Dear friends,

We’ve always enjoyed and benefited from your reactions to the Observer. Your notes are read carefully, passed around and they often shape our work in the succeeding months. The most common reaction to our July issue was captured by one reader who shared this observation:

Dear David: I really love your writing. I just wish there weren’t so much of it. Perhaps you could consider paring back a bit?

Each month’s cover essay, in Word, ranges from 22 – 35 pages, single-spaced. June and July were both around 30 pages, a length perhaps more appropriate to the cool and heartier months of late autumn and winter. In response, we’ve decided to offer you the Seersucker Edition of Mutual Fund Observer. We, along with the U.S. Senate, are celebrating seersucker, the traditional fabric of summer suits in the South. Light, loose and casual, it is “a wonderful summer fabric that was designed for the hot summer months,” according to Mississippi senator Roger Wicker. In respect of the heat and the spirit of bipartisanship, this is the “light and slightly rumpled” edition of the Observer that “retains its fashionable good looks despite summer’s heat and humidity.”

Ken Mayer, some rights reserved

For September we’ll be adding a table of contents to help you navigate more quickly around the essay. We’ll target “Tweedy”, and perhaps Tweedy Browne, in November!

“There’ll never be another Bill Gross.” Lament or marketing slogan?

Up until July 31, the market seemed to be oblivious to the fact that the wheels seemed to be coming off the global geopolitical system. We focused instead on the spectacle of major industry players acting like carnies (do a Google image search for the word, you’ll get the idea) at the Mississippi Valley Fair.

Exhibit One is PIMCO, a firm that we lauded as having the best record for new fund launches of any of the Big Five. In signs of what must be a frustrating internal struggle:

PIMCO icon Bill Gross felt compelled to announce, at Morningstar, that PIMCO was “the happiest place in the world” to work, allowing that only Disneyland might be happier. Two notes: 1) when a couple says “our marriage is doing great,” divorce is imminent, and 2) Disneyland is, reportedly, a horrible place to work.

(Reuters, Jim King)

Gross also trumpeted “a performance turnaround” which appears not to be occurring at Gross’s several funds, either an absolute return or risk-adjusted return basis.

After chasing co-CIO Mohammed el-Erian out and convincing fund manager Jeremie Banet (a French national whose accent Gross apparently liked to ridicule) that he’d be better off running a sandwich truck, Gross took to snapping at CEO Doug Hodge for his failure to stanch fund outflows.

PIMCO insiders have reportedly asked Mr. Gross to stop speaking in public, or at least stop venting to the media. Mr. Gross threatened to quit, then publicly announced that he’s never threatened to quit.

Despite PIMCO’s declaration that the Wall Street Journal article that detailed many of these promises was “full of untruths and mischaracterizations that are unworthy of a major news daily,” they’ve also nervously allowed that “Pimco isn’t only Bill Gross” and lamented (or promised) that there will never been another PIMCO “bond king” after Gross’s departure.

Others in the industry, frustrated that PIMCO was hogging the silly season limelight, quickly grabbed the red noses and cream pies and headed at each other.

The most colorful is the fight between Morningstar and DoubleLine. On July 16, Morningstar declared that “On account of a lack of information … [DoubleLine Total Return DBLNX] is Not Ratable.” That judgment means that DoubleLine isn’t eligible for a metallic (Gold, Silver, Bronze) Analyst Rating but it doesn’t affect that fund’s five-star rating or the mechanical judgment that the $34 billion fund has offered “high” returns and “below average” risk. Morningstar’s contention is that the fund’s strategies are so opaque that risks cannot be adequately assessed at arm’s length and the DoubleLine refuses to disclose sufficient information to allow Morningstar’s analysts to understand the process from the inside. DoubleLine’s rejoinder (which might be characterized as “oh, go suck an egg!”) is that Morningstar “has made false statement about DoubleLine” and “mischaracterized the fund,” in consequence of which they’ll have “no further communication with Morningstar.com” (“How Bad is the Blood Between DoubleLine and Morningstar?” 07/18/2014).

DoubleLine declined several requests for comment on the fight and, specifically, for a copy of the reported eight page letter of particulars they’d sent to Morningstar. Nadine Youssef, speaking for Morningstar, stressed that

It’s not about refusing to answer questions—it’s about having sufficient information to assign an Analyst Rating. There are a few other fund managers who don’t answer all of our questions, but we assign an Analyst Rating if we have enough information from filings and our due diligence process.

If a fund produced enough information in shareholder letters and portfolios, we could still rate it. For example, stock funds are much easier to assess for risk because our analysts can run good portfolio analytics on them. For exotic mortgages, we can’t properly assess the risk without additional information.

It’s a tough call. Many fund managers, in private, deride Morningstar as imperious, high-handed, sanctimonious and self-serving. Others aren’t that positive. But in the immediate case Morningstar seems to be acting with considerable integrity. The mere fact that a fund is huge and famous can’t be grounds, in and of itself, for an endorsement by Morningstar’s analysts (though, admittedly, Morningstar does not have a single Negative rating on even one of the 234 $10 billion-plus funds). To the extent that this kerfuffle shines a spotlight on the larger problem of investors placing their money in funds whose strategies that don’t actually understand and couldn’t explain, it might qualify as a valuable “teachable moment” for the community.

Somewhere in there, one of the founders of DoubleLine’s equity unit quit and his fund was promptly liquidated with an explanation that almost sounded like “we weren’t really interested in that fund anyway.”

Waddell & Reed, adviser to the Ivy Funds, lost star manager Bryan Krug to Artisan.  He was replaced on Ivy High Income (IVHIX) by William Nelson, who had been running Waddell & Reed High Income (UNHIX) since 2008. On July 9^th Nelson was fired “for cause” and for reasons “unrelated to his portfolio management responsibilities,” which raised questions about the management of nearly $14 billion in high-yield assets. They also named a new president, had their stock downgraded, lost a third high-profile manager, drew huge fund inflows and blew away earnings expectations.

Recovery Time

In the book “Practical Risk-Adjusted Performance Measurement,” Carl Bacon defines recovery time or drawdown duration as the time taken to recover from an individual or maximum drawdown to the original level. In the case of maximum drawdown (MAXDD), the figure below depicts recovery time from peak. Typically, for equity funds at least, the descent from peak to valley happens more quickly than the ascent from valley to recovery level.

An individual’s risk tolerance and investment timeline certainly factor into expectations of maximum drawdown and recovery time. As evidenced in “Ten Market Cycles” from our April commentary, 20% drawdowns are quite common. Since 1956, the SP500 has fallen nearly 30% or more eight times. And, three times – a gut wrenching 50%. Morningstar advises that investors in equity funds need “investment horizons longer than 10 years.”

Since 1962, SP500’s worst recovery time is actually a modest 53 months. Perhaps more surprising is that aggregate bonds experienced a similar duration, before the long bull run.  The difference, however, is in drawdown level.

 During the past 20 years, bonds have recovered much more quickly, even after the financial crisis.

Long time MFO board contributor Bee posted recently:

MAXDD or Maximum Drawdown is to me only half of the story.

Markets move up and down. Typically the more aggressive the fund the more likely it is to have a higher MAXDD. I get that.

What I find “knocks me out of a fund” in a down market is the fund’s inability to bounce back.

Ulcer Index, as defined by Peter Martin and central to MFO’s ratings system, does capture both the MAXDD and recovery time, but like most indices, it is most easily interpreted when comparing funds over same time period. Shorter recovery times will have lower UIcer Index, even if they experience the same absolute MAXDD. Similarly, the attendant risk-adjusted-return measure Martin Ratio, which is excess return divided by Ulcer Index, will show higher levels.

But nothing hits home quite like maximum drawdown and recovery time, whose absolute levels are easily understood. A review of lifetime MAXDD and recoveries reveals the following funds with some dreadful numbers, representing a cautionary tale at least:

In contrast, some notable funds, including three Great Owls, with recovery times at one year or less:

On Bee’s suggestion, we will be working to make fund recovery times available to MFO readers.

Flash Geeks and Other Vagaries of Life …..

By Edward Studzinski

“The genius of you Americans is that you never make clear-cut stupid moves, only complicated stupid moves which make us wonder at the possibility that there may be something to them which we are missing.”

                Gamal Abdel Nasser

Some fifteen to twenty-odd years ago, before Paine Webber was acquired by UBS Financial Services, it had a superb annual conference. It was their quantitative investment conference usually held in Boston in early December. What was notable about it was that the attendees were the practitioners of what fundamental investors back then considered the black arts, namely the quants (quantitative investors) from shops like Acadian, Batterymarch, Fidelity, Numeric, and many of the other quant or quasi-quant shops. I made a point of attending, not because I thought of myself as a quant, but rather because I saw that an increasing amount of money was being managed in this fashion. WHAT I DID NOT KNOW COULD HURT BOTH ME AND MY INVESTORS.

One of the things you quickly learned about quantitative methods was that their factor-based models for screening stocks and industries, and then constructing portfolios, worked until they did not work. That is, inefficiencies that were discovered could be exploited until others noticed the same inefficiencies and adjusted their models accordingly. The beauty of this conference was that you had papers and presentations from the California Technology, MIT, and other computer geeks who had gone into the investment world. They would discuss what they had been working on and back-testing (seeing how things would have turned out). This usually gave you a pretty good snapshot of how they would be investing going forward. If nothing else, it helped you to know when you might want to step out of the way to keep from being run-over. It was certainly helpful to me in 1994. 

In late 2006, I was in New York at a financial markets presentation hosted by the Santa Fe Institute and Bill Miller of Legg Mason. It was my follow-on substitute for the Paine Webber conference. The speakers included people like Andrew Lo, who is both a brilliant scientist at MIT and the chief scientific officer of the Alpha Simplex Group. One of the other people I chanced to hear that day was Dan Mathisson of Credit Suisse, who was one of the early pioneers and fathers of algorithmic trading. In New York then on the stock exchanges people were seeing change not incrementally, but on a daily basis. The floor trading and market maker jobs which had been handed down in families from generation to generation (go to Fordham or NYU, get your degree, and come into the family business) were under siege, as things went electronic (anyone who has studied innovation in technology and the markets knows that the Canadians, as with air traffic control systems, beat us by many years in this regard). And then I returned to Illinois, where allegedly the Flat Earth Society was founded and still held sway. One of the more memorable quotes which I will take with me forever is this. “Trying to understand algorithmic trading is a waste of time as it will never amount to more than ten per cent of volume on the exchanges. One will get better execution by having” fill-in-the blank “execute your trade on the floor.” Exit, stage right.

Flash forward to 2014. Michael Lewis has written and published his book, Flash Boys. I have to confess that I purchased this book and then let it sit on my reading pile for a few months, thinking that I already understood what it was about. I got to it sitting in a hotel room in Switzerland in June, thinking it would put me to sleep in a different time zone. I learned very quickly that I did not know what it was about. Hours later, I was two-thirds finished with it and fascinated. And beyond the fascination, I had seen what Lewis talked about happen many times in the process of reviewing trade executions.

If you think that knowing something about algorithmic trading, black pools, and the elimination of floor traders by banks of servers and trading stations prepares you for what you learn in Lewis’ book, you are wrong. Think about your home internet service. Think about the difference in speeds that you see in going from copper to fiber optic cable (if you can actually get it run into your home). While much of the discussion in the book is about front-running of customer trades, more is about having access to the right equipment as well as the proximity of that equipment to a stock exchange’s computer servers. And it is also about how customer trades are often routed to exchanges that are not advantageous to the customer in terms of ultimate execution cost. 

Now, a discussion of front running will probably cause most eyes to glaze over. Perhaps a better way to think about what is going on is to use the term “skimming” as it might apply for instance, to someone being able to program a bank’s computers to take a few fractions of a cent from every transaction of a particular nature. And this skimming goes on, day in and day out, so that over a year’s time, we are talking about those fractions of cents adding up to millions of dollars.

Let’s talk about a company, Bitzko Kielbasa Company, which is a company that trades on average 500,000 shares a day. You want to sell 20,000 shares of Bitzko. The trading screen shows that the current market is $99.50 bid for 20,000 shares. You tell the trader to hit the bid and execute the sale at $99.50. He types in the order on his machine, hits sell, and you sell 100 shares of Bitzko at $99.50. The bid now drops to $99.40 for 1,000 shares. When you ask what happened, the answer is, “the bid wasn’t real and it went away.” What you learn from Lewis’ book is that as the trade was being entered, before the send/execute button was pressed, other firms could read your transaction and thus manipulate the market in that security. You end up selling your Bitzko at an average price well under the original price at which you thought you could execute.

So, how is it that no one has been held accountable for this yet? I don’t know, although there seem to be a lot of investigations ongoing. You also learn that a lot here has to do with order flow, or to what exchange a sell-side firm gets to direct your order for execution. The tragi-comic aspect of this is that mutual fund trustees spend a lot of time looking at trading evaluations as to whether best execution took place. The reality is that they have absolutely no idea on whether they got best execution because the whole thing was based on a false premise from the get-go. And the consultant’s trading execution reports reflect none of that.

Who has the fiduciary obligation? Many different parties, all of whom seem to hope that if they say nothing, the finger will not get pointed at them. The other side of the question is, you are executing trades on behalf of your client, individual or institutional, and you know which firms are doing this. Do you still keep doing business with them? The answer appears to be yes, because it is more important to YOUR business than to act in the best interests of your clients. Is there not a fiduciary obligation here as well? Yes.

I would like to think that there will be a day of reckoning coming. That said, it is not an easy area to understand or explain. In most sell-side firms, the only ones who really understood what was going on were the computer geeks. All that management and the marketers understood was that they were making a lot of money, but could not explain how. All that the buy-side firms understood was that they and their customers were being disadvantaged, but by how much was another question.

As an investor, how do you keep from being exploited? The best indicators as usual are fees, expenses, and investment turnover. Some firms have trading strategies tied to executing trades only when a set buy or sell price is triggered. Batterymarch was one of the forerunners here. Dimensional Fund Advisors follows a similar strategy today. Given low turnover in most indexing strategies, that is another way to limit the degree of hurt. Failing that, you probably need to resign yourself to paying hidden tolls, especially as a purchaser or seller of individual securities. Given that, being a long-term investor makes a good bit of sense. I will close by saying that I strongly suggest Michael Lewis’ book as must-reading. It makes you wonder how an industry got to the point where it has become so hard for so many to not see the difference between right and wrong.

What does it take for Morningstar to notice that they’re not noticing you?

Based on the funds profiled in Russ Kinnel’s July 15th webcast, “7 Under the Radar Funds,” the answer is about $400 million and ten years with the portfolio.

Let’s start with the obvious: these are pretty consistently solid funds and well worth your consideration. What most strikes me about the list is the implied judgment that unless you’re from a large fund complex, the threshold for Morningstar even to admit that they’ve been ignoring you is dauntingly high. While Don Phillips spoke at the 2013 Morningstar Investment Conference of an initiative to identify promising funds earlier in their existence, that promise wasn’t mentioned at the 2014 gathering and this list seems to substantiate the judgment that from Morningstar’s perspective, small funds are dead to them.

That’s a pity given the research that Mr. Kinnel acknowledges in his introduction…when it comes to funds, bigger is simply not better.

Investors might be beginning to suspect the same thing. Kevin McDevitt, a senior analyst on Morningstar’s manager research team (that’s what they’re calling the folks who cover mutual funds now), studied fund flows and noticed two things:

1. Starting in early 2013, investors began pouring money into “risk on” funds. “Since the start of 2013, flows into the least-volatile group of funds have basically been flat. During that same six-quarter stretch, investors poured nearly $125 billion into the most-volatile category of funds.” That is, he muses, reminiscent of their behavior in the years (2004-07) immediately before the final crisis.
2. Investors are pouring money into recently-launched funds. He writes: “What’s interesting about this recent stretch is that a sizable chunk of inflows has gone to funds without a three-year track record. If those happen to be higher-risk funds too, then people really have embraced risk once more. It’s pretty astonishing that these fledgling funds have collected more inflows over the past 12 months through June ($154 billion) than the other four quartiles (that is, funds with at least a three-year record) combined ($117 billion).”

I’ve got some serious concerns about that paragraph (you can’t just assume newer funds as “higher-risk funds too”) and I’ve sent Mr. McDevitt a request for clarification since I don’t have any ideas of what “the other four quartiles” (itself a mathematical impossibility) refers to. See “Investors Show Willingness to Buy Untested Funds,” 07/31/2014.

That said, it looks like investors and their advisors might be willing to listen. Happily, the Observer’s willing to speak with them about newer, smaller, independent funds.  Our willingness to do so is based on the research, not simple altruism. Small, nimble, independent, investment-driven rather than asset-driven works.

And so, for the 3500 funds smaller than the smallest name on Morningstar’s list and the 4100 smaller than the average fund on this list, be of good cheer! For the 141 small funds that have a better 10-year record than any of these, be brave! To the 17 unsung funds that have a five-star rating for the past three years, five years, ten years and overall, your time will come!

Thanks to Akbar Poonawala for bringing the webcast to my attention!

What aren’t you reading this summer?

If you’re like me, you have at your elbow a stack of books that you promised yourself you were going to read during summer’s long bright evenings and languid afternoons.  Mine includes Mark Miodownik’s Stuff Matters: Exploring the Marvelous Materials that Shape Our Manmade World (2013) and Sherry Turkle’s Alone Together: Why We Expect More from Technology and Less from Each Other (2012). Both remain in lamentably pristine condition.

How are yours?

Professor Jordan Ellenberg, a mathematician at Wisconsin-Madison, wrote an interesting but reasonably light-hearted essay attempting to document the point at which our ambition collapses and we surrender our pretensions of literacy.  He did it by tracking the highlights that readers embed in the Kindle versions of various books.  His thought is that the point at which readers stop highlighting text is probably a pretty good marker of where they stopped reading it.  His results are presented in “The Summer’s Most Unread Book Is…” (7/5/14). Here are his “most unread” nominees:

Thinking Fast and Slow by Daniel Kahneman : 6.8% 
Apparently the reading was more slow than fast. To be fair, Prof. Kahneman’s book, the summation of a life’s work at the forefront of cognitive psychology, is more than twice as long as “Lean In,” so his score probably represents just as much total reading as Ms. Sandberg’s does.

A Brief History of Time by Stephen Hawking: 6.6% 
The original avatar backs up its reputation pretty well. But it’s outpaced by one more recent entrant—which brings us to our champion, the most unread book of this year (and perhaps any other). Ladies and gentlemen, I present:

Capital in the Twenty-First Century by Thomas Piketty: 2.4% 
Yes, it came out just three months ago. But the contest isn’t even close. Mr. Piketty’s book is almost 700 pages long, and the last of the top five popular highlights appears on page 26. Stephen Hawking is off the hook; from now on, this measure should be known as the Piketty Index.

At the other end of the spectrum, one of the most read non-fiction works is a favorite of my colleague Ed Studzinski’s or of a number of our readers:

Flash Boys by Michael Lewis : 21.7% 
Mr. Lewis’s latest trip through the sewers of financial innovation reads like a novel and gets highlighted like one, too. It takes the crown in my sampling of nonfiction books.

What aren’t you drinking this summer?

The answer, apparently, is Coca-Cola in its many manifestations. US consumption of fizzy drinks has been declining since 2005. In part that’s a matter of changing consumer tastes and in part a reaction to concerns about obesity; even Coca-Cola North America’s president limits himself to one 8-ounce bottle a day. 

Some investors, though, suspect that the problem arises from – or at least is not being effectively addressed by – Coke’s management. They argue that management is badly misallocating capital (to, for example, buying Keurig rather than investing in their own factories) and compensating themselves richly for the effort.

Enter David Winters, manager of Wintergreen Fund (WGRNX). While some long-time Coke investors (that would be Warren Buffett) merely abstain rather than endorse management proposals, Mr. Winters loudly, persistently and thoughtfully objects. His most public effort is embodied in the website Fix Big Soda. 

David’s aged more gracefully than have I. Rich, smart, influential and youthful. Nuts.

This is far from Winters’ first attempt to influence the direction of one of his holdings. He stressed two things in a long ago interview with us: (1) the normal fund manager’s impulse to simply sell and let a corporation implode struck him as understandable but defective, and (2) the vast majority of management teams welcomed thoughtful, carefully-researched advice from qualified outsiders. But some don’t, preferring to run a corporation for the benefit of insiders rather than shareholders or other stakeholders. When Mr. Winters perceives that a firm’s value might grow dramatically if only management stopped being such buttheads (though I’m not sure he uses the term), he’s willing to become the catalyst to unlock that value for the benefit of his own shareholders. A fairly high profile earlier example was his successful conflict with the management of Florida real estate firm Consolidated-Tomoka.

You surely wouldn’t want all of your managers pursuing such a strategy but having at least one of them gives you access to another source of market-independent gains in your portfolio. So-called “special situation” or “distressed” investments can gain value if the catalyst is successful, even if the broader market is declining.

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 we profile two funds that offer different – and differently successful – takes on the same strategy. There’s a lot of academic research that show firms which are seriously and structurally devoted to innovation far outperform their rivals. These firms can exist in all sectors; it’s entirely possible to have a highly innovative firm in, say, the cement industry. Conversely, many firms systematically under-invest in innovation and the research suggests these firms are more-or-less doomed.

Why would firms be so boneheaded? Two reasons come to mind:

1. Long-term investments are hard to justify in a market that demands short-term results.
2. Spending on research and training are accounted as “overhead” and management is often rewarded for trimming unnecessary overhead.

Both of this month’s profiles target funds that are looking for ways to identify firms that are demonstrably and structurally (that is, permanently) committed to innovation or knowledge leadership. While their returns are very different, each is successful on its own terms.

GaveKal Knowledge Leaders (GAVAX) combines a search for high R&D firms with sophisticated market risks screens that force it to reduce its market exposure when markets begin teetering into “the red zone.” The result is an equity portfolio with hedge fund like characteristics which many advisors treat as a “liquid alts” option.

Guinness Atkinson Global Innovators (IWIRX) stays fully invested regardless of market conditions in the world’s 30 most innovative firms. What started in the 1990s as the Wired 40 Index Fund has been crushing its competition as an actively managed for fund over a decade. Lipper just ranked it as the best performing Global Large Cap Growth fund of the past year. And of the past three years. Also the #1 performer for the past five years and, while we’re at it, for the past 10 years as well.

Elevator Talk: Jim Cunnane, Advisory Research MLP & Energy Income Fund (INFRX/INFIX)

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 Observer has presented the case for investing in Master Limited Partnerships (MLPs) before, both when we profiled SteelPath Alpha (now Oppenheimer SteelPath Alpha MLPAX) and in our Elevator Talk with Ted Gardiner of Salient MLP Alpha and Energy Infrastructure II (SMLPX). Here’s the $0.50 version of the tale:

MLPs are corporate entities which typically own energy infrastructure. They do not explore for oil and they do not refine it, but they likely own the pipelines that connect the E&P firm with the refiner. Likewise they don’t mine the coal nor produce the electricity, but might own and maintain the high tension transmission grid that distributes it.

MLPs typically make money by charging for the use of their facilities, the same way that toll road operators do. They’re protected from competition by the ridiculously high capital expenses needed to create infrastructure. The rates they charge as generally set by state rate commissions, so they’re very stable and tend to rise by slow, predictable amounts.

The prime threat to MLPs is falling energy demand (for example, during a severe recession) or falling energy production.

From an investor’s perspective, direct investment in an MLP can trigger complex and expensive tax requirements. Indeed, a fund that’s too heavily invested in MLPs alone might generate those same tax headaches.

That having been said, these are surprisingly profitable investments. The benchmark Alerian MLP Index has returned 17.2% annually over the past decade with a dividend yield of 5.2%. That’s more than twice the return of the stock market and twice the income of the bond market.

The questions you need to address are two-fold. First, do these investments make sense for your portfolio? If so, second, does an actively-managed fund make more sense than simply riding an index. Jim Cunnane thinks that two yes’s are in order.

Mr. Cunnane manages Advisory Research MLP & Energy Infrastructure Fund which started life as a Fiduciary Asset Management Company (FAMCO) fund until the complex was acquired by Advisory Research. He’d been St. Louis-based FAMCO’s chief investment officer for 15 years. He’s the CIO for the MLP & Energy Infrastructure team and chair of AR’s Risk Management Committee. He also manages two closed-end funds which also target MLPs: the Fiduciary/Claymore MLP Opportunity Fund (FMO) and the Nuveen Energy MLP Total Return Fund (JMF). Here are his 200 words (and one picture) on why you might consider INFRX:

We’re always excited to talk about this fund because it’s a passion of ours. It’s a unique way to manage MLPs in an open-end fund. When you look at the landscape of US energy, it really is an exciting fundamental story. The tremendous increases in the production of oil and gas have to be accompanied by tremendous increases in energy infrastructure. Ten years ago the INGA estimated that the natural gas industry would need $3.6 billion/year in infrastructure investments. Today the estimate is $14.2 billion. We try to find great energy infrastructure and opportunistically buy it.

There are two ways you can attack investing in MLPs through a fund. One would be an MLP-dedicated portfolio but that’s subject to corporate taxation at the fund level. The other is to limit direct MLP holdings to 25% of the portfolio and place the rest in attractive energy infrastructure assets including the parent companies of the MLPs, companies that might launch MLPs and a new beast called a YieldCo which typically focus on solar or wind infrastructure. We have the freedom to move across the firms’ capital structure, investing in either debt or equity depending on what offers the most attractive return.

Our portfolio in comparison to our peers offers a lot of additional liquidity, a lower level of volatility and tax efficiency. Despite the fact that we’re not exclusively invested in MLPs we manage a 90% correlation with the MLP index.

While there are both plausible bull and bear cases to be made about MLPs, our conclusion is that risk and reward is fairly balanced and that MLP investors will earn a reasonable level of return over a 10-year horizon. To account for the recent strong performance of MLPs, we are adjusting our long term return expectation down to 5-9% per annum, from our previous estimate of 6-10%. We also expect a 10% plus MLP market correction at some point this year.

The “exciting story” that Mr. Cunnane mentioned above is illustrated in a chart that he shared:

The fund has both institutional and retail share classes. The retail class (INFRX) has a $2500 minimum initial investment and a 5.5% load.  Expenses are 1.50% with about $725 million in assets.  The institutional share class (INFIX) is $1,000,000 and 1.25%. Here’s the fund’s homepage.

Funds in Registration

The Securities and Exchange Commission requires that funds file a prospectus for the Commission’s review at least 75 days before they propose to offer it for sale to the public. The release of new funds is highly cyclical; it tends to peak in December and trough in the summer.

This month the Observer’s other David (research associate David Welsch) tracked down nine new no-load funds in registration, all of which target a September launch. It might be the time of year but all of this month’s offerings strike me as “meh.”

Manager Changes

Just as the number of fund launches and fund liquidations are at seasonal lows, so too are the number of fund manager changes.  Chip tracked down a modest 46 manager changes, with two retirements and a flurry of activity at Fidelity accounting for much of the activity.

Top Developments in Fund Industry Litigation – July 2014

Fundfox is the only intelligence service to focus exclusively on litigation involving U.S.-registered investment companies, their directors and advisers. Publisher David Smith has agreed to share highlights with us. For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

New Lawsuit

• In a copyright infringement lawsuit, the publisher of Oil Daily alleges that KA Fund Advisors (you might recognize them as Kayne Anderson) and its parent company have “for years” internally copied and distributed the publication “on a consistent and systematic basis,” and “concealed these activities” from the publisher. (Energy Intelligence Group, Inc. v. Kayne Anderson Capital Advisors, LP.)

 Order

• The court granted American Century‘s motion for summary judgment in a lawsuit that challenged investments in an illegal Internet gambling business by the Ultra Fund. (Seidl v. Am. Century Cos.)

 Briefs

• Plaintiffs filed their opposition to BlackRock‘s motion to dismiss excessive-fee litigation regarding its Global Allocation and Dividend Equity Funds. (In re BlackRock Mut. Funds Advisory Fee Litig.)
• First Eagle filed a motion to dismiss an excessive-fee lawsuit regarding its Global and Overseas Funds. (Lynn M. Kennis Trust v. First Eagle Inv. Mgmt., LLC.)
• J.P. Morgan filed a motion to dismiss an excessive- fee lawsuit regarding its Core Bond, High Yield, and Short Duration Bond Funds. (Goodman v. J.P. Morgan Inv. Mgmt., Inc.)

Answer

• Opting against a motion to dismiss, ING filed an answer in the fee lawsuit regarding its Global Real Estate Fund. (Cox v. ING Invs. LLC.)

– – –

A potentially fascinating case arose just a bit after David shared his list with us. A former Vanguard employee is suing Vanguard, alleging that they illegally dodged billions in taxes. While Vanguard itself warns that “The issues presented in the complaint are far too complex to get a full and proper hearing in the news media” (the wimps), it appears that the plaintiff has two allegations:

1. That Vanguard charges too little for their services; they charge below-market rates while the tax code requires that, for tax purposes, transactions be assessed at market rates. A simple illustration: if your parents rented an apartment to you for $300/month when anyone else would expect to pay $1000/month for the same property, the $700 difference would be taxable to you since they’re sort of giving you a $700 gift each month.
2. That Vanguard should have to pay taxes on the $1.5 billion “contingency reserve” they’ve built.

Joseph DiStephano of the Philadelphia Inquirer, Vanguard’s hometown newspaper, laid out many of the issues in “Vanguard’s singular model is under scrutiny,” 07/30/2014. If you’d like to be able to drop legalese casually at your next pool party, you can read the plaintiff’s filing in State of New York ex rel David Danon v. Vanguard Group Inc.

Updates

Aston/River Road Long-Short (ARLSX) passed its three year anniversary in May and received its first Morningstar rating recently. They rated it as a four-star fund which has captured a bit more of the upside and a bit less of the downside than has its average peer. The fund had a bad January (down more than 4%) but has otherwise been a pretty consistently above average, risk-conscious performer.

Zac Wydra, manager of Beck, Mack and Oliver Partners Fund (BMPEX), was featured in story in the Capitalism and Crisis newsletter. I suspect the title, “Investing Wisdom from Zac Wydra,” likely made Zac a bit queasy since it rather implies that he’s joined the ranks of the Old Dead White Guys (ODWGs) also with Graham and Dodd.

Here’s a major vote of confidence: Effective August 1, 2014, John Neff and Thomas Saberhagen were named as co-portfolio managers for the Akre Focus Fund. They both joined Mr. Akre’s firm in 2009 after careers at William Blair and Aegis Financial, respectively. The elevation is striking. Readers might recall that Mr. Akre was squeezed out after running FBR Focus (now Hennessy Focus HFCSX) for 13 years. FBR decided to cut Mr. Akre’s contract by about 50% (without reducing shareholder expenses), which caused him to launch Akre Focus using the same discipline. FBR promptly poached Mr. Akre’s analysts (while he was out of town) to run their fund in his place. At that point, Mr. Akre swore never to repeat the mistake and to limit analysts to analyzing rather than teaching them portfolio construction. Time and experience with the team seems to have mellowed the great man. Given the success that the rapscallions have had at HFCSX, there’s a good chance that Mr. Akre, now in his 70s, has trained Neff and Saberhagen well which might help address investor concerns about an eventual succession plan.

Seafarer Overseas Growth & Income (SFGIX) passed the $100 million AUM threshold in July and is in the process of hiring a business development director. Manager Andrew Foster reports that they received a slug of really impressive applications. Our bottom line was, and is, “There are few more-attractive emerging markets options available.” We’re pleased that folks are beginning to have faith in that conclusion.

Stewart Capital Mid Cap Fund (SCMFX) has been named to the Charles Schwab’s Mutual Fund OneSource Select List for the third quarter of 2014. It’s one of six independent mid-caps to make the list. The recognition is appropriate and overdue.  Our Star in the Shadow’s profile of the fund concluded that it was “arguably one of the top two midcap funds on the market, based on its ability to perform in volatile rising and falling markets. Their strategy seems disciplined, sensible and repeatable.” That judgment hasn’t changed but their website has; the firm made a major and welcome upgrade to it last year.

Briefly Noted . . .

