By David Snowball

Dear friends,

Sorry about the late launch of the Observer, but we’ve been consumed by the need to deal with a campus crime.

Someone stole the dome off my academic home, Old Main, early on the morning of April 1st.

The barstids!

If you play the accompanying video (probably best with the sound muted), there are some way cool images of the pre-theft dome which occur around the: 45 second mark. It’s accompanied by some commentary by a couple of my students and my colleague, Wendy, who, like Anakin, has heard the song of the Dark Side.

Requiem for a heavyweight

The sad tale of Sequoia’s (SEQUX) unwinding continues.

Here’s the brief version of recent events:

• Investors have pulled more than a half billion from the fund, including $230 million just in the first three weeks of March. March will be the sixth consecutive month of net withdrawals.
• The fund trails 98-100% of its peers for 2015 and 2016, as well as for the past one- and three-year periods.
• Manager Bob Goldfarb, whose name is on the door at Ruane, Cunniff & Goldfarb, resigned and an unnamed analyst who was one of the cheerleaders for Valeant left.
• The remaining guys have had a period of reflection and propose a more collaborative decision-making model and less risk-taking for the years ahead.

Senator Arthur Vandenberg (served 1928-1951), a Republican committed to the critical importance of a united front when it came to foreign policy, famously declared “politics stops at the water’s edge.” The fear is that the Sequoia version might have been “independence stops at the boss’s door.”

The dark version of the Sequoia narrative would be this: Goldfarb, abetted by an analyst, became obsessed about Valeant and crushed any internal dissent. Mr. Poppe, nominally Mr. Goldfarb’s peer, wouldn’t or couldn’t stop the disaster. “All the directors had repeatedly expressed concern” over the size of the Valeant stake and the decision to double-down on it. Mr. Poppe dismissed their concerns: “recent events frustrated them.” The subsequent resignations by 40% of the board, with another apparently threatening to go, were inconsequential annoyances. Sequoia, rather snippily, noted that board members don’t control the portfolio, the managers do. Foot firmly on the gas, they turned the bus toward the cliff.

If the dark version is right, Jaffe is wrong. The headline on a recent Chuck Jaffe piece trumpeted “How a big bet on one bad stock broke a legendary mutual fund” (3/28/2016). If the dark narrative is right, “One bad stock” did not break Sequoia; an arrogant and profoundly dysfunctional management culture did.

Do you seriously think that you’d be braver? In the wake of Josef Stalin’s death, Nicolas Khrushchev gave a secret speech denouncing the horrors of Stalin’s reign and his betrayal of the nation. Daniel Schorr picks up the narrative: It was said that at one point a delegate shouted, “And Nikita Sergeyevich, where were you while all this was happening?” Khrushchev had looked up and snapped, “Who said that? Stand up!” When no one rose, Khrushchev said, “That’s where I was, comrade” (from Daniel Schorr, Stay Tuned (2001), 75-76).

Another version, though, starts with this question: “did Goldfarb fall on his sword?” His entire professional life has been entwined with Sequoia, the last living heir to the (Bill) Ruane, (Richard) Cunniff and Goldfarb legacy. Ruane and Cunniff started the firm in 1970, Goldfarb joined the next year and has spent 45 years at it. And now it was all threatening to come apart. Regardless of “who” or “why,” some dramatic gesture was called for. If the choice came down to Goldfarb, age 71, or Poppe, at 51 or 52, it was fairly clear who needed to draw his gladius.

Meanwhile, the usual suspects rushed to close the barn door.

• Morningstar reduced the fund’s Analyst Rating from Gold to Bronze. Why? In the same way that a chef might be embarrassed to celebrate the tender delights of a fish flopping around on the ground, Morningstar’s analysts might have been embarrassed to look at an operation whose wheels were coming off and declaring it “the best of the best.”

  Oddly, they also placed it “under review” on October 30, 2015. At that point, Valeant was over 30% of the fund, investors had been pulling money and the management team conducted their second, slightly-freakish public defense of their Valeant stake. Following the review, the analysts reaffirmed their traditional judgment: Gold! The described it as “compelling” in the week before the review and “a top choice” in the week afterward.

  There’s no evidence in the reaffirmation statement that the analysts actually talked to Sequoia management. If they didn’t, they were irresponsible. If they did and asked about risk management, they were either deceived by management (“don’t worry, we’re clear-eyed value investors and we’re acting to control risk”) or management was honest (“we’re riding out the storm”) and the analysts thought “good enough for us!” I don’t find any of that reassuring.

  Doubts have only set in now that the guys presumably responsible for the mess are gone and the management strategy is becoming collaborative and risk-conscious.

  Similarly, up until quite recently Morningstar’s stock analyst assigned to Valeant recognized “near-term pain” while praising the firms “flawless execution” of its acquisition strategy and the “opportunities [that] exist for Valeant long term.”

• Steve Goldberg, an investment advisor who writes for Kiplinger’s, “still had faith in the fund” back in October after the board members resigned and the extent of the Valeant malignancy was clear. But “What I didn’t know: Valeant was no Berkshire Hathaway.” (stunned silence) Uh, Steve, maybe you should let someone else hold the debit card, just to be safe? Mr. Goldberg correctly points out that Bill Nygren, manager of Oakmark Select (OAKLX), stubbornly rode his vast holdings in Washington Mutual all the way to zero. The lesson he’s learned, curiously late in his professional investing career, “I need to make sure a fund isn’t taking excessively large positions in one or two stocks or engaging in some other dicey strategy. Dramatically outsize returns almost never come without outsize risks.”

The excuse “we couldn’t have known” simply does not hold water. A pseudonymous contributor to Seeking Alpha, who describes himself only as “an engineer in Silicon Valley” wrote a remarkably prescient, widely ignored critique of Sequoia two years ago. After attending Sequoia’s Investor Day, he came away with the eerie sense that Rory Priday and Bob Goldfarb spoke most. The essay makes three prescient claims: that Valeant hadn’t demonstrated any organic growth in years, that they’d been cooking the books for years, and that Goldfarb and Priday were careless in their statements, inexperienced in pharma investing and already hostage to their Valeant stake.

Valeant’s largest shareholder, [Sequoia’s] fate has become inextricably intertwined with Valeant. Valeant is 23% of their portfolio and they own 10% of Valeant. They can’t exit without ruining their returns. This led to a highly desperate defense at the Ruane, Cunniff, Goldfarb annual meeting.

If an amateur investor could smell the rot, why was it so hard for professionals to? The answer is, we blind ourselves by knowing our answers in advance. If I start with the conclusion, “you can’t do much better than the legendary Sequoia,” then I’ll be blind, deaf and dumb on their behalf for as long as I possibly can be.

The bottom line: start by understanding the risks you’re subjecting yourself to. We ignore risks when times are good, overreact when times are bad and end up burned at both ends. If you can’t find your manager’s discussion of risk anywhere except in the SEC-mandated disclosure, run away! If you do find your manager’s discussion of risk and it feels flippant or jaded (“all investing entails risk”), run away! If it feels incomplete, call and ask questions of the advisors. (Yes, people will answer your questions. Trust me on this one.) If, at the end of it all, you’re thinking, “yeah, that makes sense” then double-check your understanding by explaining the risks you’re taking to someone else. Really. Another human being. One who isn’t you. In my academic department, our mantra is “you haven’t really learned something until you’ve proven you can teach it to someone else.” So give yourself that challenge.

Quick note to Fortune: Help staff get the basics right

In Jen Wieczner’s March 18, 2016 story for Fortune, she warns “Sequoia Fund, a mutual fund once renowned for its stock-picking prowess, has been placed under review by Morningstar.” The stakes are high:

Uhh, no. Morningstar is not Michelin. Their stars are awarded based on a mathematical model, not an analyst’s opinions (“This Valeant investor is in even bigger trouble than Bill Ackman,” Fortune.com. The error was corrected eventually).

The Honorable Thing

“Advertising is the modern substitute for argument; its function is to make the worse appear the better.”

               George Santayana

So we find one chapter at Sequoia Fund coming to a close, and the next one about to begin.  On this subject my colleague David has more to offer. I will limit myself to saying that it was appropriate, and, the right thing to do, for Bob Goldfarb to elect to retire. After all, it happened on his watch. Whether or not he was solely to blame for Valeant, we will leave to the others to sort out in the future. Given the litigation which is sure to follow, there will be more disclosures down the road.

A different question but in line with Mr. Santayana’s observations above, is, do those responsible for portfolio miscues, always do the honorable thing? When one looks at some of the investment debacles in recent years – Fannie and Freddie, Sears, St. Joe, Valeant (and not just at Sequoia), Tyco, and of course, Washington Mutual (a serial mistake by multiple firms)  – have the right people taken responsibility? Or, do the spin doctors and public relations mavens come in to do damage control? Absent litigation and/or whistle blower complaints, one suspects that there are fall guys and girls, and the perpetrators live on for another day. Simply put, it is all about protecting the franchise (or the goose that is laying the golden eggs) on both the sell side and the buy side. Probably the right analogy is the athlete who denies using performance enhancing drugs, protected, until confronted with irrefutable evidence (like pictures and test results).

Lessons Learned

Can the example of the Sequoia Fund be a teaching moment? Yes, painfully. I have long felt that the best way to invest for the long-term was with a concentrated equity portfolio (fewer than twenty securities) and some overweight positions within that concentration. Looking at the impact Sequoia has had on the retirement and pension funds invested in it, I have to revisit that assumption. I still believe that the best way to accumulate personal wealth is to invest for the long-term in a concentrated portfolio. But as one approaches or enters retirement, it would seem the prudent thing to do is to move retirement moneys into a very diverse portfolio or fund.  That way you minimize the damage that a “torpedo” stock such as Valeant can do to one’s retirement investments, and thus to one’s standard of living, while still reaping the greater compounding effects of equities. There will still be of course, market risk. But one wants to lessen the impact of adverse security selection in a limited portfolio. 

Remember, we tend to underestimate our life expectancy in retirement, and thus underweight our equity allocations relative to cash and bonds. And in a period such as we are in, the risk free rate of return from U.S. Treasuries is not 12% or 16% as it was in the early 1980’s (although it is perhaps higher than we think it is). And for that retirement equity position, what are the choices?  Probably the easiest again, is something like the Vanguard Total Stock Market or the Vanguard S&P 500 index funds, with minimal expense ratios. We have been talking about this for some time now, but Sequoia provides a real life example of the adverse possibilities.  And, it is worth noting that almost every concentrated investment fund has underperformed dramatically in recent years (although the reasons may have more to do with too much money chasing too few and the same good ideas). Is it really worth a hundred basis points to pay someone to own Bank of America, Wells Fargo, Microsoft, Johnson & Johnson, Merck, as their top twenty holdings? Take a look sometime at the top twenty holdings of the largest actively managed funds in the respective categories of growth, growth and income, etc., and see what conclusions you draw.

The more difficult issue going forward will be deflation versus inflation. We have been in a deflationary world for some time now. It is increasingly apparent that the global central banks are in the process (desperately one suspects) to reflate their respective economies out of stagnant or no growth. Thus we see a variety of quantitative easing measures which tend to favor investors at the expense of savers. Should they succeed, it is unlikely that the inflation will stop at their targets (2% here), and the next crisis will be one of currency debasement. The more things change.

Gretchen Morgenson, Take Two

As should be obvious by now, I am a fan of Ms. Morgenson’s investigative reporting and her take no prisoners approach. I don’t know her from Adam, and could be standing next to her in the line for a bagel and coffee in New York and would not know it. But, she has a wonderful knack for goring many of the oxen that need to be gored.

In this Sunday’s New York Times Business Section, she raised the question of the effectiveness of share buybacks. Now, the dirty little secret for some time has been that growth of a business is not impacted by share repurchases. Yet, if you listened to many portfolio managers wax poetic about how they only invest with shareholder friendly managements (which in retrospect turn out to have not been not so shareholder friendly after they have been indicted by a grand jury). Share repurchase does increase per share metrics, such as book value and earnings.  While the pie stays the same size, the size of the pieces changes. But often in recent years, one wonders why the number of shares outstanding does not change after a repurchase of what looked to have been 5% or so of shares outstanding during the year. 

Well, that’s because management keeps awarding themselves options, which are approved by the board. And the options have the effect of selling the business incrementally to the managers over time, unless share purchases eliminate the dilution from issuing the options.  Why approve the options packages? Well, the option packages are marketed to the share owners as critical to attracting and retaining good managers, AND, aligning the interests of management with the interests of shareholders. Which is where Mr. Santayana comes in  –  the bad (for shareholders) is made to look good with the right buzzwords.

However, I think there is another reason. Obviously growing a business is one of the most important things a management can do with shareholder capital. But today, every capital allocation move of reinvesting in a business for growth and expansion directly or by acquisition, faces a barrage of criticism. The comparison is always against the choices of dividends or share repurchase. I think the real reason is somewhat more mundane. 

