.5% over the trailing twelve months through 5/31.

Day Three: Off-the-record worries

I’ve had the pleasure of speaking with some managers frequently over months or years, and occasionally we have conversations where I’m unsure that statements were made for attribution. Here are four sets of comments attributable to “managers” who I think are bright enough to be worth listening to.

More than one manager is worried about “a credit event” in China this year. That is, the central government might precipitate a crisis in the financial system (a bond default or a bank run) in order to begin cleansing a nearly insolvent banking system. (Umm … I think we’ve been having it and I’m not sure whether to be impressed or spooked that folks know this stuff.) The central government is concerned about disarray in the provinces and a propensity for banks and industries to accept unsecured IOUs. They are acting to pursue gradual institutional reforms (e.g., stricter capital requirements) but might conclude that a sharp correction now would be useful. One manager thought such an event might be 30% likely. Another was closer to “near inevitable.”

More than one manager suspects that there might be a commodity price implosion, gold included. A 200 year chart of commodity prices shows four spikes – each followed by a retracement of more than 100% – and a fifth spike that we’ve been in recently.

More than one manager offered some version of the following statement: “there’s hardly a bond out there worth buying. They’re essentially all priced for a negative real return.”

More than one manager suggested that the term “emerging markets” was essentially a linguistic fiction. About 25% of the emerging markets index (Korea and Taiwan) could be declared “developed markets” (though, on June 11, they were not) while Saudi Arabia could become an emerging market by virtue of a decision to make shares available to non-Middle Eastern investors. “It’s not meaningful except to the marketers,” quoth one.

Day Three: Reflecting on tchotchkes

Dozens of fund companies paid for exhibits at Morningstar – little booths inside the McCormick Convention Center where fund reps could chat with passing advisors (and the occasional Observer guy). One time honored conversation starter is the tchotchke: the neat little giveaway with your name on it. Firms embraced a stunning array of stuff: barbeque sauce (Scout Funds, from Kansas City), church-cooked peanuts (Queens Road), golf tees, hand sanitizers (inexplicably popular), InvestMints (Wasatch), micro-fiber cloths (Payden), flashlights, pens, multi-color pens, pens with styluses, pens that signal Bernanke to resume tossing money from a circling helicopter . . .

Ideally, you still need to think of any giveaway as an expression of your corporate identity. You want the properties of the object to reflect your sense of self and to remind folks of you. From that standard, the best tchotchke by a mile were Vanguard’s totebags. You wish you had one. Made of soft, heavy-weight canvas with a bottom that could be flattened for maximum capacity, they were unadorned except for the word “Vanguard.” No gimmicks, no flash, utter functionality in a product that your grandkids will fondly remember you carrying for years. That really says Vanguard. Good job, guys!

vangard bag 2

The second-best tchotchke (an exceedingly comfortable navy baseball cap with a sailboat logo) and single best location (directly across from the open bar and beside Vanguard) was Seafarer’s.

It’s Charles in Charge!

My colleague Charles Boccadoro has spearheaded one of our recent initiatives: extended risk profiles of over 7500 funds. Some of his work is reflected in the tables in our long/short fund story. Last month we promised to roll out his data in a searchable form for this month. As it turns out, the programmer we’re working with is still a few days away from a “search by ticker” engine. Once that’s been tested, chip will be able to quickly add other search fields.

As an interim move, we’re making all of Charles’ risk analyses available to you as a .pdf. (It might be paranoia, but I’m a bit concerned about the prospect of misappropriation of the file if we post it as a spreadsheet.) It runs well over 100 pages, so I’d be a bit cautious about hitting the “print” button.

Charles’ contributions have been so thoughtful and extensive that, in August, we’ll set aside a portion of the Observer that will hold an archive of all of his data-driven pieces. Our current plan is to introduce each of the longer pieces in this cover essay then take readers to Charles’ Balcony where complete story and all of his essays dwell. We’re following that model in …

Timing method performance over ten decades

The Healthy Debate. In Professor David Aronson’s 2006 book, entitled “Evidence-Based Technical Analysis,” he argues that subjective technical analysis, which is any analysis that cannot be reduced to a computer algorithm and back tested, is “not a legitimate body of knowledge but a collection of folklore resting on a flimsy foundation of anecdote and intuition.”

He further warns that falsehoods accumulate even with objective analysis and rules developed after-the-fact can lead to overblown extrapolations – fool’s gold biased by data-mining, more luck than legitimate prediction, in same category as “literate monkeys, Bible Codes, and lottery players.”

Read the full story here.

Announcing Mutual Fund Contacts, our new sister-site

I mentioned some months ago a plan to launch an affiliate site, Mutual Fund Contacts. June 28 marked the “soft launch” of MFC. MFC’s mission is to serve as a guide and resource for folks who are new at all this and feeling a bit unsteady about how to proceed. We imagine a young couple in their late 20s planning an eventual home purchase, a single mom in her 30s who’s trying to organize stuff that she’s not had to pay attention to, or a young college graduate trying to lay a good foundation.

Most sites dedicated to small investors are raucous places with poor focus, too many features and a desperate need to grab attention. Feh. MFC will try to provide content and resources that don’t quite fit here but that we think are still valuable. Each month we’ll provide a 1000-word story on the theme “the one-fund portfolio.” If you were looking for one fund that might yield a bit more than a savings account without a lot of downside, what should you consider? Each “one fund” article will recommend three options: two low-minimum mutual funds and one commission-free ETF. We’ll also have a monthly recommendation on three resources you should be familiar with (this month, the three books that any financially savvy person needs to start with) and ongoing resources (this month: the updated “List of Funds for Small Investors” that highlights all of the no-load funds available for $100 or less – plus a couple that are close enough to consider).

The nature of a soft launch is that we’re still working on the site’s visuals and some functionality. That said, it does offer a series of resources that, oh, say, your kids really should be looking at. Feel free to drop by Mutual Fund Contacts and then let us know how we can make it better.

Everyone loves a crisis

Larry Swedroe wrote a widely quoted, widely redistributed essay for CBS MoneyWatch warning that bond funds were covertly transforming themselves into stock funds in pursuit of additional yield. His essay opens with:

It may surprise you that, as of its last reporting date, there were 352 mutual funds that are classified by Morningstar as bond funds that actually held stocks in their portfolio. (I know I was surprised, and given my 40 years of experience in the investment banking and financial advisory business, it takes quite a bit to surprise me.) At the end of 2012, it was 312, up from 283 nine months earlier.

The chase for higher yields has led many actively managed bond funds to load up on riskier investments, such as preferred stocks. (Emphasis added)

Many actively managed bond funds have loaded up?

Let’s look at the data. There are 1177 bond funds, excluding munis. Only 104 hold more than 1% in stocks, and most of those hold barely more than a percent. The most striking aspect of those funds is that they don’t call themselves “bond” funds. Precisely 11 funds with the word “Bond” in their name have stocks in excess of 1%. The others advertise themselves as “income” funds and, quite often, “strategic income,” “high income” or “income opportunities” funds. Such funds have, traditionally, used other income sources to supplement their bond-heavy core portfolios.

How about Larry’s claim that they’ve been “bulking up”? I looked at the 25 stockiest funds to see whether their equity stake should be news to their investors. I did that by comparing their current exposure to the bond market with the range of exposures they’ve experienced over the past five years. Here’s the picture, ranked based on US stock exposure, starting with the stockiest fund:

		Bond category	Current bond exposure	Range of bond exposure, 2009-2013
Ave Maria Bond	AVEFX	Intermediate	61	61-71
Pacific Advisors Government Securities	PADGX	Short Gov’t	82	82-87
Advisory Research Strategic Income	ADVNX	Long-Term	16	n/a – new
Northeast Investors	NTHEX	High Yield	54	54-88
Loomis Sayles Strategic Income	NEFZX	Multisector	65	60-80
JHFunds2 Spectrum Income	JHSTX	Multisector	77	75-79
T. Rowe Price Spectrum Income	RPSIX	Multisector	76	76-78
Azzad Wise Capital	WISEX	Short-Term	42	20-42 *
Franklin Real Return	FRRAX	Inflation-Prot’d	47	47-69
Huntington Mortgage Securities	HUMSX	Intermediate	85	83-91
Eaton Vance Bond	EVBAX	Multisector	63	n/a – new
Federated High Yield Trust	FHYTX	High Yield	81	81-87
Pioneer High Yield	TAHYX	High Yield	57	55-60
Chou Income	CHOIX	World	33	16-48
Forward Income Builder	AIAAX	Multisector	35	35-97
ING Pioneer High Yield Portfolio	IPHIX	High Yield	60	50-60
Loomis Sayles High Income	LSHIX	High Yield	61	61-70
Highland Floating Rate Opportunities	HFRAX	Bank Loan	81	73-88
Epiphany FFV Strategic Income	EPINX	Intermediate	61	61-69
RiverNorth/Oaktree High Income	RNHIX	Multisector	56	n/a – new
Astor Active Income ETF	AXAIX	Intermediate	74	68-88
Fidelity Capital & Income	FAGIX	High Yield	84	75-84
Transamerica Asset Allc Short Horizon	DVCSX	Intermediate	85	79-87
Spirit of America Income	SOAIX	Long-term	74	74-90

*WISEX invests within the constraints of Islamic principles. As a result, most traditional interest-paying, fixed-income vehicles are forbidden to it.

From this most stock-heavy group, 10 funds now hold fewer bonds than at any other point in the past five years. In many cases (see T Rowe Price Spectrum Income), their bond exposure varies by only a few percentage points from year to year so being light on bonds is, for them, not much different than being heavy on bonds.

The SEC’s naming rule says that if you have an investment class in your name (e.g. “Bond”) then at least 80% of your portfolio must reside in that class. Ave Maria Bond runs right up to the line: 19.88% US stocks, but warns you of that: “The Fund may invest up to 20% of its net assets in equity securities, which include preferred stocks, common stocks paying dividends and securities convertible into common stock.” Eaton Vance Bond is 12% and makes the same declaration: “The Fund may invest up to 20% of its net assets in common stocks and other equity securities, including real estate investment trusts.”

Bottom line: the “loading up” has been pretty durn minimal. The funds which have a substantial equity stake now have had a substantial equity stake for years, they market that fact and they name themselves to permit it.

Fidelity cries out: Run away!

Several sites have noted the fact that Fidelity Europe Cap App Fund (FECAX) has closed to new investors. Most skip the fact that it looks like the $400 million FECAX is about to get eaten, presumably by Fidelity Europe (FIEUX): “The Board has approved closing Fidelity Europe Capital Appreciation Fund effective after the close of business on July 19, 2013, as the Board and FMR are considering merging the fund.” (emphasis added)

Fascinating. Fidelity’s signaling the fact that they can no longer afford two Euro-centered funds. Why would that be the case?

I can only imagine three possibilities:

Fidelity no longer finds with a mere $400 million in AUM viable, so the Cap App fund has to go.
Fidelity doesn’t think there’s room for (or need for) more than one European stock strategy. There are 83 distinct U.S.-focused strategies in the Fidelity family, but who’d need more than one for Europe?

Fidelity can no longer find managers capable of performing well enough to be worth the effort.

	Expenses	Returns TTM	Returns 5 yr	Compared to peers – 5 yr
Fidelity European funds for British investors
Fidelity European Fund A-Accumulation	1.72% on $4.1B	22%	1.86	3.31
Fidelity Europe Long-Term Growth Fund	1.73 on $732M	29	n/a	n/a
Fidelity European Opportunities	1.73 on $723M	21	1.48	3.31
Fidelity European funds for American investors
Fidelity European Capital Appreciation	0.92% on $331M	24	(1.57)	(.81)
Fidelity Europe	0.80 on $724M	23	(1.21)	(0.40)
Fidelity Nordic	1.04% on $340M	32	(0.40)	The Morningstar peer group is “miscellaneous regions” – ignore it

Converted at ₤1 = $1.54, 25 June 2013.

In April of 2007, Fidelity tried to merge Nordic into Europe, but its shareholders refused to allow it. At the time Nordic was one of Fidelity’s best-performing international funds and had $600 million in assets. The announced rationale: “The Nordic region is more volatile than developed Europe as a whole, and Fidelity believes the region’s characteristics have changed sufficiently to no longer warrant a separate fund focused on the region.” The nature of those “changes” was not clear and shareholders were unimpressed.

It is clear that Fidelity has a personnel problem. When, for example, they wanted to bolster their asset allocation funds-of-funds, they added two new Fidelity Series funds for them to choose from. One is run by Will Danoff, whose Contrafund already has $95 billion in assets, and the other by Joel Tillinghast, whose Low-Priced Stock Fund lugs $40 billion. Presumably they would have turned to a young star with less on their plate … if they had a young star with less on their plate. Likewise, Fidelity Strategic Adviser Multi-Manager funds advertise themselves as being run by the best of the best; these funds have the option of using Fidelity talent or going outside when the options elsewhere are better. What conclusions might we draw from the fact that Strategic Advisers Core Multi-Manager (FLAUX) draws one of its 11 managers from Fido or that Strategic Advisers International Multi-Manager (FMJDX) has one Fido manager in 17? Both of the managers for Strategic Advisers Core Income Multi-Manager (FWHBX) are Fidelity employees, so it’s not simply that the SAMM funds are designed to showcase non-Fido talent.

I’ve had trouble finding attractive new funds from Fidelity for years now. It might well be that the contemplated retrenchment in their Europe line-up reflects the fact that Fido’s been having the same trouble.

Observer Fund Profiles:

Forward Income Builder (IAIAX): “income,” not “bonds.” This is another instance of a fund that has been reshaped in recent years into an interesting offering. Perception just hasn’t yet caught up with the reality.

Smead Value (SMVLX): call it “Triumph of the Optimists.” Mr. Smead dismisses most of what his peers are doing as poorly conceived or disastrously poorly-conceived. He thinks that pessimism is overbought, optimism in short supply and a portfolio of top-tier U.S. stocks held forever as your best friend.

Elevator Talk #5: Casey Frazier of Versus Capital Multi-Manager Real Estate Income Fund

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

Versus Capital Multi-Manager Real Estate Income Fund is a closed-end interval fund. That means that you can buy Versus shares any day that the market is open, but you only have the opportunity to sell those shares once each quarter. The advisor has the option of meeting some, all or none of a particular quarter’s redemption requests, based on cash available and the start of the market.

The argument for such a restrictive structure is that it allows managers to invest in illiquid asset classes; that is, to buy and profit from things that cannot be reasonably bought or sold on a moment’s notice. Those sorts of investments have been traditionally available only to exceedingly high net-worth investors either through limited partnerships or direct ownership (e.g., buying a forest). Several mutual funds have lately begun creating into this space, mostly structured as interval funds. Vertical Capital Income Fund (VCAPX), the subject of our April Elevator Talk, was one such. KKR Alternative Corporate Opportunities Fund, from private equity specialist Kohlberg Kravis Roberts, is another.

Casey Frazieris Chief Investment Officer for Versus, a position he’s held since 2011. From 2005-2010, he was the Chief Investment Officer for Welton Street Investments, LLC and Welton Street Advisors LLC. Here’s Mr. Frazier’s 200 (and 16!) words making the Versus case:

We think the best way to maximize the investment attributes of real estate – income, diversification, and inflation hedge – is through a blended portfolio of private and public real estate investments. Private real estate investments, and in particular the “core” and “core plus” segments of private real estate, have historically offered steady income, low volatility, low correlation, good diversification, and a hedge against inflation. Unfortunately institutional private real estate has been out of reach of many investors due to the large size of the real estate assets themselves and the high minimums on the private funds institutional investors use to gain exposure to these areas. With the help of institutional consultant Callan Associates, we’ve built a multi-manager portfolio in a 40 Act interval structure we feel covers the spectrum of a core real estate allocation. The allocation includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7% – 9% range net of fees with 5% – 6% of that coming from income. Operationally, the fund has daily pricing, quarterly liquidity at NAV, quarterly income, 1099 reporting and no subscription paperwork.

Versus offers a lot of information about private real estate investing on their website. Check the “fund documents” page. The fund’s retail, F-class shares carry an annual expense of 3.30% and a 2.00% redemption fee on shares held less than one year. The minimum initial investment is $10,000.

Conference Call Upcoming: RiverNorth/Oaktree High Income, July 11, 3:15 CT

confcall

While the Observer’s conference call series is on hiatus for the summer (the challenge of coordinating schedules went from “hard” to “ridiculous”), we’re pleased to highlight similar opportunities offered by folks we’ve interviewed and whose work we respect.

In that vein, we’d like to invite you to join in on a conference call hosted by RiverNorth to highlight the early experience of RiverNorth/Oaktree High Income Fund. The fund is looking for high total return, rather than income per se. As of May 31, 25% of the portfolio was allocated to RiverNorth’s tactical closed-end fund strategy and 75% to Oaktree. Oaktree has two strategies (high yield bond and senior loan) and it allocates more or less to each depending on the available opportunity set.

Why might you want to listen in? At base, both RiverNorth and Oaktree are exceedingly successful at what they do. Oaktree’s services are generally not available to retail investors. RiverNorth’s other strategic alliances have ranged from solid (with Manning & Napier) to splendid (with DoubleLine). On the surface the Oaktree alliance is producing solid results, relative to their Morningstar peer group, but the fund’s strategies are so distinctive that I’m dubious of the peer comparison.

If you’re interested, the RiverNorth call will be Thursday, July 11, from 3:15 – 4:15 Central. The call is web-based, so you’ll be able to read supporting visuals while the guys talk. Callers will have the opportunity to ask questions of Mr. Marks and Mr. Galley. Because RiverNorth anticipates a large crowd, you’ll submit your questions by typing them rather than speaking directly to the managers.

How can you join in? Just click

You can also get there by visiting RiverNorthFunds.com and clicking on the Events tab.

Launch Alert

Artisan Global Small Cap (ARTWX) launched on June 25, after several delays. It’s managed by Mark Yockey and his new co-managers/former analysts, Charles-Henri Hamker and Dave Geisler. They’ll apply the same investment discipline used in Artisan Global Equity (ARTHX) with a few additional constraints. Global Small will only invest in firms with a market cap of under $4 billion at the time of purchase and might invest up to 50% of the portfolio in emerging markets. Global Equity has only 7% of its money in small caps and can invest no more than 30% in emerging markets (right now it’s about 14%). Just to be clear: this team runs one five-star fund (Global), two four-star ones (International ARTIX and International Small Cap ARTJX), Mr. Yockey was Morningstar’s International Fund Manager of the Year in 1998 and he and his team were finalists again in 2012. It really doesn’t get much more promising than that. The expenses are capped at 1.50%. The minimum initial investment is $1000.

RiverPark Structural Alpha (RSAFX and RSAIX) launched on Friday, June 28. The fund will employ a variety of options investment strategies, including short-selling index options that the managers believe are overpriced. A half dozen managers and two fund presidents have tried to explain options-based strategies to me. I mostly glaze over and nod knowingly. I have become convinced that these represent fairly low-volatility tools for capturing most of the stock market’s upside. The fund will be comanaged by Justin Frankel and Jeremy Berman. This portfolio was run as a private partnership for five years (September 2008 – June 2013) by the same managers, with the same strategy. Over that time they managed to return 10.7% per year while the S&P 500 made 6.2%. The fund launched at the end of September, 2008, and gained 3.55% through year’s end. The S&P500 dropped 17.7% in that same quarter. While the huge victory over those three months explains some of the fund’s long-term outperformance, its absolute returns from 2009 – 2012 are still over 10% a year. You might choose to sneeze at a low-volatility, uncorrelated strategy that makes 10% annually. I wouldn’t. The fund’s expenses are hefty (retail shares retain the 2% part of the “2 and 20” world while institutional shares come in at 1.75%). The minimum initial investment will be $1000.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting.

Funds in registration this month won’t be available for sale until, typically, the end of August 2013. There were 13 funds in registration with the SEC this month, through June 25^th. The most interesting, by far, is:

RiverPark Strategic Income Fund. David Sherman of Cohanzick Management, who also manages the splendid but closed RiverPark Short Term High Yield Fund (RPHYX, see below) will be the manager. This represents one step out on the risk/return spectrum for Mr. Sherman and his investors. He’s giving himself the freedom to invest across the income-producing universe (foreign and domestic, short- to long-term, investment and non-investment grade debt, preferred stock, convertible bonds, bank loans, high yield bonds and up to 35% income producing equities) while maintaining a very conservative discipline. In repeated conversations, it’s been very clear that Mr. Sherman has an intense dislike of losing his investors’ money. His plan is to pursue an intentionally conservative strategy by investing only in those bonds that he deems “Money Good” and stocks whose dividends are secure. He also can hedge the portfolio and, as with RPHYX, he intends to hold securities until maturity which will make much of the fund’s volatility more apparent than real. The expense ratio is 1.25% for retail shares, 1.00% for institutional. The minimum initial investments will be $1000 for retail and $1M for institutional.

Details and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes

On a related note, we also tracked down a near-record 64 fund manager changes.

Briefly Noted . . .

If you own a Russell equity fund, there’s a good chance that your management team just changed. Phillip Hoffman took over the lead for a couple funds but also began swapping out managers on some of their multi-manager funds. Matthew Beardsley was been removed from management of the funds and relocated into client service.

SMALL WINS FOR INVESTORS

Seventeen BMO Funds dropped their 2.00% redemption fees this month.

BRC Large Cap Focus Equity Fund (BRCIX)has dropped its management fee from 0.75% to 0.47% and capped its total expenses at 0.55%. It’s an institutional fund that launched at the end of 2012 and has been doing okay.

LK Balanced Fund (LKBLX) reduced its minimum initial investment for its Institutional Class Shares from $50,000 to $5,000 for IRA accounts. Tiny fund, very fine long-term record but a new management team as of June 2012.

Schwab Fundamental International Small Company Index Fund (SFILX) and Schwab Fundamental Emerging Markets Large Company Index Fund (SFENX) have capped their expenses at 0.49%. That’s a drop of 6 and 11 basis points, respectively.

CLOSINGS (and related inconveniences)

Good news for RPHYX investors, bad news for the rest of you. RiverPark Short Term High Yield (RPHYX) has closed to new investors. The manager has been clear that this really distinctive cash-management fund had a limited capacity, somewhere between $600 million and $1 billion. I’ve mentioned several times that the closure was nigh. Below is the chart of RPHYX (blue) against Vanguard’s short-term bond index (orange) and prime money market (green).

rphyx

OLD WINE, NEW BOTTLES

For all of the excitement over China as an investment opportunity, China-centered funds have returned a whoppin’ 1.40% over the past five years. BlackRock seems to have noticed and they’ve hit the Reset button on BlackRock China Fund (BACHX). As of August 16, it will become BlackRock Emerging Markets Dividend Fund. One wonders if the term “chasing last year’s hot idea” is new to them?

On or about August 5, 2013, Columbia Energy and Natural Resources Fund (EENAX, with other tickers for its seven other share classes) will be renamed Columbia Global Energy and Natural Resources Fund. There’s no change to the strategy and the fund is already 35% non-U.S., so it’s just marketing fluff.

“Beginning on or about July 1, 2013, all references to ING International Growth Fund (IIGIX) are hereby deleted and replaced with ING Multi-Manager International Equity Fund.” Note to ING: the multi-manager mish-mash doesn’t appear to be a winning strategy.

Effective May 22, ING International Small Cap Fund (NTKLX) may invest up to 25% of its portfolio in REITs.

Effective June 28, PNC Mid Cap Value Fund became PNC Mid Cap Fund (PMCAX).

Effective June 1, Payden Value Leaders Fund became Payden Equity Income Fund (PYVLX). With only two good years in the past 11, you’d imagine that more than the name ought to be rethought.

OFF TO THE DUSTBIN OF HISTORY

Geez, the dustbin is filling quickly.

The Alternative Strategies Mutual Fund (AASFX) closed to new investors in June and will liquidate by July 26, 2013. It’s a microscopic fund-of-funds that, in its best year, trailed 75% of its peers. A 2.5% expense ratio didn’t help.

Hansberger International Value Fund (HINTX) will be liquidated on or about July 19, 2013. It’s moved to cash pending dissolution.

ING International Value Fund (IIVWX) is merging into ING International Value Equity (IGVWX ), formerly ING Global Value Choice. This would be a really opportune moment for ING investors to consider their options. ING is merging the larger fund into the smaller, a sign that the marketers are anxious to bury the worst of the ineptitude. Both funds have been run by the same team since December 2012. This is the sixth management team to run the fund in 10 years and the new team’s record is no better than mediocre.

In case you hadn’t noticed, Litman Gregory Masters Value Fund (MSVFX) was absorbed by Litman Gregory Masters Equity Fund (MSENX) in late June, 2013. Litman Gregory’s struggles should give us all pause. You have a firm whose only business is picking winning fund managers and assembling them into a coherent portfolio. Nonetheless, Value managed consistently disappointing returns and high volatility. How disappointing? Uhh … they thought it was better to keep a two-star fund that’s consistently had higher volatility and lower returns than its peers for the past decade. We’re going to look at the question, “what’s the chance that professionals can assemble a team of consistently winning mutual fund managers?” when we examine the record (generally parlous) of multi-manager funds in an upcoming issue.

Driehaus Large Cap Growth Fund (DRLGX) was closed on June 11 and, as of July 19, the Fund will begin the process of liquidating its portfolio securities.

The Board of Fairfax Gold and Precious Metals Fund (GOLMX and GOLLX) “has concluded that it is in the best interests of the Fund and its shareholders that the Fund cease operations,” which they did on June 29, 2013

Forward Global Credit Long/Short Fund (FGCRX) will be liquidated on or around July 26, 2013. I’m sure this fund seemed like a good idea at the time. Forward’s domestic version of the fund (Forward Credit Analysis Long/Short, FLSRX) has drawn $800 million into a high risk/high expense/high return portfolio. The global fund, open less than two years, managed the “high expense” part (2.39%) but pretty much flubbed on the “attract investors and reward them” piece. The light green line is the original and dark blue is Global, since launch.

flsrx

Henderson World Select Fund (HFPAX) will be liquidated on or about August 30, 2013.

The $13 million ING DFA Global Allocation Portfolio (IDFAX) is slated for liquidation, pending shareholder approval, likely in September.

ING has such a way with words. They announced that ING Pioneer Mid Cap Value Portfolio (IPMVX, a/k/a “Disappearing Portfolio”) will be reorganized “with and into the following ‘Surviving Portfolio’ (the ‘Reorganization’):

Disappearing Portfolio	Surviving Portfolio
ING Pioneer Mid Cap Value Portfolio	ING Large Cap Value Portfolio

So, in the best case, a shareholder is The Survivor? What sort of goal is that? “Hi, gramma! I just invested in a mutual fund that I hope will survive?” Suddenly the Bee Gees erupt in the background with “stayin’ alive, stayin’ alive, ah, ah, ah … “ Guys, guys, guys. The disappearance is scheduled to occur just after Labor Day.

Stephen Leeb wrote The Coming Economic Collapse (2008). The economy didn’t, his fund did. Leeb Focus Fund (LCMFX) closed at the end of June, having parlayed Mr. Leeb’s insights into returns that trailed 98% of its peers since launch.

On June 20, 2013, the board of directors of the Frontegra Funds approved the liquidation of the Lockwell Small Cap Value Fund (LOCSX). Lockwell had a talented manager who was a sort of refugee from a series of fund mergers, acquisitions and liquidations in the industry. We profiled LOCSX and were reasonably positive about its prospects. The fund performed well but never managed to attract assets, partly because small cap investing has been out of favor and partly because of an advertised $100,000 minimum. In addition to liquidating the fund, the advisor is closing his firm.

Tributary Core Equity Fund (FOEQX) will liquidate around July 26, 2013. Tributary Balanced (FOBAX), which we’ve profiled, remains small, open and quite attractive.

I’ve mentioned before that I believe Morningstar misleads investors with their descriptions of a fund’s fee level (“high,” “above average” and so on) because they often use a comparison group that investors would never imagine. Both Tributary Balanced and Oakmark Equity & Income (OAKBX) have $1000 minimum investments. In each case, Morningstar insists on comparing them to their Moderate Allocation Institutional group. Why?

In Closing . . .

We have a lot going on in the month ahead: Charles is working to create a master listing of all the funds we’ve profiled, organized by strategy and risk. Andrew and Chip are working to bring our risk data to you in an easily searchable form. Anya and Barb continue playing with graphics. I’ve got four profiles underway, based on conversations I had at Morningstar.

And … I get to have a vacation! When you next hear from me, I’ll be lounging on the patio of LeRoy’s Water Street Coffee Shop in lovely Ephraim, Wisconsin, on the Door County peninsula. I’ll send pictures, but I promise I won’t be gloating when I’m doing it.

June 1, 2013

Dear friends,

I am not, in a monetary sense, rich. Teaching at a small college pays rather less, and raising a multi-talented 12-year-old costs rather more, than you’d imagine. I tend to invest cautiously in low-minimum, risk-conscious funds. I have good friends, drink good beer, laugh a lot and help coach Little League (an activity to which the beer and laughter both contribute).

sad-romney This comes up only because I was moved to sudden and profound pity over the cruel ways in which the poor, innocent rich folks are being ruthlessly exploited. Two new articles highlight their plight.

Mark Hulbert published a fairly relentless critique, “The Verdict Is In: Hedge Funds Aren’t Worth the Money”(WSJ, 06/01/2013), (While we can’t link directly to the article, you should be able to Google the title and get in) that looks at the performance –both risk and returns – of the average hedge fund since the last market top (October 2007) and from the last market bottom (March 2009). The short version of his findings:

The average hedge fund has trailed virtually every conceivable benchmark (gold, the total bond market, the total stock market, a 60/40 index, and the average open-end mutual fund) whether measured from the top or the bottom
The downside protection offered by hedge funds during the meltdown was not greater than what a simple balanced fund would offer.
At best, one hedge fund manager in five outperforms their mutual fund counterparts, and those winners are essentially impossible to identify in advance.

Apparently Norway figured this out before you. While the Yale endowment, led by David Swensen, was making a mint investing in obscure and complex alternatives, Jason Zweig (“Norway: The New Yale,” WSJ, 03/07/2013) reported that Norway’s huge pension fund has outperformed the stock market and, recently, Yale, through the simple expedient of a globally diversified, long-only portfolio biased toward “small” and “value.” Both Swensen and the brilliantly cranky Bill Bernstein agree that the day of outsized profits from “alternative investments” has passed. Given that fact that the herd is now gorging on alternative investments:

stuck to the tablecloth “it’s somewhere between highly probable and certain that you will underperform [a stock portfolio] if you are being sold commodities, hedge funds and private equity right now.”

Think of it like this, he says: “The first person to the buffet table gets the lobster. The people who come a little later get the hamburger. And the ones who come at the end get whatever happens to be stuck to the tablecloth.”

That doesn’t deny the fact that there’s huge money to be made in hedge fund investing. Barry Ritholz published a remarkable essay, “A hedge fund for you and me? The best move is to take a pass” (Washington Post, 05/24/2013) that adds a lot of evidence about who actually profits from hedge funds. He reports on research by Simon Lack, author of The Hedge Fund Mirage,” who concludes that the usual 2 and 20 “fee arrangement is effectively a wealth transference mechanism, moving dollars from investors to managers.” Lack used to allocate money to hedge funds on behalf of JPMorgan Chase. Among Lack’s findings

From 1998 to 2010, hedge fund managers earned $379 billion in fees. The investors of their funds earned only $70 billion in investing gains.
Managers kept 84% of investment profits, while investors netted only 16%.
As many as one-third of hedge funds are funded through feeder funds and/or fund of funds, which tack on yet another layer of fees. This brings the industry fee total to $440 billion — that’s 98 %of all the investing gains, leaving the people whose capital is at risk with only 2%, or $9 billion.

Oh, poor rich people. At the same time, the SEC is looking to relax restrictions on hedge fund marketing and advertising which means that even more of them might become subject to the cruel exploitation of … well, the richer people.

On whole, I think I’m happy to be living down here in 40-Act Land.

Introducing MFO Fund Ratings

One of the most frequent requests we receive is for the reconstruction of FundAlarm’s signature “most alarming funds” database. Up until now, we haven’t done anything like it. There are two reasons: (1) Snowball lacked both the time and the competence even to attempt it and (2) the ratings themselves lacked evidence of predictive validity. That is, we couldn’t prove that an “Honor Roll” fund was any likelier to do well in the future than one not on the honor roll.

We have now budged on the matter. In the spirit of those beloved fund ratings, MFO will maintain a new system to highlight funds that have delivered superior absolute returns while minimizing down side volatility. We’re making the change for two reasons. (1) Associate editor Charles Boccadoro, a recently-retired aerospace engineer, does have the time and competence. And, beyond that, a delight in making sense of data. And (2) there is some evidence that risk persists even if returns don’t. That is, managers who’ve taken silly, out-sized, improvident risks in the past will tend to do so in the future. We think of it as a variant of the old adage, “beauty is just skin-deep, but ugly goes all the way to the bone.”

There are two ways of explaining what we’re up to. We think of them as “the mom and pop explanation” and the “Dr. Mom and Ph.D. Pop explanation.” We’ll start with the M&P version, which should be enough for most of us.

Dear Mom and Pop,

Many risk measures look at the volatility or bounciness of a portfolio, both on the upside and the downside. As it turns out, investors don’t mind having funds that outperform their peers in rising markets; that is, they don’t immediately reject upside volatility. What they (we!) dread are excessive drawdowns: that is, having their returns go down far and hard. What Charles has done is to analyze the performance of more than 7000 funds for periods ranging back 20 years. He’s calculated seven different measures of risk for each of those funds and has assigned every fund into one of five risk groups from “very conservative” funds which typically absorb no more than 20% of a stock market decline to “very aggressive” ones which absorb more than 125% of the fall. We’ve assembled those in a large spreadsheet which is on its way to becoming a large, easily searchable database.

For now, we’ve got a preview. It focuses on the funds with the most consistently excellent 20-year returns (the happy blue boxes on the right hand side, under “return group”), lets you see how much risk you had to absorb to achieve those returns (the blue to angry red boxes under risk group) and the various statistical measures of riskiness. In general, you’d like to see low numbers in the columns to the left of the risk group and high numbers in the columns to the right.

I miss the dog. My roommate is crazy. The pizza has been good. I think the rash is mostly gone but it’s hard to see back there. I’m broke. Say “hi” to gramma. Send money soon.

Love, your son,

Dave

And now back to the data and the serious explanation from Charles:

The key rating metric in our system is Martin ratio, which measures excess return divided by the drawdown (a/k/a Ulcer) index. Excess return is how much a fund delivers above the 90-day Treasury bill rate. Ulcer index measures depth and duration of drawdowns from recent peaks – a very direct gauge of unpleasant performance. (More detailed descriptions can be found at Ulcer Index and A Look at Risk Adjusted Returns.)

The rating system hierarchy is first by evaluation period, then investment category, and then by relative return. The evaluation periods are 20, 10, 5, 3, and 1 years. The categories are by Morningstar investment style (e.g., large blend). Within each category, funds are ranked based on Martin ratio. Those in the top 20 percentile are placed in return group 5, while those in bottom 20 percentile are in return group 1. Fund ratings are tabulated along with attendant performance and risk metrics, by age group, then category, then return group, and finally by absolute return.

MFO “Great Owl” designations are assigned to consistent top performers within the 20 and 10 year groups, and “Aspiring Great Owl” designations are similarly assigned within the 5 and 3 year groups.

The following fund performance and risk metrics are tabulated over each evaluation period:

legend

A risk group is also tabulated for each fund, based simply on its risk metrics relative to SP500. Funds less than 20% of market are placed in risk group 1, while those greater than 125% are placed in risk group 5. This table shows sample maximum drawdowns by risk group, depicting average to worst case levels.

risk v drawdown

Some qualifications:

The system includes oldest share class only and excludes the following categories: money market, bear market, trading inverse and leveraged, volatility, and specialized commodities.
The system does not account for category drift.
Returns reflect maximum front load, if applicable.
Funds are presented only once based on age group, but the return rankings reflect all funds existing. For example, if a 3 year fund scores a 5 return, it did so against all existing funds over the 3 year period, not just the 3 year olds.
All calculations are made with Microsoft’s Excel using monthly total returns from the Morningstar database provided in Steele Mutual Fund Expert.
The ratings are based strictly on historical returns.
The ratings will be updated quarterly.

We will roll-out the new system over the next month or two. Here’s a short preview showing the MFO 20-year Great Owl funds – there are only 48, or just about 3% of all funds 20 years and older.

2013-05-29_1925_rev1

31 May 2013/Charles

(p.s., the term “Great Owl” funds is negotiable. We’re looking for something snazzy and – for the bad funds – snarky. “Owl Chow funds”? If you’re a words person and have suggestions, we’d love to hear them. Heck, we’d love to have an excuse to trick Barb into designing an MFO t-shirt and sending it to you. David)

The Implosion of Professional Journalism will make you Poorer

You’ve surely noticed the headlines. Those of us who teach News Literacy do. The Chicago Sun-Times laid off all of its photo-journalists (28 staff members) on the morning of May 30, 2013, in hopes that folks with iPhone cameras would fill in. Shortly before the New York Daily News laid off 20, the Village Voice fired a quarter of its remaining staff, Newsweek closed its print edition and has announced that it’s looking for another owner. Heck, ESPN just fired 400 and even the revered Columbia Journalism Review cut five senior staff. The New York Times, meanwhile, has agreed to “native advertising” (ads presented as content on mobile devices) and is investigating “sponsored content;” that is, news stories identified and funded by their advertisers. All of that has occurred in under a month.

Since the rest of us remain intensely interested in receiving (if not paying for) news, two things happen simultaneously: (1) more news originates from non-professional sources and (2) fewer news organizations have the resources to check material before they publish it.

Here’s how that dynamic played out in a recent series of stories on the worst mutual funds.

Step One: NerdWallet sends out a news release heralding “the 12 most expensive and worst-performing mutual funds.”

Well, no. What they sent was a list of fund names, ticker symbols (mostly) for specific share classes of the fund and (frequently) inaccurate expense ratio reports. They report the worst of the worst as

Oppenheimer Commodity Strat. Total Return (QRACX): 2.2% e.r.

Actually QRACX is the “C” class for the Oppenheimer fund. Morningstar reports the e.r. at 2.09%. The “A” shares have a 1.26% e.r. And where did the mysterious 2.20% number come from? One of the folks at NerdWallet wrote, “it seems it was an error on the part of our data provider.” NerdWallet promised to clear up the fund versus share class distinction and to get the numbers right.

But that’s not the way things work, because NerdWallet sent their press release to other folks, too.

Step Two: Investment News mindlessly reproduces the flawed information.

Within hours, they have grafted on some random photographs and turned the press release into a slide show, now entitled “Expensive – and underperforming – funds.” NerdWallet receives credit on just one of the slides. Apparently no one at Investment News stopped to double-check any of the details before going public. But they did find pretty pictures.

Step Three: Mutual Fund Wire trumpets Investment News’s study.

MFWire’s story touting of the article, “Investment News Unveils Mutual Fund Losers List,” might be better-titled “Investment News Reproduces another Press Release”. You’ll note, by the way, that the actual source of the story has disappeared.

Step Four: CNBC makes things worse by playing with the data.

On Friday, May 17, CNBC’s Jeff Cox posts ‘Dirty Dozen’: 12 Worst Mutual Funds. And they promptly make everything worse by changing the reported results.

Here’s the original: 1. Oppenheimer Commodity Strat. Total Return (QRACX): 2.2% e.r.

Here’s the CNBC version: 1. Oppenheimer Commodity Strategy Total Return (NASDAQ:QRAAX-O), -14.61 percent, 2.12 percent.

Notice anything different? CNBC changed the fund’s ticker symbol, so that it now pointed to Oppenheimer’s “A” share class. And those numbers are desperately wrong with regard to “A” shares, which charge barely half of the claimed rate (which is, remember, wrong even from the high cost “C” shares). They also alter the ticker symbol of Federated Prudent Bear, which started as the high cost “C” shares (PBRCX) but for which CNBC substitutes the low-cost “A” shares (BEARX). For the remaining 10 funds, CNBC simply disregards the tickers despite the fact that these are all high-cost “B” and “C” share classes.

Step Five: And then a bunch of people read and forward the danged thing.

Leading MFWire to celebrate it as one of the week’s “most read” stories. Great.

Step Six: NerdWallet themselves then draw an invalid conclusion from the data.

In a blog post, NerdWallet’s Susan Lyon opines:

As you can see, all of the funds listed above are actively managed, besides the Rydex Inverse S&P 500 Strategy Fund. Do the returns generated by actively managed mutual funds usually outweigh their costs? No, a recent NerdWallet Investing study found that though actively managed funds earned 0.12% higher annual returns than index funds on average, because they charged higher fees, investors were left with 0.80% lower returns.

No. The problem here isn’t that these funds are actively managed. It’s that NerdWallet tracked down the effects of the predatory pricing model behind “C” share classes. And investors have pretty much figured out the “expense = bad” thing, which explains why the Oppenheimer “C” shares that NerdWallet indicts have $68M in assets while the lower-cost “A” shares have $228M.

Step Seven: Word spreads like cockroaches.

The story, in one of its several variants, now appears on a bunch of little independent finance sites and rarely with NerdWallet’s own discussion of their research protocol, much less a thoughtful dissection of the data.

NerdWallet (at least their “investing silo”) is a new operation, so you can understand their goof as a matter of a young staff, start-up stumbles and all that. It’s less clear how you explain Investment News‘s mindless reproduction of the results (what? verify stuff before we publish it? Edit for accuracy? Who do you think we are, journalists?) or MFWire’s touting of the article as if it represented Investment News’s own work.

Before the Observer publishes a fund profile, we give the advisor a chance to review the text for factual accuracy. My standard joke is “I’m used to making errors of judgment, but I loathe making errors of fact and so would you please let us know if there are any factual misstatements or other material misrepresentations?” I entirely agree with NerdWallet’s original judgment: these are pricey under-performers. I just wish that folks all around were a bit more attentive to and concerned about accuracy and detail.

Then Morningstar makes it All Worse

When I began working on the story above, I checked the expense reports at Morningstar. Here’s what I found for QRACX:

qracx

Ooookay. 2.09% is “Below Average.” But below average for what? Mob ransom demands? Apparently, below average for US Open-End Commodities Broad Basket Funds, right?

Well, no, not so much. Here’s Morningstar’s detailed expense report for the fund:

qracx expense cat

The average commodities fund – that is, the average fund in QRACX’s category – has a 1.32% expense ratio. So how on earth could QRACX at 2.09% be below average? Because it’s below the “fee level comparison group median.”

There are 131 funds in the “broad commodity basket” group. Exactly one has an expense ratio about 2.40%. If there’s one commodity fund above 2.40% and 130 below 2.40%, how could 2.40% be the group median?

Answer: Morningstar has, for the purpose of making expense comparisons, assigned QRACX to a group that has effectively nothing to do with commodity funds.

qracx fee level

Mr. Rekenthaler, in response to an emailed query, explains, “‘Below average’ means that QRACX has below average expenses for a C share that is an Alternative fund.”

Morningstar is not comparing QRACX to other commodity funds when they make their expense judgment. No, no. They’re comparing it only to other “C” share classes of other types of “alternative investment” funds. Here are some of the funds that Morningstar is actually judging QRACX against:

	Category	Expenses
Quantitative Managed Futures Strat C (QMFCX)	Mgd futures	9.10%
Princeton Futures Strategy C (PFFTX)	Mgd futures	5.65
Altegris Macro Strategy C (MCRCX)	Mgd futures	5.29
Prudential Jennison Market Neutral C (PJNCX)	Market neutral	4.80
Hatteras Alpha Hedged Strategies C (APHCX)	Multialternative	4.74
Virtus Dynamic AlphaSector C (EMNCX)	L/S equity	3.51
Dunham Monthly Distribution C (DCMDX)	Multialternative	3.75
MutualHedge Frontier Legends C (MHFCX)	Multi-alternative	3.13
Burnham Financial Industries C (BURCX)	L/S equity	2.86
Touchstone Merger Arbitrage C (TMGCX)	Market neutral	2.74

And so if you were choosing between the “C” class shares of this commodity fund and the “C” shares of a leveraged-inverse equity fund and a multicurrency fund, you’d know that you were probably getting a bargain for your money.

Why on earth you’d possibly benefit from the comparison of such of group of wildly incomparable funds remains unknown.

This affects every fund and every expense judgment in Morningstar’s database. It’s not just a problem for the miserable backwater that QRACX occupies.

Want to compare Artisan International (ARTIX) to the fund that Morningstar says is “most similar” to it, American Funds EuroPacific Growth, “A” shares (AEPGX)? Both are large, four-star funds in the Foreign Large Blend group. But for the purposes of an expense judgment, they have different “fee level comparison groups.” Artisan is judged as “foreign large cap no load,” which median is 1.14% while American is judged against “foreign large cap front load,” where the median is 1.44%. If Artisan charged 1.24% and American charged 1.34%, Artisan would be labeled “above average” and American “below average.” Meanwhile American’s “C” shares carry a 1.62% expense ratio and a celebratory “low” price label.

For investors who assume that Morningstar is comparing apples to apples (or foreign large blend to foreign large blend), this has the potential for being seriously misleading. I am very sympathetic to the complexity of Morningstar’s task, but they really need to be much clearer that these expense labels are not linked to the category labels immediately adjacent to them.

We Made the Cover!

Okay, so it wasn’t the cover of Rolling Stone. It was the cover of the BottomLine Personal newsletter (05/15/2013). And there wasn’t a picture (they reserved those for their two “Great Sex, Naturally” articles). And it was just 75 words long.

But at least they misrepresented my argument, so that’s something! The “Heard by our editors” column led off with “Consider ‘bear market funds’” and us. The bulk of the story is contained in the following two sentence fragments: “Consider ‘bear market funds’ as a kind of stock market disaster insurance . . . [they] should make up no more than 5% of your stock portfolio.”

Uhhh … what I said to the editors was “these funds are a disaster for almost everybody who holds them. By their nature, they’re going to lose money for you year after year … probably the best will cost you 7% a year in the long run. The only way they’ve work is if they represented a small fraction of your portfolio – say 5% – and you were absolutely disciplined about rebalancing so that you kept pouring money down this particular rat hole in order to maintain it as 5% of your portfolio. If you did that, you would indeed have a psychologically useful tool – a fund that might well soar in the face of our sharp downturn and that would help you stay disciplined and stay invested, rather than cutting and running. That said, we’re not wired that way and almost no one has that discipline. That why I think you’d be far better off recommending an equity fund with an absolute-returns discipline, such as Aston/River Road Independent Value, Cook and Bynum or FPA Crescent, or a reasonably priced long-short fund, like Aston/River Road Long-Short or RiverPark Long/Short Opportunity.”

They nodded, and wondered which specific bear market funds I’d recommend. They were trying hard to address their readers’ expressed interests, had 75 words to work with and so you got my recommendation of Federated Prudent Bear (BEARX, available at NAV) and PIMCO StocksPLUS AR Short Strategy (PSSDX).

Observer Fund Profiles

Bretton Fund (BRTNX): if you were a fund manager looking to manage just your own family’s finances for the next generation, this is probably what you’d be doing.

RiverPark/Gargoyle Hedged Value (RGHVX): RiverPark has a well-earned reputation for bringing brilliant managers from the high net worth world to us. Gargoyle, whose discipline consistently and successfully marries stock selection and a substantial stake in call options, seems to be the latest addition to a fine stable of funds.