Yikes. I mean, really yikes. On July 28, Aberdeen Asset Management Plc (ADN) reported that an unidentified but “very long standing” client had just withdrawn 4 billion pounds of assets from the firm’s global and Asia-Pacific region equity funds. The rough translation is $6.8 billion. Overall the firm saw over 8 billion pounds of outflow in the second quarter, an amount large enough that even Bill Gross would feel it.

We all have things that set us off. For some folks the very idea of “flavored” coffee (poor defenseless beans drenched in amaretto-kiwi goo) will do it. For others it’s the designated hitter rule or plans to descrecate renovate Wrigley Field. For me, it’s fund managers who refuse to invest in their own funds, followed closely behind by fund trustees who refuse to invest in the funds whose shareholders they represent.

Sarah Max at Barron’s published a good short column (07/12/14) on the surprising fact that over half of all managers have zero (not a farthing, not a penny, not a thing) invested in their own funds. The research is pretty clear (the more the insiders’ interests are aligned with yours, the better a fund’s risk-adjusted performance) and the atmospherics are even clearer (what on earth would convince you that a fund is worth an outsider’s money if it’s not worth an insider’s?). That’s one of the reasons that the Observer routinely reports on the manager and director investments and corporate policies for all of the funds we cover. In contrast to the average fund, small and independent funds tend to have persistently, structurally high levels of insider commitment.

SMALL WINS FOR INVESTORS

On June 30, both the advisory fee and the expense cap on The Brown Capital Management International Equity Fund (BCIIX) were reduced. The capped e.r. dropped from 2.00% to 1.25%.

Forward Tactical Enhanced Fund (FTEAX) is dropping its Investor Share class expense ratio from 1.99% to 1.74%. Woo hoo! I’d be curious to see if they drop their portfolio turnover rate from its current 11,621%.  (No, I’m not making that up.)

Perritt Ultra MicroCap Fund (PREOX) reopened to new investors on July 8. It had been closed for three whole months. The fund has middling performance at best and a tiny asset base, so there was no evident reason to close it and no reason for either the opening or closing was offered by the advisor.

CLOSINGS (and related inconveniences)

Effective at the close of business on August 15, 2014, Grandeur Peak Emerging Opportunities Fund (GPEOX/GPEIX) the Fund will close to all purchases. There are two exceptions, (1) individuals who invested directly through Grandeur Peak and who have either a tax-advantaged account or have an automatic investing plan and (2) institutions with an existing 401(k) arrangement with the firm. The fund reports about $370M in assets and YTD returns of 11.6% through late July, which places it in the top 10% of all E.M. funds. There are a couple more G.P. funds in the pipeline and the guys have hinted at another launch sooner rather than later, but the next gen funds are likely more domestic than international.

Effective as of the close of business on October 31, 2014, the Henderson European Focus Fund (HFEAX) will be closed to new purchases. The fund sports both top tier returns and top tier volatility. If you like charging toward closing doors, it’s available no-load and NTF at Schwab and elsewhere.

Parametric Market Neutral Fund (EPRAX) closed to new investors on July 11, 2014. The fund is small and slightly under water since inception. Under those circumstances, such closures are sometimes a signal of bigger changes – new management, new strategy, liquidation – on the horizon.

Citing “the lack of investment opportunities” and “high current cash levels” occasioned by the five year run-up in global stock prices, Tweedy Browne announced the impending soft close of Tweedy, Browne Global Value II (TBCUX).  TBCUX is an offshoot of Tweedy, Browne Global Value (TBGVX) with the same portfolio and managers but Global Value often hedges its currency exposure while Global Value II does not. The decision to close TBCUX makes sense as a way to avoid “diluting our existing shareholders’ returns in this difficult environment” since the new assets were going mostly to cash. Will Browne planned “to reopen the Fund when new idea flow improves and larger amounts of cash can be put to work in cheap stocks.”

Here’s the question: why not close Global Value as well?

The good folks at Mount & Nadler arranged for me to talk with Tom Shrager, Tweedy’s president. Short version: they have proportionately less  inflows into Global Value but significant net inflows, as a percentage of assets, into Global Value II. As a result, the cash level at GV II is 26% while GV sits at 20% cash. While they’ve “invested recently in a couple of stocks,” GV II’s net cash level climbed from 21% at the end of Q1 to 26% at the end of Q2. They tried adding a “governor” to the fund (you’re not allowed to buy $4 million or more a day without prior clearance) which didn’t work.

Mr. Shrager describes the sudden popularity of GV II as “a mystery to us” since its prime attraction over GV would be as a currency play and Tweedy doesn’t see any evidence of a particular opportunity there. Indeed, GV II has trailed GV over the past quarter and YTD while matching it over the past 12 months.

At the same time, Tweedy reports no particular interest in either Value (TWEBX, top 20% YTD) or High Dividend Yield Value (TBHDX, top 50% YTD), both at 11% cash.

The closing will not affect current shareholders or advisors who have been using the fund for their clients.

OLD WINE, NEW BOTTLES

Alpine Foundation Fund (ADABX) has been renamed Alpine Equity Income Fund. The rechristened version can invest no more than 20% in fixed income securities. The latest, prechange portfolio was 20.27% fixed income. Over the longer term, the fund trails its “aggressive allocation” peers by 160 – 260 basis points annually and has earned a one-star rating for the past three, five and ten year periods. At that point, I’m not immediately convinced that a slight boost in the equity stake will be a game-changer for anyone.

On October 1, the billion dollar Alpine Ultra Short Tax Optimized Income Fund (ATOAX) becomes Alpine Ultra Short Municipal Income Fund and promises to invest, mostly, in munis.

Effective October 1, SunAmerica High Yield Bond (SHNAX)becomes SunAmerica Flexible Credit. The change will free the fund of the obligation of investing primarily in non-investment grade debt which is good since it wasn’t particularly adept at investing in such bonds (one-star with low returns and above average risk during its current manager’s five-year tenure).

OFF TO THE DUSTBIN OF HISTORY

Thanks, as always, go to The Shadow – an incredibly vigilant soul and long tenured member of the Observer’s discussion community for his contributions to this section.  Really, very little gets past him and that gives me a lot more confidence in saying that we’ve caught of all of major changes hidden in the ocean of SEC filings.

Grazie!

CM Advisors Defensive Fund (CMDFX) “has terminated the public offering of its shares and will discontinue its operations effective on or about August 1, 2014.”  Uhhh … what would be eight weeks after launch?

Direxion U.S. Government Money Market Fund (DXMXX) will liquidate on August 20, 2014.  I’m less struck by the liquidation of a tiny, unprofitable fund than by the note that “the Fund’s assets will be converted to cash.”  It almost feels like a money market’s assets should be describable as “cash.”

Geneva Advisors Mid Cap Growth Fund (the “Fund”) will be closed and liquidated on August 28. 2014. That decision comes nine months after the fund’s launch. While the fund’s performance was weak and it gathered just $4 million in assets, such hasty abandonment strikes me as undisciplined and unprofessional especially when the advisor reminds its investors of “the importance of … a long-term perspective when it comes to the equity portion of their portfolio.”  The fund representatives had no further explanation of the decision.

GL Macro Performance Fund (GLMPX) liquidated on July 30, 2014.  At least the advisor gave this fund 20 months of life so that it had time to misfire with style:

The Board of Trustees of Makefield Managed Futures Strategy Fund (MMFAX) has concluded that “it is in the best interests of the Fund and its shareholders that the Fund cease operations.” Having lost 17% for its few investors since launch, the Board probably reached the right conclusion.  Liquidation is slated for August 15, 2014.

Following the sudden death of its enigmatic manager James Wang, the Board of the Oceanstone Fund (OSFDX) voted to liquidate the portfolio at the end of August. The fund had unparalleled success from 2007-2012 which generated a series of fawning (“awesome,” “the greatest investor you’ve never heard of,” “the most intriguing questions in the mutual fund world today”) stories in the financial media.  Mr. Wang would neither speak to be media nor permit his board to do so (“he will be upset with me,” fretted one independent trustee) and his shareholder communications were nearly nonexistent. His trustees rightly eulogize him as “very sincere, hard working, humble, efficient and caring.” Our sympathies go out to his family and to those for whom he worked so diligently.

Pending shareholder approval, Sentinel Capital Growth Fund (BRGRX) and Sentinel Growth Leaders Fund (BRFOX) will be merged into Sentinel Common Stock Fund (SENCX) sometime this fall. Here’s the best face I can put on the merger: SENCX isn’t awful.

Effective October 16, SunAmerica GNMA (GNMAX) gets merged into SunAmerica U.S. Government Securities (SGTAX). Both funds fall just short of mediocre (okay, they both trail 65 – 95% of their peers over the past three, five and ten year periods so maybe it’s “way short” or “well short”) and both added two new managers in July 2014.  We wish Tim and Kara well with their new charges.

With shareholder approval, the $16 million Turner All Cap Growth Fund (TBTBX) will soon merge into the Turner Midcap Growth Fund (TMGFX). Midcap has, marginally, the better record but All Cap has, massively, the greater assets so …

In Closing . . .

I’m busily finishing up the outline for my presentation to the Cohen Client Conference, which takes place in Milwaukee on August 20 and 21. The working title of my talk is “Seven things that matter, two that don’t … and one that might.” My hope is to tie some of the academic research on funds and investing into digestible snackage (it is at lunchtime, after all) that attempts to sneak a serious argument in under the cover of amiable banter. I’ll let you know how it goes.

I know that David Hobbs, Cook and Bynum’s president, will be there and I’m looking forward to a chance to chat with him. He’s offered some advice about the thrust of my talk that was disturbingly consistent with my own inclinations, which should worry at least one of us. I’ll be curious to get his reaction.

We’re also hoping to cover the Morningstar ETF Conference en masse; that is, Charles, Chip, Ed and I would like to meet there both to cover the presentations (Meb Faber, one of Charles’s favorite guys, and Eugene Fama are speaking) and to debate about ways to strengthen the Observer and better serve you folks. A lot depends on my ability to trick my colleagues into covering two of my classes that week. Perhaps we’ll see you there?

My son Will, still hobbled after dropping his iPad on a toe, has taken to wincing every time we approach the mall. It’s festooned with “back to school sale! Sale! sale!” banners which seem, somehow, to unsettle him.

Here’s a quick plug for using the Observer’s link to Amazon.com. If you’d like to spare your children, grandchildren, and yourself the agony of the mall parking lot and sound of wailing and keening, you might consider picking some of this stuff up online. The Observer receives a rebate equal to about 6% on whatever is purchased through our link. It’s largely invisible to you – if costs nothing extra and doesn’t involve any extra steps on your part – but it generates the majority of the funds that keep the lights on here.

Here are some ways to make support easy:

• Click on our Amazon link and bookmark it for easy referral.
• Look to your right, the dang thing is continually floating over there ->
• In Chrome, set us as one of your start pages.  On the upper right of your screen, click on the three horizontal bars then click “settings.”  You’ll see this option:

Click on “Set pages” then simply paste the Observer link in along with wherever else you like to start. Each time you open Chrome, it’ll launch several tabs including your regular homepage and our Amazon page.

• If, like many, you’re not comfortable with Amazon’s plan to take over everything …
  feel free to resort to PayPal or the USPS. It all helps and it’s all detailed on our Support Us page.

Finally, we offer cheerful greetings to our curiously large and diligent readership in Cebu City, Philippines; Cebu Citizens spend about a half hour on site per visit, about five times the global average. Greetings, too, to the good folks in A Coruña in the north of Spain. You’ve been one of our most persistent international audiences.  The Madrileños are fewer in number, but diligent in their reading. To our sole Ukrainian visit, Godspeed and great care.

As ever,

Dear friends,

Welcome to the midway point of … well, nothing in particular, really. Certainly six months have passed in 2014 and six remain, but why would you care?  Unless you plan on being transported by aliens or cashing out your portfolio on December 31^st, questions like “what’s working this year?” are interesting only to the poor saps whose livelihoods are dependent on inventing explanations for, and investment responses to, something that happened 12 minutes ago and will be forgotten 12 minutes from now.

So, what’s working for investors in 2014? If you guessed “investments in India and gold,” you’ve at least got numbers on your side.  The top funds YTD:

Oh wait!  Sorry!  My bad.  That’s how this year’s brilliant ideas did last year.  Here’s the glory I wanted to highlight for this year?

 * Enjoy it while you can.  Dreyfus India is slated for liquidation by summer’s end.

Now doesn’t that make you feel better?

The Two Morningstar conferences

We had the opportunity to attend June’s Morningstar Investor Conference where Bill Gross, the world’s most important investor, was scheduled to give an after lunch keynote address today. Apparently he actually gave two addresses: the one that Morningstar’s folks attended and the one I attended.

Morningstar heard a cogent, rational argument for why a real interest rate of 0-1% is “the new neutral.” At 2% real, the economy might collapse. In that fragile environment, PIMCO models bond returns in the 3-4% range and stocks in the 4-5% range. In an act of singular generosity, he also explained the three strategies that allows PIMCO Total Return to beat everyone else and grow to $280 billion. Oops, $230 billion now as ingrates and doubters fled the fund and weren’t around to reap this year’s fine returns: 3.07% YTD. He characterized that as something like “fine” or “top tier” returns, though the fund is actually modest trailing both its benchmark and peer group YTD.

Representatives of other news outlets also attended that speech and blandly reported Gross’s generous offer of “the keys to the PIMCO Mercedes” and his “new neutral” stance.  One went so far as to declare the whole talk “charming.”

I missed out on that presentation and instead sat in on an incoherent, self-indulgent monologue that was so inappropriate to the occasion that it made me seriously wonder if Gross was off his meds. He walked on stage wearing sunglasses and spent some time looking at himself on camera; he explained that he always wanted to see himself in shades on the big screen. “I’m 70 years old and looking good!” he concluded. He tossed the shades aside and launched into a 20 minute reflection on the film The Manchurian Candidate, a Cold War classic about brainwashing and betrayal. I have no idea of why. He seemed to suggest that we’d been brainwashed or that he wasn’t able to brainwash us but wished he could or he needed to brainwash himself into not hating the media. 20 minutes. He then declared PIMCO to be “the happiest workplace in the world,” allowing that if there was any place happier, it was 15 miles up the road at Disneyland. That’s an apparent, if inept, response to the media reports of the last month that painted Gross as arrogant, ill-tempered, autocratic and nigh unto psychotic in the deference he demanded from employees. He then did an ad for the superiority of his investment process before attempting an explanation of “the new neutral” (taking pains to establish that the term was PIMCO’s, not Bloomberg’s). After 5-10 minutes of his beating around the bush, I couldn’t take it any more and left.

Gross’s apologists claimed that this was a rhetorical masterpiece whose real audience was finance ministers who might otherwise screw up monetary policy. A far larger number of folks – managers, marketers, advisors – came away horrified. “I’ve heard Gross six times in 20 years and he’s always given to obscure analogies but this was different. This was the least coherent I’ve ever heard him,” said one. “That was absolutely embarrassing,” opined someone with 40 years in the field. “An utter train wreck,” was a third’s. I’ve had friends dependent on psychoactive medications; this presentation sounded a lot like what happens when one of them failed to take his meds, a brilliant guy stumbling about with no sense of appropriateness.

Lisa Shidler at RIA Advisor was left to wonder how much damage was done by a speech that was at times “bizarre” and, most optimistically, “not quite a disaster.”

Bottom line: Gross allowed that “I could disappear today and it wouldn’t have a material effect on PIMCO for 3-5 years.” It might be time to consider it.

The Morningstar highlight: Michael Hasenstab on emerging markets

Michael Hasenstab, a CIO and manager of the four-star, $70 billion Templeton Global Bond Fund (TPINX), was the conference keynote. Over 40% of the fund is now invested in emerging markets, including 7% in Ukraine. He argued that investors misunderstand the fundamental strength of the emerging markets. Emerging markets were, in the past, susceptible to collapse when interest rates began to rise in the developed world. Given our common understanding that the Fed is likelier to raise rates in the coming year than to reduce them, the question is: are we on the cusp of another EM collapse.

He argues that we are not. Two reasons: the Bank of Japan is about to bury Asia in cash and emerging markets have shown a fiscal responsibility far in excess of anything seen in the developed world.

The Bank of Japan is, he claims, on the verge of printing a trillion dollars worth of stimulus. Prime Minister Abe has staked his career on his ability to stimulate the Japanese economy. He’s using three tools (“arrows,” in his terms) but only one of those three (central bank stimulus) is showing results. In consequence, Japan is likely to push this one tool as far as they’re able. Hasenstab thinks that the stimulus possible from the BOJ will completely, and for an extended period, overwhelm any moderation in the Fed’s stimulus. In particular, BOJ stimulus will most directly impact Asia, which is primarily emerging. The desire to print money is heightened by Japan’s need to cover a budget deficit that domestic sources can’t cover and foreign ones won’t.

Emerging markets are in exemplary fiscal shape, unlike their position during past interest rate tightening phases. In 1991, the emerging markets as a whole had negligible foreign currency reserves; when, for example, American investors wanted to pull $100 million out, the country’s banks did not hold 100 million in US dollars and crisis ensued. Since 1991, average foreign currency reserves have tripled. Asian central banks hold reserves equal to 40% of their nation’s GDPs and even Mexico has reserves equal to 20% of GDP. At base, all foreign direct investment could leave and the EMs would still maintain large currency reserves.

Hasenstab also noted that emerging markets have undergone massive deleveraging so that their debt:GDP ratios are far lower than those in developed markets and far lower than the historic levels in the emerging markets. Finally we’re already at the bottom of the EM growth cycle with growth rates over the next several years averaging 6-7%.

As an active manager, he likely felt obliged to point out that EM stocks have decoupled; nations with negative real interest rates and negative current account balances are vulnerable. Last year, for example, Hungary’s market returned 4000 bps more than Indonesia’s which reflects their fundamentally different situations. As a result, it’s not time to buy a broad-based EM index.

Bottom line: EM exposure should be part of a core portfolio but can’t be pursued indiscriminately. While the herd runs from manic to depressed on about a six month cycle, the underlying fundamentals are becoming more and more compelling.  For folks interested in the argument, you should read the MFO discussion board thread on it.  There’s a lot of nuance and additional data there for the taking.

Feeding the Beast

by Edward Studzinski

“Finance is the art of passing currency from hand to hand until it finally disappears.”

                                                  Robert Sarnoff

A friend of mine, a financial services reporter for many years, spoke to me one time about the problem of “feeding the beast.”  With a weekly deadline requirement to come up with a story that would make the editors up the chain happy and provide something informative to the readers, it was on more than one occasion a struggle to keep from repeating one’s self and avoid going through the motions.  Writing about mutual funds and the investment management business regularly presents the same problems for me.  Truth often becomes stranger than fiction, and many readers, otherwise discerning rational people, refuse to accept that the reality is much different than their perception.  The analogy I think of is the baseball homerun hitter, who through a combination of performance enhancing chemicals and performance enhancing bats, breaks records (but really doesn’t). 

So let’s go back for a moment to the headline issue.  One of my favorite “Shoe” cartoons had the big bird sitting in the easy chair, groggily waking up to hear the break-in news announcement “Russian tanks roll down Park Avenue – more at 11.”  The equivalent in the fund world would be “Famous Fund Manager says nothing fits his investment parameters so he is sending the money back.”  There is not a lot of likelihood that you will see that happening, even though I know it is a concern of both portfolio managers and analysts this year, for similar reasons but with different motivations.  In the end however it all comes back to job security, about which both John Bogle and Charlie Ellis have written, rather than a fiduciary obligation to your investors. 

David Snowball and I interviewed a number of money managers a few months ago.  All of them were doing start-ups.  They had generally left established organizations, consistently it seemed because they wanted to do things their own way.  This often meant putting the clients first rather than the financial interests of a parent company or the senior partners.  The thing that resonated the most with me was a comment from David Marcus at Evermore Global, who said that if you were going to set up a mutual fund, set up one that was different than what was available in the market place.  Don’t just set up another large cap value fund or another global value fund.  Great advice but advice that is rarely followed it seems. 

If you want to have some fun, take a look at:

•  an S&P 500 Index Fund’s top ten holdings vs.
•  the top ten holdings at a quantitative run large cap value fund (probably one hundred stocks rather than five hundred, and thirty to sixty basis points in fees as opposed to five at the index fund) vs.
•  the top ten holdings at a diversified actively managed large cap value fund (probably sixty stocks and eighty basis points in fees) vs.
•  a non-diversified concentrated value fund (less than twenty holdings, probably one hundred basis points in fees).

Look at the holdings, look at the long-term performance (five years and up), and look at the fees, and draw your own conclusions.  My suspicion is that you will find a lot of portfolio overlap, with the exception of the non-diversified concentrated fund.  My other suspicion is that the non-diversified concentrated fund will show outlier returns (either much better or much worse).  The fees should be much higher, but in this instance, the question you should be paying attention to is whether they are worth it.  I realize this will shock many, but this is one of the few instances where I think they are justified if there is sustained outperformance.

Now I realize that some of you think that the question of fees has become an obsession with me, my version of Cato the Elder saying at every meeting of the Roman Senate, “Carthage must be destroyed.”  But the question of fees is one that is consistently under appreciated by mutual fund investors, if for no other reason that they do not see the fees.  In fact, if you were to take a poll of many otherwise sophisticated investors, they would tell you that they are not being charged fees on their mutual fund investment.  And yet, high fees without a differentiated portfolio does more to degrade performance over time than almost anything else.

John Templeton once said that if your portfolio looks like everyone else’s, your returns also will look the same.  The great (and I truly mean great) value investor Howard Marks of Oaktree Capital puts it somewhat differently but equally succinctly.  Here I am paraphrasing but, if you want to make outsized returns than you have to construct a portfolio that is different than that held by most other investors.  Sounds easy right?

But think about it.  In large investment organizations, unconventional behavior is generally not rewarded.  If anything, the distinction between the investors and the consultant intermediaries increasingly becomes blurred in terms of who really is the client to whom the fiduciary obligation is owed.  Unconventional thinking loses out to job security.  It may be sugar coated in terms of the wording you hear, with all the wonderful catch phrases about increased diversification, focus on generating a higher alpha with less beta, avoiding dispersion of investment results across accounts, etc., etc.  But the reality is that if 90% of the client assets were invested in an idea that went to zero or the equivalent of zero and 10% of them did not because the idea was avoided by some portfolio managers, the ongoing discussion in that organization will not be about lessons learned relative to the investment mistake.  Rather it will be about the management and organizational problems caused by the 10% managers not being “team players.” 

The motto of the Special Air Service in Great Britain is, “Who dares, wins.”  And once you spend some time around those people, you understand that the organization did not mold that behavior into them, but rather they were born with it and found the right place where they could use those talents (and the organization gave them a home).  Superior long-term investment performance requires similar willingness to assess and take risks, and to be different than the consensus.  It requires a willingness to be different, and a willingness to be uncomfortable with your investments.  That requires both a certain type of portfolio manager, as well as a certain type of investor.

I have written before about some of the post-2008 changes we have seen in portfolio management behavior, such as limiting position sizes to a certain number of days trading volume, and increasing the number of securities held in a portfolio (sixty really is not concentrated, no matter what the propaganda from marketing says).  But by the same token, many investors will not be comfortable with a very different portfolio.  They will also not be comfortable investing when the market is declining.  And they will definitely not be comfortable with short-term underperformance by a manager, even when the long-term record trashes the indices. 

From that perspective, I again say that if you as an investor can’t sleep at night with funds off the beaten path or if you don’t want to do the work to monitor funds off the beaten path, then focus your attention on asset-allocation, risk and time horizon, and construct a portfolio of low-cost index funds. 

At least you will sleep at night knowing that over time you will earn market returns.  But if you know yourself, and can tolerate being different – than look for the managers where the portfolio is truly different, with the potential returns that are different. 

But don’t think that any of this is easy.  To quote Charlie Munger, “It’s not supposed to be easy.  Anyone who finds it easy is stupid.”  You have to be prepared to make mistakes, in both making investments and assessing managers.  You also have to be willing to look different than the consensus.  One other thing you have to be willing to do, especially in mutual fund investing, is look away from the larger fund organizations for your investment choices (with the exception of index funds, where size will drive down costs) for by their very nature, they will not attract and retain the kind of talent that will give you outlier returns (and as we are seeing with one large European-owned organization, the parent may not be astute enough to know when decay has set in).  Finally, you have to be in a position to be patient when you are wrong, and not be forced to sell, either by reason of not having a long-term view or long-term resources, or in the case of a manager, not having the ability to weather redemptions while maintaining organizational and institutional support for the philosophy. 

Next month: Flash geeks and other diversions from the mean.

Navigating Scylla and Charybdis: reading advice from the media saturated

Last month’s lead essay, “All the noise, noise, noise noise!”  made the simple argument that you need to start paying less attention to what’s going on in the market, not more.  Our bottom line:

It’s survival. I really want to embrace my life, not wander distractedly through it. For investors, that means making fewer, more thoughtful decisions and learning to trust that you’ve gotten it right rather than second-guessing yourself throughout the day and night.

The argument is neither new nor original to us.  The argument is old.  In 1821 the poet Percy Bysshe Shelley complained “We have more moral, political, and historical wisdom than we know how to reduce into practice.”  By the end of the century, the trade journal Printer’s Ink (1890) complained that “the average [newspaper] reader skims lightly over the thousand facts massed in serried columns. To win his attention he must be aroused, excited, terrified.”  (Certain broadcast outlets apparently took note.)

And the argument is made more eloquently by others than by us.  We drew on the concerns raised by a handful of thoughtful investors who also happen to be graceful writers: Joshua Brown, Tadas Viskanta, and Barry Ritholtz. 

We should have included Jason Zweig in the roster.  Jason wrote a really interesting essay, Stock Picking for the Long, Long, Long Haul, on the need for us to learn to be long-term investors:

Fund managers helped cause the last financial crisis—and they will contribute to the next one unless they and their clients stop obsessing over short-term performance.

Jason studied the remarkable long-term performance of the British investment firm Baillie Gifford and find that their success is driven by firms whose management is extraordinarily far-sighted:

What all these companies have in common, Mr. Anderson [James, BG’s head of global equities] says, is that they aren’t “beholden to the habits of quarterly capitalism.” Instead of trying to maximize their short-term growth in earnings per share, these firms focus almost entirely on growing into the distant future.

“Very often, the best way to be successful in the long run is not to aim at being successful in the short run,” he says. “The history of capitalism has been lurched forward by people who weren’t looking primarily for the rewards of narrow, immediate gain.”

In short, he doesn’t just want to find the great companies of today—but those that will be even greater companies tomorrow and for decades to come.

The key for those corporate leaders is to find investors, fund managers and others, who “have a horizon of decades.”  “It’s amazing how some of the largest and greatest companies hunger to have shareholders who are genuinely long-term,” Mr. Anderson says.

In June I asked those same writers to shift their attention from problem to solution.  If the problem is that we become addled to paying attention – increasingly fragmented slivers of attention, anyway – to all the wrong stuff, where should we be looking?  How should we be training our minds?  Their answers were wide-ranging, eloquent, consistent and generous.  We’ll start by sharing the themes and strategies that the guys offered, then we’ll reproduce their answers in full for you on their own pages.

“What to read if you want to avoid being addled and stupid.”  It’s the Scylla and Charybdis thing: you can’t quite ignore it all but you don’t want to pay attention to most of it, so how do you steer between?  I was hopeful of asking the folks I’d quoted for their best answer to the question: what are a couple things, other than your own esteemed publication, that it would benefit folks to read or listen to regularly?

Three themes seem to run across our answers.

1. Don’t expose yourself to any more noise than your job demands.

   As folks in the midst of the financial industry, the guys are all immersed in the daily stream but try to avoid being swept away by it. Josh reports that “at no time do I ever visit the home page of a blog or media company’s site.”  He scans headlines and feeds, looking for the few appearances (whether Howard Marks or “a strategist I care about”) worth focusing on. Jason reads folks like Josh and Tadas “who will have short, sharp takes on whatever turns out to matter.”  For the rest of us, Tadas notes, “A monthly publication is for the vast majority of investors as frequent as they need to be checking in on the world of investing.”

2. Take scientific research seriously. 

   Jason is “looking for new findings about old truths – evidence that’s timely about aspects of human nature that are timeless.”  He recommends that the average reader “closely follow the science coverage in a good newspaper like The Wall Street Journal or The New York Times.”  Tadas concurs and, like me, also regularly listens to the Science Friday podcast which offers “an accessible way of keeping up.” 

3. Read at length and in depth. 

   All of us share a commitment to reading books.  They are, Tadas notes, “an important antidote to the daily din of the financial media,” though he wryly warns that “many of them are magazine articles padded out to fill out the publisher’s idea of how long a book should be.”

   Of necessity, the guys read (and write) books about finance, but those books aren’t at the top of their stacks and aren’t the ones in their homes.  Jason’s list is replete with titles that I dearly wish I could get my high achieving undergrads to confront (Montaigne’s Essays) but they’re not “easy reads” and they might well be things that won’t speak even to a very bright teenager.  Jason writes, “Learning how to think is a lifelong struggle, no matter how intelligent or educated you may be.  Books like these will help.  The chapter on time in St. Augustine’s Confessions, for instance, which I read 35 years ago, still guides me in understanding why past performance doesn’t predict future success.”  Tadas points folks to web services that specialize in long form writing, including Long Reads and The Browser.

Here’s my answer, for what interest that holds:

Marketplace, from American Public Media.  The Marketplace broadcast and podcast originate in Los Angeles and boast about 11 million listeners, mostly through the efforts of 500 public radio stations.  Marketplace, and its sister programs Marketplace Money and Marketplace Morning Report, are the only shows that I listen to daily.  Why?  Marketplace starts with the assumption that its listeners are smart and curious, but not obsessed with the day’s (or week’s) market twitches.  They help folks make sense of business and finance – personal and otherwise – and they do it in a way that makes you feel more confident of your own ability to make sense of things.  The style is lively, engaged and sometimes surprising.

Books, from publishers. I know this seems like a dodge, but it isn’t.  At Augustana, I teach about the effects of emerging technologies and on the ways they use us as much as we use them.  This goes beyond the creepiness of robots reading my mail (a process Google is now vastly extending) or organizations that can secretly activate my webcam or cellphone.  I’m concerned that we’re being rewired for inattention. Neurobiologists make it clear that our brains are very adaptive organs; when confronted with a new demand – whether it’s catching a thrown baseball or navigating the fact of constant connection – it assiduously begins reorganizing itself. We start as novices in the art of managing three email accounts, two calendars, a dozen notification sounds, coworkers we can never quite escape and the ability to continuously monitor both the market and the World Cup but, as our brains rewire, we become experts and finally we become dependent. That is, we get to a state where we need constant input.  Teens half wake at night to respond to texts. Adults feel “ghost vibrations” from phones in their pockets. Students check texts 11 times during the average class period. Board members stare quietly at devices on their laps while others present.  Dead phones become a source of physical anxiety. Electronic connectedness escapes control and intrudes on driving, meals, sleep, intimacy.  In trying never to miss anything, we end up missing everything.

Happily, that same adaptability works in the other direction.  Beyond the intrinsic value of encountering an argument built with breadth and depth, the discipline of intentionally disconnecting from boxes and reconnecting with other times and places can rebuild us.  It’s a slog at first, just as becoming dependent on your cell phone was, but with the patient willingness to set aside unconnected time each day – 20 minutes at first?  one chapter next? – we can begin distancing ourselves from the noise and from the frenetic mistakes it universally engenders.

And now the guys’ complete responses:

Thanks to them all for their generosity and cool leads.  I hadn’t looked at either The Browser or The Epicurean Dealmaker before (both look cool) though I’m not quite brave enough to try Feedly just yet for fear of becoming ensnared.

Despite the loud call of a book (Stuff Matters just arrived and is competing with The Diner’s Dictionary and A Year in Provence for my attention), I’ll get back to talking about fund stuff.

Top Developments in Fund Industry Litigation – June 2014

Fund advisors spend a surprising amount of time in court or in avoiding court.  We’ve written before about David Smith and FundFox, the only website devoted to tracking the industry’s legal travails.  I’ve asked David if he’d share a version of his monthly précis with us and he generously agreed.  Here’s his wrap up of the legal highlights from the month just passed.

For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com.  Fundfox is the only intelligence service to focus exclusively on litigation involving U.S.-registered investment companies, their directors and advisers—making it easy to remain specialized and aware in today’s fluid legal environment.