The quality of analysts on both the buy and sell side has been dumbed down to the point that they no longer know how to go out and evaluate the impact of an acquisition or other growth strategy. They are limited to running their spread sheet models against industry statistics that they pull off of their Bloomberg terminals. I remember the horror with which I was greeted when I suggested to an analyst that perhaps his understanding of a company and its business would improve if he would find out what bars near a company’s plants and headquarters were favorites of the company’s employees on a Friday after work and go sit there. Now actually I wasn’t serious about that (most of the analysts I knew lacked the social graces and skills to pull it off). I was serious about getting tickets to industry tradeshows and talking to the competitor salespeople at their booths.  You would be amazed about how much you can learn about a company and its products that way. And people love to talk about what they do and how it stands up against their competition. That was a stratagem that fell on deaf ears because you actually had to spend real dollars (rather than commission dollars), and you had to spend time out of the office. Horrors!  You might have to miss a few softball games.

The other part of this is managements and the boards, which also have become deficient at understanding the paths of growing and reinvesting in a business that was entrusted to them.

Sadly, what we have today is a mercenary class of professional managers who can and will flit from opportunity to opportunity, never really understanding (or loving) the business. And we also have a mercenary class of professional board members, who spend their post-management days running their own little business – a board portfolio. And if you doubt all of this, take a look again at Valeant and the people on the board and running the business. It was and is a world of consultants and financial engineers, reapplying the same case study or stratagem they had used many times before. The end result is often a hollowed-out shell of a company, looking good to appearances but rotting away on the inside.

By Edward Studzinski.

Steve Romick: A bit more faith is warranted

In our March issue, I reflected on developments surrounding three of the funds in which I’m invested: FPA Crescent (FPACX), my largest holding, Artisan Small Cap Value (ARTVX), my oldest holding, and Seafarer Overseas Growth & Income (SFGIX), my largest international holding. I wrote that two things worried me about FPA Crescent:

First, the fund has ballooned in size with no apparent effort at gatekeeping … Second, Romick blinked.

That is, the intro to his 2015 Annual Report appeared to duck responsibility for poor performance last year. My bottom line on FPA was “I’ve lost faith. I’m not sure whether FPA is now being driven by investment discipline, demands for ideological purity or a rising interest in gathering assets. Regardless, I’m going.”

Ryan Leggio, now a senior vice president and product specialist for FPA but also a guy who many of you would recall as a former Morningstar analyst, reached out on Mr. Romick’s behalf. There were, they believed, factors that my analysis hadn’t taken into account. The hope was that in talking through some of their decision-making, a fuller, fairer picture might emerge. That seemed both generous and thoughtful, so we agreed to talk.

On the question of Crescent’s size, Mr. Romick noted that he’d closed the fund before (from 2005-08) and would do so again if he thought that was necessary to protect his shareholders and preserve the ability to achieve their stated goal of equity-like rates of return with less risk than the market over the long-term. He does not believe that’s the case now. He made three points:

1. His investable universe has grown. That plays out in two ways: he’s now investing in securities that weren’t traditionally central to him and some of his core areas have grown dramatically. To illustrate the first point, historically, Mr. Romick purchased a security only if its potential upside was at least three times greater than its potential downside. He’s added to that an interest in compounders, stocks with the prospect of exceedingly consistent if unremarkable growth over time. Similarly, they continue to invest in mid-cap stocks, which are more liquid than small caps but respond to many of the same forces. Indeed, the correlation between the Vanguard Small Cap (NAESX) and Mid Cap (VIMSX) index funds soared after the late 1990s and is currently .96. At the same time, the number of securities in some asset classes has skyrocketed. In 2000, there was $330 billion in high-yield bonds; today that’s grown to $1.5 trillion. In an economic downturn, those securities can be very attractively priced very quickly.

2. His analytic and management resources have grown. For his first 15 years, Mr. Romick basically managed the fund alone. In recent years, as some of the long-time partners came toward the ends of their careers, FPA “reinvested in people in a very big way which has given me a very large, high capability team.” That culminated in the June 2013 appointment of two co-managers, Mark Landecker and Brian Selmo. Mr. Landecker was previously a portfolio Manager at Kinney Asset Management in Chicago and Arrow Investments. Mr. Selmo founded and managed portfolios for Eagle Lake Capital, LLC, and was an analyst at Third Avenue and Rothschild, Inc. They’re supported by six, soon to be seven analysts, a group that he calls “a tremendously strong team.”

3. Managing a closed fund is not as straightforward as it might appear. Funds are in a constant state of redemption, even if it’s not net Investors regularly want some of their money back to meet life’s other needs or to pursue other opportunities. When a fund is successful and open to new investors, those redemptions can be met – in whole or in large part – from new cash coming in. When a fund is closed, redemptions are met either from a fund’s cash reserves (or, more rarely, a secured line of credit) or from selective liquidation of securities in the portfolio. In bad times, the latter is almost always needed and plays havoc with both tax efficiency and portfolio positioning.

So, on whole, he argues that Crescent is quite manageable at its current size. While many fund managers have chosen to partially close their funds to manage inflows, Mr. Romick’s strategy is simply not to market it and allow any growth to be organic. That is, if investors show up, then fine, they show up. FPA has only two full-time marketers on payroll supporting six open-end mutual funds. While Romick speaks a lot to existing shareholders, his main outreach to potential shareholders is limited to stuff like speaking at the Morningstar conference.

While he agreed that Crescent was holding a lot of cash, reflecting a dearth of compelling investment opportunities, he’s willing to take in more money and let the fund grow. In explaining this rationale, he reflected on the maxim, “Winter is coming,” a favorite line from his daughter’s favorite television show. “The problem,” he said, “is that they never tell you when winter is coming. Just that it is. That’s the way I feel about the bond market today.” He made a point that resonated with Edward Studzinski’s repeated warnings over the past year: liquidity has been drained from the corporate bond market, making it incredibly fragile in the face of a panic. In 2007, for example, the market-makers had almost $300 billion in cash to oil the workings of the bond market; today, thanks to Dodd-Frank, that’s dwindled to less than $30 billion even as the high-yield and distressed securities markets – the trades that would most require the intervention of the market-makers – have ballooned.  Much more market, much less grease; that’s a bad combination.

On the question of dodging responsibility, Mr. Romick’s response is simple. “We didn’t try to duck. We just wrote a paragraph that didn’t effectively communicate our meaning.” They wrote:

At first glance, it appears that we’ve declined as much as the market — down 11.71% since May 2015’s market peak against the S&P 500’s 11.30% decline — but that’s looking at the market only through the lens of the S&P 500. However, roughly half of our equity holdings (totaling almost a third of the Fund’s equity exposure) are not included in the S&P 500 index. Our quest for value has increasingly taken us overseas and our portfolio is more global than it has been in the past. We therefore consider the MSCI ACWI a pertinent alternative benchmark.

My observation was that you didn’t “appear to decline” as much as the stock market; you in actual fact did decline by that much, and a bit more. Mr. Romick’s first reflection was to suggest substituting “additional” for “alternative” benchmark. As the conversation unfolded, he and Mr. Leggio seemed to move toward imagining a more substantial rewrite that better caught their meaning. I might suggest:

We declined as much as the S&P 500 – down 11.71% from the May 2015 market peak to year’s end, compared to the S&P’s 11.30% decline. That might seem especially surprising given our high cash levels which should buffer returns. One factor that especially weighed against us in the short term is the fund’s significant exposure to international securities. Those markets had suffered substantially; from the May market peak, the S&P500 dropped 11.3% but international stocks (measured by the Vanguard FTSE All-World ex-US Index Fund) declined 23.5%. We are continuing to find interesting opportunities overseas and may add the global MSCI ACWI index as an additional benchmark to help you judge our performance.

So where does that leave us? Three things seem indisputable:

1. Crescent is still a large fund. As I write this (3/10/16), Morningstar reports that Crescent has $16.6 billion in assets, well down from its $20.5 billion 2015 peak. A year ago it was larger and still growing. Now, it’s both smaller and FPA expects “modest outflows” in the year ahead. This still makes it one of the hundred largest actively managed funds, the ninth largest “moderate allocation” fund (Morningstar) and the third-largest “flexible portfolio” fund (Lipper). The larger funds tend to be multi-manager beasts from huge complexes such as American Funds, BlackRock, Fidelity, Price and Vanguard.

   On the upside, its equity positions have still managed to beat the S&P 500 in five of the past seven calendar years.

2. Crescent is led by a very talented manager. His recognition as Morningstar’s 2013 Asset Allocation Fund Manager of the Year is one of those “scratch the surface” sorts of statements. He’s beaten his Morningstar peers in eight of the past 10 years; the fund leads 99% of its peers over the past 15 years. Morningstar describes him as “one of the most accomplished” managers in the field and he routinely ends up on lists of stars, masters and gurus. He’s managed Crescent for just under a quarter century which creates a well-documented record of independence and success. While we have no independent record for his co-managers, we also have no reason to doubt their ability.

3. Crescent is not the fund it once was. It’s no longer a small fund driven by one guy’s ability to find and exploit opportunities in small and mid-cap stocks or other small issues. In the course of reflecting on the general failure of flexible funds, a rule to which Crescent is the exception, John Rekenthaler offered a graphic representation of the fund’s evolution over the past decade:

   The size of the dot reflects the size of the fund. The position of the dot reflects the positioning of the stock portion of the portfolio. Tiny dot with the black circle was Crescent a decade ago; big dot with the black circle is today. Currently, 82% of the fund’s stocks are characterized by Morningstar as “large” or “giant,” with more giants than merely large caps. The average market cap is just north of $50 billion. According to Mr. Romick, these securities are more reflective of the opportunity set based on valuations, than a byproduct of the Fund’s size.

   The unanswered question is whether the new Crescent remains a peer of the old Crescent. Over the past 15 years, Crescent has beaten 99% of its peers and it’s beaten them by a huge margin.

I don’t think the fund will be capable of reprising that dominance; conditions are too different with both the fund and the market. The question, I suppose, is whether that’s a fair standard? Likely not.

The better question is, can the fund consistently and honorably deliver on its promise to its investors; that is, to provide equity-like returns with less risk over reasonable time periods? Given that the management team is deeper, the investment process is unimpaired and its size is has become more modest, I think the answer is “yes.” Even if it can’t be “the old Crescent,” we can have some fair confidence that it’s going to be “the very good new Crescent.”

Share Classes

Last month, David Offered Without Comment: Your American Funds Share Class Options. The simple table showing 18 share classes offered for one of AF’s fixed income funds generated considerable comment via Twitter and other media, including good discussion on the MFO Discussion Board.

We first called attention to excessive share classes in June 2014 with How Good Is Your Fund Family?  (A partial update was May 2015.) American Funds topped the list then and it remains on top today … by far. It averages more than 13 share classes per unique fund offering.

The following table summarizes share class stats for the largest 20 fund management companies by assets under management (AUM) … through February 2016, excluding money market and funds less than 3 months old.

At the end of the day, share classes represent inequitable treatment of shareholders for investing in the same fund. Typically, different share classes reflect different expense ratios depending on initial investment amount, load or transaction fee, or association of some form, like certain 401K plans. Here’s a link to AF’s web page explaining Share Class Pricing Details. PIMCO’s site puts share class distinction front and center, as seen in its Products/Share Class navigator below, a bit like levels of airline frequent flyer programs:

We’ve recently added share class info to MFO Premium’s Risk Profile page. Here’s an example for Dan Ivascyn’s popular Income Fund (click on image to enlarge):

In addition to the various differences in 12b-1 fee, expense ratio (ER), maximum front load, and initial purchase amount, notice the difference in dividend yield. The higher ER of the no-load Class C shares, for example, comes with an attendant reduction in yield. And, another example, from AF, its balanced fund:

Even Vanguard, known for low fees and equitable share holder treatment, provides even lower fees to its larger investors, via so-called Admiral Shares, and institutional customers. Of course, the basic fees are so low at Vanguard that the “discount” may be viewed more as a gesture.

The one fund company in the top 20 that charges same expenses to all its investors, regardless of investment amount or association? Dodge & Cox Funds.

We will update the MFO Fund House Score Card in next month’s commentary, and it will be updated monthly on the MFO Premium site.

Shake Your Money Market

By Leigh Walzer

Reports of the death of the money market fund (“MMF”) are greatly exaggerated. Seven years of financial repression and 7-day yields you can only spot under a microscope have made surprisingly little dent in the popularity of MMF’s. According to data from the Investment Company Institute, MMF flows have been flat the past few years. The share of corporate short term assets deposited in MMFs has remained steady.

However, new regulations will be implemented this October, forcing MMFs holding anything other than government instruments to adopt a floating Net Asset Value. These restrictions will also allow fund managers to put up gates during periods of heavy outflows.

MMFs were foundational to the success of firms like Fidelity, but today they appear to be marginally profitable for most sponsors. Of note, Fidelity is taking advantage of the regulatory change to move client assets from less remunerative municipal MMFs to government money market funds carrying higher fees (management fees net of waived amounts.)

While MMFs offer liquidity and convenience, the looming changes may give investors and advisors an impetus to redeploy their assets. In a choppy market, are there safe places to park cash?  A popular strategy over the past year has been high-dividend / low-volatility funds. We discussed this in March edition of MFO. This strategy has been in vogue recently but with a beta of 0.7 it still has significant exposure to market corrections.

Short Duration Funds:  Investors who wish to pocket some extra yield with a lower risk profile have a number of mutual fund and ETF options. This month we highlight fixed income portfolios with durations of 4.3 years or under.