Scout Low Duration (SCLDX): there are very few fixed-income management teams that have earned the right to be trusted with a largely unconstrained mandate. Scout is managed by one of them on behalf of folks who need a conservative fund but can’t afford the foolishness of 0.01% interest.

Conference Call Highlights: Stephen Dodson and Bretton Fund

dodson-brettonfund Does it make sense to you that you could profit from following the real-life choices of the professionals in your life? What hospital does your doctor use when her family needs one? Where does the area’s best chef eat when he wants to go out for a weeknight dinner? Which tablet computer gets Chip and her IT guys all shiny-eyed?

If that strategy makes sense to you, so will the Bretton Fund (BRTNX).

Bretton Fund (BRTNX) is managed by Stephen Dodson. For a relatively young man, he’s had a fascinating array of experiences. After graduating from Berkeley, he booked 80-100 hour weeks with Morgan Stanley, taking telecom firms public. He worked in venture capital, with software and communications firms, before joining his father’s firm, Parnassus Investments. At Parnassus he did everything from answering phones and doing equity research, to co-managing a fixed-income fund and presiding over the company. He came to realize that “managing a family relationship and what I wanted in my career were incompatible at the time,” and so left to start his own firm.

In imagining that firm and its discipline, he was struck by a paradox: almost all investment professionals worshipped Warren Buffett, but almost none attempted to invest like him. Stephen’s estimate is that there are “a ton” of concentrated long-term value hedge funds, but fewer than 20 mutual funds (most visibly The Cook and Bynum Fund COBYX) that follow Buffett’s discipline: he invests in “a small number of good business he believes that he understands and that are trading at a significant discount to what they believe they’re worth.” He seemed particularly struck by his interviews of managers who run successful, conventional equity funds: 50-100 stocks and a portfolio sensitive to the sector-weightings in some index.

I asked each of them, “How would you invest if it was only your money and you never had to report to outside shareholders but you needed to sort of protect and grow this capital at an attractive rate for the rest of your life, how would you invest. Would you invest in the same approach, 50-100 stocks across all sectors.” And they said, “absolutely not. I’d only invest in my 10-20 best ideas.”

And that’s what Bretton does. It holds 15-20 stocks in industries that the manager feels he understands really well. “Understands really well” translates to “do I think I understand who’ll be making money five years from now and what the sources of those earnings will be?” In some industries (biotech, media, oil), his answer was “no.” “Some really smart guys say oil will be $50/bbl in a couple years. Other equally smart analysts say $150. I have no hope of knowing which is right, so I don’t invest in oil.” He does invest in industries such as retail, financial services and transportation, where he’s fairly comfortable with his ability to make sense of their dynamics.

When I say “he does invest,” I mean “him, personally.” Mr. Dodson reports that “I’ve invested all my investible net-worth, all my family members are invested in the fund. My mother is invested in the fund. My mother-in-law is invested in the fund (and that definitely sharpens the mind).” Because of that, he can imagine Bretton Fund functioning almost as a family office. He’s gathering assets at a steady pace – the fund has doubled in size since last spring and will be able to cover all of its ‘hard’ expenses once it hits $7 million in assets – but even if he didn’t get a single additional outside dollar he’d continue running Bretton as a mechanism for his family’s wealth management. He’s looking to the prospect of some day having $20-40 million, and he suspects the strategy could accommodate $500 million or more.

Bottom Line: The fund is doing well – it has handily outperformed its peers since inception, outperformed them in 11 of 11 down months and 18 of 32 months overall. It’s posted solid double-digit returns in 2012 and 2013, through May, with a considerable cash buffer. It will celebrate its three-year anniversary this fall, which is the minimum threshold for most advisors to consider the fund. While he’s doing no marketing now, he’s open to talking with folks and imagines some marketing effort once he’s got a three year record to talk about. Frankly, I think he has a lot to talk about already.

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

The BRTNX Conference Call

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

Launch Alert: T. Rowe and Vanguard

T. Rowe Price Global Allocation (RPGAX) launched on May 28, 2013. Color me intrigued. Price has always been good at asset allocation research and many of their funds allow for tactical tweaks to their allocations. This is Price’s most ambitious offering to date. The fund targets 60% stocks, 30% bonds and 10% hedge funds and other alternative investments and promises “an active asset allocation strategy” in pursuit of long-term capital appreciation and income. The fund will be managed by Charles M. Shriver, who has been with Price since 1991. Mr. Shriver also manages Price Balanced (RPBAX) fund and its Spectrum and Personal Strategy line of funds. The funds expenses are capped at 1.05% through 2016. There’s a $2500 initial investment minimum, reduced to $1000 for IRAs.

Vanguard Emerging Markets Government Bond Index Fund (VGOVX) and its ETF clone (VWOB) will launch in early June. The funds were open for subscription in May – investors could send Vanguard money but Vanguard wouldn’t invest it until the end of the subscription period. There are nearly 100 e.m. bond funds or ETFs already, though Vanguard’s will be the first index and the cheapest option (at 30-50 basis points). Apparently the launch was delayed by more than a year because Vanguard didn’t like the indexes available for e.m. bonds, so they commissioned a new one: Barclays USD Emerging Markets Government RIC Capped Index. The fund will invest only in bonds denominated in U.S. dollars. Investor shares start at $3000 and 0.50% e.r.

Pre-launch Alerts: Artisan and Grandeur Peak, Globe-trotting Again

Artisan Global Small Cap Fund launches June 19. It will be run by Mark Yockey and team. It’s been in registration for a while and its launch was delayed at least once.

Grandeur Peak Global Reach Fund (GPROX/GPRIX) will launch June 19, 2013 and will target owning 300-500 stocks, “with a strong bias” toward small and micro-caps in the American, developed, emerging and frontier markets. There’s an intriguing tension here, since the opening of Global Reach follows just six weeks after the firm closed Global Opportunities to new investors. At the time founder Robert Gardiner argued:

To be good small and micro cap investors it’s critical to limit your assets. Through my career I have seen time and again small cap managers who became a victim of their own success by taking in too many assets and seeing their performance languish.

Their claim is that they have six or seven potential funds in mind and they closed their first two funds early “in part to leave room for future funds that we intend to launch, like the Global Reach Fund.”

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

Funds in registration this month won’t be available for sale until, typically, the beginning of August 2013. We found 10 – 20 no-load, retail funds in the pipeline, notably:

The 11 new T. Rowe Price Target Retirement 2005 – 2055 Funds will pursue that usual goal of offering a one-stop retirement investing solution. Each fund invests in a mix of other T. Rowe Price funds. Each mix becomes progressively more conservative as investors approach and move through retirement. T. Rowe Price already has an outstanding collection of retirement-date funds, called “Retirement [date]” where these will be “Target Retirement [date].” The key is that the new funds will have a more conservative asset allocation than their siblings, assuming “bonds” remain “conservative.” At the target date, the new funds will have 42.5% in equities while the old funds have 55% in equities. For visual learners, here are the two glidepaths:


The new funds’ glidepath	The old fund’s glidepath

The relative weights within the asset classes (international vs domestic, for example) are essentially the same. Each fund is managed by Jerome Clark and Wyatt Lee. The opening expense ratios vary from 0.60% – 0.77%, with the longer-dated funds incrementally more expensive than the shorter-dated ones (that is, 2055 is more expensive than 2005). These expenses are within a basis point or two of the older funds’. The minimum initial investment is $2500, reduced to $1000 for various tax-advantaged accounts.

This is a very odd time to be rolling out a bond-heavy line-up. On May 15^th, The Great Gross tweeteth:

Gross: The secular 30-yr bull market in bonds likely ended 4/29/2013. PIMCO can help you navigate a likely lower return 2 – 3% future.

At least he doesn’t ramble when he’s limited to 140 characters.

The inclusion of hedge funds is fascinating, given the emerging sense (see this month’s intro) that they’re not worth a pitcher of warm bodily fluid (had I mentioned that the famous insult attributed to John Gardner, that the vice presidency “isn’t worth a bucket of warm spit” actually focused on a different bodily fluid but the newspaper editors of the day were reticent to use the word Gardner used?). The decision to shift heavily toward bonds at this moment, perplexing.

Details and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

MANAGER CHANGES

On a related note, we also tracked down 37 fund manager changes.

Updates …

Oakseed Opportunity (SEEDX) released their first portfolio report (on a lovely form N-Q on file with the SEC). The fund has about $48 million in its portfolio. Highlights include:

32 well-known stocks, one ETF, two individual shorts and a tiny call option

The largest five stock holdings are Teva Pharmaceuticals, Leucadia National, AbbVie (a 2013 spin-off of Abbott’s pharmaceutical division), Ross Stores, and Loews Corp.

15.8% of the fund is in cash

2.8% is in three short positions, mostly short ETF

The three largest sectors are pharmaceuticals (15.4%, four stocks), insurance (7%, two stocks) and retail (6.6%, two stocks).

(Thanks to Denny Baran of lovely Great Falls, MT, for the heads up on Oakseed’s filing.)

Three more honors for RiverPark/Wedgewood (RWGFX). In May, Wedgewood became one of the Morningstar 500, “the top 500 funds that should be on your radar.” That same month, Wedgewood’s David Rolfe was recognized as SMA Manager of the Year at the Envestnet’s 2013 Advisor Summit. SMA’s are “separately managed accounts,” a tool for providing personalized portfolios for high net-worth investors. Wedgewood runs a bunch using the strategy behind the RiverPark/Wedgewood fund and they were selected from among 1600 management teams. Finally, Wedgewood received one of overall Large Cap awards from Envestnet, a repeat of a win in 2011, for its Large-Cap Focused Growth strategy. Those who haven’t listened to David talk about investing, should. Happily, we have a recorded hour-long conversation with David.

Valley Forge Fund (VAFGX) closes the gap, a bit. We reported in May that Valley Forge’s manager died on November 3, but that the Board of Directors didn’t seem to have, well, hired a new one. We stand corrected. First, according to an April proxy statement, the Board had terminated the manager three days before his actual, well, you know, termination.

The Board determined to terminate the Prior Advisory Agreement because of, among other things, (i) the Prior Advisor’s demonstrated lack of understanding of the requirements set forth in the Fund’s prospectus, policies and procedures, (ii) the Prior Advisor’s demonstrated lack of knowledge of the terms of the Prior Advisory Agreement, (iii) the Prior Advisor’s failure to adhere to directives from the Board of Directors with respect to the Fund’s portfolio holdings; and (iv) the Fund’s poor performance.

That pretty much covers it. According to the newest prospectus (May 01, 2013), they did have a manager. Up until December 31^st.

Investment Adviser Portfolio Managers: Boyle Capital Management, LLC (BCM) from November 01, 2012 to December 31, 2012.

And, for the months of April and May, the Board of Trustees ran the fund. Here’s the “principal risks” statement from the Prospectus:

Management Risk: for the months of April and May of 2013, the Board of Directors has taken over all trading pending the Shareholders’ Approval to be obtained in May 2013.

Still a bit unclear on January, February and March. Good news: under the Board’s leadership, the fund crushed the market in April and May based on a jump in NAV during the first week of May. Also a bit unclear about what happens now that it’s June: most of the Valley Forge website now leads to blank pages. Stay tuned!

Security Alert: A Word from our IT Folks

We know that many of you – fund managers, financial planners, restaurateurs and all – maintain your own websites. If, like the Mutual Fund Observer and 72.4 million others, your site runs on the WordPress software, you’re under attack. WordPress sites have been targeted for a relentless effort to gain access to your admin controls and, through them, to the resources of your web-host’s servers.

You’ve doubtless heard of “zombie computers,” individual PCs that have been compromised and which fall under the control of The Forces of Evil. In some cases zombie PCs serve spammers and phishers. In other cases, they’re used as part of coordinated distributed denial of service (DDoS) attacks directed against high-profile targets including MasterCard, the Federal Reserve Bank, Google, and others.

There are three very, very bad aspects of these attacks:

They’re aiming to seize control of enormously powerful network servers, using your website as a tool for achieving that. If you can imagine a zombie PCs potential output as equivalent to a garden hose set on full, then you could imagine a server as a fire hose set on full.
They’re designed to keep you from knowing that you’ve been compromised; it’s not like a virus that goofs with your ability to use your machine or your site, these hacks are designed to be invisible to you.
Once compromised, the hackers install secret backdoors into your system; that means that installing security patches or protocols after the fact does not work, you can close the main door but they’ve already built a separate entrance for themselves.

lockout MFO has periodically been the object of as many at 400 break-in attempts an hour. Either manually or through our security software we’ve “blacklisted” nearly a thousand IP addresses, including a vast number from China.

Here are three quick recommendations for anyone responsible for a small business or family website using WordPress (these tips might work for other platforms, too):

Do not use the default administrator account! Rename it or create a new account with administrative rights. About 99% of the break-in attempts have been using some version of “admin” or “administrator” as the username.
Use strong passwords. Yes, I know you hate them. They’re a pain in the butt. Use them anyway. This recent attack uses a brute force method, attempting to log in with the most commonly used passwords first. You can find some basic tips and passwords to avoid at “The 25 most common passwords of 2012.”
Use security plug-ins. In WordPress, two to consider are Limit Login Attempts and Better WP Security. Both will temporarily lock out an IP address from which repeated login attempts occur. Better WP Security will allow you to easily make the temporary ban permanent, which is . . . strangely satisfying. (If you decide to try one of these, follow the directions carefully. It’s all too easy to lock yourself out!)

Good luck! Chip and the MFO IT crowd

Meanwhile, in Footloose Famous Guys Land …

On May 3, hedge fund (and former Fidelity Magellan fund) manager Jeffrey Vinik announced plans to shut down his hedge fund and return all assets to his fund’s investors. Again. He did the same thing at the end of 2000, when he announced a desire to focus on his own investments. Now, he wants to focus on his sports investments (he owns the NHL’s Tampa Bay Lightning), his foundation, and his family. Given that he recently moved his family to Tampa to be closer to his hockey team, the priorities above might be rank-ordered.

The speculation is that three of Vinik’s managers (Doug Gordon, Jon Hilsabeck and Don Jabro) will band together to launch a long/short hedge fund based in Boston.

The fourth, David Iben, plans to start his own investment management firm. Up until Vinik recruited him in March 2012, Iben was CIO for Nuveen Investments’ Tradewinds affiliate. His departure, followed by the swift migration of three of Iben’s managers to Vinik (Isabel Satra, Alberto Jimenez Crespo and Gregory Padilla) cost Tradewinds billions in assets with a few days.

Vinik left Magellan in 1995 after getting grief for an ill-timed macro bet: be bailed on tech stocks and bought bonds about four years too early. The same boldness (dumping US stocks and investing in gold) cost his hedge fund dearly this year.

Former Janus Triton and Venture managers Chad Meade and Brian Schaub have joined Arrowpoint Partners, which has $2.3 billion in assets and a lot Janus refugees on staff. Their six portfolio managers (founders David Corkins and Karen Reidy, Tony Yao, Minyoung Sohn, Meade and Schaub) and two senior executives (COO Rick Grove and Managing Director Christopher Dunne) were Janus employees. Too, they own 100,000 shares of Janus stock. Arrowpoint runs Fundamental Opportunity, Income Opportunity, Structured Opportunity and Life Science funds.

For those who missed the earlier announcement, former T. Rowe Price Health Sciences Fund manager Kris Jenner will launch the Rock Springs Capital hedge fund by later this year. He’s raised more than $100 million for the health and bio-tech hedge fund and has two former T. Rowe analysts, Mark Bussard and Graham McPhail, on-board with him.

Briefly Noted . . .

Abelson Alan Abelson (October 12, 1925 – May 9, 2013), Barron’s columnist and former editor, passed away at age 87. He joined Barron’s the year I was born, began his “Up & Down Wall Street” column during the Johnson Administration and continued it for 47 years. His crankiness made him, for a long while, one of the folks I actively sought out each week. In recent years he seemed to have become a sort of parody of his former self, cranky on principle rather than for any particular cause. I’ll remember him fondly and with respect. Randall Forsyth will continue the column.

Speaking of cranks, John Rekenthaler has resumed his Rekenthaler Report with a vengeance. During the lunatic optimism and opportunism of the 1990s (who now remembers Alberto Vilar, the NetNet and Nothing-but-Net funds, or mutual funds that clocked 200-300% annual returns?), Mr. R and FundAlarm founder Roy Weitz spent a lot of time kicking over piles of trash – often piles that had attracted hundreds of millions of dollars from worshipful innocents. John had better statistical analyses, Roy had better snarky graphics. At the end of 2000, John shifted his attention from columnizing to Directing Research. Beginning May 22, he returned to writing a daily column at Morningstar which he bills as an attempt to leverage his quarter century in the industry to “put today’s investment stories into perspective.” It might take him a while to return to his full stride, but column titles like “Die, Horse, Die!” do give you something to look forward to.

Shareholders of Kinetics Alternative Income Fund (formerly, the Kinetics Water Infrastructure Fund) participated in a 10:1 reverse split on May 30, 2013. Insert: “Snowball rolls eyes” about here. Neither the radical mission change nor the silly repricing strike me as signs of a distinguished operation.

SMALL WINS FOR INVESTORS

The Berwyn Cornerstone Fund’s (BERCX) minimum initial investment requirement for taxable accounts has been dropped from $3,000 to $1,000. It’s a tiny large cap value fund of no particular distinction.

Vanguard continues to press down its expense ratios. Vanguard Dividend Appreciation Index (VDAIX), Dividend Appreciation ETF (VIG), Dividend Growth (VDIGX), Energy (VGENX), and Precious Metals and Mining (VGPMX) dropped their expenses by two to five basis points.

CLOSINGS (and related inconveniences)

Effective May 31, 2013, Invesco closed a bunch of funds to new investors. The funds involved are

Invesco Constellation Fund (CSTGX)
Invesco Dynamics Fund (IDYAX)
Invesco High Yield Securities Fund (ACTHX)
Invesco Leaders Fund (VLFAX)
Invesco Leisure Fund (ILSAX)
Invesco Municipal Bond Fund (AMBDX)

The four equity funds, three of which were once legitimate first-tier growth options, are all large underperformers that received new management teams in 2010 and 2011. The High Yield fund is very large and very good, while Muni is fine but not spectacular. No word on why any of the closures were made.

Effective July 1, 2013, Frontegra MFG Global Equity Fund (FMGEX) is bumping its Minimum Initial Investment Amount from $100k to $1 million.

Effective at market close on June 14, 2013, the Matthews Asia Dividend Fund (MAPIX) will be closed to most new investors.

Oppenheimer Discovery (OPOCX) will close to new investors on June 28, 2013. Top-tier returns over the past three years led to a doubling of the fund’s size and its closure.

Templeton Frontier Markets Fund (TFMAX) will close to new investors effective June 28, 2013. This is another “trendy niche, hot money” story: the fund has done really well and has attracted over a billion in assets in a fairly thinly-traded market niche.

Wasatch’s management continues trying to manage Wasatch Emerging Markets Small Cap (WAEMX) popularity. The fund continues to see strong inflows, which led Wasatch to implement a soft close in February 2012. They’ve now extended their purchase restrictions. As of June 7, 2013, investors who own shares through third-party distributions, such as Schwab and Scottrade, will not be able to add to their accounts. In addition, some financial advisors are also being locked out.

OLD WINE, NEW BOTTLES

American Century continues to distance itself from Lance Armstrong and his LiveStrong Foundation. All of the LiveStrong target date funds (e.g., LIVESTRONG® 2015 Portfolio) are now One Choice target date funds. No other changes were announced.

The Artio Global Funds (née Julius Baer) have finally passed away. The equity managers have been replaced, some of the funds (Emerging Markets Local Debt, for example) have been liquidated and the remaining funds rechristened:

Former Fund Name	New Fund Name
Artio International Equity Fund	Aberdeen Select International Equity Fund
Artio International Equity Fund II	Aberdeen Select International Equity Fund II
Artio Total Return Bond Fund	Aberdeen Total Return Bond Fund
Artio Global High Income Fund	Aberdeen Global High Income Fund
Artio Select Opportunities Fund	Aberdeen Global Select Opportunities Fund

The International Equity Fund, International Equity Fund II and the Select Opportunities Fund, Inc. will be managed by Aberdeen’s Global Equity team, a dedicated team of 16 professionals based in Edinburgh, Scotland. The Total Return Bond Fund and the Global High Income Fund will continue to be managed by their current portfolio managers, Donald Quigley and Greg Hopper, respectively, along with their teams.

BlackRock Long Duration Bond Portfolio is changing its name on July 29, 2013, to BlackRock Investment Grade Bond Portfolio. They’ll also shift the fund’s primary investment strategies to allow for a wider array of bonds.

Having failed as a multisector long/short bond fund, the Board of Trustees of the Direxion Funds thought it would be a good idea to give HCM Freedom Fund (HCMFX) something more challenging. Effective July 29, 2013, HCMFX goes from long/short global fixed income to long/short global fixed income and equities. There’s no immediate evidence that the Board added any competence to the management team to allow them to succeed.

Fidelity U.S. Treasury Money Market Fund has been renamed Fidelity Treasury Only Money Market Fund because otherwise you might think . . . well, actually, I have no idea of why this makes any sense on earth.

GAMCO Mathers (MATRX) is a dour little fund whose mission is “to achieve capital appreciation over the long term in various market conditions without excessive risk of capital loss.” Here’s a picture of what that looks like:

GAMCO

Apparently operating under the assumption that Mathers didn’t have sufficient flexibility to be as negative as they’d like, the advisor has modified their primary investment strategies to allow the fund to place 75% of the portfolio in short positions on stocks. That’s up from an allowance of 50% short.

Effective June 28, 2013, Lazard US Municipal Portfolio (UMNOX) becomes Lazard US Short Duration Fixed Income Portfolio. In addition to shortening its target duration, the revamped fund gets to choose among “US government securities, corporate securities, mortgage-related and asset-backed securities, convertible securities, municipal securities, structured products, preferred stocks and inflation-indexed-securities.” I’m always baffled by the decision to take a fund that’s overwhelmed by one task (buying munis) and adding a dozen more options for it to fumble.

On August 1, 2013 Oppenheimer U.S. Government Trust (OUSGX) will change its name to Oppenheimer Limited-Term Bond Fund. Apparently Trust in Government is wavering. The rechristened fund will be able to add corporate bonds to its portfolio. Despite being not very good, the fund has drawn nearly a billion in assets

Pinnacle Capital Management Balanced Fund (PINBX) is about to become Pinnacle Growth and Income Fund. The word “Balanced” in the name imposed a requirement “to have a specified minimum mix of equity and fixed income securities in its portfolio at all times.” By becoming un-Balanced, the managers gain the freedom to make more dramatic asset allocation shifts. It’s a tiny, expensive 30-month old fund whose manager seems to be trailing most reasonable benchmarks. I’m always dubious of giving more tools to folks who haven’t yet succeeded with the ones they have.

Pioneer Absolute Credit Return Fund (RCRAX) will, effective June 17, 2013, be renamed Pioneer Dynamic Credit Fund. Two years old, great record, over $300 million in assets … don’t get the need for the change.

Vanguard MSCI EAFE ETF has changed its name to Vanguard FTSE Developed Markets ETF.

OFF TO THE DUSTBIN OF HISTORY

AllianceBernstein U.S. Strategic Research Portfolio and AllianceBernstein International Focus 40 Portfolio will both be liquidated by June 27, 2013.

The CAMCO Investors Fund (CAMCX) has closed and will liquidate on June 27, 2013. After nine years of operation, it had earned a one-star rating and had gathered just $7 million in assets.

Litman Gregory will merge Litman Gregory Masters Value (MSVFX) into Litman Gregory Masters Equity (MSEFX) in June. Litman Gregory’s claim is that they’re expert at picking and monitoring the best outside management teams for its funds. In practice, none of their remaining funds has earned more than three stars from Morningstar (as of May, 2013). Value, in particular, substantially lagged its benchmark and saw a lot of shareholder redemptions. Litman Gregory Masters Alternative Strategies (MASNX), which we’ve profiled, has gathered a half billion in assets and continues to perform solidly.

Having neither performed nor preserved, the PC&J Performance Fund and PC&J Preservation Fund have been closed and will be liquidated on or about June 24, 2013.

ProShares Ultra High Yield and ProShares Ultra Investment Grade Corporate have been disappeared by their Board. The cold text reads: “Effective May 23, 2013, all information pertaining to the Funds is hereby removed from the Prospectus.”

I’m saddened to report that Scout International Discovery Fund (UMBDX) is being liquidated for failure to attract assets. It will be gone by June 28, 2013. This was a sort of smaller-cap version of Scout International (UMBWX) which has long distinguished itself for its careful risk management and competitive returns. Discovery followed the same discipline, excelled at risk management but gave up more in returns than it earned in risk-control. This is Scout’s second recent closure of an equity fund, following the elimination of Scout Stock.

Tatro Tactical Appreciation Fund (TCTNX ) has concluded that it can best serve its shareholders by ceasing operation, which will occur on June 21, 2013.

Tilson Focus Fund (TILFX) has closed and will be liquidated by June 21, 2013. The fund had been managed by Whitney Tilson and Glenn Tongue, founders of T2 Partners Management. Mr. Tilson removed himself from management of the fund a year ago. We’ve also found the fund perplexing and unattractive. It had two great years (2006 and 2009) in its seven full years of operation, but also four utterly horrible ones (2007, 2008, 2011, 2012), which meant that it was able to be bad in all sorts of market conditions. Mr. Tilson is very good at promotion but curiously limited at management it seems. Tilson Dividend Fund (TILDX), which we’ve profiled and which has a different manager, continues to thrive.

In Closing . . .

I will be at the Morningstar Investment Conference on your behalf, 12 – 14 June 2013. Friends have helped arrange interviews with several high-visibility professionals and there are a bunch of media breakfasts, media lunches and media dinners (some starting at hours that Iowans more associate with bedtimes than with meals). I also have one dinner and one warm beverage scheduled with incredibly cool people. I’m very excited. If you have leads you’d like me to pursue or if you’re going to be there and have a burning desire to graze the afternoon snack table with me, just drop me a note.

We’ll look for you.

As part of our visual upgrade, Barb (she of the Owl) has designed new business cards (which I’ll have for Morningstar) and new thank-you cards. I mention that latter because I need to extend formal thanks for three readers who’ve sent checks. Sorry about the ungracious delay, but I was sort of hoping to send grateful words along via the cards that haven’t yet arrived.

But will, soon! Keep an eye out in the mail.

In addition to our continuing work on visuals, the MFO folks will spend much of June putting together some wide-ranging improvements. Junior has been busily reviewing all of our “Best of the Web” features, and we’ll be incorporating new text throughout the month. Chip and Charles are working to create a friendly, easy-to-use screener for our new fund risk ratings database. Barb and Anya are conspiring to let the Owl perch in our top banner. And I’ll be learning as much as I can at the conference. We hope you like what we’ll be able to share in July.

Until then, take care and celebrate your friends and family!

The Bretton Fund (BRTNX)

The fund:	The Bretton Fund (BRTNX)
Manager:	Stephen Dodson, portfolio manager, president, and founder of the fund.
The call:	Does it make sense to you that you could profit from following the real-life choices of the professionals in your life? What hospital does your doctor use when her family needs one? Where does the area’s best chef eat when he wants to go out for a weeknight dinner? Which tablet computer gets Chip and her IT guys all shiny-eyed? If that strategy makes sense to you, so will the Bretton Fund (BRTNX). Bretton Fund (BRTNX) is managed by Stephen Dodson. For a relatively young man, he’s had a fascinating array of experiences. After graduating from Berkeley, he booked 80-100 hour weeks with Morgan Stanley, taking telecom firms public. He worked in venture capital, with software and communications firms, before joining his father’s firm, Parnassus Investments. At Parnassus he did everything from answering phones and doing equity research, to co-managing a fixed-income fund and presiding over the company. He came to realize that “managing a family relationship and what I wanted in my career were incompatible at the time,” and so left to start his own firm. In imagining that firm and its discipline, he was struck by a paradox: almost all investment professionals worshipped Warren Buffett, but almost none attempted to invest like him. Stephen’s estimate is that there are “a ton” of concentrated long-term value hedge funds, but fewer than 20 mutual funds (most visibly The Cook and Bynum Fund COBYX) that follow Buffett’s discipline: he invests in “a small number of good business he believes that he understands and that are trading at a significant discount to what they believe they’re worth.” He seemed particularly struck by his interviews of managers who run successful, conventional equity funds: 50-100 stocks and a portfolio sensitive to the sector-weightings in some index. I asked each of them, “How would you invest if it was only your money and you never had to report to outside shareholders but you needed to sort of protect and grow this capital at an attractive rate for the rest of your life, how would you invest. Would you invest in the same approach, 50-100 stocks across all sectors.” And they said, “absolutely not. I’d only invest in my 10-20 best ideas.” And that’s what Bretton does. It holds 15-20 stocks in industries that the manager feels he understands really well. “Understands really well” translates to “do I think I understand who’ll be making money five years from now and what the sources of those earnings will be?” In some industries (biotech, media, oil), his answer was “no.” “Some really smart guys say oil will be $50/bbl in a couple years. Other equally smart analysts say $150. I have no hope of knowing which is right, so I don’t invest in oil.” He does invest in industries such as retail, financial services and transportation, where he’s fairly comfortable with his ability to make sense of their dynamics. When I say “he does invest,” I mean “him, personally.” Mr. Dodson reports that “I’ve invested all my investible net-worth, all my family members are invested in the fund. My mother is invested in the fund. My mother-in-law is invested in the fund (and that definitely sharpens the mind).” Because of that, he can imagine Bretton Fund functioning almost as a family office. He’s gathering assets at a steady pace – the fund has doubled in size since last spring and will be able to cover all of its ‘hard’ expenses once it hits $7 million in assets – but even if he didn’t get a single additional outside dollar he’d continue running Bretton as a mechanism for his family’s wealth management. He’s looking to the prospect of some day having $20-40 million, and he suspects the strategy could accommodate $500 million or more. Bottom Line: The fund is doing well – it has handily outperformed its peers since inception, outperformed them in 11 of 11 down months and 18 of 32 months overall. It’s posted solid double-digit returns in 2012 and 2013, through May, with a considerable cash buffer. It will celebrate its three-year anniversary this fall, which is the minimum threshold for most advisors to consider the fund. While he’s doing no marketing now, he’s open to talking with folks and imagines some marketing effort once he’s got a three year record to talk about. Frankly, I think he has a lot to talk about already. The conference call (When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded.)
The profile:	Bretton has the courage of its convictions. Those convictions are grounded in an intelligent reading of the investment literature and backed by a huge financial commitment by the manager and his family. It’s a fascinating vehicle and deserves careful attention. The Mutual Fund Observer profile of BRTNX, updated June 2013. The BRTNX audio profile
Web:	The Bretton Fund website 2013 Q3 Shareholder Letter Fund Focus: Resources from other trusted sources

Bretton Fund (BRTNX), Updated June 2013

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

Objective and Strategy

The Bretton Fund seeks to achieve long-term capital appreciation by investing in a small number of undervalued securities. The fund invests in common stocks of companies of all sizes. It normally holds a core position of between 15 to 20 securities whose underlying firms combine a defensible competitive advantage, relevant products, competent and shareholder-oriented management, growth, and a low level of debt. The manager wants to invest “in ethical businesses” but does not use any formal ESG screens; mostly he avoids tobacco and gaming companies.

Adviser

Bretton Capital Management, LLC. Bretton was founded in 2010 to advise this fund, which is its only client.

Manager

Stephen Dodson. From 2002 to 2008, Mr. Dodson worked at Parnassus Investments in San Francisco, California, where he held various positions including president, chief operating officer, chief compliance officer and was a co-portfolio manager of a $25 million California tax-exempt bond fund. Prior to joining Parnassus Investments, Mr. Dodson was a venture capital associate with Advent International and an investment banking analyst at Morgan Stanley. Mr. Dodson attended the University of California, Berkeley, and earned a B.S. in Business Administration from the Haas School of Business.

Management’s Stake in the Fund

Mr. Dodson has over a million dollars invested in the fund and a large fraction of the fund’s total assets come from the manager’s family.

Opening date

September 30, 2010.

Minimum investment

$2000 for regular accounts, $1000 for IRAs or accounts established with an automatic investment plan. The fund’s available for purchase through E*Trade and Pershing.

Expense ratio

1.35% on $67.7 million in assets.

Comments

We first profiled Bretton Fund in February, 2012. If you’re interested in our original analysis, it’s here.

Does it make sense to you that you could profit from following the real-life choices of the professionals in your life? What hospital does your doctor use when her family needs one? Where does the area’s best chef eat when he wants to go out for a weeknight dinner? Which tablet computer gets our IT staff all shiny-eyed?

If that strategy makes sense to you, so will the Bretton Fund.

Bretton is managed by Stephen Dodson. For a relatively young man, he’s had a fascinating array of experiences. After graduating from Berkeley, he booked 80-100 hour weeks with Morgan Stanley, taking telecom firms public. He worked in venture capital, with software and communications firms, before joining his father’s firm, Parnassus Investments. At Parnassus he did everything from answering phones and doing equity research, to co-managing a fixed-income fund and presiding over the company. He came to realize that “managing a family relationship and what I wanted in my career were incompatible at the time,” and so left to start his own firm.

I asked each of them, “How would you invest if it was only your money and you never had to report to outside shareholders but you needed to sort of protect and grow this capital at an attractive rate for the rest of your life, how would you invest. Would you invest in the same approach, 50-100 stocks across all sectors.” And they said, “absolutely not. I’d only invest in my 10-20 best ideas.”

He might well have launched a hedge fund, but decided he’d rather help average families do well than having the ultra-rich become ultra-richer. Too, he might have considered a venture capital capital of the kind he’s worked with before, but venture capitalist bank on having one investment out of ten becoming a huge winner while nine of 10 simply fail. “That’s not,” he reports, “what I want to do.”

What he wants to do is to combine a wide net (the manager reports spending most of his time reading), a small circle of competence (representing industries where he’s confident he understands the dynamic), a consistent discipline (target undervalued companies, defined by their ability to generate an attractive internal rate of return – currently he’s hoping for investments that have returns in the low double-digits) and patience (“five years to forever” are conceivable holding periods for his stocks). He’s currently leveraging to fund’s small size, which allows him to benefit from a stake in companies too small for larger funds to even notice.

This is a one-man operation. Economies of scale are few and the opportunity for a lower expense ratio is distant. It’s designed for careful compounding, which means that it will rarely be fully invested (imagine 10-20% cash as normal) and it will show weak relative returns in markets that are somewhat overvalued and still rising. Many will find that frustrating.

Bottom Line

The fund is doing well – it has handily outperformed its peers since inception, outperformed them in 11 of 11 down months and 18 of 32 months overall. It’s posted solid double-digit returns in 2012 and 2013, through May, with a considerable cash buffer. It will celebrate its three-year anniversary this fall, which is the minimum threshold for most advisors to consider the fund. While he’s doing no marketing now, the manager imagines some marketing effort once he’s got a three year record to talk about. Frankly, I think he has a lot to talk about already.

Fund website

Bretton Fund

Fund Documents

May 1, 2013

Dear friends,

I know that for lots of you, this is the season of Big Questions:

Is the Fed’s insistence on destroying the incentive to save (my credit union savings account is paying 0.05%) creating a disastrous incentive to move “safe” resources into risky asset classes?
Has the recent passion for high quality, dividend-paying stocks already consumed most of their likely gains for the next decade?
Should you Sell in May and Go Away?
Perhaps, Stay for June and Endure the Swoon?

My set of questions is a bit different:

Why haven’t those danged green beans sprouted yet? It’s been a week.
How should we handle the pitching rotation on my son’s Little League team? We’ve got four games in the span of five days (two had been rained out and one was hailed out) and just three boys – Will included! – who can find the plate.
If I put off returning my Propaganda students’ papers one more day, what’s the prospect that I’ll end up strung up like Mussolini?

Which is to say, summer is creeping upon us. Enjoy the season and life while you can!

Of Acorns and Oaks

It’s human nature to make sense out of things. Whether it’s imposing patterns on the stars in the sky (Hey look! It’s a crab!) or generating rules of thumb for predicting stock market performances (It’s all about the first five days of the day), we’re relentless in insisting that there’s pattern and predictability to our world.

One of the patterns that I’ve either discerning or invented is this: the alumni of Oakmark International seem to have startlingly consistent success as portfolio managers. The Oakmark International team is led by David Herro, Oakmark’s CIO for international equities and manager of Oakmark International (OAKIX) since 1992. Among the folks whose Oakmark ties are most visible:

	Current assignment	Since	Snapshot
David Herro	Oakmark International (OAKIX), Oakmark International Small Cap (OAKEX)	09/1992	Five stars for 3, 5, 10 and overall for OAKIX; International Fund Manager of the Decade
Dan O’Keefe and David Samra	Artisan International Value (ARTKX), Artisan Global Value (ARTGX)	09/2002 and 12/2007	International Fund Manager of the Year nominees, two five star funds
Abhay Deshpande	First Eagle Overseas A (SGOVX)	Joined First Eagle in 2000, became co-manager in 09/2007	Longest-serving members of the management team on this five-star fund
Chad Clark	Select Equity Group, a private investment firm in New York City	06/2009	“extraordinarily successful” at “quality value” investing for the rich
Pierre Py (and, originally, Eric Bokota)	FPA International Value (FPIVX)	12/2011	Top 2% in their first full year, despite a 30% cash stake
Greg Jackson	Oakseed Opportunity (SEEDX)	12/2012	A really solid start entirely masked by the events of a single day
Robert Sanborn
Ralph Wanger	Acorn Fund
Joe Mansueto	Morningstar		Wonderfully creative in identifying stock themes

The Oakmark alumni certainly extend far beyond this list and far back in time. Ralph Wanger, the brilliant and eccentric Imperial Squirrel who launched the Acorn Fund (ACRNX) and Wanger Asset Management started at Harris Associates. So, too, did Morningstar founder Joe Mansueto. Wanger frequently joked that if he’d only hired Mansueto when he had the chance, he would not have been haunted by questions for “stylebox purity” over the rest of his career. The original manager of Oakmark Fund (OAKMX) was Robert Sanborn, who got seriously out of step with the market for a bit and left to help found Sanborn Kilcollin Partners. He spent some fair amount of time thereafter comparing how Oakmark would have done if Bill Nygren had simply held Sanborn’s final portfolio, rather than replacing it.

In recent times, the attention centers on alumni of the international side of Oakmark’s operation, which is almost entirely divorced from its domestic investment operation. It’s “not just on a different floor, but almost on a different world,” one alumnus suggested. And so I set out to answer the questions: are they really that consistently excellent? And, if so, why?

The answers are satisfyingly unclear. Are they really consistently excellent? Maybe. Pierre Py made a couple interesting notes. One is that there’s a fair amount of turnover in Herro’s analyst team and we only notice the alumni who go on to bigger and better things. The other note is that when you’ve been recognized as the International Fund Manager of the Decade and you can offer your analysts essentially unlimited resources and access, it’s remarkably easy to attract some of the brightest and most ambitious young minds in the business.

What, other than native brilliance, might explain their subsequent success? Dan O’Keefe argues that Herro has been successful in creating a powerful culture that teaches people to think like investors and not just like analysts. Analysts worry about finding the best opportunities within their assigned industry; investors need to examine the universe of all of the opportunities available, then decide how much money – if any – to commit to any of them. “If you’re an auto industry analyst, there’s always a car company that you think deserves attention,” one said. Herro’s team is comprised of generalists rather than industry specialists, so that they’re forced to look more broadly. Mr. Py compared it to the mindset of a consultant: they learn to ask the big, broad questions about industry-wide practices and challenges, rising and declining competitors, and alternatives. But Herro’s special genius, Pierre suggested, was in teaching young colleagues how to interview a management team; that is, how to get inside their heads, understand the quality of their thinking and anticipate their strengths and mistakes. “There’s an art to it that can make your investment process much better.” (As a guy with a doctorate in communication studies and a quarter century in competitive debate, I concur.)

The question for me is, if it works, why is it rare? Why is it that other teams don’t replicate Herro’s method? Or, for that matter, why don’t they replicate Artisan Partner’s structure – which is designed to be (and has been) attractive to the brightest managers and to guard (as it has) against creeping corporatism and groupthink? It’s a question that goes far beyond the organization of mutual funds and might even creep toward the question, why are so many of us so anxious to be safely mediocre?

Three Messages from Rob Arnott

Courtesy of Charles Boccadoro, Associate Editor, 27 April 2013.

Robert D. Arnott manages PIMCO’s All Asset (PAAIX) and leveraged All Asset All Authority (PAUIX) funds. Morningstar gives each fund five stars for performance relative to moderate and world allocation peers, in addition to gold and silver analyst ratings, respectively, for process, performance, people, parent and price. On PAAIX’s performance during the 2008 financial crises, Mr. Arnott explains: “I was horrified when we ended the year down 15%.” Then, he learned his funds were among the very top performers for the calendar year, where average allocation funds lost nearly twice that amount. PAUIX, which uses modest leverage and short strategies making it a bit more market neutral, lost only 6%.

Of 30 or so lead portfolio managers responsible for 110 open-end funds and ETFs at PIMCO, only William H. Gross has a longer current tenure than Mr. Arnott. The All Asset Fund was launched in 2002, the same year Mr. Arnott founded Research Affiliates, LLC (RA), a firm that specializes in innovative indexing and asset allocation strategies. Today, RA estimates $142B is managed worldwide using its strategies, and RA is the only sub-advisor that PIMCO, which manages over $2T, credits on its website.

On April 15^th, CFA Society of Los Angeles hosted Mr. Arnott at the Montecito Country Club for a lunch-time talk, entitled “Real Return Investing.” About 40 people attended comprising advisors, academics, and PIMCO staff. The setting was elegant but casual, inside a California mission-style building with dark wooden floors, white stucco walls, and panoramic views of Santa Barbara’s coast. The speaker wore one of his signature purple-print ties. After his very frank and open talk, which he prefaced by stating that the research he would be presenting is “just facts…so don’t shoot the messenger,” he graciously answered every question asked.

Three takeaways: 1) fundamental indexing beats cap-weighed indexing, 2) investors should include vehicles other than core equities and bonds to help achieve attractive returns, and 3) US economy is headed for a 3-D hurricane of deficit, debt, and demographics. Here’s a closer look at each message:

Fundamental Indexation is the title of Mr. Arnott’s 2005 paper with Jason Hsu and Philip Moore. It argues that capital allocated to stocks based on weights of price-insensitive fundamentals, such as book value, dividends, cash flow, and sales, outperforms cap-weighted SP500 by an average of 2% a year with similar volatilities. The following chart compares Power Shares FTSE RAFI US 1000 ETF (symbol: PRF), which is based on RA Fundamental Index (RAFI) of the Russell 1000 companies, with ETFs IWB and IVE:

chart

And here are the attendant risk-adjusted numbers, all over same time period:

table

RAFI wins, delivering higher absolute and risk-adjusted returns. Are the higher returns a consequence of holding higher risk? That debate continues. “We remain agnostic as to the true driver of the Fundamental indexes’ excess return over the cap-weighted indexes; we simply recognize that they outperformed significantly and with some consistency across diverse market and economic environments.” A series of RAFIs exist today for many markets and they consistently beat their cap-weighed analogs.

All Assets include commodity futures, emerging market local currency bonds, bank loans, TIPS, high yield bonds, and REITs, which typically enjoy minimal representation in conventional portfolios. “A cult of equities,” Mr. Arnott challenges, “no matter what the price?” He then presents research showing that while the last decade may have been lost on core equities and bonds, an equally weighted, more broadly diversified, 16-asset class portfolio yielded 7.3% annualized for the 12 years ending December 2012 versus 3.8% per year for the traditional 60/40 strategy. The non-traditional classes, which RA coins “the third pillar,” help investors “diversify away some of the mainstream stock and bond concentration risk, introduce a source of real returns in event of prospective inflation from monetizing debt, and seek higher yields and/or rates of growth in other markets.”

Mr. Arnott believes that “chasing past returns is likely the biggest mistake investors make.” He illustrates with periodic returns such as those depicted below, where best performing asset classes (blue) often flip in the next period, becoming worst performers (red)…and rarely if ever repeat.

returns

Better instead to be allocated across all assets, but tactically adjust weightings based on a contrarian value-oriented process, assessing current valuation against opportunity for future growth…seeking assets out of favor, priced for better returns. PAAIX and PAUIX (each a fund of funds utilizing the PIMCO family) employ this approach. Here are their performance numbers, along with comparison against some competitors, all over same period:

comparison

The All Asset funds have performed very well against many notable allocation funds, like OAKBX and VWENX, protecting against drawdowns while delivering healthy returns, as evidenced by high Martin ratios. But static asset allocator PRPFX has actually delivered higher absolute and risk-adjusted returns. This outperformance is likely attributed its gold holding, which has detracted very recently. On gold, Mr. Arnott states: “When you need gold, you need gold…not GLD.” Newer competitors also employing all-asset strategies are ABRYX and AQRIX. Both have returned handsomely, but neither has yet weathered a 2008-like drawdown environment.

The 3-D Hurricane Force Headwind is caused by waves of deficit spending, which artificially props-up GDP, higher than published debt, and aging demographics. RA has published data showing debt-to-GDP is closer to 500% or even higher rather than 100% value oft-cited, after including state and local debt, Government Sponsored Enterprises (e.g., Fannie Mae, Freddie Mac), and unfunded entitlements. It warns that deficit spending may feel good now, but payback time will be difficult.

“Last year, the retired population grew faster than the population of working age adults, yet there was no mention in the press.” Mr. Arnott predicts this transition will manifest in a smaller labor force and lower productivity. It’s inevitable that Americans will need to “save more, spend less, and retire later.” By 2020, the baby boomers will be outnumbered 2:1 by votes, implying any “solemn vows” regarding future entitlements will be at risk. Many developed countries have similar challenges.

Expectations going forward? Instead of 7.6% return for the 60/40 portfolio, expect 4.5%, as evidenced by low bond and dividend yields. To do better, Mr. Arnott advises investing away from the 3-D hurricane toward emerging economies that have stable political systems, younger populations, and lower debt…where fastest GDP growth occurs. Plus, add in RAFI and all asset exposure.

Are they at least greasy high-yield bonds?

One of the things I most dislike about ETFs – in addition to the fact that 95% of them are wildly inappropriate for the portfolio of any investor who has a time horizon beyond this afternoon – is the callous willingness of their boards to transmute the funds. The story is this: some marketing visionary decides that the time is right for a fund targeting, oh, corporations involved in private space flight ventures and launches an ETF on the (invented) sector. Eight months later they notice that no one’s interested so, rather than being patient, tweaking, liquidating or merging the fund, they simply hijack the existing vehicle and create a new, entirely-unrelated fund.

Here’s news for the five or six people who actually invested in the Sustainable North American Oil Sands ETF (SNDS): you’re about to become shareholders in the YieldShares High Income ETF. The deal goes through on June 21. Do you have any say in the matter? Nope. Why not? Because for the Sustainable North American Oil Sands fund, investing in oil sands companies was legally a non-fundamental policy so there was no need to check with shareholders before changing it.