New Lawsuit

• A new excessive-fee lawsuit alleges that Davis provides substantially the same investment advisory services to subadvised funds for lower fees than its own New York Venture Fund. (Hebda v. Davis Selected Advisers, L.P.)

Settlements

• The court preliminarily approved a $14.95 million settlement of the ERISA class action regarding ING’s receipt of revenue-sharing payments. (Healthcare Strategies, Inc. v. ING Life Ins. & Annuity Co.)
• The court preliminarily approved a $22.5 million settlement of the ERISA class action alleging that Morgan Keegan defendants permitted Regions retirement plans to invest in proprietary RMK Select Funds despite excessive fees. (In re Regions Morgan Keegan ERISA Litig.)

Briefs

• A former portfolio manager filed his opposition to Allianz’s motion to dismiss his breach-of-contract suit regarding deferred compensation under two incentive plans; and Allianz filed a reply brief. (Minn v. Allianz Asset Mgmt. of Am. L.P.)
• BlackRock filed an answer and motion to dismiss an excessive-fee lawsuit alleging that two BlackRock funds charge higher fees than comparable funds subadvised by BlackRock. (In re BlackRock Mut. Funds Advisory Fee Litig.)
• Harbor filed a reply brief in support of its motion to dismiss an excessive-fee lawsuit regarding a subadvised fund. (Zehrer v. Harbor Capital Advisors, Inc.)

Advisor Perspectives launches APViewpoint, a discussion board for advisors

We spent some time at Morningstar chatting with Justin Kermond, a vice president with Advisor Perspectives (AP).  We’ve collaborated with AP on other issues over the years, they’re exploring the possibility of using some of our fund-specific work their site and they’ve recently launched a discussion board that’s exclusive to the advisor community.   We talked for a while about MFO’s experience hosting a lively (oh so lively) discussion board and what AP might be doing to build on our experience.  For the sake of those readers in the advisor community, I asked Justin to share some information about their new discussion community.  Here’s his description>

[We] recently launched APViewpoint, a secure discussion forum and “online study group.” APViewpoint enables investment advisers, registered reps, and financial planners to learn from each other by sharing their experiences and knowledge on a wide range of topics of interest to the profession. Current topics of discussion include Thomas Pikkety’s views on inequality; whether small cap and value stocks truly outperform the market; the pros and cons of rebalancing; and the potential transformative effect of robo-advisors. APViewpoint is free to all financial advisors. The site formally launched mid May, 2014 and currently has more than 900 members.

One of APViewpoint’s key differentiators is the participation of more than 40 nationally recognized industry thought leaders, including Bob Veres, Carl Richards, Harold Evensky, Wade Pfau, Doug Short, Michael Kitces, Dan Solin, Michael Edesess, Geoff Considine, Marylin Capelli Dimitroff, Ron Rhoades, Sue Stevens and Advisor Perspectives CEO and editor Robert Huebscher. These thought leaders start and participate in discussions on a variety of topics, and advisors are invited to learn and share their own views, creating a vibrant, highly respectful environment that encourages the free exchange of ideas.

For advisors interested in discussing funds, APViewpoint automatically recognizes mutual fund and ETF symbols mentioned in discussions, permitting users to easily search for conversations about specific products. Users can also create a specific list of funds they wish to “follow,” and be alerted when these funds are mentioned in conversations.

APViewpoint is also designed to foster discussion of the content featured on the Advisor Perspectives web site and weekly newsletter. Every article now features a direct link to an associated discussion on APViewpoint, allowing members to provide spontaneous feedback.

Only advisors can be members of APViewpoint; investors may not join. A multi-step validation process ensures that only advisors are approved, and the content on APViewpoint is not accessible to the general public. This relieves advisors of some of the compliance issues that often restrict their ability to post their thoughts on social media platforms such as Linkedin, where investors can view messages posted in groups where advisors congregate.

Advisors can sign up today at www.apviewpoint.com. 

The piece in between the pieces

I’ve always been honored, and more than a little baffled, that folks as sharp as Charles, Chip and Ed have volunteered to freely and continually contribute so much to the Observer and, through us, to you. Perhaps they share my conviction that you’re a lot brighter than you know and that you’re best served by encountering smart folks who don’t always agree and who know that’s just fine. 

Our common belief is not that we learn by listening to a smart person with whom we agree (isn’t that the very definition of a smart person?  Someone who tells us we’re right?), but to listening to a variety of really first rate people whose perspectives are a bit complicated and whose argument might (gasp!) be more than one screen long.

The problem is that they’re often smarter than we are and often disagree, leaving us with the question “who am I to judge?”  That’s at the heart of my day job as a college professor: helping learners get past the simple, frustrated impulse of either (1) picking one side and closing your ears, or (2) closing your ears without picking either. 

One of the best expressions of the problem was offered by Leo Strauss,  a 20^th century political philosopher and classicist:

To repeat: liberal education consists of listening to the conversation among the greatest minds.  But here we are confronted with the overwhelming difficulty that this conversation does not take place without our help – that in fact we must bring about that conversation.  The greatest minds utter monologues.  We must transform their monologues into a dialogue, their “side by side” into a “together.”  The greatest minds utter dialogues even when they write monologues.

Let us face this difficulty, a difficulty so great that it seems to condemn liberal education to an absurdity.  Since the greatest minds contradict one another regarding the most important matters, they compel us to judge their monologues; we cannot take on trust what any one of them says.  On the other hand, we cannot be notice that we are not competent to be judges.  In Liberalism Ancient and Modern (1968)

The two stories that follow are quick attempts to update you on what a couple of first-rate guys have been thinking and doing.  The first is Charles’s update on Mebane Faber, co-founder and CIO of Cambria Funds and a prolific writer.  The second is my update on Andrew Foster, founder and CIO of Seafarer Funds.

Meb Faber gets it right in interesting ways

A quick follow-up to our feature on Mebane Faber in the May commentary, entitled “The Existential Pleasure of Engineering Beta.”

On May 16, Mebane posted on his blog “Skin in the Game – My Portfolio,” which states that he invests 100% of his liquid net worth in his firm’s funds: Global Tactical Hedge Fund (private), Global Value ETF (GVAL), Shareholder Yield ETF (SYLD), Foreign Shareholder Yield ETF (FYLD) – all offered by Cambria Investment Management.

His disclosure meets the “Southeastern Asset Management” rule, as coined and proposed by our colleague Ed Studzinski. It would essentially mandate that all employees of an investment firm limit their investments to funds offered by the firm. Ed proposes such a rule to better attune “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.”

While Mr. Faber did not specify the dollar amount, he did describe it as “certainly meaningful.” The AdvisorShares SAI dated December 30, 2013, indicated he had upwards of $1M invested in his first ETF, Global Tactical ETF (GTAA), which was one of largest amounts among sub-advisors and portfolio managers at AdvisorShares.

Then, on June 5^th, more clarity: “The two parties plan on separating, and Cambria will move on” from sub-advising GTAA and launch its own successor Global Momentum ETF (GMOM) at a full 1% lower expense ratio. Here’s the actual announcement:

Same day, AdvisorShares announced: “After a diligent review and careful consideration, we have decided to propose a change of GTAA’s sub-advisor. At the end of the day, our sole focus remains our shareholders’ best interests…” The updated SAI indicates the planned split is to be effective end of July.

Given the success of Cambria’s own recently launched ETFs, which together represent AUM of $357M or more than 10 times GTAA, the split is not surprising. What’s surprising is that AdvisorShares is not just shuttering GTAA, but chose instead to propose a new sub-advisor, Mark Yusko of Morgan Creek Capital Management.

On the surface, Mr. Yusko and Mr. Faber could not be more different. The former writes 25 page quarterly commentaries without including a single data graph or table. The latter is more likely to give us 25 charts and tables without a single paragraph.

When Mebane does write, it is casual, direct, and easily understood, while Mr. Yusko seems to read from the corporate play book: “We really want to think differently. We really want to embrace alternative strategies. Not alternative investments but alternative strategies. To gain access to the best and brightest. To invest on that global basis. To take advantage of where we see biggest return opportunities around the world.”

When we asked Mebane for a recent photo to use in the May feature, he did not have one and sent us a self-photo taken with his cell phone. In contrast, Mark Yusko offers a professionally produced video introducing himself and his firm, accompanied with scenes of a lovely creek (presumably Morgan’s) and soft music.   

Interestingly, Morgan Creek launched its first retail fund last September, aptly named Morgan Creek Tactical Allocation Fund (MAGTX/MIGTX). MAGTX carries a 5.75% front-load with a 2% er. (Gulp.) But, the good news is institutional share class MIGTX waives load on $1M minimum and charges only 1.75% er.

Mr. Yusko says “I don’t mind paying [egregious] fees as long as my net return is really high.” While Mr. Faber made a point during the recent Wine Country Conference that a goal for Cambria is to “disrupt the traditional high fee mutual fund and hedge fund business, mostly through launching ETFs.”

The irony here is that GTAA was founded on the tenants described in Mebane’s first book “The Ivy Portfolio,” which includes attempting to replicate Yale’s endowment success with all-asset strategy using an ETF.

Mr. Yusko’s earned his reputation managing the endowments at Notre Dame and University of North Carolina, helping to transform them from traditional stock/bond/cash portfolios to alternative hedge fund/venture capital/private investment portfolios. But WSJ reports that he was asked to step-down last year as CIO of the $3.5B Endowment Fund, which also attempted to mimic endowments like Yale’s. He actually established the fund in partnership with Salient Partners LP in 2004. “After nearly a decade of working with our joint venture partner in Texas, we found ourselves differing on material aspects of how to best run an endowment portfolio and run the business…” Perhaps with AdvisorShares, Mark Yusko will once again be able to see eye-to-eye.

As for Mebane? We will look forward with interest to the launch of GMOM (a month or two away), his continued insights and investment advice shared generously, and wish him luck in his attempts to disrupt the status quo. 

Seafarer gets it right in interesting ways

Why am I not surprised?

Seafarer is an exceedingly independent, exceedingly successful young emerging markets fund run by an exceedingly thoughtful, exceedingly skilled manager (and team).  While most funds imply a single goal (“to make our investors rich, rich, rich!”), Seafarer articulated four.  In their most recent shareholder letter, Andrew and president Michelle Foster write:

Our abiding goal as an investment adviser is to deliver superior long-term performance to our clients. However, we also noted three ancillary objectives:

1. to increase the transparency associated with investment in developing countries;
2. to mitigate a portion of the volatility that is inherent to the emerging markets; and
3. to deliver lower costs to our clients, over time and with scale.

They’ve certainly done a fine job with their “abiding goal.”  Here’s the picture, with Seafarer represented by the blue line:

That success is driven, at least in part, by Seafarer’s dogged independence, since you can’t separate yourself from the herd by acting just like it. Seafarer’s median market cap ($4 billion) is one-fifth of its peers’ while still being spread almost evenly across all market capitalizations, it has no exposure at all to some popular countries (Russia: 0) and sectors (commodities: 0), and a simple glance at the portfolio stats (higher price, lower earnings)  belies the quality of the holdings.

Four developments worth highlighting just now:

Seafarer’s investment restrictions are being loosened

One can profit from developments in the emerging markets either by investing in firms located there or by investing in firms located here than do business there (for example, BMW’s earnings are increasingly driven by China). Seafarer does both and its original prospectus attempted to give investors a sense of the comparative weights of those two approaches by enunciating guideline ranges: firms located in developed nations might represent 20-50% of the portfolio and developing nations would be 50-80%.  Those numeric ranges will disappear with the new prospectus. The advisor’s experience was that it was confusing more investors than it was informing.  “I found in practice,” he writes, “that some shareholders were wrongly but understandably interpreting these percentages as precise restrictions, and so we removed the percentage ranges to reduce confusion.”

Seafarer’s gaining more flexibility to add bonds to the portfolio

Currently the fund’s principal investment strategy has it investing in “dividend-paying common stocks, preferred stocks, convertible securities and debt obligations of foreign companies.” Effective August 29, “the Fund may also pursue its investment objective by investing in the debt obligations of foreign governments and their agencies.” Andrew notes that “they help bolster liquidity, yield, and to some extent improve the portfolio’s stability — so we have made this change accordingly. Still, I think it’s unlikely they will become a big part of what we do here at Seafarer.”

Seafarer’s expenses are dropping (again)

Effective September 1, the expense ratio on retail shares drops from 1.49% to 1.25% and the management fee – the money the advisor actually gets to keep – drops from 0.85% to 0.75%.  Parallel declines occur in the Institutional shares.

Given their choice, Seafarer would scoot more investors into its lower cost institutional shares but agreements with major distributions (think “Schwab”) keep them from reducing the institutional minimum. That said, the current shareholder letter actually lists three ways that investors might legally dodge the $100k minimum and lower their expenses. Those are details in the final six paragraphs of the shareholder letter. If you’re a large individual investor or a smaller advisor, you might want to check out the possibilities.

Active management is working!

Seafarer’s most recent conference call was wide-ranging. For those unable to listen in (sadly, the mp3 isn’t available), the slide deck offers some startling information.  Here’s my favorite slide:

Dark blue: stocks the make money for the portfolio.  White: break-even.  Light blue: losers (“negative contributors”).  If you buy a broad-based EM index, exactly 38% of the stocks in your fund actually make you money. If you buy Seafarer, that proportion doubles.

That strikes me as incredibly cool.  Also consistent with my suspicion (and Andrew’s research) that indexes are often shockingly careless constructs.

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: fixed income investing from A to Z (or zed).

Artisan High Income (ARTFX): Artisan continues to attract highly-talented young managers with promises of integrity, autonomy and support. The latest emigrant is Bryan Krug, formerly the lead manager of the four star, $10 billion Ivy High Income fund. Mr. Krug is a careful risk manager who invests in a mix of high-yield bonds and secured and unsecured loans. And yes, he does know what everybody is saying about the high yield market.

Zeo Strategic Income (ZEOIX): Manager Venk Reddy has been honing his craft in private partnerships for years now as the guy who put the “hedging” in hedge funds but he aspires to more. He wanted to get out and pursue his own vision. In Latin, EXEO is pronounced “ek-zeo” and means something like “I’m outta here.” And so he left the world of high alpha for the land of low beta. Mr. Reddy is a careful risk manager who invests in an unusually compact portfolio of short term high-yield bonds and secured loans designed to produce consistent, safe inflation-beating returns for investors looking for “cash” that’s not trash.

Launch Alert: Touchstone Sands Emerging Markets Growth Fund

In May, 2014, Touchstone Investments launched the Touchstone Sands Capital Emerging Markets Growth Fund, sub-advised by Sands Capital Management. Sands Capital, with about $42 billion in AUM, has maintained an exclusive focus on growth-oriented equity investing since 1992. They began investing in the emerging markets in 2006 as part of their Global Growth strategy then launched a devoted EM strategy at the very end of 2012. Over time they’ve added resources to allow their EM team to handle ever greater responsibilities.

The EM composite has done exceedingly well since launch, substantially outperforming the standard EM index in both 2013 and 2014. The more important factor is that there are rational decisions which increase the prospect that the strategy’s success with be repeated in the fund. At base, there are good places to be in emerging markets and bad places to be.

Good places: small firms that tap into the growing affluence of the EMs and the emergence of their middle class.

Bad places: large firms that are state-owned or state-controlled that are economically tied to the slow-growing developed world. Banks, telecoms, and energy companies are pretty standard examples.

Structurally, indexes and many funds that benchmark themselves against the indexes tend to over-invest in the bad places because they are, well, big.  Cap-weighted means buy whatever’s big, corrupt and inefficient or not.

Steve Owens of Touchstone talked with me about Sands’ contrasting approach to EM investing:

Sands Capital’s investment philosophy is based on a belief that over time, common stock prices will reflect the earnings power and growth of the underlying businesses. Sands Capital utilizes the same six investment criteria to evaluate all current and potential business investments across its [three] strategies.

Sands Capital has found many innovative and distinctive businesses that are similar to those which the firm has historically invested in its developed market portfolios. Sands Capital seeks dominant franchises that are taking market share in a growing business space, while generating significant free cash flow to self-fund their growth. Sands Capital tends to avoid most commodity-based companies, state-owned enterprises or companies that are highly leveraged with opaque balance sheets (i.e. many Utilities and Financials). It seeks to avoid emerging market businesses that are levered to developed market demand rather than local consumption.

This process results in a benchmark agnostic, high active share, all-cap portfolio of 30-50 businesses which tends to behave differently from traditional Emerging Market indices. Sands Capital opportunistically invests in Frontier Market Equities when it finds a great business opportunity.

Sands other funds are high growth, low turnover four- and five-star funds, now closed to new investors.  The new fund is apt to be likewise.  The minimum initial investment in the retail class is $2500, reduced to $1000 for IRAs.  The expenses are capped at 1.49%. Here’s the fund’s homepage.

Sands will likely join Seafarer Overseas Growth & Income and Dreihaus Emerging Markets Small Cap Growth Fund on the short list of still-open EM funds that we keep a close eye on.  Investors who are more cautious but still interested in enhanced EM exposure should watch Amana Developing World as well. 

Funds in Registration

The summer doldrums continue with only nine new no-load funds in registration. The most interesting might be an institutional fund from T. Rowe Price which focuses on frontier markets. Given Price’s caution, the launch of this fund seems to signal the fact that the frontier markets are now mainstream investments.

Manager Changes

Fifty-six funds underwent partial or total manager changes this month, a substantial number that’s a bit below recent peaks. One change in particular piqued Chip’s curiosity. As you know, our esteemed technical director also tracks industry-wide manager changes. She notes, with some perplexity, that Wilmington Multi-Manager Alternative might well be renamed Wilmington Ever-changing Manager Alternative fund. She writes:

Normally, writing up the manager changes is relatively straight-forward. This month, one caught my eye. The Wilmington Multi-Manager Alternatives Fund (WRAAX) turned up with a manager change for the third month in a row. A quick check of the data shows that the fund has had 42 managers since its inception in 2012. Twenty-eight of them are no longer with the fund.

The fund currently sports 14 managers but they also dismiss about 14 managers a year. Our recommendation to the current crew: keep your resumes polished and your bags packed.

We’d be more sympathetic to the management churn if it resulted in superior returns for the fund’s investors, but we haven’t seen that yet. $10,000 invested in the fund at launch would have swollen to $10,914 today. In the average multialternatives fund, it would be $10,785. That’s a grand total of $129 in excess returns generated by almost constant staff turnover.

By way of an alternative, rather than paying a 5% load and 2.84% expenses here in order to hedge yourself, you might consider Vanguard Balanced Index (VBINX). The world’s dullest fund charges 0.24% and would have turned your $10,000 into $13,611.

Briefly Noted . . .

Special thanks, as always, to The Shadow for independently tracking down 14 or 15 fund changes this month, sometimes posting changes just before the fund companies realize they’re going to make them. That’s spooky-good.

SMALL WINS FOR INVESTORS

American Century Equity Income Fund (TWEIX) reopens to new investors on August 1. The folks on the discussion board react with three letters (WTF) and one question: Why? The fund’s assets have risen just a bit since the closure while its performance has largely been mediocre.

On July 1, 2014, ASTON/LMCG Emerging Markets Fund (ALEMX) reduced its expense ratio from 1.65% to 1.43% on its retail “N” shares and from 1.40% down to 1.18% on its institutional shares. The fund has had a tough first year. The fund returned about 9% over the past 12 months while its peers made 15%. A lower expense ratio won’t solve all that, but it’s a step in the right direction.

CCM Alternative Income (CCMNX) is lowering its investment minimum from $100,000 to $1,000. While the Morningstar snapshot of the fund trumpets expenses of 0.00%, they’re actually capped at 1.60%.

Effective June 23, 2014, Nuveen converted all of their funds’ “B” shares into “A” shares.

We should have mentioned this earlier: Effective May 7, 2014, Persimmon Long/Short (LSEAX/LSEIX) agreed to reduce its management fee from 2.50% to 1.99%. This is really a small win since the resulting total expense ratio remains around 3.25% and the fund sports a 5% sales load. Meaning no disrespect to the doubtless worthy folks behind the fund, but I’m baffled at how they expect to gain traction in the market with such structurally high expenses.

Good news for all Lutherans out there! For the month of August 2014 only, the sales load on the “A” shares of Thrivent Growth and Income Plus Fund (TEIAX), Thrivent Balanced Income Plus Fund (AABFX), Thrivent Diversified Income Plus Fund (AAHYX), Thrivent Opportunity Income Plus Fund (AAINX), and Thrivent Municipal Bond Fund (AAMBX) will be temporarily waived. Bad news for all Lutherans out there: other than Diversified Income, these really aren’t very good.

CLOSINGS (and related inconveniences)

As of August 1, 2014, AMG Managers Skyline Special Equities Fund (SKSEX) will close to new investors. In the nature of such things, the fund’s blistering performance in 2013 (up 51.6%) drew in a rush of eager new money. The newbies are now enjoying the fund’s bottom 10% performance YTD and might well soon head out again for greener pastures. These are, doubtless, folks who should have read Erma Bombeck’s classic The Grass Is Always Greener over the Septic Tank (1976) rather than watching CNBC.

As of July 11, 2014, Columbia Acorn Emerging Markets Fund (CAGAX) is closing to new investors. The fund reached the half billion plateau well before it reached its third birthday, driven by a surge in performance that began in May 2012.

On July 8, 2014, the $1.3 billion Franklin Biotechnology Discovery Fund (FBDIX) is closed to new folks as well.

The Board of Trustees approved the imposition of a 2% redemption fee on shares of the Hotchkis & Wiley High Yield Fund (HWHAX) that are redeemed or exchanged in 90 days or less. Given the fact that high yield is hot and overpriced (those two do go together), it strikes me as a good thing that H&W are trying to slow folks down a bit.

Any guesses about why Morningstar codes half of the H&W funds as “Hotchkis and Wiley” and the other half as “Hotchkis & Wiley”? It really goofs up my attempts to search the danged database.

OLD WINE, NEW BOTTLES

I’ve placed this note here because I hadn’t imagined the need for a section named “Coups and Other Uprisings.” Effective August 1, Forward Endurance Long/Short Fund (FENRX) becomes a new fund. The name changes (to Forward Equity Long/Short), the mandate changes, fees drop by 25 bps, it ceases to be “non-diversified” and the management team changes (the earlier co-manager left on one week’s notice in May, two new in-house guys are … well, in).

The old mandate was “to identify trends that may have a disruptive impact on and result in significant changes to global business markets, including new technology developments and the emergence of new industries.” The less disruptive new strategy is “to position the Fund in the stronger performing sectors using a proprietary relative strength model and in high conviction fundamental ideas.”

Other than for a few minutes in the spring of 2014, they were actually doing a pretty solid job.

On July 7, 2014, the Direxion Monthly Commodity Bull 2X Fund (DXCLX) will be renamed as Direxion Monthly Natural Resources Bull 2X Fund, with a corresponding change to the underlying index.

At the beginning of September, Dreyfus Select Managers Long/Short Equity Fund (DBNAX) becomes Dreyfus Select Managers Long/Short Fund. I’m deeply grateful for Dreyfus’s wisdom in choosing to select managers rather than randomly assigning them. Thanks, guy!

On October 1, 2014, SunAmerica High Yield Bond Fund (SHNAX) becomes SunAmerica Flexible Credit Fund, and that simultaneously make “certain changes to their principal investment strategy and techniques.” In particular, they won’t have to invest in high yield bonds if they don’t wanna. That good because, as a high yield bond fund, they’ve pretty much trail the pack by 50-100 bps over most trailing time periods.

At the end of July, the $300 million Vice Fund (VICEX) becomes the Barrier Fund. It’s a nice fund run by a truly good person, Gerry Sullivan. The new mandate does, however, muddy things a bit. First, the fund only commits to investing at least 25% of assets to its traditional group of alcohol, tobacco, gaming and defense (high barrier-to-entry) stocks but it’s not quite clear where else the money would go, or why. And the fund will reserve for itself the power to short and use options.

OFF TO THE DUSTBIN OF HISTORY

Apparently diversification isn’t working for everybody. Diversified Risk Parity Fund (DRPAX/DRPIX) will “cease operations, close and redeem all outstanding shares” on July 30, 2014. ASG Diversifying Strategies Fund (DSFAX) is slated to be liquidated about a week later, on August 8.   The omnipresent Jason Zweig has a thoughtful essay of the fund’s liquidation, “When hedging cuts both ways.”  At base, the ASG product was a hedge-like fund that … well, would actually hedge a portfolio.  Investors loved the theory but were impatient with the practice:

If you want an investment that can do well when stocks and bonds do badly, a liquid-alt fund can do that for you. But you will have nobody but yourself to blame when stocks and bonds do well and you get annoyed at your alternative fund for underperforming. That is what it is supposed to do.

If you can’t accept that, maybe you should just keep some of your money in cash.

Dreyfus is giving up on a variety of its funds: one bad hedge-y fund Global Absolute Return (DGPAX, which has returned absolutely nothing since launch), one perfectly respectable hedge-y fund, Satellite Alpha (DSAAX), with under a million in assets and the B and I of the BRICs: India (DIIAX) and Brazil (DBZAX) are all being liquidated in late August.

Driehaus Mid Cap Growth Fund (DRMGX) has closed to new investors and will liquidate at the end of August. It’s not a very distinguished fund but it’s undistinguished in an unDriehaus way. Normally Driehaus funds are high vol / high return, which is sometimes their undoing.

Got a call into Fidelity on this freak show: Strategic Advisers® U.S. Opportunity Fund (FUSOX) is about to be liquidated. It’s a four star fund with $5.5 billion in assets. Low expenses. Top tier long-term returns. Apparently that makes it a candidate for closure. Manager Robert Vick left on June 4^th, ahead of his planned retirement at the end of June. (Note to Bob: states with cities named Portland are really lovely places to spend your later years!). On June 6 they appointed two undertakers new managers to “oversee all activities relating to the fund’s liquidation and will manage the day-to-day operations of the fund until the final liquidation.” Wow. Fund Mortician.

Special note to Morningstar: tell your programmers to stop including the ® symbol in fund names. It makes it impossible to search for the fund since the ® is invisible, there’s no way to type it in the search box and the search will fail unless you type it.

JPMorgan International Realty Fund (JIRAX) experiences “liquidation and dissolution” on July 31, 2014

The $100 million Nationwide Enhanced Income Fund (NMEAX) and the $73 million Nationwide Short Duration Bond Fund (MCAPX)are both, simultaneously, merging into $300 million Nationwide Highmark Short Term Bond Fund (NWJSX). The Enhanced Duration shareholders must approve the move but “[s]hareholders of the Short Duration Bond Fund are not required, and will not be requested, to approve the Merger.” No timetable yet.

Legg Mason’s entire lineup of tiny, underperforming, overcharged retirement date funds (Legg Mason Target Retirement 2015 – 50 and Retirement Fund) “are expected to cease operations during the fourth quarter of 2014.”

Payden Tax Exempt Bond Fund (PYTEX) will be liquidated on July 22. At $6.5 million and an e.r. of 0.65%, the fund wasn’t generating enough income to pay its postage bills much less its manager.

On June 11, the Board of the Plainsboro China Fund (PCHFX) announced that the fund had closed and that it would be liquidated on the following day. Curious. The fund had under $2 million in assets, but top 1% returns over the past 12 months. The manager, Yang Xiang, used to be a portfolio manager for Harding Loevner. On whole, the “liquidated immediately and virtually without notice” sounds rather more like the Plainsboro North Korea Fund (JONGX).

RPg Emerging Market Sector Rotation Fund (EMSAX/EMSIX) spins out for the last time on July 30, 2014.

Royce Focus Value Fund (RYFVX) will be liquidated at the end of July “because it has not attracted and maintained assets at a sufficient level for it to be viable.” Whitney George, who runs seven other funds for Royce, isn’t likely even to notice that it’s gone.

SunAmerica GNMA Fund (GNMAX) is slated to merge into SunAmerica U.S. Government Securities Fund (SGTAX), a bit sad for shareholders since SGTAX seems the weaker of the two.

Voya doesn’t merge funds. They disappear them. And when some funds disappear, others are survivors. On no particular date, Voya Core Equity Research Fund disappears while Voya Large Cap Value Fund (IEDAX) survives. Presumably at the same time, Voya Global Opportunities Fund but Voya Global Equity Dividend Fund (IAGEX) doesn’t.

With the retirement of Matthew E. Megargel, Wellington Management’s resulting decision to discontinue its U.S. multi-cap core equity strategy. That affects some funds subadvised by Wellington.

William Blair Commodity Strategy Long/Short Fund (WCSNX)has closed and will liquidate on July 24, 2014. It’s another of the steadily shrinking cadre of managed futures funds, a “can’t fail” strategy backed by scads of research, modeling and backtested data. Oops.

In Closing . . .

A fund manager shared this screen cap from his browser:

It appears that T. Rowe is looking over us! I guess if I had to pick someone to be sitting atop up, they’d surely make the short list.  The manager speculates that Price might have bought the phrase “Mutual Fund Observer” as one they want to associate with in Google search results.  Sort of affirming if true, but no one knows for sure.

See ya in August!

Dear friends,

It’s been that kind of month. Oh so very much that kind of month. In addition to teaching four classes and cheering Will on through 11 baseball games, I’ve spent much of the past six weeks buying a new (smaller, older but immaculate) house and beginning to set up a new household. It was a surprisingly draining experience, physically, psychologically and mentally. Happily I had the guidance and support of family and friends throughout, and I celebrated the end of April with 26 signatures, eight sets of initials, two attorneys, one large and one moderately-large check, and the arrival of a new set of keys and a new garage door clicker. All of which slightly derailed my focus on the world of funds. Fortunately the indefatigable Charles came to the rescue with …

The Existential Pleasures of Engineering Beta

Mebane Faber is a quant.

He is a student of financial markets, investor behavior, trend-following, and market bubbles. He pursues absolute return, value, and momentum strategies. And, he likes companies that deliver cash to shareholders.

He recognizes alpha is elusive, so instead focuses on engineering beta, which promises a more pragmatic and enduring reward.

In a field full of business majors and MBAs, he holds degrees in engineering and biology.

He distills a wealth of financial literature, research, and conditions into concise and actionable investing advice, shared through books, his blog, and lectures.

Given low-cost ETFs and mutual funds available today, he thinks people generally should no longer need to hire advisors, or “brokers back in the day,” at 1-2% fees to tell them how to allocate buy-and-hold portfolios. “It kind of borderlines on criminal,” he tells Michael Covel in a recent interview, since such advisors “do not do enough to justify their fees.”

He is a portfolio manager and CIO of Cambria Investment Management, L.P., which he co-founded along with Eric Richardson in 2006. It is located in El Segundo, CA.

His down-to-earth demeanor is at once confident and refreshingly approachable. He cites philosopher Henry David Thoreau: “There is no more fatal blunderer than he who consumes the greater part of his life getting his living.”

The Paper. Mebane (pronounced “meb-inn”) started his career as biotech equity analyst during the genome revolution and internet bubble. While at University of Virginia, he attended an advanced seminar in security analysis taught by the renowned hedge fund manager John Griffin of Blue Ridge Capital. In fulfillment of the Chartered Market Technician program, Mebane drafted a paper that became the basis for “A Quantitative Approach To Tactical Asset Allocation,” published in the Journal of Wealth Management in 2007.

The paper originally included the words “market timing,” but he soon discovered that to a lot of people, the phrase comes with “enormous emotional baggage” and “can immediately shut-down all synapses in their brains.” Similar to Ed Thorp’s experience with his first academic paper on winning at blackjack, Mebane had to change the title to get it published. (It continues to stimulate synapses, as discussed in David’s July 2013 commentary, “Timing Method Performance Over Ten Decades” and periodically on the MFO discussion board.)

He attributes the paper’s ultimate popularity to 1) its simple presentation and explanation of the compelling results, and 2) the fortuitous timing of the publication itself – just before the financial meltdown of 2008/9. Practitioners of the method during that period were rewarded with a maximum drawdown of only -2% through versus -51% for the S&P 500.

The Books. There are three. All insightful, concise, and well-received:

• The first published by Wiley in 2009, entitled “The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets.”
• The second, self-published in 2013, entitled “Shareholder Yield: A Better Approach to Dividend Investing.”
• The third, also self-published and just released, “Global Value: How to Spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock Market.”