We count roughly 300 funds with short or ultraShort Duration from approximately 125 managers. Combined assets exceed 500 billion dollars.  Approximately one quarter of those are tax-exempt.  For investors willing to risk a little more duration, illiquidity, credit exposure, or global exposure there are roughly 1500 funds monitored by Trapezoid.

Duration is a measure of the effective average life of the portfolio. Estimates are computed by managers and reported either on Morningstar.com or on the manager’s website. There is some discretion in measuring duration, especially for instruments subject to prepayment.  While duration is a useful way to segment the universe, it is not the only factor which determines a fund’s volatility.

Reallocating from a MMF to a Short Duration fund entails cost. Expenses average 49 basis points for Short Term funds compared with 13 basis points for the average MMF.  Returns usually justify those added costs. But how should investors weigh the added risk. How should investors distinguish among strategies and track records? How helpful is diversification?

To answer these questions, we applied two computer models, one to measure skill and another to select an optimal portfolio.

We have discussed in these pages Trapezoid’s Orthogonal Attribution Engine which measures skill of actively managed equity portfolio managers. MFO readers can learn more and register for a demo at www.fundattribution.com. Our fixed income attribution model is a streamlined adaptation of that model and has some important differences. Among them, the model does not incorporate the forward looking probabilistic analysis of our equity model. Readers who want to learn more are invited to visit our methodology page. The fixed income model is relatively new and will evolve over time.

We narrowed the universe of 1500 funds to exclude not only unskilled managers but fund classes with AUM too small, duration too long, tenure too short (<3 years), or expenses too great (skill had to exceed expenses, adjusted for loads, by roughly 1%). We generally assumed investors could meet institutional thresholds and are not tax sensitive. For a variety of reasons, our model portfolio might not be right for every investor and should not be construed as investment advice.

DoubleLine Total Return Bond (DBLTX), MassMutual Premier High Yield Fund (MPHZX), and PIMCO Mortgage Opportunities Fund (PMZIX) all receive full marks from Morningstar and Lipper (except in the area of tax efficiency.)  Diversifying among credit classes and durations is a benefit – but the model suggests these three funds are all you need.

Honorable Mentions: The model finds Guggenheim Total Return Bond Fund (GIBIX) is a good substitute for DBLTX and Shenkman Short Duration High Income Fund (SCFIX) is a serviceable substitute for MPHZX. We ran some permutations in which other funds received allocations. These included: Victory INCORE Fund for Income (VFFIX), Nuveen Limited term Municipal Bond (FLTRX), First Trust Short Duration High Income Fund (FDHIX), Guggenheim Floating Rate Strategies (GIFIX), and Eaton Vance High Income Opportunities Fund (EIHIX). 

The Trapezoid Model Portfolio generated positive returns over a 12 and 36-month time frame. (Our data runs through January 2016.) The PIMCO Mortgage fund wasn’t around 5 years ago, but it looks like the five-year yield would have been close to 6%.

The portfolio has an expense ratio of 53 basis points. Our algorithms reflect Trapezoid’s skeptical attitude to high cost managers.  There are alternative funds in the same asset classes with expense ratios of 25 basis points of better. But superb performance more than justifies the added costs. Our analysis suggests the rationale for passive managers like Vanguard is much weaker in this space than in equities. However, investors in the retail classes may see higher expenses and loads which could change the analysis.

No Return Without Risk: How much risk are we taking to get this extra return? The duration of this portfolio is just under 3.5 years.  There is some corporate credit risk: MPHZX sustained a loss in the twelve months ending January. It is mostly invested in BB and B rated corporate bonds. To do well the fund needs to keep credit loss under 3%/yr.  Although energy exposure is light, we see dicey credits including Valeant, Citgo, and second lien term loans. The market rarely gives away big yields without attaching strings.

The duration of this portfolio hurt returns over the past year. What advice can we give to investors unable to take 3.5 years of duration risk? We haven’t yet run a model but we have a few suggestions.

1. For investors who can tolerate corporate credit risk, Guggenheim Floating Rate Strategies (GIFIX) did very well over the past 5 years and weathered last year with only a slight loss.
2. A former fixed income portfolio manager who now advises clients at Merrill Lynch champions Pioneer Short Term Income Fund (PSHYX). Five-year net return is only 2.2%, but the fund has a duration of only 0.7 years and steers clear of corporate credit risk.
3. A broker at Fidelity suggested Touchstone UltraShort Duration Fixed Income Fund (TSDOX) which has reasonable fees and no load.

Short Duration funds took a hit during the subprime crisis.  At the trough bond fund indices were down 7 to 10% from peak, depending on duration. Funds with concentrations in corporate credit and mortgage paper were down harder while funds like VFFIX which stuck to government or municipal bonds held up best. MassMutual High Yield was around during that period and fell 21% (before recovering over the next 9 months.) The other two funds were not yet incepted; judging from comparable funds the price decline during the crisis was in the mid-single digits. Our model portfolio is set up to earn 2.5% to 3% when rates and credit losses are stable. Considering that their alternative is to earn nothing, investors deploying cash in Short Duration funds appear well compensated, even weighing the risk of a once-in-a-generation 10% drawdown.

Bottom Line: The impact of new money market fund regulations is not clear. Investors with big cash holdings have good alternatives.  Expenses matter but there is a strong rationale for selecting active managers with good records, even when costs are above average.  Investors get paid to take risk but must understand their exposure and downside. A moderate amount of diversification among asset classes seems to be beneficial. Our model portfolio is a good starting point but should be tailored to the needs of particular investors.

The Alt Perspective: Commentary and news from DailyAlts.

For anyone who enjoys roller coasters, Q1 2016 was for you. While it seemed a bit wild at times, it was really just a trip down to the bottom of a trough, and a consistent tick back up to where we started. Thanks to a coordinated plan of attack on part of global sovereign bankers, and reiterated by new policy actions from the European Central Bank, the markets shrugged off early losses in the year with a very solid recovery in March. As they say, don’t fight the Fed. And in this case, don’t fight the globally coordinated Fed.

Let’s first take a look at how alternative funds faired in the bull month of March.

Performance

The returns for the month of March were positive, except for managed futures and bear market funds. Commodities led the way over the month, while bear market funds got hammered with the strong rally in equities. Managed futures struggled to add value as markets tended to be one directional in March.

Commodities Broad Basket        4.32%

Long/Short Equity  2.53%

Multicurrency         2.52%

Nontraditional Bond         1.65%

Multialternative      1.27%

Market Neutral       0.46%

Managed Futures    -2.79%

Bear Market  -10.86%

Cleary, equity based alternative strategies, such as long/short equity, struggled to keep up with the strong rally in March, however, nontraditional bond funds performed well relative to their long-only counterpart (Intermediate Term Bonds). Below are a few traditional mutual fund categories:

Large Blend (US Equity)    6.37%

Foreign Large Blend         6.86%

Intermediate Term Bond  1.30%

Moderate Allocation        4.72%

Data Source: Morningstar

Research

Two interesting pieces of research emerged over the month. The first is from an investment advisor in La Jolla, California, called AlphaCore Capital. In a piece written by their director of research, they highlight the importance of research and due diligence when choosing alternative investment managers (or funds) – not because the strategies are more complex (which is also a reason), but because the range of returns for funds in each category is so wide. This is called “dispersion,” and it is a result of the investment strategies and the resulting returns of funds in the same category being so different. Understanding these differences is where the expertise is needed.

The second piece of research comes from Goldman Sachs. In their new research report, they note that liquid alternatives outperformed the pricier hedge funds across all five of the major categories of funds they track. While the comparative results in some categories were close, the two categories that stood out with significant differences were Relative Value and Event Driven. In both cases, alternative mutual funds outperformed their hedge fund counterparts by a wide margin.

Fund Liquidations

Nineteen alternative mutual funds were liquidated over the quarter, with seven of those in March. Most notably, Aberdeen (the new owner of the fund-of-hedge fund firm Arden Asset Management) closed down the larger of the two Arden multi-alternative funds, the Arden Alternative Strategies Fund (ARDNX). The fund had reached a peak of $1.2 billion in assets back in November 2014, but lackluster performance in 2015 put the fund on the chopping block.

In addition to the Arden fund, Gottex Fund Management (another institutional fund-of-hedge funds, as is Arden) liquidated their only alternative mutual fund, the Gottex Endowment Strategy Fund (GTEAX), after losing nearly 6% in 2015. Both of these closures create concerns about the staying power and commitment by institutional alternative asset management firms. And both come on the back of other similar firms, such as Collins Capital and Whitebox (the latter being a hedge fund manager), who both liquidated funds in February.

Where to from here?

Challenging performance periods always serve to clean out the underperformers. In many ways, Q1 served as a housecleaning quarter whereby funds that wrapped up 2015 with few assets and/or below average (or well-below average) performance took the opportunity to shut things down. A little housecleaning is always good. Looking forward, there is significant opportunity for managers with strong track records, compelling diversification, and consistent management teams.

Alternative investment strategies, and alternative asset classes, both have a role to play in a well-diversified portfolio. That fact hasn’t changed, and as more financial advisors and individual investors grow accustom to how these strategies and asset classes behave, the greater the uptake will be in their portfolios.

Be well, stay diversified and do your due diligence.

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. 

AQR Equity Market Neutral (QMNIX) and AQR Long-Short Equity (QLEIX): our colleague Sam Lee, principal of Severian Asset Management, offers a close assessment of two institutional AQR funds. The bottom line is: “AQR does long-short investing right. Check these out.”

Intrepid Endurance (ICMAX): at 70% cash, what’s to like? Well, the highest Sharpe ratio of any small cap fund – domestic, global, or international – of the course of the full market cycle. Also the lower Ulcer Index. And peer-beating returns. Heck, what’s not to like?

Otter Creek Long/Short Opportunity (OTCRX): we’d describe the young Otter Creek fund as “pure alpha” – it has outperformed its peers by 11% a year since inception – except that it’s also done it was lower volatility and a near-zero correlation to the market. We’ll leave it to you to sort out.

Funds in Registration

Whether it’s the time of year or the sense of an industry-wide death spiral, the number of new funds in registration has been steadily declining. This month saw either six or 20 filings, depending on how you could a weird series of options funds from a group called Vest Financial. Two funds start out:

Moerus Worldwide Value Fund marks the return of Amit Wadhwaney, who managed Third Avenue International Value (TAVIX) from 2001-2013. Morningstar described Mr. Wadhwaney as “skilled and thoughtful.” His fund was distinguished by somewhat better than average returns with “markedly lower” volatility and strong down-market performance.  The fund’s performance since his departure has been disastrous.

Sit ESG Growth Fund which targets financially sound firms with good ESG records. The success of the other funds in the Sit family suggests that values-driven investors might find it worth investigating.

Manager Changes

We’ve track down rather more than 70 manager changes this month plus, of course, the one MANAGER CHANGE! Which is to say, Mr. Goldfarb’s departure from Sequoia.

Updates

Congratulations to the good folks at Seafarer. Seafarer Overseas Growth & Income (SFGIX), topped $1.1 billion in assets in March, a singular achievement. In just over four years of operation, the fund has returned 24.8% while its average peer has lost 9.75%. Seafarer seems to have SEC clearance to launch their Seafarer Overseas Value fund, but has not yet done so.

Briefly Noted . . .

GlobalX and Janus are locked in a struggle to see who can release the greatest number of pointless ETFs in a month. The Global X entries are Health & Wellness Thematic ETF (BFIT), Longevity Thematic ETF (LNGR) and Millennials Thematic ETF (MILN). The latter focuses, like a laser, on those uniquely Millennial passions: “social and entertainment, clothing and apparel, travel and mobility, food/restaurants and consumer staples, financial services and investments, housing and home goods, education and employment, and health and fitness.” Janus weighed in with The Health and Fitness ETF, The Long Term Care ETF, The Obesity ETF and The Organics ETF. None have symbols but all will be available on May 31.

Upon further consideration of tax and other stuff, the Board of Trustees of Midas Series Trust has determined not to proceed with the merger of Midas Magic (MISEX) into the Midas Fund (MIDSX). This was an almost incalculably stupid plan from the get-go. MISEX is a diversified domestic equity fund whose top holdings include Berkshire-Hathaway, Google and Johnson & Johnson. Midas invests in gold miners. Over the last decade, Magic shares are up 74% while Midas lost 70%. And no, that’s not just because gold was down over the period; from 2006-2015, the spot price of gold rose from around $560 to about $1060. Here would be your investment options: Midas in blue, the average gold fund in, well, gold or Magic in yellow.

It’s easy to see why liquidating both funds makes sense. They’ve got $12-14 million in assets, weak to horrible long-term records and expenses pushing 4.0%. It’s hard to see how the Trustees managed to declare that “it’s in the best interest of the shareholders” to place them in Midas.

Effective March 31, 2016, the Templeton Foreign (TEMFX), Global Opportunities (TEGOZ) and World (TEMWX) funds gained the flexibility to “to hedge (protect) against currency risks using certain derivative instruments including currency and cross currency forwards and currency futures contracts.”