The change is a cost-saving shortcut for the fund sponsors. An even better shortcut would be to avoid launching the sort of micro-focused funds (did you really think there was going to be huge investor interest in livestock or sugar – both the object of two separate exchange-traded products?) that end up festooning Ron Rowland’s ETF Deathwatch list.

Introducing the Owl

Over the past month chip and I have been working with a remarkably talented graphic designer and friend, Barb Bradac, to upgrade our visual identity. Barb’s first task was to create our first-ever logo, and it debuts this month.

MFO Owl, final

Cool, eh?

Great-Horned-Owl-flat-best- We started by thinking about the Observer’s mission and ethos, and how best to capture that visually. The apparent dignity, quiet watchfulness and unexpected ferocity of the Great Horned Owl – they’re sometimes called “tigers with wings” and are quite willing to strike prey three times their own size – was immediately appealing. Barb’s genius is in identifying the essence of an image, and stripping away everything else. She admits, “I don’t know what to say about the wise old owl, except he lends himself soooo well to minimalist geometric treatment just naturally, doesn’t he? I wanted to trim off everything not essential, and he still looks like an owl.”

At first, we’ll use our owl in our print materials (business cards, thank-you notes, that sort of thing) and in the article reprints that funds occasionally commission. For those interested, the folks at Cook and Bynum asked for a reprint of Charles’s excellent “Inoculated by Value” essay and our new graphic identity debuted there. With time we’ll work with Barb and Anya to incorporate the owl – who really needs a name – into our online presence as well.

The Observer resources that you’ve likely missed!

Each time we add a new resource, we try to highlight it for folks. Since our readership has grown so dramatically in the past year – about 11,000 folks drop by each month – a lot of folks weren’t here for those announcements. As a public service, I’d like to highlight three resources worth your time.

The Navigator is a custom-built mutual fund research tool, accessible under the Resources tab. If you know the name of a fund, or part of the name or its ticker, enter it into The Navigator. It will auto-complete the fund’s name, identify its ticker symbols and immediately links you to reports or stories on that fund or ETF on 20 other sites (Yahoo Finance, MaxFunds, Morningstar). If you’re sensibly using the Observer’s resources as a starting point for your own due diligence research, The Navigator gives you quick access to a host of free, public resources to allow you to pursue that goal.

Featured Funds is an outgrowth of our series of monthly conference calls. We set up calls – free and accessible to all – with managers who strike us as being really interesting and successful. This is not a “buy list” or anything like it. It’s a collection of funds whose managers have convinced me that they’re a lot more interesting and thoughtful than their peers. Our plan with these calls is to give every interested reader to chance to hear what I hear and to ask their own questions. After we talk with a manager, the inestimably talented Chip creates a Featured Fund page that draws together all of the resources we can offer you on the fund. That includes an mp3 of the conference call and my take on the call’s highlights, an updated profile of the fund and also a thousand word audio profile of the fund (presented by a very talented British friend, Emma Presley), direct links to the fund’s own resources and a shortcut to The Navigator’s output on the funds.

There are, so far, seven Featured Funds:

ASTON/RiverRoad Long/Short (ARLSX)
Cook and Bynum (COBYX)
Matthews Asia Strategic Income (MAINX)
RiverPark Long/Short Opportunity (RLSFX)
RiverPark Short-Term High Yield (RPHYX)
RiverPark/Wedgewood (RWGFX)
Seafarer Overseas Growth and Income (SFGIX)

Manager Change Search Engine is a feature created by Accipiter, our lead programmer, primarily for use by our discussion board members. Each month Chip and I scan hundreds of Form 497 filings at the SEC and other online reports to track down as many manager changes as we can. Those are posted each month (they’re under the “Funds” tab) and arranged alphabetically by fund name. Accipiter’s search engine allows you to enter the name of a fund company (Fidelity) and see all of the manager changes we have on record for them. To access the search engine, you need to go to the discussion board and click on the MGR tab at top. (I know it’s a little inconvenient, but the program was written as a plug-in for the Vanilla software that underlies the discussion board. It will be a while before Accipiter is available to rewrite the program for us, so you’ll just have to be brave for a bit.)

Valley Forge Fund staggers about

For most folks, Valley Forge Fund (VAFGX) is understandably invisible. It was iconic mostly because it so adamantly rejected the trappings of a normal fund. It was run since the Nixon Administration by Bernard Klawans, a retired aerospace engineer. He tended to own just a handful of stocks and cash. For about 20 years he beat the market then for the next 20 he trailed it. In the aftermath of the late 90s mania, he went back to modestly beating the market. He didn’t waste money on marketing or even an 800-number and when someone talked him into having a website, it remained pretty much one page long.

Mr. Klawans passed away on December 22, 2011, at the age of 90. Craig T. Aronhalt who had co-managed the fund since the beginning of 2009 died on November 3, 2012 of cancer. Morningstar seems not to have noticed his death: six months after passing away, they continue listing him as manager. It’s not at all clear who is actually running the thing though, frankly, for a fund that’s 25% in cash it’s having an entirely respectable year with a gain of nearly 10% through the end of April.

The more-curious development is the Board’s notice, entitled “Important information about the Fund’s Lack of Investment Adviser”

For the period beginning April 1, 2013 through the date the Fund’s shareholders approve a new investment advisory agreement (estimated to be achieved by May 17, 2013), the Fund will not be managed by an investment adviser or a portfolio manager (the “Interim Period”). During the Interim Period, the Fund’s portfolio is expected to remain largely unchanged, subject to the ability of the Board of Directors of the Fund to, as it deems appropriate under the circumstances, make such portfolio changes as are consistent with the Fund’s prospectus. During the Interim Period, the Fund will not be subject to any advisory fees.

Because none of the members of Fund’s Board of Directors has any experience as portfolio managers, management risk will be heightened during the Interim Period, and you may lose money.

How does that work? The manager died at the beginning of November but the board doesn’t notice until April 1? If someone was running the portfolio since November, the law requires disclosure of that fact. I know that Mr. Buffett has threatened to run Berkshire Hathaway for six months after his death, so perhaps … ?

If that is the explanation, it could be a real cost-savings strategy since health care and retirement benefits for the deceased should be pretty minimal.

Observer Fund Profiles:

FPA International Value (FPIVX): It’s not surprising that manager Pierre Py is an absolute return investor. That is, after all, the bedrock of FPA’s investment culture. What is surprising is that it has also be an excellent relative return vehicle: despite a substantial cash reserve and aversion to the market’s high valuations, it has also substantially outperformed its fully-invested peers since inception.

Oakseed Opportunity Fund (SEEDX): Finally! Good news for all those investors disheartened by the fact that the asset-gatherers have taken over the fund industry. Jackson Park has your back.

“Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Artisan Global Value Fund (ARTGX): I keep looking for sensible caveats to share with you about this fund. Messrs. Samra and O’Keefe keep making my concerns look silly, so I think I might give up and admit that they’re remarkable.

Payden Global Low Duration Fund (PYGSX): Short-term bond funds make a lot of sense as a conservative slice of your portfolio, most especially during the long bull market in US bonds. The question is: what happens when the bull market here stalls out? One good answer is: look for a fund that’s equally adept at investing “there” as well as “here.” Over 17 years of operation, PYGSX has made a good case that they are that fund.

Elevator Talk #4: Jim Hillary, LS Opportunity Fund (LSOFX)

elevator

M Jim Hillary r. Hillary manages Independence Capital Asset Partners (ICAP), a long/short equity hedge fund he launched on November 1, 2004 that serves as the sub-advisor to the LS Opportunity Fund (LSOFX), which in turn launched on September 29, 2010. Prior to embarking on a hedge fund career, Mr. Hillary was a co-founder and director of research for Marsico Capital Management where he managed the Marsico 21^st Century Fund (MXXIX) until February 2003 and co-managed all large cap products with Tom Marsico. In addition to his US hedge fund and LSOFX in the mutual fund space, ICAP runs a UCITS for European investors. Jim offers these 200 words on why his mutual fund could be right for you:

In 2004, I believed that after 20 years of above average equity returns we would experience a period of below average returns. Since 2004, the equity market has been characterized by lower returns and heightened volatility, and given the structural imbalances in the world and the generationally low interest rates I expect this to continue. Within such an environment, a long/short strategy provides exposure to the equity market with a degree of protection not provided by “long-only” funds.

In 2010, we agreed to offer investors the ICAP investment process in a mutual fund format through LSOFX. Our process aims to identify investment opportunities not limited to style or market capitalization. The quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance. Our in-depth research and long-term orientation in our high conviction ideas provide us with a considerable advantage. It is often during times of stress that ICAP uncovers unusual investment opportunities. A contrarian approach with a longer-term view is our method of generating value-added returns. If an investor is searching for a vehicle to diversify away from long-only, balanced or fixed income products, a hedge fund strategy like ours might be helpful.

The fund has a single share class with no load and no 12b-1 fees. The minimum initial investment is $5,000 and net expenses are capped at 1.95%. More information about the Advisor and Sub-Advisor can be found on the fund’s website, www.longshortadvisors.com. Jim’s most recent commentary can be found in the fund’s November 2012 Semi-Annual Report.

RiverPark/Wedgewood Fund: Conference Call Highlights

I had a chance to speak with David Rolfe of Wedgewood Partners and Morty Schaja, president of RiverPark Funds. A couple dozen listeners joined us, though most remained shy and quiet. Morty opened the call by noting the distinctiveness of RWGFX’s performance profile: even given a couple quarters of low relative returns, it substantially leads its peers since inception. Most folks would expect a very concentrated fund to lead in up markets. It does, beating peers by about 10%. Few would expect it to lead in down markets, but it does: it’s about 15% better in down markets than are its peers. Mr. Schaja is invested in the fund and planned on adding to his holdings in the week following the call.

The strategy: Rolfe invests in 20 or so high-quality, high-growth firms. He has another 15-20 on his watchlist, a combination of great mid-caps that are a bit too small to invest in and great large caps a bit too pricey to invest in. It’s a fairly low turnover strategy and his predilection is to let his winners run. He’s deeply skeptical of the condition of the market as a whole – he sees badly stretched valuations and a sort of mania for high-dividend stocks – but he neither invests in the market as a whole nor are his investment decisions driven by the state of the market. He’s sensitive to the state of individual stocks in the portfolio; he’s sold down four or five holdings in the last several months nut has only added four or five in the past two years. Rather than putting the proceeds of the sales into cash, he’s sort of rebalancing the portfolio by adding to the best-valued stocks he already owns.

His argument for Apple: For what interest it holds, that’s Apple. He argues that analysts are assigning irrationally low values to Apple, somewhere between those appropriate to a firm that will never see real topline growth again and one that which see a permanent decline in its sales. He argues that Apple has been able to construct a customer ecosystem that makes it likely that the purchase of one iProduct to lead to the purchase of others. Once you’ve got an iPod, you get an iTunes account and an iTunes library which makes it unlikely that you’ll switch to another brand of mp3 player and which increases the chance that you’ll pick up an iPhone or iPad which seamlessly integrates the experiences you’ve already built up. As of the call, Apple was selling at $400. Their sum-of-the-parts valuation is somewhere in the $600-650 range.

On the question of expenses: Finally, the strategy capacity is north of $10 billion and he’s currently managing about $4 billion in this strategy (between the fund and private accounts). With a 20 stock portfolio, that implies a $500 million in each stock when he’s at full capacity. The expense ratio is 1.25% and is not likely to decrease much, according to Mr. Schaja. He says that the fund’s operations were subsidized until about six months ago and are just in the black now. He suggested that there might be, at most, 20 or so basis points of flexibility in the expenses. I’m not sure where to come down on the expense issue. No other managed, concentrated retail fund is substantially cheaper – Baron Partners and Edgewood Growth are 15-20 basis points more, Oakmark Select and CGM Focus are 15-20 basis points less while a bunch of BlackRock funds charge almost the same.

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

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

The RWGFX Conference Call

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

Conference Call Upcoming: Bretton Fund (BRTNX), May 28, 7:00 – 8:00 Eastern

Stephen Dodson Manager Steve Dodson, former president of the Parnassus Funds, is an experienced investment professional, pursuing a simple discipline. He wants to buy deeply discounted stocks, but not a lot of them. Where some funds tout a “best ideas” focus and then own dozens of the same large cap stocks, Mr. Dodson seems to mean it when he says “just my best.”

As of 12/30/12, the fund held just 16 stocks. Nearly as much is invested in microcaps as in megacaps. In addition to being agnostic about size, the fund is also unconstrained by style or sector. Half of the fund’s holdings are characterized as “growth” stocks, half are not. The fund offers no exposure at all in seven of Morningstar’s 11 industry sectors, but is over weighted by 4:1 in financials.

In another of those “don’t judge it against the performance of groups to which it doesn’t belong” admonitions, it has been assigned to Morningstar’s midcap blend peer group though it owns only one midcap stock.

Our conference call will be Tuesday, May 28, from 7:00 – 8:00 Eastern.

How can you join in? Just click

Members of our standing Conference Call Notification List will receive a reminder, notes from the manager and a registration link around the 20^th of May. If you’d like to join about 150 of your peers in receiving a monthly notice (registration and the call are both free), feel free to drop me a note.

Launch Alert: ASTON/LMCG Emerging Markets (ALEMX)

aston This is Aston’s latest attempt to give the public – or at least “the mass affluent” – access to managers who normally employ distinctive strategies on behalf of high net worth individuals and institutions. LMCG is the Lee Munder Capital Group (no, not the Munder of Munder NetNet and Munder Nothing-but-Net fame – that’s Munder Capital Management, a different group). Over the five years ended December 30, 2012, the composite performance of LMCG’s emerging markets separate accounts was 2.8% while their average peer lost 0.9%. In 2012, a good year for emerging markets overall, LMCG made 24% – about 50% better than their average peer. The fund’s three managers, Gordon Johnson, Shannon Ericson and Vikram Srimurthy, all joined LMCG in 2006 after a stint at Evergreen Asset Management. The minimum initial investment in the retail share class is $2500, reduced to $500 for IRAs. The opening expense ratio will be 1.65% (with Aston absorbing an additional 4.7% of expenses). The fund’s homepage is cleanly organized and contains links to a few supporting documents.

Launch Alert II: Matthews Asia Focus and Matthews Emerging Asia

On May 1, Matthews Asia launched two new funds. Matthews Asia Focus Fund (MAFSX and MIFSX) will invest in 25 to 35 mid- to large-cap stocks. By way of contrast, their Asian Growth and Income fund has 50 stocks and Asia Growth has 55. The manager wants to invest in high-quality companies and believes that they are emerging in Asia. “Asia now [offers] a growing pool of established companies with good corporate governance, strong management teams, medium to long operating histories and that are recognized as global or regional leaders in their industry.” The fund is managed by Kenneth Lowe, who has been co-managing Matthews Asian Growth and Income (MACSX) since 2011. The opening expense ratio, after waivers, is 1.91%. The minimum initial investment is $2500, reduced to $500 for an IRA.

Matthews Emerging Asia Fund (MEASX and MIASX) invests primarily in companies located in the emerging and frontier Asia equity markets, such as Bangladesh, Cambodia, Indonesia, Malaysia, Myanmar, Pakistan, Philippines, Sri Lanka, Thailand and Vietnam. It will be an all-cap portfolio with 60 to 100 names. The fund will be managed by Taizo Ishida, who also manages managing the Asia Growth (MPACX) and Japan (MJFOX) funds. The opening expense ratio, after waivers, is 2.16%. The minimum initial investment is $2500, reduced to $500 for an IRA.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

Funds in registration this month won’t be available for sale until, typically, the beginning of July 2013. We found fifteen no-load, retail funds (and Gary Black) in the pipeline, notably:

AQR Long-Short Equity Fund will seek capital appreciation through a global long/short portfolio, focusing on the developed world. “The Fund seeks to provide investors with three different sources of return: 1) the potential gains from its long-short equity positions, 2) overall exposure to equity markets, and 3) the tactical variation of its net exposure to equity markets.” They’re targeting a beta of 0.5. The fund will be managed by Jacques A. Friedman, Lars Nielsen and Andrea Frazzini (Ph.D!), who all co-manage other AQR funds. Expenses are not yet set. The minimum initial investment for “N” Class shares is $1,000,000 but several AQR funds have been available through fund supermarkets for a $2500 investment. AQR deserves thoughtful attention, but their record across all of their funds is more mixed than you might realize. Risk Parity has been a fine fund while others range from pretty average to surprisingly weak.

RiverPark Structural Alpha Fund will seek long-term capital appreciation while exposing investors to less risk than broad stock market indices. Because they believe that “options on market indices are generally overpriced,” their strategy will center on “selling index equity options [which] will structurally generate superior returns . . . [with] less volatility, more stable returns, and reduce[d] downside risk.” This portfolio was a hedge fund run by Wavecrest Asset Management. That fund launched on September 29, 2008 and will continue to operate under it transforms into the mutual fund, on June 30, 2013. The fund made a profit in 2008 and returned an average of 10.7% annually through the end of 2012. Over that same period, the S&P500 returned 6.2% with substantially greater volatility. The Wavecrest management team, Justin Frankel and Jeremy Berman, has now joined RiverPark – which has done a really nice job of finding talent – and will continue to manage the fund. The opening expense ratio with be 2.0% after waivers and the minimum initial investment is $1000.

Curiously, over half of the funds filed for registration on the same day. Details on these funds and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes

On a related note, we also tracked down 37 fund manager changes. Those include Oakmark’s belated realization that they needed at least three guys to replace the inimitable Ed Studzinski on Oakmark Equity and Income (OAKBX), and a cascade of changes triggered by the departure of one of the many guys named Perkins at Perkins Investment Management.

Briefly Noted . . .

Seafarer visits Paris: Seafarer has been selected to manage a SICAV, Essor Asie (ESSRASI). A SICAV (“sea cav” for the monolingual among us, Société d’Investissement À Capital Variable for the polyglot) is the European equivalent of an open-end mutual fund. Michele Foster reports that “It is sponsored by Martin Maurel Gestion, the fund advisory division of a French bank, Banque Martin Maurel. Essor translates to roughly arising or emerging, and Asie is Asia.” The fund, which launched in 1997, invests in Asia ex-Japan and can invest in both debt and equity. Given both Mr. Foster’s skill and his schooling at INSEAD, it seems like a natural fit.

Out of exuberance over our new graphic design, we’ve poured our Seafarer Overseas Growth and Income (SFGIX) profile into our new reprint design template. Please do let us know how we could tweak it to make it more visually effective and functional.

Nile spans the globe: Effective May 1, 2013, Nile Africa Fixed Income Fund became Nile Africa and Frontier Bond Fund. The change allows the fund to add bonds from any frontier-market on the planet to its portfolio.

Nationwide is absorbing 17 HighMark Mutual Funds: The changeover will take place some time in the third quarter of 2013. This includes most of the Highmark family and the plan is for the current sub-advisers to be retained. Two HighMark funds, Tactical Growth & Income Allocation and Tactical Capital Growth, didn’t make the cut and are scheduled for liquidation.

USAA is planning to launch active ETFs: USAA has submitted paperwork with the SEC seeking permission to create 14 actively managed exchange-traded funds, mostly mimicking already-existing USAA mutual funds.

Small Wins for Investors

On or before June 30, 2013, Artio International Equity, International Equity II and Select Opportunities funds will be given over to Aberdeen’s Global Equity team, which is based in Edinburgh, Scotland. The decline of the Artio operation has been absolutely stunning and it was more than time for a change. Artio Total Return Bond Fund and Artio Global High Income Fund will continue to be managed by their current portfolio teams.

ATAC Inflation Rotation Fund (ATACX) has reduced the minimum initial investment for its Investor Class Shares from $25,000 to $2,500 for regular accounts and from $10,000 to $2,500 for IRA accounts.

Longleaf Partners Global Fund (LLGLX) reopened to new investment on April 16, 2013. I was baffled by its closing – it discovered, three weeks after launch, that there was nothing worth buying – and am a bit baffled by its opening, which occurred after the unattractive market had risen by another 3%.

Vanguard announced on April 3 that it is reopening the $9 billion Vanguard Capital Opportunity Fund (VHCOX) to individual investors and removing the $25,000 annual limit on additional purchases. The fund has seen substantial outflows over the past three years. In response, the board decided to make it available to individual investors while leaving it closed to all financial advisory and institutional clients, other than those who invest through a Vanguard brokerage account. This is a pretty striking opportunity. The fund is run by PRIMECAP Management, which has done a remarkable job over time.

Closings

DuPont Capital Emerging Markets Fund (DCMEX) initiated a “soft close” on April 30, 2013.

Effective June 30, 2013, the FMI Large Cap (FMIHX) Fund will be closed to new investors.

Eighteen months after launching the Grandeur Peak Funds, Grandeur Peak Global Advisors announced that it will soft close both the Grandeur Peak Global Opportunities Fund (GPGOX) and the Grandeur Peak International Opportunities (GPIOX) Fund on May 1, 2013.

After May 17, 2013 the SouthernSun Small Cap Fund (SSSFX) will be closed to new investors. The fund has pretty consistently generated returns 50% greater than those of its peers. The same manager, Michael Cook, also runs the smaller, newer, midcap-focused SouthernSun US Equity Fund (SSEFX). The latter fund’s average market cap is low enough to suggest that it holds recent alumni of the small cap fund. I’ll note that we profiled all four of those soon-to-be-closed funds when they were small, excellent and unknown.

Touchstone Merger Arbitrage Fund (TMGAX) closed to new accounts on April 8, 2013. The fund raised a half billion in under two years and substantially outperformed its peers, so the closing is somewhere between “no surprise” and “reassuring.”

Old Wine, New Bottles

In one of those “what the huh?” announcements, the Board of Trustees of the Catalyst Large Cap Value Fund (LVXAX) voted “to change in the name of the Fund to the Catalyst Insider Buying Fund.” Uhh … there already is a Catalyst Insider Buying Fund (INSAX).

Lazard U.S. High Yield Portfolio (LZHOX) is on its way to becoming Lazard U.S. Corporate Income Portfolio, effective June 28, 2013. It will invest in bonds issued by corporations “and non-governmental issuers similar to corporations.” They hope to focus on “better quality” (their term) junk bonds.

Off to the Dustbin of History

Dreyfus Small Cap Equity Fund (DSEAX) will transfer all of its assets in a tax-free reorganization to Dreyfus/The Boston Company Small Cap Value Fund (STSVX).

Around June 21, 2013, Fidelity Large Cap Growth Fund (FSLGX) will disappear into Fidelity Stock Selector All Cap Fund (FDSSX). This is an enormously annoying move and an illustration of why one might avoid Fidelity. FSLGX’s great flaw is that it has attracted only $170 million; FDSSX’s great virtue is that it has attracted over $3 billion. FDSSX is an analyst-run fund with over 1100 stocks, 11 named managers and a track record inferior to FSLGX (which has one manager and 134 stocks).

Legg Mason Capital Management All Cap Fund (SPAAX) will be absorbed by ClearBridge Large Cap Value Fund (SINAX). The Clearbridge fund is cheaper and better, so that’s a win of sorts.

In Closing …

If you haven’t already done so, please do consider bookmarking our Amazon link. It generates a pretty consistent $500/month for us but I have to admit to a certain degree of trepidation over the imminent (and entirely sensible) change in law which will require online retailers with over a $1 million in sales to collect state sales tax. I don’t know if the change will decrease Amazon’s attractiveness or if it might cause Amazon to limit compensation to the Associates program, but it could.

As always, the Amazon and PayPal links are just … uhh, over there —>

That’s all for now, folks!

David

April 1, 2013

Dear friends,

As most of you know, my day job is as a professor at Augustana College in Rock Island, Illinois. We have a really lovely campus (one prospective student once joked that we’re the only college he’d visited that actually looked like its postcards) and, as the weather has warmed, I’ve returned to taking my daily walk over the lunch hour.

stained glass 2 We have three major construction projects underway, a lot for a school our size. We’re renovating Old Main, which was built in 1884, originally lit gas lanterns and warmed by stoves in the classrooms. After a century of fiddling with it, we finally resolved to strip out a bunch of “improvements” from days gone by, restore some of its original grandeur and make it capable of supporting 21^st century classes.

We’re also building Charles D. Lindberg Stadium, where our football team will finally get to have a locker room and seating for 1800. It’s emblematic that our football stadium is actually named for a national debate champion; we’re kind of into the whole scholar-athlete ethos. (We have the sixth greatest number of Academic All-Americans of any school in the country, just behind Stanford and well ahead of Texas.)

And we’re creating a Center for Student Life, which is “fused” to the 4^th floor of our library. The Center will combine dining, study, academic support and student activities. It’s stuff we do now but that’s scattered all over creation.

Two things occurred to me on my latest walk. One is that these buildings really are investments in our future. They represent acts of faith that, even in turbulent times, we need to plan and act prudently now to create the future we imagine. And the other is that they represent a remarkable balance: between curricular, co-curricular and extra-curricular, between mind, body and spirit, between strengthening what we’ve always had and building something new.

On one level, that’s just about one college and one set of hopes. But, at another, it strikes me as surprisingly useful guidance for a lot more than that: plan, balance, act, dare.

Oh! So that’s what a Stupid Pill looks like!

In a widely misinterpreted March 25^th column, Chuck Jaffe raises the question of whether it’s time to buy a bear market fund. Most folks, he argues, are addicted to performance-chasing. What better time to buy stocks than after they’ve doubled in price? What better time to hedge your portfolio than after they’re been halved? That, of course, is the behavior of the foolish herd. We canny contrarians are working now to hedge our gains with select bets against the market, right?

Talk to money managers and the guys behind bear-market funds, however, and they will tell you their products are designed mostly to be a hedge, diversifying risks and protecting against declines. They say the proper use of their offerings involves a small-but-permanent allocation to the dark side, rather than something to jump into when everything else you own looks to be in the tank.

They also say — and the flows of money into and out of bear-market issues shows — that investors don’t act that way.

At base, he’s not arguing for the purchase of a bear-market fund or a gold fund. He’s using those as tools for getting folks to think about their own short time horizons and herding instincts.

stupidpills

He generously quotes me as making a more-modest observation: that managers, no matter the length or strength of their track records, are quickly dismissed (or ignored) if they lag their peers for more than a quarter. Our reaction tends to be clear: the manager has taken stupid pills and we’re leaving. Jeff Vinik at Magellan: Manager of the Year in 1993, Stupid Pill swallower in ’95, gone in ’96. (Started a hedge fund, making a mint.) Bill Nygren at Oakmark Select: intravenous stupid drip around 2007. (Top 1% since then on both his funds.) Bruce Berkowitz at Fairholme: Manager of the Decade, slipped off to Walgreen’s in 2011 for stupid pills, got trashed and saw withdrawals of a quarter billion dollars a week. (Top 1% in 2012, closed his funds to new investments, launching a hedge fund now).

By way of example, one of the most distinguished small cap managers around is Eric Cinnamond who has exercised the same rigorous absolute-return discipline at three small cap funds: Evergreen, Intrepid and now Aston/River Road. His discipline is really simple: don’t buy or hold anything unless it offers a compelling, absolute value. Over the period of years, that has proven to be a tremendously rewarding strategy for his investors.

When I spoke to Eric late in March, he offered a blunt judgment: “small caps overall appear wildly expensive as people extrapolate valuations from peak profits.” That is, current valuations make sense only if you believe that firms experiencing their highest profits won’t ever see them drop back to normal levels. And so he’s selling stuff as it becomes fully valued, nibbling at a few things (“hard asset companies – natural gas, precious metals – are getting treated as if they’re in a permanent depression but their fundamentals are strong and improving”), accumulating cash and trailing the market. By a mile. Over the twelve months ending March 29, 2013, ARIVX returned 7.5% – which trailed 99% of his small value peers.

The top SCV fund over that period? Scott Barbee’s microcap Aegis Value (AVALX) fund with a 32% return and absolutely no cash on the books. As I noted in a FundAlarm profile, it’s perennially a one- or two-star fund with more going for it than you’d imagine.

Mr. Cinnamond seemed acquainted with the sorts of comments made about his fund on our discussion board: “I bailed on ARIVX back in early September,” “I am probably going to bail soon,” and “in 2012 to the present the funds has ranked, in various time periods, in the 97%-100% rank of SCV… I’d look at other SCV Funds.” Eric nods: “there are investors better suited to other funds. If you lose assets, so be it but I’d rather lose assets than lose my shareholders’ capital.” John Deysher, long-time manager of Pinnacle Value (PVFIX), another SCV fund that insists on an absolute rather than relative value discipline, agrees, “it’s tough holding lots of cash in a sizzling market like we’ve seen . . . [cash] isn’t earning much, it’s dry powder available for future opportunities which of course aren’t ‘visible’ now.”

One telling benchmark is GMO Benchmark-Free Allocation IV (GBMBX). GMO’s chairman, Jeremy Grantham, has long argued that long-term returns are hampered by managers’ fear of trailing their benchmarks and losing business (as GMO so famously did before the 2000 crash). Cinnamond concurs, “a lot of managers ‘get it’ when you read their letters but then you see what they’re doing with their portfolios and wonder what’s happening to them.” In a bold move, GMO launched a benchmark-free allocation fund whose mandate was simple: follow the evidence, not the crowd. It’s designed to invest in whatever offers the best risk-adjusted rewards, benchmarks be damned. The fund has offered low risks and above-average returns since launch. What’s it holding now? European equities (35%), cash (28%) and Japanese stocks (17%). US stocks? Not so much: just under 5% net long.

For those interested in other managers who’ve followed Mr. Cinnamond’s prescription, I sorted through Morningstar’s database for a list of equity and hybrid managers who’ve chosen to hold substantial cash stakes now. There’s a remarkable collection of first-rate folks, both long-time mutual fund managers and former hedge fund guys, who seem to have concluded that cash is their best option.

This list focuses on no-load, retail equity and hybrid funds, excluding those that hold cash as a primary investment strategy (some futures funds, for example, or hard currency funds). These folks all hold over 25% cash as of their last portfolio report. I’ve starred the funds for which there are Observer profiles.

Name	Ticker	Type	Cash %
* ASTON/River Road Independent Value	ARIVX	Small Value	58.4
Beck Mack & Oliver Global	BMGEX	World Stock	31.8
Beck Mack & Oliver Partners	BMPEX	Large Blend	27.0
* Bretton Fund	BRTNX	Mid-Cap Blend	28.7
Buffalo Dividend Focus	BUFDX	Large Blend	25.6
Chadwick & D’Amato	CDFFX	Moderate Allocation	33.5
Clarity Fund	CLRTX	Small Value	67.8
First Pacific Low Volatility	LOVIX	Aggressive Allocation	27.3
* FMI International	FMIJX	Foreign Large Blend	60.0
Forester Discovery	INTLX	Foreign Large Blend	59.6
FPA Capital	FPPTX	Mid-Cap Value	31.0
FPA Crescent	FPACX	Moderate Allocation	33.7
* FPA International Value	FPIVX	Foreign Large Value	34.4
GaveKal Knowledge Leaders	GAVAX	Large Growth	26.1
Hennessy Balanced	HBFBX	Moderate Allocation	51.7
Hennessy Total Return Investor	HDOGX	Large Value	51.1
Hillman Focused Advantage	HCMAX	Large Value	27.8
Hussman Strategic Dividend Value	HSDVX	Large Value	53.3
Intrepid All Cap	ICMCX	Mid-Cap Value	27.5
Intrepid Small Cap	ICMAX	Small Value	49.3
NorthQuest Capital	NQCFX	Large Value	29.9
Oceanstone Fund	OSFDX	Mid-Cap Value	83.3
Payden Global Equity	PYGEX	World Stock	44.6
* Pinnacle Value	PVFIX	Small Value	36.8
PSG Tactical Growth	PSGTX	World Allocation	46.2
Teberg	TEBRX	Conservative Allocation	34.1
* The Cook & Bynum Fund	COBYX	Large Blend	32.6
* Tilson Dividend	TILDX	Mid-Cap Blend	28.0
Weitz Balanced	WBALX	Moderate Allocation	45.1
Weitz Hickory	WEHIX	Mid-Cap Blend	30.6

(We’re not endorsing all of those funds. While I tried to weed out the most obvious nit-wits, like the guy who was 96% cash and 4% penny stocks, the level of talent shown by these managers is highly variable.)

Mr. Deysher gets to the point this way: “As Buffett says, Rule 1 is ‘Don’t lose capital.’ Rule 2 is ‘Don’t forget Rule 1.’” Steve Romick, long-time manager of FPA Crescent (FPACX), offered both the logic behind FPA’s corporate caution and a really good closing line in a recent shareholder letter:

At FPA, we aspire to protect capital, before seeking a return on it. We change our mind, not casually, but when presented with convincing evidence. Despite our best efforts, we are sometimes wrong. We take our mea culpa and move on, hopefully learning from our mistakes. We question our conclusions constantly. We do this with the approximately $20 billion of client capital entrusted to us to manage, and we simply ask the same of our elected and appointed officials whom we have entrusted with trillions of dollars more.

Nobody has all the answers. Genius fails. Experts goof. Rather than blind faith, we need our leaders to admit failure, learn from it, recalibrate, and move forward with something better. Although we cannot impose our will on this Administration as to Mr. Bernanke’s continued role at the Fed, we would at least like to make our case for a Fed chairman more aware (at least publicly) of the unintended consequences of ultra-easy monetary policy, and one with less hubris. As the author Malcolm Gladwell so eloquently said, “Incompetence is the disease of idiots. Overconfidence is the mistake of experts…. Incompetence irritates me. Overconfidence terrifies me.”

It’s clear that over-confidence can infest pessimists as well as optimists, which was demonstrated in a March Business Insider piece entitled “The Idiot-Maker Rally: Check Out All Of The Gurus Made To Look Like Fools By This Market.” The article is really amusing and really misleading. On the one hand, it does prick the balloons of a number of pompous prognosticators. On the other, it completely fails to ask what happened to invalidate – for now, anyway – the worried conclusions of some serious, first-rate strategists?

Triumph of the optimists: Financial “journalists” and you

It’s no secret that professional journalism seems to be circling a black hole: people want more information, but they want it now, free and simple. That’s not really a recipe for thoughtful, much less profitable, reporting. The universe of personal finance journals is down to two (the painfully thin Money and Kiplinger’s), CNBC’s core audience viewership is down 40% from 2008, the PBS show “Nightly Business Report” has been sold to CNBC in a bid to find viewers, and collectively newspapers have cut something like 40% of their total staff in a decade.

One response has been to look for cheap help: networks and websites look to publish content that’s provided for cheap or for free. Often that means dressing up individuals with a distinct vested interest as if they were journalists.

Case in point: Mellody Hobson, CBS Financial Analyst

I was astounded to see the amiable talking heads on the CBS Morning News turn to “CBS News Financial Analyst Mellody Hobson” for insight on how investors should be behaving (Bullish, not a bubble, 03/18/2013). Ms. Hobson, charismatic, energetic, confident and poised, received a steady stream of softball pitches (“Do you see that there’s a bubble in the stock market?” “I know people are saying we’re entering bubble territory. I don’t agree. We’re far from it. It’s a bull market!”) while offering objective, expert advice on how investors should behave: “The stock market is not overvalued. Valuations are really pretty good. This is the perfect environment for a strong stock market. I’m always a proponent of being in the market.” Nods all around.

Hobson

The problem isn’t what CBS does tell you about Ms. Hobson; it’s what they don’t tell you. Hobson is the president of a mutual fund company, Ariel Investments, whose only product is stock mutual funds. Here’s a snippet from Ariel’s own website:

HobsonAriel

Should CBS mention this to you? The Code of Ethics for the Society of Professional Journalists kinda hints at it:

Journalists should be free of obligation to any interest other than the public’s right to know.

Journalists should:

Avoid conflicts of interest, real or perceived.
Remain free of associations and activities that may compromise integrity or damage credibility.
Refuse gifts, favors, fees, free travel and special treatment, and shun secondary employment, political involvement, public office and service in community organizations if they compromise journalistic integrity.
Disclose unavoidable conflicts.

CBS’s own 2012 Business Conduct Statement exults “our commitment to the highest standards of appropriate and ethical business behavior” and warns of circumstances where “there is a significant risk that the situation presented is likely to affect your business judgment.” My argument is neither that Ms. Hobson was wrong (that’s a separate matter) nor that she acted improperly; it’s that CBS should not be presenting representatives of an industry as disinterested experts on that industry. They need to disclose the conflict. They failed to do so on the air and don’t even offer a biography page for Hobson where an interested party might get a clue.

MarketWatch likewise puts parties with conflicts of interest center-stage in their Trading Deck feature which lives in the center column of their homepage, but at least they warn people that something might be amiss:

tradingdeck

That disclaimer doesn’t appear on the homepage with the teasers, but it does appear on the first page of stories written by people who . . . well, probably shouldn’t be taken at face value.

The problem is complicated when a publisher such as MarketWatch mixes journalists and advocates in the same feature, as they do at The Trading Deck, and then headline writers condense a story into eight or ten catchy, misleading words.

The headline says “This popular mutual fund type is losing you money.” The story says global stock funds could boost their returns by up to 2% per year through portfolio optimization, which is a very different claim.

The author bio says “Roberto Rigobon is the Society of Sloan Fellows Professor of Applied Economics at MIT’s Sloan School of Management.” He is a first-class scholar. The bio doesn’t say “and a member of State Street Associates, which provides consulting on, among other things, portfolio optimization.”

The other response by those publications still struggling to hold on is adamant optimism.

In the April 2013 issue of Kiplinger’s Personal Finance, editor Knight Kiplinger (pictured laughing at his desk) takes on Helaine Olen’s Pound Foolish: Exposing the Dark Side of the Personal Finance Industry (2012). She’s a former LA Times personal finance columnist with a lot of data and a fair grasp of her industry. She argues “most of the financial advice published and dished out by the truckload is useless” – its sources are compromised, its diagnosis misses the point and its solutions are self-serving. To which Mr. Kiplinger responds, “I know quite a few longtime Kiplinger readers who might disagree with that.” That’s it. Other than for pointing to Obamacare as a solution, he just notes that . . . well, she’s just not right.

Skipping the stories on “How to Learn to Love (Stocks) Again” and “The 7 Best ETFs to Buy Now,” we come to Jane Bennett Clark’s piece entitled “The Sky Isn’t Falling.” The good news about retirement: a study by the Investment Company Institute says that investment companies are doing a great job and that the good ol’ days of pensions were an illusion. (No mention, yet again, of any conflict of interest that the ICI might have in selecting either the arguments or the data they present.) The title claim comes from a statement of Richard Johnson of the Employee Retirement Benefit Institute, whose argument appears to be that we need to work as long as we can. The oddest statement in the article just sort of glides by: “43% of boomers … and Gen Xers … are at risk of not having enough to cover basic retirement expenses and uninsured health costs.” Which, for 43% of the population, might look rather like their sky is falling.

April’s Money magazine offered the same sort of optimistic take: bond funds will be okay even if interest rates rise, Japan’s coming back, transportation stocks are signaling “full steam ahead for the market,” housing’s back and “fixed income never gets scary.”

Optimism sells. It doesn’t necessarily encourage clear thinking, but it does sell.

Folks interested in examples of really powerful journalism might turn to The Economist, which routinely runs long and well-documented pieces that are entirely worth your time, or the radio duo of American Public Media (APM) and National Public Radio (NPR). Both have really first rate financial coverage daily, serious and humorous. The most striking example of great long-form work is “Unfit for Work: The startling rise of disability in America,” the NPR piece on the rising tide of Americans who apply for and receive permanent disability status. 14 million Americans – adults and children – are now “disabled,” out of the workforce (hence out of the jobless statistics) and unlikely ever to hold a job again. That number has doubled in a generation. The argument is that disability is a last resort for older, less-educated workers who get laid off from a blue collar job and face the prospect of never being able to find a job again. The piece stirred up a storm of responses, some of which are arguable (telling the story of hard-hit Hale County makes people think all counties are like that) and others seem merely to reinforce the story’s claim (the Center for Budget and Policy Priorities says most disabled workers are uneducated and over 50 – which seems consistent with the story’s claim).

Who says mutual funds can’t make you rich?

Forbes magazine published their annual list of “The Richest People on the Planet” (03/04/2013), tracking down almost 1500 billionaires in the process. (None, oddly, teachers by profession.)

MFWire scoured the list for “The Richest Fundsters in the Game” (03/06/2013). They ended up naming nine while missing a handful of others. Here’s their list with my additions in blue:

Charles Brandes, Brandes funds, #1342, $1.0 billion
Thomas Bailey, Janus founder, #1342, $1.0 billion
Mario Gabelli, Gamco #1175, $1.2 billion
Michael Price, former Mutual Series mgr, #1107, $1.3 billion
Fayez Sarofim, Dreyfus Appreciation mgr, #1031, $1.4 billion
Ron Baron, Baron Funds #931, $1.6 billion
Howard Marks, TCW then Oaktree Capital, #922, $1.65 billion
Joe Mansueto, Morningstar #793, $1.9 billion
Ken Fisher, investment guru and source of pop-up ads, #792, $1.9 billion
Bill Gross, PIMCO, #641, $2.3 billion
Charles Schwab (the person), Charles Schwab (the company) #299, $4.3 billion
Paul Desmarais, whose Power Financial backs Putnam #276, $4.5 billion
Rupert Johnson, Franklin Templeton #215, $5.6 billion
Charles Johnson, Franklin Templeton #211, $5.7 billion
Ned Johnson, Fidelity #166, worth $7 billion
Abby Johnson, Fidelity #74, $12.7 billion

For the curious, here’s the list of billionaire U.S. investors, which mysteriously doesn’t include Bill Gross. He’s listed under “finance.”

The thing that strikes me is how much of these folks I’d entrust my money to, if only because so many became so rich on wealth transfer (in the form of fees paid by their shareholders) rather than wealth creation.

Two new and noteworthy resources: InvestingNerd and Fundfox

I had a chance to speak this week with the folks behind two new (one brand-new, one pretty durn new) sites that might be useful to some of you folks.

InvestingNerd (a little slice of NerdWallet)

investingnerd_logo

NerdWallet launched in 2010 as a tool to find the best credit card offers. It claimed to be able to locate and sort five times as many offers as its major competitors. With time they added other services to help consumers save money. For example the TravelNerd app to help travelers compare costs related to their travel plans, like finding the cheapest transportation to the airport or comparing airport parking prices, the NerdScholar has a tool for assessing law schools based on their placement rates. NerdWallet makes its money from finder’s fees: if you like one of the credit card offers they find for you and sign up for that card, the site receives a bit of compensation. That’s a fairly common arrangement used, for example, by folks like BankRate.com.

On March 27, NerdWallet launched a new site for its investing vertical, InvestingNerd. It brings together advice (TurboTax vs H&R Block: Tax Prep Cost Comparison), analysis (Bank Stress Test Results: How Stressful Were They?) and screening tools.

I asked Neda Jafarzadeh, a public relations representative over at InvestingNerd, what she’d recommend as most distinctive about the site. She offered up three features that she thought would be most intriguing for investors in particular:

InvestingNerd recently rolled out a new tool – the Mutual Fund Screener. This tool allows investors to find, search and compare over 15,000 funds. In addition, it allows investors to filter through funds based on variables like the fund’s size, minimum required investment, and the fund’s expense ratio. Also, investors can screen funds using key performance metrics such as the fund’s risk-adjusted return rate, annual volatility, market exposure and market outperformance.
In addition, InvestingNerd has a Brokerage Comparison Tool which provides an unbiased comparison of 69 of the most popular online brokerage accounts. The tool can provide an exact monthly cost for the investor based on their individual trading behavior.
InvestingNerd also has a blog where we cover news on financial markets and the economy, release studies and analyses related to investing, in addition to publishing helpful articles on various other investment and tax related topics.

Their fund screener is . . . interesting. It’s very simple and updates a results list immediately. Want an equity fund with a manager who’s been around more than 10 years? No problem. Make it a small cap? Sure. Click. You get a list and clickable profiles. There are a couple problems, though. First, they have incomplete or missing explanations of what their screening categories (“outperformance”) means. Second, their results list is inexplicably incomplete: the same search in Morningstar turns up noticeably more funds. Finally, they offer a fund rating (“five stars”) with no evidence of what went into it or what it might tell us about the fund’s future. When I ask with the folks there, it seemed that the rating was driven by risk-adjusted return (alpha adjusted for standard deviation) and InvestingNerd makes no claim that their ratings have predictive validity.

It’s worth looking at and playing with. Their screener, like any, is best thought of as a tool for generating a due diligence list: a way to identify some funds worth digging into. Their articles cover an interesting array of topics (considering a gray divorce? Shopping tips for folks who support gay rights?) and you might well use one of their tools to find the free checking account you’ve always dreamed of.

Fundfox

Fundfox is a site for those folks who wake in the morning and ask themselves, “I wonder who’s been suing the mutual fund industry this week?” or “I wonder what the most popular grounds for suing a fund company this year is?”

Which is to say fund company attorneys, compliance folks, guys at the SEC and me.

It was started by David Smith, who used to work for the largest liability insurance provider to the fund industry, as a simpler, cleaner, more specialized alternative to services such as WestLaw or Lexis. It covers lawsuits filed against mutual funds, period. That really reduces the clutter. The site does include a series of dashboards (what fund types are most frequently the object of suits?) and some commentary.

You can register for free and get a lot of information a la Morningstar or sign up for a premium membership and access serious quantities of filings and findings. There’s a two week trial for the premium service and I really respect David’s decision to offer a trial without requiring a credit card. Legal professionals might well find the combination of tight focus, easy navigation and frequent updates useful.

Introducing: The Elevator Talk

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

Elevator Talk #3: Bayard Closser, Vertical Capital Income Fund (VCAPX)

Mr. Closser is president of the Vertical Capital Markets Group and one of the guys behind Vertical Capital Income Fund (VCAPX), which launched on December 30, 2011. VCAPX is structured as an interval fund, a class of funds rare enough that Morningstar doesn’t even track them. An interval fund allows you access to your investment only at specified intervals and only to the extent that the management can supply redemptions without disrupting the portfolio. The logic is that certain sorts of investments are impossible to pursue if management has to be able to accommodate the demands of investors to get their money now. Hedge funds, using lock-up periods, pursue the exact same logic. Given the managers’ experience in structuring hedge funds, that seems like a logical outcome. They do allow for the possibility that the fund might, with time, transition over to a conventional CEF structure:

Vertical chose an interval fund structure because we determined that it is the best delivery mechanism for alternative assets. It helps protect shareholders by giving them limited liquidity, but also provides the advantages of an open-end fund, including daily pricing and valuation. In addition, it is easy to convert an interval fund to a closed-end fund as the fund grows and we no longer want to acquire assets.

Here’s what Bayard has to say (in a Spartan 172 words) about VCAPX:

A closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves through our sister company Vertical Recovery Management, which can even restructure loans for committed homeowners to help them keep current on monthly payments.

Increasingly, even small investors are seeking alternative investments to increase diversification. VCAPX can play that role, as its assets have no correlation or a slight negative correlation with the stock market.

While lenders are still divesting mortgages at a deep discount, the housing market is improving, creating a “Goldilocks” effect that may be “just right” for the fund.

VCAPX easily outperformed its benchmark in its first year of operation (Dec. 30, 2011 through Dec. 31, 2012), with a return of 12.95% at net asset value, compared with 2.59% for the Barclays U.S. Mortgage-Backed Securities (MBS) Index.