As summarized above, each contains straight-forward strategies that investors can follow on their own using publically available information. That said, each also forms the basis of ETFs launched by Cambria Investment Management.

The First Fund. Last December, Mebane tweeted “Diversification was deworseification in 2013.” To understand what he meant, just compare US stock return against just about all other asset classes – it trounced them. Several all-asset strategies have underperformed during the current bull market, as seen in the comparison below, including AdvisorShares Cambria Global Tactical ETF Fund (GTAA). GTAA was Cambria’s first ETF, launched in November 2010, as a sub-advisor through ETF house AdvisorShares, and based on the strategy outlined in “The Ivy Portfolio.”

If it helps, Mebane is in good company. Rob Arnott’s all asset and John Hussman’s total return strategies have not received much love lately either. In fact, since GTAA’s inception, the “generic” all-asset allocation of US stocks, foreign stocks, bonds, REITs, and broad commodities has underperformed US equity index by 40% and traditional 60/40 balanced index by 15%.

GTAA’s actual portfolio currently shows more than 50 holdings, virtually all ETFs. Looking back, the fund has held substantial cash at times, approaching 40% in mid-2013…”assuming a defensive posture and utilizing cash as an alternative to its long positions.”

Market volatility has likely hurt GTAA as well. Its timing strategy, shown to thrive in trending markets, can struggle with short-term gyrations, which have been present in commodity, foreign equity, and real estate markets during this time. Finally, AdvisorShares’ high expense ratio, even after waivers, only adds to the headwind. At the 3.5-year mark, GTAA remains at $36M assets under management (AUM).

The New Funds. Cambria has since launched three other ETFs, based on the strategies outlined in Mebane’s two new books, but this time the funds were kept in-house to have “control over the process and charge reasonable fees.” Each fund invests in some 100 companies with capitalizations over $200M. And, each has quickly attracted AUM, rather remarkably given the proliferation of ETFs today. They are:

GVAL is the newest and actually tracks to a Cambria-developed index, maintained daily. It focuses on companies that trade 1) below their assessed intrinsic value, and 2) in countries with the most undervalued markets determined by parameters like CAPE, as depicted in earlier figure. These days, Mebane believes that means outside the US. “We certainly don’t think the [US] market is in a bubble, rather, valuations will be a headwind. There are much better opportunities abroad.”

SYLD is actively managed and focuses primarily on US companies that exhibit strong characteristics of returning free cash flow to their shareholders; specifically, “shareholder yield,” which comprises dividend payments, share buybacks, and debt pay-down. FYLD seeks the same types of companies, but in developed foreign countries and it passively tracks to Cambria’s FYLD index.

Mebane believes that these are the first ETFs to incorporate the shareholder yield strategy. And, based on their reception in the crowded ETF market, he seems pretty pleased: “I certainly think alpha is possible…lots of jargon across smart beta, alpha, etc., but beating a market cap index is a great first step.” Morningstar’s Samuel Lee noted them among best new ETFs of 2013. Approaching its first year, SYLD is certainly off to a strong start:

Interestingly, none of these three ETFs employ explicit draw-down control or trend-following, like GTAA, although GVAL does “start moving to cash if markets don’t pass an absolute valuation filter … no sense in buying what is cheapest when everything is expensive,” Mebane explains. SYLD too has the discretion to take the entire portfolio to “Temporary Defensive Positions.”

When asked if his approach to risk management is changing, given the incorporation of more traditional strategies, he asserts that he’s “still a firm believer in trend-following and future funds will have trend components.” (Other funds in pipeline at Cambria include Global Momentum ETF and Value and Momentum ETF).

Mebane remains one of the largest shareholders on record among the portfolio managers at AdvisorShares. His overall skin-in-the-game? “100% of my investable net worth is in our funds and strategies.”

The Blog. mebfaber.com (aka “World Beta”) started in November 2006. It is a pleasant blend of perspective, opinion, results from his and other’s research – quantitative and factual, images, and references. He shares generously on both personal and professional levels, like in the recent posts “My Investing Mentor” and “How to Start an ETF.”

There is a great reading list and blogroll. There are sources for data, references, and research papers. It’s free, with occasional plugs, but no annoying pop-ups. For the more serious investors, fund managers, and institutions, he offers a premium subscription to “The Idea Farm.”

He once wrote actively for SeekingAlpha, but stopped in 2010, explaining: “I find the quality control of the site is poor, and the respect for authors to be low. Also, [it] becomes a compliance risk and headache.”

He strikes me as having the enviable ability to absorb enormous about of information, from past lessons to today’s water-hose of publications, blogs, tweets, and op-eds, then distill it all down to chart a way forward. Asked whether this comes naturally or does he use a process, he laughs: “I would say it comes unnaturally and painfully!”

29Apr14/Charles

It Costs How Much?

by Edward Studzinski

A democracy is a government in the hands of men of low birth, no property, and vulgar entitlements.

Aristotle

One of the responses I received to last month’s diatribe about mutual fund fees was that the average mutual fund investor did not object to them because they were unseen. They painlessly and invisibly disappeared every quarter. The person who pointed this out noted that lawyers charged a bill for services rendered, as did accountants. Why then, should not a quarterly mutual fund statement show the gross amount invested at the beginning of the period, the investment appreciation or depreciation, and then the deduction of fees to arrive at a net amount invested at the end of the period ? Not a bad idea. But one that has been resisted (or gutted) at every turn by the industry and one that the regulators have never felt strongly enough to move forward on.

But do clients truly understand what they are giving up or what they are actually paying? Charlie Ellis, in an article in the current issue of the Financial Analysts Journal would argue that they do not. He goes on to make the case that the enormity of the fees as a percentage makes the 2% and 20% that many hedge funds charge seem reasonable in comparison. His rationale is thus. Assume an S&P 500 Index Fund achieves in a year a total return of 36% and charges investment management fees of 5 basis points (0.05%). Assume your other investment is Mick the Bookie’s Select Investment Fund which had a total return of 41% over the same period and charges 85 basis points (0.85%). Your incremental return is 500 basis points (5%) for which you paid an extra 80 basis points (0.80%). Ellis would argue, and I believe correctly so, that your incremental fee for achieving that excess return was SIXTEEN PER CENT. And don’t forget that the money that went into the account to begin with was already your money that you had earned.

So, one question that I hear coming is – the outside trustees or directors have to approve fees annually and they wouldn’t do it if it was not fair and reasonable, especially given the returns. Answer #1 – eighty per cent of the time the active manager does not beat the benchmark and achieve an excess return. Answer #2 – the 20% of the time when the active manager beats the return, it is not on a sustainable basis, but rather almost random. Answer #3 – rarely does the investor actually get a benchmark beating return because he or she moves their investments too frequently to even achieve the performance numbers advertised by the investment management firm. Answer #4 – all too rarely do the outside trustees or directors have an aligned vested interest in the fee question (a) because in most instances they have at best a de minimis investment in the fund or funds that they are overseeing and (b) oddly enough the outside trustees or directors often have more of a vested interest in the success of the investment management company. Growth and profitability there will lead to increases in their fees.

So you say, I must be getting something of value for the incremental fees at those times when the investment returns don’t justify the added expense? Well, sadly, if recent history is any guide, the kinds of things you have gotten for such excess incremental fees include things like vicarious interests in yachts and sports cars; race horses in Lexington, Kentucky; and multiple homes and pent houses on the lake front in the greater Chicago area. I could go on and on in a similar vein. Rather than outperforming benchmarks or making money for investors, the primary goal has morphed to the creation and accumulation of substantial personal wealth, often to the tune of hundreds of millions of dollars.

To paraphrase Don Corleone in that scene in New York City where he says to the heads of the Five Families, “How did we let things go so far?” I don’t have a good answer for that. I suspect that the painlessness of fee extraction explains part of it. Having had the present administration in Washington serving in the role of defender of Middle Class America, one has to wonder why they have allowed the savings and investments of the Middle Class to effectively be clipped by dollars and cents every month. What has happened is one of the great hidden wealth transfers in our society, similar to what happens when hackers get into a bank computer and start skimming fractions of cents from millions of transactions. It is not solely the administration’s fault however, as neither the regulators nor the courts have wanted to clean up the fee mess. Everyone really wants to believe that there is a Santa Claus, or more appropriately, a Horatio Alger ending to the story.

One might hope that financial publications such as Morningstar, would through their media outlets as well as their conferences, address the subject of fees and their excessive nature. Certainly when they first started with their primary conference at the Grand Hyatt at Illinois Center in Chicago, there was a decided tilt to the content and substance that favored and indeed championed the small investor. However, since then in terms of content the current big Morningstar conference here has taken on more of an industry tilt or bias.

Why do I keep harping on this subject? For this reason – mutual fund investors cannot negotiate their own fees. Institutional investors can, and corporate and endowment investors do just that, every day. And often, their fee agreements with the investment manager will have a “most favored nation” clause, which means if someone else in the institutional world with a similar amount of assets negotiates a lower fee agreement with that investment firm the existing clients get the benefit of it. If you sit in enough presentations from fund managers, it becomes obvious that, public industry statements notwithstanding, in many instances the mutual fund business (and the small investor) is being used as the cash cow that subsidizes the institutional business.

Remember, expenses matter as they lessen the compounding ability of your investment. That in turn keeps the investment from growing as much as it should have over a period of time. With interest rates and tax rates where they are, it is hard enough to compound at a required rate to meet future accumulation targets without having even further degradation occur from the impact of high fees. Rule Number One of investing is “Don’t lose money” and Rule Number Two is “Don’t forget Rule Number One.” However, Rule Number Three is “Keep the expenses low to maximize the compounding effect.”

From Russia, with Love

While journalist Brett Arends bravely offered to explain “Why I’m going to invest in the Russian stock market” – roughly, Russian stocks are cheap and Putin couldn’t be that crazy, right? – a whole series of Russia-oriented funds have amended their statements of principal risks to include potential financial warfare:

SSgA Emerging Markets (SSEMX)

In response to recent political and military actions undertaken by Russia, the United States and European Union have instituted numerous sanctions against certain Russian officials and Bank Rossiya. These sanctions, and other intergovernmental actions that may be undertaken against Russia in the future, may result in the devaluation of Russian currency, a downgrade in the country’s credit rating, and a decline in the value and liquidity of Russian stocks. These sanctions could result in the immediate freeze of Russian securities, impairing the ability of the Fund to buy, sell, receive or deliver those securities. Retaliatory action by the Russian government could involve the seizure of U.S. and/or European residents’ assets and any such actions are likely to impair the value and liquidity of such assets. Any or all of these potential results could push Russia’s economy into a recession. These sanctions, and the continued disruption of the Russian economy, could have a negative effect on the performance of funds that have significant exposure to Russia, including the Fund.

SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF (EMCD) uses the same language, apparently someone was sharing drafts.

iShares MSCI Russia Capped ETF (ERUS) posits similar concerns:

The United States and the European Union have imposed economic sanctions on certain Russian individuals and a financial institution. The United States or the European Union could also institute broader sanctions on Russia. These sanctions, or even the threat of further sanctions, may result in the decline of the value and liquidity of Russian securities, a weakening of the ruble or other adverse consequences to the Russian economy. These sanctions could also result in the immediate freeze of Russian securities, impairing the ability of the Fund to buy, sell, receive or deliver those securities. Sanctions could also result in Russia taking counter measures or retaliatory actions which may further impair the value and liquidity of Russian securities.

ING Russia Fund (LETRX) adds the prospect that they might not be able to honor redemption requests:

… the sanctions may require the Fund to freeze its existing investments in Russian companies, prohibiting the Fund from selling or otherwise transacting in these investments. This could impact the Fund’s ability to sell securities or other financial instruments as needed to meet shareholder redemptions. The Fund could seek to suspend redemptions in the event that an emergency exists in which it is not reasonably practicable for the Fund to dispose of its securities or to determine the value of its net assets.

I’ve continued my regular investments in two diversified emerging markets funds whose managers have earned my trust: Andrew Foster at Seafarer Overseas Growth & Income (SFGIX) and Robert Gardiner at Grandeur Peak Emerging Markets Opportunities (GPEOX). I don’t think I have nearly the expertise needed to run toward that particular fire, nor to know when it’s gotten too hot. I wish Mr. Arends well, but would advise others to consider finding a manager whose experience and judgment is tested and true.

Here’s my rule of thumb: Avoid rules of thumb at all costs

The folks on our discussion board have posted links to two “rule of thumb” articles about investing. Just a quick word on why they’re horrifying.

Rule One: You need to invest $82.28 a day! 

The story comes from USA Today, by way of Lifehacker. “Want to live well in old age? You’d better get cracking: $82.28 a day to be exact.”

That’s $29,000 a year. Cool! That’s just $1000 more than the average per capita income in the US! In fairness, though, it’s just 54% of the median family income: $53,046. So here’s the advice: if you’re living paycheck-to-paycheck, remember to set aside 54% of your income. BankRate.com, by the way, advises you to invest 10%. Why 10%? Presumably because it’s a nice round number.

Rule Two: Your age should be your bond allocation!

More of the same: where to put it? Your bond allocation should be equal to your age, which Lifehacker shares from Bankrate.com. But why is this a good rule of thumb? Like “remember to drink eight glasses of water each day,” it’s catchy and memorable but I’ve seen no research that validates it.

Forbes magazine places it #1 on its list of “10 Terrible Pieces of Investment Advice.” Fund companies flatly reject it in their own retirement planning products. The target-date 2030 funds are designed for folks about 50; that is, people who might retire in 15 years or so. If this advice were sound, some or all of those funds would have 50% in bonds. They don’t. T. Rowe Price Retirement 2030 is 16% bonds, American Funds is 10%, Fidelity is 12%, TIAA-CREF is 21% and Vanguard 20%. JPMorgan (23%) and BlackRock (30-33%) seem to represent the high end.

Especially at the end of a three decade bull market in bonds, we owe it to ourselves and our readers to be particularly thoughtful about quick ‘n’ easy advice.

I’m sorry, they paid Gabelli what?

The folks are MFWire did a nice, nearly snarky story on The Mario’s most recent payday. (I’m Sorry, They Paid Gabelli What?). I’ll share the intro and suggest that you read one of the two linked stories:

Mario Gabelli made $85 million in salary in 2013.

That’s one eighth the global domestic product of Somoa.

According to USA Today, the GAMCO founder, chief executive and investment officer was paid not only $85 million last year, but his three-year total compensation came to over $215 million.

No wonder he looks like that.

Morningstar Goes on Autopilot

On April 23^rd, Morningstar’s Five-Star Investor feature trumpeted “9 Core Funds That Beat the Market,” which they might reasonably have subtitled “Small funds need not apply.”

Morningstar highlights nine funds in the article, with assets up to $101 billion. Those are drawn from a list of 28 that made the cut. Of those 28, one has under a billion in assets.

The key to making the cut: Morningstar must designate it a “core” fund, a category for which there are no hard-and-fast rules. They’re generally large cap and generally diversified, but also fairly large. There’s only one free-standing fund with under $250 million in assets that they think of as “core.”

There are a lot of “core” funds under $250 million but that occurs only when they’re part of a target-date suite: Fidelity Retirement 2090 might have only $12 in it but it becomes “core” because the whole Fido series is core.

Morningstar’s implied judgments (“we don’t trust anyone over 30 or with under a billion in assets”) might be fair, but would be fairer if more explicit.

They followed that up with a list of 4 Medalist Ideas for Long-Short Strategies.”Some of the funds we like in this area are Robeco Boston Partners Long/Short Equity, Robeco Boston Partners Research Fund, MainStay Marketfield, and Wasatch Long/Short.”

I’d describe those as Long-Closed, Recently-Closed, Bloated (they had $1 billion three years ago and $21 billion today; trailing 12 month performance is exactly mediocre which might be a blip or might be the effects of the $11 billion they picked up last year) and Very Solid, respectively.

Russel Kinnel finished the month by asking “How Bloated is your Fund?” He calculates a “bloat ratio” which “tries to find out how much a fund trades and how liquid its holdings are. It multiplies turnover by the average day’s trading volume of a fund’s holdings (asset-weighted).” At base, Russel’s assumption is that the only cost of bloat is a loss of the ability to trade quickly in and out of stocks.

With due respect, that seems silly. As assets grow, fund managers necessarily target the sorts of stocks that they can trade and begin avoiding the ones that they can’t. If your fund’s size constrains you to invest mostly in stocks worth $10 billion or more (the upper end of the mid-cap range), your investable universe is just 420 stocks. You may trade those 420 effectively, but you’re not longer capable of benefiting from the 6360 stocks at below $10 billion.

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.

Martin Focused Value (MFVRX): it’s easy for us to get stodgy as we age; to become sure that whatever we did back then is quite exactly what we should be doing today. Frank Martin, who has been doing this stuff for 40 years, could certainly be excused if he did stick with the tried and true. But he hasn’t. There’s clear evidence that this absolute value equity investor has been grappling with new ideas and new evidence, and they’ve led him to construct his portfolio around the notion of “an antifragile dumbbell” (with insights credited to Nassim Talib). His argument, as much as his fund, are worth your attention.

Conference Call Upcoming

We’re toying with the possibility of talking with Dr. Ian Mortimer (Oxford, no less) and Matt Page of Guinness Atkinson Global Innovators (IWIRX), which targets investments in firms that are demonstrably engaged in creative thinking and are demonstrably beginning from it. They appear to be the single best performer in Lipper’s global growth category and we know from our work on Guinness Atkinson Inflation-Managed Dividend (GAINX) that they’re awfully bright and articulate. Both of their funds have small asset bases, distinctive and rigorous disciplines and splendid performance. The hang-up is the time difference between here and London; our normal nighttime slot (7:00 Eastern) would be midnight for them. Hmmm … we’ll work on it.

Launch Alert

It says something regrettable about the industry that Morningstar reports 156 new funds since mid-March, of which 153 are new share classes of older funds, one is Artisan Global High Income (ARTFX) and two aren’t terribly interesting. We’ll keep looking… Found another worth noting, just launched 4/28: Whitebox Tactical Income (WBIVX/WBINX).

Funds in Registration

Funds currently in registration with the SEC will generally be available for purchase around the end of June, 2014. Our dauntless research associate David Welsch tracked down 17 new no-load funds in registration this month. There are several intriguing possibilities:

Catalyst added substantially to their collection of quirky funds (uhhh … Small Cap Insider Buying (CTVAX) might be a decent example) with the registration of five more funds, of which three (Catalyst Absolute Total Return, Catalyst/Stone Beach Income Opportunity and Catalyst/Groesbeck Aggressive Growth Funds) will be sub-advised by folks with strong documented performance records.

LSV GLOBAL Managed Volatility Fund will follow the recent vogue for investing in low-volatility stocks. The fund gains credibility from the pedigree of its managers (“L” is a particularly renowned academic who was one of the path-breaking researchers in behavioral finance) and by the strength of the other four LSV funds (all three of the rated funds have earned four stars, though tend toward high volatility).

North Star Bond Fund will invest primarily in the bonds, convertible securities and (potentially) equities issued by small cap companies. I’m not sure that I know of any other fund with that specialization. The management team includes North Star’s microcap and opportunistic equity managers. Their equity funds have had very solid performance in not-quite three years of operation (though I’m a bit puzzled by Morningstar’s assignment of the North Star Opportunity fund to the “aggressive allocation” category given its high stock exposure). In any case, this strikes me as an interesting idea and we’re apt to follow up in the months after launch.

All of the new registrants are available on the May Funds in Registration page.

Manager Changes

On a related note, we also tracked down 52 sets of fund manager changes. The most intriguing of those include the exit of Stephen and Samuel Lieber, Alpine Woods founders and Alpine Small Cap’s founding managers, from Alpine Small Cap (ADIAX) and Chuck McQuaid’s long-anticipated departure from Columbia Acorn (ACRNX).

Active share updates

“Active share” is a measure of the degree to which a fund’s portfolio differs from what’s in its benchmark index. Researchers have found that active share is an important predictor of a fund’s future performance. Highly active fund are more like to outperform their benchmarks than are index funds (which should never outperform the index itself) or “closet index” funds which charge for active management but really only play around the edges of an indexed portfolio.

In March, we began publishing a list of active share data for as many funds as we could. And the same time, we asked folks to share data for any funds that we’d missed. We’re maintaining a master list of all funds, which you can get to by clicking on our Resources tab:

Each month we try to update our list with new funds submitted by our readers. This month folks shared seven more data reports:

Thanks to jlev, one of the members of the Observer’s discussion community and Mike P from Litman Gregory for sharing these leads with us. Couldn’t do it without you!

The return of Jonathan Clements

Jonathan Clements had an interesting valedictory column when he left The Wall Street Journal. He said he had about three messages for his readers and he’d repackaged them into 1008 columns: “Forget spending more money at the mall — and instead spend more time with friends. Your bank account may still be skimpy, but your life will be far, far richer.”

Apparently he’s found either a fourth message to share, or renewed passion for the first three, because he returned to the Journal in April. Oddly, his work appears only on Sundays and only online; he doesn’t even use a Dow Jones email address. When I asked him about the plan, he noted:

I didn’t want a fulltime position with the WSJ again, at least not at this juncture. The column gives a little variety to my week. But most of my time is currently devoted to a new personal-finance book. The book is a huge undertaking, and it wouldn’t be possible if I was fulltime at the WSJ.

He’s written several really solid columns (on the importance of saving even in a zero-interest environment and on the role of dividend funds in a retirement portfolio) and has a useful website that shares personal finance resources and works to dispel the rumor that he’s an accomplished writer of erotica. (Really.)

On whole, I’m glad he’s back.

MFO in the news!

Indeed

The English-language version of the article by Javier Espinosa, “Travel Guide: Do Acronyms Aid ‘Emerging’ Investing?” ran on April 7^th but lacked the panache of the Malay version.

MFO on the road

For those of you interested in dropping by and saying “hi,” we’ll be present at a couple conferences this summer.

I’ve been asked to provide the keynote address at the Cohen Client Conference, August 20 – 21, 2014. The conference, in Milwaukee, is run by Cohen Fund Audit Services. This will be Cohen’s third annual client conference. Last year’s version, in Cleveland OH, drew about 100 clients from 23 states.

Cohen offers the conference as a way of helping fund professionals – directors, compliance officers, tax and accounting guys, operating officers and the occasional curious hedge fund manager –develop both professional competence and connections within the fund community. Which is to say, the Cohen folks promised that there would be both serious engagement – staff presentations, panels by industry experts, audience interaction – and opportunities for fellowshipping. (My first, unworthy impulse is to drive a bunch of compliance officers over to Horny Goat Brewing, buy a round or two, then get them to admit that they’re making stuff up as they go.)

The good and serious folks at Cohen want to offer fund professionals help with fund operations, accounting, governance, tax, legal and compliance updates, and sales, marketing and distribution best practices.

And they want me to say something interesting and useful for 45 minutes or so. Hmmm … so here’s a request for assistance. Many of you folks work in the industry (I don’t) and all of you know the sorts of stuff I talk about. What do you think I could say that would most help someone trying to be a good fund trustee or operations professional? Drop me a line through this link, please!

For more information about the conference itself, you can contact

Chris Bellamy, 216-649-1701 or [email protected] or

Megan Howell, 216-774-1145 or [email protected].

They’d love to hear from you. So would I.

We’ll also spend three full days in and around the Morningstar Investment Conference, June 18 – 20, in Chicago. We try to divide our time there into thirds: interviewing fund managers and talking to fund reps, listening to presentations by famous guys, and building our network of connections by spending time with readers, friends and colleagues. If you’d like to connect with us somewhere in the bowels of McCormick Place, just let me know.

Briefly Noted . . .

Interesting developments in the neighborhood of Gator Focus Fund and Gator Opportunities Fund. At the end of February, Brad W. Olecki and Michael Parks resigned from their positions as Trustees of the Trust. No new Trustees have been appointed. On the same date Andres Sandate resigned from his position as President, Secretary and Treasurer of the Trust.

Do recall that, for reasons that continue to elude me, ING Funds have been rebranded as Voya Funds.

LS Opportunity Fund (LSOFX) just reclassified itself from “diversified” to “non-diversified.” It’s not clear why or what effect that will have on its 100 stock portfolio.

SMALL WINS FOR INVESTORS

IMS Capital Management is reorganizing three of its funds (IMS Capital Value,Strategic Income Fund, and Dividend Growth funds) into a new series of the 360 funds. I’m guessing they’ll be rebranded and the advisor is guessing that the reorganization will result in lower administration, fund accounting and transfer agency costs.” With luck, those savings will be passed along to investors.

Effective immediately, the Leader Total Return Fund (LCTRX) has discontinued the redemption fee.

Vanguard has decreased, generally by one basis point, the expense ratios on seven of its ETFs include Vanguard Total Bond Market ETF (BND), Vanguard FTSE Developed Markets ETF (VEA), Vanguard Value ETF (VTV), Vanguard Growth ETF (VUG), Vanguard Small-Cap ETF (VB) and a couple others

CLOSINGS (and related inconveniences)

First Eagle Overseas Fund (SGOVX) will close to new investors on May 9, 2014. Good fund but with $15 billion in AUM, its best days might be in the past.

Grandeur Peak Global Reach (GPROX) closed on April 30^th. That closure was the subject of our first mid-month alert to readers, which we sent to 4800 of you about 10 days before the closure was effective. We heard back from four readers who said that the information was useful to them. My hope is that we didn’t overly annoy the other 99.9% of recipients.

On May 9, 2014, the Wasatch Frontier Emerging Small Countries Fund (WAFMX) will close to new investors. Wasatch avers that it “takes fund capacity very seriously. We monitor assets in each of our funds carefully and commit to shareholders to close funds before asset levels rise to a point that would alter our intended investment strategy.” At $1.2 billion with investments in Nigeria, Kuwait and Kenya, it seems like a prudent move for a fund with top decile returns. (Thanks to JimJ on the Observer’s discussion board for timely notice of the closing.)

OLD WINE, NEW BOTTLES

Bridgehampton Value Strategies Fund (BVSFX) is being rebranded as the Tocqueville Alternative Strategies Fund. Same management and a “substantially similar” strategy but lower expenses for investors. The change becomes effective on June 27, 2014. Looks like a pretty decent fund.

The Board of John Hancock Rainier Growth Fund decided to axe Rainier and hire Baillie Gifford to manage it. As of mid-April, it was rechristened as JHancock Select Growth Fund (RGROX).

 Neuberger Berman Dynamic Real Return Fund (NDRAX) becomes Neuberger Berman Inflation Navigator Fund on June 2.

Hansberger International Growth Fund is being reorganized into the Madison Fund.

On June 2, 2014, Neuberger Berman International Select Fund changed its name from Neuberger Berman International Large Cap Fund. Two year record, slightly below-average returns and absolutely no investor interest.

Neuberger Berman Emerging Markets Income Fund’s name has changed to Neuberger Berman Emerging Markets Debt Fund.

Effective on May 1, 2014, Parnassus Equity Income Fund (PRBLX) became Parnassus Core Equity Fund while Parnassus Workplace Fund (PARWX) became Parnassus Endeavor. There were no changes to management, strategy or fees.

Effective December 29, 2014, the T. Rowe Price Retirement Income Fund (TRRIX) will change its name to the T. Rowe Price Retirement Balanced Fund. It’s a really solid fund but with 40% of its portfolio in equities, it’s probably not what most folks think of as a “retirement income” fund.

OFF TO THE DUSTBIN OF HISTORY

Ever wonder why it’s “The Dustbin of History”? It’s Leon Trotsky’s dismissal of the Menshevik revolutionaries, who he saw as failed agents: “You are pitiful, isolated individuals. You are bankrupts; your role is played out. Go where you belong from now on – in the dustbin of history!” It was in Russian, of course, so translations vary (occasional “the trash heap of history”) but the spirit is there.

CMG SR Tactical Bond Fund (CMGTX/CMGOX) liquidated on April 29, 2014. Nope, I’d never heard of it either.

The Board of Directors of Nomura Partners Funds approved the merger of The Japan Fund (NPJAX) into Matthews Japan (MJFOX), effective in late July, 2014. Japan Fund has sort of bounced from adviser to adviser over the years and is more the victim of Nomura’s decision to get out of the U.S. fund business than of crippling incompetence. The investors are getting a stronger fund with lower expenses, with the merger boosting MJFOX’s size by about 30%.

Morgan Stanley Institutional Total Emerging Markets Portfolio (MTEPX) will liquidate on May 30, 2014.

Principal intends to merge Principal Large Cap Value Fund I (PVUAX) into the Large Cap Value Fund III (PESAX). Shareholders are scheduled to rubbersta vote on the proposal at the end of May. Neither fund is particularly attractive, but the dying fund actually has the stronger record of the two.

On April 17, 2014, Turner’s Board of Trustees decided ed to close and liquidate the Turner Market Neutral Fund (TMNFX) on or about June 1, 2014. Three stars but also $3 million in assets. Sadly the performance was decent and steadily improving.

Vanguard continues with its surprising shakeup. It has decided to merge Vanguard Tax-Managed Growth and Income Fund (VTMIX) into Vanguard 500 Index Fund (VFISX) on about May 16, 2014. Why surprising? VTMIX has over $3 billion in assets, 0.08% expenses, a “Gold” analyst rating and four stars, which are not usually characteristics associated with descendent funds. Vanguard is looking to lower investor expenses (by about three basis points in this case) and simplify their line-up. On an after-tax basis, it looks like investors will gain two basis points in returns.

World Commodity Fund (WCOMX) has closed and will liquidate on May 26, 2014. It’s got rather less than a million in the portfolio and has, over the course of its seven-and-a-half year life, managed to turn a $10,000 initial investment into $10,120 which averages out to rather less than 0.10% per year. That saddest part? That’s not nearly the worst record, at least over the past five years, in either the “natural resources equity” or “broad commodities” groups.

In Closing . . .

Thanks to folks who’ve been supporting MFO financially, with a special tip of the cap to Capt. Neel (thank you, sir) and the Right Reverend Rick (I’m guided here by Luke: “In every way and everywhere we accept this with all gratitude”).

Especially for the benefit of the 6000 first-time readers we see each month, if you’re inclined to support the Observer, the easiest way is to use the Observer’s Amazon link. The system is simple, automatic, and painless. We receive an amount equivalent to about 7% of the value of almost anything you purchase through our Amazon link (used books, Kindle downloads, groceries, sunscreen, power tools, pool toys …). You might choose to set it as a bookmark or, in my case, you might choose to have one of your tabs open in Amazon whenever you launch your browser. Some purchases generate a dime, some generate $10-12 and all help keep the lights on!

June: the month for income. With the return of summer turbulence and Janet Yellen’s insistent dovishness about rates, we thought we’d take some time to look at four new funds that promise high income and managed volatility:

Artisan High Income (ARTFX) run by former Ivy High Income manager Bryan Krug. The fund has drawn $76 million in its first six weeks.

Dodge & Cox Global Bond, which went live on May 1.

RiverNorth Oaktree High Income (RNOTX), which combines RiverNorth’s distinctive CEF strategy with Oaktree’s first-rate institutional income one.

(maybe) West Shore Real Asset Income (AWSFX) which combines an equity-oriented income strategy with substantial exposure to alternative investments. We’ve had a couple readers ask, and we’ve been trying to learn enough to earn an opinion but it’s a bit challenging.

We’ve also scheduled a conversation with the folks at Arrowpoint, adviser to the new Meridian Small Cap Growth Fund (MSGAX) which is run by former Janus Triton managers Brian Schaub and Chad Meade.

As ever.

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:

1. They hate cash.  As a matter of fact, it’s second on their most-hated list behind only “risking permanent impairment of capital”.
2. 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.
3. 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.
4. 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.
5. 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

* 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?   

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 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.

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?

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.

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)

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:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures.  We’re saddened to report that Tom chose to liquidate the fund.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (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.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “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.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.
10. November 2013: Jeffrey Ringdahl of American Beacon Flexible Bond (AFXAX) gives teams from Brandywine Global, GAM and PIMCO incredible leeway wth which to pursue “positive total return regardless of market conditions.” Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

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:

1. The fund might outperform the stock market by 200 bps/year over a full, 3-5 year market cycle.
2. The fund can maintain a beta at 0.3 to 0.5, in part because of their systematic Drawdown Plan.
3. 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. 