Tobin Smith, a financial tout for Fox News from 2000-2013, was nailed by the SEC for nearly $258,000 on charges that he fraudulently promoted a penny stock, IceWEB, to investors. Apparently the firm’s CEO wanted to pump its trading volume and price and, for a price, Mr. Smith and his firm was happy to oblige. The IceWEB scam occurred in 2012. He was terminated in 2013 over the on-air promotion of yet another stock.

SMALL WINS FOR INVESTORS

As of April 11, 2016, AllianzGI Ultra Micro Cap Fund (GUCAX) will reopen.

Effective April 1, 2016, the Boston Trust Small Cap Fund (BOSOX) and the Walden Small Cap Innovations Fund (WASOX) will no longer be closed to new investors.

The Gotham Index Plus Fund (GINDX) is reducing their administrative fee by 2 basis points, from 1.17% to 1.15%. Woo hoo! Including the “acquired fund fees and expenses,” the fund continues to cost institutional investors 3.28% per year. The reduction came on the $15 million fund’s first anniversary. The fund posted returns in the top 2% of its large-core peer group.

Invesco International Growth Fund (AIIEX) reopened to all investors on March 18, 2016. Class B shares are closed and will not re-open.

J.P. Morgan U.S. Large Cap Core Plus Fund (JLCAX) has reopened to new investors

Effective April 1, 2016, Kaizen Advisory, LLC (the “Advisor”) has lowered its annual advisory fee on Kaizen Hedged Premium Spreads Fund (KZSAX) from 1.45% to 1.10% and agreed to reduce the limit on total annual fund operating expenses by 0.35% to 1.75% for “A” shares.

CLOSINGS (and related inconveniences)

Effective April 30, 2016, the Diamond Hill Small-Mid Cap Fund (DHSCX) will close to most new investors. 

On the general topic of “related inconveniences,” several fund advisors have decided that they need more of your money. The shareholders of LoCorr Managed Futures Strategy Fund (LFMAX) agreed, and voted to raise their fees management fees to 1.85%. To be clear: that’s not the fund’s expense ratio, that’s just the part of the fee that goes to pay the managers for their services. Similarly, shareholders at Monte Chesapeake Macro Strategies Fund (MHBAX) have voted to bump their managers’ comp to 1.70% of assets. In each case, the explanation is that the advisor needs the more to hire more sub-advisers.

OLD WINE, NEW BOTTLES

On May 2, American Century Strategic Inflation Opportunities Fund (ADSIX) will be renamed the Multi-Asset Real Return Fund. The plan is to invest primarily in TIPs with “a portion” in commodities-related securities and REITs.

As of April 1, 2016, Cavanal Hill Balanced Fund became Cavanal Hill Active Core Fund (APBAX). The big accompanying change: The percentage of equity securities that the Fund normally invest in shall change from “between 40% and 75%” to “between 40% and 75%.” If you’re thinking to yourself, “but Dave, those are identical ranges,” I concur.

Effective April 18, 2016, Columbia Small Cap Core (LSMAX) will change its name to Columbia Disciplined Small Core Fund.

Liquidation of JPMorgan Asia Pacific Fund (JAPFX). The Board of Trustees of the JPMorgan Asia Pacific Fund has approved the liquidation and dissolution of the fund on or about April 29, 2016. 

Matthews Asia Science and Technology (MATFX) has been rechristened as Matthews Asia Innovators Fund. They formerly were constrained to invest at least 80% of their assets in firms that “derive more than 50% of their revenues from the sale of products or services in science- and technology-related industries and services.” That threshold now drops to 25%.

Pear Tree PanAgora Dynamic Emerging Markets Fund has been renamed Pear Tree PanAgora Emerging Markets Fund (QFFOX). At the same time, expenses have been bumped up from 1.37% (per Morningstar) to 1.66% (in the amendment on file). Why, you ask? The old version of the fund “allocate[d] its assets between two proprietary strategies: an alpha modeling strategy and a risk-parity strategy.” The new version relies on “two proprietary risk-parity sub-strategies: an alternative beta risk-parity sub-strategy and a “smart beta” risk-parity sub-strategy.” So there’s your answer: beta costs more than alpha.

The PENN Capital High Yield Fund has changed its name to the PENN Capital Opportunistic High Yield Fund (PHYNX).

The managers of the Rainier High Yield Fund (RIMYX), Matthew Kennedy and James Hentges, have announced their intention to resign from Rainier Investment Management and join Angel Oak Capital Advisors. Subject to shareholder approval (baaaaaa!), the fund will follow them and become Angel Oak High Yield. Shareholders are slated to vote in mid-April.

Effective on or about May 1, 2016, the name of each Fund set forth below will be changed to correspond with the following table:

Current Fund Name	Fund Name Effective May 1, 2016
Salient Risk Parity Fund	Salient Adaptive Growth Fund
Salient MLP & Energy Infrastructure Fund II	Salient MLP & Energy Infrastructure Fund
Salient Broadmark Tactical Plus Fund	Salient Tactical Plus Fund

The Board of Trustees of Franklin Templeton Global Trust recently approved a proposal to reposition the Templeton Hard Currency Fund (ICPHX) as a global currency fund named Templeton Global Currency Fund. That will involve changing the investment goal of the fund and modifying the fund’s principal investment strategies.

Seeing not advantage in value, Voya is making the fourth name change in two years to one of its funds. Effective May 1, we’ll be introduced to Voya Global Equity Fund (NAWGX) which has been Voya Global Value Advantage since May 23, 2014. For three weeks it has been called Voya International Value Equity (May 1 – 23, 2014). Prior to that, it was just International Value Equity. The prospectus will remove “value investing” as a risk factor.

Thirty days later, Voya Mid Cap Value Advantage Fund (AIMAX) becomes Voya Mid Cap Research Enhanced Index Fund. The expense ratio does not change as it moves from “active” to “enhanced index,” though both the strategy and management do.

OFF TO THE DUSTBIN OF HISTORY

Breithorn Long/Short Fund (BRHAX) has closed and will liquidate on April 8, 2016.

Crow Point Defined Risk Global Equity Income Fund (CGHAX) has closed and will liquidate on April 25, 2016.

The Board of Trustees of Dreyfus Opportunity Funds has approved the liquidation of Dreyfus Strategic Beta U.S. Equity Fund (DOUAX), effective on or about April 15, 2016

DoubleLine just liquidated the last of three equity funds launched in 2013: DoubleLine Equities Growth Fund (DDEGX), which put most of its puddle of assets in high-growth mid- and large cap stocks. Based on its performance chart, you could summarize its history as: “things went from bad to worse.”

Dunham Alternative Income Fund (DAALX) will be exterminated (!) on April 25, 2016. (See, ‘cause the ticker reads like “Daleks” and the Daleks’ catchphrase was not “Liquidate!”)

On August 26, 2016, Franklin Flex Cap Growth Fund (FKCGX) will be devoured. Franklin Growth Opportunities Fund (FGRAX) will burp, but look appropriately mournful for its vanished sibling.

Frost Natural Resources Fund (FNATX) liquidated on March 31, 2016. Old story: seemed like a good idea when oil was $140/barrel, not so much at $40. In consequence, the fund declined 36% from inception to close.

Hodges Equity Income Fund (HDPEX) merged into the Hodges Blue Chip Equity Income Fund (HDPBX) on March 31, 2016. At $13 million each, neither is economically viable, really. $26 million will be tough but the fund’s record is okay, so we’ll be hopeful for them.

The Board of Trustees of LKCM Funds, upon the recommendation of Luther King Capital Management Corporation, the investment adviser to each fund, has approved a Plan of Reorganization and Dissolution pursuant to which the LKCM Aquinas Small Cap Fund (AQBLX) and the LKCM Aquinas Growth Fund (AQEGX), would be reorganized into the LKCM Aquinas Value Fund (AQEIX).

The Board of Trustees of the MassMutual Premier Funds has approved a Plan of Liquidation and Termination pursuant to which it is expected that the MassMutual Barings Dynamic Allocation Fund (MLBAX) will be dissolved. Effective on or about June 29, 2016 (the “Termination Date”), shareholders of the various classes of shares of the fund will receive proceeds in proportion to the number of shares of such class held by each of them on the Termination Date.

Oberweis Asia Opportunities Fund (OBAOX), a series of The Oberweis Funds (the “Trust”), scheduled for April 22, 2016, you will be asked to vote upon an important change affecting your fund. The purpose of the special meeting is to allow you to vote on a reorganization of your fund into Oberweis China Opportunities Fund (OBCHX).

On March 21, the Board of RX Traditional Allocation Fund (FMSQX) decided to close and liquidate it. Ten days later it was gone.

Satuit Capital U.S. Small Cap Fund (SATSX) will be liquidating its portfolio, winding up its affairs, and will distribute its assets to fund shareholders as soon as is practicable, but in no event later than April 15, 2016.

SignalPoint Global Alpha Fund (SPGAX) will liquidate on April 29, 2016.

Toroso Newfound Tactical Allocation Fund was liquidated on March 30, 2016.

On March 17, 2016, the Virtus Board of Trustees voted to liquidate the Virtus Alternative Income Solution (VAIAX), Virtus Alternative Inflation Solution (VSAIX), and Virtus Alternative Total Solution (VATAX) funds. They’ll liquidate around April 29, 2016.

In Closing . . .

May’s a big month for us as we celebrate our fifth anniversary. When we launched, Chip reported that the average life expectancy for a site like ours is … oh, six weeks. Even I’m a bit stunned as we begin a sixth year.

It goes without saying that you make it possible but, heck, I thought I’d say it anyway. Thanks and thanks and thanks again to you all!

Each month about 24,000 people read the Observer but about 6,000 of them are reading it for the first time. For their benefit, I need to repeat the explanation for the “hey, if you’re not charging and there aren’t any ads, how do you stay in business?” question.

Here’s the answer: good question! There are two parts to the answer. First, the Observer reflects the passions of a bunch of folks who are working on your behalf because they want to help, not because they’re looking for money.  And so all of us work for somewhere between nothing (Brian, Charles, Ed, Sam, Leigh – bless you all!) and next-to-nothing (Chip and me). That’s not sustainable in the long term but, for now, it’s what we got and it works. So, part one: low overhead.

Second, we’re voluntarily supported by our readers. Some folks make tax-deductible contributions now and then (Thanks, Gary, Edward, and Mr. West!), some contribute monthly through an automatic PayPal setup (waves to Deb and Greg!) and many more use of Amazon link. The Amazon story is simple: Amazon rebates to us and amount equal to about 7% of the value of any purchase you make using our Amazon Associates link. It’s invisible, seamless and costs you nothing. The easiest way is set it and forget it: bookmark our Amazon link or copy it and paste it into your web browser of choice as a homepage. After that, it’s all automatic. A few hundred readers used our link in March; if we could get everybody who reads us to use the system, it would make a dramatic difference.

In May we’re also hoping to provide new profiles of two old friends: Aston River Road Independent Value and Matthews Asian Growth & Income. And, with luck, we’ll have a couple other happy birthday surprises to share.

Until then, keep an eye out in case you spot a huge dome wandering by. If so, let me know since we seem to be missing one!

By David Snowball

Dear friends,

It’s spring! Sort of. Despite the steady, light snow falling outside my window, March 1 is the beginning of “meteorological spring” and I’m indisputably in the middle of Augustana’s Spring Break. (It always looked better on MTV.) Spring training, both for major leaguers and my son’s high school team, has begun. There are stirrings in my garden and a couple newly-arrived catalogs (yes, I still get real mail) are encouraging horticultural fantasies: a swath of pollinator-friendly native plants taking over the southwest corner of the yard, a new home for my towering wall of sunflowers, some experiments with carrots, replacing more of the lawn with a rain garden to reduce run-off, regrowing a full head of hair … anything’s imaginable and everything’s possible, at least until I have to figure out how to pull it off.

Sadly, as Rudyard Kipling observed, “gardens are not made by sitting in the shade.”

For one more month, at least, I focus on tidying up my financial garden. We start this month’s issue with three of the most important kind of story: ones that actually affect me.

Artisan pulls the plug

Artisan has announced the liquidation of Artisan Small Cap Value (ARTVX), my oldest holding. My first fund, purchased when I was young and dumb, was AIM Constellation, then a very good mid-cap growth fund that carried a 5.5% load. After a bit, I learned that paying sales loads without any compensating benefit was stupid, so I stopped. I sold my shares and, shortly before it closed, invested the proceeds in Artisan Small Cap (ARTSX). Shortly after Artisan launched Small Cap Value in 1997, I moved my investment over from Small Cap. The $367 million fund, down from a peak of $3 billion in 2011, will be merged into Artisan Mid Cap Value (ARTQX) in May, 2016.

After a couple withdrawals and almost 19 years of paying taxes on the account, I’m disconcerted to report that I’ll be able to report a 30% tax loss on my 2016 taxes.

What happened? The managers’ discipline (and the dictates of marketing to advisors who want to execute their own asset allocation plans) does not encompass holding significant cash. And so, despite the fact that “We’ve complained for a long time now that too much of the market is fully- or fairly valued,” they stayed fully-invested. Their discipline also pushed them toward overweighting the best-valued stocks they could find and those turned out to be in two of the market’s worst areas: energy and industrials, that latter of which “have backdoor exposure to energy.” They eventually overweighted those areas by more than 2:1. That’s, at best, a very partial explanation for the fact that the fund trailed 90% or more of its small-value peers in five of the past six years, including years with high oil prices.