At the fund’s maximum 4.50% sales charge, the return was 7.91%. The fund also declared a 4.01% annualized dividend (3.54% after the sales charge).

The fund’s minimum initial investment is $5,000 for retail shares, reduced to $1,000 for IRAs. There’s a front sales load of 4.5% but the fund is available no-load at both Schwab and TDAmeritrade. They offer a fair amount of background, risk and performance information on the fund’s website. You might check under the “Resource Center” tab for copies of their quarterly newsletter.

The Cook and Bynum Fund, Conference Call Highlights

Recently published research laments the fact that actively-managed funds have become steadily less active and more index-like over time.

The changing imperatives of the fund industry have led many managers to become mediocre by design. Their response is driven by the anxious desire for so-called “sticky” assets. The strategy is simple: design a product to minimize the risk that it will ever spectacularly trail its peer group. If you make your fund very much like its benchmark, you will never be a singular disaster and so investors (retirement plan investors, particularly) will never be motivated to find something better. The fact that you never excel is irrelevant. The result is a legion of large, expensive, undistinguished funds who seek safety in the herd.

The Cook and Bynum Fund (COBYX) strikes me as the antithesis of those. Carefully constructed, tightly focused, and intentionally distinct. On Tuesday, March 5, we spoke with Richard Cook and Dowe Bynum in the first of three conversations with distinguished managers who defy that trend through their commitment to a singular discipline: buy only the best. For Richard and Dowe, that translates to a portfolio with only seven holdings and a 34% cash stake. Since inception (through early March, 2013), they managed to capture 83% of the market’s gains with only 50% of its volatility; in the past twelve months, Morningstar estimates that they captured just 7% of the market’s downside.

Among the highlights of the call for me:

The guys are willing to look stupid. There are times, as now, when they can’t find stocks that meet their quality and valuation standards. The rule for such situations is simply: “When compelling opportunities do not exist, it is our obligation not to put capital at risk.” They happily admit that other funds might well reap short-term gains by running with the pack, but you “have to be willing to look stupid.” Their current cash stake is about 34%, “the highest cash level ever in the fund.” That’s not driven by a market call; it’s a simple residue of their inability to find great opportunities.
The guys are not willing to be stupid. Richard and Dowe grew up together and are comfortable challenging each other. Richard knows the limits of Dowe’s knowledge (and vice versa), “so we’re less likely to hold hands and go off the cliff together.” In order to avoid that outcome, they spend a lot of time figuring out how not to be stupid. They relegate some intriguing possibilities to the “too hard pile,” those businesses that might have a great story but whose business model or financials are simply too hard to forecast with sufficient confidence. They think about common errors (commitment bias, our ability to rationalize why we’re not going to stop doing something once we’ve started, chief among them) and have generated a set of really interesting tools to help contain them. They maintain, for example, a list all of the reasons why they don’t like their current holdings. In advance of any purchase, they list all of the conditions under which they’d quickly sell (“if their star CEO leaves, we do too”) and keep that on top of their pile of papers concerning the stock.
They’re doing what they love. Before starting Cook & Bynum (the company), both of the guys had high-visibility, highly-compensated positions in financial centers. Richard worked for Tudor Investments in Stamford, CT, while Dowe was with Goldman Sachs in New York. The guys believe in a fundamental, value- and research-driven, stock-by-stock process. What they were being paid to do (with Tudor’s macro event-driven hedge fund strategies for Richard) was about as far from what they most wanted as they could get. And so they quit, moved back to Alabama and set up their own shop to manage their own money and the investments of high net-worth individuals. They created Cook & Bynum (the fund) in response to an investor’s request for a product accessible to family and friends. The $250 million invested with them (about $100 million in the fund) includes 100% of their own liquid net worth, with their investment split between the fund and the partnerships. Since both sets of vehicles use the same fees and structure, there’s no conflict between the two.
They do prodigious research without succumbing to the “gotta buy something” impulse. While they spend the majority of their time in their offices, they’re also comfortable with spending two or three weeks at a time on the road. Their argument is that they’ve got to understand the entire ecosystem in which a firm operates – from the quality of its distribution network to the feelings of its customers – which they can only do first-hand. Nonetheless, they’ve been pretty good at resisting “deal momentum.” They spent, for example, some three weeks traveling around Estonia, Poland and Hungary. Found nothing compelling. Traveled Greece and Turkey and learned a lot, including how deeply dysfunctional the Greek economy is, but bought nothing.
They’re willing to do what you won’t. Most of us profess a buy low / buy the unloved / break from the herd / embrace our inner contrarian ethos. And most of us are deluded. Cook and Bynum seem rather less so: they’re holding cash now while others buy stocks after the market has doubled and profits margins hit records but in the depth of the 2008 meltdown they were buyers. (They report having skipped Christmas presents in 2008 in order to have extra capital to invest.) As the market bottomed in March 2009, the fund was down to 2% cash.

Bottom Line: the guys seem to be looking for two elusive commodities. One is investments worth pursuing. The other is investing partners who share their passion for compelling investments and their willingness to let other investors charge off in a herd. Neither is as common as you might hope.

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

The COBYX conference call

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

We periodically invite our colleague, Charles Boccadoro, to share his perspectives on funds which were the focus of our conference calls. Charles’ ability to apprehend and assess tons of data is, we think, a nice complement to my strengths which might lie in the direction of answering the questions (1) does this strategy make any sense? And (2) what’s the prospect that they can pull it off? Without further ado, here’s Charles on Cook and Bynum

Inoculated By Value

To describe Richard P. Cook and J. Dowe Bynum (C&B) as value investors would be accurate, but certainly not adequate. Their website is rich with references to value investment principles championed by Benjamin Graham, John Burr Williams, Charlie Munger, and Warren Buffet. “The value investing inoculation took immediately,” C&B explain, after reading Mr. Buffett’s biography in high school. They have been investing together literally since childhood and at age 23 they actually tried to start their own mutual fund. That did not happen, but years later in 2001 they established Cook & Bynum Capital Management and in mid-2009 they launched their namesake The Cook & Bynum Fund COBYX, which turned out to be perfect timing.

Like many experienced investors on MFO, C&B do not view volatility as risk, but as opportunity. That said, the lack of volatility in 43 months of COBYX performance through February 2013 is very alluring and likely helped propel the fund’s popularity, now with $102M AUM. Its consistent growth rate resembles more a steady bond fund, say PONDX, than an equity fund. The fund received a 5-Star Morningstar Rating for the 3-year period ending mid-2012.

Other than strictly adhering to the three most important words of value investing (“Margin of Safety”) when assessing stock price against inherent value, C&B do not impose explicit drawdown control or practice dynamic allocation, like risk-parity AQRNX or long-short ARLSX. They try instead to buy wonderful businesses at discounted prices. To quote Mr. Buffett: “If you’re right about what, you don’t have to worry about when very much.”

Fortunately, history is on their side. The chart below depicts drawdowns for the last 50 years, comparing value versus growth large cap fund averages. Value funds indeed generally suffer smaller and shorter drawdowns. But not always. The term “value trap” became ubiquitous during the financial collapse of 2008, when many highly respected, long established, and top performing value funds (prime example DODGX) were simply hammered. And, when the forest is burning, all the trees go with it.

drawdown

While Mr. Cook and Mr. Bynum must have managed their private accounts through such turbulent times, COBYX has enjoyed bull market conditions since its inception. (Perhaps a reluctant bull, but nonetheless…) Still, when the market dipped 7% in May 2012, COBYX did not drop at all. In September 2011, SP500 dropped 16%, COBYX dipped only 5%. Its biggest drawdown was June 2010 at 9% versus 13% for the market. The tame behavior is due partly to C&B’s propensity to hold cash. Not as a strategy, they explain, but as residual to value opportunities available. They unloaded Kraft, for example, shortly after the company split its international and domestic businesses. Here is an excerpt from COBYX’s 2012 annual report explaining their move:

Despite neither of the companies’ fundamental business prospects changing one iota, the market reacted to the news by trading both of the stocks higher. We used this opportunity to liquidate our stake in both companies. It is popular, even within our value discipline, for investors to advocate various financial engineering strategies in an attempt to drive near-term stock price appreciation rather than to focus on a company’s long-term cash flows – where real value resides.

C&B take pride in not being “closet indexers” to their benchmarks SP500 and MSCI All Country World Index (ACWI). So far they have tended to hold consumer defensive stocks, like Wal-Mart, Procter & Gamble, and Coca-Cola. Although more recently, they own Microsoft, which accounts for 16% of the portfolio. COBYX’s lifetime correlation to SP500 is 66% and its beta is only 0.47.

The strategy has delivered handsomely. Just how good is it? Below compares COBYX with several other Morningstar 5 star funds, including Charles Akre’s AKREX, Steven Romick’s FPA Crescent Fund, Donald Yacktman’s YAFFX, Sequoia Fund (perhaps the greatest fund ever), plus landmark Berkshire Hathaway.

cobyx table

Since COBYX inception, it has produced the highest risk adjusted returns, based on both Sharpe and Sortino Ratios, with the lowest standard and downside volatilities. It has delivered more than 90% of SP500 total return with less than 60% of its volatility. Interestingly, all of these top-performing mutual funds have low beta against SP500, like COBYX, but again for the record, C&B reject metrics like beta: “Risk is not volatility.”

COBYX is also highly concentrated. As of December 2012, it held only seven equities. C&B’s strategy is to focus only on companies whose businesses they can understand – depth of insight is the edge they seek. They employ Kelly Criterion to size positions in their portfolio, which represents an implicit form of risk management. John Kelly developed it in 1950s at AT&T’s Bell Labs to optimize transmission rate through long distance phone lines. Edward Thorpe then famously employed the technique to “Beat the Dealer” and later to help optimize his hedge fund investments at Princeton/Newport Partners. In C&B’s implementation, Kelly is edge over odds, or expected returns over range of outcomes. What is currently their biggest position? Cash at 34%.

Bottom-line: Hard not to love this young fund, performance to date, and philosophy employed by its managers. High ER, recently dropped from 1.88 to 1.49, has been its one detractor. Hopefully, ER reduction continues with AUM growth, since world-stock fund median is already a hefty 1.20 drag.

(Thank you, sir! David)

Conference Call Upcoming: RiverPark Wedgewood Growth, April 17

Large-cap funds, and especially large large-cap funds, suffer from the same tendency toward timidity and bloat that I discussed above. On average, actively-managed large growth funds hold 70 stocks and turn over 100% per year. The ten largest such funds hold 311 stocks on average and turn over 38% per year.

The well-read folks at Wedgewood see the path to success differently. Manager David Rolfe endorses Charles Ellis’s classic essay, “The Losers Game” (Financial Analysts Journal, July 1975). Reasoning from war and sports to investing, Ellis argues that losers games are those where, as in amateur tennis:

The amateur duffer seldom beats his opponent, but he beats himself all the time. The victor in this game of tennis gets a higher score than the opponent, but he gets that higher score because his opponent is losing even more points.

Ellis argues that professional investors, in the main, play a losers game by becoming distracted, unfocused and undistinguished. Mr. Rolfe and his associates are determined not to play that game. They position themselves as “contrarian growth investors.” In practical terms, that means:

They force themselves to own fewer stocks than they really want to. After filtering a universe of 500-600 large growth companies, Wedgewood holds only “the top 20 of the 40 stocks we really want to own.” Currently, 55% of the fund’s assets are in its top ten picks.
They buy when other growth managers are selling. Most growth managers are momentum investors, they buy when a stock’s price is rising. Wedgewood would rather buy during panic than during euphoria.
They hold far longer once they buy. The historical average for Wedgewood’s separate accounts which use this exact discipline is 15-20% turnover and the fund is around 25%.
And then they spend a lot of time watching those stocks. “Thinking and acting like business owners reduces our interest to those few businesses which are superior,” Rolfe writes, and he maintains a thoughtful vigil over those businesses.

David is articulate, thoughtful and successful. His reflections on “out-thinking the index makers” strike me as rare and valuable, as does his ability to manage risk while remaining fully invested.

Our conference call will be Wednesday, April 17, from 7:00 – 8:00 Eastern.

How can you join in?

Observer Fund Profiles

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

The Cook and Bynum Fund (COBYX): an updated profile of this concentrated value fund.

Whitebox Long Short Equity (WBLSX): the former hedge fund has a reasonably distinctive, complicated strategy and I haven’t had much luck in communicating with fund representatives over the last month or so about the strategy. Given a continued high level of reader interest in the fund, it seemed prudent to offer, with this caveat, a preliminary take on what they do and how you might think about it.

Launch Alert: BBH Global Core Select (BBGRX)

There are two things particularly worth knowing about BBH (for Brown Brothers Harriman) Core Select (BBTRX): (1) it’s splendid and (2) it’s closed. It’s posted a very consistent pattern of high returns and low risk, which eventually drew $5 billion to the fund and triggered its soft close in November. At the moment that BBH closed Core Select, they announced the launch of Global Core Select. That fund went live on March 28, 2013.

Global Core Select will be co-managed by Regina Lombardi and Tim Hartch, two members of the BBH Core Select investment team. Hartch is one of Core Select’s two managers; Lombardi is one of 11 analysts. The Fund is the successor to the BBH private investment partnership, BBH Global Funds, LLC – Global Core Select, which launched on April 2, 2012. Because the hedge fund had less than a one year of operation, there’s no performance record for them reported. The minimum initial investment in the retail class is $5,000. The expense ratio is capped at 1.50% (which represents a generous one basis-point sacrifice on the adviser’s part).

The strategy snapshot is this: they’ll invest in 30-40 mid- to large-cap companies in both developed and developing markets. They’ll place at least 40% outside the US. The strategy seems identical to Core Select’s: established, cash generative businesses that are leading providers of essential products and services with strong management teams and loyal customers, and are priced at a discount to estimated intrinsic value. They profess a “buy and own” approach.

What are the differences: well, Global Core Select is open and Core Select isn’t. Global will double Core’s international stake. And Global will have a slightly-lower target range: its investable universe starts at $3 billion, Core’s starts at $5 billion.

I’ll suggest three reasons to hesitate before you rush in:

There’s no public explanation of why closing Core and opening Global isn’t just a shell game. Core is not constrained in the amount of foreign stock it owns (currently under 20% of assets). If Core closed because the strategy couldn’t handle the additional cash, I’m not sure why opening a fund with a nearly-identical strategy is warranted.
Expenses are likely to remain high – even with $5 billion in a largely domestic, low turnover portfolio, BBH charges 1.25%.
Others are going to rush in. Core’s record and unavailability is going to make Global the object of a lot of hot money which will be rolling in just as the market reaches its seasonal (and possibly cyclical) peak.

That said, this strategy has worked elsewhere. The closed Oakmark Select (OAKLX) begat Oakmark Global Select (OAKWX) and closed Leuthold Core (LCORX) led to Leuthold Global (GLBLX). In both cases, the young fund handily outperformed its progenitor. Here’s the nearly empty BBH Global Core Select homepage.

Launch Alert: DoubleLine Equities Small Cap Growth Fund (DLESX)

DoubleLine continues to pillage TCW, the former home of its founder and seemingly of most of its employees. DoubleLine, which manages more than $53 billion in mostly fixed income assets, has created a DoubleLine Equity LP division. The unit’s first launch, DoubleLine Equities Small Cap Growth Fund, occurs April 1, 2013. Growth Fund (DLEGX) and Technology Fund (DLETX) are close behind in the pipeline.

Husam Nazer, who oversaw $4-5 billion in assets in TCW’s Small and Mid-Cap Growth Equities Group, will manage the new fund. DoubleLine hired Nazer’s former TCW investing partner, Brendt Stallings, four stock analysts and a stock trader. Four of the new hires previously worked for Nazer and Stallings at TCW.

The fund will invest mainly in stocks comparable in size to those in the Russell US Growth index (which tops out at around $4 billion). They’ll invest mostly in smaller U.S. companies and in foreign small caps which trade on American exchanges through ADRs. The manager professes a “bottom up” approach to identify investment. He’s looking for a set of reasonable and unremarkable characteristics: consistent and growing earnings, strong balance sheet, good competitive position, good management and so on. The minimum initial investment in the retail class is $2,000, reduced to $500 for IRAs. The expense ratio is capped at 1.40%.

I’ll suggest one decent reason to hesitate before you bet that DoubleLine’s success in bonds will be matched by its success in stocks:

Mr. Nazer’s last fund wasn’t really all that good. His longest and most-comparable charge is TCW Small Cap Growth (TGSNX). Morningstar rates it as a two-star fund. In his eight years at the fund, Mr. Nazer had a slow start (2005 was weak) followed by four very strong years (2006-2009) and three really bad ones (2010-2012). The fund’s three-year record trails 97% of its peers. It has offered consistently above-average to high volatility, paired with average to way below-average returns. Morningstar’s generally-optimistic reviews of the fund ended in July 2011. Lipper likewise rates it as a two-star fund over the past five years.

The fund might well perform brilliantly, assuming that Mr. Gundlach believed he had good reason to import this team. That said, the record is not unambiguously positive.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

Funds in registration this month won’t be available for sale until, typically, the beginning of June 2013. We found a handful of no-load, retail funds in the pipeline, notably:

Robeco Boston Partners Global Long/Short Fund will offer a global take on Boston Partner’s highly-successful long/short strategy. They expect at least 40% international exposure, compared to 10% in their flagship Long/Short Equity Fund (BPLEX) and 15% in the new Long/Short Research Fund (BPRRX). There are very few constraints in the prospectus on their investing universe. The fund will be managed by Jay Feeney, an original Boston Partner, co-CEO and CIO-Equities, and Christopher K. Hart, Equity Portfolio Manage. The minimum initial investment in the retail class is $2,500. The expense ratio will be 3.77% after waivers. Let me just say: “Yikes.” At the risk of repeating myself, “Yikes!” With a management fee of 1.75%, this is likely to remain a challenging case.

T. Rowe Price Global Allocation Fund will invest in stocks, bonds, cash and hedge funds. Yikes! T. Rowe is getting you into hedge funds. They’ll active manage their asset allocation. The baseline is 30% US stocks, 30% international stocks, 20% US bonds, 10% international bonds and 10% alternative investments. A series of macro judgments will allow them to tweak those allocations. The fund will be managed by Charles Shriver, lead manager for their Balanced, Personal Strategy and Spectrum funds. The minimum initial purchase is $2500, reduced to $1000 for IRAs. Expense ratio will be 1.05%.

Details on these funds and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes: Two giants begin to step back

On a related note, we also tracked down 71 fund manager changes. Those include decisions by two fund company founders to begin lightening their loads. Nicholas Kaiser, president of Saturna Investments which advises the Sextant and Amana funds, no longer co-manages Sextant Growth (SSGFX) and John Kornitzer, founder of Kornitzer Capital which advises the Buffalo funds, stepped back from Buffalo Dividend Focus (BUFDX) four months after launch.

Snowball on the transformative power of standing around, doing little

I’m occasionally asked to contribute 500 words to Amazon’s Money & Markets blog. Amazon circulates a question (in this case, “how should investors react to sequestration?”) and invites responses. I knew they won’t publish “oh, get real,” so I wrote something just slightly longer.

Don’t Just Do Something. Stand There.

When exactly did the old midshipman’s rule, “When in danger or in doubt, run in circles, scream and shout,” get enshrined as investing advice?

There are just three things we don’t know about sequestration: (1) what will happen, (2) how long it will last and (3) what will follow. Collectively, they tell you that the most useful thing a stock investor might do in reaction to the sequestration is, nothing. Whatever happens will certainly roil the markets but stock markets are forever being roiled. This one is no different than all of the others. Go check your portfolio and ask four things:

Do I have an adequate reserve in a cash-management account to cover my basic expenses – that is, to maintain a normal standard of living – if I need six months to find a new job?
Do I have very limited stock exposure (say, under 20%) in the portion of the portfolio that I might reasonably need to tap in the next three or five years?
Do I have a globally diversified portfolio in the portion that I need to grow over a period of 10 years or more?
Am I acting responsibly in adding regularly to each?

If yes, the sequestration is important, but not to your portfolio. If no, you’ve got problems to address that are far more significant than the waves caused by this latest episode of our collective inability to manage otherwise manageable problems. Address those, as promptly and thoughtfully as you can.

The temptation is clear: do something! And the research is equally clear: investors who reactively do something lose. Those who have constructed sensible portfolios and leave them be, win.

Be a winner: stand there.

Happily, the other respondents were at least as sensible. There’s the complete collection.

Briefly Noted ….

Vanguard is shifting

Perhaps you should, as well? Vanguard announced three shifts in the composition of income sleeve of their Target Retirement Funds.

They are shifting their bond exposure from domestic to international. Twenty percent of each fund’s fixed income exposure will be reallocated to foreign bonds through investment in Vanguard Total International Bond Index Fund.
Near term funds are maintaining their exposure to TIPS but are shifting all of their allocation to the Short-Term Inflation-Protected Securities Index Fund rather than Vanguard Inflation-Protected Securities Fund.
The Retirement Income and Retirement 2010 funds are eliminating their exposure to cash. The proceeds will be used to buy foreign bonds.

PIMCO retargets

As of March 8, 2013 the PIMCO Global Multi-Asset Fund changed its objective from “The Fund seeks total return which exceeds that of a blend of 60% MSCI World Index/40% Barclays U.S. Aggregate Index” to “The Fund seeks maximum long-term absolute return, consistent with prudent management of portfolio volatility.” At the same time, the Fund’s secondary index is the 1 Month USD LIBOR Index +5% which should give you a good idea of what they expect the fund to be able to return over time.

PIMCO did not announce any change in investment policies but did explain that the new, more conservative index “is more closely aligned with the Fund’s investment philosophy and investment objective” than a simple global stock/bond blend would be.

Capital Group / American Funds is bleeding

Our recent series on new fund launches over the past decade pointed out that, of the five major fund groups, the American Funds had – by far – the worst record. They managed to combine almost no innovation with increasingly bloated funds whose managers were pleading for help. A new report in Pensions & Investments (Capital Group seeking to rebuild, 03/18/2013) suggests that the costs of a decade spent on cruise control were high: the firm’s assets under management have dropped by almost a half-trillion dollars in six years with the worst losses coming from the institutional investment side.

Matthews and the power of those three little words.

Several readers have noticed that Matthews recently issued a supplement to the Strategic Income Fund (MAINX) portfolio. The extent of the change is this: the advisor dropped the words “and debt-related” from a proviso that at least 50% of the fund’s portfolio would be invested in “debt and debt-related securities” which were rated as investment-grade.

In talking with folks affiliated with Matthews, it turns out that the phrase “and debt-related” put them in an untenable bind. “Debt-related securities” includes all manner of derivatives, including the currency futures contracts which allow them to hedge currency exposure. Such derivatives do not receive ratings from debt-rating firms such as Fitch meaning that it automatically appeared as if the manager was buying “junk” when no such thing was happening. That became more complicated by the challenge of assigning a value to a futures contract: if, hypothetically, you buy $1 million in insurance (which you might not need) for a $100 premium, do you report the value of $100 or $1 million?

In order to keep attention focused on the actual intent of the proviso – that at least 50% of the debt securities will be investment grade – they struck the complicating language.

Good news and bad for AllianzGI Opportunity Fund shareholders

Good news, guys: you’re getting a whole new fund! Bad news: it’s gonna cost ya.

AllianzGI Opportunity Fund (POPAX) is a pretty poor fund. During the first five years of its lead manager’s ten year tenure, it wasn’t awful: two years with well above average returns, two years below average and one year was a draw. The last five have been far weaker: four years way below average, with 2013 on course for another. Regardless of returns, the fund’s volatility has been consistently high.

The clean-up began March 8 2013 with the departure of co-manager Eric Sartorius. On April 8 2013, manager Mike Corelli departs and the fund’s investment strategy gets a substantial rewrite. The current strategy “focuses on bottom-up, fundamental analysis” of firms with market caps under $2 billion. Ironically, despite the “GI” designation in the name (code for Growth & Income, just as TR is Total Return and AR is Absolute Return), the prospectus assures us that “no consideration is given to income.” The new strategy will “utilize a quantitative process to focus on stocks of companies that exhibit positive change, sustainability, and timely market recognition” and the allowable market cap will rise to $5.3 billion.

Two bits of bad news. First, it’s likely to be a tax headache. Allianz warns that “the Fund will liquidate a substantial majority of its existing holdings” which will almost certainly trigger a substantial 2013 capital gains bill. Second, the new managers (Mark Roemer and Jeff Parker) aren’t very good. I’m sure they’re nice people and Mr. Parker is CIO for the firm’s U.S. equity strategies but none of the funds they’ve been associated with (Mr. Roemer is a “managed volatility” specialist, Mr. Parker focuses on growth) have been very good and several seem not to exist anymore.

Direxion splits

A bunch of Direxion leveraged index and reverse index products split either 2:1 or 3:1 at the close of business on March 28, 2013. They were

Fund Name	Split Ratio
Direxion Daily Financial Bull 3X Shares	3 for 1
Direxion Daily Retail Bull 3X Shares	3 for 1
Direxion Daily Emerging Markets Bull 3X Shares	3 for 1
Direxion Daily S&P 500 Bull 3X Shares	3 for 1
Direxion Daily Real Estate Bull 3X Shares	2 for 1
Direxion Daily Latin America Bull 3X Shares	2 for 1
Direxion Daily 7-10 Year Treasury Bull 3X Shares	2 for 1
Direxion Daily Small Cap Bull 3X Shares	2 for 1

Small Wins for Investors

Effective April 1, 2013, Advisory Research International Small Cap Value Fund’s (ADVIX) expense ratio is capped at 1.25%, down from its current 1.35%. Morningstar will likely not reflect this change for a while

Aftershock Strategies Fund (SHKNX) has lowered its expense cap, from 1.80 to 1.70%. Their aim is to “preserve capital in a challenging investment environment.” Apparently the absence of a challenging investment environment inspired them to lose capital: the fund is down 1.5% YTD, through March 29, 2013.

Good news: effective March 15, 2013, Clearwater Management increased its voluntary management fee waiver for three of its Clearwater Funds (Core, Small Companies, Tax-Exempt Bond). Bad news, I can’t confirm that the funds actually exist. There’s no website and none of the major the major tracking services now recognizes the funds’ ticker symbols. Nothing posts at the SEC suggests cessation, so I don’t know what’s up.

Fidelity is offering to waive the sales loads on an ever-wider array of traditionally load-only funds through its supermarket. I learned of the move, as I learn of so many things, from the folks at MFO’s discussion board. The list of load-waived funds is detailed in msf’s thread, entitled Fidelity waives loads. A separate thread, started by Scott, with similar good news announces that T. Rowe Price funds are available without a transaction fee at Ameritrade.

Vanguard is dropping expenses on two more funds including the $69 billion Wellington (VWELX) fund. Wellington’s expenses have been reduced in three consecutive years.

Closings

American Century Equity Income (TWEAX) closed to new investors on March 29, 2013. The fund recently passed $10 billion in assets, a hefty weight to haul. The fund, which has always been a bit streaky, has trailed its large-value peers in five of the past six quarters which might have contributed to the decision to close the door.

The billion-dollar BNY Mellon Municipal Opportunities Fund (MOTIX) closed to new investors on March 28, 2013.

Effective April 30, 2013 Cambiar Small Cap Fund (CAMSX) will close to new investors. It’s been a very strong performer and has drawn $1.4 billion in assets.

Prudential Jennison Mid Cap Growth (PEEAX) will close to new investors on April 8, 2013. The fund’s assets have grown substantially over the past three years from under $2 billion at the beginning of 2010 to over $8 billion as of February 2013. While some in the media describe this as “a shareholder-friendly decision,” there’s some question about whether Prudential friended its shareholders a bit too late. The fund’s 10 year performance is top 5%, 5-year declines to top 20%, 3 year to top 40% and one year to mediocre.

Effective April 12, 2013, Oppenheimer Developing Markets Fund (ODMAX) closed to both new and existing shareholders. In the business jargon, that’s a “hard close.”

Touchstone Sands Capital Select Growth (PTSGX) and Touchstone Sands Institutional Growth (CISGX), both endorsed by Morningstar’s analysts, will close to new investors effective April 8, 2013. Sands is good and also subadvises from for GuideStone and MassMutual.

Touchstone has also announced that Touchstone Merger Arbitrage (TMGAX), subadvised by Longfellow Investment Management, will close to new investors effective April 8. The two-year old fund has about a half billion in assets and management wants to close it to maintain performance.

Effective April 29, 2013, Westcore International Small-Cap Fund (WTIFX) will close to all purchase activity with the exception of dividend reinvestment. That will turn the current soft-close into a hard-close.

Old Wine in New Bottles

On or about May 31, 2013. Alger Large Cap Growth Fund (ALGAX) will become Alger International Growth Fund, but its investment objective to seek long-term capital appreciation will not change. The Fund will be managed by Pedro V. Marcal. At the same time, Alger China-U.S. Growth Fund (CHUSX) will become Alger Global Growth Fund, but its investment objective to seek long-term capital appreciation will not change. The Fund will continue to be managed by Dan Chung and Deborah Vélez Medenica, with the addition of Pedro V. Marcal. These are both fundamentally sorrowful funds. About the only leads I have on Mr. Marcal is that he’s either a former Olympic fencer for Portugal (1960) or the author of a study on market timing and technical analysis. I’m not sure which set of skills would contribute more here.

Effective April 19, BlackRock S&P 500 Index (MASRX) will merge into BlackRock S&P 500 Stock (WFSPX). Uhhh … they’re both S&P500 index funds. The reorganization will give shareholders a tiny break in expenses (a drop from 13 bps to 11) but will slightly goof with their tax bill.

Buffalo Micro Cap Fund (BUFOX) will become Buffalo Emerging Opportunities Fund, around June 3, 2013. That’s a slight delay in the scheduled renaming, which should have already taken place under the original plan. The renamed beast will invest in “domestic common stocks, preferred stocks, convertible securities, warrants and rights of companies that, at the time of purchase by the Fund, have market capitalizations of $1 billion or less.

Catalyst Large Cap Value Fund (LVXAX) will, on May 27 2013, become Catalyst Insider Buying Fund. The fund will no longer be constrained to invest in large cap value stocks.

Effective April 1, 2013, Intrepid All Cap Fund (ICMCX) changed its name to Intrepid Disciplined Value Fund. There was a corresponding change to the investment policies of the fund to allow it to invest in common stocks and “preferred stocks, convertible preferred stocks, warrants and foreign securities, which include American Depositary Receipts (ADRs).”

PIMCO Worldwide Fundamental Advantage TR Strategy (PWWIX) will change its name to PIMCO Worldwide Fundamental Advantage AR Strategy. Also, the fund will change from a “total return” strategy to an “absolute return” strategy, which has more flexibility with sector exposures, non-U.S. exposures, and credit quality.

Value Line changed the names of Value Line Emerging Opportunities Fund to the Value Line Small Cap Opportunities Fund (VLEOX) and the Value Line Aggressive Income Trust to the Value Line Core Bond Fund (VAGIX).

Off to the Dustbin of History

AllianzGI Focused Opportunity Fund (AFOAX) will be liquidated and dissolved on or about April 19, 2013.

Armstrong Associates (ARMSX) is merging into LKCM Equity Fund (LKEQX) effective on or about May 10, 2013. C.K. Lawson has been managing ARMSX for modestly longer – 45 years – than many of his peers have been alive.

Artio Emerging Markets Local Debt (AEFAX) will liquidate on April 19, 2013.

You thought you invested in what? The details of db X-trackers MSCI Canada Hedged Equity Fund will, effective May 31 2013, be tweaked just a bit. The essence of the tweak is that it will become db X-trackers MSCI Germany Hedged Equity Fund (DBGR).

The Forward Focus and Forward Strategic Alternatives funds will be liquidated pursuant to a Board-approved Plan of Liquidation on or around April 30, 2013.

The Guardian Fund (LGFAX) guards no more. It is, as of March 28, 2013, a former fund.

ING International Value Choice Fund (IVCAX) will merge with ING International Value Equity Fund (NIVAX, formerly ING Global Value Choice Fund), though the date is not yet set.

Janus Global Research Fund merged into Janus Worldwide Fund (JAWWX) effective on March 15, 2013.

In a minor indignity, Dreman has been ousted as the manager of MIST Dreman Small Cap Value Portfolio, an insurance product distributed by MET Investment Series Trust (hence “MIST”) and replaced by J.P. Morgan Investment Management. Effective April 29, 2013, the fund becomes JPMorgan Small Cap Value Portfolio. No-load investors can still access Mr. Dreman’s services through Dreman Contrarian Small Cap Value (DRSVX). Folks with the attention spans of gnats and a tendency to think that glancing at the stars is the same as due diligence, will pass quickly by. This small fund has a long record of outperformance, marred by 2010 (strong absolute returns, weak relative ones) and 2011 (weak relative and absolute returns). 2012 was so-so and 2013, through March, has been solid.

Munder Large-Cap Value Fund was liquidated on March 25, 2013.

JPMorgan is planning a leisurely merger JPMorgan Value Opportunities (JVOIX) into JPMorgan Large Cap Value (HLQVX), which won’t be effective until Oct. 31, 2014. The funds share the same manager and strategy and . . . . well, portfolio. Hmmm. Makes you wonder about the delay.

Lord Abbett Stock Appreciation Fund merged into Lord Abbett Growth Leaders Fund (LGLAX) on March 22, 2013.

Pioneer Independence Fund is merging into Pioneer Disciplined Growth Fund (SERSX) which is expected to occur on or about May 17, 2013. The Disciplined Growth management team, fees and record survives while Independence’s vanishes.

Effective March 31, 2013 Salient Alternative Strategies Fund, a hedge fund, merged into the Salient Alternative Strategies I Fund (SABSX) because, the board suddenly discovered, both funds “have the same investment objectives, policies and strategies.”

Sentinel Mid Cap II Fund (SYVAX) has merged into the Sentinel Mid Cap Fund (SNTNX).

Target Growth Allocation Fund would like to merge into Prudential Jennison Equity Income Fund (SPQAX). Shareholders consider the question on April 19, 2013 and approval is pretty routine but if they don’t agree to merge the fund away, the Board has at least resolved to firm Marsico as one of the fund’s excessive number of sub-advisers (10, currently).

600,000 visits later . . .

609,000, actually. 143,000 visitors since launch. About 10,000 readers a month nowadays. That’s up by 25% from the same period a year ago. Because of your support, either direct contributions (thanks Leah and Dan!) or use of our Amazon link (it’s over there, on the right), we remain financially stable. And a widening circle of folks are sharing tips and leads with us, which gives us a chance to serve you better. And so, thanks for all of that.

The Observer celebrates its second anniversary with this issue. We are delighted and honored by your continuing readership and interest. You make it all worthwhile. (And you make writing at 1:54 a.m. a lot more manageable.) We’re in the midst of sprucing the place up a bit for you. Will, my son, clicked through hundreds of links to identify deadsters which Chip then corrected. We’ve tweaked the navigation bar a bit by renaming “podcasts” as “featured” to better reflect the content there, and cleaned out some dead profiles. Chip is working to track down and address a technical problem that’s caused us to go offline for between two and 20 minutes once or twice a week. Anya is looking at freshening our appearance a bit, Junior is updating our Best of the Web profiles in advance of adding some new, and a good friend is looking at creating an actual logo for us.

Four quick closing notes for the months ahead:

We are still not spam! Some folks continue to report not receiving our monthly reminders or conference call updates. Please check your spam folder. If you see us there, just click on the “not spam” icon and things will improve.
Morningstar is coming. Not the zombie horde, the annual conference. The Morningstar Investor Conference is June 12-14, in Chicago. I’ll be attending the conference on behalf of the Observer. I had the opportunity to spend time with a dozen people there last year: fund managers, media relations folks, Observer readers and others. If you’re going to be there, perhaps we might find time to talk.
We’re getting a bit backed-up on fund profiles, in several cases because we’ve had trouble getting fund reps to answer their mail. Our plan for the next few months will be to shorten the cover essay by a bit in order to spend more time posting new profiles. If you have folks who strike you as particularly meritorious but unnoticed, drop me a note!
Please do use the Amazon link, if you don’t already. We’re deeply grateful for direct contributions but they tend to be a bit unpredictable (many months end up in the $50 range while one saw many hundreds) while the Amazon relationship tends to produce a pretty predictable stream (which makes planning a lot easier). It costs you nothing and takes no more effort than clicking and hitting the “bookmark this page” button in your browser. After that, it’s automatic and invisible.

Take great care!

David

The Cook and Bynum Fund

The fund:	The Cook and Bynum Fund (COBYX)
Manager:	Richard P. Cook and J. Dowe Bynum, managers and founding partners.
The call:	Recently published research laments the fact that actively-managed funds have become steadily less active and more index-like over time. The changing imperatives of the fund industry have led many managers to become mediocre by design. Their response is driven by the anxious desire for so-called “sticky” assets. The strategy is simple: design a product to minimize the risk that it will ever spectacularly trail its peer group. If you make your fund very much like its benchmark, you will never be a singular disaster and so investors (retirement plan investors, particularly) will never to motivated to find something better The fact that you never excel is irrelevant. The result is a legion of large, expensive, undistinguished funds who seek safety in the herd. The Cook and Bynum Fund (COBYX) strikes me as the antithesis of those. Carefully constructed, tightly focused, and intentionally distinct. On Tuesday, March 5, we spoke with Richard Cook and Dowe Bynum in the first of three conversations with distinguished managers who defy that trend through their commitment to a singular discipline: buy only the best. For Richard and Dowe, that translates to a portfolio with only seven holdings and a 34% cash stake. Since inception (through early March, 2013), they managed to capture 83% of the market’s gains with only 50% of its volatility; in the past twelve months, Morningstar estimates that they captured just 7% of the market’s downside. Among the highlights of the call for me: *The guys are willing to look* stupid. There are times, as now, when they can’t find stocks that meet their quality and valuation standards. The rule for such situations is simply: “When compelling opportunities do not exist, it is our obligation not to put capital at risk.” They happily admit that other funds might well reap short-term gains by running with the pack, but you “have to be willing to look stupid.” Their current cash stake is about 34%, “the highest cash level ever in the fund.” That’s not driven by a market call; it’s a simple residue of their inability to find great opportunities. The guys are not willing to be stupid. Richard and Dowe grew up together and are comfortable challenging each other. Richard knows the limits of Dowe’s knowledge (and vice versa), “so we’re less likely to hold hands and go off the cliff together.” In order to avoid that outcome, they spend a lot of time figuring out how not to be stupid. They relegate some intriguing possibilities to the “too hard pile,” those businesses that might have a great story but whose business model or financials are simply too hard to forecast with sufficient confidence. They think about common errors (commitment bias, our ability to rationalize why we’re not going to stop doing something once we’ve started, chief among them) and have generated a set of really interesting tools to help contain them. They maintain, for example, a list all of the reasons why they don’t like their current holdings. In advance of any purchase, they list all of the conditions under which they’d quickly sell (“if their star CEO leaves, we do too”) and keep that on top of their pile of papers concerning the stock. They’re doing what they love. Before starting Cook & Bynum (the company), both of the guys had high-visibility, highly-compensated positions in financial centers. Richard worked for Tudor Investments in Stamford, CT, while Dowe was with Goldman, Sachs in New York. The guys believe in a fundamental, value- and research-driven, stock-by-stock process. What they were being paid to do (with Tudor’s macro event-driven hedge fund strategies for Richard) was about as far from what they most wanted as they could get. And so they quit, moved back to Alabama and set up their own shop to manage their own money and the investments of high net-worth individuals. They created Cook & Bynum (the fund) in response to an investor’s request for a product accessible to family and friends. The $250 million invested with them (about $100 million in the fund) includes 100% of their own liquid net worth, with their investment split between the fund and the partnerships. Since both sets of vehicles use the same fees and structure, there’s no conflict between the two. They do prodigious research without succumbing to the “gotta buy something” impulse. While they spend the majority of their time in their offices, they’re also comfortable with spending two or three weeks at a time on the road. Their argument is that they’ve got to understand the entire ecosystem in which a firm operates – from the quality of its distribution network to the feelings of its customers – which they can only do first-hand. Nonetheless, they’ve been pretty good at resisting “deal momentum.” They spent, for example, some three weeks traveling around Estonia, Poland and Hungary. Found nothing compelling. Traveled Greece and Turkey and learned a lot, including how deeply dysfunctional the Greek economy, is but bought nothing. They’re willing to do what you won’t. Most of us profess a buy low / buy the unloved / break from the herd / embrace our inner contrarian ethos. And most of us are deluded. Cook and Bynum seem rather less so: they’re holding cash now while others buy stocks after the market has doubled and profits margins hit records but in the depth of the 2008 meltdown they were buyers. (They report having skipped Christmas presents in 2008 in order to have extra capital to invest.) As the market bottomed in March 2009, the fund was down to 2% cash. Bottom Line:** the guys seem to be looking for two elusive commodities. One is investments worth pursuing. The other is investing partners who share their passion for compelling investments and their willingness to let other investors charge off in a herd. Neither is as common as you might hope. The conference call (When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded.)
The profile:	It’s working. Cook and Bynum might well be among the best. They’re young. The fund is small and nimble. Their discipline makes great sense. It’s not magic, but it has been very, very good and offers an intriguing alternative for investors concerned by lockstep correlations and watered-down portfolios. The Mutual Fund Observer profile of COBYX, April 2013. The COBYX audio profile
Web:	The Cook & Bynum Fund website The Cook and Bynum Fact Sheet Fund Focus: Resources from other trusted sources

Inoculated By Value

Originally published in April 1, 2013 Commentary

April 1, 2013

Despite neither of the companies’ fundamental business prospects changing one iota, the market reacted to the news by trading both of the stocks higher. We used this opportunity to liquidate our stake in both companies. It is popular, even within our value discipline, for investors to advocate various financial engineering strategies in an attempt to drive near-term stock price appreciation rather than to focus on a company’s long-term cash flows – where real value resides.

April 1, 2013

(Thank you, sir! David)

March 1, 2013

Dear friends,

Welcome to the end of a long, odd month. The market bounced. The pope took a long victory lap around St. Peter’s Square in his Popemobile before giving up the red shoes for life. King Richard III was discovered after 500 years buried under a parking lot with evidence of an ignominious wound in his nether regions. At about the same time, French scientists discovered the Richard the Lionheart’s heart had been embalmed with daisies, myrtle, mint and frankincense and stored in a lead box. A series of named storms (Nemo? Really? Q?) wacked the Northeast.

And I, briefly, had fantasies of enormous wealth. My family discovered a long forgotten stock certificate issued around the time of the First World War in my grandfather’s name. After some poking about, it appeared that a chain of mergers and acquisitions led from a small Ohio bank to Fifth Third Bank, to whom I sent a scan of the stock certificate. While I waited for them to marvel at its antiquity and authenticity, I reviewed my lessons in the power of compounding. $100 in 1914, growing at 5% per year, would be worth $13,000 now. Cool. But, growing at 10% per year – the amount long-term stock investors are guaranteed, right? – it would have grown to $13,000,000. In the midst of my reverie about Chateau Snowball, Fifth Third wrote back with modestly deflating news: there was no evidence that the stock hadn’t been redeemed. There was also no evidence that it had been, but after 90 years presumption appears to shift in the bank’s favor. (Who’d have guessed?)

It looks like I better keep my day job. (Which, happily enough, is an immensely fulfilling one.)

Longleaf Global and its brethren

Two bits of news lay behind this story. First, Longleaf freakishly closed its new Longleaf Partners Global Fund (LLGFX) after just three weeks. Given that Longleaf hadn’t launched a fund in 15 years, it seemed odd that this one was so poorly-planned that they’d need to immediately close the door.

At around the same time, I received a cheerful note from Tom Pinto, a long-time correspondent of ours and vice president at Mount & Nadler. Mount & Nadler (presided over, these last 33 years, by the redoubtable Hedda Nadler) does public relations for mutual funds and other money management folks. They’ve arranged some really productive conversations (with, for example, David Winters and Bruce Berkowitz) over the years and I tend to take their notes seriously. This one celebrated an entirely remarkable achievement for Tweedy Browne Global Value (TBGVX):

Incredibly, when measured on a rolling 10-year basis since its inception through 11/30/12 using monthly returns, the fund is batting 1000, having outperformed its benchmark – MSCI EAFE — in 115 out of 115 possible 10-year holding periods over the last 19 plus years it has been in existence. It also outperformed its benchmark in 91% of the rolling five-year periods and 82% of the rolling three-year periods.

That one note combined three of my favorite things: (1) consistency in performance, (2) Tweedy, Browne and (3) Hedda.

Why consistency? It helps investors fight their worst enemy: themselves. Very streaky funds have very streaky investors, folks who buy and sell excessively and, in most cases, poorly. Morningstar has documented a regrettably clear pattern of investors earning less –sometimes dramatically less – than their funds, because of their ill-time actions. Steady funds tend to have steady investors; in Tweedy’s case, “investor returns” are close to and occasionally higher than the fund’s returns.

Why Tweedy? It’s one of those grand old firms – like Dodge & Cox and Northern – that started a century or more ago and that has been quietly serving “old wealth” for much of that time. Tweedy, founded in 1920 as a brokerage, counts Benjamin Graham, Walter Schloss and Warren Buffett among its clients. They’ve only got three funds (though one does come in two flavors: currency hedged and not) and they pour their own money into them. The firm’s website notes:

As of December 31, 2012, the current Managing Directors and retired principals and their families, as well as employees of Tweedy, Browne had more than $759.5 million in portfolios combined with or similar to client portfolios, including approximately $101.9 million in the Global Value Fund and $57.9 million in the Value Fund, $6.8 million in the Worldwide High Dividend Yield Value Fund and $3.7 million in the Global Value Fund II — Currency Unhedged.

Value (low risk, four stars) and Global Value (low risk, five stars) launched in 1993. The one with the long name (low risk, five stars) launched 14 years later, in 2007. Our profile of the fund, Tweedy Browne Worldwide High Dividend Yield Value (TBHDX), appeared as soon as it was launched. At that point, Global Value was rated by Morningstar as a two-star fund. Nonetheless, I plowed in with the argument that it represented a compelling opportunity:

They are really good stock-pickers. I know, I know: “gee, Dave, can’t you read? Two blinkin’ stars.” Three things to remember. First, the validity of Morningstar’s peer ratings depend on the validity of their peer group assignment. In the case of Global Value, they’re categorized as small-mid foreign value (which has been on something of a tear in recent years), despite the fact that 60% of their portfolio is in large cap stocks.

Second, much of the underperformance for Global Value is attributable to their currency hedging.

Third, they provide strong absolute returns even when they have weak relative ones. In the case of Global Value they have churned out returns around 17-18% over the trailing three- and five-year periods. Combine that with uniformly “low” Morningstar risk scores for both funds and you get an awfully compelling risk/return profile.

Bottom Line: there’s a lot to be said, especially in uncertain times, for picking cautious, experienced managers and giving them broad latitude. Worldwide High Dividend Yield has both of those attributes and it’s likely to be a remarkably rewarding instrument for folks who like to sleep well at night.

Why Hedda? I’ve never had the pleasure of meeting Hedda in person, but our long phone conversations over the years make it clear that she’s smart, funny, and generous and has an incredible institutional memory. When I think of Hedda, the picture that pops into mind is Edna Mode from The Incredibles, darling.