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?

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.

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

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.

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. 

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

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:

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:

1. 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.
2. 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.
3. 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.
4. 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.

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,

Dear friends,

My colleagues in the English department are forever yammering on about this Shakespeare guy.I’m skeptical. First, he didn’t even know how to spell his own name (“Wm Shakspē”? Really?). Second, he clearly didn’t understand seasonality of the markets. If you listen to Gloucester’s famous declamation in Richard III, you’ll see what I mean:

Now is the winter of our discontent
Made glorious summer by this sun of York;
And all the clouds that lour’d upon our house
In the deep bosom of the ocean buried.
Now are our brows bound with victorious wreaths;
Our bruised arms hung up for monuments;
Our stern alarums changed to merry meetings,
Our dreadful marches to delightful measures.

It’s pretty danged clear that we haven’t had anything “made glorious summer by the sun of [New] York.” By Morningstar’s report, every single category of bond and hybrid fund has lost money over the course of the allegedly “glorious summer.” Seven of the nine domestic equity boxes have flopped around, neither noticeably rising nor falling.

And now, the glorious summer passed, we enter what historically are the two worst months for the stock market. To which I can only reply with three observations (The Pirates are on the verge of their first winning season since 1992! The Steelers have no serious injuries looming over them. And Will’s fall baseball practices are upon us.) and one question:

Is it time to loathe the emerging markets? Again?

Yuh, apparently. A quick search in Google News for “emerging markets panic” turns up 3300 stories during the month of August. They look pretty much like this:

With our preeminent journalists contributing:

Many investors have responded as they usually do, by applying a short-term perspective to a long-term decision. Which is to say, they’re fleeing. Emerging market bond funds saw a $2 billion outflow in the last week of August and $24 billion since late May (Emerging Markets Fund Flows Investors Are Dumping Emerging Markets at an Accelerating Pace, Business Insider, 8/30/13). The withdrawals were indiscriminate, affecting all regions and both local currency and hard currency securities. Equity funds saw $4 billion outflows for the week, with ETFs leading the way down (Emerging markets rout has investors saying one word: sell, Marketwatch, 8/30/13).

In a peculiar counterpoint, Jason Kepler of Investment News claims – using slightly older data – that Mom and pop can’t quit emerging-market stocks. And that’s good (8/27/13). He finds “uncharacteristic resiliency” in retail investors’ behavior. I’d like to believe him. (The News allows a limited number of free article views; if you’d exceeded your limit and hit a paywall, you might try Googling the article title. Or subscribing, I guess.)

We’d like to make three points.

• Emerging markets securities are deeply undervalued
• Those securities certainly could become much more deeply undervalued.
• It’s not the time to be running away.

Emerging markets securities are deeply undervalued

Wall Street Ranter, an anonymous blogger from the financial services industry and sometime contributor to the Observer’s discussion board, shared two really striking bits of valuation data from his blog.

The first, “Valuations of Emerging Markets vs US Stocks” (7/20/13) looks at a PIMCO presentation of the Shiller PE for the emerging markets and U.S., then at how such p/e ratios have correlated to future returns. Shiller adjusts the market’s price/earnings ratio to eliminate the effect of atypical profit margins, since those margins relentlessly regress to the mean over time. There’s a fair amount of research that suggests that the Shiller PE has fair predictive validity; that is, abnormally low Shiller PEs are followed by abnormally high market returns and vice versa.

Here, with Ranter’s kind permission, is one of the graphics from that piece:

At June 30, 2013 valuations, this suggests that US equities were priced for 4% nominal returns (2-3% real), on average, over the next five years while e.m. equities were priced to return 19% nominal (17% or so real) over the same period. GMO, at month’s end, reached about the same figure for high quality US equities (3.1% real) but a much lower estimate (6.8%) for emerging equities. By GMO’s calculation, emerging equities were priced to return more than twice as much as any other publicly traded asset class.

Based on recent conversations with the folks at GMO, Ranter concludes that GMO suspects that changes in the structure of the Chinese economy might be leading them to overstate likely emerging equity returns. Even accounting for those changes, they remain the world’s most attractive asset class:

While emerging markets are the highest on their 7 year forecast (approx. 7%/year) they are treating it more like 4%/year in their allocations . . . because they believe they need to account for a longer-term shift in the pace of China’s growth. They believe the last 10 years or so have skewed the mean too far upwards. While this reduces slightly their allocation, it still leaves Emerging Markets has one of their highest forecasts (but very close to International Value … which includes a lot of developed European companies).

Ranter offered a second, equally striking graphic in “Emerging Markets Price-to-Book Ratio and Forward Returns (8/9/13).”

At these levels, he reports, you’d typically expect returns over the following year of around 55%. That data is available in his original article. 

In a singularly unpopular observation, Andrew Foster, manager of Seafarer Overseas Growth & Income (SFGIX/SIGIX), one of the most successful and risk-alert e.m. managers (those two attributes are intimately connected), notes that the most-loathed emerging markets are also the most compelling values:

The BRICs have underperformed to such an extent that their aggregate valuation, when compared to the emerging markets as a whole, is as low as it has been in eight years. In other words, based on a variety of valuation metrics (price-to-book value, price-to-prospective-earnings, and dividend yield), the BRICs are as cheap relative to the rest of the emerging markets as they have been in a long time. I find this interesting. . . for the (rare?) subset of investors contemplating a long-term (10-year) allocation to EM, just as they were better off to avoid the BRICs over the past 5 years when they were “hot,” they are likely to be better off over the next 10 years emphasizing the BRICs now they are “not.”

Those securities certainly could become much more deeply undervalued.

The graphic above illustrates the ugly reality that sometimes (late ’98, all of ’08), but not always (’02, ’03, mid ’11), very cheap markets become sickeningly cheap markets before rebounding. Likewise, Shiller PE for the emerging markets occasionally slip from cheap (10-15PE) to “I don’t want to talk about it” (7 PE). GMO mildly notes, “economic reality and investor behavior cause securities and markets to overshoot their fair value.”

Andrew Foster gently dismisses his own predictive powers (“my record on predicting short-term outcomes is very poor”). At the same time, he finds additional cause for short-term concern:

[M]y thinking on the big picture has changed since [early July] because currencies have gotten into the act. I have been worried about this for two years now — and yet even with some sense it could get ugly, it has been hard to avoid mistakes. In my opinion, currency movements are impossible to predict over the short or long term. The only thing that is predictable is that when currency volatility picks up, is likely to overshoot (to the downside) in the short run.

It’s not the time to be running away.

There are two reasons driving that conclusion. First, you’ve already gotten the timing wrong and you’re apt to double your error. The broad emerging markets index has been bumping along without material gain for five years now. If you were actually good at actively allocating your portfolio, you’d have gotten out in the summer of 2007 instead of thinking that five consecutive years of 25%+ gains would go on forever. And you, like the guys at Cook and Bynum, would have foregone Christmas presents in 2008 in order to plow every penny you had into an irrationally, shockingly cheap market. If you didn’t pull it off then, you’re not going to pull it off this time, either.

Second, there are better options here than elsewhere. These remain, even after you adjust down their earnings and adjust them down again, about the best values you’ll find. Ranter grumbles about the thoughtless domestic dash:

Bottom line is I fail to see, on a relative basis, how the US is more tempting looking 5 years out. People can be scared all they want of catching a falling knife…but it’s a lot easier to catch something which is only 5 feet in the air than something that is 10 feet in the air.

If you’re thinking of your emerging markets stake as something that you’ll be holding or building over the next 10-15 years (as I do), it doesn’t matter whether you buy now or in three months, at this level or 7% up or down from here. It will matter if you panic, leave and then refuse to return until the emerging markets feel “safe” to you – typically around the top of the next market cycle.

It’s certainly possible that you’re systemically over-allocated to equities or emerging equities. The current turbulence might well provide an opportunity to revisit your long-term plan, and I’d salute you for it. My argument here is against actions driven by your gut.

Happily, there are a number of first rate options available for folks seeking risk-conscious exposure to the emerging markets. My own choice, discussed more fully below, is Seafarer. I’ve added to my (small investor-sized) account twice since the market began turning south in late spring. I have no idea of whether those dollars with be worth a dollar or eighty cents or a plugged nickel six months from now. My suspicion is that those dollars will be worth more a decade from now having been invested with a smart manager in the emerging markets than they would have been had I invested them in domestic equities (or hidden them away in a 0.01% bank account). But Seafarer isn’t the only “A” level choice. There are some managers sitting on large war chests (Amana Developing World AMDWX), others with the freedom to invest across asset classes (First Trust/Aberdeen Emerging Opportunities FEO) and even some with both (Lazard Emerging Markets Multi-Strategy EMMOX).

To which Morningstar says, “If you’ve got $50 million to spend, we’ve got a fund for you!”

On August 22^nd, Morningstar’s Fund Spy trumpeted “Medalist Emerging-Markets Funds Open for Business,” in which they reviewed their list of the crème de la crème emerging markets funds. It is, from the average investor’s perspective, a curious list studded with funds you couldn’t get into or wouldn’t want to pay for. Here’s the Big Picture:

Our take on those funds follows.

Our recommendations differ from theirs, given our preference for smaller funds that are actually available to the public. Our shortlist:

Amana Developing World (AMDWX): offers an exceedingly cautious take on an exceedingly risky slice of the world. Readers were openly derisive of Amana’s refusal to buy at any cost, which led the managers to sit on a 50% cash stake while the market’s roared ahead. As those markets began their swoon in 2011, Amana began moving in and disposing of more than half of its cash reserves. Still cash-rich, the fund’s relative performance is picking up and its risks remain very muted.

First Trust/Aberdeen Emerging Opportunity (FEO): one of the first emerging markets balanced funds, it’s performed very well over the long-term and is currently selling at a substantial discount to NAV: 12.6%, about 50% greater than its long-term average. That implies that investors might see something like a 5% arbitrage gain once the current panic abates, above and beyond whatever the market provides.

Grandeur Peak Emerging Markets Opportunities (GPEOX): the Grandeur Peak team has been brilliantly successful both here and at Wasatch. Their intention is to create a single master fund (Global Reach) and six subsidiary funds whose portfolios represent slices of the master profile. Emerging Markets has already cleared the SEC registration procedures but hasn’t launched. The Grandeur Peak folks say two factors are driving the delay. First, the managers want to be able to invest directly in Indian equities which requires registration with that country’s equity regulators. They couldn’t begin the registration until the fund itself was registered in the US. So they’re working through the process. Second, they wanted to be comfortable with the launch of Global Reach before adding another set of tasks. Give or take the market’s current tantrum (one manager describes it as “a taper tantrum”), that’s going well. With luck, but without any guarantees, the fund might be live sometime in Q4.

Seafarer Overseas Growth & Income (SFGIX): hugely talented manager, global portfolio, risk conscious, shareholder-centered and successful.

Wasatch Frontier Emerging Small Countries (WAFMX): one of the very few no-load, retail funds that targets the smaller, more dynamic markets rather than markets with billions of people (India and China) or plausible claim to be developed markets (e.g., Korea). The manager, Laura Geritz, has been exceedingly successful. Frontier markets effectively diversify emerging markets portfolios and the fund has drawn nearly $700 million. The key is that Wasatch is apt to close the fund sooner rather than later.

Snowball’s portfolio

Some number of folks have, reasonably enough, asked whether I invest in all of the funds I profile (uhhh … there have been over 150 of them, so no) or whether I have found The Secret Formula (presumably whatever Nicholas Cage has been looking for in all those movies). The answer is less interesting than the question.

I guess my portfolio construction is driven by three dictums:

1. Don’t pretend to be smarter than you are
2. Don’t pretend to be braver than you are
3. There’s a lot of virtue in doing nothing

Don’t pretend to be smarter than you are. If I knew which asset classes were going to soar and which were going to tank in the next six months or year or two, two things would happen. First, I’d invest in the winners. Second, I’d sell my services to ridiculously rich people and sock them with huge and abusive fees that they’d happily pay. But, I don’t.

As a result, I tend to invest in funds whose managers have a reasonable degree of autonomy about investing across asset classes, rather than ones pigeonholed into a small (style) box. That’s a problem: it makes benchmarking hard, it makes maintaining an asset allocation plan hard and it requires abnormally skilled managers. My focus has been on establishing a strategic objective (“increasing exposure to fast growing economies”) and then spending a lot of time trying to find managers whose strategies I trust, respect and understand.

Don’t pretend to be braver than you are. Stocks have a lot in common with chili peppers. In each case, you get a surprising amount of benefit from a relatively small amount of exposure. In each case, increasing exposure quickly shifts the pleasure/pain balance from pleasantly piquant to moronically painful. Some readers think of my non-retirement asset allocation is surprisingly timid: about 50% stocks, 30% bonds, 20% cash equivalents. They’re not much happier about my 70% equity stake in retirement funds. But, they’re wrong.

T. Rowe Price is one of my favorite fund companies, in part because they treat their investors with unusual respect. I found two Price studies, in 2004 and again in 2010, particularly provocative. Price constructed a series of portfolios representing different levels of stock exposure and looked at how the various portfolios would have played out over the past 50-60 years.

The original study looked at portfolios with 20/40/60/80/100% stocks. The update dropped the 20% portfolio and looked at 0/40/60/80/100%. Below I’ve reproduced partial results for three portfolios. The original 2004 and 2010 studies are available at the T. Rowe Price website.

 Over a 10 year period – reasonable for a non-retirement account – a portfolio that’s 20% stocks would grow from $10,000 to $21,000. A 100% stock portfolio would grow to $28,000. Roughly speaking, the conservative portfolio ends up at 75% of the size of the aggressive one but a pure stock portfolio increases the probability of losing money by 400% (from a 6% chance to 23%), increases the size of your average loss by 2500% (from 0.5% to 12.5%) and triples your volatility. Somewhere in there, it will face the real prospect of a 51% loss, which is the average maximum drawdown for large core stock funds that have been around 20 years or more. Sadly, there’s no way of knowing whether the 51% loss will occur in Year One (where you might have some recovery time) or Year Ten (where you’d be toast).

At 50% equities, I might capture 80% of the market’s gain with 50% of its volatility. If domestic bonds weren’t in such dismal straits, a smaller stock exposure might be justifiable. But they suck so I’m stuck.

There’s a lot of virtue in doing nothing. Our action tends to be a lot more costly than our inaction, so I change my target allocation slowly and change my fund line-up slowly. I’ve held a few retirement plan funds (e.g., Fidelity Low Priced Stock FLPSX) for decades and a number of non-retirement funds since their inception. In general, I’ll only add a fund if it represents an entirely new opportunity set or if it’s replacing an existing fund. On average, I might change out one fund every year or two.

My retirement portfolio is dominated by the providers in Augustana’s 403(b) plan: Fidelity, T. Rowe Price and TIAA-CREF. The college contribution to retirement goes exclusively into TIAA-CREF. CREF Stock accounts for 68%, TIAA Real Estate holds 22% and the rest is in a target-date fund. The Fidelity and Price allocations mirror one another: 33% domestic stock (with a value bias), 33% international stock (with an emerging markets bias) and 33% income (of the eclectic Spectrum Income/Global High Income sort).

My non-retirement portfolio is nine funds and some cash waiting to be deployed.

Is anyone likely to make it into my portfolio in 2013-14? There are two candidates:

ASTON/River Road Long-Short (ARLSX). We’ve both profiled the fund and had a conference call with its manager, both of which are available on the Observer’s ARLSX page. I’m very impressed with the quality and clarity of their risk-management disciplines; they’ve left little to chance and have created a system that forces them to act when it’s time. They’ve performed well since inception and have the prospect of outperforming the stock market with a fraction of its risk. If this enters the portfolio, it would likely be as a substitute for Northern Global Tactical since the two serve the same risk-dampening function.

RiverPark Strategic Income (not yet launched). This fund will come to market in October and represents the next step out on the risk-return spectrum from the very successful RiverPark Short Term High Yield (RPHYX). I’ve been impressed with David Sherman’s intelligence and judgment and with RPHYX’s ability to deliver on its promises. We’ll be doing fairly serious inquiries in the next couple months, but the new fund might become a success to T. Rowe Price Spectrum Income.

Sterling Capital hits Ctrl+Alt+Delete

Sterling Capital Select Equity (BBTGX) has been a determinedly bad fund for years. It’s had three managers since 1993 and it has badly trailed its benchmark under each of them. The strategy is determinedly nondescript. They’ve managed to return 3.2% annually over the past 15 years. That’s better – by about 50 bps – than Vanguard’s money market fund, but not by much. Effective September 3, 2013, they’re hitting “reformat.”

The fund’s name changes, to Sterling Capital Large Cap Value Diversified Fund.

The strategy changes, to a “behavioral financed” based system targeting large cap value stocks.

The benchmark changes, to the Russell 1000 Value

And the management team changes, to Robert W. Bridges and Robert O. Weller. Bridges joined the firm in 2008 and runs the Sterling Behavioral Finance Small Cap Diversified Alpha. Mr. Weller joined in 2012 after 15 years at JPMorgan, much of it with their behavioral finance team.

None of which required shareholders’ agreement since, presumably, all aspects of the fund are “non-fundamental.” 

One change that they should pursue but haven’t: get the manager to put his own money at risk. The departing manager was responsible for five funds since 2009 and managed to find nary a penny to invest in any of them. As a group, Sterling’s bond and asset allocation team seems utterly uninterested in risking their own money in a lineup of mostly one- and two-star funds. Here’s the snapshot of those managers’ holdings in their own funds:

You’ll notice the word “none” appears 32 times. Let’s agree that it would be silly to expect a manager to own tax-free bonds anywhere but in his home jurisdiction. That leaves 26 decisions to avoid their own funds out of a total of 27 opportunities. Most of the equity managers, by contrast, have made substantial personal investments.

Warren Buffett thinks you’ve come to the right place

Fortune recently published a short article which highlighted a letter that Warren Buffett wrote to the publisher of the Washington Post in 1975. Buffett’s an investor in the Post and was concerned about the long-term consequences of the Post’s defined-benefit pension. The letter covers two topics: the economics of pension obligations in general and the challenge of finding competent investment management. There’s also a nice swipe at the financial services industry, which most folks should keep posted somewhere near their phone or monitor to review as you reflect on the inevitable marketing pitch for the next great financial product.

I particularly enjoy the “initially.” Large money managers, whose performance records were generally parlous, “felt obliged to seek improvement or at least the approach of improvement” by hiring groups “with impressive organizational charts, lots of young talent … and a record of recent performance (pg 8).” Unfortunately, he notes, they found it.

The pressure to look like you were earning your keep led to high portfolio turnover (Buffett warns against what would now be laughably low turnover: 25% per annum). By definition, most professionals cannot be above average but “a few will succeed – in a modest way – because of skill” (pg 10). If you’re going to find them, it won’t be by picking past winners though it might be by understanding what they’re doing and why:

The key: abandon all hope ye who invest in behemoths:

For those interested in Buffett’s entire reflection, Chip’s embedded the following:

Warren Buffett Katharine Graham Letter

And now for something completely different …

We can be certain of some things about Ed Studzinski. As an investor and co-manager of Oakmark Equity & Income (OAKBX), he was consistently successful in caring for other people’s money (as much as $17 billion of it), in part because he remained keenly aware that he was also caring for their futures. $10,000 entrusted to Ed and co-manager Clyde McGregor on the day Ed joined the fund (01 March 2000) would have grown to $27,750 on the day of his departure (31 December 2011). His average competitor (I’m purposefully avoiding “peer” as a misnomer) would have managed $13,900.

As a writer and thinker, he minced no words.

The Equity and Income Fund’s managers have both worked in the investment industry for many decades, so we both should be at the point in our careers where dubious financial-industry innovations no longer surprise us. Such an assumption, however, would be incorrect.

For the past few quarters we have repeatedly read that the daily outcomes in the securities markets are the result of the “Risk On/Risk Off” trade, wherein investors (sic?) react to the most recent news by buying equities/selling bonds (Risk On) or the reverse (Risk Off). As value investors we think this is pure nonsense. 

Over the past two years, Ed and I have engaged in monthly conversations that I’ve found consistently provocative and information-rich. It’s clear that he’s been paying active attention for many years to contortions of his industry which he views with equal measures of disdain and alarm. 

I’ve prevailed upon Ed to share a manager’s fuss and fulminations with us, as whim, wife and other obligations permit. His first installment, which might also be phrased as the question “Whose skin in the game?” follows.

“Skin in the Game, Part One”

One of the more favored sayings of fund managers is that they like to invest with managements with “skin in the game.” This is another instance where the early Buffett (as opposed to the later Buffett) had it right. Managements can and should own stock in their firms. But they should purchase it with their own money. That, like the prospect of hanging as Dr. Johnson said, would truly clarify the mind. In hind sight a major error in judgment was made by investment professionals who bought into the argument that awarding stock options would beneficially serve to align the interests of managements and shareholders. Never mind that the corporate officers should have already understood their fiduciary obligations. What resulted, not in all instances but often enough in the largest capitalization companies, was a class of condottieri such as one saw in Renaissance Italy, heading armies that spent their days marching around avoiding each other, all the while being lavishly paid for the risks they were NOT facing. This sub-set of managers became a new entitled class that achieved great personal wealth, often just by being present and fitting in to the culture. Rather than thinking about truly long-term strategic implications and questions raised in running a business, they acted with a short-duration focus, and an ever-present image of the current share price in the background. Creating sustainable long-term business value rarely entered into the equation, often because they had never seen it practiced.

I understood how much of a Frankenstein’s monster had been created when executive compensation proposals ended up often being the greater part of a proxy filing. A particularly bothersome practice was “reloading” options annually. Over time, with much dilution, these programs transferred significant share ownership to management. You knew you were on to something when these compensation proposals started attracting negative vote recommendations. The calls would initially start with the investor relations person inquiring about the proxy voting process. Once it was obvious that best practices governance indicated a “no” vote, the CFO would call and ask for reconsideration.

How do you determine whether a CEO or CFO actually walks the walk of good capital allocation, which is really what this is all about? One tip-off usually comes from discussions about business strategy and what the company will look like in five to ten years. You will have covered metrics and standards for acquisitions, dividends, debt, share repurchase, and other corporate action. Following that, if the CEO or CFO says, “Why do you think our share price is so low?” I would know I was in the wrong place. My usual response was, “Why do you care if you know what the business value of the company is per share? You wouldn’t sell the company for that price. You aren’t going to liquidate the business. If you did, you know it is worth substantially more than the current share price.” Another “tell” is when you see management taking actions that don’t make sense if building long-term value is the goal. Other hints also raise questions – a CFO leaves “because he wants to enjoy more time with his family.” Selling a position contemporaneously with the departure of a CFO that you respected would usually leave your investors better off than doing nothing. And if you see the CEO or CFO selling stock – “our investment bankers have suggested that I need to diversify my portfolio, since all my wealth is tied up in the company.” That usually should raise red flags that indicate something is going on not obvious to the non-insider.

Are things improving? Options have gone out of favor as a compensation vehicle for executives, increasingly replaced by the use of restricted stock. More investors are aware of the potential conflicts that options awards can create and have a greater appreciation of governance. That said, one simple law or regulation would eliminate many of the potential abuses caused by stock options. “All stock acquired by reason of stock option awards to senior corporate officers as part of their compensation MAY NOT BE SOLD OR OTHERWISE DISPOSED OF UNTIL AFTER THE EXPIRATION OF A PERIOD OF THREE YEARS FROM THE INDIVIDUAL’S LAST DATE OF SERVICE.” Then you might actually see the investors having a better chance of getting their own yachts.

Edward A. Studzinski

If you’d like to reach Ed, click here. An artist’s rendering of Messrs. Boccadoro and Studzinski appears below.

Introducing Charles’ Balcony

Since his debut in February 2012, my colleague Charles Boccadoro has produced some exceedingly solid, data-rich analyses for us, including this month’s review of the risk/return profiles of the FundX family of funds. One of his signature contributions was “Timing Method Performance Over Ten Decades,” which was widely reproduced and debated around the web.

We’re pleased to announce that we’ve collected his essays in a single, easy-to-access location. We’ve dubbed it “Charles’ Balcony” and we even stumbled upon this striking likeness of Charles and the shadowy Ed Studzinski in situ. I’m deeply hopeful that from their airy (aerie or eery) perch, they’ll share their sharp-eyed insights with us for years to come.

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. 

Advisory Research Strategic Income (ADVNX): you’ve got to love a 10 month old fund with a 10 year track record and a portfolio that Morningstar can only describe as 60% “other.” AR converted a successful limited partnership into the only no-load mutual fund offering investors substantial access to preferred securities.

Beck, Mack and Oliver Partners (BMPEX): we think of it as “Dodge and Cox without the $50 billion in baggage.” This is an admirably disciplined, focused equity fund with a remarkable array of safeguards against self-inflicted injuries.

FPA Paramount (FPRAX): some see Paramount as a 60-year-old fund that seeks out only the highest-quality mid-cap growth stocks. With a just-announced change of management and philosophy, it might be moving to become a first-rate global value fund (with enough assets under management to start life as one of the group’s most affordable entries).

FundX Upgrader (FUNDX): all investors struggle with the need to refine their portfolios, dumping losers and adding winners. In a follow-up to his data-rich analysis on the possibility of using a simple moving average as a portfolio signal, associate editor Charles Boccadoro investigated the flagship fund of the Upgrader fleet.

Tributary Balanced (FOBAX): it’s remarkable that a fund this consistently good – in the top tier of all balanced funds over the past five-, ten-, and fifteen-year periods and a Great Owl by my colleague Charles’ risk/return calculations – hasn’t drawn more attention. It will be more remarkable if that neglect continues despite the recent return of the long-time manager who beat pretty much everyone in sight.

Elevator Talk #8: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX)

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.

Steven Vannelli, Manager

GaveKal Knowledge Leaders (GAVAX) believes in investing only in firms that are committed to being smart, so where did the dumb name come from? GaveKal is a portmanteau formed from the names of the firm’s founders: Charles Gave, Anatole Kaletsky and Louis-Vincent Gave. Happily it changed the fund’s original name from GaveKal Platform Company Fund (named after its European counterpart) to Knowledge Leaders. 

GaveKal, headquartered in Hong Kong, started in 2001 as a global economics and asset allocation research firm. Their other investment products (the Asian Balanced Fund – a cool idea which was rechristened Asian Absolute Return – and Greater China Fund) are available to non-U.S. investors as, originally, was Knowledge Leaders. They opened a U.S. office in 2006. In 2010 they deepened their Asia expertise by acquiring Dragonomics, a China-focused research and advisory firm.

Knowledge Leaders has generated a remarkable record in its two-plus years of U.S. operation. They look to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility. Currently, approximately 30% of the portfolio is in cash, down from 40% earlier in summer.

Manager Steven Vannelli researches intangible capital and corporate performance and leads the fund’s investment team. Before joining GaveKal, he spent a decade at Alexander Capital, a Denver-based investment advisor. Here’s Mr. Vannelli’s 200 words making his case:

We invest in the world’s most innovative companies. Decades of academic research show that companies that invest heavily in innovation are structurally undervalued due to lack of information on innovative activities. Our strategy capitalizes on this market inefficiency.

To find investment opportunities, we identify Knowledge Leaders, or companies with large stores of intangible assets. These companies often operate globally across an array of industries from health care to technology, from consumer to capital goods. We have developed a proprietary method to capitalize a company’s intangible investments, revealing an important, invisible layer of value inherent to intangible-rich companies. 

The Knowledge Leaders Strategy employs an active strategy that offers equity-like returns with bond-like risk. Superior risk-adjusted returns with low correlation to market indices make the GaveKal Knowledge Leaders Strategy a good vehicle for investors who seek to maximize their risk and return objectives.

The genesis of the strategy has its origin in the 2005 book, Our Brave New World, by GaveKal Research, which highlights knowledge as a scare asset.

As a validation of our intellectual foundation, in July, the US Bureau of Economic Analysis began to capitalize R&D to measure the contribution of innovation spending on growth of the US economy.

The minimum initial investment on the fund’s retail shares is $2,500. There are also institutional shares (GAVIX) with a $100,000 minimum (though they do let financial advisors aggregate accounts in order to reach that threshold). The fund’s website is clean and easily navigated. It would make a fair amount of sense for you to visit to “Fund Documents” page, which hosts the fund’s factsheet and a thoughtful presentation on intangible capital. 

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (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.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “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.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.

Upcoming conference call: A discussion of the reopening of RiverNorth Strategy Income (RNDLX)

The folks at RiverNorth will host a conference call between the fund’s two lead managers, Patrick Galley of RiverNorth and Jeffrey Gundlach of DoubleLine, to discuss their decision to reopen the fund to new investors at the end of August and what they see going forward (the phrase “fear and loathing” keeps coming up). 

The call will be: Wednesday, September 18, 3:15pm – 4:15pm CDT

To register, go to www.rivernorthfunds.com/events/

The webcast will feature a Q&A with Messrs. Galley and Gundlach.

RNDLX (RNSIX for the institutional class), which the Observer profiled shortly after launch, has been a very solid fund with a distinctive strategy. Mr. Gundlach manages part of his sleeve of the portfolio in a manner akin to DoubleLine Core Fixed Income (DLFNX) and part with a more opportunistic income strategy. Mr. Galley pursues a tactical fixed-income allocation and an utterly unique closed-end fund arbitrage strategy in his slice. The lack of attractive opportunities in the CEF universe prompted the fund’s initial closure. Emily Deter of RiverNorth reports that the opening “is primarily driven by the current market opportunity in the closed-end fund space. Fixed-income closed-end funds are trading at attractive discounts to their NAVs, which is an opportunity we have not seen in years.” Investment News reported that fixed-income CEFs moved quickly from selling at a 2% premium to selling at a 7% discount. 

That’s led Mr. Galley’s move from CEFs from occupying 17% of the portfolio a year ago to 30% today and, it seems, he believes he could pursue more opportunities if he had more cash on hand.

Given RiverNorth’s ongoing success and clear commitment to closing funds well before they become unmanageable, it’s apt to be a good use of your time.

The Observer’s own series of conference calls with managers who’ve proven to be interesting, sharp, occasionally wry and successful, will resume in October. We’ll share details in our October issue.

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 David Welsch, an exceedingly diligent research assistant at the Observer, scours new SEC filings to see what opportunities might be about to present themselves. David tracked down nearly 100 new funds and ETFs. Many of the proposed funds offer nothing new, distinctive or interesting. Some were downright mystifying. (Puerto Rico Shares? Colombia Capped ETF? The Target Duration 2-month ETF?) There were 26 no-load funds or actively-managed ETFs in registration with the SEC this month. 

Funds in registration this month won’t be available for sale until, typically, the end of October or early November 2013.

There are probably more interesting products in registration this month than at any time in the seven years we’ve been tracking them. Among the standouts:

Brown Advisory Strategic European Equity Fund which will be managed by Dirk Enderlein of Wellington Management. Wellington is indisputably an “A-team” shop (they’ve got about three-quarters of a trillion in assets under management). Mr. Enderlein joined them in 2010 after serving as a manager for RCM – Allianz Global Investors in Frankfurt, Germany (1999-2009). Media reports described him as “one of Europe’s most highly regarded European growth managers.”

DoubleLine Shiller Enhanced CAPE will attempt to beat an index, Shiller Barclays CAPE® US Sector TR USD Index, which was designed based on decades of research by the renowned Robert Shiller. The fund will be managed by Jeffrey Gundlach and Jeffrey Sherman.

Driehaus Micro Cap Growth Fund, a converted 15 year old hedge fund

Harbor Emerging Markets Equity Fund, which will be sub-advised by the emerging markets team at Oaktree Capital Management. Oaktree’s a first-tier institutional manager with a very limited number of advisory relationships (primarily with Vanguard and RiverNorth) in the mutual fund world. 

Meridian Small Cap Growth, which will be the star vehicle for Chad Meade and Brian Schaub, who Meridian’s new owner hired away from Janus. Morningstar’s Greg Carlson described them as “superb managers” who were “consistently successful during their nearly seven years at the helm” of Janus Triton.

Plus some innovative offerings from Northern, PIMCO and T. Rowe Price. 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 record 85 fund manager changes. Investors should take particular note of Eric Ende and Stephen Geist’s exit from FPA Paramount after a 13 year run. The change is big enough that we’ve got a profile of Paramount as one of the month’s Most Intriguing New Funds.