The folks at Artisan position this as a simple economic decision: “a determination was made that the strategy/fund was no longer commercially viable… Given our past few years of underperformance, we have seen outflows (and passive has been an asset flow winner here). We are also hearing that fewer folks plan to use dedicated small-cap value allocations going forward.” The management team “drove the decision” and they “still believe in the asset class.”

This is the first fund liquidation in Artisan’s history.

The team manages two other funds, Mid Cap Value (ARTQX) and the large-cap oriented Value (ARTLX). Over the full market cycle, ARTQX modestly leads its peer group in performance (40 bps/year) with subdued volatility. ARTLX trails its Lipper peers (80 bps/year) with somewhat higher volatility.

Bottom line

I prefer to maintain exposure to small value stocks, so I won’t wait around for the impending transition to the team’s mid-cap value fund. I’ll book my tax loss and move on.

The finalists for this slot in my portfolio are two cash-rich, low-vol funds: John Deysher’s Pinnacle Value Fund (PVFIX) and the team-managed Intrepid Endurance Fund (ICMAX, formerly Intrepid Small Cap). Both are run by absolute value investors. They have similar expense ratios, though Intrepid is five times Pinnacle’s size. Intrepid’s about two-thirds cash right now, Pinnacle about 50%. They are, by far, the two least volatile small cap funds around. Pinnacle’s market cap and turnover are both far lower.

We profiled Pinnacle one year ago. I think we’ll try to prepare a profile of Intrepid for our April issue and see if that helps decide things.

The tough question remaining

How long should you wait before you write off a manager or a fund? My normal rule is pretty straightforward: if I haven’t changed and they haven’t changed, then we’re not going to change. That is, if my portfolio needs remain the same, the management team remains intact and true to their discipline, then I’m not going to second-guess my due diligence. This may be the first time I’ve sold a fund in a decade. Leigh Walzer’s research on stumbling funds suggests that I should have sold in mid-2014 which would have spared me about a 10% loss assuming that I’d put it in a merely average SCV fund.

Romick stares reality in the face, and turns away

My single largest non-retirement holding is FPA Crescent (FPACX), which has always struck me as the quintessence of active management. While other managers were constrained to invest in a single asset class or in a single country, or to remain fully invested or unhedged, manager Steve Romick declared himself to be “the free-range chicken” of the investing world. He’d look for firms that offered compelling advantages, would analyze their capital structure and then invest in whatever instrument – common stock, warrants, senior debt – offered the most compelling opportunities. If nothing was compelling, he sat on cash.

That strategy performed wonderfully for years. Over the past decade the fund has led its Morningstar peer group by 1.12% annually though, by freakish coincidence, Morningstar also calculates that you lost 1.12% annually to taxes over the same period. Over the past three years, the fund has either been about average (using Morningstar’s “moderate allocation” peer group) or well-above average (using Lipper’s “flexible portfolio” one). In 2015, the fund lost money and finished in the bottom third of its Morningstar peer group.

Those two things do not bother me. Two others do. First, the fund has ballooned in size with no apparent effort at gatekeeping. In 2005, it performed gloriously but had under $1 billion in assets. In 2010, it performed solidly with $2.7 billion. It hit $10 billion in 2013 and $20 billion in 2015 and remains open today. While some funds have doubtless thrived in the face of huge, continual inflows, those are rare.

Second, Romick blinked. His recently released Annual Report offered the following announcement on page two:

At first glance, it appears that we’ve declined as much as the market — down 11.71% since May 2015’s market peak against the S&P 500’s 11.30% decline — but that’s looking at the market only through the lens of the S&P 500. However, roughly half of our equity holdings (totaling almost a third of the Fund’s equity exposure) are not included in the S&P 500 index. Our quest for value has increasingly taken us overseas and our portfolio is more global than it has been in the past. We therefore consider the MSCI ACWI a pertinent alternative benchmark.

What?

“We look pretty good compared to a global all-equity benchmark”?

Uhhh … the fund is 37% cash. Morningstar reports a net exposure (11% long minus 3% short) of only 8.5% to international stocks. The most recent report on FPA’s website suggests 16% but doesn’t separate long/short. If Morningstar is right, net exposure is way less global than either its Morningstar benchmark or Morningstar peer group.

Underperformance doesn’t bother me. Obfuscation does. The irony is that it bothers Mr. Romick as well, at least when it’s being practiced by others. In a 2012 letter criticizing the Fed, he explained what we ought to demand of our leaders and ourselves:

Blind faith has gotten us into trouble repeatedly throughout history. Just consider the rogue’s gallery of false idols, dictators, and charlatans we have followed, hoping for something different, something better. That misplaced conviction corrupts and destroys. Daily life does require we put our trust in others, but we should do so judiciously.

Nobody has all the answers. Genius fails. Experts goof. Rather than blind faith, we need our leaders to admit failure, learn from it, recalibrate, and move forward with something better… As the author Malcolm Gladwell so eloquently said, “Incompetence is the disease of idiots. Overconfidence is the mistake of experts…. Incompetence irritates me. Overconfidence terrifies me.”

FPA once ran funds in a couple of different styles, Mr. Romick’s and the other one. They’ve now purged themselves of their quality-growth team and have renamed and repurposed those funds. In repurposing Paramount, they raised the expense ratio, ostensibly to create parity with the Perennial fund. In a private exchange I asked why they didn’t simply lower Perennial’s e.r. rather than raising it and was assured that they really needed the extra cash for as-yet undisclosed enhancements.

I’ve lost faith.

Bottom line

I’m not sure whether FPA is now being driven by investment discipline, demands for ideological purity or a rising interest in gathering assets. Regardless, I’m going. I have long respected the folks at the Leuthold Group and we recently profiled their flagship Leuthold Core Investment Fund (LCORX). Leuthold has delivered on such promises more consistently, with more discipline, for a longer period than virtually any competitor.” They’re apt to be the home for the proceeds from an FPA sale plus closing two small accounts.

Morningstar doesn’t share my reservations and FPACX retains a “Gold” analyst rating from the firm.

The tough question remaining

How do we account for cultural change in assessing a firm? Firms never admit to their internal machinations, the story is always “a long heritage and a strict discipline, honored, preserved, extended!” They say it because they must and, often, because they believe it. From the outside, it’s about impossible to test those claims and people get downright offended when you even broach the subject. Some folks have managed beautifully; Mairs and Power come to mind. Some have been disasters, Third Avenue most recently. And others, such as Royce Funds, are just now trying to navigate it. Without access to contacts within the organization or with their peers, we only see shadows and flickers, “as through a glass, darkly.”

Hate it when that happens.

Andrew Foster, Sufi master

Sell your cleverness and buy bewilderment.
Cleverness is mere opinion, bewilderment intuition.
― Rumi, Masnavi I Ma’navi,ca. 1270

I like Andrew Foster, manager of Seafarer Overseas Growth & Income (SFGIX). I also respect him. The confluence of those two is rare.

In his essay “Self Reliance,” Emerson describes “foolish consistency” as “the hobgoblin of little minds.” The rough translation is the people don’t like to admit that they’re unsure, whether it’s about what to think or what to do, even to themselves. And so they come up with procedures, policies, explanations, Great Insights and Magic Rules and claim you can stop thinking worrying now. You’ll notice this in the classroom: young teachers are terrified at losing control or losing respect while really experienced ones are comfortable admitting that they simply don’t have nearly as many answers as they’ve got questions, suspicions or possibilities.

That came to mind in reading two of Mr. Foster’s recent pieces, his Fourth Quarter 2015 Portfolio Review and his Semi-Annual Report. Between the two, you get a sense of a guy who is really sharp but not under the illusion of his own omniscience.

The short version of investing in the emerging markets over the last couple years: things have been wildly volatile and mostly negative, China’s been a concern, Seafarer’s doing better than the great majority of its peers.

Most managers, whether they’re small minded or they think you are, would have said that in about three paragraph – emphasizing their own excellence in the latter – and hit “send.”

Mr. Foster approached things differently. His analysis was more nuanced, sharper, more self-effacing and more respectful of his readers’ intelligence than almost any of what I’ve read in the professional press. You should read it, but only if you have the time to think about what you’ve read because you’ll encounter more careful speculation than illusory certainty.

Why was the market rising at the start of the fourth quarter?

Between October 1 and November 4, the benchmark index rose 9.72%. There was no obvious reason for this gain.

Okay, so what explains Seafarer’s outperformance?

The Fund’s marginal outperformance was due to selected holdings in China, Japan, Indonesia and Turkey. Those holdings had no unifying theme or idea that could explain the basis for their performance during the quarter.

Perhaps it’s because you were defensively positioned on China?

Unfortunately, my notion of “defensive” valuations proved faulty.

Oh. Dja do any better on currencies?

My prediction [there] was terribly wrong.

Ah, I see. You’ve described Seafarer as a China-centric portfolio. What’s going on there?

I wish I knew with certainty. Unfortunately, the situation is sufficiently opaque that facts are scant, and thus I can only speculate as to the cause behind the A-share market’s sudden collapse.

Well, how about a guess then? Surely you’ll do better than the bobbleheads in the media.

Unfortunately, I can only speculate as to the actual cause of the decline, so my thoughts on the matter are frankly no better than the media’s. I have very few facts to substantiate my arguments; all I can do is look at the pattern of events that has unfolded, and speculate as to the causes. 

I’m getting desperate here, Andrew. Why not just fling a wild speculation or two at us?

I would suggest two possible scenarios that might have caused the sell-off:

1. The Renminbi’s weakness is not the direct cause of the decline, but it is a precursor for a growing liquidity shortage within the Chinese financial system. The currency’s persistent weakness may indicate that one or more banks, or perhaps some portion of the “shadow banking system,” may soon experience a liquidity crisis. This explanation would suggest the currency is signaling stressed liquidity within the financial system, to which stocks have reacted swiftly and punitively.
2. The current government is unstable. Over the past three years, the government has propagated a sweeping anti-corruption campaign that has sometimes terminated in controversial political purges. The government has also introduced bold economic reforms – reforms that I largely support – but that have undoubtedly alienated powerful vested interests. Meanwhile, the current president has sought to consolidate power in a manner not seen since Mao’s era. It might be that such dramatic actions have silently eroded support for the current government among powerful factions within the Communist party. If so, the weakness in the currency and the stock market might portend a deeper source of instability.

Either scenario might have been the root cause of the volatility we observed; it is also possible that both acted in tandem.

You get the idea, I think: rather more insight than ego, important arguments made in a clear and accessible style.

In terms of portfolio positioning, he’s finding better values in Latin America and Emerging Europe than in Asia, so the portfolio is the least Asia-centered in its history. Similarly, there are intriguing opportunities in larger firms than in smaller ones right now; he’s actually been surprised at his portfolio’s small- to mid-cap positioning, but that’s where the value has been.

Bottom line

Seafarer remains a core position in my non-retirement portfolio and I’ve been adding to it steadily. Valuations in the emerging markets are compelling, with stocks trading at P/E ratios of 5 or 6. I’m tempted to sell my holdings in Matthews Asia Growth & Income (MACSX) and roll them into Seafarer, mostly as an attempt to simplify, but the two really do seem to be driven by diverse forces.

For now, I’ll continue to invest in each and, mostly, ignore the noise.

The tough question remaining

If emerging markets are simultaneously our best and our worst investment option, what on earth do we do with them? There’s a near-universal agreement that they represent the cheapest stocks and most dynamic economies in the world. And yet, collectively, over the last decade EM equity funds have made 1.3% annually with a standard deviation of 23. Run away? Pretend that investing in Nestle is the same just because they sell a lot in emerging markets? Hedge, which is tough? Hybrid? Hope? The worst case is “hire Greed and Panic to manage your investments,” though that seems awfully popular.

The Weather

By Edward Studzinski

“When we unleash the dogs of war, we must go where they take us.”

Dowager Countess of Grantham

Starting off one of these monthly discussions with a title about the weather should be indicative that this piece will perhaps be more disjointed than usual, but that is how the world and markets look to me at present. And there is very little in the way of rational explanation for why the things that are happening are happening. My friend Larry Jeddeloh, of The Institutional Strategist, would argue that this country has been on a credit cycle rather than a business cycle for more than fifteen years now. Growth in the economy is tied to the price and availability of credit. But the cost of high yield debt is rising as spreads blow out, so having lots of cheap credit available is not doing much to grow the economy. Put another way, those who need to be able to borrow to either sustain or grow their business, can’t. A friend in the investment banking business told me yesterday about a charter school that has been trying to refinance a debt package for several years now, and has not been able to (thank you, Dodd-Frank). So once again we find ourselves in a situation where those who don’t need the money can easily borrow, and those who need it, are having difficulty obtaining it. We see this in another area, where consumers, rather than spend and take on more debt, have pulled back.