The Observer’s specialty are new and small funds. The problem in covering Tweedy is that the next new fund is apt to launch around about the time that you folks start receiving copies of the Observer by direct neural implants. I had similar enthusiasm for other long-interval launches, including Dodge and Cox Global (“Let’s be blunt about this. If this fund fails, it’s pretty much time for us to admit that the efficient market folks are right and give up on active management.”) and Oakmark Global Select (“both of the managers are talented, experienced and disciplined. Investors willing to take the risk are getting access to a lot of talent and a unique vehicle”).

That led to the question: what happens when funds that never launch new funds, launch new funds?

With the help of the folks on the Observer’s discussion board and, most especially, Charles Boccadoro, we combed through hundreds of records and tracked down all of the long-interval launches that we could. “Long-interval launches” were those where a firm hadn’t launched in anew fund in 10 years or more. (Dodge & Cox – with five fund launches in 81 years – was close enough, as was FMI with a launch after nine-and-a-fraction years.) We were able to identify 17 funds, either retail or nominally institutional but with low minimum shares, that qualified.

We looked at two measures: how did they do, compared to their Morningstar peers, in their first full year (so, if they launched in October 2009, we looked at 2010) and how have they done since launch?

Fund	Ticker	Launch	Years since the last launch	First full year vs peers	Cumulative (not annual!) return since inception vs peers
Acadian Emerging Markets Debt	AEMDX	12/10	17	(2.1) vs 2.0	22.7 vs 20.0
Advance Capital I Core Equity	ADCEX	01/08	15	33.2 vs 24.1	17.8 vs 9.7
API Master Allocation A	APIFX	03/09	12	19.9 vs 4.1	103.1 vs 89.1
Assad Wise Capital	WISEX	04/10	10	0.9 vs 1.7	7.4 vs 8.4
Dodge & Cox Global	DODWX	05/08	7	(44.5) vs (38.3)	85.5 v 68.4
Fairholme Allocation	FAAFX	12/10	11	(14.0) vs (4.0)	5.0 vs 21.1
FMI International	FMIJX	12/10	9	(1.8) vs (14.0)	23.8 vs 4.6
FPA International Value	FPIVX	12/11	18	20.6 vs 10.3	27.8 vs 18.8
Heartland International Value	HINVX	10/10	14	(22.0) vs (16.0)	9.3 vs 16.3
Jensen Quality Value	JNVIX	03/10	18	2.4 vs (3.8)	23.7 vs 36.4
LKCM Small-Mid Cap	LKSMX	04/11	14	9.3 vs 14.1	0.8 vs 5.0
Mairs & Power Small Cap	MSCFX	08/11	50	34.9 vs 13.7	59.4 vs 31.1
Oakmark Global Select	OAKWX	10/06	11	11.7 vs 12.5	54.8 vs 20.5
Pear Tree Polaris Foreign Value Small Cap	QUSIX	05/08	10	83.4 vs 44.1	26.3 vs 0.8
Thomas White Emerging Markets	TWEMX	06/10	11	(17.9) vs (19.9)	26.1 vs 16.5
Torray Resolute	TOREX	12/10	20	2.2 vs (2.5)	29.0 vs 18.4
Tweedy, Browne Worldwide High Dividend Yield Value	TBHDX	09/07	14	(13) vs (17.7)	18.2 vs 1.5

	Ticker	First full year	Since launch
Acadian	AEMDX	L	W
Advance Capital	ADCEX	W	W
API	APIFX	W	W
Assad	WISEX	L	L
Dodge & Cox	DODWX	L	W
Fairholme	FAAFX	L	L
FMI	FMIJX	W	W
FPA	FPIVX	W	W
Heartland	HINVX	W	L
Jensen	JNVIX	W	L
LKCM	LKSMX	L	L
Mairs & Power	MSCFX	W	W
Oakmark	OAKWX	L	W
Pear Tree	QUSIX	W	W
Thomas White	TWEMX	W	W
Torray	TOREX	W	W
Tweedy, Browne	TBHDX	W	W
Batting average		.647	.705

While this isn’t a sure thing, there are good explanations for the success. At base, these are firms that are not responding to market pressures and that have extremely coherent disciplines. The fact that they choose to launch after a decade or more speaks to a combination of factors: they see something important and they’re willing to put their reputation on the line. Those are powerful motivators driving highly talented folks.

What might be the next funds to track? Two come to mind. Longleaf Global launched 15 years after Longleaf International (LLINX) and would warrant serious consideration when it reopens. And BBH Global Core Select will be opening in the next month, 15 years after BBH Core Select (BBTRX and BBTEX). Core Select has been wildly successful and has just closed to new investors. Global Core Select will use the same team and the same strategy.

(Thanks to my collaborators on this piece: Mike M, Andrei, Charles and MourningStars.)

The Phrase, “Oh, that can’t be good” comes to mind

I read a lot of fund reports – annual, semi-annual and monthly. I read most of them to find up what’s going on with the fund. I read a few because I want to find up what’s going on with the world. One of the managers whose opinion I take seriously is Steven Romick, of FPA Crescent (FPACX).

They wanted to make two points. One: you were exactly right to notice that one paragraph in the Annual Report. It was, they report, written with exceeding care and intention. They believe that it warrants re-reading, perhaps several times. For those who have not read the passage in question:

Opportunity: When thinking about closing, we also think about the investing environment —both the current opportunity set and our expectations for future opportunities. Currently, we find limited prospects. However, we believe the future opportunity set will be substantial. As we have oft discussed, we are managing capital in the face of Central Bankers’ “grand experiment” that we do not believe will end well, fomenting volatility and creating opportunity. We continue to maintain a more defensive posture until the fallout. Though underperformance might be the price we pay in the interim should the market continue to rise, we believe in focusing on the preservation of capital before considering the return on it. The imbalances that we see, coupled with the current positioning of our Fund, give us confidence that over the long term, we will be able to invest our increased asset base in compelling absolute value opportunities.

Fund flows: We are sensitive to the negative impact that substantial asset flows (in or out) can have on the management and performance of a portfolio. At present, asset flows are not material relative to the size of the Fund, so we believe that the portfolio is not harmed. However, while members of the Investment Committee will continue to be available to existing clients, we have restricted discussions with new relationships so that our attention can be on investment management rather than asset gathering.

For now, we are satisfied with the team’s capabilities, the Fund’s positioning, and the impact of asset flows. As fellow shareholders, should anything cause us to doubt the likelihood of meeting our stated objectives we will close the Fund as we did before, and/or return capital to our shareholders.

What might be the sound bites in that paragraph? “We think about future opportunities. They will be substantial. For now we’ll focus on the preservation of capital. Soon enough, there will be billions of dollars’ worth of compelling absolute value opportunities.” In the interim, they know that they’re both growing and underperforming. They’ve cut off talk with potential new clients to limit the first and are talking with the rest of us so that we understand the second.

Point two: they’ve closed Crescent before. They’ll do it again if they don’t anticipate the opportunity to find good uses for new cash.

Artisan goes public. Now what?

Artisan Partners are one on my favorite investment management firms. Their policies are consistently shareholder friendly, their management teams are stable and disciplined, and their funds are consistently top-notch.

And now you’ll be able to own a piece of the action. Artisan will offer shares to the public, with the proceeds used to resolve some debt and make it possible for some of the younger partners to gain an equity stake in the firm. Three questions arise:

Is this good for the investors in Artisan’s funds?
Should you consider buying the stock?
And would it all work a bit better with Godiva chocolate?

What happens now with the Artisan funds?

The concern is that Artisan is gaining a fiduciary responsibility to a large set of outside shareholders. Their obligation to those shareholders is to increase Artisan’s earnings which, with other fund companies, has translated to (1) gather assets and (2) gather attention. There’s only been one academic study on the difference in performance between publicly-owned and privately-held fund companies, and that study looked only at Canadian firms. That study found:

… publicly-traded management companies invest in riskier assets and charge higher management fees relative to the funds managed by private management companies. At the same time, however, the risk-adjusted returns of the mutual funds managed by publicly-traded management companies do not appear to outperform those of the mutual funds managed by private management companies. This finding is consistent with both the risk reduction and agency cost arguments that have been made in the literature. (M K Berkowitz, Ownership, Risk and Performance of Mutual Fund Management Companies, 2001)

The only other serious investigation that I know of was undertaken by Bill Bernstein, and reported in his book The Investor’s Manifesto. Bernstein’s opinion of the financial services industry in general and of actively-managed funds in particular is akin to his opinions on astrology and reading goat entrails. Think I’m kidding? Here’s Bill:

The prudent investor treats almost the entirety of the financial industrial landscape as an urban combat zone. This means any stock broker or full-service brokerage firm, any newsletter, any advisor who purchases individual securities, any hedge fund. Most mutual fund companies spew more toxic waste into the investment environment than a third-world refinery. Most financial advisors cannot invest their way out a paper bag. Who can you trust? Almost no one.

Bill looked at the performance of 18 fund companies, five of which were not publicly-traded. In particular, he looked at the average star ratings for their funds (admittedly an imperfect measure, but among the best we’ve got). The privately-held firms placed 1st, 2nd, 3rd, 6th and 9^th in performance. The lowest positions were all public firms with a record of peddling bloated, undistinguished funds to an indolent public. His recommendation is categorical: “Do not invest with any mutual fund family that is owned by a publicly traded parent company.”

While the conflicts between the interests of the firm’s stockholders and the funds’ shareholders are real and serious, it’s also true that a number of public firms – the Affiliated Managers Group and T. Rowe Price, notably – have continued offered solid funds and reasonable prices. While it’s possible that Artisan will suddenly veer off the path that’s made them so admirable, that’s neither necessary nor immediately probable.

So, should you buy the stock instead of the funds?

In investor mythology, the fund companies’ stock always seems the better bet than the fund company’s funds. That seems, broadly speaking, true. Fund company stock has broadly outperformed the stock market and the financial sector stocks over time. I’ve gathered a listing of all of the publicly-traded mutual fund companies that I can identify, excluding only those instances where the funds are a tiny slice of a huge financial empire.

Here’s the performance of the companies’ stock, for various periods through February, 2013.

		3 year	5 year	10 year
Affiliated Managers Group	AMG	27.1	7.8	17.7
AllianceBernstein	AB	-1.6	-14.6	4.9
BlackRock	BLK	5.5	5.5	20.6
Calamos	CLMS	-2.7	-8.7	—
Cohen & Steers	CNS	21.7	9.0	—
Diamond Hill	DHIL	16.4	9.1	39.3
Eaton Vance	EV	11.3	4.3	13.2
Federated Investors	FII	3.4	-5.0	3.8
Franklin Resources	BEN	13.8	8.6	17.2
GAMCO Investors	GBL	10.6	1.5	8.8
Hennessy Advisors	HNNA	41.5	3.0	9.8
Invesco	IVZ	12.7	1.4	13.3
Janus Capital Group	JNS	-8.0	-17.8	-1.6
Legg Mason	LM	4.3	-15.4	0.4
Manning & Napier	MN	—	—	—
Northern Trust	NTRS	2.1	-3.8	7.2
State Street Corp	STT	9.3	-6.4	5.7
T. Rowe Price Group	TROW	14.7	7.6	20.3
US Global Investors	GROW	-22.2	-21.8	15.9
Waddell & Reed	WDR	10.9	6.1	11.4
Westwood Holdings	WHG	7.1	7.0	15.3
	Average:	8.9	-1.1	12.4
Vanguard Total Stock		13.8	4.8	9.1
Financials		6.6	6.8	5.4
Morningstar (just for fun)		16.3	1.1	—

Several of the largest fund companies – Capital Group Companies, Fidelity Management & Research, and Vanguard – are all private. Vanguard alone is owned by its fund shareholders.

Several high visibility firms – Janus and U.S. Global Investors – have had miserable performance and several others are extremely volatile. The chart for Hennessy Advisors, for example, shows a 90% decline in value during the financial crisis, flat performance for three years, then a freakish 90% rise in the past three months.

On whole, you’d have to conclude that “buy the company, not the funds” is no path to easy money.

Have They Even Considered Using Godiva as a Sub-advisor?

Artisan’s upcoming IPO has been priced at $27-29 a share, which would give Artisan a fully-diluted market value of about $1.8 billion. That’s roughly the same as the market capitalizations for Cheesecake Factory, Inc. (CAKE) or for Janus Capital Group (JNS).

So, for $1.8 billion you could buy all of Artisan or at least all of the publicly-available stock for CAKE or JNS. The question for all of you with $1.8 billion burning a hole in your pockets is “which one?” While an efficient market investor might shrug and suggest a screening process that begins with the words “Eenie” and “Meenie,” we know that you depend on us for better.

Herewith, our comprehensive comparison of Artisan, Cheesecake Factory and Janus:

	Artisan Partners	Cheesecake Factory	Janus Capital
No. of four- and five-star funds or cheesecake flavors	7 (of 11)	33	17 (of 41)
No. of one- and two-star funds or number of restaurants in Iowa	1	1	8
Number of closed funds or entrees with over 3000 calories and four days’ worth of saturated fat	5 (Intl Small Cap, Intl Value, Mid Cap, Mid Cap Value, Small Cap Value)	1 (Bistro Shrimp Pasta, 3,120 calories, 89 grams of saturated fat)	1 (Perkins Small Cap Value)
Assets under management or calories in a child’s portion of pasta with Alfredo sauce	$75 billion	1,810	$157 billion
Average assets under management per fund or number of Facebook likes	$3 billion	3.4 million	$1.9 billion

Jeez, that’s a tough call. Brilliant management or chocolate? Brilliant management or chocolate? Oh heck, who am I kidding:

USA Today launches a new portfolio tracker

In February, USA Today announced a partnership with SigFig (whose logo is a living piggy bank) to create a new and powerful portfolio tracker. Always game for a new experience, I signed up (it’s free, which helps). I allowed it to import my Scottrade portfolio and then to run an analysis on it.

Two pieces of good news. First, it made one sensible fund recommendation: that I sell Northern Global Tactical Asset Allocation (BBALX) and replace it with Buffalo Flexible Income (BUFBX). BBALX is a fund of index funds which represents a sort of “best ideas” approach from Northern’s investment policy committee. It has low expenses and I like the fact that it’s using index funds, which decreases complexity and increases predictability. That said, the Buffalo fund is very solid and has certainly outperformed Northern over the past several years. A FundAlarm profile of the fund, then called Buffalo Balanced, concluded:

This is clearly not a mild-mannered fund in the mold of Mairs & Power or Bridgeway. It takes more risks but is managed by an immensely experienced professional who has a pretty clearly-defined discipline. That has paid off, and likely will continue to pay off.

So, that’s sensible.

Second bit of good news, the outputs are pretty:

Now the bad news: the recommendations completely missed the problem. Scottrade holds five funds for me. They are RiverPark Short-Term High Yield (RPHYX), one of two cash-management accounts, Northern and three emerging markets funds. Any reasonable analyst would have said: “Snowball, what are you thinking? You’ve got over two-thirds of your money in the emerging markets, virtually no U.S. stocks and a slug of very odd bonds. This is wrong, wrong, wrong!”

None of which USAToday/SigFig noticed. They were unable even to categorize 40% of the portfolio, saw only 2% cash (it’s actually about 10%), saw no dividends (Morningstar calculates it at 2.4%) and had no apparent concern about my wild asset allocation skew.

Bottom line: look if you like, but look very skeptically at these outputs. This system might work for a very conventional portfolio, but even that isn’t yet proven.

Fidelity spirals (and not upward)

Investors pulled nearly $36 billion from Fidelity’s funds in 2012. That’s from Fido’s recently-released 2012 annual report. Their once-vaunted stock funds (a) had a really strong year in terms of performance and (b) bled $24 billion in assets regardless (Fidelity Sees More Fund Outflows, 02/15/13). The company’s operating income of $2.3 billion fell 29% compared with 2011.

The most troubling sign of Fidelity’s long-term malaise comes from a January announcement. Reuters reported that Fido’s target-date retirement funds were steadily losing market share to Vanguard. As a result, they needed to act to strengthen them.

Fidelity Investments’ target-date funds will start 2013 with more stock-picking firepower, as star money managers Will Danoff and Joel Tillinghast pick up new assignments to protect a No. 1 position under fire from rival Vanguard Group.

Why is that bad? Because Tillinghast and Danoff seem to be all that they have left. Danoff has been running Contrafund since 1990 and was moved in Fidelity Advisor New Insights in 2003 to beef up the Fidelity Advisor funds and now Fidelity Series Opportunistic Insights in 2012 to beef up the funds used by the target-date series. Even before the first dollar goes to Opportunistic Insights, Danoff was managing $107 billion in equity investments. Tillinghast has been running Low-Priced Stock, a $35 billion former small cap fund, since 1989 and now adds Fidelity Series Intrinsic Opportunities Fund. This feels a lot like a major league ball team staking their playoff chances on two 39-year-old power hitters; the old guys have a world of talent but you have to ask, what’s happened to the farm system?

One more slap at Morningstar’s new ratings

There was a long, healthy, and not altogether negative discussion of Morningstar’s analyst ratings on the Observer’s discussion board. For those trying to think through the weight to give a “Gold” analyst rating, it’s a really worthwhile use of your time. Three concerns emerge:

There may be a positivity bias in the ratings. It’s clear that the ratings are vastly skewed, so that negative assessments are few and far between. Some writers speculate that Morningstar’s corporate interests (drawing advertising, for example) might create pressure in that direction.
There’s no clear relationship between the five pillars and the ultimate rating. Morningstar’s analysts look at five factors (people, price, process, parent, performance – side note, be skeptical of any system designed for alliteration) and assign a positive, neutral or negative judgment to each. Some writers express bewilderment that one fund with a single “positive” might be silver while another with two positives might be “neutral.”
There’s no evidence, yet, that the ratings have predictive validity. The anonymous author of the Wall Street Rant blog produced a fairly close look at the 2012 performance of the newly-rated funds. Here’s the visual summary of Ranter’s research:

In short, “Not much really stands out after the first year. While there was a slight positive result for Gold and Silver rated funds, Neutral rated funds did even better.” The complete analysis is in a post entitled Performance of Morningstar’s New Analyst Ratings For Mutual Funds in 2012 (02/17/2013)

My own view is in accord with what Morningstar says about their ratings (use them as one element of your due diligence in assessing a fund) but, in practice, Morningstar’s functional monopoly in the fund ratings business means that these function as marketing tools far more than as analytic ones.

Five-star and Gold is surely a lot better than one-star and negative, but it’s not nearly as good as a careful, time-consuming inquiry into what the manager does, what the risks look like, and whether this makes even marginal sense in your own portfolio.

Introducing: The Elevator Talk

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

Elevator Talk #2: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX)

Mr. Harvey manages the Poplar Forest Partners (PFPFX and IPFPX), which launched on December 31, 2009. For 16 years, Dale co-managed several of the flagship American Funds including Investment Company of America (AIVSX), Washington Mutual (AWSHX) and American Mutual (AMRMX). Some managers start their own firms in order to get rich. Others because asset bloat was making them crazy. A passage from an internal survey that Dale completed, quoted by Morningstar, gives you some idea of his motivation:

Counselor Dale Harvey remarked that Capital should “[c]lose all the funds. Don’t just close the biggest or fastest growing. Doing that would simply shift the burden on to other funds. Keep them shut until we figure out the new unit structure and relieve the pressure of PCs managing $20 billion.”

Many of his first investors were former colleagues at the American Funds.

Dale offers these 152 words on why folks should check in:

This is a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own. The last was the late Howard Schow, who left to launch the Primecap Funds.

The real reason to leave is about size, the funds just kept taking in money. There came a point where it was a real impediment to performance. That will never be the case at Poplar Forest. Everyone here invests heavily in our funds, so our interests are directly aligned with yours.

From a process perspective, we’re defined by a contrarian value perspective with a long-term time horizon. This is a high conviction portfolio with no second choices or fillers. Because we’re contrarian, we’ll sometimes be out of step with the market as we were in 2011. But we’ve always known that the best time to invest in a four- or five-star fund is when it only has two stars.

The fund’s minimum initial investment is $25,000 for retail shares, reduced to $5,000 for IRAs. They maintain a minimal website for the fund and a substantially more informative site for their investment firm, Poplar Forest LLC. Dale’s most-recent discussion of the fund appears in his 2012 Annual Review.

Conference Call Highlights

On February 19^th, about 50 people phoned-in to listen to our conversation with Andrew Foster, manager of Seafarer Overseas Growth and Income Fund (SFGIX and SIGIX). The fund has an exceptional first year: it gathered $35 million in asset and returned 18% while the MSCI emerging market index made 3.8%. The fund has about 70% of its assets in Asia, with the rest pretty much evenly split between Latin America and Emerging Europe. Their growth has allowed them to institute two sets of expense ratio reductions, one formal and one voluntary.

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

The SFGIX conference call

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

Among the highlights of the call, for me:

China has changed. Andrew offered a rich discussion about his decision to launch the fund. The short version: early in his career, he concluded that emergent China was “the world’s most under-rated opportunity” and he really wanted to be there. By late 2009, he noticed that China was structurally slowing. That is, it was slow because of features that had no “easy or obvious” solution, rather than just slowly as part of a cycle. He concluded that “China will never be the same.” Long reflection and investigation led him to begin focusing on other markets, many of which were new to him, that had many of the same characteristics that made China exciting and profitable a decade earlier. Given Matthews’ exclusive and principled focus on Asia, he concluded that the only way to pursue those opportunities was to leave Matthews and launch Seafarer.
It’s time to be a bit cautious. As markets have become a bit stretched – prices are up 30% since the recent trough but fundamentals have not much changed – he’s moved at the margins from smaller names to larger, steadier firms.
There are still better opportunities in equities than fixed income; hence he’s about 90% in equities.
Income has important roles to play in his portfolio. (1) It serves as a check on the quality of a firm’s business model. At base, you can’t pay dividends if you’re not generating substantial, sustained free cash flow and generating that flow is a sign of a healthy business. (2) It serves as a common metric across various markets, each of which has its own accounting schemes and regimes. (3) It provides as least a bit of a buffer in rough markets. Andrew likened it to a sea anchor, which won’t immediately stop a ship caught in a gale but will slow it, steady it and eventually stop it.

Bottom-line: the valuations on emerging equities look good if you’ve got a three-to-five year time horizon, fixed-income globally strikes him as stretched, he expects to remain fully invested, reasonably cautious and reasonably concentrated.

Conference Call Upcoming: Cook and Bynum, March 5^th

Cook and Bynum (COBYX) is an intriguing fund. COBYX holds only seven holdings and a 33% cash stake. Since two-thirds of the fund is in the stock market, you might reasonably expect to harvest two-thirds of the market’s gains but suffer through just two-thirds of its volatility. Cook and Bynum has done far better. Since launch they’ve captured nearly 100% of the market’s gains with only one third of its volatility. In the past twelve months, Morningstar estimates that they’ve captured just 7% of the market’s downside.

We’ll have a chance to hear from Richard and Dowe (Cook and Bynum, respectively) about their approach to high-conviction investing and their amazing research efforts. To help facilitate the discussion, they prepared a short document that walks through their strategy with you. You can download that document here.

Our conference call will be Tuesday, March 5, from 7:00 – 8:00 Eastern.

How can you join in?

This will be the first of three conversations with distinguished managers who defy that trend through their commitment to a singular discipline: buy only the best. In the months ahead, we plan to talk with David Rolfe of RiverPark/Wedgewood Fund (RWGFX) and Stephen Dodson of Bretton Fund (BRTNX).

Observer Fund Profiles

Seafarer Overseas Growth & Income (SFGIX/SIGIX): The evidence is clear and consistent. It’s not just different. It’s better.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble (see “Synthetic Reverse Convertibles,” below).

Funds in registration this month won’t be available for sale until, typically, the beginning of May 2013. We found a dozen funds in the pipeline, notably:

Grandeur Peak Emerging Markets Opportunities Fund will seek long-term growth of capital by investing in small and micro-cap companies domiciled in emerging or frontier markets. They’re willing to consider common stock, preferred and convertible shares. The most reassuring thing about it is the Grandeur Peak’s founders, Robert Gardiner & Blake Walker, are running the fund and have been successfully navigating these waters since their days at Wasatch. The minimum initial investment is $2,000, reduced to $1,000 for accounts with an automatic investing plan and $100 for UGMA/UTMA or a Coverdell Education Savings Accounts. Expenses not yet set.

Matthews Emerging Asia Fund will pursue long-term capital appreciation by investing in common and preferred stock and convertible securities of companies that have “substantial ties” to the countries of Asia, except Japan. Under normal conditions, you might expect to see companies from Bangladesh, Cambodia, China, India, Indonesia, Laos, Malaysia, Mongolia, Myanmar, Pakistan, Papua New Guinea, Philippines, Sri Lanka, Thailand and Vietnam. They’ll run an all-cap portfolio which might invest in micro-cap stocks. Taizo Ishida, who serves on the management team of two other funds (Growth and Japan), will be in charge. The minimum initial investment in the fund is $2500, reduced to $500 for IRAs and Coverdell accounts. Expenses for both Investor and Institutional shares are capped at 1.90%.

Details on these funds and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes

On a related note, we also tracked down 31 fund manager changes, including the blockbuster departure of Kris Jenner from T. Rowe Price Health Sciences (PRHSX) and the departure, after nearly 20 years, of Patrick Rogers from Gateway Fund (GATEX).

There was also a change on a slew of Vanguard funds, though I see no explanation at Vanguard for most of them. The affected funds are a dozen Target Retirement Date funds plus

Diversified Equity
Extended Duration Treasury Index
FTSE All-World ex-US Small Index
Global ex-US Real Estate
Long-Term Bond Index
Long-Term Government Bond Index
Short-Term Bond Index
STAR
Tax-Managed Growth & Income
Tax-Managed International

Vanguard did note that five senior executives were being moved around (including to and from Australia) and, at the end of that announcement, nonchalantly mentioned that “Along with these leadership changes, 15 equity funds, 11 fixed income funds, two balanced funds, and Vanguard Target Retirement Funds will have new portfolio managers rotate onto their teams.” The folks being moved did actually manage the funds affected so the cause is undetermined.

Snowball and the fine art of Jaffe-casting

Despite the suspicion that I have a face made for radio but a voice made for print, Chuck Jaffe invited me to appear as a guest on the February 28 broadcast of MoneyLife with Chuck Jaffe. (Ted tells me that I appear at the 34:10 mark and that you can just move the slider there if you’d like.) We chatted amiably for a bit under 20 minutes, about what to look for and what to avoid in the fund world. I ended up doing capsule critiques of five funds that his listeners had questions about:

WisdomTree Emerging Markets Equity Income (DDEM) for Rick in York, Pa. Certainly more attractive than the Vanguard index, despite high expenses. High dividend-yield stocks. Broader market cap diversification, lower beta – 0.8

Fidelity Total Emerging Markets (FTEMX), also for Rick. I own it. Why? Not because it’s good but because it looks better than the alternatives in my 403(b). Broad and deep management team but, frankly, First Trust/Aberdeen Emerging Opportunity (FEO) is vastly better.

Fidelity Emerging Markets (FEMKX) for Jim in Princeton, NJ. Good news, Jim. They don’t charge much. Bad news: they haven’t really earned what they do charge. Good news: they got a new manager in October. Sammy Simnegar. Bad news: he’s not been very consistent, trades a lot, and is likely to tank tax efficiency in repositioning. Seafarer Overseas Growth & Income (SFGIX) is vastly better.

Nile Pan Africa (NAFAX) for Bruce in Easton, Pa. This fund will be getting its first Morningstar star rating this year. Ignore it! It’s a narrow fund being compared to globally-diversified ones. 75% of its money is in two countries, Nigeria and South Africa. If this were called the Nile Nigeria and South Africa Fund, would you even glance at it?

EP Asia Small Companies (EPASX), also for Bruce. Two problems, putting aside the question of whether you want to be investing in small Asian companies. First, the manager’s record at his China fund is mediocre. Second, he doesn’t actually seem to be investing in small companies. Morningstar places them at just 10% of the portfolio. I’d be more prone to trust Matthews.

I was saddened to learn that Chuck has lost the sponsor for his show. His listenership is large, engaged and growing. And his expenses are really pretty modest (uhhh … rather more than the Observer’s, rather less than the Pennysaver paper that keeps getting tossed on your porch). If any of you want to become even a part-sponsor of a fairly high-visibility show/podcast, you should drop Chuck a line. Heck, he could even help you launch your own line of podcasts.

Briefly Noted ….

Kris Jenner’s curious departure

Kris Jenner, long-time manager of T. Rowe Price Health Sciences (PRHSX) left rather abruptly on February 15^th. The fund carries a Gold rating and five stars from Morningstar (but see the discussion, above, about what that might mean) and Jenner was a finalist for Morningstar’s Domestic Manager of the Year award in 2011. A doctor by training, Price long touted Jenner’s special expertise as one source of the fund’s competitive advantage.

So, what’s up? No one who’s talking knows, and no one who knows is talking. The best coverage of his departure comes from Bloomberg, which makes four notes that many others skip:

Jenner left with two of his (presumably) top analysts from his former team of eight,
he reached out to lots of his contacts in the industry after he left,
he’s being represented by a public relations firms, Burns McClennan, Inc. and
he’s being coy as part of his p.r. campaign: “We cannot share our plans with you at this time, in part due to regulatory and reporting requirements.”

Price seems a bit offended at the breach of collegiality. “They are leaving to pursue other opportunities,” Price spokesman Brian Lewbart told The Baltimore Sun. “They didn’t share what they are.”

My guess would be that some combination of the desire to be fabulously rich and the desire to facilitate medical innovation might well lead him to found something like a biotech venture capital firm or business development company. Regardless, it seems certain that the mutual fund world has seen the last of one of its brighter stars.

FPA announces conversion to a pure no-load fund family

Effective April 1, 2013, all of the FPA Funds will be available as no-load funds. This change will affect FPA Capital (FPPTX), New Income (FPNIX), Paramount (FPRAX) and Perennial Funds (FPPFX), since these funds are currently structured as front-load mutual funds. FPA Capital Fund will remain closed to new investors. This also means that shareholders of FPA Crescent Fund (FPACX) and International Value Fund (FPIVX) will now be able to exchange into the other FPA Funds without incurring a sales charge.

And apologies to FPA: in the first version of our February issue, we misidentified the role Victor Liu will play on FPA’s International Value team. Mr. Liu, who spent eight years with Causeway Capital Management as Vice President and Research Analyst, will serve in a similar capacity as FPA and will report to Pierre Py, portfolio manager of FPA International Value Fund [FPIVX].

Morningstar tracks down experienced managers in new funds

Morningstar recently “gassed up the Premium Fund Screener tool and set it to find funds incepted since 2010 that have Analyst Ratings of Gold, Silver, or Bronze” (Young Funds, Old Pros, 02/20/2013). Setting aside the unfortunate notion of “gassing up” one’s software and the voguish “incepted,” here are editor Adam Zoll’s picks for new funds headed by highly experienced managers.

Royce Special Equity Multi-Cap (RSMCX), managed by Charlie Dreifus. Dreifus has a great long-term record with the small cap Royce Special Equity fund. This would be an all-cap application of that same discipline. I’ll note, in passing, the Special hasn’t been quite as special in the past decade as in the one preceding it and Dreifus, in his mid60s, is closer to the conclusion of his career than its launch.

PIMCO Inflation Response Multi-Asset (PZRMX) , managed by Mihir Worah who also manages PIMCO Real Return (PRTNX), Commodity Real Return Strategy (PCRAX) and Real Estate Real Return Strategy (PETAX). The fund combines five inflation-linked assets (TIPS, commodities, emerging market currencies, REITs and gold) to preserve purchasing power in times of rising inflation. PIMCO’s reputation is such that after six months of meager performance, the fund is moving toward a quarter billion in assets.

Ariel Discovery (ARDFX), managed by David Maley. As I’ve noted before, Morningstar really likes the Ariel family of funds. Maley has no prior experience in managing a mutual fund, though he has been managing the Ariel Micro-Cap Value separate accounts for a decade. So far ARDFX has pretty consistently trailed its small-value peer group as well as most of the micro-cap funds (Aegis, Bridgeway, Wasatch) that I follow.

Rebalancing matters.

In investigating the closure of Vanguard Wellington, I came across an interesting argument that the simple act of annual rebalancing can substantially boost returns. It’s reflected in the difference in the first two columns. The first column is what you’d have earned with a 65/35 portfolio purchased in 2002 and never rebalanced. Column 2 shows the effect of rebalancing. (Column 3 is the ad for the mostly-closed Wellington fund.)

How big is the difference? A $10,000 investment in 2002, split 65/35 and never again touched, would have grown to $18,500. A rebalanced portfolio, which would have triggered some additional taxes unless it was in an IRA, would end a bit over $19,000. Not bad for 10 minutes a year.

On a completely unrelated note, here’s one really striking fund in registration: NYSE Arca U.S. Equity Synthetic Reverse Convertible Index Fund? Really? Two questions: (1) what on earth is that? And (2) why does it strike anyone as “just what the doctor ordered”?

Small Wins for Investors

Vanguard has dropped the expense ratios on three funds, while boosting them on two.

Vanguard fund	Share class	Former expense ratio	Current expense ratio*
High Dividend Yield Index Fund	ETF	0.13%	0.10%
High Dividend Yield Index Fund	Investor	0.25%	0.20%
International Explorer™ Fund	Investor	0.42%	0.43%
Mid-Cap Growth Fund	Investor	0.53%	0.54%
Selected Value Fund	Investor	0.45%	0.38%

Not much else to celebrate this month.

Closings

Fidelity closed Fidelity Small Cap Value Fund (FCPVX) on March 1, 2013. This is the second of Charles L. Myers’ funds to close this year. Just one month ago they closed Fidelity Small Cap Discovery (FSCRX). Between them they have ten stars and $8 billion in assets.

Huber Small Cap Value (HUSIX and HUSEX) is getting close to closing. Huber is about the best small cap value fund still open and available to retail investors. Its returns are in the top 1% of its peer group for the past one, three and five years. It has a five-star rating from Morningstar. It’s a Lipper Leader for Total Returns, Consistency of Returns and Tax Efficiency.

“Effectively managing capacity of our strategies is one of the core tenets at Huber Capital Management, and we believe it is important in both small and large cap. Our small cap strategy has a capacity of approximately $1 billion in assets and our large cap/equity income strategy has a capacity of between $10 – $15 billion. As of 2/22/13, small cap strategy assets were over $810 mm and large cap/equity income strategy assets were over $1 billion. We are committed to closing our strategies in such a way as to maintain our ability to effectuate our process on behalf of investors who have been with us the longest.”

Vanguard has partially closed to giant funds. The $68 billion Vanguard Wellington Fund (VWELX, VWENX) and the $39 billion Vanguard Intermediate-Term Tax-Exempt Fund (VWITX) closed to new institutional and advisor accounts on February 28^th. Reportedly individual investors will be able to buy-in, but I wasn’t able to confirm that with Vanguard.

RS Global Natural Resources Fund (RSNRX) will close on March 15, 2013. It’s been consistently near the top of the performance charts, has probably improved with age and is dragging about $4.5 billion around.

Old Wine in New Bottles

Effective February 20, 2013, Frontegra SAM Global Equity Fund (FSGLX) became Frontegra RobecoSAM Global Equity Fund. That’s because the sub-adviser of this undistinguished institutional fund went from being SAM to RobecoSAM USA.

PL Growth LT Fund has been renamed PL Growth Fund and MFS took over as the sub-advisor. PL is Pacific Life and these are likely sold through the firm’s agents.

A peculiarly odd announcement from the folks at New Path Tactical Allocation Fund (GTAAX): “During the period from February 28, 2013 to April 29, 2013, the investment objective of Fund will be to seek capital appreciation and income.” With turnover well north of 400% and returns well south of “awful,” there are more sensible things for New Path to seek than a revised objective.

The board of the Touchstone funds apparently had a rollicking meeting in February, where they approved nine major changes. They approved reorganizing Touchstone Focused Equity Fund into the Touchstone Focused Fund. Touchstone Micro Cap Value Fund will, at the end of April, become Touchstone Small Cap Growth Fund. Sensibly, the strategy changes from investing in micro-caps to investing in small caps. Oddly, the objective changes from “capital appreciation” to “long-term capital growth.” The difference is, to an outsider, indiscernible.

Effective May 1, 2013, Western Asset High Income Fund (SHIAX) will be renamed Western Asset Short Duration High Income Fund. The fund’s mandate will be changed to allow investing in shorter duration high yield securities as well as adjustable-rate bank loans, among others. The sales load has been reduced to 2.25% and, in May, the expense ratio will also drop.

Off to the Dustbin of History

Guggenheim, after growing briskly through acquisitions, seems to be cleaning out some clutter. Between the end of March and beginning of May, the following funds are slated for execution:

Guggenheim Large Cap Concentrated Growth (GIQIX)
Small Cap Growth (SSCAX)
Large Cap Value Institutional (SLCIX)
Global Managed Futures Strategy (GISQX)
All-Asset Aggressive Strategy (RYGGX)
All-Asset Moderate Strategy (RYMOX)
All-Asset Conservative Strategy (RYEOX)

Guggenheim is also bumping off nine of their ETFs. They are the ABC High Dividend, MSCI EAFE Equal Weight, S&P MidCap 400 Equal Weight, S&P SmallCap 600 Equal Weight, Airline, 2x S&P 500, Inverse 2x S&P 500, Wilshire 5000 Total Market, and Wilshire 4500 Completion ETFs.

Legg Mason Capital Management All Cap (SPAAX) will merge with ClearBridge Large Cap Value (SINAX) in mid-July. Good news there, since the ClearBridge fund is a lot cheaper.

Shelton California Insured Intermediate (CATFX) is expected to cease operations, liquidate its assets and distribute the proceeds by mid-March. The fund evolved from “mediocre” to “bad” over the years and had only $4 million in assets.

The Board of Trustees of Sterling Capital approved the liquidation of the $7 million Sterling Capital Strategic Allocation Equity (BCAAX) at the end of April.

Back to the aforementioned Touchstone board meeting. The board approved one merger and a series of executions. The merge occurs when Touchstone Short Duration Fixed Income (TSDYX), a no-load, will merge into Touchstone Ultra Short Duration Fixed Income (TSDAX), a low-load one. The dead walking are:

Touchstone Global Equity (TGEAX)
Touchstone Large Cap Relative Value (TRVAX)
Touchstone Market Neutral Equity (TSEAX) – more “reverse” than “neutral”
Touchstone International Equity (TIEAX)
Touchstone Emerging Growth (TGFAX)
Touchstone U.S. Long/Short (TUSAX). This used to be the Old Mutual Analytic U.S. Long/Short which, prior to 2006, didn’t short stocks.

The “walking” part ends on or about March 26, 2013.

In Closing . . .

Here’s an unexpectedly important announcement: we are not spam! You can tell because spam is pink, glisteny goodness. We are not. I mention that because there’s a good chance that if you signed up to be notified about our monthly update or our conference calls, and haven’t been receiving our mail, it’s because we’ve been trapped by your spam filter. Please check your spam folder. If you see us there, just click on the “not spam” icon and things will improve.

It’s also the case that if you want to stop receiving our monthly emails, you should use the “unsubscribe” button and we’ll go away. If you click on the “that’s spam” button instead (two or three people a month do that, for reasons unclear to me), it makes Mail Chimp anxious. Please don’t.

In April, the Observer celebrates its second anniversary. It wouldn’t be worthwhile without your readership and your thoughtful feedback. And it wouldn’t be possible without your support, either directly or by using our Amazon link. The Amazon system is amazingly simple and painless. If you set our link as your default bookmark for Amazon (or, as I do, use Amazon as your homepage), the Observer receives a rebate from Amazon equivalent to 6% or more of the amount of your purchase. It doesn’t change your cost by a penny since the money comes from Amazon’s marketing budget. While 6% of the $11 you’ll pay for Bill Bernstein’s The Investor’s Manifesto (or 6% of a pound of coffee beans or Little League bat) seems trivial, it adds up to about 75% of our income. Thanks for both!

In April, we’re going to look at closed-end s (CEFs) as an alternative to “regular” (or open-ended) mutual s and ETFs. We’ve had a chance to talk with some folks whose professional work centered on trading CEFs. We’ll talk through Morningstar’s recent CEF studies, a bit of what the academic literature says and the insights of the folks we’ve interviewed, and we’ll provide a couple intriguing possibilities. That will be on top of – not in place of – our regular features.

See you then!

February 1, 2013

Yep, January’s been good. Scary-good. There are several dozen funds that clocked double-digit gains, including several scary-bad ones (Birmiwal Oasis? Legg Mason Capital Management Opportunity C?) but no great funds. So if your portfolio is up six or seven or eight percent so far in 2013, smile and then listen to Han Solo’s call: “Great, kid. Don’t get cocky.” If, like mine, yours is up just two or three percent so far in 2013, smile anyway and say, “you know, Bill, Dan, Jeremy and I were discussing that very issue over coffee last week. I mentioned your portfolio and two of the three just turned pale. The other one snickered and texted something to his trading desk.”

American Funds: The Past Ten Years

In October we launched “The Last Ten,” a monthly series, running between then and February, looking at the strategies and funds launched by the Big Five fund companies (Fido, Vanguard, T Rowe, American and PIMCO) in the last decade.

Here are our findings so far:

Fidelity, once fabled for the predictable success of its new fund launches, has created no compelling new investment option in a decade.

T. Rowe Price continues to deliver on its promises. Investing with Price is the equivalent of putting a strong singles-hitter on a baseball team; it’s a bet that you’ll win with consistency and effort, rather than the occasional spectacular play.

PIMCO has utterly crushed the competition, both in the thoughtfulness of their portfolios and in their performance.

Vanguard’s launches in the past decade are mostly undistinguished, in the sense that they incorporate neither unusual combinations of assets (no “emerging markets balanced” or “global infrastructure” here) nor innovative responses to changing market conditions (as with “real return” or “inflation-tuned” ones). Nonetheless, nearly two-thirds of Vanguard’s new funds earned four or five star ratings from Morningstar, reflecting the compounding advantage of Vanguard’s commitment to low costs and low turnover.

We’ve saved the most curious, and most disappointing, for last. American Funds has always been a sort of benevolent behemoth. They’re old (1931) and massive. They manage more than $900 billion in investments and over 50 million shareholder accounts, with $300 billion in non-U.S. assets.

It’s hard to know quite what to make of American. On the one hand, they’re an asset-sucking machine. They have 34 funds over $1 billion in assets, 19 funds with over $10 billion each in assets, and two over $100 billion. In order to maximize their take, each fund is sold in 16 – 18 separate packages.

By way of example, American Funds American Balanced is sold in 18 packages and has 18 ticker symbols: six flavors of 529-plan funds, six flavors of retirement plan accounts, the F-1 and F-2 accounts, the garden-variety A, B and C and a load-waived possibility. Which plan you qualify for makes a huge difference. The five-year record for American Balanced R5 places it in the top 10% of its peer group but American Balanced 529B only makes it into the top 40%.

On the other hand, they’re very conservative and generally quite successful. Every American fund is also a fund-of-funds; it has multiple managers … uhh, “portfolio counselors,” each of whom manages just one sleeve of the total portfolio. In general, costs are below average to low, risk scores are below average to low and their Morningstar ratings are way above average.

	Expected Value	Observed value
American Funds, Five Star Funds, overall	43	38
American Funds, Four and Five Star Funds, overall	139	246
Five Star funds, launched since 9/2002	1	0
Four and Five Star funds, launched since 9/2002	4	1

In the past decade, the firm has launched almost no new funds and has made no evident innovations in strategy or product.

It’s The Firm that Time Forgot

Over those 10 years, American Funds launched 31 funds. Sort of. In reality, they repackaged existing American Funds into 10 new target-date funds. Then they repackaged existing American Funds into 16 new funds for college savings plans. After that, they repackaged existing American Funds into new tax-advantaged bond funds. In the final analysis, their new fund launches are three niche bond funds: two muni and one short-term.

The Repackaged College Funds
Balanced Port 529	—	Moderate Allocation	513
College 2015 529	—	Conservative Allocation	77
College 2018 529	—	Conservative Allocation	86
College 2021 529	—	Moderate Allocation	78
College 2024 529	—	Moderate Allocation	62
College 2027 529	—	Aggressive Allocation	44
College 2030 529	—	Aggressive Allocation	33
College Enrollment 529	—	Intermediate-Term Bond	29
Global Balanced 529	—	World Allocation	3,508
Global Growth Port 529	—	World Stock	139
Growth & Income 529	—	Aggressive Allocation	613
Growth Portfolio 529	—	World Stock	254
Income Portfolio 529	—	Conservative Allocation	596
International Growth & Income 529	★★★★	Foreign Large Blend	5,542
Mortgage 529	—	Intermediate-Term Bond	730
The Repackaged Target-Date Funds
Target Date Ret 2010	★	Target Date	1,028
Target Date Ret 2015	★★	Target Date	1,629
Target Date Ret 2020	★★	Target Date	2,376
Target Date Ret 2025	★★	Target Date	2,071
Target Date Ret 2030	★★★	Target Date	2,065
Target Date Ret 2035	★★	Target Date	1,416
Target Date Ret 2040	★★★	Target Date	1,264
Target Date Ret 2045	★★	Target Date	679
Target Date Ret 2050	★★★	Target Date	622
Target Date Ret 2055	—	Target-Date	119
The Repackaged Funds-of-Bond-Funds
Preservation Portfolio	—	Intermediate-Term Bond	368
Tax-Advantaged Income Portfolio	—	Conservative Allocation	113
Tax-Exempt Preservation Portfolio	—	National Muni Bond	164
The Actual New Funds
Short-Term Tax-Exempt	★ ★	National Muni Bond	719
Short Term Bond Fund of America	★	Short-Term Bond	4,513
Tax-Exempt Fund	—	New York Muni Bond	134

A huge firm. Ten tumultuous years. And they manage to image three pedestrian bond funds, none of which they execute with any particular panache.

Not to sound dire, but phrases like “rearranging the deck chairs” and “The Titanic was huge and famous, too” come unbidden to mind.

Morningstar, Part One: Rating the Rater

Morningstar’s “analyst ratings” have come in for a fair amount of criticism lately. Chuck Jaffe notes that, like the stock analysts of yore, Morningstar seems never to have met a fund that it doesn’t like. “The problem,” Jaffe writes, “is the firm’s analysts like nearly two-thirds of the funds they review, while just 5% of the rated funds get negative marks. That’s less fund watchdog, and more fund lap dog” (“The Fund Industry’s Worst Offenders of 2012,” 12/17/12). Morningstar, he observes, “howls at that criticism.”

The gist of Morningstar’s response is this: “we only rate the funds that matter, and thousands of these flea specks will receive neither our attention nor the average investor’s.” Laura Lallos, a senior mutual-fund analyst for Morningstar, puts it rather more eloquently. “We focus on large funds and interesting funds. That is, we cover large funds whether they are ‘interesting’ or not, because there is a wide audience of investors who want to know about them. We also cover smaller funds that we find interesting and well-managed, because we believe they are worth bringing to our subscribers’ attention.”

More recently Javier Espinoza of The Wall Street Journal noted that the different firms’ rating methods create dramatically different thresholds for being recognized as excellent (“The Ratings Game,” 01/04/13). Like Mr. Jaffe, he notes the relative lack of negative judgments by Morningstar: only 235 of 4299 ratings – about 5.5% – are negative.