Updates

Bretton Fund (BRTNX) is now available through Vanguard. Manager Stephen Dodson writes that after our conference call, several listeners asked about the fund’s availability and Stephen encouraged them to speak directly with Vanguard. Mirabile dictu, the Big V was receptive to the idea.

Stephen recently posted his most recent letter to his shareholders. He does a nice job of walking folks through the core of his investing discipline with some current illustrations. The short version is that he’s looking for firms with durable competitive advantages in healthy industries whose stocks are selling at a substantial discount. He writes:

There are a number of relevant and defensible companies out there that are easily identifiable; the hard part is finding the rare ones that are undervalued. The sweet spot for us continues to be relevant, defensible businesses at low prices (“cheap compounders”). I continue to spend my waking hours looking for them.

Q2 2013 presented slim pickin’s for absolute value investors (Bretton “neither initiated nor eliminated any investments during the quarter”). For all of the market’s disconcerting gyrations this summer, Morningstar calculates that valuations for its Wide Moat and Low Business Uncertainty groups (surrogates for “high quality stocks”) remains just about where they were in June: undervalued by about 4% while junkier stocks remain modestly overvalued.

Patience is hard.

Briefly Noted . . .

Calamos loses another president

James Boyne is resigning as president and chief operating officer of Calamos Investments effective Sept. 30, just eight months after being promoted to president. The firm has decided that they need neither a president nor a chief operating officer. Those responsibilities will be assumed “by other senior leaders” at the firm (see: Black, Gary, below). The preceding president, Nick P. Calamos, decided to “step back” from his responsibilities in August 2012 when, by coincidence, Calamos hired former Janus CEO Gary Black. To describe Black as controversial is a bit like described Rush Limbaugh as opinionated.

They’re not dead yet!

Back in July, the Board of Caritas All-Cap Growth (CTSAX): “our fund is tiny, expensive, bad, and pursues a flawed investment strategy (long stocks, short ETFs).” Thereupon they reached a sensible conclusion: euthanasia. Shortly after the fund had liquidated all of its securities, “the Board was presented with and reviewed possible alternatives to the liquidation of the Fund that had arisen since the meeting on July 25, 2013.”

The alternative? Hire Brenda A. Smith, founder of CV Investment Advisors, LLC, to manage the fund. A quick scan of SEC ADV filings shows that Ms. Smith is the principal in a two person firm with 10 or fewer clients and $5,000 in regulated AUM. 

(I don’t know more about the firm because they have a one page website.)

At almost the same moment, the same Board gave Ms. Smith charge of the failing Presidio Multi-Strategy Fund (PMSFX), an overpriced long/short fund that executes its strategy through ETFs. 

I wish Ms. Smith and her new investors all the luck in the world, but it’s hard to see how a Board of Trustees could, with a straight face, decide to hand over one fund and resuscitate another with huge structural impediments on the promise of handing it off to a rookie manager and declare that both moves are in the best interests of long-suffering shareholders.

Diamond Hill goes overseas, a bit

Effective September 1, 2013, Diamond Hill Research Opportunities Fund (DHROX) gains the flexibility to invest internationally (the new prospectus allows that it “may also invest in non-U.S. equity securities, including equity securities in emerging market countries”) and the SEC filing avers that they “will commence investing in foreign securities.” The fund has 15 managers; I’m guessing they got bored. As a hedge fund (2009-2011), it had a reasonably mediocre record which might have spurred the conversion to a ’40 fund. Which has also had a reasonably mediocre lesson, so points to the management for consistency!

Janus gets more bad news

Janus investors pulled $2.2 billion from the firm’s funds in July, the worst outflows in more than three years. A single investor accounted for $1.3 billion of the leakage. The star managers of Triton and Venture left in May. And now this: they’re losing business to Legg Mason.

The Board of Trustees of Met Investors Series Trust has approved a change of subadviser for the Janus Forty Portfolio from Janus Capital Management to ClearBridge Investments to be effective November 1, 2013 . . . Effective November 1, 2013, the name of the Portfolio will change to ClearBridge Aggressive Growth Portfolio II.

Matthews chucks Taiwan

Matthews Asia China (MCHFX), China Dividend (MCDFX) and Matthews and China Small Companies (MCSMX) have changed their Principal Investment Strategy to delete Taiwan. The text for China Dividend shows the template:

Under normal market conditions, the Matthews China Dividend Fund seeks to achieve its investment objective by investing at least 80% of its net assets, which include borrowings for investment purposes, in dividend-paying equity securities of companies located in China and Taiwan.

To:

Under normal market conditions, the Matthews China Dividend Fund seeks to achieve its investment objective by investing at least 80% of its nets assets, which include borrowings for investment purposes, in dividend-paying equity securities of companies located in China.

A reader in the financial services industry, Anonymous Dude, checked with Matthews about the decision. AD reports

T. Rowe tweaks

Long ago, as a college administrator, I was worried about whether the text in a proposed policy statement might one day get us in trouble. I still remember college counsel shaking his head confidently, smiling and saying “Not to worry. We’re going to fuzz it up real good.” One wonders if he works for T. Rowe Price now? Up until now, many of Price’s funds have had relatively detailed and descriptive investment objectives. No more! At least five of Price’s funds propose new language that reduces the statement of investment objectives to an indistinct mumble. T. Rowe Price Growth Stock Fund (PRGFX) goes from

The fund seeks to provide long-term capital growth and, secondarily, increasing dividend income through investments in the common stocks of well-established growth companies.

To

The fund seeks long-term capital growth through investments in stocks.

Similar blandifications are proposed for Dividend Growth, Equity Income, Growth & Income and International Growth & Income.

Wasatch redefines “small cap”

A series of Wasatch funds, Small Growth, Small Value and Emerging Markets Small Cap are upping the size of stocks in their universe from $2.5 billion or less to $3.0 billion or less. The change is effective in November.

Can you say whoa!? Or WOA?

The Board of Trustees of an admittedly obscure little institutional fund, WOA All Asset (WOAIX), has decided that the best way to solve what ails the yearling fund is to get it more aggressive.

The Board approved certain changes to the Fund’s principal investment strategies. The changes will be effective on or about September 3, 2013. . . the changes in the Fund’s strategy will alter the Fund’s risk level from balanced strategy with a moderate risk level to an aggressive risk level.

Here’s the chart of the fund’s performance since inception against conservative and moderate benchmarks. While that might show that the managers just need to fire up the risk machine, I’d also imagine that addressing the ridiculously high expenses (1.75% for an institutional balanced fund) and consistent ability to lag in both up and down months (11 of 16 and counting) might actually be a better move. 

WOA’s Trustees, by the way, are charged with overseeing 24 funds. No Trustee has a dollar invested in any of those funds.

SMALL WINS FOR INVESTORS

The Board of Trustees of the Direxion Funds and Rafferty Asset Management have decided to make it cheaper for you to own a bunch of funds that you really shouldn’t own. They’re removed the 25 bps Shareholder Servicing Fee from

• Direxion Monthly S&P 500® Bull 2X Fund
• Direxion Monthly S&P 500® Bear 2X Fund
• Direxion Monthly NASDAQ-100® Bull 2X Fund
• Direxion Monthly Small Cap Bull 2X Fund
• Direxion Monthly Small Cap Bear 2X Fund
• Direxion Monthly Emerging Markets Bull 2X Fund
• Direxion Monthly Latin America Bull 2X Fund
• Direxion Monthly China Bull 2X Fund
• Direxion Monthly Commodity Bull 2X Fund
• Direxion Monthly 7-10 Year Treasury Bull 2X Fund
• Direxion Monthly 7-10 Year Treasury Bear 2X Fund
• Dynamic HY Bond Fund and
• U.S. Government Money Market Fund.

Because Eaton Vance loves you, they’ve decided to create the opportunity for investors to buy high expense “C” class shares of Eaton Vance Bond (EVBCX). The new shares will add a 1.00% back load for sales held less than a year and a 1.70% expense ratio (compared to 0.7 and 0.95 for Institutional and A, respectively). 

The Fairholme Fund (FAIRX) reopened to new investors on August 19, 2013. The other Fairholme family funds, not so much.

The Advisor Class shares of Forward Select Income Fund (FSIMX) reopened to new investors at the end of August.

The Board of Directors of the Leuthold Global Industries Fund (LGINX) has agreed to reduce the Fund’s expense cap from 1.85% to 1.60%.

JacksonPark Capital reduced the minimum initial investment on Oakseed Opportunity Institutional shares (SEDEX) from $1 million to $10,000. Given the 18% lower fees on the institutional class (capped at 1.15% versus 1.40% for retail shares), reasonably affluent retail investors ought to seriously consider pursuing the institutional share class. That said, Oakseed’s minimum investment for the retail shares, as low as $100 for accounts set up with an AIP, are awfully reasonable.

RiverNorth DoubleLine Strategic Income (RNDLX/RNSIX) reopened to new investors at the end of August. Check the “upcoming conference calls” feature, above, for more details.

Westcore Blue Chip Dividend Fund (WTMVX ) lowered the expense ratio on its no-load retail shares from 1.15% to 0.99%, effective September 1. They also changed from paying distributions annually to paying them quarterly. It’s a perfectly agreeable, mild-mannered little fund: stable management, global diversified, reasonable expenses and very consistently muted volatility. You do give up a fair amount of upside for the opportunity to sleep a bit more quietly at night.

CLOSINGS (and related inconveniences)

American Beacon Stephens Small Cap Growth Fund (STSGX) will close to new investors, effective as of September 16, 2013. The no-class share class has returned 11.8% while its peers made 9.3% and it did so with lower volatility. The fund is closing at a still small $500 million.

Neither high fees nor mediocre performance can dim the appeal of AQR Multi-Strategy Alternative Fund (ASANX/ASAIX). The fund has drawn $1.5 billion and has advertised the opportunity for rich investors (the minimum runs between $1 million and $5 million) to rush in before the doors swing shut at the end of September. It’s almost always a bad sign that a fund feels the need to close and the need to put up a flashing neon sign six weeks ahead.

Morgan Stanley Institutional Global Franchise (MSFAX) will close to new investors on Nov. 29, 2013. The current management team came on board four years ago (June 2009) and have posted very good risk-adjusted returns since then. Investors might wonder why a large cap global fund with a small asset base needs to close. The answer is that the mutual fund represents just the tip of the iceberg; this team actually manages almost $17 billion in this strategy, so the size of the separate accounts is what’s driving the decision.

OLD WINE, NEW BOTTLES

At the end of September Ariel International Equity Fund (AINTX) becomes Ariel International Fund and will no longer be required to invest at least 80% of its assets in equities. At the same time, Ariel Global Equity Fund (AGLOX) becomes Ariel Global Fund. The advisor avers that it’s not planning on changing the funds’ investment strategies, just that it would be nice to have the option to move into other asset classes if conditions dictate.

Effective October 30, Guggenheim U.S. Long Short Momentum Fund (RYAMX) will become plain ol’ Guggenheim Long-Short Fund. In one of those “why bother” changes, the prospectus adds a new first sentence to the Strategy section (“invest, under normal circumstances, at least 80% of its assets in long and short equity or equity-like securities”) but maintains the old “momentum” language in the second and third sentences. They’ll still “respond to the dynamically changing economy by moving its investments among different industries and styles” and “allocates investments to industries and styles according to several measures of momentum. “ Over the past five years, the fund has been modestly more volatile and less profitable than its peers. As a result, they’ve attracted few assets and might have decided, as a marketing matter, that highlighting a momentum approach isn’t winning them friends.

As of October 28, the SCA Absolute Return Fund (SCARX) will become the Granite Harbor Alternative Fund and it will no longer aim to provide “positive absolute returns with less volatility than traditional equity markets.” Instead, it’s going for the wimpier “long-term capital appreciation and income with low correlation” to the markets. SCA Directional Fund (SCADX) will become Granite Harbor Tactical Fund but will no longer seek “returns similar to equities with less volatility.” Instead, it will aspire to “long term capital appreciation with moderate correlation to traditional equity markets.” 

Have you ever heard someone say, “You know, what I’m really looking for is a change for a moderate correlation to the equity markets”? No, me neither.

Thomas Rowe Price, Jr. (the man, 1898-1983) has been called “the father of growth investing.” It’s perhaps then fitting that T. Rowe Price (the company) has decided to graft the word “Growth” into the names of many of its funds effective November 1.

T. Rowe Price Institutional Global Equity Fund becomes T. Rowe Price Institutional Global Focused Growth Equity Fund. Institutional Global Large-Cap Equity Fund will change its name to the T. Rowe Price Institutional Global Growth Equity Fund. T. Rowe Price Global Large-Cap Stock Fund will change its name to the T. Rowe Price Global Growth Stock Fund.

Effective October 28, 2013, USB International Equity Fund (BNIEX) gets a new name (UBS Global Sustainable Equity Fund), new mandate (invest globally in firms that pass a series of ESG screens) and new managers (Bruno Bertocci and Shari Gilfillan). The fund’s been a bit better under the five years of Nick Irish’s leadership than its two-star rating suggests, but not by a lot.

Off to the dustbin of history

There were an exceptionally large number of funds giving up the ghost this month. We’ve tracked 26, the same as the number of new no-load funds in registration and well below the hundred or so new portfolios of all sorts being launched. I’m deeply grateful to The Shadow, one of the longest-tenured members of our discussion board, for helping me to keep ahead of the flood.

American Independence Dynamic Conservative Plus Fund (TBBIX, AABBX) will liquidate on or about September 27, 2012.

Dynamic Canadian Equity Income Fund (DWGIX) and Dynamic Gold & Precious Metals Fund (DWGOX), both series of the DundeeWealth Funds, are slated for liquidation on September 23, 2013. Dundee bumped off Dynamic Contrarian Advantage Fund (DWGVX) and announced that it was divesting itself of three other funds (JOHCM Emerging Markets Opportunities Fund JOEIX, JOHCM International Select Fund JOHIX and JOHCM Global Equity Fund JOGEX), which are being transferred to new owners.

Equinox Commodity Strategy Fund (EQCAX) closed to new investors in mid-August and will liquidate on September 27^th.

The Evolution Funds face extinction! Oh, the cruel irony of it.

Evolution Managed Bond (PEMVX) Evolution All-Cap Equity (PEVEX), Evolution Market Leaders (PEVSX) and Evolution Alternative Investment (PETRX) have closed to all new investment and were scheduled to liquidate by the end of September. Given their disappearance from Morningstar, one suspects the end came more quickly than we knew.

Frontegra HEXAM Emerging Markets Fund (FHEMX) liquidates at the end of September.

The Northern Lights Board of Trustees has concluded that “based on, among other factors, the current and projected level of assets in the Fund and the belief that it would be in the best interests of the Fund and its shareholders to discontinue the Hundredfold Select Global Fund (SFGPX).”

Perhaps the “other factors” would be the fact that Hundredfold trailed 100% of its peers over the past three- and five-year periods? The manager was unpaid and quite possibly the fund’s largest shareholder ($50-100k in a $2M fund). His Hundredfold Select Equity (SFEOX) is almost as woeful as the decedent, but Hundredfold Select Alternative (SFHYX) is in the top 1% of its peer group for the same period that the others are bottom 1%. That raises the spectre that luck, rather than skill, might be involved.

JPMorgan is cleaning house: JPMorgan Credit Opportunities Fund (JOCAX), JPMorgan Global Opportunities Fund (JGFAX) and JPMorgan Russia Fund (JRUAX) are all gone as of October 4.

John Hancock intends to merge John Hancock High Income (JHAQX) into John Hancock High Yield (JHHBX). I’m guessing at the fund tickers because the names in the SEC filing don’t quite line up with the Morningstar ones.

Legg Mason Esemplia Emerging Markets Long-Short Fund (SMKAX) will be terminated on October 1, 2013. Let’s see: hard-to-manage strategy, high risk, high expenses, high front load, no assets . . . sounds like Legg.

Leuthold Asset Allocation Fund (LAALX) is merging into Leuthold Core Investment Fund (LCORX). The Board of Directors approved a proposal for the Leuthold Asset Allocation to be acquired by the Leuthold Core, sometime in October 2013. Curious. LAALX, with a quarter billion in assets, modestly lags LCORX which has about $600 million. Both lag more mild-mannered funds such as Northern Global Tactical Asset Allocation (BBALX) and Vanguard STAR (VGSTX) over the course of LAALX’s lifetime. This might be less a story about LAALX than about the once-legendary Leuthold Core. Leuthold’s funds are all quant-driven, based on an unparalleled dataset. For years Core seemed unstoppable: between 2003 and 2008, it finished in the top 5% of its peer group four times. But for 2009 to now, it has trailed its peers every year and has bled $1 billion in assets. In merging the two, LAALX investors get a modestly less expensive fund with modestly better performance. Leuthold gets a simpler administrative structure. 

I halfway admire the willingness of Leuthold to close products that can’t distinguish themselves in the market. Clean Tech, Hedged Equity, Undervalued & Unloved, Select Equities and now Asset Allocation have been liquidated.

MassMutual Premier Capital Appreciation Fund (MCALX) will be liquidated, but not until January 24, 2014. Why? 

New Frontiers KC India Fund (NFIFX) has closed and began the process of liquidating their portfolio on August 26^th. They point to “difficult market conditions in India.” The fund’s returns were comparable to its India-focused peers, which is to say it lost about 30% in 18 months.

Nomura Partners India Fund (NPIAX), Greater China Fund (NPCAX) and International Equity Fund (NPQAX) will all be liquidated by month’s end.

Nuveen Quantitative Enhanced Core Equity (FQCAX) is slated, pending inevitable shareholder approval, to disappear into Nuveen Symphony Low Volatility Equity Fund (NOPAX, formerly Nuveen Symphony Optimized Alpha Fund)

Oracle Mutual Fund (ORGAX) has “due to the relatively small size of the fund” underwent the process of “orderly dissolution.” Due to the relatively small size? How about, “due to losing 49.5% of our investors’ money over the past 30 months, despite an ongoing bull market in our investment universe”? To his credit, the advisor’s president and portfolio manager went down with the ship: he had something between $500,000 – $1,000,000 left in the fund as of the last SAI.

Quantitative Managed Futures Strategy Fund (QMFAX) will “in the best interests of the Fund and its shareholders” redeem all outstanding shares on September 15^th.

The directors of the United Association S&P 500 Index Fund (UASPX/UAIIX) have determined that it’s in their shareholders’ best interest to liquidate. Uhhh … I don’t know why. $140 million in assets, low expenses, four-star rating …

Okay, so the Oracle Fund didn’t seem particularly oracular but what about the Steadfast Fund? Let’s see: “steadfast: firmly loyal or constant, unswerving, not subject to change.” VFM Steadfast Fund (VFMSX) launched less than one year ago and gone before its first birthday.

In Closing . . .

Interesting stuff’s afoot. We’ve spoken with the folks behind the surprising Oberweis International Opportunities Fund (OBIOX), which was much different and much more interesting that we’d anticipated. Thanks to “Investor” for poking us about a profile. In October we’ll have one. RiverPark Strategic Income is set to launch at the end of the month, which is exciting both because of the success of the other fund (the now-closed RiverPark Short Term High Yield Fund RPHYX) managed by David Sherman and Cohanzick Asset Management and because Sherman comes across as such a consistently sharp and engaging guy. With luck, I’ll lure him into an extended interview with me and a co-conspirator (the gruff but lovable Ed Studzinski, cast in the role of a gruff but lovable curmudgeon who formerly managed a really first-rate mutual fund, which he did).

MFO returns to Morningstar! Morningstar is hosting their annual ETF Invest Conference in Chicago, from October 2 – 4. While, on whole, we’d rather drop by their November conference in Milan, Italy it was a bit pricey and I couldn’t get a dinner reservation at D’O before early February 2014 so we decided to pass it up. While the ETF industry seems to be home to more loony ideas and regrettable business practices than most, it’s clear that the industry’s maturing and a number of ETF products offer low cost access to sensible strategies, some in areas where there are no tested active managers. The slow emergence of active ETFs blurs the distinction with funds and Morningstar does seem do have arranged both interesting panels (skeptical though I am, I’ll go listen to some gold-talk on your behalf) and flashy speakers (Austan Goolsbee among them). With luck, I’ll be able to arrange a couple of face-to-face meetings with Chicago-based fund management teams while I’m in town. If you’re going to be at the conference, feel free to wave. If you’d like to chat, let me know.

If you shop Amazon, please do remember to click on the Observer’s link and use it. If you click on it right now, you can bookmark it or set it as a homepage and then you won’t forget. The partnership with Amazon generates about $20/day which, while modest, allows us to reliably cover all of our “hard” expenses and underwrites the occasional conference coverage. If you’d prefer to consider other support options, that’s great. Just click on “support us” on the top menu bar. But the Amazon thing is utterly painless for you.

The Sufi poet Attar records the fable of a powerful king who asks assembled wise men to create a ring that will make him happy when he is sad, and vice versa. After deliberation the sages hand him a simple ring with the words “This too will pass.” That’s also true of whatever happens to the market and your portfolio in September and October.

Be brave and we’ll be with you in a month!

Dear friends,

Welcome to the Vacation 2013 issue of the Observer. I’ve spent the past two weeks of July and the first days of August enjoying myself in Door County, the Cape Cod-like peninsula above Green Bay. I’ve done substantial damage to two Four Berry pies from Bea’s Ho-made Pies (jokes about the makers of the pie have been deleted), enjoyed rather more Leinies than usual, sailed on a tall ship, ziplined (ending in a singularly undignified position), putt-putted, worked with my son on his pitching, hiked miles and learned rather more than I cared to about alewives, gobies and lake levels.

I did not think (much) about mutual funds, Mr. Market, my portfolio, or the Dow’s closing level.  Indeed, I have no idea of what the market’s been doing.

Life is good.

Risk spectrum for Observer funds

We have published some dozens of profiles of new, distinguished and distinctive funds in the past couple years (click on the Funds tab if you’re curious).  Charles Boccadoro, our Associate Editor, has been working on ways to make those profiles more organized and accessible.  Here’s his take on one way of thinking about the collection.

Dashboard of MFO Profiled Funds

Each month, David provides in-depth analysis of two to four funds, continuing a FundAlarm tradition. Today, more than 75 profiles are available on MFO Funds index page. Most are quite current, but a few date back, under “Archives of FundAlarm,” so reference appropriately.

This month we roll out a new summary or “dashboard” of the many profiled funds. It’s intended to help identify funds of interest, so that readers can better scroll the index to retrieve in-depth profiles.

The dashboard presents funds by broad investment type, consistent with MFO Rating System. The three types are: fixed income, asset allocation, and equity. (See also Definitions page.)

Here is dashboard of profiled fixed income and asset allocation funds:

For each fund, the dashboard identifies current investment style or category as defined by Morningstar, date (month/year) of latest profile published, fund inception date (from first whole month), and latest 12-month yield percentage, as applicable.

Risk group is also identified, consistent with latest MFO rating. In the dashboard, funds with lowest risk will generally be at top of list, while those with highest risk will be at bottom, agnostic of M* category. Probably good to insert a gentle reminder here that risk ratings can get elevated, temporarily at least, when funds hit a rough patch, like recently with some bond and all-asset funds.

The dashboard also depicts fund absolute return relative to cash (90-day T-Bill), bonds (US Aggregate TR), and stocks (S&P 500 TR), again agnostic of M* category. If a fund’s return from inception through the latest quarter exceeds any of these indices, “Return Beats…” column will be shaded appropriately.

The Enhanced Strategy column alerts readers of a fund’s use of leverage or hedge via short positions, or if a fund holds any derivatives, like swaps or futures. If so, regardless of how small, the column will show “Yes.” It’s what David calls a kind of complexity flag. This assessment is strictly numerical using latest portfolio allocations from Morningstar’s database in Steele Mutual Fund Expert.

Finally, the column entitled “David’s Take” is a one-word summary of how each fund was characterized in its profile. Since David tends to only profile funds that have promising or at least intriguing strategies, most of these are positive. But every now and then, the review is skeptical (negative) or neutral (mixed).

We will update the dashboard monthly and, as always, improve and tailor based on your feedback. Normally the dashboard will be published atop the Funds index page, but for completeness this month, here’s dashboard of remaining equity funds profiled by MFO:

Charles/28Jul13

Would you ever need more than one long-short fund?

By bits, investors have come to understand that long-short (and possible other alternative) funds may have a place in their portfolios.  That’s a justifiable conclusion.  The question is, would you ever want need more than one long-short fund?

The lead story in our July issue made the argument, based on interviews with executives and managers are a half dozen firms, that there are at least three very distinct types of long-short funds (pure long/short on individual stocks, long on individual stocks/short on sectors or markets, long on individual stocks plus covered called exposure) .  They have different strategies and different risk-return profiles.  They are not interchangeable in a portfolio.

The folks at Long-Short Advisors gave permission to share some fascinating data with you.  They calculated the correlation matrix for their fund, the stock market and ten of their largest competitors, not all of which are pure long/short funds.  By way of context, the three-year correlation between the movement of Vanguard’s Small Cap Index Fund (NAESX) and their S&P 500 Index Fund (VFINX) is .93; that is, when you buy a small cap index as a way to diversify your large cap-heavy portfolio, you’re settling for an investment with a 93% correlation to your original portfolio.

Here are the correlations between various long/short funds:

This does not automatically justify inclusion of a second or third long-short fund in your portfolio, but it does demonstrate two things.  First, that long-short funds really are vastly different from one another, which is why their correlations are so low.  Second, a single long-short fund offers considerable diversification in a long-only portfolio and a carefully selected second fund might add a further layer of independence.

Royce Value Trust plans on exporting its investors

Royce Value Trust (RVT) is a very fine closed-end fund managed by a team led by Chuck Royce.  Morningstar rates it as a “Gold” CEF despite the fact that it has modestly trailed its peers for more than a decade.  The fund has attracted rather more than a billion in assets.

Apparently the managers aren’t happy with that development and so have propsoed exporting some of their investors’ money to a new fund.  Here’s the SEC filing:

I invite you to a special stockholder meeting of Royce Value Trust Inc. to be held on September 5, 2013. At the meeting, stockholders will be asked to approve a proposal to contribute a portion of Value Trust’s assets to a newly-organized, closed-end management investment company, Royce Global Value Trust, Inc. and to distribute to common stockholders of Value Trust shares of common stock of Global Trust.

And why would they “contribute” a portion of your RVT portfolio to their global fund?

Although Value Trust and Global Trust have the exact same investment objective of long-term growth of capital, Value Trust invests primarily in U.S. domiciled small-cap companies while Global Trust will invest primarily in companies located outside the U.S. and may invest up to 35% of its assets in the securities of companies headquartered in “developing countries.” For some time, we have been attracted to the opportunities for long-term capital growth presented in the international markets, particularly in small-cap stocks. To enable Value Trust’s stockholders to participate more directly in these opportunities, we are proposing to contribute approximately $100 million of Value Trust’s assets to Global Trust.

I see.  RVT shareholders, by decree, need more international and emerging markets exposure.  Rather than risking the prospect that they might do something foolish (for example, refuse to buy an untested new fund on their own), Royce proposes simply diversifying your portfolio into their favorite new area.  By the same logic, they might conclude that you could also use some emerging markets bonds.  Were you silly enough to think that you needed domestic small cap exposure and, hence, bought a domestic small cap fund?  “No problem!  We’ll launch and move you into …”

And why $100 million exactly?  “The $100 million target size (approximately 8% of Value Trust’s current net assets) was established to satisfy New York Stock Exchange listing standards and to seek to ensure that Global Trust has sufficient assets to conduct its investment program while maintaining an expense ratio that is competitive with those of other global small-cap value funds.”  So, as a portfolio move, RVT shareholders gain perhaps 4% exposure to small caps in developed foreign markets and 2% in emerging markets.

In one of Morningstar’s odder tables, they classified RVT as having the worst performance ever, anywhere, by anything:

You might notice the frequency with which RVT trails 100% of its peers.  Odd in a “Gold” fund?  Not so much as you might think.  When I asked Morningstar’s peerless Alexa Auerbach to check, she reported that RVT’s category contains only two funds.  The other, slightly better one is also from Royce and so the 100^th percentile ranking translates to “finished second in a two-person race.”

Experienced managers launching their own firms: Barron’s gets it (mostly) right

Barron’s featured a nice story on the challenge of launching a new fund firm and highlighted four star managers who choose to strike out on their own (“Introducing the New Guard,” July 8, p.p. L17-19). (We can’t link directly to this article, but if you Google the title you should be able to gain complimentary access to it.) They focus on four firms about which, you might have noticed, I have considerable enthusiasm:

Vulcan Value Partners, whose Vulcan Value Small Cap Fund we profiled.

Highlights: C.T. Fitzpatrick – one of the few managers whose funds I’ve profiled but with whom I’ve never spoken – distinguishes Vulcan’s approach from the Longleaf (his former employer) approach because “we place as much emphasis on business quality as we do on the discount.” He also thinks that his location in Birmingham is a plus since it’s easier to stand back from the Wall Street consensus if you’re 960 (point eight!) miles away from it. He also thinks that it makes recruiting staff easier since, delightful as New York City is, a livable, affordable smaller city with good schools is a remarkable draw.

Seafarer Capital Partners, whose Seafarer Overseas Growth & Income is in my own portfolio and to which I recently added shares.

Highlight: Andrew Foster spends about a third of this time running the business. Rather than a distraction, he thinks it’s making him a better investor by giving him a perspective he never before had. He frets about investors headlong rush into the more volatile pieces of an intrinsically volatile sector. He argues in this piece for slow-and-steady growers and notes that “People often forget that when you invest in emerging markets, you’re investing in something that is flawed but that you believe can eventually improve.”

Grandeur Peak Global Advisors, whose Grandeur Peak Global Opportunities was profiled in February 2012 and about whom we offer a short feature article and two fund profiles, all below.

Highlight: Lead manager Robert Gardiner and president Eric Huefner both began working for Wasatch as teenagers? (Nuts. I worked at a public library for $1.60/hour and was doing landscaping for less.) They reject the domestic/international split when it comes to doing security analysis and allow Mr. Gardiner to focus entirely on investing while Mr. Huefner obsesses about running a great firm. 

Okay, Barrons’ got it mostly right. They got the newest name of the fund wrong (it’s Reach, not Research), the photo caption wrong and a provocative quote wrong. Barron’s claimed that Gardiner is “intent on keeping Grandeur Peak, which is now on the small side, just shy of $1 billion under management.” Apparently Mr. Huefner said Grandeur Peak currently had a bit under a billion, that their strategies’ collective capacity was $3 billion but they’re apt to close once they hit $2 billion to give them room for growth.

RiverPark Advisors, five of whose funds we’ve profiled, two more of which we’ve pointed to and one of which is in my personal portfolio (and Chip’s). 

Highlight: Mitch Rubin’s reflection on the failure of their first venture, a hedge fund “Our mistake, we realized, was trying to create strategies we thought investors wanted to buy rather than structuring the portfolios around how we wanted to invest” and Mitch Rubin’s vitally important note, “Managers often think of themselves as the talent. But the ability to run these businesses well takes real talent.” Ding, ding, ding, ding! Exactly. There are only a handful of firms, including Artisan, RiverPark and Seafarer, where I think the quality of the business operation is consistently outstanding. (It’s a topic we return, briefly, to below in the discussion of “Two questions for potential fund entrepreneurs.”)  Lots of small firms handicap themselves by making the operations part of the business an afterthought. Half of the failure of Marx’s thought was his inability to grasp the vital and difficult role of organizing and managing your resources.

Will casting off at Anderson’s Pier in Ephraim, WI.

Two questions for potential fund entrepreneurs

Where will you find your first $100 million?  And who’s got the 263 hours to spend on the paperwork?

I’d expressed some skepticism about the claim in Barron’s (see above) that mutual funds need between $100 – 200 million in AUM in order to be self-sustaining.  That is, to cover both their external expenses such as legal fees, to pay for staff beyond a single manager and to – here’s a wild thought – pay the manager a salary. 