Why? We truly are in a moment of deflation on the one hand (think fuel and energy costs) and the hints of inflation on the other (think food, property taxes, and prescription drug costs on the other). And the debt overload, especially public debt, has reached a point where something has to be done other than kicking the can down the road, or other major crisis. I would argue we are on the cusp of that crisis now, where illiquidity and an inability to refinance, is increasingly a problem in the capital markets. And we see that, where the business models of businesses such as energy-related master limited partnerships, premised on always being able to refinance or raise more equity, face issues.

I was reading through some old articles recently, and came across the transcript in Hermes, the Columbia Business School publication, of a seminar held in May 1985 there. The speakers were Warren Buffett, James Rogers, Jr., and Donald Kurtz. As is often the case, sifting through the older Buffett can be rewarding albeit frustrating when you realize he saw something way before its time. One of the things Buffett said then was that, based on his observations of our political system, “ … there is a small but not insignificant probability that we will lose fiscal control at some point.” His point was that given a choice, politicians will always opt for an implicit tax rather than an explicit tax. If expenditures should determine the level of explicit taxes, than taxes should cover expenditures. Instead, we have built in implicit taxation, expecting inflation to cover things without the citizens realizing it (just as you are not supposed to notice how much smaller the contents are with the packaging changes in food products – dramatically increasing your food budget).

The easier way to think of this is that politicians will always do what allows them to keep doing what they like, which is to stay in office. Hence, the bias ends up being to debase the currency through the printing presses. So you say, what’s the problem? We have more deflation than inflation at this point?

And the problem is, if you look at history, especially Weimar Germany, you see that you had bouts of severe inflation and sharp deflationary periods – things did not move in a straight line.

Now we have had many years of a bull market in stocks and other assets, which was supposed to create wealth, which would than drive increases in consumption. The wealth aspect happened, especially for the top 5%, but the consumption did not necessarily follow, especially for those lower on the economic ladder. So now we see stock and asset prices not rising, and the unspoken fear is – is recession coming?

My take on it, is that we have been in a huge jobless recovery for most of the country, that the energy patch and those industries related to it (and the banks that lent money) are now beyond entering recession, and that those effects will continue to ripple through the rest of the economy. Already we see that, with earnings estimates for the S&P 500 continuing to drift lower. So for most of you, again, my suggestion is to pay attention to what your investment time horizons and risk tolerances are.

Moving totally down a different path, I would like to suggest that an article in the February 28, 2016 New York Sunday Times Magazine entitled “Stocks & Bots” is well worth a read. The focus of the article is about the extent to which automation will eliminate jobs in the financial services industry going forward. We are not talking about clerks and order entry positions. That revolution has already taken place, with computerized trading over the last twenty years cutting by way of example, the number of employees buying and selling stock over the phone from 600 to 4 at one of the major investment banking firms. No, we are talking about the next level of change, where the analysts start getting replaced by search programs and algorithms. And it then moves on from there to the people who provide financial advice. Will the Millennials seek financial advice from programs rather than stock brokers? Will the demand grow exponentially for cheaper investment products?

I think the answer to these questions is yes, the Millennials will do things very differently in terms of utilizing financial services, and the profit margins of many of today’s investment products, such as mutual funds, will be driven much lower in the not too distant future. Anecdotally, when one has a year in the markets like 2015 and the beginning of 2016, many investment firms would push down the bonus levels and payments from the highest paid to take care of the lower ranks of employees. I was not surprised however to hear that one of the largest asset managers in the world, based in Boston, had its senior employees elect to keep the bonuses high at the “partner” levels and not take care of the next levels down this past year. They could see the handwriting on the wall.

All of which brings me back to the weather. Probably suggesting that one should read a politically incorrect writer like Mark Twain is anathema to many today, but I do so love his speech on the New England weather. For a preview for those so inclined, “The lightning there is peculiar; it is so convincing that, when it strikes a thing it doesn’t leave enough of that thing behind for you tell whether – Well, you’d think it was something valuable, and a Congressman had been there.”

At a future point I will come back for a discussion of Mr. Twain’s essay “On the Decay of the Art of Lying” which might be essential reading as this year’s elections take shape.

High Dividends, Low Volatility

From the Trapezoid Mailbag:

A financial advisor in Florida is interested in low-volatility products. With the market so choppy, he would like to dial down risk in his client’s portfolio. He wondered whether SEI Institutional Managed Trust Tax-Managed Volatility Fund (TMMAX) was a suitable choice.

As Exhibit I illustrates low-volatility has been a successful investment strategy in recent years. A good argument can be made that historically, low-volatility stocks were mispriced. Players like Berkshire Hathaway and private equity capitalized on this by levering up these firms to deliver strong risk-adjusted returns. There is a heavy overlap between the low-volatility universe and the high-dividend universe. Many high-dividend stocks have dropped assets into REITs in recent years which have fueled better returns for this sector. Low volatility has outperformed the broad market meaningfully for the past two quarters, partly due its lower beta.

Trapezoid doesn’t take a view on whether these trends will continue or whether low-volatility is the best place to hide out in a tough market. In this instance, we wonder whether the “private equity bid” which contributed to the sector’s strong performance will be as reliable as corporate credit markets tighten and whether the increasing use of REIT/MLP structures has about run its course. What Trapezoid does do is help investors, advisors, and allocators find the best instruments to express their investment strategy based on extrapolation of historic skill in relation to risk.

There are several passive strategies which express the same theme. For example, Power Shares markets an S&P 500 Low Volatility Portfolio (SPLV) and an S&P 500 High Dividend Low Volatility Portfolio (SPHD). Those two funds move virtually in lockstep, underscoring the overlap between high dividend and low volatility. The correlation between the PowerShares indices and TMMAX is 98.5% and the expense ratio is 70-75 basis points lower.

Despite the availability of good passive indices, we would nonetheless consider TMMAX. The fund’s track record has been slightly above average, making us slightly confident (53%) it is worth the added cost. SEI also manages the SEI US Managed Volatility Fund which has a 50% confidence rating (slightly lower due mainly to higher expense ratio.)

SEI relies on three subadvisors to manage the fund. The largest sleeve is managed by Analytic Investors (39%) followed by LSV (35%) and AJO. While we don’t have sleeve-level data, we can evaluate the body of work by Analytic and LSV looking at comparable sole-managed funds. Analytic’s track record the past five years on Touchstone Dynamic Equity Fund (TDELX) is good but the previous five years were poor. LSV’s record at LSV Conservative Value Equity Fund (LSVVX) and Harbor Mid-Cap Value Fund (HIMVX) was middling.

We have discussed in the past that Morningstar star ratings have some predictive value but that even a five-star rating is not sufficient to make an investment decision. The SEI funds are good examples. TMMAX, SEVIX, and SXMAX all carry five star ratings, and we agree investors are better off choosing these funds than many of the alternatives but the evidence of manager skill is inconclusive.

If the advisor is willing to expand his horizons a little, he can find similar funds which improve the odds a little. We used the Orthogonal Attribution Engine to find highly correlated funds with better confidence ratings and came up with the following.

A few observations

• T. Rowe Price Capital Appreciation Fund (PRWCX) is closed to new investors
• The two Vanguard funds attempt to outperform their benchmark indices using a quantitative strategy.
• Many of the other similar funds have higher betas, which may be a deal breaker for our advisor who wants to reduce his client’s market exposure
• Many of these funds are large blend funds, accessible to demo customers at the www.fundattribution.com website.
• Our confidence ratings are based on data through 10/30/15. In the subsequent months TMMAX’s performance lagged the lower-cost PowerShares indices. This may serve to erode our confidence that active management pays for itself. Updated data will be posted shortly

The heightened appeal of low-volatility funds might suggest something else: Advisors are more focused on extreme negative outcomes which could get them fired than extreme positive outcomes. In a choppy market, low-volatility funds have the allure of a safe haven. We don’t have a view on the wisdom of this. But we are interested in helping allocators avoid individual managers who have the potential to “blow up.” One of Trapezoid’s forthcoming new metrics hones in on this risk by focusing on the likelihood of extreme negative outcomes.

Offered without comment: Your American Funds share class options

MFO Rating Metrics

When MFO introduced its rating system in June of 2013, it chose Martin Ratio as the principal performance rating metric. Martin is a risk adjusted return metric that is the ratio between excess return, which is the compounded annualized total return above risk free T-Bill return, divided by the so-called Ulcer Index, which is a measure of extent and duration of drawdown. Our friend Peter Matin formulated the Ulcer Index as described in An Alternative Approach to the Measurement of Investment Risk & Risk-Adjusted Performance.

For each fund category, like Large Growth or Moderate Allocation, the MFO Rating system divides funds into five groups or “quintiles” based on the risk adjusted return over selected evaluation periods. Funds with the highest Martin in each category are assigned a 5, while those with the lowest receive a 1.

While this approach suits many MFO readers just fine, especially having lived through two 50 percent equity market drawdowns in the past 15 years, others like Investor on the MFO Discussion Board, were less interested in risk adjusted return and wanted to see ratings based on absolute return. Others wanted to see ratings based on the more traditional risk adjusted Sharpe Ratio. (For more definitions, see A Look A Risk Adjusted Returns.)

It took a while, but subscribers on our MFO Premium site can now choose which rating metric they prefer, including multiple rating metrics simultaneously.

For example, since the start of the current market cycle in November 2007, which Small Cap funds have delivered the best absolute return (APR) and the best Martin Ratio and the best Sharpe Ratio? To find the answer, enter the selection criteria on the MFO MultiSearch tool, as depicted below (click image to enlarge), then hit the “Submit Search” button …

A total of 28 funds appear from the more than 9,000 unique funds in the MFO database. Here are the first 10, sorted by MFO Risk and then name:

Notables include Brown Capital Mgmt Small Company (BCSIX), Champlain Small (CIPSX), Conestoga Small Cap (CCASX), and FMI Common Stock (FMIMX). The closed BCSIX is both an MFO Great Owl and Fund Alarm Honor Roll fund. It is also a Morningstar Gold Medal fund, while Silver goes to CIPSX and CCASX.

Intrepid Endurance (ICMAX) has the lowest risk rating with a MFO Risk of 3, which means this fund has historically carried volatility suited for investors with Moderate risk tolerance. Unlike other metrics in the MFO ratings system, and in fact the risk metric in Morningstar’s rating system, which assign risk relative to other funds in category, the MFO Risk metric assigns its rating based on volatility relative to the overall market.

The MFO MultiSearch tool now enables searches using more than 55 screening criteria, organized by Basic Info, Period Metrics, Composite Period Metrics, MFO Designations, Portfolio Characteristics, and Purchase Info. A list of current criteria can be found here.

The Alt Perspective: Commentary and news from DailyAlts.

Pruning Season

You can call it a cycle, a season, or even a cleansing process, but when one looks at the liquid alternatives market, it’s apparent that there is some pruning going on. Some cleaning out of the products that no longer appeal to investors, those that hit a performance patch from which it would be near impossible to recover, or just didn’t gather the requisite assets for a fund to be viable. Clean out the funds that are not producing the intended results, or just aren’t resonating with investors.

This is all a healthy process as it makes room for newer products, the next generation. It also allows for a greater investment into existing products. Interestingly, we have already seen 9 alternative funds liquidated in the first two months of the year (and at least two more schedule to be liquidated) – some announced late last year, but nonetheless, fully liquidated in 2016. And these are from some bigger names in the industry, such as Lazard, Collins, Whitebox, Virtus, Ramius and Clinton. Some seasoned hedge fund managers in there, along with seasoned asset management firms.

Four of the liquidate funds were long/short equity funds, two were multi-alternative funds, and the remaining three included market neutral, event driven and non-traditional bonds. All in all, I think we will see more pruning in the coming months as fund managers rationalize their fund lineup as markets sell off, and begin thinking about the next set of products to introduce to the market.

The pruning process is healthy and helps future growth, so don’t be surprised to see more down the road. It’s just part of the natural cycle.

Asset Flows

January saw a continuation of 2015 where investors continued to pour money into multi-alternative funds and managed futures funds (inflows of $1.2 billion and $1.5 billion, respectively), while pulling assets from non-traditional bond funds, long/short equity and market neutral (-$3 billion, -$390 million and -$340 million, respectively). Excluding non-traditional bond funds and commodities, alternative mutual funds and ETFs gathered a total of $2.4 billion in January, bringing the total 12-month haul to $18.7 billion, third of any category behind international equity and municipal bonds and 11.5% of all net asset inflows.

Commodities bounced back in January with total inflows of $3.3 billion, led primarily by flows to precious metals funds, and gold funds in particular. Non-traditional bond funds, viewed as an alternative to long-only bond funds and a protective hedge against interest rate increases, have continued to disappoint in the aggregate. As a result, investors have pulled $17.9 billion of assets from these funds over the past 12 months.

Extended Reading

What did DailyAlts readers enjoy the most this past month? The three of the most widely read articles this past month were:

• Adding Liquid Alts to DC Plans and Target-Date Funds
• Distinction Between Mutual Funds and Hedge Funds Is Eroding
• Understanding Liquid Alternatives: Ask The Right Questions

While it appears to be pruning season, that doesn’t mean it is time to stop looking for alternative funds. With Spring approaching, now is a good time to take a look across your portfolio at the risks you have exposure to, and perhaps do a bit of pruning of your own to balance risks and hedge for what might be more volatility ahead.