Since the Observer’s universe centers on funds too small or too new to be worthy of Morningstar’s attention, we were pleased at Morningstar’s avowed intent to cover “smaller funds that we find interesting and well-managed.” A quick check of Morningstar’s database shows:

2390 funds with under $100 million in assets.

41 funds that qualify as “worthy of our subscribers’ attention.” It could be read as good news that Morningstar thinks 1.7% of small funds are worth looking at. One small problem. Of the 41 funds they rate, 34 are target-date or retirement income funds and many of those target-date offerings are actually funds-of-funds. Which leaves …

7 actual funds that qualify for attention. That would be one-quarter of one percent of small funds. One quarter of one percent. Uh-huh.

But that also means that the funds which survive Morningstar’s intense scrutiny and institutional skepticism of small funds must be SPLENDID! And so, here they are:

Ariel Discovery Investor (ARDFX), rated Bronze. This is a small cap value fund that we considered profiling shortly after launch, but where we couldn’t discern any compelling argument for it. On whole, Morningstar rather likes the Ariel funds despite the fact that they don’t perform very well. Five of the six Ariel funds have trailed their peers since inception and the sixth, the flagship Ariel Fund (ARGFX) has trailed the pack in six of the past 10 years. That said, they have an otherwise-attractive long-term, low-turnover value orientation.

Matthews China Dividend Investor (MCDFX), rated Bronze. Also five stars, top 1% performer, low risk, low turnover, with four of five “positive” pillars and the sponsorship of the industry’s leading Asia specialist. I guess I’d think of this as rather more than Bronze-y but Matthews is one of the fund companies toward which I have a strong bias.

TCW International Small Cap (TGICX), rated Bronze also only one of the five “pillars” of the rating is actually positive. The endorsement is based on the manager’s record at Oppenheimer International Small Company (OSMAX). Curiously, TGICX turns its portfolio at three times the rate of OSMAX and has far lagged it since launch.

The Collar (COLLX), rated Bronze, uses derivatives to offset the stock market’s volatility. In three years it has twice made 3% and once lost 3%. The underlying strategy, executed in separate accounts, made a bit over 4% between 2005-2010. Low-risk, low-return and different from – if not demonstrably better than – other options-based funds.

Quaker Akros Absolute Return (AAARFX) rated Neutral. Well … this fund does have exceedingly low risk, about one-third of the beta of the average long/short fund. On the other hand, over the eight years between inception and today, it managed to turn a $10,000 investment into a $10,250 portfolio. Right. Invest $10,000 and make a cool $30/year. Your account would have peaked in September 2009 (at $11,500) and have drifted down since then.

Quaker Event Arbitrage A (QEAAX), rated Neutral. Give or take the sales load, this is a really nice little fund that the Observer profiled back when it was the no-load Pennsylvania Avenue Event Driven Fund (PAEDX). Same manager, same discipline, with a sales force attached now.

Van Eck Multi-Manager Alternatives A (VMAAX), which strikes me as the most baffling pick of the bunch. It has a 5.75% load, 2.84% expense ratio, 250% turnover (stop me when I get to the part that would attract you), and 31 managers representing 14 different sub-advisers. Because Van Eck cans managers pretty regularly, there are also 20 former managers of the fund. Morningstar rates the fund as “Neutral” with the sole positive pillar being “people.” It’s not clear whether Morningstar was endorsing the fund on the dozens already fired, the dozens recently hired or the underlying principle of regularly firing people (see: Romney, Mitt, “I like firing people”).

I’m afraid that on a Splendid-o-meter, this turns out to be one Splendid (Matthews), one Splendid-ish (Quaker Event Driven), four Meh and one utterly baffling (Van Ick).

Of 57 small, five-star funds, only one (Matthews) warrants attention? Softies that we are, the Observer has chosen to profile seven of those 57 and a bunch of non-starred funds. We’re actually pretty sure that they do warrant rather more attention – Morningstar’s and investors’ – than they’ve received. Those seven are:

Huber Small Cap Value (HUSIX)

Marathon Value (MVPFX)

Pinnacle Value (PVFIX)

Stewart Capital Mid Cap (SCMFX)

The Cook and Bynum Fund (COBYX)

Tilson Dividend (TILDX)

Tributary Balanced (FOBAX)

Introducing: The Elevator Talk

Being the manager of a small fund can be incredibly frustrating. You’re likely very bright. You have a long record at other funds or in other vehicles. You might well have performed brilliantly for a long time: top 1% for the trailing year, three years and five years, for example. (There are about 10 tiny funds with that distinction.) And you still can’t get anybody to notice you.

Dang.

The Observer helps, both because we’ve got 11,000 or so regular readers and an interest in small and new funds. Sadly, there’s a limit to how many funds we can profile; likely somewhere around 20 a year. I’m frequently approached by managers, asking if we’d consider profiling their funds. When we say “no,” it’s as often because of our resource limits as of their records.

Frustration gave rise to an experimental new feature: The Elevator Talk. We’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

Elevator Talk #1: Tom Kerr, Rocky Peak Small Cap Value (RPCSX)

Mr. Kerr manages the Rocky Peak Small Cap Value Fund (RPCSX), which launched on April 2, 2012. He co-managed RCB’s Small Cap Value strategy and the CNI Charter RCB Small Cap Value Fund (formerly RCBAX, now CSCSX) fund. Tom offers these 200 words on why folks should check in:

Although this is a new Fund, I have a 14-years solid track record managing small cap value strategies at a prior firm and fund. One of the themes of this new Fund is improving on the investment processes I helped develop. I believe we can improve performance by correcting mistakes that my former colleagues and I made such as not making general or tactical stock market calls, or not holding overvalued stocks just because they are perceived to be great quality companies.

The Fund’s valuation process of picking undervalued stocks is not dogmatic with a single approach, but encompasses multivariate valuation tools including discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics. Taken together those don’t give up a single “right number” but range of plausible valuations, for which our shorthand is “the Circle of Value.”

As a small operation with one PM, two intern analysts and one administrative assistant, I can maintain patience and diligence in the investment process and not be influenced by corporate politics, investment committee bureaucracy and water cooler distractions.

The Fund’s goal is to be competitive in up markets but significantly outperform in down markets, not by holding high levels of cash (i.e. making a market call), but by carefully buying stocks selling at a discount to intrinsic value and employing a reasonable margin of safety.

The fund’s minimum initial investment is $10,000, reduced to $1,000 for IRAs and accounts set up with AIPs. The fund’s website is Rocky Peak Funds . Tom’s most-recent discussion of the fund appears in his September 2012 Semi-Annual Report. If you meet him, you might ask about the story behind the “rocky peak” name.

Morningstar, Part Two: “Speaking of Old Softies”

There are, in addition, 123 beached whales: funds with more than a billion in assets that have trailed their peer groups for the past three, five and ten years. Of those, 29 earn ratings in the Bronze to Gold range, 31 are Neutral and just six warrant Negative ratings. So, being large and consistently bad makes you five times more likely to earn a positive rating than a negative one.

Hmmm … what about being very large and consistently wretched? There are 25 funds with more than two billion in assets that have trailed at least two-thirds of their peers for the past three, five and ten years. Of those, seven earn Bronze or Silver ratings while just three are branded with the Negative. So, large and wretched still makes you twice as likely to earn Morningstar’s approval as their disapproval.

What are huge and stinkin’ like Limburger cheese left to ripen in the August sun? Say $5 billion and trailing 75% of your peers? There are five such funds, and not a Negative in sight.

Morningstar’s Good Work

Picking on Morningstar is both fun and easy, especially if you don’t have the obligation to come up with anything better on your own. It’s sad that much of the criticism, as when pundits claim that Morningstar’s system has no predictive validity (check our “Best of the Web” discussion: Morningstar has better research to substantiate their claims than any other publicly accessible system), is uninformed blather. I’d like to highlight two particularly useful pieces that Morningstar released this month.

Their annual “Buy the Unloved” recommendations were released on January 24. This is an old and alluring system that depends on the predictable stupidity of the masses in order to make money. At base, their recommendation is to buy in 2013 funds in the three categories that saw the greatest investor flight in 2012. Conversely, avoiding the sector that others have rushed to, is wise. Katie Rushkewicz Reichart reports that

From 1993 through 2012, the “unloved” strategy gained 8.4% annualized to the “loved” strategy’s 5.1% annualized. The unloved strategy has also beaten the MSCI World Index’s 6.9% annualized gain and has slightly beat the Morningstar US Market Index’s 8.3% return.

So, where should you be buying? Large cap U.S. stocks of all flavors. “The most unloved equity categories are also the most unpopular overall: large growth (outflows of $39.5 billion), large value (outflows of $16 billion), and large blend (outflows of $14.4 billion).”

A second thought-provoking feature offered a comparison that I’ve never before encountered. Within each broad fund category, Morningstar tracked the average performance of mutual funds in comparison to ETFs and closed-end funds. In terms of raw performance, CEFs were generally superior to both mutual funds and ETFs. That makes some sense, at least in rising markets, because CEFs make far greater use of leverage than do other products. The interesting part was that CEFs maintained their dominance even when the timeframe included part of the 2007-09 meltdown (when leverage was deadly) and even when risk-adjusted, rather than raw, returns are used.

There’s a lot of data in their report, entitled There’s More to Fund Investing Than Mutual Funds (01/29/13), and I’ll try to sort through more of it in the month ahead.

Matthews Asia Strategic Income Conference Call

We spent an hour on Tuesday, January 22, talking with Teresa Kong of Matthews Asia Strategic Income. The fund is about 14 months old, has about $40 million in assets, returned 13.6% in 2012 and 11.95% since launch (through Dec. 31, 2012).

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

The MAINX conference call

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

Quick highlights:

this is designed to offer the highest risk-adjusted returns of any of the Matthews funds. In this case “risk-adjusted” is measured by the fund’s Sharpe ratio. Since launch, its Sharpe ratio has been around 2.0 which would be hard for any fixed-income fund to maintain indefinitely. They’ve pretty comfortable that they can maintain a Sharpe of 1.0 or so.
the manager describes the US bond market, and most especially Treasuries, as offering “asymmetric risk” over the intermediate term. Translation: more downside risk than upside opportunity. She does not embrace the term “bubble” because that implies an explosive risk (i.e., “popping”) where she imagines more like the slow leak of air out of a balloon. (Thanks for Joe N for raising the issue.)
given some value in having a fixed income component of one’s portfolio, Asian fixed-income offers two unique advantages in uncertain times. First, the fundamentals of the Asian fixed-income market – measures of underlying economic growth, market evolution, ability to pay and so on – are very strong. Second, Asian markets have a low beta relative to US intermediate-term Treasuries. If, for example, the 5-year Treasury declines 1% in value, U.S. investment grade debt will decline 0.7%, the global aggregate index 0.5% and Asia fixed-income around 0.25%.
MAINX is one of the few funds to have positions in both dollar-denominated and local currency Asian debt (and, of course, equities as well). She argues that the dollar-denominated debt offers downside protection in the case of a market disruption since the panicked “flight to quality” tends to benefit Treasuries and linked instruments while local currency debt might have more upside in “normal” markets. (Jeff Wang’s question, I believe.)
in equities, Matthews looks for stocks with “bond-like characteristics.” They target markets where the dividend yield in the stock market exceeds the yield on local 10-year bonds. Taiwan is an example. Within such markets, they look for high yielding, low beta stocks and tend to initiate stock positions about one-third the size of their initial bond positions. A new bond might come in at 200 basis points while a new stock might be 75. (Thanks to Dean for raising the equities question and Charles for noticing the lack of countries such as Taiwan in the portfolio.)
most competitors don’t have the depth of expertise necessary to maximize their returns in Asia. Returns are driven by three factors: currency, credit and interest rates. Each country has separate financial regimes. There is, as a result, a daunting lot to learn. That will lead most firms to simply focus on the largest markets and issuers. Matthews has a depth of expertise that allows them to do a better job of dissecting markets and of allocating resources to the most profitable part of the capital structure (for example, they’re open to buying Taiwanese equity but find its debt market to be fundamentally unattractive). There was an interesting moment when Teresa, former head of BlackRock’s emerging markets fixed-income operations, mused, “even a BlackRock, big as we were, I often felt we were a mile wide and [pause] … not as deep as I would have preferred.” The classic end of the phrase, of course, is “and an inch deep.” That’s significant since BlackRock has over 10,000 professionals and about $1.4 trillion in assets under management.

AndyJ, one of the members of the Observer’s discussion board and a participant in the call, adds a seventh highlight:

TK said explicitly that they have no neutral position or target bands of allocation for anything, i.e., currency exposure, sovereign vs. corporate, or geography. They try to get the biggest bang for the level of risk across the portfolio as a whole, with as much “price stability” (she said that a couple of times) as they can muster.

Matthews Asia Strategic Income, Take Two

One of the neat things about writing for you folks is the opportunity to meet all sorts of astonishing people. One of them is Charles Boccadoro, an active member of the Observer’s discussion community. Charles is renowned for the care he takes in pulling together data, often quite powerful data, about funds and their competitors. After he wrote an analysis of MAINX’s competitors, Rick Brooks, another member of the board, encouraged me to share Charles’s work with a broader audience. And so I shall.

By way of background, Charles describes himself as

Strictly amateur investor. Recently retired aerospace engineer. Graduated MIT in 1981. Investing actively in mutual funds since 2002. Was heavy FAIRX when market headed south in 2008, but fortunately held tight through to recovery. Started reading FundAlarm in 2007 and have followed MFO since inception in May 2011. Tries to hold fewest funds in portfolio, but many good recommendations by MFO community make in nearly impossible (e.g., bought MAINX after recent teleconference). Live in Central Coast California.

Geez, the dude’s an actual rocket scientist.

After carefully considering eight funds which focus on Asian fixed-income, Charles concludes there are …

Few Alternatives to MAINX

Matthews Asia Strategic Income Fund (MAINX) is a unique offering for US investors. While Morningstar identifies many emerging market and world bond funds in the fixed income category, only a handful truly focus on Asia. From its prospectus:

Under normal market conditions, the Strategic Income Fund seeks to achieve its investment objective by investing at least 80% of its total net assets…in the Asia region. ASIA: Consists of all countries and markets in Asia, including developed, emerging, and frontier countries and markets in the Asian region.

Fund manager Teresa Kong references two benchmarks: HSBC Asian Local Bond Index (ALBI) and J.P. Morgan Asia Credit Index (JACI), which cover ten Asian countries, including South Korea, Hong Kong, India, Singapore, Taiwan, Malaysia, Thailand, Philippines, Indonesia and China. Together with Japan, these eleven countries typically constitute the Asia region. Recent portfolio holdings include Sri Lanki and Australia, but the latter is actually defined as Asia Pacific and falls into the 20% portfolio allocation allowed to be outside Asia proper.

As shown in following table, the twelve Asian countries represented in the MAINX portfolio are mostly republics established since WWII and they have produced some of the world’s great companies, like Samsung and Toyota. Combined, they have ten times the population of the United States, greater overall GDP, 5.1% GDP annual growth (6.3% ex-Japan) or more than twice US growth, and less than one-third the external debt. (Hong Kong is an exception here, but presumably much of its external debt is attributable to its role as the region’s global financial center.)

Very few fixed income fund portfolios match Matthews MAINX (or MINCX, its institutional equivalent), as summarized below. None of these alternatives hold stocks.

Aberdeen Asian Bond Fund CSBAX and WisdomTree ETF Asian Local Debt ALD cover the most similar geographic region with debt held in local currency, but both hold more government than corporate debt. CSBAX recently dropped “Institutional” from its name and stood-up investor class offerings early last year. ALD maintains a two-tier allocation across a dozen Asian countries, ex Japan, monitoring exposure and rebalancing periodically. Both CSBAX and ALD have about $500M in assets. ALD trades at fairly healthy volumes with tight bid/ask spreads. WisdomTree offers a similar ETF in Emerging Market Local Debt ELD, which comprises additional countries, like Russia and Mexico. It has been quite successful garnering $1.7B in assets since inception in 2010. Powershares Chinese Yuan Dim Sum Bond ETF DSUM (cute) and similar Guggenheim Yuan Bond ETF RMB (short for Renminbi, the legal tender in mainland China, ex Hong Kong) give US investors access to the Yuan-denominated bond market. The fledgling RMB, however, trades at terribly low volumes, often yielding 1-2% premiums/discounts.

A look at life-time fund performance, ranked by highest APR relative to 3-month TBill:

Matthews Strategic Income tops the list, though of course it is a young fund. Still, it maintains low down side volatility DSDEV and draw down (measured by Ulcer Index UI). Most of the offerings here are young. Legg Mason Western Asset Global Government Bond (WAFIX) is the oldest; however, last year it too changed its name, from Western Asset Non-U.S. Opportunity Bond Fund, with a change in investment strategy and benchmark.

Here’s look at relative time frame, since MAINX inception, for all funds listed:

Charles, 25 January 2013

February’s Conference Call: Seafarer Overseas Growth & Income

As promised, we’re continuing our moderated conference calls through the winter. You should consider joining in. Here’s the story:

Each call lasts about an hour
About one third of the call is devoted to the manager’s explanation of their fund’s genesis and strategy, about one third is a Q&A that I lead, and about one third is Q&A between our callers and the manager.
The call is, for you, free. Your line is muted during the first two parts of the call (so you can feel free to shout at the danged cat or whatever) and you get to join the question queue during the last third by pressing the star key.

Our next conference call features Andrew Foster, manager of Seafarer Overseas Growth and Income (SFGIX). It’s Tuesday, February 19, 7:00 – 8:00 p.m., EST.

Why you might want to join the call?

Put bluntly: you can’t afford another lost decade. GMO is predicting average annual real returns for U.S. large cap stocks of 0.1% for the next 5-7 years. The strength of the January 2013 rally is likely to push GMO’s projections into the red. Real return on US bonds is projected to be negative, about -1.1%. Overseas looks better and the emerging markets – source of the majority of the global economy’s growth over the next decade – look best of all.

The problem is that these markets have been so volatile that few investors have actually profited as richly as they might by investing in them. The average e.m. fund dropped 55% in 2008, rose 75% in 2009, then alternated between gaining and losing 18% per year before 2010 – 2012. That sort of volatility induces self-destructive behavior on most folk’s part; over the past five years (through 12/30/12), Vanguard’s Emerging Market Stock Index fund lost 1% per year but the average investor in that fund lost 6% per year. Why? Panicked selling in the midst of crashes, panicked buying at the height of upbursts.

In emerging markets investing especially, you benefit from having an experienced manager who is as aware of risks as of opportunities. For my money (and he has some small pile of my money), no one is better at it than Andrew Foster of Seafarer. Andrew had a splendid record as manager of Matthews Asian Growth and Income (MACSX), which for most of his watch was the least risky, most profitable way to invest in Asian equities. Andrew now runs Seafarer, where he runs an Asia-centered portfolio which has the opportunity to diversify into other regions of the world. He’ll join us immediately after the conclusion of Seafarer’s splendid first year of operation to talk about the fund and emerging markets as an opportunity set, and he’ll be glad to take your questions as well.

How can you join in?

Click on the “register” button and you’ll be taken to Chorus Call’s site, where you’ll get a toll free number and a PIN number to join us. On the day of the call, I’ll send a reminder to everyone who has registered.

Would an additional heads up help?

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

Bonus Time! RiverNorth Explains Dynamic Buy-Write

A couple months ago we profiled RiverNorth Dynamic Buy-Write Fund (RNBWX), which uses an options strategy to pursue returns in excess of the stock market’s with only a third of the market’s volatility. RiverNorth is offering a webcast about the fund and its strategy for interested parties. It will be hosted by Eric Metz, RNBWX’s manager and a guy with a distinguished record in options investing. He’s entitled the webcast “Harnessing Volatility.” The webcast will be Wednesday, February 20th, 2013 3:15pm CST – 4:15pm CST.

The call will feature:

Overview of volatility
Growth of options and the use of options strategies in a portfolio
How volatility and options strategies pertain to the RiverNorth Dynamic Buy-Write Fund (RNBWX)
Advantages of viewing the world with volatility in mind

To register, navigate over to www.rivernorthfunds.com and click on the “Events” link.

Cook & Bynum On-Deck

Our March conference call will occur unusually early in the month, so I wanted to give you advance word of it now. On Tuesday, March 5, from 7:00 – 8:00 CST, we’ll have a chance to talk with Richard Cook and Dow Bynum, of The Cook and Bynum Fund (COBYX). The guys run an ultra-concentrated portfolio which, over the past three years, has produced returns modestly higher than the stock market’s with less than half of the volatility.

You’d imagine that a portfolio with just seven stocks would be wildly erratic. It isn’t. Our bottom line on our profile of the fund: “It’s working. Cook and Bynum might well be among the best. They’re young. The fund is small and nimble. Their discipline makes great sense. It’s not magic, but it has been very, very good and offers an intriguing alternative for investors concerned by lockstep correlations and watered-down portfolios.”

How can you join in?

Observer Fund Profiles

Artisan Global Equity (ARTHX): after the January 11 departure of lead manager Barry Dargan, the argument for ARTHX is different but remains compelling.

Matthews Asia Strategic Income (MAINX): the events of 2012 and early 2013 make an already-intriguing fund much more interesting.

PIMCO Short Asset Investment, “D” shares (PAIUX): Bill Gross trusts this manager and this strategy to management tens of billions in cash for his funds. Do you suppose he might be good enough to warrant your attention to?

Whitebox Long Short Equity, Investor shares (WBLSX): yes, I know I promised a profile of Whitebox for this month. This converted hedge fund has two fundamentally attractive attributes (crushing its competition and enormous amounts of insider ownership), but I’m still working on the answer to two questions. Once I get those, I’ll share a profile. But not yet.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble.

Funds in registration this month won’t be available for sale until, typically, the beginning of March 2013. We found a dozen funds in the pipeline, notably:

Artisan Global Small Cap Fund (ARTWX) will be Artisan’s fourth overly-global fund and also the fourth for Mark Yockey and his team. They’re looking pursue maximum long-term capital growth by investing in a global portfolio of small-cap growth companies. . The plan is to apply the same investing discipline here as they do with Artisan International Small Cap (ARTJX) and their other funds. The investment minimum is $1000 and expenses are capped at 1.5%.

Driehaus Event Driven Fund seeks to provide positive returns over full-market cycles. Generally these funds seek arbitrage gains from events such as bankruptcies, mergers, acquisitions, refinancings, earnings surprises and regulatory rulings. They intend to have a proscribed volatility target for the fund, but have not yet released it. They anticipate a concentrated portfolio and turnover of 100-200%. K.C. Nelson, Portfolio Manager for Driehaus Active Income (LCMAX) and Driehaus Select Credit (DRSLX), will manage the fund. The minimum initial investment is $10,000, reduced to $2000 for IRAs. Expenses not yet set.

Details on these funds and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

On a related note, we also tracked down 20 fund manager changes, including a couple high profile departures.

Launch Alert: Eaton Vance Bond

On January 31, Eaton Vance launched Eaton Vance Bond Fund (EVBAX), a multi-sector bond fund that can invest in U.S. investment grade and high yield bonds, floating-rate bank loans, non-U.S. sovereign and corporate debt, convertible securities and preferred stocks. Why should you care? Its lead manager is Kathleen Gaffney, once the investing partner of and heir apparent to Dan Fuss. Fuss and Gaffney managed Loomis Sayles Bond (LSBRX), a multisector fund strikingly similar to the new fund, to an annualized return of 10.6% over their last decade together. That beat 94% of their peers, as well as beating the long-term record of the stock market. “A” class shares carry a 4.75% front load, expenses after waivers of 0.95% and a minimum initial investment of $1000.

Launch Alert: Longleaf Global Opens

On Jan. 2, Southeastern Asset Management rolled out its first U.S. open-end fund since 1998 and its first global mutual fund ever available in the United States. The new fund is Longleaf Global (LLGLX), a concentrated fund that invests at least 40% of its assets outside the U.S. A version of the strategy already is available in Europe.

Mason Hawkins and Staley Cates, who received Morningstar’s Domestic-Stock Fund Manager of the Year award in 2006, manage the fund. Like other Longleaf funds, the portfolio targets holding between 15 and 25 companies. The fund will have an unconstrained portfolio that invests in companies of all market capitalizations and geographies. Its expense ratio is capped at 1.65%.

Sibling funds Longleaf Partners (LLPFX) and Longleaf Partners Small-Cap (LLSCX) receive Morningstar Analyst Ratings of Gold while Longleaf Partners International (LLINX) is rated Bronze.

Launch Just-A-Second-There: Longleaf Global Closes

After just 18 trading days, Longleaf Global closed to new investors. The fund drew in a manageable $28 million and then couldn’t manage it. On January 28, the fund closed without warning and without explanation. The fund’s phone reps said they had “no idea of why” and the fund’s website contained a single line noting the closure.

A subsequent mailing to the fund’s investors explained that there simply was nowhere immediately worth investing. The $16 trillion U.S. stock market didn’t contain $30 million in investible good ideas. With the portfolio 50% in cash, their judgment was that the market offered no more than about $15 million in worthwhile opportunities.

Here’s the official text:

We are temporarily closing Longleaf Partners Global Fund to new investors. Although the Fund was only launched on December 31, 2012, our Governing Principles guide our decision to close until we can invest the large cash position currently in the Fund. Since October when we began planning to open the Global Fund, stock prices have risen rapidly, leaving few good businesses that meet our 60% of appraisal discount. Limited qualifying investments, combined with relatively quick inflows from shareholders, have left us with more cash than we can invest. Remaining open would dilute existing investors by further raising our cash level.

Our Governing Principle, “We will consider closing to new investors if closing would benefit existing clients,” has caused us to close the three other Longleaf Funds at various times over the past 20 years. When investment opportunities enable us to put the Fund’s cash to work, and additional inflows will benefit our partners, we will re-open the Global Fund to new investors.

Artisan Gets Active

One of my favorite fund advisers are the Artisan Partners. I’ve had modest investments with the Artisan Funds since 1996 when I owned Artisan Small Cap (ARTSX) and Artisan International (ARTIX). I sold my Small Cap stake when Small Cap Value (ARTVX) became available and International when International Value (ARTKX) opened, but I’ve stayed with Artisan throughout. The Observer has profiles of five Artisan funds.

Why? Three reasons. (1) They do consistently good work. (2) Their funds build upon their teams’ expertise. And (3) their policies – from low minimums to the willingness to close funds – are shareholder friendly.

And they’ve had a busy month.

Two of Artisan’s management teams were finalists for Morningstar’s international fund manager of the year honors: David Samra and Daniel O’Keefe of Artisan International Value (ARTKX) and Artisan Global Value (ARTGX) and the team headed by Mark Yockey of Artisan International (ARTIX) and Artisan International Small Cap (ARTJX).

In a rarity, one of the managers left Artisan. Barry Dargan, formerly of MFS International and lead manager of Artisan Global Equity (ARTHX), left the firm following a year-end conversation with Yockey and others. ARTHX was managed by a team led by Mr. Dargan and it employed a consistent, well-articulated discipline. The fund will continue being managed by the same team with the same discipline, though Mr. Yockey will now take the lead.

Artisan has filed to launch Artisan Global Small Cap Fund (ARTWX), which will be managed by Mark Yockey, Charles-Henri Hamker and David Geisler. Yockey and Hamker co-manage other funds together and Mr. Geisler has been promoted to co-manager in recognition of his excellent work as a senior analyst on the team. Artisan argues that their teams have managed such smooth transitions from primarily domestic or primary international charges into global funds because all of their investing has a global focus. The international managers need to know the U.S. market inside and out since, for example, they can’t decide whether Fiat is a “buy” without knowing whether Ford is a better buy. We’ll offer more details on the fund when it comes to market.

Briefly Noted …

FPA has announced the addition of a new analyst, Victor Liu, for FPA International Value (FPIVX). The fund started with two managers, Eric Bokota and Pierre Py. Mr. Bokota left suddenly for personal reasons and FPA has been moving carefully to find a successor for him. Mr. Py expects Victor Liu to become that successor. Prior to joining FPA, Mr. Liu was a Vice President and Research Analyst for a highly-respected firm, Causeway Capital Management LLC, from 2005 until 2013. The fund posted top 2% results in 2012 and investors have reason to be optimistic about the year ahead.

Rivers seem to be all the rage in the mutual fund world. In addition to River Road Asset Management which sub-advises several ASTON funds, there’s River Oak Discovery (RIVSX) and the Riverbridge, RiverFront (note the trendy mid-word capitalization), RiverNorth, RiverPark and RiverSource fund families. Equally-common bits of geography seem far less popular. Hills (Beech, Cavanal, Diamond), lakes (Great and Partners), mounts (Lucas), and peaks (Aquila, Grandeur, Rocky) are uncommon while ponds, streams, creeks, gorges and plateaus are invisible. (Swamps and morasses are regrettably common, though seldom advertised.)

Small Wins for Investors

Calamos Growth & Income (CVTRX) reopened to new investors in January. Despite a lackluster return in 2012, the fund has a strong long-term record, beating 99% of its peers during the trailing 15-year period through December 2012. In August 2012, Calamos announced that lead manager and firm co-CIO Nick Calamos would be leaving the firm. Gary Black, former Janus CIO, joined the management team as his replacement.

The folks at FPA have lowered the expense ratio for FPA International Value (FPIVX). FPA has also extended the existing fee waiver and reduced the Fund’s fees effective February 1, 2013. FPA has contractually capped the Fund’s fees at 1.32% through June 30, 2015, several basis points below the current rate.

Scout Unconstrained Bond (SUBYX and SUBFX) is now available in a new, lower-cost retail package. On December 31, 2012, the old retail SUBFX became the institutional share class with a $100,000 minimum. At the same time Scout launched new “Y” shares that are no-load with the same minimum investment as the old shares, but also with a substantial expense reduction. When we profiled the fund in November, the after-waiver e.r. was 99 basis points while the “Y” shares are at 80 bps. Scout also reduces the minimum initial investment to $100 for accounts set up with an automatic investing plan.

Scout has also released “Unconstrained Fixed-Income Investing: A Timely Alternative in a Perilous Environment.” They argue that unconstrained investing:

Has the potential to make portfolios less vulnerable to higher interest rates and enduring economic uncertainty;
May better position assets to grow long term purchasing power;
Is worth consideration as investors may need to consider more opportunistic strategies to complement or replace the core strategies that have worked well so far.

They also explain the counter-cyclical investment approach which they have successfully employed for more than three decades. Mark Egan and team were also finalists for 2012 Fixed Income Manager of the Year honors.

Vanguard has cut expense ratios on four more funds, by 1 -3 basis points. Those are Equity Income, PRIMECAP Core, Strategic Equity and Strategic Small Cap Equity. It raised the e.r. on Growth Equity by 2 basis points.

Closings

ASTON/River Road Independent Value (ARVIX) closed to new investors on January 18 after being reopened just four months. I warned you.

Fairholme Fund (FAIRX) is closing on February 28, 2013. Here’s the perfect illustration of the risks and rewards of high-conviction investing: top 1% in 2010, bottom 1% in 2011, top 1% in 2012, closed in 2013. The smaller Fairholme Allocation (FAAFX), which has actually outperformed Fairholme since launch, and Fairholme Focused Income (FOCIX) funds are closing at the same time.

Fidelity Small Cap Discovery (FSCRX) closed to new investors on January 31. The fund has been a rarity for Fidelity: a really good small cap fund. Most of its success has come under manager Chuck Myers. Fans of his work might still check out Fidelity Small Cap Value (FCPVX). It’s nearly as big as Discovery ($3.1 versus $3.9 billion) but hasn’t had to deal with huge inflows.

JPMorgan Mid Cap Value (JAMCX) will close to new investors at the end of February.

MainStay Large Cap Growth Fund closed to new investors on January 17. They ascribe the decision to “a significant increase in the net assets” and a desire “to moderate cash flows.”

Virtus announced it will close Virtus Emerging Markets Opportunities (HEMZX) to new investors on Feb. 1. The fund had strong inflows in recent years, ending 2012 with more than $6.8 billion in assets. Rajiv Jain was named Morningstar International-Stock Fund Manager of the Year for 2012. In three of the past five calendar years the fund has outpaced more than 95% of its peers (it landed in the bottom decile of its category for 2009, despite a 48% return for the year, and placed in the top half of the category in 2011).

Old Wine in New Bottles

DWS is changing the names of its three Dreman Value Management-run funds, including the Neutral-rated DWS Dreman Small Cap Value (KDSAX), to drop the subadvisor’s name. Dreman’s assets under management have shrunk dramatically to just $4.1 billion today from $20 billion in 2007. The firm previously subadvised a large-cap value fund for DWS but was dropped after that fund (now called DWS Equity Dividend (KDHAX)) lost 46% in 2008, leading to massive outflows. The three funds Dreman subadvises for DWS now account for roughly half of the firm’s total assets under management.

We noted earlier in fall that several of the Legg Mason affiliates are shrinking from the Legg name. The most recent manifestations: Legg Mason Global Currents International All Cap Opportunity and Legg Mason Global Currents International Small Cap Opportunity changed their names to ClearBridge International All Cap Opportunity (SBIEX) and ClearBridge International Small Cap Opportunity (LCOAX) on Dec. 5, 2012.

Off to the Dustbin of History

ASTON Dynamic Allocation (ASENX) has been closed to new investment and will be shut down on January 30. The fund’s performance has been weak and 2012 was its worst year yet. The fact that it drew only $22 million in investments and carried a one-star rating from Morningstar likely contributed to the decision. The fund, subadvised by Smart Portfolios, was launched early 2008. This will be ASTON’s third closure of late, following the shutdown of ASTON/Cardinal Mid Cap Value and ASTON/Neptune International in mid-autumn.

Fidelity plans to merge the Fidelity 130/30 Large Cap (FOTTX) and Fidelity Advisor Strategic Growth (FTQAX) into Fidelity Stock Selector All Cap (FDSSX) in June in June. Neither of the deadsters had distinguished records and neither drew much in assets, at least by Fidelity’s standards.

Invesco Powershares will liquidate thirteen more ETFs on February 26. Those are

Dynamic Insurance Portfolio (PIC)
Morningstar StockInvestor Core Portfolio (PYH)
Dynamic Banking Portfolio (PJB)
Global Steel Portfolio (PSTL)
Active Low Duration Portfolio (PLK)
Global Wind Energy Portfolio (PWND)
Active Mega-Cap Portfolio (PMA)
Global Coal Portfolio (PKOL)
Global Nuclear Energy Portfolio (PKN)
Ibbotson Alternative Completion Portfolio (PTO)
RiverFront Tactical Balanced Growth Portfolio (PAO)
RiverFront Tactical Growth & Income Portfolio (PCA)
Convertible Securities Portfolio (CVRT)

Just when you thought the industry was all dull and normal, along comes Janus. Janus’s Board approved the merger of Janus Global Research into Janus Worldwide (JAWWX) on March 15, 2013. Now in a dull and normal world, that would mean the disappearance of the Global Research fund. Not with Janus! Global Research will merge into Worldwide, resulting in “the Combined Fund.” The Combined Fund will then be named “Janus Global Research,” will adopt Global Research’s management team and will use Global Research’s performance record. Investors get rewarded with a four basis point decrease in their expense ratio.

The RS Capital Appreciation Fund will be merged with RS Growth Fund in March. In the interim, RS removed Cap App’s entire management team and replaced them with Growth’s: Stephen Bishop, Melissa Chadwick-Dunn, and D. Scott Tracy.

RiverPark Small Cap Growth (RPSFX) liquidated on Jan. 25, 2013. I like and respect Mr. Rubin and the RiverPark folks as a whole, but this fund never struck me as particularly compelling. With only $4.5 million in assets, it seems the others agreed. On the upside, this leaves the managers free to focus on their noticeably-promised RiverPark Long/Short Opportunity (RLSFX) fund.

Scout Stock (UMBSX) will liquidate in March. Scout has always been a very risk averse fund for which Morningstar and the Observer both had considerable enthusiasm. The problem is that the combination of low risk with below average returns was not compelling in the marketplace and assets have dropped by well over half in the past decade.

In a move fraught with covert drama, Sentinel Asset Management is merging the $51 million Sentinel Mid Cap II (SYVAX) into Sentinel Mid Cap (SNTNX). The drama started when Sentinel fired Mid Cap II’s management team in 2011. The fund’s shareholders then refused to ratify a new management team. Sentinel responded by converting Mid Cap II into a clone of Mid Cap with the same management team. Then in August 2012, that management team resigned to join a competitor. Sentinel rotated in the team that manages Sentinel Common Stock (SENCX) to manage both and, soon, to manage just the survivor.

Torray Institutional (TORRX) liquidated at the end of December. Like many institutional funds, it was hostage to one or two large accounts. When a major investor pulled out, the fund was left with too few assets to be profitable. Torray Fund (TORYX), on which it was based, has had a long stretch of wretched performance (in the bottom quartile of its large cap peer group for six of the past 10 years) but retains over $300 million in assets.

In Closing . . .

We received a huge and humbling stack of mail in January, very little of which I’ve yet responded to. Some folks, including some professional practices, shared contributions (including one in the … hmm, “mid three digit” range) for which we’re really grateful. Other folks shared holiday greetings (Zak, Hoyt and River Road Asset Management won, hands down, for the cutest and classiest card of the season), offers, reflections and requests. Augustana settles into Spring Break in early February and I’m resolved to settle in for an afternoon and catch up with you folks. Preliminary notes include:

Major congratulations, Maryrose! Great news.
Pretty much any afternoon during Spring Break, Peter
Thanks for sharing the Fund Investor’s Classroom, Richard. I’ll sort through it as soon as I’m out of my own classroom.
Rick, Mohan, it’s always good to hear from old friends
Fraud Catcher, fascinating book and a fascinating life. Thanks for sharing it, Tom.
And, to you all, it’s always good to hear from new friends.

Thanks, as always, for your support and encouragement. It makes a world of difference. Do consider joining us for the Seafarer conference call in a couple weeks. Otherwise, I’ll see you all in March.

January 1, 2013

Dear friends,

We’ve been listening to REM’s “It’s the End of the World (as we know it)” and thinking about copyrighting some useful terms for the year ahead. You know that Bondpocalypse and Bondmageddon are both getting programmed into the pundits’ vocabulary. Chip suggests Bondtastrophe and Bondaster.

Bad asset classes (say, TIPs and long bonds) might be merged in the Frankenfund. Members of the Observer’s discussion board offered bond doggle (thanks, Bee!), the Bondfire of the Vanities (Shostakovich’s entry and probably our most popular), the New Fed (which Hank thinks we’ll be hearing by year’s end) which might continue the racetodebase (Rono) and bondacious (presumably blondes, Accipiter’s best). Given that snowstorms now get their own names (on the way to Pittsburgh, my son and I drove through the aftermath of Euclid), perhaps market panics, too? We’d start of course with Market Crisis Alan, in honor of The Maestro, but we haven’t decided whether that would rightly be followed by Market Crisis Ben, Barack or Boehner. Hopeful that they couldn’t do it again, we could honor them all with Crash B3 which might defame the good work done by vitamin B3 in regulating sex and stress.

Feel free to join in on the 2013 Word of the Year thread, if only if figure out how Daisy Duke got there.

The Big Bond Bubble Boomnanza?

I’m most nervous when lots of other folks seem to agree with me. It’s usually a sign that I’ve overlooked something.

I’ve been suggesting for quite a while now that the bond market, as a whole, might be in a particularly parlous position. Within the living memory of almost the entire investing community, investing in bonds has been a surefire way to boost your portfolio. Since 1981, the bond market has enjoyed a 31-year bull market. What too many investors forget is that 1981 was preceded by a 35-year year bear market for bonds. The question is: are we at or near another turning point?

The number of people reaching that conclusion is growing rapidly. Floyd Norris of The New York Times wrote on December 28^th: “A new bear market almost certainly has begun” (Reading Pessimism in the Market for Bonds). The Wall Street Journal headlined the warning, “Danger Lurks Inside the Bond Boom amid Corporate-Borrowing Bonanza, Some Money Managers Warn of Little Room Left for Gains” (12/06/2012). Separately, the Journal warned of “a rude awakening” for complacent bond investors (12/24/2012). Barron’s warns of a “Fed-inflated bond bubble” (12/17/2012). Hedge fund manager Ray Dalio claims that “The biggest opportunity [in 2013] will be – and it isn’t imminent – shorting bond markets around the world” (our friends at LearnBonds.com have a really good page of links to commentaries on the bond market, on which this is found).

I weighed in on the topic in a column I wrote for Amazon’s Money and Markets page. The column, entitled “Trees Do Not Grow to the Sky,” begins:

You thought the fallout from 2000-01 was bad? You thought the 2008 market seizure provoked anguish? That’s nothing, compared to what will happen when every grandparent in America cries out, as one, “we’ve been ruined.”

In the past five years, investors have purchased one trillion dollars’ worth of bond mutual fund shares ($1.069 trillion, as of 11/20/12, if you want to be picky) while selling a half trillion in stock funds ($503 billion).

Money has flowed into bond mutual funds in 53 of the past 60 weeks (and out of stock funds in 46 of 60 weeks).

Investors have relentlessly bid up the price of bonds for 30 years so they’ve reached the point where they’re priced to return less than nothing for the next decade.

Morningstar adds that about three-quarters of that money went to actively-managed bond funds, a singularly poor bet in most instances.

I included a spiffy graph and then reported on the actions of lots of the country’s best bond investors. You might want to take a quick scan of their activities. It’s fairly sobering.

Among my conclusions:

Act now, not later. “Act” is not investment advice, it’s communication advice. Start talking with your spouse, financial adviser, fund manager, and other investors online, about how they’ve thought about the sorts of information I’ve shared and how they’ve reacted to it. Learn, reflect, then act.

We’re not qualified to offer investment advice and we’re not saying that you should be abandoning the bond market. As we said to Charles, one of our regular readers,

I’m very sensitive to the need for income in a portfolio, for risk management and for diversification so leaving fixed-income altogether strikes me as silly and unmanageable. The key might be to identify the risks your exposing yourself to and the available rewards. In general, I think folks are most skeptical of long-term sovereign debt issued by governments that are … well, broke. Such bonds have the greatest interest rate sensitivity and then to be badly overpriced because they’ve been “the safe haven” in so many panics.

So I’d at the very least look to diversify my income sources and to work with managers who are not locked into very narrow niches.

MFWire: Stock Fund Flows Are Turning Around

MF Wire recently announced “Stock Funds Turn Around” (December 28, 2012), which might also be titled “Investors continue retreat from U.S. stock funds.” In the last full week of 2012, investors pulled $750 million from US stock funds and added $1.25 billion into international ones.

Forbes: Buy Bonds, Sleep Well

Our take might be, Observer: buy bonds, sleep with the fishes. On December 19^th, Forbes published 5 Mutual Funds for Those Who Want to Sleep Well in 2013. Writer Abram Brown went looking for funds that performed well in recent years (always the hallmark of good fund selection: past performance) and that avoided weird strategies. His list of winners:

PIMCO Diversified Income (PDVDX) – a fine multi-asset fund.

MFS Research Bond R3 (MRBHX) – R3 shares are only available through select retirement plans. The publicly available “A” shares carry a sales load, which has trimmed about a percent a year off its returns.

Russell Strategic Bond (RFCEX) – this is another unavailable share class; the publicly available “A” shares have higher expenses, a load, and a lower Morningstar rating.

TCW Emerging Markets Income (TGEIX) – a fine fund whose assets have exploded in three years, from $150 million to $6.2 billion.

Loomis Sayles Bond (LBFAX) – the article points you to the fund’s Administrative shares, rather than the lower-cost Retail shares (LSBRX) but I don’t know why.

Loomis might illustrate some of the downsides to investing in the past. Its famous lead manager, Dan Fuss, is now 79 years old and likely in the later stages of his career. His heir apparent, Kathleen Gaffney, recently left the firm. That leaves the fund in the hands of two lesser-known managers.

I’m not sure of how well most folks will sleep when their manager’s toting 40-100% emerging markets exposure or 60% junk bonds when the next wave crashes over the market, but it’s an interesting list.

Forbes is, by the way, surely a candidate for the most badly junked up page in existence, and one of the least useful. Only about a third of the screen is the story, the rest are ads and misleading links. See also “10 best mutual funds” does not lead to a Forbes story on the subject – it leads to an Ask search results page with paid results at top.

Vanguard: The Past 10 Years

In October we launched “The Last Ten,” a monthly series, running between now and February, looking at the strategies and funds launched by the Big Five fund companies (Fido, Vanguard, T Rowe, American and PIMCO) in the last decade.

Here are our findings so far:

Fidelity, once fabled for the predictable success of its new fund launches, has created no compelling new investment option and only one retail fund that has earned Morningstar’s five-star designation, Fidelity International Growth (FIGFX). We suggested three causes: the need to grow assets, a cautious culture and a firm that’s too big to risk innovative funds.

T. Rowe Price continues to deliver on its promises. Of the 22 funds launched, only Strategic Income (PRSNX) has been a consistent laggard; it has trailed its peer group in four consecutive years but trailed disastrously only once (2009). Investing with Price is the equivalent of putting a strong singles-hitter on a baseball team; it’s a bet that you’ll win with consistency and effort, rather than the occasional spectacular play.

PIMCO has utterly crushed the competition, both in the thoughtfulness of their portfolios and in their performance. PIMCO has, for example, about three times as many five-star funds – both overall and among funds launched in the last decade – than you’d predict.

The retirement of Gus Sauter, Vanguard’s long-time chief investment officer, makes this is fitting moment to look back on the decade just past.

Measured in terms of the number of funds launched or the innovativeness of their products, the decade has been unremarkable. Vanguard:

Has 112 funds (which are sold in over 278 packages or share classes)
29 of their funds were launched in the past decade
106 of them are old enough to have earned Morningstar ratings
8 of them has a five star rating (as of 12/27/12)
57 more earned four-star ratings.

Morningstar awards five-stars to the top 10% of funds in a class and four-stars to the next 22.5%. The table below summarizes what you’d expect from a firm of Vanguard’s size and then what they’ve achieved.

	Expected Value	Observed value
Vanguard, Five Star Funds, overall	10	8
Vanguard, Four and Five Star Funds, overall	34	65
Five Star funds, launched since 9/2002	2	1
Four and Five Star funds, launched since 9/2002	7	18

What does the chart suggest? Vanguard is less likely to be “spectacular” than the numbers would suggest but more than twice as likely to be “really good.” That makes a great deal of sense given the nature of Vanguard’s advantage: the “at cost” ethos and tight budget controls means that they enter each year with a small advantage over the market. With time that advantage compounds but remains modest.

The funds launched in the past decade are mostly undistinguished, in the sense that they incorporate neither unusual combinations of assets (no “emerging markets balanced” or “global infrastructure” here) nor innovative responses to changing market conditions (as with “real return” or “inflation-tuned” ones). The vast bulk are target-date funds, other retirement income products, or new indexed funds for conventional market segments.

They’ve launched about five new actively-managed retail funds which, as a group, peak out at “okay.”