In conversations over the past month with Andrew Foster at Seafarer and Greg Parcella at Long/Short Advisors, it became clear that the figure quoted in Barron’s was pretty reasonable.  Mr. Foster points out that the break-even is lower for a second or third fund, since a viable first fund might cover most of the firm’s overhead expenses, but for a firm with a single product (and most especially an international or global one), $100 million is a pretty reasonable target. 

Sadly, many of the managers I’ve spoken with – even guys with enormous investment management skill – have a pretty limited plan for getting there beyond the “build a better mousetrap” fiction.  In truth, lots of “better mousetraps” languish.  There are 2400 funds with fewer than $100 million in the portfolio, 10% of which are current four- or five-star funds, according to Morningstar.  (Many of the rest are too new to have a Morningstar rating.)

What I didn’t realize was how long the danged paperwork for a fund takes.  One recent prospectus on file with the SEC contained the following disclosure that’s required under a federal paperwork reduction act:

Which is to say, writing a prospectus is estimated to take six weeks.  I’m gobsmacked.

The big picture at Grandeur Peak

In the course of launching their new Global Reach fund, profiled below, Grandeur Peak decided to share a bit of their firm’s long-term planning with the public. Grandeur Peak’s investment focus is small- to micro-cap stocks.  The firm estimates that they will be able to manage about $3 billion in assets before their size becomes an impediment to their performance.  From that estimate, they backed out the point at which they might need to soft close their products in order to allow room for capital growth (about $2 billion) and then allocated resource levels for each of their seven envisioned strategies.

Those strategies are:

• Global Reach, their 300-500 stock flagship fund
• Global Opportunities, a more concentrated version of Global Reach
• International Opportunities, the non-U.S. sub-set of Global Reach
• Emerging Markets Opportunities, the emerging and frontier markets subset of International Opportunities
• US Opportunities, the U.S.-only subset of Global Opportunities
• Global Value, the “Fallen Angels” sub-set of Global Reach
• Global Microcap, the micro-cap subset of Global Reach

President Eric Huefner remarks that “Remaining nimble is critical for a small/micro cap manager to be world-class,” hence “we are terribly passionate about asset capping across the firm.”  With two strategies already closed and another gaining traction, it might be prudent to look into the opportunity.

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. 

Grandeur Peak Global Opportunity (GPGOX): this now-closed star goes where few others dare, into the realm of global and emerging markets small to micro-caps.  With the launch of its sibling, Global Reach, its portfolio is about to tighten and focus.

Grandeur Peak Global Reach (GPGRX): this is the fund that Grandeur Peak wanted to offer you two years ago.  It will be their most broadly-diversified, lowest-cost portfolio and will serve as the flagship for the Grandeur Peak fleet. 

LS Opportunity (LSOFX): Jim Hillary left Marsico in 2004 with a lot of money and the burning question, “what’s the best way to sustainably grow my wealth?”  His answer was a pure long/short portfolio that’s served him, his hedge fund investors, his European investors, and his high net worth investors really well.  LSOFX gives retail investors a chance to join the party.

Sextant Global High Income (SGHIX): what do income-oriented investors do when The Old Reliables fail?  Saturna Capital, which has a long and distinguished record of bond-free income investing at Amana Income (AMANX), offers this highly adaptable, benchmark-free fund as one intriguing option.

Elevator Talk #6: Brian Frank of Frank Value Fund (FRNKX)

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.

Frank Value Fund (FRNKX) is not “that other Frank Fund” (John Buckingham’s Al Frank fund VALUX). It’s a concentrated, all-cap value fund that’s approaching its 10^th anniversary. It’s entirely plausible that it will celebrate its 10^th anniversary with returns in the top 10% of its peer group.

Most funds that claim to be “all cap” are sorting of spoofing you; most mean “all lot of easily-researched large companies with the occasional SMID-cap tossed in.”  To get an idea of how seriously Brian Frank means “go anywhere” when he says “go anywhere,” here’s his Morningstar portfolio map in comparison to that of the Vanguard Total Stock Market Index (VTSMX):

Vanguard Total Stock Market	Frank Value

Brian Frank is Frank Capital Partners’ co-founder, president and chief investment officer.  He’s been interested in stock investing since he was a teenager and, like many entrepreneurial managers, was a voracious reader.  At 19, his grandfather gave him $100,000 with the injunction, “buy me the best stocks.”  In pursuit of that goal, he founded a family office in 2002, an investment adviser in 2003 and a mutual fund in 2004. He earned degrees in accounting and finance from NYU.  Here’s Mr. Frank’s 200 words making his case:

What does the large-cap growth or small-cap value manager do when there are no good opportunities in their style box? They hold cash, which lowers your exposure to the equity markets and acts as a lead-weight in bull markets, or they invest in companies that do not fit their criteria and end up taking excess risk in bear markets. Neither one of these options made any sense when I was managing family-only money, and neither one made sense as we opened the strategy to the public through The Frank Value Fund. Our strategy is quantitative, meaning we go where we can numerically prove to ourselves there is opportunity. If there is no opportunity, we leave the space. It sounds simple, and it’s probably what you would do with your own money if you were an investment professional, but it is not how the fund industry is structured. If you believe in buying low-valuation, high-quality companies, and you allow your principles, not the Morningstar style-box to be your guide, I believe our fund has the structure and discipline to maintain this strategy, and I also believe because of this, we will continue to generate significant outperformance over the long-term.

The fund’s minimum initial investment is $1,500.  The fund’s website is clean and well-organized.  Brian’s most-recent discussion of the fund appears in his Second Quarter 2013 shareholder letter, though you might also enjoy his rant about the perils of passive investing.

Elevator Talk #7: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX)

Guinness Atkinson Inflation-Managed Dividend (GAINX) is about the most “normal” fund in GA’s Asia/energy/innovation-dominated line-up.  Its global equity portfolio targets “moderate current income and consistent dividend growth that outpace inflation.”  The centerpiece of their portfolio construction is what they call the “10 over 10” methodology: in order to qualify for consideration, a corporation must have demonstrated at least 10% cash flow return on investment for 10 years.  By their estimation, only 3% of corporations clear this first hurdle.

They then work their way down from a 400 stock universe to a roughly equally-weighted portfolio of 35 names, representing firms with the potential for sustained dividend growth rather than just high current yields.  Morningstar reports that their trailing twelve-month yield is 3.02% while the 10-year U.S. Treasury sits at 2.55% (both as of July 17, 2013).

Managers Ian Mortimer and Matthew Page have a curious distinction: they are British, London-based managers of a largely-U.S. equity portfolio.  While that shouldn’t be remarkable, virtually every other domestic or global fund manager of a U.S. retail fund is American and domiciled here.  Dr. Mortimer earned a Master’s degree from University College London (2003) and a doctorate from Christ College, Oxford, both in physics.  He joined GA in 2006.  Mr. Page earned a Master’s degree in physics from New College, Oxford, worked at Goldman Sachs for a year and joined GA in 2005.  The duo co-manages GA Global Innovators (IWIRX) together.  Each also co-manages an energy fund.  Here are Ian and Matt, sharing 211 words on their strategy:

In the environment of historically low bond yields, investors looking for income are concerned with the possibility of rising inflation and rising yields. We believe a rising dividend strategy that seeks either a rising dividend stream over time or the accumulation of shares through dividend reinvestment offers a systematic method of investing, where dividends provide a consistent, growing income stream through market fluctuations.

Our investment process screens for sustainable dividend paying companies.  For a company to pay a sustainable and potentially rising dividend in the future, it needs to generate consistently high return on capital, creating value each year, and distribute it in the form of a dividend.  We therefore do not seek to maximize the yield of our portfolio by screening for high yield companies, but rather focus on companies that have robust business models and settle for a moderate yield.

Companies generating consistent high return on capital exist all around the world, with 50% based in US. We also find a growing number of them in emerging markets.  They also exist across industries and market capitalisations. Given their high returns on capital 90% of these companies pay dividends.

Further, employing a bottom up value driven approach, we seek to buy these good companies when they are out of favour.

The fund’s minimum initial investment is $10,000, reduced to $5,000 for tax-advantaged accounts.  It’s available for $2500 at Fidelity and Schwab. GA is providing GAINX at 0.68%, which represents a massive subsidy for a $2 million fund.  The fund fact sheet and its homepage include some helpful and concise information about fund strategy, holdings, and performance, as well as biographies of the managers.  Given the importance of the “10 over 10” strategy to the fund’s operation, potential investors really should review their “10 over 10 Dividend Investment Strategy” white paper piece.

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (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.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund, a second closed-end interval fund whose portfolio “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.”

Pre-Launch Alert: Sarofim and Robeco

This is normally the space where we flag really interested funds which had become available to the public within the past 30 days.   Oddly, two intriguing funds became legal in July but have not yet launched.  This means that the fund companies might open the fund any day now, but might also mean that they’ll sit on the option for months or years.  I’ve been trying, with limited success to uncover the back story.

Robeco Boston Partners Global Long/Short Fund could have launched July 12.  It will be a global version of their Long/Short Research Fund (BPRRX).  When queries, a representative of the fund simply reported “they have yet [to] decide when they will actually launch the fund.” About the worst you can say about Long/Short Research is that it’s not as great as their flagship Robeco Boston Partners L/S Equity Fund (BPLEX).  Since launch, BPRRX has modestly trailed BPLEX but has clubbed most of its competitors.  With $1.5 billion already in the portfolio, it’s likely to close by year’s end.  The global version will be managed by Jay Feeney, Chief Investment Officer-Equities and co-manager of Long/Short Research, and Christopher K. Hart.  $2500 minimum investment.3.77%, the only redeeming feature of which is that institutional investors are getting charged almost as much (3.52%). The recent (July 1) acquisition of 90.1% of Robeco by ORIX might be contributing to the delay since ORIX has their own strategic priorities for Robeco – mostly expanding in Asia and the Middle East – but that’s not been confirmed.

Sarofim Equity (SRFMX) didn’t launch on July 1, though it might have. Sarofim sub-advises the huge Dreyfus Appreciation Fund (DGAGX) whose “principal investment strategies” bear to striking resemblance to this fund’s. (In truth, there appears to be a two word difference between the two.) DGAGX is distinguished by its negligible turnover (typically under 1%), consistently low risk and mega-cap portfolio (the average market cap is north of $100 billion). It typically captures about 80% of the market’s movements, both up and down. Over periods of three years and longer, that translates to trailing the average large cap fund by less than a percent a year while courting a bit under 90% of the short-term volatility. So why launch a direct competitor to DGAGX, especially one that’s priced below what Dreyfus investors are charged for their shares of a $6 billion fund? Good question! Dan Crumrine, Sarofim’s CFO, explained that Sarofim would like to migrate lots of their smaller separately managed accounts (say, those with just a few hundred thousand) into the mutual fund. That would save money for both Sarofim and their clients, since the separate accounts offer a level of portfolio tuning that many of these folks don’t want and that costs money to provide. Dan expects a launch sometime this fall. The fund will have a $2500 minimum and 0.71% expense ratio after waivers (and only 0.87% – still below DGAGX – before waivers).

Sarofim will not market the fund nor will they place it on the major platforms since they aren’t seeking to compete with Dreyfus; they mostly need a “friends and family” fund to help out some of their clients. This has, with other firms, been a recipe for success since the funds don’t need to charge exorbitant amounts, are grounded in a well-tested discipline, and the managers are under no pressure to grow assets.

I’ll keep you posted.

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 September 2013. There were 12 funds in registration with the SEC this month, through July 15th.  We’ll catch up on the last two weeks of July and all of August in our September issue; we had an early cut-off date this month to accommodate my vacation.

This month’s registrations reveal two particularly interesting developments:

The re-emergence of Stein Roe.  Stein, Roe&Farnham, founded in 1932, had a very well-respected family of no-load funds, most notably Stein Roe Young Investor. There was much drama surrounding the firm. Terrible performance in 1999 led to management shake-ups and botched mergers. Columbia (formerly FleetBoston Financial, then an arm of the Bank of America, later bought by Ameriprise which itself used to be American Express Financial Advisers – jeez, are you keeping a scorecard?) bought the Stein Roe funds in 2001, first renaming them and then merging them out of existence (2007).Somewhere in there, Columbia execs took the funds hip deep in a timing scandal. In 2004, Stein Roe Investment Council – which had been doing separate accounts after the departure of its mutual funds – was purchased by Invesco and became part of their Atlantic Trust private investment group.  In the last two months, Stein Roe has begun creeping back into the retail, no-load fund world as adviser to the new family of AT funds.  Last month it announced the rebranding of Invesco Disciplined Equity (AWIEX) as AT Disciplined Equity.  This month it’s added two entirely new funds to the line-up: AT Mid Cap Equity Fundand AT Income Opportunities Fund.  The former invests in mid-cap stocks while the latter pursues income and growth through a mix of common and preferred stocks and bonds.  The minimum initial investment is $3000 for either and the expense ratios are 1.39% and 1.25%, respectively. 

The first fund to advertise training wheels. Baron is launching Baron Discovery Fund, whose market cap target is low enough to qualify it as a micro-cap fund.  It will be co-managed by two guys who have been working as Baron analysts for more than a decade.  Apparently someone at Baron was a bit ambivalent about the promotion and so they’ve created an entirely new position at the fund: “Portfolio Manager Adviser.”   They’ve appointed the manager of Baron Small Cap, Cliff Greenberg, to make sure that the kids don’t get in over their heads.  His responsibility is to “advise the co-managers of the Fund on stock selection and buy and sell decisions” and, more critically, he’s responsible “for ensuring the execution of the Fund’s investment strategy.”  Uhh … what does it tell you when the nominal managers of the fund aren’t trusted to execute the fund’s investment strategy? Perhaps that they shouldn’t be the managers of the fund?  Make no mistake: many funds have “lead” managers and “co-managers,” who presumably enact the same sort of mentorship role and oversight that Baron is building here. The difference is that, in all of the other cases that come to mind, the guy in charge is the manager.  The minimum initial investment is $2000, reduced to $500 for accounts set up with an AIP. Expenses not yet announced.

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.  Freakishly, that’s the exact number of changes we identified last month.  Investors should take particular note of Bill Frels’ year-end departure from Mairs and Power and Jesper Madsen’s impended exit from Matthews and from the finance industry.  Both firms have handled past transitions very smoothly, but these are both lead managers with outstanding records.

Update #1: Celebrating three years for the ASTON/River Road Long-Short strategy

ASTON/River Road Long/Short Fund (ARLSX) launched on May 4, 2011.  It will have to wait until May 2014 to celebrate its third anniversary and June 2014 to receive its first Morningstar rating.  The strategy behind the fund, though, began operating in a series of separate accounts in June 2010.  As a result, the strategy just completed its third year and we asked manager Matt Moran about the highlights of his first three years.  He points to two in particular:

We are thrilled to have just completed our third year for the composite.  The mutual fund track record is now just a bit over two years.

[Co-manager] Daniel [Johnson] and I think there are two important points about our strategy now that we’ve hit three years:

1. Based on the Sharpe ratio, our composite ranks as the #1 strategy (attached with disclosures) of all 129 funds in the Morningstar Long-Short category over the past three years.

   We like what legendary investor Howard Marks wrote about the Sharpe ratio on page 39-40 of his 2011 masterpiece The Most Important Thing, “…investors who want some objective measure of risk-adjusted return…can only look to the so-called Sharpe ratio…this calculation seems serviceable for public market securities that trade and price often…and it truly is the best we have (my emphasis)”.

2. We’ve grown our AUM from $8 MM at the beginning of 2013 to $81.7 MM as of [mid-July, 2013].

   We are very pleased to have returned +14.1% annualized (gross) versus the Russell 3000 at +18.6% over the past three years with just [about] 45% of the volatility, a beta of 0.36, and a maximum drawdown of [about] 7.65% (vs. 20.4% for the Russell 3000).

Their long/short strategy has a nicely asymmetrical profile: it has captured 59% of the market’s upside but only 33% of the downside since inception.  ARLSX, the mutual fund which is one embodiment of the strategy, strikes us as one of three really promising “pure” long/short funds.  Folks anxious about abnormal market highs and considerable sensitivity to risk might want to poke around ARLSX’s homepage. There’s a separate and modestly more-detailed discussion on the River Road Asset Management Long-Short Equity Strategy homepage, including a nicely-done factsheet.

Update #2: Celebrating the new website for Oakseed Opportunity Fund

Okay, I suppose it’s possible that, at the end of our profile of Oakseed Opportunity Fund (SEEDX), I might have harshed on the guys just a little bit about the quality of their website:

Mr. Park mentioned that neither of them much liked marketing.  Uhhh … it shows.  I know the guys are just starting out and pinching pennies, but really these folks need to talk with Anya and Nina about a site that supports their operations and informs their (prospective) investors.  

One of the great things about the managers of small funds is that they’re still open to listening and reacting to what they’ve heard.  And so with some great delight (and a promise to edit the snarky comment at the end of their profile), we note the appearance of an attractive and far more useful Oakseed website: 

Welcome, indeed.  Nicely done, guys!

Briefly Noted . . .

DWS Enhanced Emerging Markets Fixed Income Fund (SZEAX), an emerging markets junk bond fund (and don’t you really need more exposure to the riskiest of e.m. bonds?) changed its principal investment strategy from investing in emerging markets junk to strike the proviso “the fund invests at least 50% of its total assets in sovereign debt securities issued or guaranteed by governments, government-related entities, supranational organizations and central banks based in emerging markets.”

ING International Growth Fundbecame ING Multi-Manager International Equity Fund (IIGIX) on July 1, 2013. More Marsico fallout: the nice folks from Marsico Capital Management were shown the door by Harbor International Growth (HIIGX) in May.  Baillie Gifford pulled two managers from the ING fund to help manage the Harbor one.  ING then decided to add Lazard and J.P. Morgan as sub-advisers to the fund, in addition to Baillie Gifford and T. Rowe Price.

As of August 1, TIAA-CREF LIFECYCLE FUNDS added TIAA-CREF International Opportunities Fund to their investable universe and increased their exposure to international stocks.

As set forth more fully below, effective as of August 1, 2013, Teachers Advisors, Inc. has increased the maximum exposure of the Funds to the international sector. In addition, the Advisor has begun investing in the and, effective August 1, 2013, the international component of each Fund’s composite benchmark has been changed from the MSCI EAFE® + EM Index to the MSCI ACWI ex-USA® Index.

SMALL WINS FOR INVESTORS

Hmmm … a bit thin this month.

The folks at Fleishman/Hillard report that Cognios Market Neutral Large Cap (COGMX) has been added to the Charles Schwab, Fidelity and Pershing platforms. It’s a new no-load that’s had a bit of a shaky start.

Melissa Mitchell of CWR & Partners reports some success on the part of the Praxis funds (socially responsible, faith-based, front loaded and institutional classes) in getting Hershey’s to commit to eliminating the use of child slaves in the cocoa plantations that serve it:

The chocolate industry’s history is riddled with problems related to child slavery on African cocoa bean farms. Everence, through its Praxis Mutual Funds, is actively working with chocolate companies to address the conditions that lead to forced child labor. For the last three years, Praxis has co-led shareholders in working with Hershey – one of the world’s largest chocolatiers – to shape new solutions to this long-standing problem.

Their Intermediate Income Fund (MIIAX) has purchased $2 million in International Finance Facility for Immunisation (IFFIm) bonds, funding a program which will help save millions of children from preventable diseases. Okay, those aren’t wins for investors per se but they’re danged admirable pursuits regardless and deserve some recognition.

CLOSINGS (and related inconveniences)

Fidelity will close Fidelity Ultra-Short Bond (FUSFX) to most investors on Aug. 2, 2013. It’s one of the ultra-short funds that went off a cliff in last 2007 and never quite regained its stride. Given that the fund’s assets are far below their peak, the closure might be a sign of some larger change on the way.

Artisan is closing Artisan Small Cap (ARTSX), the flagship fund, on August 2nd. This is the second closure in the fund’s history. In October 2009, Artisan rotated a new management team in: Andrew Stephens and the folks responsible for Artisan Midcap.  Since that time, the fund’s performance has improved dramatically and assets have steadily accumulated to $1.2 billion now.  Artisan has a long tradition of closing their funds in order to keep them manageable, so the move is entirely laudable.

OLD WINE, NEW BOTTLES

Marsico has gotten the boot so often that they’re thinking of opening a shoe store. The latest round includes their dismissal from the AST Marsico Capital Growth Portfolio, which became the AST Loomis Sayles Large-Cap Growth Portfolio on July 15, 2013.  This is the second portfolio that AST pulled from Marsico in recent weeks.  The firm’s assets are now down by $90 billion from their peak.  At the same time, The New York Times celebrated Marsico Global (MGLBX) as one of three “Mutual Funds that Made Sense of a Confusing Market” (July 6, 2013).

Invesco Global Quantitative Core (GTNDX) changed its name to Invesco Global Low Volatility Equity Yield on July 31, 2013.

OFF TO THE DUSTBIN OF HISTORY

Compak Dynamic Asset Allocation Fund (CMPKX) will be liquidated on or about September 13, 2013.  It closed to all new investment on July 31, 2013.  It’s a little fund-of-funds run by Moe and Faroz Ansari, both of whom appear to be interesting and distinguished guys.  High expenses, front load, undistinguished – but not bad – performance.

Invesco Dynamics (IDYAX) merged into Invesco Mid Cap Growth (VGRAX) and Invesco Municipal Bond (AMBDX) merged into Invesco Municipal Income (VKMMX).

John Hancock Funds liquidated two tiny funds on July 30: the $1.9 million JHancock Leveraged Companies (JVCAX) and the $3.5 million JHancock Small Cap Opportunities (JCPAX).  Do you suppose it’s a coincidence that JHancock Leveraged Companies was launched at the very peak of Fidelity Leverage Company’s performance?  From inception to April 28, 2008, FLVCX turned $10,000 into $41,000 while its midcap peers reached only $16,000. Sadly, and typically, Fidelity trailed its peers and benchmark noticeably from that day to this. JHancock did better but with its hopes of riding Fidelity’s coattails smashed …

Lord Abbett Small Cap Blend Fund melted into the Lord Abbett Value Opportunities Fund (LVOAX) on July 19, 2013. The fact that Value Opps doesn’t particularly invest in small cap stocks and has struggled to transcend “mediocre” in the last several years makes this a less-than-ideal merger.

My favorite liquidation notice, quoted in its entirety: “On July 31,2013, the ASG Growth Markets Fund (AGMAX) was liquidated. The Fund no longer exists, and as a result, shares of the Fund are no longer available for purchase or exchange.” It appears mostly to have bet on emerging markets currencies. Over its short life, it managed to transform $10,000 into $9,400.

COUNTRY Bond Fund (CTLAX) and COUNTRY Growth Fund (CGRAX) will be liquidated “on or before October 31, 2013, and in any event no later than December 31, 2013.” I have no idea (1) why the word “Country” is supposed to appear in all caps (same with ASTON) or (2) why you’d liquidate a reasonably solid fund with over $300 million in assets or a mediocre one with $250 million. No word of explanation in the filing.

The King is Dead: Fountainhead Special Value Fund (KINGX) has closed to new investors in anticipation of an October liquidation. Twas a $7 million midcap growth fund that had a promising start, cratered in the 2007-09 crisis and never recovered.

In Closing . . .

That’s about it from Door County.  I’ll soon be back at my desk as we pull together the September issue.  We’ll have a look inside your target-date funds and will share four more fund profiles (including one that we’ve dubbed “Dodge and Cox without all the excess baggage”).  It’s work, but joyful.

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.   Our readership, curiously enough, has spiked to 15,014 “unique visitors” this month, though our revenue through Amazon is flat.  So, we thought we’d mention the system for the benefit of the new folks.  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, back-to-school loot or an Easton S1 composite big barrel bat) seems trivial, it adds up to about 75% of our income.  Thanks for both!

We’ll look for you.

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:

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

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:

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

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.

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:

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.

Cool, eh?

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:

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. 

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)

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.

Mr. 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

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)

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!

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? 

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.

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:

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:

1. 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.
2. 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.”
3. 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:

1. 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.
2. 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.
3. There are still better opportunities in equities than fixed income; hence he’s about 90% in equities.
4. 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?

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. 

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

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:

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:

1. Jenner left with two of his (presumably) top analysts from his former team of eight,
2. he reached out to lots of his contacts in the industry after he left,
3. he’s being represented by a public relations firms, Burns McClennan, Inc. and
4. 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. 

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!

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.

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. 

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. 

Quick highlights:

1. 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.
2. 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.)
3. 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%.
4. 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.)
5. 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.)
6. 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:

1. 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

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?

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.

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.

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:

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.

Dear friends,

And now, we wait.  After the frenzy of recent months, that seems odd and unnatural.

Will and his minions wait for the holidays, anxious for the last few weeks of school to pass but secure in the knowledge that their folks are dutifully keeping the retail economy afloat.

Photo by Drew Barnes ’14, Augustana Photo Bureau

My colleagues at Augustana are waiting for winter and then for spring.  The seemingly endless string of warm, dry weeks has left much of our fall foliage intact as we enter December. As beautiful as it is, we’re sort of rooting for winter, or at least the hope of seasonal weather, to reassert itself. And we’re waiting for spring, when the $13 million renovation of Old Main will be complete and we escape our warren of temporary offices and ersatz classrooms. I’ve toured the half-complete renovation. It’s going to be so cool.

And investors wait. Most of us are waiting for a resolution of “the fiscal cliff” (alternately: fiscal slope, obstacle course, whatchamacallit or, my favorite, Fiscal Clifford the Big Red Dog), half fearful that they won’t find a compromise and half fearful that they will.

Then there are The Two Who Wouldn’t Wait. And they worry me. A lot. We’ve written for a year or so about our concerns that the bond market is increasingly unstable. That concern has driven our search for tools, other than Treasuries or a bond aggregate, that investors might use to manage volatility. In the past month, the urgency of that search has been highlighted by The Two. One of The Two is Jeffrey Gundlach, founder of the DoubleLine funds and widely acknowledged as one of the best fixed-income managers anyway. Gundlach believes that “[d]eeply indebted countries and companies, which Gundlach doesn’t name, will default sometime after 2013” (Bond Investor Gundlach Buys Stocks, Sees ‘Kaboom’ Ahead, 11/30/2012). Gundlach says, “I don’t believe you’re going to get some sort of an early warning. You should be moving now.”  Gundlach, apparently, is moving into fine art.

GMO, the other of The Two, has moved. GMO (Grantham, Mayo, van Otterloo) has an outstanding record for anticipating asset class crashes. They moved decisively in 2000 and again in 2007, knowing that they were likely early and knowing that leaving the party early would cost them billions (one quarter of the firm’s assets) as angry investors left. But when the evidence says “run,” they ran. In a late-November interview with the Financial Times, GMO’s head of asset allocation revealed that, firm-wide, GMO had sold off all of their bond holdings (GMO abandons bond market, 11/26/2012). “We’ve largely given up on traditional fixed income,” Inker says, including government and corporate debt in the same condemnation. They don’t have any great alternatives (high quality US stocks are about the best option), but would prefer to keep billions in cash to the alternatives.

I don’t know whether you should wait. But I do believe that you should acquaint yourself with those who didn’t.

The Last Ten: PIMCO in the Past Decade

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.

And just as you’re about to conclude that large fund companies will necessarily produce cautious funds that can aspire just to “pretty good,” along comes PIMCO.  PIMCO was once known as an almost purely fixed-income investor.  Its flagship PIMCO Total Return Fund has gathered over a quarter trillion dollars in assets and tends to finish in the top 10% of its peer group over most trailing time periods.

But PIMCO has become more.  This former separate accounts managers for Pacific Life Insurance Company now declares, “We continue to evolve. Throughout our four decades we have been pioneers and continue to evolve as a provider of investment solutions across all asset classes.”

Indeed they have.  PIMCO has spent more time thinking about, and talking about, the global economic future than any firm other, perhaps, than GMO.  More than talk about the changing sources of alpha and the changing shape of risk, PIMCO has launched a bunch of unique funds targeting emerging challenges and opportunities that other firms would prefer simply to ignore (or to eventually react to).

Perhaps as a result, PIMCO has created more five-star funds in the last decade than any other firm and, among larger firms, has a greater fraction of their funds earning four- or five-stars than anyone else.  Here’s the snapshot:

• PIMCO has 84 funds (which are sold in over 536 packages or share classes)
• 56 of their funds were launched in the past decade
• 61 of them are old enough to have earned Morningstar ratings
• 20 of them have five-star ratings (as of 11/14/12)
• 15 more earned four-star ratings.

How likely this that?  In each Morningstar category, the top 10 percent of funds receive five stars, the next 22.5 percent receive four stars, and the next 35 percent receive three.  In the table below, those are the “expected values.”  If PIMCO had just ordinary skill or luck, you’d expect to see the numbers in the expected values column.  But you don’t.

Only their RealRetirement funds move between bad and mediocre, and even those funds made yet be redeemed.  The RealRetirement funds, like PIMCO’s other “Real” funds, are designed to be especially sensitive to inflation.  That’s the factor that poses the greatest long-term risk to most of our portfolios, especially as they become more conservative.  Until we see a sustained uptick in inflation, we can’t be sure of how well the RealRetirement funds will meet their mandates.  But, frankly, PIMCO’s record counsels patience.

Here are all of the funds that PIMCO has launched in the last 10 years, which their Morningstar rating (as of mid-November, 2012), category and approximate assets under management.

In January, we’ll continue the series of a look at Vanguard.  We know that Vanguard inspires more passion among its core investors than pretty much any other firm.  Since we’re genial outsiders to the Vanguard culture, if you’ve got insights, concerns, tips, kudos or rants you’d like to share, dear Bogleheads, drop me a note.

RiverPark Long/Short Opportunity Conference Call

Volatility is tremendously exciting for many investment managers.  You’d be amazed by the number who get up every morning, hoping for a market panic.  For the rest of us, it’s simply terrifying.

For the past thirty years, the simple, all-purpose answer to unacceptable volatility has been “add Treasuries.”  The question we began debating last spring is, “where might investors look if Treasuries stop functioning as the universal answer?”  We started by looking at long/short equity funds as one possible answer.  Our research quickly led to one conclusion, and slowly to a second.

The quick conclusion: long/short funds, as a group, are a flop. They’re ridiculously expensive, with several dozen charging 2.75% or more plus another 1.5-2% in short interest charges.  They offered some protection in 2008, though several did manage to lose more that year than did the stock market.  But their longer term returns have been solidly dismal.  The group returned 0.15% over the past five years, which means they trailed far behind the stock market, a simple 60/40 hybrid, moderate allocation funds, very conservative short-term bond funds . . . about the only way to make this bunch look good is to compare them to “market neutral” funds (whose motto seems to be, “we can lose money in up markets and down!”).

The slower conclusion: some long-short funds have consistently, in a variety of markets, managed to treat their investors well and a couple more show the real promise of doing so. The indisputable gold standard among such funds, Robeco Long Short (BPLEX) returned 16% annually over the past five years.  The second-best performer, Marketfield (MFLDX) made 9% while funds #3 (Guggenheim Alpha) and #4 (Wasatch Long/Short) made 4%. Sadly, BPLEX is closed to new investors, Guggenheim has always had a sales load and Marketfield just acquired one. Wasatch Long-Short (FMLSX), which we first profiled three years ago, remains a strong, steady performer with reasonable expenses.

Ultimately we identified (and profiled) just three, newer long-short funds worthy of serious attention: Marketfield, RiverPark Long/Short Opportunity (RPLSX) and ASTON/River Road Long Short (ARLSX).

For about an hour on November 29th, Mitch Rubin, manager of RiverPark Long/Short Opportunity(RLSFX) fielded questions from Observer readers about his fund’s strategy and its risk-return profile.  Nearly 60 people signed up for the call.

For folks interested but unable to join us, here’s the complete audio of the hour-long conversation.  It starts with Morty Schaja, RiverPark’s president, talking about the fund’s genesis and Mr. Rubin talking about its strategy.  After that, I posed five questions of Rubin and callers chimed in with another half dozen.

If you’d like a preview before deciding whether you listen in, you might want to read our profile of RLSFX (there’s a printable .pdf of the profile on RiverPark’s website).  Here are some of the highlights of the conversation:

Rubin believes that many long/short mutual fund managers (as opposed to the hedge fund guys) are too timid about using the leverage allowed them.  As a result, they’re not able to harvest the full returns potential of their funds.  Schaja describes RLSFX’s leverage as “moderate,” which generally means having investments equal to 150-200% of assets.