Have a great March, and to keep up with daily or weekly news in the liquid alts market, be sure to sign up for our newsletter.

Observer Fund Profiles: LSOFX / RYSFX

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.

LS Opportunity Fund (LSOFX): this was a really solid long/short fund that had to press the “reset” button last May when their sub-advisor decided to pack it up and call it a career. In Prospector Partners, they may have found a team that executes the same stock-by-stock discipline even more excellently than their predecessors.

Royce Global Financial Services (RYFSX): when you think “financial services,” you likely think “monstrous big banks with tendrils everywhere and eight-figure bonuses.” Royce thinks differently, and their focus on smaller firms that dominate financial niches worldwide has made a remarkable difference for their investors.

Elevator Talk: Jim Robinson, Robinson Tax-Advantaged Income (ROBAX)

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.

Jim Robinson formed Robinson Capital Management, located in Detroit’s ritzy Grosse Pointe suburb, in December, 2012. The firm manages about a quarter billion in assets for a handful of high net worth clients and advises two (soon to be three) mutual funds.

From 1987-1999, Mr. Robinson served as the Fixed Income CIO for the Munder Funds. During his stint, he grew fixed income AUM from $100 million to $20 billion. Eventually promoted to Chairman, CEO and President, he was responsible for about $38 billion in assets. He left Munder for Telemus Capital Partners, LLC, with whom his firm still has a relationship.

Robinson Capital uses a variety of strategies in their separate accounts. The Tax-Advantaged Income Fund pursues one strategy: it invests in closed-end muni bond funds. Closed-end funds (CEFs) are strange creatures, the forerunners of today’s actively-managed ETFs. They have managers and portfolios like open-end mutual funds do, but trade on exchanges like stocks and ETFs do. Such funds have several relevant characteristics:

1. They are far more likely to pursue income-oriented strategies than are open-end funds
2. They are far more likely to make extensive use of leverage and hold more illiquid securities than are open-end funds
3. Because they trade on exchanges, the managers never need to worry about meeting redemptions or closing the fund to new investors; they issue a set number of shares of the CEF during their initial public offering but after that they let buyers and sellers find each other.
4. Because they trade on exchanges, the market price of their shares changes minute-by-minute, and
5. Because they trade on exchanges, the net asset value of a share (the market value of all of the fund’s holdings divided by the number of shares outstanding) can diverge dramatically from that share’s market price (that is, the amount a potential seller can get at one particular moment for a share of the fund).

When shareholders panic, they may succumb to the temptation to sell shares of their fund for 15, 20 or even 40% less than they’re nominally worth, just because the seller really wants cash-in-hand. That’s mostly irrational. A handful of mutual fund firms – RiverNorth, Matisse, and Robinson among them – look to profit from panic. Using various metrics, they decide when to move in and buy shares that are selling at an unsustainable discount to their net asset values.

If everything goes according to plan, that strategy offers the potential for sustained, substantial, market-neutral gains: as soon as panic subsides, even if the market is still falling, a degree of rationality returns, investors start buying the discounted CEF shares, that bids up the price and the discount closes. If you invest before the crowd, you benefit when the shares you bought at, say, a 25% discount can now be sold at just a 5% discount.

Here’s a hypothetical illustration: the NAV of the Odd Income Fund is $100/share but, when rumors of dinosaurs rampaging down Wall Street rattles people, its market price drops to $75/share. Robinson moves in. In six months, the panic has passed, Odd Income’s NAV has risen a couple percent and its discount contracted to its non-panic norm of 5%. In such a scenario, Odd Income has earned 2% but folks who bought shares during the panic earned 29%.

There are distinct risks to playing this game, of course. The falling knife might continue to fall harder and faster than you’d imagined so that the 25% discount might widen to 35%. The manager of the underlying CEF might find that using leverage in a panicky market drives down the fund’s NAV as well as its market price. And, too, the CEF manager might simply do something stupid. It happens.

The folks who manage CEF-focused funds argue that downside risks are manageable through a combination of careful security selection, position-size limits and hedging. The upside can be dramatic. Here is the performance chart for ROBAX against two possible benchmarks: its Morningstar non-traditional bond peer group (orange) and long-term national muni bond group (yellow).

Here are Mr. Robinson’s 200 words on why investors concerned about income and income taxes should add ROBAX to their due-diligence list:

I generally tell people that the first three things you need to know about our fund are these:

• We pay out 40 basis points a month in tax-exempt income, on average
• We present very little credit risk; our portfolio’s credit quality is A/A+
• We hedge out interest rate risk, such that our effective duration is under a year.

There are 191 Tax-exempt closed-end funds. Today, 150 are trading at a discount to NAV. Some of those discounts are rational; if you have a poorly-managed fund buying difficult-to-price securities and misusing leverage, it should be trading at a discount. Heck, I analyze some of these funds and suspect the discount should be bigger than it is.

What we do is move money from rationally discounted funds to irrationally discounted ones. Six large fund companies – BlackRock, PIMCO, Nuveen and company – dominate the CEF space. That’s important because those companies have pretty good governance practices in place; BlackRock is aggressive about merging funds to harvest economies of scale, others do share buybacks and so on. When funds with good management, good governance and good portfolios sell at irrational discounts, we move. Bill Gross did me a big favor. Two days before we launched, he resigned from PIMCO. Gross had nothing to do with PIMCO’s CEFs but suddenly funds that always trade at a premium were available at a discount. We moved in, the discount predictably reversed, and we closed the position at a nice profit. That discount arbitrage adds about 200 bps to our performance.

The other thing we do that individual investors can’t, and that most advisors would find tough, time-consuming and expensive, is we largely hedge interest rate risk out of the portfolio. Tax-exempt CEFs tend to be long-dated and leveraged so they typically have 10-12 year weighted durations. In a year like 2013 when rates rise 1%, they lose 10-12% in principal value. Our hedge is not perfect, since Treasuries and munis don’t trade in perfect sync, but it’s pretty good.

Robinson Tax-Advantaged Income has a $2500 minimum initial investment for the “A” shares and $1,000,0000 for “I” shares. While there’s a sales load, load-waived shares are widely available. Direct expenses are capped at 1.60% on the “A” shares. Since the fund invests in other funds, you indirectly pay (through lower returns) a portion of those funds’ expenses. In 2014, that added 1.14% to ROBAX’s today expenses. The fund has about gathered about $74 million in assets since its September 2014 launch. Here’s the fund’s homepage.

Funds in Registration

Funds need to submit their prospectuses for SEC review before they’re permitted to offer the fund to the public. The SEC has 75 days in which to ponder the matter, which means that proposed new funds cool their heels for about two and a half months. During that time their prospectuses are available for review on the SEC’s website but fund advisors are forbidden to talk publicly about them. Each month Funds in Reg gives you a heads-up about what’s in the SEC pipeline.

Except for last month, when I stupidly forgot to include the file in our February issue. As a result, this month we cover the last two sets of no-load retail funds that will become available between March and May. We found 17 funds that qualify. Particularly interesting morsels include:

• 361 Domestic Long/Short Equity Fund, which will be managed by a really renowned investor – Harindra de Silva – who has a earned a great deal of respect in the industry and who already manages a number of top-ranked funds.
• Matthews Asia Credit Opportunities, which appears to be a high-yield, distressed securities version of the very fine Matthews Asia Strategic Income Fund.
• RiverPark Commercial Real Estate Fund, the latest entry in RiverPark’s quest to bring hedge fund strategies to “the mass affluent.” This fund has been running as a hedge fund for about five years now.

Sadly, there are a handful of future “Off to the Dustbin of History” nominees as well but I suppose that’s the magic of capitalism: 90% of the stuff we try fails, 9% does okay and 1% changes the world.

Uzès Grands Crus I

The French, being French, have their financial priorities in order. In February, Financière D’uzès announced the launch of their third mutual fund devoted to the investment potential of bottles of fine wine. At least 75% of the fund’s assets will be bottles of fine and their aim is “to outperform the annual rate for the five-year French treasury bond (OAT) with a minimum return of 5%.”

I reflected, very very briefly, on the investment value of the bottle of Lambrusco I bought at Trader Joe’s for $4.99, then made mid-winter sangria instead.

Manager Changes

The biggest news, by far, this month is the impending departure of Taymour R. Tamaddon from T. Rowe Price Health Sciences (PRHSX) and Donald Yacktman from his namesake funds. When Kris Jenner left the fund three years ago (how time flies!), the accepted wisdom was that nobody could live up to his legacy. Mr. Tamaddon then led the fund to 22.4% annualized returns, nearly 500 bps above his peers and good enough for a top 2% record.

Mr. Tamaddon steps down on July 1, 2016, is succeeded by Ziad Bakri then becomes manager of the $12 billion T. Rowe Price Institutional Large-Cap Growth Fund (TRLGX) on January 1, 2017.

Effective May 1, 2016, Donald A. Yacktman will transition to an advisory role and will no longer serve as a portfolio manager for AMG Yacktman (YACKX) and AMG Yacktman Focused (YAFFX) funds. The roughly corresponds with his 75^th birthday. Mr. Yacktman has been managing mutual funds since 1968, starting with Stein, Roe and the Selected American Shares before founding Yacktman Asset Management in 1992. $10,000 invested in YACKX that year would have grown to $95,000 today, which compares well to the returns on an investment in the S&P500 ($76,000) or the average large-value fund ($56,000). He was named Morningstar’s Manager of the Year in 1991 and was joined on the management team by his son, Stephen, in 2002. Stephen Yacktman and Jason Subotky will manage the funds after the transition.

Other than that, we found about 36 manager changes, a few years overdue.

Updates

Sequoia Fund (SEQUX) continues its defense of Valeant Pharmaceuticals in its Annual Report (2016) and they continued dodging the issue.

For the stock to regain credibility with long-term investors, Valeant will need to generate strong earnings and cash flow this year, make progress in paying down some of its debt, demonstrate that it can launch new drugs from its own development pipeline and avoid provoking health care payers and the government. The company has committed to doing all of these things and we are confident interim CEO Howard Schiller and interim board chairman Robert Ingram are focused on the right metrics. Before CEO J. Michael Pearson went out on an extended medical leave, he also seemed committed to this path.

“Avoid provoking health care payers.” Oh, right. That would be the predatory pricing model that attracted Sequoia to Valeant in the first place: Valeant would borrow money to buy a small pharmaceutical firm, then quintuple the price of the firm’s products. If that meant putting a few inexpensive lives at risk, well, that wasn’t Valeant’s problem.

Until it was. Before the blow-up, manager David Poppe’s tone was openly affectionate about “Mike,” Valeant’s president and almost giddy about the prospects. Valeant’s high-profile implosion cost Sequoia a lot:

As the largest shareholder of Valeant, our own credibility as investors has been damaged by this saga. We’ve seen higher-than-normal redemptions in the Fund, had two of our five independent directors resign in October and been sued by two Sequoia shareholders over our concentration in Valeant. We do not believe the lawsuit has merit and intend to defend ourselves vigorously in court. Moving along …

“Moving along”? No, it’s not time to move along, guys. Barron’s Chris Dieterich provides a nice synopsis of developments that transpired on February 29, the day Sequoia released their report:

Monday ushered in a nightmarish combination of trouble. First, Valeant said it would delay the release of its quarterly results. Then, news broke that Allergan (AGN) is challenging the patent to Xifaxan. Third, Moody’s Investors Service warned that it may need to downgrade portions of the company’s $31 billion of debt. Finally, headlines crossed the tape that Valeant faces a previously undisclosed investigation by the Securities and Exchange Commission.

All told, the stock plunged 18% to $65.80 — a fresh three-year low (“Sequoia Fund Picked A Bad Time To Stick Up For Valeant”).

The bigger, unanswered question is what does this say about you as investors? Any damage to your credibility is (a) self-inflicted and (b) deserved. You committed one third of your fund and all of your credibility to an amoral little schemer who, on his best days, stayed right at the edge of what’s legal. That’s a fact you acknowledged. Then you implicitly compared him to Warren Buffett, an investor whose moral compass, operating style and record makes him utterly incomparable.

Investors might, heck, investors must, ask: where was your brain? Were you so blinded by the prospect of easy money that you chose to ignore the hard questions? The most optimistic interpretation is that you’re not addressing such questions because you’re being sued and you can’t afford to admit to whatever idiocy led to the resignations of 40% of your board last fall. The worrisome interpretation is that Sequoia isn’t Sequoia anymore; that the clarity of thought that guided it to renown in decades past mostly now serves to mask a less exalted management.

Think it can’t happen? Check Magellan, Fidelity (FMAGX), the other Titan which has now managed to trail its peers over the past five, ten, fifteen and twenty year periods. Utterly dominant in the market cycle from 1973-1987 when it beat its peers by 1000 basis points/year, the fund hasn’t even managed consistent mediocrity since.

Morningstar doesn’t share my reservations and SEQUX retains a “Gold” analyst rating from the firm. Their equity analyst also doesn’t share my concerns about Valeant, which they rate (on 3/1/16) as a five-star stock whose shares are selling at about one-third of their fair value. Senior equity analyst Michael Waterhouse doesn’t “anticipate any major shift in our long-term thinking for the company.”

Briefly Noted . . .