Ticker	Fund Name	Morningstar Rating	Morningstar Category	Total Assets ($mil)
VDEQX	Diversified Equity Income	★★★	Large Growth	1180
VMMSX	Emerging Markets Select Stock	—	Diversified Emerging Mkts	120
VEVFX	Explorer Value	—	Small Blend	126
VEDTX	Extended Duration Treasury Index	★★	Long Government	693
VFSVX	FTSE All-World ex-US Small Cap Index	★★	Foreign Small/Mid Blend	1344
VGXRX	Global ex-US Real Estate	—	Global Real Estate	644
VLCIX	Long-Term Corporate Bond	★★★★	Long-Term Bond	1384
VLGIX	Long-Term Gov’t Bond I	—	Long Government	196
VPDFX	Managed Payout Distribution Focused	★★★★	Retirement Income	592
VPGDX	Managed Payout Growth & Distribution Focused	★★★★	Retirement Income	365
VPGFX	Managed Payout Growth Focused	★★★	Retirement Income	72
VPCCX	PRIMECAP Core	★★★★	Large Growth	4684
VSTBX	Short-Term Corp Bond Index	★★★★	Short-Term Bond	4922
VSTCX	Strategic Small-Cap Equity	★★★★	Small Blend	257
VSLIX	Structured Large-Cap Equity	★★★★	Large Blend	507
VSBMX	Structured Broad Market Index	★★★★	Large Blend	384
VTENX	Target Retirement 2010	★★★★	Target Date 2000-2010	6327
VTXVX	Target Retirement 2015	★★★★	Target Date 2011-2015	17258
VTWNX	Target Retirement 2020	★★★★	Target Date 2016-2020	16742
VTTVX	Target Retirement 2025	★★★★	Target Date 2021-2025	20670
VTHRX	Target Retirement 2030	★★★★	Target Date 2026-2030	13272
VTTHX	Target Retirement 2035	★★★★	Target Date 2031-2035	14766
VFORX	Target Retirement 2040	★★★★	Target Date 2036-2040	8448
VTIVX	Target Retirement 2045	★★★★	Target Date 2041-2045	8472
VFIFX	Target Retirement 2050	★★★★	Target Date 2046-2050	3666
VFFVX	Target Retirement 2055	—	Target-Date 2051+	441
VTTSX	Target Retirement 2060	—	Target-Date 2051+	50
VTINX	Target Retirement Income	★★★★★	Retirement Income	9629
VTBIX	Total Bond Market II	★★	Intermediate-Term Bond	62396

This is not to suggest that Vanguard has been inattentive of their shareholders best interests. Rather they seem to have taken an old adage to heart: “be like a duck, stay calm on the surface but paddle like hell underwater.” I’m indebted to Taylor Larimore, co-founder of the Bogleheads, for sharing the link to a valedictory interview with Gus Sauter, who points out that Vanguard’s decided to shift the indexes on which their funds are based. That shift will, over time, save Vanguard’s investors hundreds of millions of dollars. It also exemplifies the enduring nature of Vanguard’s competitive advantage: the ruthless pursuit of many small, almost invisible gains for their investors, the sum of which is consistently superior results.

Celebrating Small Cap Season

The Observer has, of late, spent a lot of time talking about the challenge of managing volatility. That’s led us to discussions of long/short, covered call, and strategic income funds. The two best months for small cap funds are January and February. Average returns of U.S. small caps in January from 1927 to 2011 were 2.3%, more than triple those in February, which 0.72%. And so we teamed up again with the folks at FundReveal to review the small cap funds we’ve profiled and to offer a recommendation or two.

The Fund	The Scoop	2012, thru 12/29	Three year
Aegis Value (AVALX):	$153 million in assets, 75% microcaps, top 1% of small value funds over the past five years, driven by a 91% return in 2009.	23.0	14.7
Artisan Small Cap (ARTSX)	$700 million in assets, a new management team – those folks who manage Artisan Mid Cap (ARTMX) – in 2009 have revived Artisan’s flagship fund, risk conscious strategy but a growthier profile, top tier returns under the new team.	15.5	13.7
ASTON/River Road Independent Value (ARIVX)	$720 million in assets. The fund closed in anticipation of institutional inflows, then reopened when those did not appear. Let me be clear about two things: (1) it’s going to close again soon and (2) you’re going to kick yourself for not taking it more seriously. The manager has an obsessive absolute-return focus and will not invest just for the sake of investing; he’s sitting on about 50% cash. He’s really good at the “wait for the right opportunity” game and he’s succeeded over his tenure with three different funds, all using the same discipline. I know his trailing 12-month ranking is abysmal (98^th percentile in small value). It doesn’t matter.	7.1	n/a
Huber Small Cap Value (HUSIX)	$55 million in assets, pretty much the top small-value fund over the past one, three and five years, expenses are high but the manager is experienced and folks have been getting more than their money’s worth	27.0	19.0
Lockwell Small Cap Value Institutional (LOCSX)	Tiny, new fund, top 16% among small blend funds over the past year, the manager had years with Morgan Stanley before getting downsized. Scottrade reports a $100 minimum investment in the fund.	17.1	n/a
Mairs and Power Small Cap Fund (MSCFX) –	$40 million in assets, top 1% of small blend funds over the past year, very low turnover, very low key, very Mairs and Power.	27.1	n/a
Pinnacle Value (PVFIX)	$52 million in assets, microcap value stocks plus 40% cash, it’s almost the world’s first microcap balanced fund. It tends to look relatively awful in strongly rising markets, but still posts double-digit gains. Conversely tends to shine when the market’s tanking.	18.9	8.4
RiverPark Small Cap Growth (RPSFX)	$4 million in assets and relatively high expenses. I was skeptical of this fund when we profiled it and its weak performance so far hasn’t given me cause to change my mind.	5.5	n/a
SouthernSun Small Cap Fund (SSSFX)	$400 million, top 1% returns among small blend funds for the past three and five years, reasonable expenses but a tendency to volatility	18.0	21.9
Vulcan Value Partners Small Cap Fund (VVPSX)	$200 million, top 4% among small blend funds over the past year, has substantially outperformed them since inception; it will earn its first Morningstar rating (four stars or five?) at the beginning of February. Mr. Fitzpatrick was Longleaf manager for 17 years before launching Vulcan and was consistently placed in the top 5% of small cap managers.	24.3	n/a
Walthausen Small Cap Value Fund (WSCVX)	$550 million in assets, newly closed, with a young sibling fund. This has been consistently in the top 1% of small blend funds, though its volatility is high.	30.6	19.8

You can reach the individual profiles by clicking in the “Funds” tab on our main navigation bar. We’re in the process of updating them all during January. Because our judgments embody a strong qualitative element, we asked our resolutely quantitative friends at FundReveal to look at our small caps and to offer their own data-driven reading of some of them. Their full analysis can be found on their blog.

FundReveal’s strategy is to track daily return and volatility data, rather than the more common monthly or quarterly measures. They believe that allows them to look at many more examples of the managers’ judgment at work (they generate 250 data points a year rather than four or twelve) and to arrive at better predictions about a fund’s prospects. One of FundReveal’s key measures is Persistence, the likelihood that a particular pattern of risk and return repeats itself, day after day. In general, you can count on funds with higher persistence. Here are their highlights:

The MFO funds display, in general, higher volatility than the S&P 500 for both 2012 YTD and the past 5 years. The one fund that had lower volatility in both time horizons is Pinnacle Value (PVFIX). PVFIX demonstrates consistent performance with low volatility, factors to be combined with subjective analysis available from other sources.

Two other funds have delivered high ADR (Average Daily Return), but also present higher risk than the S&P. In this case Southern Sun Small Cap (SSSFX) and Walthausen Small Cap (WSCVX) have high relative volatility, but they have delivered high ADR over both time horizons. From the FundReveal perspective, SSSFX has the edge in terms of decision-making capability because it has delivered higher ADR than the S&P in 10 Quarters and lower ADR in 6 Quarters, while WSCVX had delivered higher ADR than the S&P in 7 Quarters and lower ADR in 7 Quarters.

So, bottom line, from the FundReveal perspective PVFIX and SSSFX are the more attractive funds in this lineup.

Some Small Cap funds worthy of consideration:

Small Blend

Schwartz Value fund (RCMFX): Greater than S&P ADR, Lower Volatility (what we call “A” performance) for 2012 YTD and 2007-2012 YTD. It has a high Persistence Rating (40%) that indicates a historic tendency to deliver A performance on a quarterly basis.
Third Avenue Small-Cap Fund (TVSVX): Greater than S&P ADR, Lower Volatility with a medium Persistence Rating (33%).

Small Growth

Wasatch Micro Cap Value fund (WAMVX): Greater than S&P ADR, Lower Volatility 2007-2012 YTF, with a medium Persistence Rating (30%). No FundReveal covered Small Growth funds delivered “A” performance in 2012 YTD. (WAMVX is half of Snowball’s Roth IRA.)

Small Value

Pinnacle Value Fund (PVFIX): An MFO focus fund, discussed above. It has a high Persistence Rating (50%).
Intrepid Small Cap Fund (ICMAX ): Greater than S&P ADR, Lower Volatility for 2007-2012 YTF, with a high Persistence Rating (55%). Eric Cinnamond, who now manages Aston River Road Independent Value, managed ICMAX from 2005-10.
ING American Century Small-Mid Cap Value (ISMSX): Greater than S&P ADR, Lower Volatility for 2007-2012 YTF, with a medium Persistence Rating (25%).

If you’re intrigued by the potential for fine-grained quantitative analysis, you should visit FundReveal. While theirs is a pay service, free trials are available so that you can figure out whether their tools will help you make your own decisions.

Ameristock’s Curious Struggle

Nick Gerber’s Ameristock (AMSTX) fund was long an icon of prudent, focused investing but, like many owner-operated funds, is being absorbed into a larger firm. In this case, it’s moving into the Drexel Hamilton family of funds.

Or not. While these transactions are generally routine, a recent SEC filing speaks to some undiscussed turmoil in the move. Here’s the filing:

As described in the Supplement Dated October 9, 2012 to the Prospectus of Ameristock Mutual Fund, Inc. dated September 28, 2012, a Special Meeting of Shareholders of the Ameristock Fund was scheduled for December 12, 2012 at 11:00 a.m., Pacific Time, for shareholders to vote on a proposed Agreement and Plan of Reorganization and Termination pursuant to which the Ameristock Fund would be reorganized into the Drexel Hamilton Centre American Equity Fund, a series of Drexel Hamilton Mutual Funds, resulting in the complete liquidation and termination of the Ameristock Fund. The Special Meeting convened as scheduled on December 12, 2012, but was adjourned until … December 27, 2012. … The Reconvened Special Meeting was reconvened as scheduled on December 27, 2012, but has again been adjourned and will reconvene on Thursday, January 10, 2012 …

Uh-huh.

Should Old Acquaintance Be Forgot and Never Brought to Mind?

Goodness, no.

How long can a fund be incredibly, eternally awful and still survive? The record is doubtless held by the former Steadman funds, which were ridiculed as the Deadman funds and eventually hid out as the Ameritor funds. They managed generations of horrible ineptitude. How horrible? In the last decade of their existence (through 2007), they lost 98.98%. That’s the transformation of $10,000 into $102. Sufficiently horrible that they became a case study at Stanford’s Graduate School of Business.

In celebrating the season of Auld Lang Syne, I set out to see whether there were any worthy successors on the horizon. I scanned Morningstar’s database for funds which trailed at least 99% of the peers this year. And over the past five years. And 10 and 15 years.

Five funds actually cropped up as being that bad that consistently. The good news for investors is that the story isn’t quite as bleak as it first appears.

The Big Loser’s Name	Any explanation?
Delaware Tax-Free Minnesota Intermediate Term, B (DVSBX) and C (DVSCX) shares	Expenses matter. The fund’s “A” shares are priced at 0.84% and earn a three-star rating. “C” shares cost 1.69% – that’s close to a third of the bonds’ total return.
DFA Two-Year Global Fixed Income (DFGFX)	DFA is among the fund world’s more exclusive clubs. Individuals can’t buy the funds nor can most advisors; advisors need to pass a sort of entrance exam just to be permitted to sell them. Bad DFA funds are rare. In the case of DFGFX, it’s a category error: it’s an ultra-short bond fund in an intermediate-term bond category. It returns 1-5% per year, never loses money and mostly looks wretched against higher return/higher risk peers in Morningstar’s world bond category.
Fidelity Select Environment and Alternative Energy (FSLEX)	This is a singularly odd result. Morningstar places it in the “miscellaneous sector” category then, despite a series of 99^th percentile returns, gives it a four-star rating. Morningstar’s description: “this new category is a catchall.” Given that the fate of “green” funds seems driven almost entirely by politicians’ agendas, it’s a dangerous field.
GAMCO Mathers AAA (MATRX)	Mathers is glum, even by the standards of bear market funds. The good news can be summarized thus: high management stability (Mr. Van der Eb has been managing the fund since 1974) and it didn’t lose money in 2008. The bad news is more extensive: it does lose money about 70% of the time, portfolio turnover is 1700%, expenses are higher, Mr. Eb is young enough to continue doing this for years and an inexplicably large number of shareholders ($20 million worth) are holding on. Mr. Eb and about half of the trustees are invested in the fund. Mr. Gabelli, the “G” of GAMCO, is not.
Nysa (NYSAX)	This is an entirely conventional little all-cap fund. Mr. Samoraj is paid about $16,000/year to manage it. It’s lost 6.8% a year under his watch. You figure out whether he’s overpaid. He’s also not invested a penny of his own money in the fund. Smart man. Do ye likewise. (The fund’s website doesn’t exist, so you’re probably safe.)

Jaffe’s Year-End Explosion

I’m not sure that Chuck Jaffe is the hardest-working man in the fund biz, but he does have periods of prodigious output. December is one of those periods. Chuck ran four features this month worth special note.

Farewell to Stupid Investments. After nearly a decade, Chuck has ended down his “Stupid Investment of the Week” column. Chuck’s closing columns echoes Cassius, in Shakespeare’s Julius Caesar: “The fault, dear Brutus, is not in our stars, But in ourselves, that we are underlings.” Or perhaps Pogo, “we have met the enemy and he is us.”
17^th Annual Lump of Coal Awards, December 10 and December 17. This is the litany of stupidity surrounding the fund industry, from slack-wit regulators to venal managers. One interesting piece discusses Morningstar’s analyst ratings. Morningstar’s ratings roughly break the universe down into good ideas (gold, silver, bronze), okay ideas (neutral) and bad ideas (negative). Of the 1000+ funds rated so far, only 5%qualify for negative ratings. Morningstar’s rejoinder is that there are 5000 unrated funds, the vast bulk of which don’t warrant any attention. So while the 5% might be the tip of a proverbial iceberg, they represent the funds with the greatest risk of attracting serious investor attention.
My recommendation, which didn’t make Chuck’s final list, was to present a particularly grimy bit o’ bituminous to the fund industry for its response to the bond mania. Through all of 2012, the industry closed a total of four funds to new investment while at the same time launching 39 new bond funds. That’s looks a lot like the same impulse that led to the launch of B2B Internet Services funds (no, I’m not making that up) just before the collapse of the tech bubble in 2000; a “hey, people want to buy this stuff so we’ve got an obligation to market it to them” approach.

Tales from the Mutual Fund Crypt, December 26: stories of recently-departed funds. A favorite: the Auto-Pilot fund’s website drones on, six months after the fund’s liquidation. It continues to describe the fund as “new,” six years after launch.
My nominee was generic: more funds are being shut down after 12 – 18 months of operation which smacks of hypocrisy (have you ever heard of a manager who didn’t preach the “long-term investor” mantra yet the firms themselves have a short-term strategy) and incompetence (in fund design and marketing both).

Chuck’s still podcasting, MoneyLife with Chuck Jaffe. One cool recent interview was with Doug Ramsey, chief investment officer for the Leuthold Funds.

ASTON/River Road Long-Short Conference Call

On December 17, about fifty readers joined us for an hour-long conversation with Matt Moran and Daniel Johnson, managers of ASTON/River Road Long-Short (ARLSX). For folks interested but unable to join us, here’s the complete audio of the hour-long conversation. It starts with Morty Schaja, River Road’s president, talking about the fund’s genesis and River Road’s broader discipline and track record:

The ARLSX conference call

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

If you’d like a preview before deciding whether you listen in, you might want to read our profile of ARLSX (there’s a printable .pdf of the profile on Aston’s website and an audio profile, which we discuss below). Here are some of the highlights of the conversation:

Quick highlights:

they believe they can outperform the stock market by 200 bps/year over a full market cycle. Measuring peak to peak or trough to trough, both profit and stock market cycles average 5.3 years, so they think that’s a reasonable time-frame for judging them.
they believe they can keep beta at 0.3 to 0.5. They have a discipline for reducing market exposure when their long portfolio exceeds 80% of fair value. The alarms rang in September, they reduce expose and so their beta is now at 0.34, near their low.
risk management is more important than return management, so all three of their disciplines are risk-tuned. The long portfolio, 15-30 industry leaders selling at a discount of at least 20% to fair value, tend to be low-beta stocks. Even so their longs have outperformed the market by 9%.
River Road is committed to keeping the fund open for at least 8 years. It’s got $8 million in asset, the e.r. is capped at 1.7% but it costs around 8% to run. The president of River Road said that they anticipated slow asset growth and budgeted for it in their planning with Aston.
The fund might be considered an equity substitute. Their research suggests that a 30/30/40 allocation (long, long/short, bonds) has much higher alpha than a 60/40 portfolio.

An interesting contrast with RiverPark, where Mitch Rubin wants to “play offense” with both parts of the portfolio. Here the strategy seems to hinge on capital preservation: money that you don’t lose in a downturn is available to compound for you during the up-cycle.

Conference Calls Upcoming: Matthews, Seafarer, Cook & Bynum on-deck

As promised, we’re continuing our moderated conference calls through the winter. You should consider joining in. Here’s the story:

Each call lasts about an hour
About one third of the call is devoted to the manager’s explanation of their fund’s genesis and strategy, about one third is a Q&A that I lead, and about one third is Q&A between our callers and the manager.
The call is, for you, free. Your line is muted during the first two parts of the call (so you can feel free to shout at the danged cat or whatever) and you get to join the question queue during the last third by pressing the star key.

Our next conference call features Teresa Kong, manager of Matthews Asia Strategic Income (MAINX). It’s Tuesday, January 22, 7:00 – 8:00 p.m., EST.

Matthews is the fund world’s best, deepest, and most experienced team of Asia investors. They offer a variety of funds, all of which have strong – and occasionally spectacular – long-term records investing in one of the world’s fastest-evolving regions. While income has been an element of many of the Matthews portfolios, it became a central focus with the December 2011 launch of MAINX. Ms. Kong, who has a lot of experience with first-rate advisors including BlackRock, Oppenheimer and JPMorgan, joined Matthews in 2010 ahead of the launch of this fund.

Why might you want to join the call?

Bonds across the developed world seem poised to return virtually nothing for years and possibly decades. For many income investors, Asia is a logical destination. Three factors support that conclusion:

Asian governments and corporations are well-positioned to service their debts. Their economies are growing and their credit ratings are being raised.
Most Asian debt supports infrastructure, rather than consumption.
Most investors are under-exposed to Asian debt markets. Bond indexes, the basis for passive funds and the benchmark for active ones, tend to be debt-weighted; that is, the more heavily indebted a nation is, the greater weight it has in the index. Asian governments and corporations have relatively low debt levels and have made relatively light use of the bond market. An investor with a global diversified bond portfolio (70% Barclays US Aggregate bond index, 20% Barclays Global Aggregate, 10% emerging markets) would have only 7% exposure to Asia. However you measure Asia’s economic significance (31% of global GDP, rising to 38% in the near future or, by IMF calculations, the source of 50% of global growth), even fairly sophisticated bond investors are likely underexposed.

The question isn’t “should you have more exposure to Asian fixed-income markets,” but rather “should you seek exposure through Matthews?” The answer, in all likelihood, is “yes.” Matthews has the largest array of Asia investment products in the U.S. market, the deepest analytic core and the broadest array of experience. They also have a long history of fixed-income investing in the service of funds such as Matthews Asian Growth & Income (MACSX). Their culture and policies are shareholder-friendly and their success has been consistent. Ms. Kong has outstanding credentials and has had an excellent first year.

How can you join in?

Would an additional heads up help?

Podcasts and Profiles

If you look at our top navigation bar, you’ll see a new tab and a new feature for the Observer. We’re calling it our Podcast page, but it’s much more. It began as a suggestion from Ira Artman, a talented financial services guy and a longtime member of the FundAlarm and Observer community. Ira suggested that we archive together the audio recordings of our conference calls and audio versions of the corresponding fund profiles.

Good idea, Ira! We went a bit further and create a resource page for each fund. The page includes:

The fund’s name, ticker symbols and its manager’s name
Written highlights from the conference call
A playable/downloadable .mp3 of the call
A link to the fund profile
A playable/downloadable .mp3 of the fund profile. The audio profiles start with the print profile, which we update and edit for aural clarity. Each profile is recorded by Emma Presley, a bright and mellifluous English friend of ours.
A link to the fund’s most recent fact sheet on the fund’s website.

We have resource pages for RiverPark Short Term High-Yield, RiverPark Long/Short Opportunity and Aston/River Road Long Short. The pages for Matthews Asia Strategic Income, Seafarer Overseas Growth & Income, and Cook and Bynum are in the works.

Observer Fund Profiles

Bridgeway Managed Volatility (BRBPX): Dick Cancelmo appreciates RiverNorth Dynamic Buy-Write’s strategy and wishes them great success, but also points out that others have been successful using a similar strategy for well over a decade. Indeed, over the last 10 years, BRBPX has quietly produced 70% of the stock market’s gains with just 40% of its volatility.

BRBPX and the Mystery of the Incredible Shrinking Fund

While it’s not relevant to the merit of BRBPX and doesn’t particularly belong in its profile, the collapse of the fund’s asset base is truly striking. In 2005, assets stood around $130 million. Net assets have declined in each of the past five years from $75 million to $24 million. The fund has made money over that period and is consistently in the top third of long/short funds.

Why the shrinkage? I don’t know. The strategy works, which should at least mean that existing shareholders hang on but they don’t. My traditional explanation has been, because this fund is dull. Dull, dull, dull. Dull stocks and dull bonds with one dull (or, at least, technically dense) strategy to set them apart. Part of the problem is Bridgeway. This is the only Bridgeway fund that targets conservative, risk-conscious investors which means the average conservative investor would find little to draw them to Bridgeway and the average Bridgeway investor has limited interest in conservative funds. Bridgeway’s other funds have had a performance implosion. When I first profiled BRBPX, five of the six funds rated by Morningstar had five-star designations. Today none of them do. Instead, five of eight rated funds carry one or two stars. While BRBPX continues to have a four-star rating, there might be a contagion effect.

Mr. Cancelmo attributes the decline to Bridgeway’s historic aversion to marketing. “We had,” he reports, “the ‘if you build a better mousetrap’ mindset. We’ve now hired a business development team to help with marketing.” That might explain why they weren’t drawing new assets, but hardly explains have 80% of assets walking out the door.

If you’ve got a guess or an insight, I’d love to hear of it. (Dick might, too.) Drop me a note.

As a side note, Bridgeway probably offers the single best Annual Report in the industry. You get a startling degree of honesty, thoughtfulness and clarity about both the funds and their take on broader issues which impact them and their investors. I was particularly struck by a discussion of the rising tide of correlations of stocks within the major indices. Here’s the graphic they shared:

What does it mean? Roughly, a generation ago you could explain 20% of the movement of the average stock’s price by broader movements in the market. As a greater and greater fraction of the stock market’s trades are made in baskets of stocks (index funds, ETFs, and so on) rather than individual names, more and more of the fate of each stock is controlled by sentiments surrounding its industry, sector, peers or market cap. That’s the steady rise of the line overall. And during a crisis, almost 80% of a stock’s movement is controlled by the market rather than by a firm’s individual merits. Bridgeway talks through the significance of that for their funds and encourages investors to factor it into their investment decisions.

The report offers several interesting, insightful discussions, making it the exact opposite of – for example – Fidelity’s dismal, plodding, cookie cutter reports.

Here’s our recommendation: if you run a fund, write such like Bridgeway’s 2012 Annual Report. If you’re trying to become a better investor, read it!

Launch Alert: RiverNorth/Oaktree High Income (RNHIX, RNOTX)

RiverNorth/Oaktree High Income Fund launched on December 28. This is a collaboration between RiverNorth, whose specialty has been tactical asset allocation and investing in closed-end funds (CEFs), and Oaktree. Oaktree is a major institutional bond investor with about $80 billion under management. Oaktree’s clientele includes “75 of the 100 largest U.S. pension plans, 300 endowments and foundations, 10 sovereign wealth funds and 40 of the 50 primary state retirement plans in the United States.” Their specialties include high yield and distressed debt and convertible securities. Until now, the only way for retail investors to access them was through Vanguard Convertible Securities (VCVSX), a four-star Gold rated fund.

Patrick Galley, RiverNorth’s CIO, stresses that this is “a core credit fund (managed by Oaktree) with a high income opportunistic CEF strategy managed by RiverNorth.” The fund has three investment strategies, two managed by Oaktree. While, in theory, Oaktree’s share of the portfolio could range from 0 – 100%, as a normal matter they’ll manage the considerable bulk of the portfolio. Oaktree will have the freedom to allocate between their high-yield and senior loan strategies. RiverNorth will focus on income-producing CEFs.

For those already invested in RiverNorth funds, Mr. Galley explained the relationship of RNHIX to its siblings:

We are staying true to the name and focusing on income producing closed-end funds, but unlike RNSIX (which focuses on income producing fixed income) and RNDIX (which focuses on income producing equities) and RNCOX (which doesn’t have an income mandate and only distributes once a year), RNHIX will invest across the CEF spectrum (i.e. all asset classes) but with a focus on income without sacrificing/risking total return.

The argument for considering this fund is similar to the argument for considering RiverNorth/DoubleLine Strategic Income. You’re hiring world-class experts who work in inefficient segments of the fixed-income universe.

RiverNorth had the risk and return characteristics for a bunch of asset classes charted.

You might read the chart as saying something like: this is a strategy that could offer equity-like returns with more nearly bond-like volatility. In a world where mainstream, investment-grade bonds are priced to return roughly nothing, that’s an option a reasonable person would want to explore.

The retail expense ratio is capped at 1.60% and the minimum initial investment is $5000.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting. Some are downright horrors of Dilbertesque babble.

Funds in registration this month won’t be available for sale until, typically, the beginning of March 2013. We found 15 funds in the pipeline, notably:

Investors Variable NAV Money Market Fund, one of a series of four money markets managed by Northern Trust, all of which will feature variable NAVs. This may be a first step in addressing a serious problem: the prohibition against “breaking the buck” is forcing a lot of firms to choose between underwriting the cost of running their money funds or (increasingly) shutting them down.

LSV Small Cap Value Fund is especially notable for its management team, led by Josef Lakonishok is a reasonably famous academic who did some of the groundbreaking work on behavioral finance, then translated that research into actual investment strategies through private accounts, hedge funds, and his LSV Value Equity Fund (LSVEX) fund.

Details on these funds and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

On a related note, we also tracked down 31 fund manager changes, including a fair number of folks booted from ING funds.

Briefly Noted

According to a recent SEC filing, Washington Mutual Investors Fund and its Tax-Exempt Fund of Maryland and Tax-Exempt Fund of Virginia “make available a Spanish translation of the above prospectus supplement in connection with the public offering and sale of its shares. The English language prospectus supplement above is a fair and accurate representation of the Spanish equivalent.” I’m sure there are other Spanish-language prospectuses out there, but I’ve never before seen a notice about one. It’s especially interesting given that tax-exempt bond funds target high income investors.

Effective January 1, DWS is imposing a $20/year small account service fee for shareholders in all 49 of their funds. The fee comes on top of their sales loads. The fee applies to any account with under $10,000 which is regrettable for a firm with a $1,000 minimum initial investment. (Thanks to chip for having spotted this filing in the SEC’s database. Regrets for having gotten friends into the habit of scanning the SEC database.)

Closings

Eaton Vance Atlanta Capital SMID-Cap (EAASX) is closing to new investors on Jan. 15. More has been pouring in (on the order of $1.5 billion in a year); at least in part driven by a top-notch five-year rating.

Walthausen Small Cap Value (WSCVX) closed to new investors at the end of the year. At the same time, the minimum initial investment for the $1.7 million Walthausen Select Value Investor Class (WSVIX) went from $10,000 to $100,000. WSCVX closed on January 1 at $560 million which might explain was they’re making the other fund’s institutional share class harder to access.

William Blair International Growth (WBIGX) closed to new investors, effective Dec. 31.

Old Wine in New Bottles

American Century Inflation Protection Bond (APOIX) has been renamed American Century Short Duration Inflation Protection Bond. The fund has operated as a short-duration offering since August 2011, when its benchmark changed to the Barclays U.S. 1-5 Year Treasury Inflation Protected Securities Index.

Federated Prudent Absolute Return (FMAAX) is about to become less Prudent. They’re changing their name to Federated Absolute Return and removed the manager of the Prudent Bear fund from the management team.

Prudential Target Moderate Allocation (PAMGX) is about to get a new name (Prudential Defensive Equity), mandate (growth rather than growth and income) and management structure (one manager team rather than multiple). It is, otherwise, virtually unchanged.

Prudential Target Growth Allocation (PHGAX) is merging into Prudential Jenison Equity Income (SPQAX).

U.S. Global Investors Global MegaTrends (MEGAX) is now U.S. Global Investors MegaTrends and no longer needs to invest outside the U.S.

William Blair Global Growth (WGGNX) will change its name to William Blair Global, and William Blair Emerging Leaders Growth (WELNX) will change its name to William Blair Emerging Markets Leaders.

Small wins for investors

Cook & Bynum Fund (COBYX), a wildly successful, super-concentrated value fund, has decided to substantially reduce their expense ratio. President David Hobbs reports:

… given our earlier dialogue about fees, I wanted to let you know that as of 1/1/13 the all-in expense ratio for the fund will be capped at 1.49% (down from 1.88%). This is a decision that we have been wrestling with for some time internally, and we finally decided that we should make the move to broaden the potential appeal of the fund. . . . With the fund’s performance (and on-going 5-star ratings with Morningstar and S&P Capital IQ), we decided to take a calculated risk that this new fee level will help us grow the fund.

Our 2012 profile of the fund concluded, “Cook and Bynum might well be among the best. They’re young. The fund is small and nimble. Their discipline makes great sense. It’s not magic, but it has been very, very good and offers an intriguing alternative for investors concerned by lockstep correlations and watered-down portfolios.” That makes the decreased cost especially welcome. (They also have a particularly good website.)

Effective January 2, 2013, Calamos Growth and Income and Global Growth and Income Funds re-opened to new investors. (Thanks to The Shadow for catching this SEC filing.)

ING Small Company (AESAX) has reopened. It’s reasonably large and not very good, really.

JPMorgan (JPM) launched Total Emerging Markets (TMGGX), an emerging-markets allocation fund.

Fund firms have been cutting expenses of late as they pressure to gather and hold assets builds.

Fidelity has reduced the minimum investment on its Advantage share class from $100,000 to $10,000. The Advantage class has lower expense ratios (which is good) and investors who own more than $10,000 in a fund’s retail Investor class will be moved automatically to the less-expensive Advantage class.

Fido also dropped the minimums on nearly two dozen index and enhanced index products from $10,000 to $2,500, which gives a lot more folks access to low-cost passive (or nearly-passive) shares.

Fido also cut fees on eight Spartan index funds, between one to eight basis points. The Spartan funds had very low expenses to begin with (10 basis points in some cases), so those cuts are substantial.

GMO Benchmark-Free Allocation (GBMFX) has decreased its expense ratio from 87 basis points down to 81 bps by increasing its fee waiver. The fund is interesting and important not because I intend to invest in in soon (the minimum is $10 million) but because it represents where GMO thinks that an investor who didn’t give a hoot about other people’s opinions (that’s the “benchmark-free” part) should invest.

Effective January 1, Tocqueville Asset Management L.P. capped expenses for Tocqueville International Value at 1.25% of the fund’s average daily net assets. Until now investors have been paying 1.56%.

Also effective January 1, TCW Investment Management Company reduced the management fees for the TCW High Yield Bond Fund from 0.75% to 0.45%.

Vanguard has cut fees on 47 products, which include both ETFs and funds. Some of the cuts went into effect on Dec. 21, while others went into effect on Dec. 27th. The reductions on eleven ETFs — four stock and seven bond — on December 21. Those cuts range from one to two basis points. That translates to reductions of 3 – 15%.

Off to the Dustbin of History

The board of trustees of Altrius Small Cap Value (ALTSX) has closed the fund and will likely have liquidated it by the time you read this. On the one hand, the fund only drew $180,000 in assets. On the other, the members of the board of trustees receive $86,000/year for their services, claim to be overseeing between 97 – 100 funds and apparently have been doing so poorly, since they received a Wells Notice from the SEC in May 2012. They were bright even not to place a penny of their own money in the fund. One of the two managers was not so fortunate: he ate a fair portion of his own cooking and likely ended up with a stomach cramp.

American Century will liquidate American Century Equity Index (ACIVX) in March 2013. The fund has lost 75% of its assets in recent years, a victim of investor disillusionment with stocks and high expenses. ACIVX charged 0.49%, which seems tiny until you recall that identical funds can be had for as little as 0.05% (Vanguard, naturally).

Aston Asset Management has fired the Veredus of Aston/Veredus Small Cap Growth (VERDX) and will merge the fund in Aston Small Cap Growth (ACWDX). Until the merger, it will go by the name Aston Small Cap.

The much-smaller Aston/Veredus Select Growth (AVSGX) will simply be liquidated. But were struggling.

Federated Capital Appreciation, a bottom 10% kind of fund, is merging Federated Equity-Income (LEIFX). LEIFX has been quite solid, so that’s a win.

GMO is liquidating GMO Inflation Indexed Plus Bond (GMIPX). Uhh, good move. Floyd Norris, in The New York Times, points out that recently-auctioned inflation-protected bonds have been priced to lock in a loss of about 1.4% per year over their lifetimes. If inflation spikes, you might at best hope to break even.

HSBC will liquidate two money-market funds, Tax-Tree and New York Tax-Free in mid-January.

ING Index Plus International Equity (IFIAX) has closed and is liquidating around Feb. 22, 2013. No, I don’t know what the “Plus” was.

Invesco is killing off, in April, some long-storied names in its most recent round of mergers. Invesco Constellation (CSTGX) and Invesco Leisure (ILSAX) are merging into American Franchise (VAFAX). Invesco Dynamics (IDYAX) goes into Mid Cap Growth (VGRAX), Invesco High-Yield Securities (HYLAX) into High Yield (AMHYX), Invesco Leaders (VLFAX) into Growth Allocation (AADAX), and Invesco Municipal Bond (AMBDX) will merge into Municipal Income (VKMMX). Any investors in the 1990s who owned AIM Constellation (I did), Invesco Dynamics and Invesco Leisure would have been incredibly well-off.

Leuthold Global Clean Technology (LGCTX) liquidated on Christmas Eve Day. Steve Leuthold described this fund, at its 2009 launch, as “the investment opportunity of a generation.” Their final letter to shareholders lamented the fund’s tiny, unsustainable asset base despite “strong performance relative to its comparable benchmark index” and noted that “the Fund operates in a market sector that has had challenging.” Losses of 20% per year are common for green/clean/alternative funds, so one can understand the limited allure of “strong relative performance.”

Lord Abbett plan to merge Lord Abbett Stock Appreciation (LALCX) into Lord Abbett Growth Leaders (LGLAX) in late spring, 2013.

Munder International Equity (MUIAX) is merging into Munder International Core Equity (MAICX).

Natixis Absolute Asia Dynamic Equity (DEFAX) liquidated in December. (No one noticed.)

TCW Global Flexible Allocation Fund (TGPLX) and TCW Global Moderate Allocation Fund (TGPOX) will be liquidated on or about February 15, 2013. Effective the close of business on February 8, 2013, the Funds will no longer sell shares to new investors or existing shareholders. These consistent laggards, managed by the same team, had only $10 million between them. Durn few of those $10 million came from the managers. Only one member of the management team had as much as a dollar at risk in any of TCW’s global allocation funds. That was Tad Rivelle who had a minimal investment in Flexible.

In Closing …

Thank you all for your support in 2012. There are a bunch of numerical measures we could use. The Observer hosted 78,645 visitors and we averaged about 11,000 readers a month. Sixty folks made direct contributions to the Observer and many others picked up $88,315.15 worth of cool loot (3502 items) at Amazon. And a thousand folks viewed something like 1.6 million discussion topics.

But, in many ways, the note that reads “coming here feels like sitting down with an old friend and talking about something important” is as valuable as anything we could point to.

So thanks for it all.

If you get a chance and have a suggestion about how to make the Observer better in the year ahead, drop me a note and let me know. For now, we’ll continue offering (and archiving) our monthly conference calls. During January we’ll be updating our small cap profiles and February will see new profiles for Whitebox Long Short Equity (WBLSX) and PIMCO Short Asset Investment (PAIUX).

Until then, take care.

With hopes for a blessed New Year,

Mutual Funds That Beat The Market

From the Mutual Fund Observer discussion board, December 2012, compiled from original five parts

Wise advice by MJG in the recent post “Will you revise your fund holdings going into 2013, regardless of “fiscal cliff”, etc.?” got me thinking…

He said, “The accumulated data finds that only a small percentage of wizards beat their proper benchmarks annually, and that percentage drops precipitously as the time horizon is expanded. Superior performance persistence is almost nonexistent.”

So I dug into it a bit. Here are the results, divided into five sections: Summary, Equity, Asset Allocation, Fixed Income, and Money Market.

Summary

The table below summarizes how many funds have beaten the market since their inception (or since Jan 1962, as far back as my Steele Mutual Fund Expert database goes). I used only whole months in the calculations so that I could be consistent with two market benchmarks, the SP500 total return (since 1970, price only before) and the 30-day Treasury Bill.

Nearly 9000 mutual funds and ETFs were evaluated. I used load adjusted returns and only the oldest share class. I apologize to the bench mark police for using only SP500 and T-Bill. Nonetheless, I find the results interesting.

First, MJG is right. Less than half of all equity funds have beaten the SP500 over their life times; in fact, one in four have not even beaten the T-Bill, which means their Sharpe Ratios are less than zero!

Second, nearly all fixed income funds have beaten T-Bill performance, which is re-assuring, but fuels the perception that you can’t lose money with bonds. The money market comparison is a bit skewed, because many of these funds are tax exempt. Still, expense ratios must be having their negative effect as only one in five such funds beat the T-Bill.

Digging a bit further, I looked at how the funds did by inception date. Here is a result I can’t yet explain and would ask for the good help on MFO to better understand. It seems like the period from 1998 to 2002, which book-end the tech bubble, is a golden age, if you will, for funds, as more than 60% of the funds initiated during this period have beaten the SP500 over their life times. That’s extraordinary, no? I thought maybe that it was because they were heavily international, small cap, or other, but I have not yet found the common thread for the superior performance.

On the other hand, the period from 1973 to 1982 was abysmal for funds, since only one in ten equity funds created during these years have beaten the SP500 over their life times. And it is not much better between 1983 and 1992.

I next broke-out this same performance by type: equity, asset allocation, fixed income, and money market:

Note that fixed income funds helped contribute to the “golden period” as more than a quarter of those incepted between 1998 and 2000 beat the SP500.

Some other interesting points:

Relatively few money market funds have been created since the cash bull run of the ’80s.
But otherwise, fund creation is alive and well, with nearly 2000 funds established in the past three years, which accounts for one fifth of all funds in existence.
Fixed income fund performance has dropped a bit this year with 15 out of 100 losing money.

I next looked at the best and worst performers in their respective time frames.

Best being top three funds, typically, producing highest APR relative to SP500 for equity and asset allocation types and relative to T-Bill for fixed income and money market types, color coded purple. Best also includes funds with highest Sharpe Ratios, color coded blue, when different from top APR funds. Again, I tried to pick three if there were enough funds for the inception period evaluated. Worst being relative APR, color coded yellow.

I included other notables based on David’s fund profiles (there are nearly 70 in the index), suggestions by other MFO folks, a few runner-ups, and some funds of my own interest.

First up, equity funds…

Equity Funds

Some items that jump out:

ETFs take top and bottom APR slots in recent years, but their volatility is frighteningly high.
If you invested $10,000 in Fidelity Magellan Fund FMAGX in June of 1963 (fourteen years prior to Peter Lynch’s rein), you are looking at more than $15 million today. Can you believe? Of course, to MJG’s point, the fund’s best years were in the ’60’s when it had two 10er years, then again during Lynch’s reign from 1977 to 1990, when it averaged more than 29% APR. Unfortunately, you have less money today than you did in 2000.
Oceanstone Fund OSFDX made all its gains in 2009 with an extraordinary 264% return. That said, it avoided the 2008 financial collapse with only a -10% loss versus -37% for the SP500, and it retains the highest Sharpe Ratio of ALL funds five years or older, except PIMCO Equity Series Long/Short Institutional PMHIX. And, the mysterious OSFDX is up about 21% YTD or 7% higher than the SP500.
Four notable funds score top life time Sharpe Ratio for their periods, but did not beat the SP500: Calamos Market Neutral Income A CVSIX and Merger MERFX, both 20+ year funds, Gabelli ABC AAA GABCX, a 15+ year fund, and AQR Diversified Arbitrage I ADAIX, a 3+ year fund. I would think all would be considered as alternatives to bond funds. (Note: MERFX and GABCX are both no load and open to new investors.)
Similarly, Pinnacle Value PVFIX from the 7+ year class, MainStay Marketfield I MFLDX from the 5+ year class, and The Cook & Bynum Fund COBYX from the 3+ year class all have superior life time Sharpe performance with STDEVs less than SP500.
On the other hand, Evermore Global Value A EVGBX is not yet living up to expectations. It was first reviewed on MFO in April 2011. Guinness Atkinson Alternative Energy GAAEX is doing downright terribly. It was first reviewed in FundAlarm in September 2007.

Next up, a review of asset allocation…

Asset Allocation Funds

Asset allocation or so-called balanced funds, of which there are more than 1200 (oldest share class only). This type of fund can hold a mixed portfolio of equities, bonds, cash and/or property.

I followed consistent methodology used for the equity funds.

Again, I realize that balanced funds do not use either SP500 or T-Bill as a benchmark, but nonetheless I find the comparison helpful. More than one in four such funds actually have beaten the SP500 over their life times. It’s a bit re-assuring to me, since these funds typically have lower volatility. And, nearly nine in ten have done better than cash.

In the tabulation below, purple means the fund was a top performer relative to SP500 over its life time, blue represents highest Sharpe (if not already a top APR), and yellow represents worst performing APR. I included other notables based on David’s commentaries, past puts by catch22, scott, and other folks on MFO, and some funds of my own interest.

Here’s the break-out, by inception date:

Some observations:

If you invested $10K in Mairs & Power Balanced MAPOX in Jan 1962, you would have more than $1M today and nearly four times more than if you had invested in American Funds American Balanced ABALX. But ABALX has $56B AUM, while the five star MAPOX has attracted less than $300M.
Value Line Income & Growth VALIX does not even warrant coverage by M*.
2008 was a really bad year.
Some attractive ETFs have started to emerge in this generally moderate fund type, including iShares Morningstar Multi-Asset Income IYLD.
Putnam Capital Spectrum A PVSAX, managed by David Glancy, has outperformed just about everybody in this category since its inception mid 2009.
RiverNorth Core Opportunity RNCOX, first reviewed on MFO in June 2011, has had a great run since its inception in 2007. Unfortunately, its availability is now limited.

Next up, fixed income funds.

Fixed Income Funds

A review of fixed income funds, which for this post includes funds that invest in government or corporate bonds, loan stock and non-convertible preferred stock. This type of fund has been getting considerable attention lately on MFO with a growing concern that investors could be lulled into false sense of security.

To recap a little, there are about 1880 funds of this type, of which 30% have actually delivered higher life-time returns than the SP500, and more importantly and relevant, 98% have beaten cash.

In the tabulation below, purple means the fund was a top performer relative to T-Bill over its life time, blue represents highest Sharpe (if not already a top APR), and yellow represents worst performing APR. I included other notables based on David’s profiles, numerous suggestions in the various threads by MFO readers (bee, catch22, claimui, fundalarm, hank, Hiyield007, Investor, johnN, MaxBialystock, MikeM, Mona, msf, Old_Joe, scott, Shostakovich, Skeeter, Ted and others), and some of my own interest.

A reminder that I only used oldest share class, so for popular funds like PONDX, you will find PONAX, similarly MAINX is MINCX, etc.

Here’s the break-out, by fund inception date:

Some observations:

Every fund listed (5 years or older) with current yields of 6% or more, lost more than 20% of its value in 2008, except three: PIMCO Income A PONAX, which lost only 6.0%; TCW Total Return Bond I TGLMX, which lost only 6.2% (in 1994); and First Eagle High Yield I FEHIX, which lost 15.8%.
In fact, of all fixed income funds more than five years or older that have current yields of 6% or more, nearly 3 out of 4 had a down-year of 20% or more. Those yielding 5% or more did not do much better. For what it’s worth, the break point appears to be between 4 and 5%. Funds with less than 4% current yield did much, much better. Here is summary…

Just glance over the list…you will see that PIMCO has produced many top performing fixed income funds.
Fortunately, again, nearly every fixed income fund existing today has beaten cash over its life time, some 98%. The 44 funds with negative Sharpe actually fall into two distinct categories: First, those with negative Sharpe, but positive life-time APR. These are generally funds with short duration and/or tax exempt funds. Second, those with negative Sharpe and negative life-time APR. There are 25 such funds, but it’s reassuring to find only 3 older than three years old, which presumably means fixed income funds that actually lose money don’t stay around very long. The three enduring poor performers, tabulated below, are: AMF Ultra Short AULTX, SEI Instl Mgd Enhanced Income A SEEAX, and WisdomTree Euro Debt EU.

Both AULTX and EU have less than $10M AUM, but SEEAX is fairly substantial AUM at $170M, which is simply hard to believe…

Money Market Funds

The last part – money market funds, which tend to offer lowest risk, but with attendant lowest return over the long run. There have been times, however, when money market or “cash” has ruled, like from 1966 – 1984 when cash provided a strong 7.8% APR. Here’s a reminder from Bond Fund Performance During Periods of Rising Interest Rates:

Some observations up-front:

There are only 500 or so money market funds.
The earliest inception date is 1972. It belongs to American Century Capital Presv Investor CPFXX. (But it is not one of better offerings.)
Few new money market funds have been created in recent years.
Few MFO readers discuss them and none have been profiled. M* does not appear to rate them or provide analyst reports of money market funds.
No money market funds have loads, but many impose 12b-1 fees. The average EP is 0.5%.
Fortunately, none have a negative absolute return over their life times.
There are two main categories of money market funds: taxable and tax-free. The latter have existed since 1981 and represent about a third of offerings today. This plot summarizes average performance for the two types compared to the T-Bill:

Since 1981, the annualized return for T-Bill is 5.0%. For money market funds, the average APR is 4.6% for the taxable (about the difference in average EP), and 2.9% for tax-free.
Only 1 in 3 taxable money market funds have beaten the T-Bill over their life times. And virtually no tax-free funds have beaten, as you would expect.

Because of the strong tax dependency with these funds, I broke out this distinction in the tabulation below. Purple means the fund was a top performer relative to T-Bill over its life time, and yellow represents worst performing APR. (For the money market funds, I did not break-out top Sharpe in blue, since APR ranking relative T-Bill is fairly close to Sharpe ranking.)