The second problem with long/short managers as a group, he believes, is that they’re too skittish.  They obsess about short-term macro-events (the fiscal cliff) and dilute their insights by trying to bet for or against industry groups (by shorting ETFs, for example) rather than focusing on identifying the best firms in the best industries.

One source of RLSFX’s competitive advantage is the team’s long history of long investing.  They started following many of the firms in their portfolio nearly two decades ago, following their trajectory from promising growth stocks (in which they invested), stodgy mature firms (which they’d sold) and now old firms in challenged industries (which are appearing in the short portfolio).

A second source of advantage is the team’s longer time horizon.  Their aim is to find companies which might double their money over the next five years and then to buy them when their price is temporarily low.

I’d like to especially thank Bill Fuller, Jeff Mayer and Richard Falk for the half dozen really sharp, thoughtful questions that they posed during the closing segment.  If you catch no other part of the call, you might zoom in on those last 15 minutes to hear Mitch and the guys in conversation.

Mr. Rubin is an articulate advocate for the fund, as well as being a manager with a decades-long record of success.  In addition to listening to his conversation, there are two documents on the Long/Short fund’s homepage that interested parties should consult.  First, the fund profile has a lot of information about the fund’s performance back when it was a hedge fund which should give you a much better sense of its composition and performance over time.  Second, the manager’s commentary offers an intriguing list of industries which they believe to be ascendant or failing.  It’s sort of thought-provoking.

Conference Calls Upcoming: Great managers 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 Matt Moran and Dan Johnson, co-managers of ASTON / River Road Long Short (ARLSX).   I’ve had several conversations with the team and they strike me as singularly bright, articulate and disciplined.  When we profiled the fund in June, we noted:

The strategy’s risk-management measures are striking.  Through the end of Q1 2012, River Road’s Sharpe ratio (a measure of risk-adjusted returns) was 1.89 while its peers were at 0.49.  Its maximum drawdown (the drop from a previous high) was substantially smaller than its peers, it captured less of the market’s downside and more of its upside, in consequence of which its annualized return was nearly four times as great.

Among the crop of newer offerings, few are more sensibly-constructed or carefully managed that ARLSX seems to be.  It deserves attention.

If you’d like to share your attention with them, our call with ASTON / River Road Long  Short is Monday, December 17, from 7:00 – 8:00 Eastern.  To register for the call, just click on this link and follow the instructions.  I’ll send a reminder email on the day of the call to all of the registered parties.

As a service to our readers, we’ve constructed a mailing list that we’ll use to notify folks of upcoming conference call opportunities.  If you’d like to join but haven’t yet, feel free to drop me a note.

Fidelity’s Advice to Emerging Markets Investors: Avoid Us

Fidelity runs several distinct sets of funds, including Fidelity, Fidelity Advisor, Fidelity Select, and Fidelity Series.  In many ways, the most interesting are their Strategic Adviser funds which don’t even bear the Fidelity name.  The Strategic Adviser funds are “exclusive to clients of Portfolio Advisory Services. . . They allow Strategic Advisers to hire (and fire) sub-advisers as well as to buy, sell, and hold mutual funds and exchange-traded funds (ETFs) within the fund.”  In short, these are sort of “best ideas”  funds, two of which are funds of funds.

Which led to the question: would the smartest folks Fidelity could find, who could choose any funds around which to build a portfolio, choose Fidelity?

In the case of emerging markets, the answer is “uhh … no.”  Here’s the portfolio for Strategic Advisers Emerging Markets Fund of Funds (FLILX).

What should you notice?

1. The fund’s managers seem to find many funds more compelling than Fidelity Emerging Markets, and so it ends up sixth on the list.  Fidelity’s corporate folks seem to agree and they replaced the long-time manager of this one-star fund in mid October, 2012.
2. Measured against the March 2012 portfolio, Fidelity E.M. has seen the greatest decrease in its weighing (about 3.2%) of any fund in the portfolio.
3. Missing entirely from the list: Fidelity’s entire regional lineup including China Region, Emerging Asia, Emerging Middle East and Latin America.
4. For that matter, missing entirely from the list are anything but diversified large cap emerging markets stock funds.

Fidelity does noticeably better in the only other Strategic Advisers fund of funds, the Strategic Advisers^® Income Opportunities Fund of Funds (FSADX).

Why, exactly, the managers have invested in three different classes of the same Fidelity fund is a bit unclear but at least they are willing to invest with Fido.  It may also speak to the continuing decline of the Fidelity equity-investing side of the house while fixed-income becomes increasingly

A Site Worth Following: Learn Bonds

Junior Yearwood, our friend and contributing editor who has been responsible for our Best of the Web reviews, has been in conversation with Marc Prosser, a Forbes contributor and proprietor of the Learn Bonds website.  While the greatest part of Marc’s work focuses broadly on bond investing, he also offers ratings for a select group of bond mutual funds.  He has a sort of barbell approach, focusing on the largest bond fund companies and on the smallest.  His fund ratings, like Morningstar’s analyst ratings, are primarily qualitative and process-focused.

Marc doesn’t yet have data by which to assess the validity of his ratings (and, indeed, is articulately skeptical of that whole venture), so we can’t describe him as a Best of the Web site.  That said, Junior concluded that his site was clean, interesting, and worth investigating.  It was, he concluded, a new and notable site.

Launch Alert: Whitebox Long Short Equity (WBLSX,WBLRX,WBLFX)

On November 1, Whitebox Advisors converted their Whitebox Long Short Equity Partners hedge fund into the Whitebox Long Short Equity Fund which has three share classes.  As a hedge fund, Whitebox pretty much kicked butt.  From 2004 – 2012, it returned 15.8% annually while the S&P500 earned 5.2%.  At last report, the fund was just slightly net-long with a major short against the Russell 2000.

There’s great enthusiasm among the Observer’s discussion board members about Whitebox’s first mutual fund, Whitebox Tactical Opportunities (WBMAX) , which strongly suggests this one warrants some attention, if only from advisors who can buy it without a sales load. The Investor shares carry at 4.5% front load, 2.48% expense ratio and a $5000 minimum initial investment.  You might check the fund’s homepage for additional details.

Observer Fund Profiles

Had I mentioned that we visited RiverNorth?

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

Artisan Global Equity Fund (ARTHX):  you know a firm is in a good place when the most compelling alternatives to one of their funds are their other funds.  Global, run by Mark Yockey and his team, extends on the long-term success of Artisan International and International Small Cap.

RiverNorth Dynamic Buy Write (RNBWX): one of the most consistently successful (and rarely employed) strategies for managing portfolios in volatile markets is the use of covered calls.  After spending several hours with the RiverNorth team and several weeks reading the research, we may have an answer to a version of the old Ghostbusters question, “who you gonna (covered) call?”

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 February 2013. Since firms really like launching by December 31^st if they can, the number of funds in the pipeline is modest: seven this month, as compared to 29 last month.  That said, two of the largest fixed-income teams are among those preparing to launch:

DoubleLine Floating Rate Fund, the tenth fund advised or sub-advised by DoubleLine, will seek a high level of current income by investing in floating rate loans and “other floating rate investments.”  The fund will be managed by Bonnie Baha and Robert Cohen.  Ms. Baha was part of Mr. Gundlach’s original TCW team and co-manages Multi-Asset Growth, Low-Duration Bond and ASTON/DoubleLine Core Plus Fixed Income.

PIMCO Emerging Markets Full Spectrum Bond Fund will invest in “a broad range of emerging market fixed income asset classes, such as external debt obligations of sovereign, quasi-sovereign, and corporate entities; currencies, and local currency-denominated obligations of sovereigns, quasi-sovereigns, and corporate issuers.”  The manager has not yet been named but, as we noted in our lead story, the odds are that this is going to be a top-of-class performer.

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 40 fund manager changes, down from last month’s bloodbath in which 70 funds changed management.

The Observer in the News

Last month, we ran our annual Honor Roll of Consistently Bearable Funds, which asks the simple question:  “which mutual funds are never terrible?”  Our basic premise is that funds that earn high returns but crash periodically are, by and large, impossible for investors to hold.  And so we offered up a list of funds that have avoided crashing in any of the past ten years.  As it turns out, by managing beta, those funds ended up with substantial alpha.  In English: they made good money by avoiding losing money.

Chuck Jaffe has been looking at a related strategy for years, which led him to talk about and elaborate on our article.  His story, “A fund-picking strategy for nervous investors,” ran on November 19^th, ended up briefly (very briefly: no one can afford fifteen minutes of fame any more) on the front page of Google News and caused a couple thousand new folks to poke their heads in at the Observer.

Briefly Noted . . .

Artisan Partners has again filed for an initial public offering.  They withdrew a 2011 filing in the face of adverse market conditions.  Should you care?  Investors can afford to ignore it since it doesn’t appear that the IPO will materially change operations or management; it mostly generates cash to buy back a portion of the firm from outsiders and to compensate some of the portfolio guys.  Competitors, frankly, should care.  Artisan is about the most successful, best run small firm fund that I know of: they’ve attracted nearly $70 billion in assets, have a suite of uniformly strong funds, stable management teams and a palpable commitment to serving their shareholders.  If I were in the business, I’d want to learn a lot – and think a lot – about how they’ve managed that feat.  Sudden access to a bunch more information would help.

One of The Wall Street Journal columnists surveyed “financial advisers, mutual-fund experts and academics” in search of the five best books for beginning investors.  Other than for the fact that they missed Andrew Tobias’s The Only Investment Guide You’ll Ever Need, it’s a pretty solid list with good works from the efficient market and behavioral finance folks.

SMALL WINS FOR INVESTORS

Clipper (CFIMX), Davis New York Venture (NYVTX), and Selected American Shares (SLASX) have waived their 30-day trading restriction for the rest of 2012, in case investors want to do some repositioning in anticipation of higher capital gains tax rates in 2013.

Dreyfus/The Boston Company Small Cap Growth (SSETX) reopened to new investors on Nov. 1.

Victoria 1522 (VMDIX/VMDAX), an emerging markets stock fund, is cutting its expense ratio by 40 basis points. That’s much better news than you think. Glance at Morningstar’s profile of the lower-minimum Advisor shares and you’ll see a two-star fund and move on.  That reading is, for two reasons, short-sighted.  First, the lower expense ratio would make a major difference; the institutional shares, at 25 bps below the Advisor shares, gain a star (as of 11/30/12) and this reduction gives you 40 bps.  Second, the three-year record masks an exceedingly strong four-plus year record.  From inception (10/08) through the end of 11/12, Victoria 1522 would have turned a $10,000 investment into $19,850.  Its peer over the same period would have returned $13,500. That’s partly attributable to good luck: the fund launched in October 2008 and made about 3% in the quarter while its peers dropped nearly 21%.  Even excluding that great performance (that is, looking at 1/09 – 11/12), the fund has modestly outperformed its peer group despite the drag of its soon-to-be-lowered expenses.  ManagerJosephine Jiménez has a long, distinguished record, including long stints running Montgomery Asset Management’s emerging markets division.  (Thanks to Jake Mortell of Candlewood Advisory for the heads up!)

Wells Fargo has reopened the Class A shares of its Wells Fargo Advantage Dow Jones Target funds: Target Today, 2010, 2020, 2030 and 2040.

CLOSINGS

AllianceBernstein Small Cap Growth (QUASX) will close to new investors on January 31, 2013. That’s all I noticed this month.

OLD WINE, NEW BOTTLES

Calvert Enhanced Equity (CMIFX) will be renamed Calvert Large Cap Core in January 2013.

Actually, this one is a little bit more like “old vinegar in new bottles.”  Dominion Insight Growth Fund was reorganized into the Shepherd Large Cap Growth Fund in 2002.  Shepherd LCG changed its name to the Shepherd Fund in 2008. Then Shepherd Fund became Foxhall Global Trends Fund in 2009, and now Foxhall Global Trends has become Fairfax Global Trends Fund (DOIGX). In all of the name changes, some things have remained constant: low assets, high expenses, wretched performance (they’ve finished in the 98^th -99^th percentile for the trailing one, three, five and ten year periods).

Forward Aggressive Growth Allocation Fund became Forward Multi-Strategy Fund on December 3, 2012, which is just a bit vanilla. The 50 other multi-strategy funds in Morningstar’s database include Dynamic, Ethical, Global, Hedged and Progressive flavors of the marketing flavor du jour.

In non-news, Marathon Value Portfolio (MVPFX) is moving from the Unified Series Trust to  Northern Lights Fund Trust III. That’s their third move and I mention it only because the change causes the SEC to flag MVPFX as a “new” fund.  It isn’t new, though it is a five-star, “Star in the Shadows” fund and worth knowing about.

Wells Fargo Advantage Total Return Bond (MBFAX) will be renamed Wells Fargo Advantage Core Bond sometime in December.

OFF TO THE DUSTBIN OF HISTORY

Geez, the dustbin of history is filling up fast . . .

BNY Mellon Intermediate U.S. Government (MOVIX) is merging into BNY Mellon Intermediate Bond (MIIDX) in February, though the manager is the same for both funds.

Buffalo plans to merge Buffalo China (BUFCX) into Buffalo International (BUFIX) in January, 2013. The fund was originally sub-advised by Jayhawk Capital and I long ago wrote a hopeful profile of the then-new fund. Jayhawk ran it for three years, making huge amounts twice (2007 and 2009), lost a huge amount once (2008), lived in the basement of a highly volatile category and were replaced in 2009 by an in-house management team. The fund has been better but never rose to “good” and never drew assets.

Dreman is killing off five of the six funds: Contrarian International Value (DRIVX), Contrarian Mid Cap Value (DRMVX), Contrarian Value Equity (DRVAX), High Opportunity (DRLVX), and Market Over-Reaction (DRQLX).  Mr. Dreman has a great reputation and had a great business sub-advising load-bearing funds.  Around 2003, Dreman launched a series of in-house, no-load funds.  That experiment, by and large, failed.  The funds were rebranded and repriced, but never earned their way.  The fate of their remaining fund, Dreman Contrarian Small Cap Value (DRSVX), is unknown.

Dreyfus/The Boston Company Small Cap Tax-Sensitive Equity (SDCEX) will liquidate on January 8, 2013 and Dreyfus Small Cap (DSVAX) disappears a week later. Dreyfus is also liquidating a bunch of money market and state bond funds.

Fidelity is pulling a rare 5:1 reverse split by merging Tax Managed Stock (FTXMX), Advisor Strategic Growth (FTQAX), Advisor 130/30 Large Cap (FOATX), and Large Cap Growth (FSLGX) into Fidelity Stock Selector All Cap (FSSKX).

Guggenheim Flexible Strategies (RYBSX) (formerly Guggenheim Long Short Interest Rate Strategies) is slated to merge into Guggenheim Macro Opportunities (GIOAX).

Henderson Global is liquidating their International All Cap Equity (HFNAX) and the Japan Focus (HFJAX) funds in December.

Legg Mason has decided to liquidate Legg Mason Capital Management Disciplined Equity Research (LGMIX), likely on the combination of weak performance and negligible assets.

Munder International Equity (MUIAX) will merge into Munder International Core Equity (MAICX) on Dec. 7.

The board of Northern Funds approved the liquidation of Northern Global Fixed Income (NOIFX) for January 2013.

Pear Tree Columbia Micro Cap (MICRX) just liquidated.  They gave the fund all of one year before declaring it to be a failed experiment.

RidgeWorth plans to merge RidgeWorth Large Cap Core Growth Stock (CRVAX) will be absorbed by RidgeWorth Large Cap Growth Stock (STCIX).

Turner is merging Turner Concentrated Growth (TTOPX) into Turner Large Growth (TCGFX) in early 2013.

Westwood has decided to liquidate Westwood Balanced (WHGBX) less than a year after the departure of longtime lead manager Susan Byrne.

In February, Wells Fargo Advantage Diversified Small Cap (NVDSX) disappears into Wells Fargo Advantage Small Company Growth (NVSCX), Advantage Equity Value (WLVAX) into Advantage Intrinsic Value (EIVAX) and Advantage Small/Mid Cap Core (ECOAX) into Advantage Common Stock (SCSAX).

Well Fargo is also liquidating its Wells Fargo Advantage Core builder Series (WFBGX) in early 2013.

Coming Attractions!

The Observer is trying to help two distinct but complementary groups of folks.  One group are investors who are trying to get past all the noise and hype.  (CNBC’s ratings are dropping like a rock, which should help.)  We’re hoping, in particular, to help folks examine evidence or possibilities that they wouldn’t normally see.  The other group are the managers and other folks associated with small funds and fund boutiques.  We believe in you.  We believe that, as the industry evolves, too much emphasis falls on asset-gathering and on funds launched just for the sake of dangling something new and shiny (uhh … the All Cap Insider Sentiment ETF).  We believe that small, independent funds run by smart, passionate investors deserve a lot more consideration than they receive.  And so we profile them, write about them and talk with other folks in the media about them.

As the Observer has become a bit more financially sustainable, we’re now looking at the prospect of launching two sister sites.  One of those sites will, we hope, be populated with the best commentaries gathered from the best small fund managers and teams that we can find.  Many of you folks write well and some write with grace that far exceeds mine.  The problem, managers tell me, is that fewer people than you’d like find their way to your sites and to your insights.

Our technical team, which Chip leads, thinks that they can create an attractive, fairly vibrant site that could engage readers and help them become more aware of some of the smaller fund families and their strategies.  We respect intellectual property, and so we’d only use content that was really good and whose sharing was supported by the adviser.

That’s still in development.  If you manage a fund or work in support of one and would like to participate in thinking about what would be most helpful, drop Chip a note and we’ll find a way to think through this together.  (Thanks!)

Small cap funds tend to have their best performance in the first six weeks of each year and so we’re planned a smallcapfest for our January issue, with new or revised profiles of the most sensible small cap funds as well as a couple outside perspectives on where you might look.

In Closing . . .

I wanted to share leads on three opportunities that you might want to look in on.  The Observer has no financial stake in any of this stuff but I like sharing word of things that strike me as really first-rate.

QuoteArts.com is a small shop that consistently offers a bunch of the most attractive, best written greeting cards (and refrigerator magnets) that I’ve seen.  Steve Metivier, who runs the site, gave us permission to reproduce one of their images (normally the online version is watermarked):

The text reads “A time to quiet our hearts… (inside) to soften our edges, clear our minds, enjoy our world, and to share best wishes for the season. May these days and all the new year be joyful and peaceful.”  It strikes me as an entirely-worthy aspiration.

The best book there is on the subject of practical persuasion is Robert Cialdini’s Influence: The Psychology of Persuasion (revised edition, 2006).  Even if you’re not impressed that I’ve used the book in teaching persuasion over the past 20 years, you might be impressed by Charlie Munger’s strong endorsement of it.  In a talk entitled “The Psychology of Human Misjudgment,” Munger reports being so impressed with Cialdini’s work that he read the book, gave copies of it to all his children and sent Cialdini (“chawl-dee-nee,” if you care) a share of Berkshire Hathaway in thanks.   Cialdini has since left academe, founded the consulting group Influence at Work and now offers Principles of Persuasion workshops for professionals and the public. While I have not researched the workshops in any depth, I suspect that if I were a small business owner, marketer or financial planner who needed to both attract clients and change their behavior for the better. I’d take a serious look.

Finally, at Amazon’s invitation, I contributed an essay that will be posted at their new “Money and Markets” store from December 5th until about the 12th.  Its original title was, “It’s time to go,” but Amazon’s project director and I ended up settling on the less alarming “Trees don’t grow to the sky.”  If you’ve shopped at, say, Macy’s, you’re familiar with the store-within-a-store notion: free-standing, branded specialty shops (Levenger’s, LUSH, FAO Schwarz) operating within a larger enterprise.  It looks like Amazon is trying an experiment in the same direction and, in November, we mentioned their “Money and Markets” store.  Apparently the Amazonians noticed the fact that some of you folks went to look around, they followed your footprints back here and did some reading of their own.  One feature of the Money and Markets store is a weekly guest column and the writers have included Jack Bogle and Tadas Viskanta, the founder of Abnormal Returns which is one of the web’s two best financial news aggregators.  In any case, they asked if I’d chip in a piece during the second week of December.   We’re not allowed to repost the content for a week or so, but I’ll include it in the January cover essay.  Feel free to drop by if you’re in the area.

In the meanwhile, I wanted to extend sincere thanks from all of the folks here (chip, Anya, Junior, Accipiter and me) for the year you’ve shared with us.  You really do make it all worthwhile and so blessings of the season on you and yours.

As ever,

Dear friends,

I had imagined this as the “post-storm, pre-cliff” edition of the Observer but it appears that “post-storm” would be a very premature characterization.  For four million of our friends who are still without power, especially those along the coast or in outlying areas, the simple pleasures of electric lighting and running water remain a distant hope.  And anything that looks like “normal” might be months in their future.  Our thoughts, prayers, good wishes and spare utility crews go out to them.

I thought, instead, I’d say something about the U.S. presidential election.  This is going to sting, but here it is:

It’s going to be okay.

Hard to believe, isn’t it?  We’re acculturated into viewing the election if as it were some apocalyptic video game whose tagline reads: “America can’t survive .”  The reality is, we can and we will.  The reality is that both Obama and Romney are good guys: smart, patriotic, obsessively hard-working, politically moderate, fact-driven, given to compromise and occasionally funny.  The reality is that they’re both trapped by the demands of electoral politics and polarized bases.

But, frankly, freed of the constraints of those bases, these guys would agree on rather more than they disagree on.  In a less-polarized world, they could run together as a ticket (Obomney 2020!) and do so with a great deal of camaraderie and mutual respect. (Biden-Ryan, on the other hand, would be more than a little bit scary.)  Neither strikes me as a great politician or polished communicator; that’s going to end up constraining – and perhaps crippling – whoever wins.

Why are we so negative?  Because negative (“fear and loathing on the campaign trail”) raises money (likely $6 billion by the time it’s all done) and draws viewers.  While it’s easy to blame PACs, super PACs and other dark forces for that state, the truth is that the news media – mainstream and otherwise – paint good men as evil.  A startling analysis conducted by the Project for Excellence in Journalism found that 72% of all character references to Messrs. Obama and Romney are negative, one of the most negative set of press portrayals on record.

I live in Iowa, labeled a “battleground state,” and I receive four to six (largely poisonous) robo-calls a day.  And so here’s the final reality: Iowa is not a battleground and we’d all be better off if folks stopped using the term.  It’s a place where a bunch of folks are worried, a bunch of folks (often the same ones) are hopeful and we’re trying to pick as best we can.

The Last Ten: T. Rowe Price in the Past Decade

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.  We started with Fidelity, once fabled for the predictable success of its new fund launches.  Sadly, the pattern of the last decade is clear and clearly worse: despite 154 fund launches since 2002, Fidelity 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 is a far smaller firm.  Where Fidelity has $1.4 trillion in assets under management, Price is under $600 billion.  Fidelity manages 340 funds.  Price has 110.  Fidelity launched 154 funds in a decade, Price launched 22.

What are the patterns?

1. Most Price funds reflect the firm’s strength in asset allocation and emerging asset classes. Price does really first-rate work in thinking about which assets classes make sense and in what configuration. They’ve done a good job of communicating that research to their investors, making things clear without making them childish.
2. Most Price funds succeed. Of the 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).
3. Most Price funds remain reasonably nimble. While Fido funds quickly swell into the multi-billion range, a lot of the Price funds have remaining under $200 million which gives them both room to grow and to maneuver. The really large funds are the retirement-date series, which are actually funds of other funds.
4. Price continues to buck prevailing wisdom. There’s no sign of blossoming index fund business or the launch of a series of superfluous ETFs. There’s a lot to be said for knowing your strengths and continuing to develop them.

Finally, 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. The success of that strategy is evident in Price’s domination of . . .

The Observer’s Honor Roll, Unlike Any Other

Last month, in the spirit of FundAlarm’s “three-alarm” fund list, we presented the Observer’s second Roll Call of the Wretched.  Those were funds that managed to trail their peers for the past one-, three-, five- and ten-year periods, with special commendation for the funds that added high expenses and high volatility to the mix.

This month, I’d like to share the Observer’s Honor Roll of Consistently Bearable Funds.  Most such lists start with a faulty assumption: that high returns are intrinsically good.

Wrong!

While high returns can be a good thing, the practical question is how those returns are obtained.  If they’re the product of alternately sizzling and stone cold performances, the high returns are worse than meaningless: they’re a deadly lure to hapless investors and advisors.  Investors hate losing money much more than they love making it.

In light of that, the Observer asked a simple question: which mutual funds are never terrible?  In constructing the Honor Roll, we did not look at whether a fund ever made a lot of money.  We looked only at whether a fund could consistently avoid being rotten.  Our logic is this: investors are willing to forgive the occasional sub-par year, but they’ll flee in terror in the face of a horrible one.  That “sell low” – occasionally “sell low and stuff the proceeds in a zero-return money fund for five years” – is our most disastrous response.

We looked for no-load, retail funds which, over the past ten years, have never finished in the bottom third of their peer groups.   And while we weren’t screening for strong returns, we ended up with a list of funds that consistently provided them anyway.

U.S. stock funds

International stock funds

Blended asset funds

Specialty funds

Reflections on the Honor Roll

These funds earn serious money.  Twenty-nine of the 33 funds earn four or five stars from Morningstar.  Four earn three stars, and none earn less.  By screening for good risk management, you end up with strong returns.

This is consistent with the recent glut of research on low-volatility investing.  Here’s the basic story: a portfolio of low-volatility stocks returns one to two percent more than the stock market while taking on 25% less risk.

That’s suspiciously close to the free lunch we’re not supposed to get.

There’s a very fine, short article on low-volatility investing in the New York Times: “In Search of Funds that Don’t Rock the Boat” (October 6, 2012).  PIMCO published some of the global data, showing (at slightly numbing length) that the same pattern holds in both developed and developing markets: “Stock Volatility: Not What You Might Think” (January 2012). There are a slug of ETFs that target low-volatility stocks but I’d be hesitant to commit to one until we’d looked at other risk factors such as turnover, market cap and sector concentration.

The roster is pretty stable.  Only four funds that qualified under these screens at the end of 2011 dropped out in 2012.  They are:

FPA Crescent (FPACX) – a 33% cash stake isn’t (yet) helping.  That said, this has been such a continually excellent fund that I worry more about the state of the market than about the state of Crescent.

New Century Capital (NCCPX) – a small, reasonably expensive fund-of funds that’s trailing 77% of its peers this year.  It’s been hurt, mostly, by being overweight in energy and underweight in resurgent financials.

New Century International (NCFPX) – another fund-of-funds that’s trailing about 80% of its peers, hurt by a huge overweight in emerging markets (primarily Latin), energy, and Canada (which is sort of an energy play).

Permanent Portfolio (PRPFX) – it hasn’t been a good year to hold a lot of Treasuries, and PRPFX by mandate does.

The list shows less than half of the turnover you’d expect if funds were there by chance.

One fund deserves honorable mention.  T. Rowe Price Capital Appreciation (PRCWX) has only had one relatively weak year in this century; in 2007, it finished in the 69^th percentile which made it (barely) miss inclusion.

What you’ve heard about T. Rowe Price is true.  You know all that boring “discipline, consistency, risk-awareness” stuff.  Apparently so.  There are 10 Price funds on the list, nearly one-third of the total.  Second place: Fidelity and Vanguard, far larger firms, with six funds.

Sure bets?  Nope.  Must have?  Dear God, no.  A potentially useful insight into picking winners by dodging a penchant for the occasional disaster?  We think so.

In dullness there is strength.

“TrimTabs ETF Outperforms Hedge Funds”

And underperforms pretty much everybody else.  The nice folks at FINAlternatives (“Hedge Fund and Private Equity News”) seem to have reproduced (or condensed) a press release celebrating the first-year performance of TrimTabs Float Shrink ETF (TTFS).

(Sorry – you can get to the original by Googling the title but a direct-link always takes you to a log-in screen.)

Why is this journalism?  They don’t offer the slightest hint about what the fund does.  And, not to rain on anybody’s ETF, but their trailing 12-month return (21.46% at NAV, as of 10/18) places them 2050th in Morningstar’s database.  That list includes a lot of funds which have been consistently excellent (Akre Focus, BBH Core Select (closing soon – see below), ING Corporate Leaders, Mairs & Power Growth and Sequoia) for decades, so it’s not immediately clear what warrants mention.

Seafarer Rolls On

Andrew Foster’s Seafarer Overseas Growth & Income Fund (SFGIX) continues its steady gains.

The fund is outperforming every reasonable benchmark: $10,000 invested at the fund’s inception has grown to $10,865 (as of 10/26/12).  The same amount invested in the S&P’s diversified emerging markets, emerging Asia and emerging Latin America ETFs would have declined by 5-10%.

Assets are steadily rolling in: the fund is now at $17 million after six months of operation and has been gaining nearly two million a month since summer.

Opinion-makers are noticing: Andrew and David Nadel of Royce Global Value (and five other funds ‘cause that’s what Royce managers do) were the guests on October 26th edition of Wealth Track with Consuelo Mack.  It was good to hear ostensible “growth” and “value” investors agree on so much about what to look for in emerging market stocks and which countries they were assiduously avoiding.  The complete interview on video is available here.  (Thanks to our endlessly vigilant Ted for both the heads-up and the video link.)

Legg Mason Rolls Over

Legg Mason seems to be struggling.  On the one hand we have the high visibility struggles of its former star manager, Bill Miller, who’s now in the position of losing more money for more people than almost any manager.  Their most recent financial statement, released July 27, shows that assets, operating revenue, operating income, and earnings are all down from the year before.   Beside that, there’s a more fundamental struggle to figure out what Legg Mason is and who wants to bear the name.

On October 5 2009 Legg announced a new naming strategy for its funds:

Most funds that were formerly named Legg Mason or Legg Mason Partners will now include the Legg Mason name, the name of the investment affiliate and the Fund’s strategy (such as the Legg Mason ClearBridge Appreciation Fund or the Legg Mason Western Asset Managed Municipals Fund).

The announced rationale was to “leverage the Legg Mason brand awareness.”

Welcome to the age of deleveraging:  This year those same funds are moving to hide the Legg Mason taint.  Western Asset dropped the Legg Mason number this summer.  Clearbridge is now following suit, so that the Legg Mason ClearBridge Appreciation Fund is about to become just Clearbridge Appreciation.

Royce, another Legg Mason affiliate, has never advertised that association.  Royce has always had a great small-value discipline. Since being acquired by Legg Mason in 2001, the firm acquired two other, troubling distinctions.

1. Managers who are covering too many funds.  By way of a quick snapshot, here are the funds managed by 72-year-old Chuck Royce (and this is after he dropped several):
   

   Since …	He’s managed …
   12/2010	Royce Global Dividend Value
   08/2010	Royce Micro-Cap Discovery
   04/2009	Royce Partners
   06/2008	Royce International Smaller-Companies
   09/2007	Royce Enterprise Select
   12/2006	Royce European Smaller Companies
   06/2005	Royce Select II
   05/2004	Royce Dividend Value
   12/2003	Royce Financial Services
   06/2003	Royce 100
   11/1998	Royce Select I
   12/1995	Royce Heritage
   12/1993	Royce Total Return
   12/1991	Royce Premier
   11/1972	Royce Pennsylvania Mutual

    

   Their other senior manager, Whitney George, manages 11 funds.  David Nadel works on nine, Lauren Romeo helps manage eight.

2. A wild expansion out of their traditional domestic small-value strength.  Between 1962 and 2001, Royce launched nine funds – all domestic small caps.  Between 2001 and the present, they launched 21 mutual funds and three closed-end funds in a striking array of flavors (Global Select Long/Short, International Micro-Cap, European Smaller Companies).  While many of those later launches have performed well, many have found no traction in the market.  Fifteen of their post-2001 launches have under $100 million in assets, 10 have under $10 million.  That translates into higher expenses in some already-expensive niches and a higher hurdle for the managers to overcome.Legg reports progressively weaker performance among the Royce funds in recent years:
   

   Three out of 30 funds managed by Royce outperformed their benchmarks for the 1-year period; 4 out of 24 for the 3-year period; 12 out of 19 for the 5-year period; and all 11 outperformed for the 10-year period.