Here’s the break-out, by fund inception date:

For those interested, I’ve posted results of this thread in an Excel file Funds That Beat The Market – Nov 12.

Here is link to original thread.

August 1, 2012

Dear friends,

Welcome to the Summer Break edition of the Mutual Fund Observer. I’m writing from idyllic Ephraim, Wisconsin, a beautiful little village in Door County on the shores of Green Bay. Here’s a quick visual representation of how things are going:

Thanks to Kathy Glasnap, a very talented artist who has done some beautiful watercolors of Door County, for permission to use part of one of her paintings (“All in a Row”). Whether or not you’ve (yet) visited the area, you should visit her gallery online at http://www.glasnapgallery.com/

Chip, Anya, Junior and I bestirred ourselves just long enough to get up, hit <send>, refill our glasses with sangria and settle back into a stack of beach reading and a long round of “Mutual Fund Truth or Dare.” (Don’t ask.)

In celebration of the proper activities of summer (see above), we offer an abbreviated Observer.

MFO in Other Media: David on Chuck Jaffe’s MoneyLife Radio Show

I’ll be the first to admit it: I have a face made for radio and a voice made for print. Nonetheless, I was pleased to make an appearance on Chuck Jaffe’s MoneyLife radio show (which is also available as a podcast). I spoke about three of the funds that we profiled this month, and then participated in a sort of “stump the chump” round in which I was asked to offer quick-hit opinions in response to listener questions.

Dodge & Cox Global Stock (DODWX) for Rick in York, Pa. It’s easy to dismiss DODWX if you’ve give a superficial glance at its performance. The fund cratered immediately after launch in 2008 when the managers bought financial stocks that were selling at a once-in-a-generation price only to see them fall to a once-in-a-half-century price. But those purchases set up a ferocious run in 2009. It was hurt in 2011 by an oversized emerging markets stake which paid off handsomely in the first quarter of 2012. It’s got a great management team and an entirely sensible investment discipline. It’ll be out-of-step often enough but will, in the long run, be a really good investment.

Fidelity Emerging Markets (FEMKX) for Brad in Cazenovia, NY. My bottom line was “it’s not as bad as it used to be, but there’s still no compelling reason to own it.” If you’re investing with Fido, their new Fidelity Total Emerging Markets (FTEMX) is a more much intriguing option.

Leuthold Core Investment (LCORX) for Scott in Redmond, Ore. This was the original go-anywhere fund, born of Leuthold’s sophisticated market analysis service. Quant driven, quite capable of owning pallets of lead or palladium. Brilliant for years but, like many computer-driven funds, largely hamstrung lately by the market’s irrational jerks and twitches. If you anticipate a return to a more-or-less “normal” market where returns aren’t driven by fears of the Greeks, it’s likely to resume being an awfully attractive, conservative holding.

Matthews Asia Dividend Fund (MAPIX) for Robert in Steubenville, Ohio. With Matthews Asian Growth & Income (MACSX), this fund has the best risk-return profile of any Asian-focused fund. The manager invests in strong companies with lots of free cash flow and a public commitment to their dividend. What it lacks in MACSX’s bond and convertibles holdings, it makes up for in good country selection and stock picking. If you want to invest in Asia, Matthews is the place to start.

T. Rowe Price Capital Appreciation (PRWCX) for Dennis in Strongsville, Ohio. PRWCX usually holds about 65% of the portfolio in large, domestic dividend-paying stocks and a third in other income-producing securities. Traditionally the fund held a lot of convertible securities though David Giroux, manager since 2006, has held a bit more stock and fewer converts. The fund has lost money once in a quarter century and a former manager chuckled over the recollection that Price’s internal allocation models kept coming to the same conclusion: “invest 100% in PRWCX.”

MFO in Other Media: David on “The Best Fund for the Next Six Months … and Beyond”

Early in July, John Waggoner wrote to ask for recommendations for “the remainder of 2012.” Answers from three “mutual fund experts” (I shudder) appear in John’s July 5^th column. Dan Wiener tabbed PrimeCap Odyssey Aggressive Growth (POAGX) and Jim Lowell picked Fidelity Total Emerging Markets (FTEMX). I highlighted the two most recent additions to my non-retirement portfolio:

RiverPark Short Term High Yield (RPHYX), which I described as “one of the most misunderstood funds I cover. It functions as a cash management fund for me — 3% to 4% returns with (so far) negligible volatility. Its greatest problem is its name, which suggests that it invests in short-term, high-yield bonds (which, in general, it doesn’t) or that it has the risk profile of a high-yield fund (ditto).”

David Sherman, the manager, stresses that RPHYX “is not an ATM machine.” That said, the fund returned 2.6% in the first seven months of 2012 with negligible volatility (the NAV mostly just drops with the month-end payouts). That’s led to a Sharpe ratio above 3, which is simply great. Mr. Sherman says that he thinks of it as a superior alternative to, say, laddered bonds or CDs. While in a “normal” bond market this will underperform a diversified fund with longer durations, in a volatile market it might well outperform the vast majority.

Seafarer Overseas Growth & Income (SFGIX), driven by the fact that Mr. Foster “performed brilliantly at Matthews Asian Growth & Income (MACSX), which was the least volatile (hence most profitable) Asian fund for years. With Seafarer, he’s able to sort of hedge a MACSX-like portfolio with limited exposure to non-Asian emerging markets. The strategy makes sense, and Mr. Foster has proven able to consistently execute it.”

SFGIX has substantially outperformed the average emerging-Asia, Latin America and diversified emerging markets fund in the months since its launch, though it trails MACSX. The folks on our discussion board mostly maintain a “deserves to be on the watch-list” stance, based mostly on MACSX’s continued excellence. I’m persuaded by Mr. Foster’s argument on behalf of a portfolio that’s still Asia-centered but not Asia exclusively.

Seafarer Overseas Piques Morningstar’s Interest

One of Morningstar’s most senior analysts, Gregg Wolper, examined the struggles of two funds that should be attracting more investor interest than they are, in “Two Young Funds Struggle to Get Noticed” (July 31, 2012).

One is TCW International Small Cap (TGICX) which launched in March 2011. It’s an international small-growth fund managed by Rohit Sah. Sah had “an impressive if volatile record” in seven years at Oppenheimer International Small Company (OSMAX). The problem is that Sah has a high-volatility strategy even by the standards of a high-volatility niche, which isn’t really in-tune with current investor sentiment. Its early record is mostly negative which isn’t entirely surprising. No load, $2000 investment minimum, 1.44% expense ratio.

The other is Seafarer Overseas Growth and Income (SFGIX). Wolper recognizes Mr. Foster’s “impressive record” at Matthews and his risk-conscious approach to emerging markets investing. “His fund tries to cushion the risks of emerging-markets investing by owning less-volatile, dividend-paying stocks and through other means, and in fact over the past three months it has suffered a much more moderate loss than the average diversified emerging-markets fund.” Actually, from inception through July 31 2012, Seafarer was up by 0.4% while the average emerging markets fund had lost 7.4%.

Mr. Wolper concludes that when investors’ appetite for risk returns, these will both be funds to watch:

At some point, though, certain investors will be looking for a bold fund to fill a small slot in their portfolio. Funds with modest asset bases have more flexibility than their more-popular rivals to own smaller, less-liquid stocks in less-traveled markets should they so choose. For that reason, it’s worth keeping these offerings in mind. Their managers are accomplished, and though there are caveats with each, including their cost, they feature strategies that are not easy to find at rival choices.

It’s What Makes Yahoo, Yahoo

Archaic, on the Observer’s discussion board, complained, “When I use Yahoo Finance to look at a particular fund … [its] Annual Total Return History, the history is complete through 2010 but ends there. No 2011. Anyone know why?”

The short answer is: because it’s Yahool. This is a problem that Yahoo has known about for months, but has been either unable or unmotivated to correct. Here’s their “Help” page on the problem:

I added a large arrow only because I don’t know how to add either a flashing one or an animated GIF of a guy slapping himself on the forehead. Yahoo has known about this problem for at least three months without correcting it.

Note to Marissa Mayer, Yahoo’s new CEO: Yahoo describes itself as “a company that helps consumers find what they are looking for and discover wonders they didn’t expect.” In this case, we’re looking for 2011 data and the thing we wonder about is what it says about Yahoo’s corporate culture and competence. Perhaps you might check with the folks at Morningstar for an example of how quickly and effectively a first-rate organization identifies, addresses and corrects problems like this.

Too Soon Gone: Eric Bokota and FPA International Value (FPIVX)

I had the pleasure of a long conversation with Eric Bokota at the Morningstar Investment Conference in June. I was saddened to hear that events in his private life have obliged him to resign from FPA. The FPA folks seemed both deeply saddened and hopeful that one day he’ll return. I wish him Godspeed.

Four Funds That Are Really Worth Your Time (even in summer!)

FPA International Value (FPIVX): led by Oakmark alumnus Pierre Py, FPA’s first new fund in almost 30 years has the orientation, focus, discipline and values to match FPA’s distinguished brand.

ING Corporate Leaders Trust (LEXCX): the ghost ship of the fund world sails into its 78^th year, skipperless and peerless.

RiverPark Long/Short Opportunity Fund (RLSFX): RiverPark’s successful hedge, now led by a guy who’s been getting it consistently right for almost two decades, is now available for the rest of us.

The Cook and Bynum Fund (COBYX): you think your fund is focused? Feh! You don’t know focused until you’ve met Messrs. Cook and Bynum.

The Best Small Fund Websites: Seafarer and Cook & Bynum

The folks at the Observer visit scores of fund company websites each month and it’s hard to avoid the recognition that most of them are pretty mediocre. The worst of them post as little content as possible, updated as rarely as possible, signaling the manager’s complete disdain for the needs and concerns of his (and very rarely, her) investors.

Small fund companies can’t afford such carelessness; their prime distinction from the industry’s bloated household names is their claim to a different and better relationship with their investors. If investors are going to win the struggle against the overwhelming urge to buy high and leave in a panic, they need a rich website and need to use it. If they can build a relationship of trust and understanding with their managers, they’ve got a much better chance of holding through rough stretches and profiting from rich ones.

This month, Junior and I enlisted the aid of two immensely talented web designers to help us analyze three dozen small fund websites in order to find and explain the best of them. One expert is Anya Zolotusky, designer of the Observer’s site and likely star of a series of “Most Interesting Woman in the World” sangria commercials. The other is Nina Eisenman, president of Eisenman Associates and founder of FundSites, a firm which helps small to mid-sized fund companies design distinctive and effective websites.

If you’re interested in why Seafarer and Cook & Bynum are the web’s best small company sites, and which twelve earned “honorable mention” or “best of the rest” recognition, the entrance is here!

Launch Alert: RiverNorth and Manning & Napier, P. B. and Chocolate

Two really good fund managers are combining forces. RiverNorth/Manning & Napier Dividend Income (RNMNX) launched on July 18^th. The fund is a hybrid of two highly-successful strategies: RiverNorth’s tactical allocation strategy based, in part, on closed-end fund arbitrage, and Manning & Napier’s largely-passive dividend focus strategy. Both are embedded in freestanding funds, though the RiverNorth fund is closed to new investors. There’s a lively discussion of the fund and, in particular, whether it offers any distinct value, on our discussion board. The minimum investment is $5000 and we’re likely to profile the fund in October.

Briefly Noted . . .

As a matter of ongoing disclosure about such things, I want to report several changes in my personal portfolio that touch on funds we’ve profiled or will soon profile. In my non-retirement portfolio, I sold off part of my holdings of Matthews Asian Growth and Income (MACSX) and invested the proceeds in Seafarer Overseas Growth & Income (SFGIX). As with all my non-retirement funds, I’ve established an automatic investment plan in Seafarer. In my retirement accounts, I sold my entire position in Fidelity Diversified International (FDIVX) and Canada (FICDX) and invested the proceeds in a combination of Global Balanced (FGBLX) and Total Emerging Markets (FTEMX). FDIVX has gotten too big and too index-like to justify inclusion and Canada’s new-ish manager is staggering around, and I’m hopeful that the e.m. exposure in the other two funds will be a significant driver while the fixed-income components offer some cushion. Finally, also in my retirement accounts, I sold T. Rowe Price New Era (PRENX) and portions of two other funds to buy Real Assets Fund (PRAFX). What can I say? Jeremy Grantham is very persuasive.

SMALL WINS FOR INVESTORS

A bunch of funds have tried to boost their competitiveness by cutting expenses or at least waiving a portion of them.

Cohen & Steers Dividend Value (DVFAX) will limit fund expenses to 1.00% for A shares through June 2014.

J.P. Morgan announced 9 basis point cuts for JP Morgan US Dynamic Plus (JPSAX) and JP Morgan US Large Cap Core Plus (JLCAX).

Legg Mason capped expenses on Legg Mason BW Diversified Large Cap Value (LBWAX) at between 0.85% – 1.85%, depending on share class.

Madison Investment Advisors cuts fees on Madison Mosaic Investors (MINVX) by 4 bps, Madison Mosaic Mid Cap (GTSGX) by 10, and Madison Mosaic Dividend Income (BHBFX, formerly Balanced) by 30.

Managers is dropping fees for Managers Global Income Opportunity (MGGBX), Managers Real Estate Securities (MRESX), and Managers AMG Chicago Equity Partners Balanced (MBEAX) by 11 – 16 bps.

Alger Small Cap Growth (ALSAX) and its institutional brother reopened to new investors on Aug. 1, 2012. It was once a really solid fund but it’s been sagging in recent years so your ability to get into it really does qualify as a “small win.”

CLOSINGS

Columbia Small Cap Value (CSMIX) has closed to new investors. For those interested, The Wall Street Journal publishes a complete closed fund list each month. It’s available online with the almost-poetic name, Table of Mutual Funds Closed to New Investors.

OLD WINE, NEW BOTTLES

Just as a reminder, the distinguished no-load Marketfield (MFLDX) will become the load-bearing MainStay Marketfield Fund on Oct. 5, 2012. The Observer profile of Marketfield appeared in July.

At the end of September, Lord Abbett Capital Structure (LAMAX), a billion dollar hybrid fund, will be relaunched as Lord Abbett Calibrated Dividend Growth, with a focus on dividend-paying stocks and new managers: Walter Prahl and Rick Ruvkun. No word about why.

Invesco announced it will cease using the Van Kampen name on its funds in September. By way of example, Invesco Van Kampen American Franchise “A” (VAFAX) will simply be Invesco American Franchise “A”.

Oppenheimer Funds is buying and renaming the five SteelPath funds, all of which invest in master limited partnerships and all of which have sales loads. There was a back door into the fund, which allowed investors to buy them without a load, but that’s likely to close.

OFF TO THE DUSTBIN OF HISTORY

BlackRock is merging its S&P 500 Index (MDSRX) and Index Equity (PNIEX) funds into BlackRock S&P 500 Stock (WFSPX). And no, I have no idea of what sense it made to run all three funds in the first place.

DWS Clean Technology (WRMAX) will be liquidated in October 2012.

Several MassMutual funds (Strategic Balanced, Value Equity, Core Opportunities, and Large Cap Growth) were killed-off in June 2012.

Oppenheimer is killing off their entry into the retirement-date fund universe by merging their regrettable Transition Target-Date into their regrettable static allocation hybrid funds. Oppenheimer Transition 2030 (OTHAX), 2040 (OTIAX), and 2050 (OTKAX) will merge into Active Allocation (OAAAX). The shorter time-frame Transition 2015 (OTFAX), 2020 (OTWAX), and 2025 (OTDAX) will merge into Moderate Investor (OAMIX). Transition 2010 (OTTAX) will, uhhh … transition into Conservative Investor (OACIX). The same management team oversaw or oversees the whole bunch.

Goldman Sachs took the easier way out and announced the simple liquidation of its entire Retirement Strategy lineup. The funds have already closed to new investors but Goldman hasn’t yet set a date for the liquidation. It’s devilishly difficult to compete with Fidelity, Price and Vanguard in this space – they’ve got good, low-cost products backed up by sophisticated allocation modeling. As a result they control about three-quarters of the retirement/target-date fund universe. If you start with that hurdle and add mediocre funds to the mix, as Oppenheimer and Goldman did, you’re somewhere between “corpse” and “zombie.”

Touchstone Emerging Markets Equity II (TFEMX), a perfectly respectable performer with few assets, is merging into Touchstone Emerging Markets Equity (TEMAX). Same management team, similar strategies.

In a “scraping their name off the door” move, ASTON has removed M.D. Sass Investors Services as a subadvisor to ASTON/MD Sass Enhanced Equity (AMBEX). Anchor Capital Advisors, which was the other subadvisor all along, now gets its name on the door at ASTON/Anchor Capital Enhanced Equity.

Destra seems already to have killed off Destra Next Dimension (DLGSX), a tiny global stock fund managed by Roger Ibbotson.

YieldQuest Total Return Bond (YQTRX), one of the first funds I profiled as an analyst for FundAlarm, has finally ceased operations. (P.S., it was regrettable even six years ago.)

In Closing . . .

Some small celebrations and reminders. This month the Observer passed its millionth pageview on the main site with well over two million additional pageviews on our endlessly engaging discussion board (hi, guys!). We’re hopeful of seeing our 100,000^th new reader this fall.

Speaking of the discussion board, please remember that registration for participating in the board is entirely separate from registering to receive our monthly email reminder. Signing up for board membership, a necessary safeguard against increasingly agile spambots, does not automatically get you on the email list and vice versa.

And speaking of fall, it’s back-to-school shopping time! If you’re planning to do some or all of your b-t-s shopping online, please remember to Use the Observer’s link to Amazon.com. It’s quick, painless and generates the revenue (equal to about 6% of the value of your purchases) that helps keep the Observer going. Once you click on the link, you may want to bookmark it so that your future Amazon purchases are automatically and invisibly credited to the Observer. Heck, you can even share the link with your brother-in-law.

A shopping lead for the compulsive-obsessive among you: How to Sharpen Pencils: A Practical & Theoretical Treatise on the Artisanal Craft of Pencil Sharpening for Writers, Artists, Contractors, Flange Turners, Anglesmiths, & Civil Servants (2012). The book isn’t yet on the Times’ bestseller lists, though I don’t know why.

A shopping lead for folks who thought they’d never read poems about hedge funds: Katy Lederer’s The Heaven-Sent Leaf (2008). Lederer’s an acclaimed poet who spent time working at, and poetrifying about, a New York hedge fund.

In September, we’ll begin looking at the question “do you really need to buy a dedicated ‘real assets’ fund?” T. Rowe Price has incorporated one into all of their retirement funds and Jeremy Grantham is increasingly emphatic on the matter. There’s an increasing area of fund and ETF options, including Price’s own fund which was, for years, only available to the managers of Price funds-of-funds.

We’ll look for you.

July 1, 2012

photo by rcbodden on Flickr.

Dear friends,

“Summertime and the livin’ is easy”?

“Roll out those lazy, hazy, crazy days of summer,
Those days of soda and pretzels and beer”

“That’s when I had most of my fun back …
Hot fun in the summertime.”

“In summer, the song sings itself.”

What a crock. I’m struck by the intensity of the summer storms, physical and financial. As I write, millions are without power along the Eastern seaboard after a ferocious storm that pounded the Midwest, roared east and killed a dozen. Wildfires continue unchecked in the west and the heat and drought in Iowa have left the soil in my yard fissured and hard. Conditions in the financial markets are neither better nor more settled. The ferocious last day rally in June created the illusion of a decent month, when in fact it was marked by a series of sharp, panicky dislocations.

I’m struck, too, by the ways in which our political leaders have responded, which is to say, idiotically. Republicans continue to deny the overwhelming weight of climate science. Democrats acknowledge it, then freeze for fear of losing their jobs. And both sides’ approach to the post-election fiscal cliff is the same: “let’s get through the election first.”

It’s striking, finally, how rarely the thought “let’s justify being elected” seems to get any further than “let’s convince voters that the other side is worse.”

Snippets from MIC

I had the pleasure of attending the Morningstar Investment Conference in late June. The following stories are derived from my observations there. I also had an opportunity to interview two international value managers, David Marcus of Evermore and Eric Bokota of FPA, there. Those interviews will serve as elements of an update of the Evermore Global Value profile and a new FPA International Value profile, both in August.

David Snowball at MIC, courtesy of eventtoons.com

BlackRock and the Graybeards

On Day One of the conference, Morningstar hosted a keynote panel titled “A Quarter-Century Club” in which a trio of quarter-centenarians (Susan Byrne, Will Danof and Brian Rogers) reflected in their years in the business. All three seemed to offer the same cautionary observation: “the industry has lost its moral compass.” All three referred to the pressure, especially on publicly traded firms, to “grow assets” as the first priority and “serve shareholders” somewhere thereafter.

Susan Byrne, chairman and founder of Westwood Management Corp., the investment advisor to the Westwood Funds, notes that, as a young manager, it was drilled into her head that “this is not our money.” It was money held in trust, “there are people who trust you (the manager) individually to take care for them.” That’s a tremendously important value to her but, she believes, many younger professionals don’t hear the lesson.

Will Danoff, manager of Fidelity Contrafund (FCNTX), made a thoughtful, light-hearted reference to one of his early co-workers, George. “George didn’t manage money and he didn’t manage the business. His job, so far as I can tell, was to walk up to the president every morning, look him in the eye and ask ‘how are you going to make money today for our shareholders?’ You don’t hear that much anymore.”

Brian Rogers, CIO of T Rowe Price made a similar, differently nuanced point: “when we were hired, it was by far smaller firms with a sense of fiduciary obligation, not a publicly-traded company with an obligation to shareholders. Back then we learned this order of priorities: (1) your investors first, (2) your employees and then (3) your shareholders.” In an age of large, publicly-traded firms, “new folks haven’t learned that as deeply.”

As I talk with managers of small funds, I often get a clear sense of personal connection with their shareholders and a deep concern for doing right by them. In a large, revenue-driven firm, that focus might be lost.

The extent of that loss has been highlighted by some very solid reporting by Aaron Pressman and Jessica Toonkel of Reuters. Pressman and Toonkel document what looks like the unraveling of BlackRock, the world’s largest private investment manager. In short order:

Robert Capaldi, senior client strategist for Chief Executive Laurence Fink, left.
Susan Wagner, a founding partner and vice chairman, announced her immediate retirement. Wagner had overseen much of BlackRock’s growth-through-acquisition strategy which included purchase of Barclay’s Global Investors and Merrill Lynch’s funds, a total of $2.4 trillion in assets.
Chief equity strategist Boll Doll announced his retirement (at 57) as evidence began to surface that his and BlackRock’s long-time claim of “proprietary” investment models was false.
Star energy fund manager Daniel Rice resigned in the wake of criticism of his decision to invest substantial amounts of his shareholders’ money into a firm in which he had a personal, if indirect, stake. He did so without notifying anyone outside of the firm. BlackRock, reportedly, had no explanation for investors.

Insiders report to Reuters that “further senior-level changes” are imminent.

BlackRock’s plans to double its mutual fund business in the next 18 months by targeting RIAs remain in place. Why double the business? Whose interests does it serve? BlackRock has demonstrated neither any great surplus of investment talent nor of innovative investment ideas, nor can they plausibly appeal (at $4 trillion of AUM) to “economies of scale.”

No, doubling their business is in the best interests of BlackRock executives (bonuses get tied to such things) and, likely, to BlackRock shareholders. There’s no evidence for why RIAs or fundholders are anything more than tools in BlackRock’s incessant drive from growth. The American essayist and critic Edward Abbey observed, “Growth for the sake of growth is the ideology of the cancer cell.” And, apparently, of the publicly traded megacorp.

Advice from a Conservative Domestic Equity Manager: Go Elsewhere

The Quarter Century panel of senior started talking about the equity market going forward. They were uniformly, if cautiously, optimistic. Rogers drew some parallels to the economy and market of 1982. I liked Susan Byrne’s comments rather more: “It feels like 1982 when you believed that any rally was a trap, designed to fool me, humiliate me and keep me poor.” Mr. Danoff argued that global blue chips “have absolutely flat-lined for years,” and represent substantial embedded value. They argued for pursuing stocks with growing dividends, a strategy that will consistently beat fixed income or inflation.

In closing, Don Phillips asked each for one bit of closing advice or insight. Brian Rogers, T. Rowe Price’s CIO and manager of their Equity Income fund (PRFDX) offered these two:

1. it’s time to remember Buffett’s adage, “be fearful when others are greedy, and greedy when others are fearful.”

and

2. “take a look at the emerging markets again.”

That’s striking advice, given Mr. Rogers’ style: he’s famously cautious and consistent, invests in large dividend-paying companies and rarely ventures abroad (5% international, 0.25% emerging markets). He didn’t elaborate but his observation is consistent with the recurring theme, “emerging markets are beginning to look interesting again.”

Note to the Scout Funds: “See Grammarian”

The marketing slogan for the Scout Funds is “See Further.” Uhhh .. no. “Farther.” In this usage, “further” would be “additional,” as in “see further references in the footnotes.” Farther refers to distance (“dad, how much farther is it?”) which is presumably what would concern a scout.

Scout’s explanation for the odd choice: “One of our executives wanted ‘See Farther’ but discovered that some other fund company already used it and so he went with ‘See Further’ instead.”

I see.

No, I don’t. First, I can’t find a record for the “see farther” motto (though it is plausible) and, second, that still doesn’t justify an imprecise and ungrammatical slogan.

Kudos to Morningstar: They Get It Right, and Make It Right, Quickly

In June I complained about inconsistencies in Morningstar’s data reports on expense ratios and turnover, and the miserable state of the Securities and Exchange Commission database.

The folks at Morningstar looked into the problems quite quickly. The short version is this: fund filings often contain multiple versions of what’s apparently the same data point. There are, for example, a couple different turnover ratios and up to four expense ratios. Different functions, developed by different folks at different times, might inadvertently choose to pull stats from different places. Mr. Rekenthaler described them as “these funny little quirks where a product somewhere sometime decided to do something different.” Both stats are correct but also inconsistent. If they aren’t flagged so that readers can understand the differences, they can also be misleading.

Morningstar is interested in providing consistent, system-wide data. Both John Rekenthaler, vice president of research, and Alexa Auerbach in corporate communications were in touch with us within a week. Once they recognized the inconsistency, they moved quickly to reconcile it. Rekenthaler reports that their data-improvement effort is ongoing: “senior management is on a push for Morningstar-wide consistency in what data we publish and how we label the data, so we should be ferreting out the remaining oddities.” As of June 19, the data had been reconciled. Thanks to the Wizards on West Wacker for their quick work.

FBR Funds Get Sold, Quickly

On June 26 2012, FBR announced the sale of their mutual fund unit to Hennessy Advisors. Of the 10 FBR funds, seven will retain their current management teams. The managers of FBR’s Large Cap, Mid Cap and Small Cap funds are getting dumped and their funds are merging into Hennessy funds. One of the mergers (Large Cap) is likely a win for the investors. One of the mergers (Mid Cap) is a loss and the third (Small Cap) has the appearance of a disaster.

FBR Large Cap (FBRPX, 1.25% e.r., 9.2% over three years) merges into Hennessy Cornerstone Large Growth (HFLGX), three year old large value fund, 1.3% e.r., 13.8% over 3 years. Win for the FBR shareholders.

FBR Mid Cap (FBRMX, 1.35% e.r., five year return of 3.0%) merges into Hennessy Focus 30 (HFTFX), midcap fund, 1.36% e.r., five year return of 1.25%. Higher minimum, same e.r., lower returns – loss for FBR shareholders.

FBR Small Cap (FBRYX, 1.45% e.r., five year return of 4.25%) merges into Hennessy Cornerstone Growth (HGCGX), small growth fund, 1.33% e.r., five year return of (8.2). Huh? Slightly lower expenses but a huge loss in performance. The 1250 basis point difference is 5-year performance does not appear to be a fluke. The Hennessy fund is consistently at the bottom of its peer group, going back a decade. The fact that founder and CIO Neil Hennessy runs Cornerstone Growth might explain the decision to preserve the weaker fund and its strategy. This is a clear “run away!” for the FBR shareholders.

One alternative for FBRYX investors is into FBR’s own Small Cap Financial fund (FBRSX), run by Dave Ellison, FBR’s CIO. Ellison’s funds used to bear the FBR Pegasus brand. The fund only invests in the finance industry, but does it really well. That said, it’s more expensive than FBRYX with weaker returns, reflecting the sector’s disastrous decade.

The fate of FBR’s Gas Utility Index fund (GASFX) is unclear. The key question is whether Hennessy will increase fees. An FBR representative at Morningstar expressed doubt that they’d do any such thing.

The Long-Short Summer Series: Trying to Know if You’re Winning

As part of our summer series on long-short funds, we look this month at the performance of the premier long-short funds, of interesting newcomers, and of two benchmarks.

The challenge is to know when you’re winning if your goal is not the easily measurable “maximum total return.” With long-short funds, you’re shooting for something more amorphous, akin to “pretty solid returns without the volatility that makes me crazy.” In pursuit of funds that meet those criteria, we looked at the performance of long-short funds on one terrible day (June 1) and one great day (June 29), as well as during one terrible month (May 2012) and one really profitable period (January – June, 2012).

We looked at the return of Vanguard’s Total Stock Market Index fund for each period, and highlighted (in green) those funds which managed to lose half as much as the market in the two down periods (May and June 1) but gain at least two-thirds of the market in the two up periods. Here are the results, sorted by 2012 returns.

	May 2012 (down)	June 1 (down)	June 29 (up)	2012, through July 1
Royce Opportunity Select	(6.3)	(4.0)	2.9	16.8
RiverPark Long Short Oppy	(5.3)	(2.0)	1.6	16.7 – mostly as a hedge fund
Vanguard Total Stock Market	(6.2)	(2.6)	2.6	9.3
Marketfield	(0.1)	(2.25)	1.2	8.8
Vanguard Balanced Index	(3.3)	(1.4)	1.5	6.5
Robeco Long Short	(0.6)	0.1	0.3	6.1
Caldwell & Orkin Market Oppy	0.1	(2.3)	1.5	4.7
ASTON/River Road Long Short	(3.1)	(0.2)	1.8	4.6
Bridgeway Managed Volatility	(2.4)	(1.8)	1.6	4.2
James Long Short	(3.0)	(0.9)	0.7	4.0
Robeco Boston Partners Long/Short Research		(4.8)	1.25	3.8
RiverPark/Gargoyle Hedged Value	(5.5)	(2.2)	1.4	2.7 – mostly as a hedge fund
Schwab Hedged Equity	(3.3)	(1.7)	1.9	2.5
GRT Absolute Return	(2.0)	(0.1)	1.4	1.7
Wasatch Long-Short	(6.3)	(1.3)	2.0	1.3
Forester Value	(0.5)	0.25	0.8	1.2
ASTON/MD Sass Enhanced Equity	(4.4)	(0.6)	1.5	1.1
Turner Spectrum	(2.5)	(0.6)	0.4	(0.1)
Paladin Long Short	(0.9)	(0.1)	0.1	(1.9)
Hussman Strategic Growth	2.8	1.3	(1.3)	(7.6)

As we noted last month, in comparing the long-term performance of long-short funds to a very conservative bond index, consistent winners are hard to find. Interesting possibilities from this list:

RiverPark Long Short Opportunity (RLSFX), which converted from an in-house hedge fund in March and which we’ll profile in August.

Marketfield (MFLDX), the mutual fund version of a global macro hedge fund, which we’re profiling this month.

ASTON/River Road Long Short (ARLSX), a disciplined little fund that we profiled last month.

New on our radar is Robeco Boston Partners Long/Short Research (BPRRX), sibling to the one indisputable gold-standard fund in the group, Robeco Long Short (BPLEX). While the two follow the same investment discipline, BPLEX has a singular focus on small and micro stocks while BPRRX has a more traditional mid- to large-cap portfolio.

The chart below tracks BPPRX against its peer group average (orange) and the group’s top funds, including BPLEX (green), Marketfield (burgundy), and Wasatch (gold). BPPRX itself is the blue line.

Since inception, BPRRX has been (1) well above average and (2) well below BPLEX. It’s worth further research.

FundReveal perspective on Long-Short funds

Our collaborators at FundReveal are back, and are weighing-in with a discussion of long-short funds based on their fine-grained daily volatility and return data. Their commentary follows, and is expanded-upon at their blog.

Nearly all of the Long-Short funds examined exhibit consistently low risk. Many of them also beat the S&P 500’s Average Daily Returns. Of the six funds analyzed by David (see bullets below) those rated as “A-Best” in one year most often beat the S&P in total returns the next year, a finding consistent with the out-of-sample forward testing that we have conducted for the entire market.

One thing that remains surprising is that the Long-Short funds great idea hasn’t really panned out. It makes such sense to use all positive and negative information about companies and securities available when investing. Doesn’t only investing long leave “money [information] on the table.” But, in general, these funds have not delivered on that perceived potential.

BPLSX, Robeco Boston Partners Long/Short Fund has been delivering. We agree with David that it can be seen as the gold standard. From FundReveal’s perspective, the fund has persistently delivered “A-Best” performance, beating the S&P on both risk and return measures. Since 2005 the fund has been rated A-Best six times and C twice. This includes a whopping 82% total return in 2009. In 2009, 2010, and 2011 positive total returns followed A Best risk return rating in the preceding year. Don’t get too excited: the fund is closed.

David has commented or will comment on the following funds in the Mutual Fund Observer.

ARLSX – Aston/River Road Long/Short
FMLSX – Wasatch 1st Source Long/Short
MFLDX – Marketfield Fund
AMBEX – Aston/River Long/Short
JAZZX – James Advantage Long/Short
GRTHX – GRT Absolute Return Fund

Good:

The two funds with positive investment decision-making attributes based on the FundReveal model are FMLSX and MFLDX. Both persistently deliver A-Best risk-return performance, and relatively high Persistence Ratings, a measurement of the likelihood of A performance in the future: FMLSX: 40%, and MFLDX: 44%.

Not so Good:

JAZZX has demonstrated high Volatility and low Average Daily Return relative to its peers and the S&P. It has only been in existence a short time; we have data from 2011 and 2012 YTD, but it is not faring well. A wait and see position is probably justified.

Some additional candidates for consideration garnered from the FundReveal “Best Funds List” (free the FundReveal site).

VMNFX Vanguard Market Neutral Fund. A solid low risk fund with 45% Persistence. It has not hit the ball out of the park, but the team is demonstrating good decision- making as inferred from FundReveal measurements.

ALHIX American Century Equity Market Neutral Fund. A solid fund with 4% volatility, market beating Average Daily Return in 2011, and Persistence of 44%.

FLSRX Forward Long/Short Credit Analysis Fund. This fund may not even belong in this discussion since the others are stock funds. Morningstar classifies this as an alternative bond fund. Its portfolio is nearly exclusively Muni Bonds. It is 34% Short and 132% Long in the Muni Bonds that make up 99% of its portfolio. It has low Volatility, high Average Daily Return, Persistence Rating of 44%, and extraordinary performance in down markets (32% above the S&P).

A complete version of this analysis with tables and graphics is available on the FundReveal blog.

Best of the Web: Our Summer Doldrums Edition

Our contributing editor, Junior Yearwood, in collaboration with financial planner Johanna Fox-Turner have fine-tuned their analysis of retirement income calculators, a discussion they initiated last month. In addition, Junior added a review of Chuck Jaffe’s new MoneyLife podcast. Drop by Best of the Web to sample both!

Two Funds and Why They’re Really Worth Your While

Each month, the Observer profiles between two and four mutual funds that you likely have not heard about, but really should have. Our “Most intriguing new funds: good ideas, great managers” do not yet have a long track record, but have other virtues which warrant your attention. They might come from a great boutique or be offered by a top-tier manager who has struck out on his own. The “stars in the shadows” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought. Two intriguing funds are:

Seafarer Overseas Growth & Income (SFGIX): Andrew Foster, who performed brilliantly as a risk-conscious emerging Asia manager for Matthews, is now leading this Asia-centric diversified emerging markets fund. It builds on his years of experience and maintains its cautiousness, while adding substantial flexibility.

Marketfield (MFLDX): there are two reasons to read, now and closely, about Marketfield. One, it’s about the most successful alternative-investment fund available to retail investors. Two, it’s just been bought by New York Life and will be slapped with a front-end load come October. Investors wanting to maintain access to no-load shares need to think, now, about their options.

Rest in Peace: Industry Leaders Fund (ILFIX)

I note with sadness the closing of Industry Leaders fund, a small sensible fund run by Gerry Sullivan, a remarkably principled investor. The fund identified industries in which there was either one or two dominant players, invested equally in them and rebalanced periodically. The idea (patented) was to systematically exclude sectors where leaders never emerged or were quickly overthrown. The fund did brilliantly for the first half of its existence and passably in the second half, weighed down by exposure to global financial firms, but never managed any marketing track.

Sullivan continues as the (relatively new) manager of Vice Fund (VICEX), which has a long and oddly-distinguished record.

Briefly noted …

Several months ago we reported on the Zacks fund rating service, noting that it was sloppy, poorly explained, unclear, and possibly illogical. Doubtless emboldened by our praise, Mitch and Ben Zacks have launched two ETFs: Zacks Sustainable Dividend ETF and Zacks MLP ETF. There’s no evident need for either, an observation quite irrelevant in the world of ETFs.

Small Wins for Investors

Schwab reduced the expense ratio on Laudus Small-Cap MarketMasters (SWOSX) by 10 basis points and Laudus International MarketMasters (SWOIX) by 19 basis points.

Forward Frontier Strategy (FRNMX) has capped the fund’s expenses at 1.09 – 1.49%, depending on share class.

The three Primecap Odyssey funds (Stock POSKX, Growth POGRX and Aggressive Growth POAGX) have all dropped their 2% redemption fees. That’s not really much of a win for investors since the redemption fees are designed to discourage rapid trading of fund shares (which is a bad thing), but I take what small gains I can find.

Touchstone Emerging Markets Equity (TEMAX) has reopened to new investors after 16 months.

Former Seligman Manager in Insider-Trading Case

The SEC announced that former Seligman Communications and Information comanager Reema Shah pled guilty to securities fraud and is barred permanently from the securities industry. The SEC says that Shah and a Yahoo (YHOO) executive swapped insider tips and that the Seligman fund she comanaged and others at the firm netted a $389,000 profit from trading based on insider information on Yahoo.

Farewells

Gary Motyl, chief investment officer for the Franklin, Templeton, and Mutual Series fund families, passed away. Motyl was one of Sir John Templeton’s first hires and he’s been Franklin’s CIO for 12 years. Pending the appointment of a new CIO later this summer, his duties are being covered by three other members of Franklin’s staff.

Closings

Delaware Select Growth (DVEAX) closed to new month on June 8th.

Franklin Double Tax-Free Income (FPRTX) initiated a soft close on June 15^th and will switch to a hard close on August 1^st.

Prudential Jennison Health Sciences (PHLAX) closed on June 29^th after siphoning up $300 million in 18 months.

For those interested, The Wall Street Journal publishes a complete closed fund list each month. It’s available online with the almost-poetic name, Table of Mutual Funds Closed to New Investors.

Old Wine, New Bottles

JPMorgan Asia Pacific Focus has changed its name to JPMorgan Asia Pacific (JASPX). The management of the team will be Mark Davids and Geoff Hoare.

Columbia Strategic Investor (CSVAX) will be renamed Columbia Global Dividend Opportunity. Actually it will become an entirely different fund under the guise of being “tweaked.” I love it when they do that. The former small cap and convertibles fund gets reborn as an all-cap global stock fund benchmarked against the MSCI All World Country Index. CSVAX’s managers have been fired and replaced by a team of guys who already run six other Columbia funds.

Ivy International Balanced (IVBAX) is being renamed Ivy Global Income Allocation. It also picked up a second manager.

Off to the Dustbin of History

September will be the last issue of SmartMoney, a magazine once head-and-shoulders sharper and more data-driven than its peers. According to a phone rep for SmartMoney, Dow is likely to convert SmartMoney.com into a pay site. Dow will, they promise, “beef up” the online version and add editorial staff. Plans have not yet been made final, but it sounds like SmartMoney subscribers will get free access to the site and might get downloadable versions of the articles.

It was a busy month for Acadia Principal Conservation Fund (APCVX). On June one, the board cut its offensively high 12(b)1 fee in half (to an industry-standard 0.25%) and dropped its expense ratio by 10 basis points. On June 25^th, they closed and liquidated the fund. On the upside, the fund (mostly) preserved principal in its two years of existence. On the downside, it made no money for its investors and had a negative real return. Still, that doesn’t speak to the coherence of their planning.

Effective June 1, Bridgeway Aggressive Investors 2 (which I once dubbed “Bridgeway Not Quite So Aggressive Investors”) and Micro-Cap Limited both ceased to exist, having merged into Aggressive Investors 1 (BRAGX) and Ultra-Small Company (BRUSX). Both of the remaining funds had long, brilliant runs before getting nailed in recent years by the apparent implosion of Bridgeway’s quant models.

Fido plans to merge Fidelity Advisor Stock Selector All Cap (FARAX) into Fidelity Stock Selector All Cap (FDSSX), which would lead to an expense reduction for the Advisor shareholders. By year’s end, Fidelity will merge Mid Cap Growth (FSMGX) into Stock Selector Mid Cap Fund (FSSMX). They’ve already closed Mid Cap Growth in preparation for the move.

JPMorgan Asia Equity (JAEAX) is being liquidated on July 20, 2012. It’s a bad fund that has seen massive outflows. The managers, nonetheless, will remain with JPMorgan.

Nuveen Large Cap Value (FASKX) merges into Nuveen Dividend Value (FFEIX), also in October. That’s a win for Large Cap shareholders: they get the same management team and a comparable strategy with lower expenses.

Oppenheimer Fixed Income Active Allocation (OAFAX) will merge into Oppenheimer Global Strategic Income (OPSIX) in early October, 2012.

Victory Value (SVLSX), which spiraled from mediocre to awful in the last two years, will liquidate at the end of August. Friends and mourners still have access to Victory Special Value (SSVSX, a weak mid-cap growth fund) and Victory Established Value (VETAX, actually very solid mid-cap value fund).

I’m off to Washington for the Fourth of July week with family. Preparation for that trip and ten days of often-hectic travel in June kept me from properly thanking several contributors (thanks! A formal acknowledgement is coming!) and from completing profiles of a couple fascinating funds: Cook and Bynum (COBYX) and FPA International (FPIVX), one of which will be part of a major set of new profiles in August.

Until then, take care, keep cool and celebrate family!

Bretton Fund (BRTNX) – February 2012

Objective and Strategy

The Bretton Fund seeks to achieve long-term capital appreciation by investing in a small number of undervalued securities. The fund invests in common stocks of companies of all sizes. It normally holds a core position of between 15 to 20 securities whose underlying firms combine a defensible competitive advantage, relevant products, competent and shareholder-oriented management, growth, and a low level of debt. The manager wants to invest “in ethical businesses” but does not use any ESG screens; mostly he avoids tobacco and gaming companies.

Adviser

Bretton Capital Management, LLC. Bretton was founded in 2010 to advise this fund, which is its only client.

Manager

Management’s Stake in the Fund

Mr. Dodson has over a million dollars invested in the fund. As of April 5, 2011, Mr. Dodson and his family owned about 75% of the fund’s shares.

Opening date

September 30, 2010.

Minimum investment

$5000 for regular accounts, $1000 for IRAs or accounts established with an automatic investment plan. The fund’s available for purchase through E*Trade and Pershing.

Expense ratio

1.5% on $3 million in assets.

Comments

Mr. Dodson is an experienced investment professional, pursuing a simple discipline. He wants to buy deeply discounted stocks, but not a lot of them. Where some funds tout a “best ideas” focus and then own dozens of the same large cap stocks, Bretton seems to mean it when he says “just my best.”

As of 9/30/11, the fund held just 15 stocks. Of those, six were large caps, three mid-caps and six small- to micro-cap. His micro-cap picks, where he often discerns the greatest degree of mispricing, are particularly striking. Bretton is one of only a handful of funds that owns the smaller cap names and it generally commits ten or twenty times as much of the fund’s assets to them.

In addition to being agnostic about size, the fund is also unconstrained by style or sector. Half of the fund’s holdings are characterized as “growth” stocks, half are not. The fund offers no exposure at all in seven of Morningstar’s 11 industry sectors, but is over weighted by 4:1 in financials.

This is the essence of active management, and active management is about the only way to distinguish yourself from an overpriced index. Bretton’s degree of concentration is not quite unprecedented, but it is remarkable. Only six other funds invest with comparable confidence (that is, invests in such a compact portfolio), and five of them are unattractive options.

Biondo Focus (BFONX) holds 15 stocks and (as of January 2012) is using leverage to gain market exposure of 130%. It sports a 3.1% e.r. A $10,000 investment in the fund on the day it launched was worth $7800 at the end of 2011, while an investment in its average peer for the same period would have grown to $10,800.

Huntington Technical Opportunities (HTOAX) holds 12 stocks (briefly: it has a 440% portfolio turnover), 40% cash, and 10% S&P index fund. The expense ratio is about 2%, which is coupled with a 4.75% load. From inception, $10,000 became $7200 while its average peer would be at $9500.

Midas Magic (MISEX). The former Midas Special Fund became Midas Magic on 4/29/2011. Dear lord. The ticker reads “My Sex” and the name cries out for Clara Peller to squawk “Where’s The Magic?” The fund reports 0% turnover but found cause to charge 3.84% in expenses anyway. Let’s see: since inception (1986), the fund has vastly underperformed the S&P500, its large cap peer group, short-term bond funds, gold, munis, currency . . . It has done better than the Chicago Cubs, but that’s about it. It holds 12 stocks.

Monteagle Informed Investor Growth (MIIFX) holds 12 stocks (very briefly: it reports a 750% turnover ratio) and 20% cash. The annual report’s lofty rhetoric (“The Fund’s goal is to invest in these common stocks with demonstrated informed investor interest and ownership, as well as, solid earnings fundamentals”) is undercut by an average holding period of six weeks. The fund had one brilliant month, November 2008, when it soared 36% as the market lost 10%. Since then, it’s been wildly inconsistent.

Rochdale Large Growth (RIMGX) holds 15 stocks and 40% cash. From launch through the end of 2011, it turned $10,000 to $6300 while its large cap peer group went to $10,600.

The Cook & Bynum Fund (COBYX) is the most interesting of the lot. It holds 10 stocks (two of which are Sears and Sears Canada) and 30% cash. Since inception it has pretty much matched the returns of a large-value peer group, but has done so with far lower volatility.

And so fans of really focused investing have two plausible candidates, COBYX and BRTNX. Of the two, Bretton has a far more impressive, though shorter, record. From inception through the end of 2011, $10,000 invested in Bretton would have grown to $11,500. Its peer group would have produced an average return of $10,900. For 2011 as a whole, BRTNX’s returns were in the top 2% of its peer group, by Morningstar’s calculus. Lipper, which classifies it as “multi-cap value,” reports that it had the fourth best record of any comparable fund in 2011. In particular, the fund outperformed its peers in every month when the market was declining. That’s a particularly striking accomplishment given the fund’s concentration and micro-cap exposure.

Bottom Line

Bretton has the courage of its convictions. Those convictions are grounded in an intelligent reading of the investment literature and backed by a huge financial commitment by the manager and his family. It’s a fascinating vehicle and deserves careful attention.

Fund website

Bretton Fund