SMALL WINS FOR INVESTORS

Chou has voluntarily decided to waive its entire advisory fee on the Chou Opportunity Fund (CHOEX) beginning on January 1, 2016. In addition, on February 18, 2016 Chou made a voluntary capital contribution to the Opportunity Fund in the amount of $918,468, which approximates the advisory fees retained by Chou with respect the Opportunity Fund last year. Why, you ask? The advisor describes it as “a gesture of goodwill … in recognition of the fund’s underperformance” in 2015. That’s an oblique reference to having lost 22% in 2015 and another 20% in the first two months of 2016.

The advisor to the Great Lakes Bond Fund has closed the fund’s Investor Class (GLBDX) and converted the former Investor accounts into Institutional Class (GLBNX) ones. They then lowered the minimum on the Institutional shares by 99%, from $100,000 to $1,000. Net, potential retail investors save 25 bps.

Hotchkis & Wiley Mid-Cap Value Fund (HWMAX) has reopened to new investors.

RS Partners Fund (RSPFX) reopened to new investors on March 1, 2016. None of the fund’s independent trustees have chosen to partner with you by investing in the fund. The managers’ investment in the fund ranges between “modest” and “none.”

Walthausen Small Cap Value Fund (WSCVX) reopened to new investors on March 1, 2016.

Wasatch Emerging Markets Small Cap Fund (WAEMX) has reopened to new investors. Thanks for the heads up, Openice!

CLOSINGS (and related inconveniences)

Nope, turns out “turning away money” wasn’t a popular move in February. We found no funds closing their doors.

OLD WINE, NEW BOTTLES

Armor Alternative Income Fund (AAIFX) has become Crow Point Alternative Income Fund. 

Diamond Hill Strategic Income Fund (DSIAX) has been renamed the Diamond Hill Corporate Credit Fund to better reflect what it’s up to.

Forward no more. On May 1, 2016, the name “Forward” disappears from the world of mutual funds. In general, all of the former Forward Funds will be renamed as Salient Funds, which no change other than substituting “Salient” for “Forward” in the name. There are a few exceptions,

Current Forward Name	New Salient Name
Commodity Long/Short Strategy	Commodity Long/Short Strategy
Credit Analysis Long/Short	Tactical Muni Strategy
Dynamic Income	US Dividend Signal
EM Corporate Debt	EM Corporate Debt
Emerging Markets	EM Dividend Signal
Frontier Strategy	Frontier Strategy
Global Infrastructure	EM Infrastructure
Growth Allocation	Adaptive Balanced
High Yield Bond	High Yield
Income Builder	Adaptive Income
International Dividend	International Dividend Signal
International Real Estate	International Real Estate
International Small Companies	International Small Cap
Investment Grade Fixed-Income	Investment Grade
Real Estate	Real Estate
Real Estate Long/Short	Tactical Real Estate
Select Income	Select Income
Select Opportunity	Select Opportunity
Tactical Growth	Tactical Growth
Total MarketPlus	Adaptive US Equity

TIAA-CREF has boldly rebranded itself as TIAA.

Straightforward. Yep. 74%. Unless you’re buying the retail share class in which case it’s nine of 33 funds excluding money markets, or 27%. 32.5% of all funds receive either four- or five-stars from Morningstar.

And about that “uncomplicated” thing? Count the number of clicks it takes you to get to any particular fund. It took me two cups of coffee before I finally got to the one I wanted.

As of May 9, 2016, Transparent Value becomes … well, insert your own snark here. In any case, the Transparent Value Funds become Guggenheim Funds.

Current Name	New Name
Trans Value Directional Allocation	Guggenheim Directional Allocation
Trans Value Dividend	Guggenheim RBP® Dividend
Trans Value Large-Cap Defensive	Guggenheim RBP® Large-Cap Defensive
Trans Value Large-Cap Market	Guggenheim RBP® Large-Cap Market
Trans Value Large-Cap Value	Guggenheim RBP® Large-Cap Value

On March 1, 2016, The Wall Street Fund (WALLX) became Evercore Equity Fund (EWMCX). The word “Equity” in the name also triggered a new promise in the prospectus that the fund, which already invests in equities, promises to invest in equities.

OFF TO THE DUSTBIN OF HISTORY

On whole, fund companies would be well-advised to extract their heads from their behinds. If you’re not willing to stick with a new fund for, say, a whole market cycle, then don’t launch the damned thing. The hypocrisy of declaring that you’re “long-term investors” and that you want to be “partners” with your investors, then closing a fund after 12-24 months, is toxic. It conveys some combination of the following three messages: (1) we’re panicked. (2) We have no ability to plan. (3) Pretty much everything we said when we launched the fund was cynical B.S. crafted by marketers who were, themselves, probably disgusted with us.

Which of those messages do you really want to be associated with?

Okay, back to the ranks of the walking dead and the dead dead after a short word of thanks to The Shadow, one of the stalwarts of our discussion board whose daily updates on the comings and goings is enormously helpful in keeping this list current.

Let’s go to Plan B: Under Plan A, Arden Alternative Strategies Fund (ARDNX) was slated to become Aberdeen Multi-Manager Alternative Strategies Fund (no ticker) on March 31, 2016. That made perfect sense since Aberdeen acquired Arden. Plan A survived for about a week when someone likely noticed that the fund wasn’t actually very good, was shrinking in size and required an annual expense subsidy from the adviser, whereupon Plan B emerged: kill it. Same date.

BPV Core Diversification Fund (BPADX) has closed and will be terminated on March 11, 2016. It’s a tiny, conservative fund that’s still managed to lose money over the past three years and trail 90% of its peers.

On February 17, 2016, the CGM Advisor Targeted Equity Fund (NEFGX, reflecting its birth name: New England Growth Fund) was liquidated. Financial Advisor magazine managed to wax nostalgic over the loss of a “venerable” and “once-vaunted” fund. Two quick notes about this: (1) the fund hasn’t earned its keep over the past 20 years. Its closing NAV was below its NAV in 1994. The 20 year performance chart is the very image of what to avoid in your investments:

And (2) you can still access the manager’s skills, if you’d like. Natixis, the fund’s sponsor, no longer has an ownership stake in CGM and so they had no interest in continuing to sponsor a fund. Mr. Heebner continues to run three other CGM funds. Their website would also win the award for the industry’s least useful.

Collins Alternative Solutions Fund (CLLAX) liquidated on February 26, 2016. The fund had about $19 million in assets and dropped 19% in its final year of operation.

Crystal Strategy Absolute Income Fund (CSTFX), Crystal Strategy Absolute Return Fund (CSRAX) and Crystal Strategy Absolute Return Plus Fund (CSLFX) will, based on the recommendation of Brinker Capital, LLC, the investment adviser, be liquidated on March 18, 2016. The funds are just past their second anniversary. Between them they have $16 million in assets and a sorrowful performance record.

Dreyfus Strategic Beta U.S. Equity Fund (DOUAX) will liquidate in mid-April.

The Fortress has fallen! Fortress Long/Short Credit Fund (LPLAX) liquidated on February 12, 2016, about three years too late. The fund lost about 25% over its lifetime. It peaked in December 2012 and its chart since then looks, for all the world, like a child’s drawing of steps leading down to the basement.

Frost International Equity Fund (FANTX) will liquidate on March 31, 2016. The announcement helpfully notes that they’ll refer to that as “the liquidation date.” I think I went on one of those in college.

Gottex Endowment Strategy Fund (GTEAX) is liquidating after about 20 months of operation. In that time it lost about 12% for its few investors.

Guidestone Real Assets Fund (GRAZX) will liquidate on April 29, 2016. It’s a tiny fund-of-funds that’s designed to protect you from inflation by investing in things that are cratering. That’s not intentional, of course, but sectors that would be durable if inflation arose – energy, natural resources, real estate – have been disasters.

The $3 million JPMorgan Asia Pacific Fund (JAPFX) will liquidate on April 6, 2016.

Investors in the Lazard Master Alternatives Portfolio (LALOX) need to find an alternative since the fund was liquidated on March 1, 2016. The fund was 14 months old.

MassMutual Barings Dynamic Allocation Fund (MLBAX) will be dissolved on July 8, 2016. It isn’t an awful tactical allocation fund but it’s tiny and misallocated in the last year, costing its investors 11.5%.

Merk Asian Currency Fund (MEAFX) liquidated on February 29, 2016. From inception in 2008 until liquidation, the fund was above water once, briefly, in 2011.

Meyers Capital Aggressive Growth Fund (MAGFX) liquidated on February 29, 2016, on about three weeks’ notice. Since the manager owns 87% of the funds’ shares, he might have seen it coming. The oddest development is the collapse of the fund’s asset base: in May, Mr. Meyers owned over $1,000,000 in fund shares. By February 2016,the fund only had $130,000 in assets.

Oberweis Asia Opportunities Fund (OBAOX) will be merged into Oberweis China Opportunities Fund (OBCHX) on or about April 29, 2016.

Philadelphia Investment Partners New Generation Fund (PIPGX), having lost 35% in the past 12 months, is now going to lose its head. The execution is March 30, 2016.

After the advisor concluded that Satuit Capital U.S. SMID Cap Fund (SATDX) was not economically viable, they decided “to close the Fund, wind up its affairs, liquidate its portfolio.” I’ve never seen “wind up its affairs,” which the announcement uses twice, in a fund liquidation filling before. Huh. The fund is not yet two years old and had attracted only a couple million, despite a really strong record. The deed is done on April 30, 2016.

Having concluded that the Smith Group Small Cap Focused Growth Fund (SGSVX) has “limited prospects for meaningful growth,” its board authorized liquidation of the fund on March 31, 2016. One can’t fault the managers for a lack of commitment: internal ownership accounted for about two-thirds of the fund’s $600,000 in assets.

Strategic Latin America Fund (SLATX) liquidated in late February, 2016. 

Touchstone Global Real Estate Fund (TGAAX) will liquidate on March 30, 2016. The board attributes the decision to “the Fund’s small size and limited growth potential.” An interim manager, apparently someone who specializes in “safeguard[ing] shareholder interests during the liquidation period,” has been appointed. It’s the sad case of a good fund not finding its audience: top 25% returns over the past five years and even better returns recently, but still only $17 million in assets.

Sometime in mid-summer Victory CEMP Multi-Asset Balanced Fund (CTMAX) will be absorbed by Victory Strategic Allocation Fund (SBALX). As is so often the case, CTMAX is larger and weaker so they’ll bury its record while tripling SBALX’s assets.

On February 5, 2016, Virtus Dynamic Trend Fund merged into Virtus Equity Trend Fund (VAPAX). I’m slightly startled to report that, despite trailing 98—99% of its peers over the intermediate term, VAPAX retains $1.5 billion in assets.

Wanger International Select (WAFFX) will liquidate at the end of March. It appears to be available only through insurance products.

WHV/EAM Emerging Markets Small Cap Equity Fund (WVEAX) and WHV/EAM International Small Cap Equity Fund (WHSAX), rather less than two years old, will liquidate on or about March 31, 2016. Both funds had very strong performance. WHV/Seizert Small Cap Value Equity Fund (WVSAX), a bit more than two years old, will liquidate a month later.

In Closing . . .

Thanks, as always, to folks who’ve supported the Observer in thought, word or deed. Welcome, especially, to Nick Burnett, long-time friend, grad school roommate and mastermind behind the CapRadioCurriculum which helps teachers connect public radio content with classroom lessons. There’s a cool one on multilingual public relations that I rather liked. Thanks, as ever to the ongoing generosity of the folks at Gardey Financial and our first subscribers, Deb and Greg. Thanks to Gary, who didn’t particularly want premium access but did want to help out. Mission accomplished, big guy! Too, to MaryRose, we’re trying to help. Welcome to Abdon Bolivar, working hard to get people to understand the role that plan administrators play in creating and sustaining bad options for investors. By coincidence, Tony Isola and the folks are Ritholtz Wealth Management are pursuing a parallel track trying to educate educators about what to do if they’re getting screwed by the 403(b). And, in a horrifying number of cases, they are.

And so, thanks to you all, not just for your support of the Observer but for all the good work you’re doing for a lot of people.

We’re waiting to talk with the folks at Otter Creek Partners, a hedge fund firm with a small long/short fund that’s performed splendidly. That conversation will let us finish up our profile of Otter Creek Long/Short Opportunity (OTCRX) and share it with you. We’ll add a look at Intrepid Endurance (ICMAX) in conjunction with my own portfolio review. We’ll look for the launch of Seafarer Overseas Value, likely around the 75^th day of 2016. We’ll look for you.

By David Snowball

Dear friends,

It’s the BOJ’s fault. Or the price of oil’s. Perhaps the Fed. Probably China. Possibly Putin. Likely ISIL (or Assad). Alternately small investors. (ETF.com assures us it’s definitely not the effect of rapid, block-trading of ETFs on the market, though.) It’s all an overreaction or, occasionally, a lagging one. Could be fears of recession or even fears of fears.

We don’t like randomness. That’s why conspiracy theories are so persistent: they offer simple, satisfying explanations for otherwise inexplicable occurrences. We want explanations and, frankly, the financial media are addicted to offering them. The list in that opening paragraph captures just some of the explanations offered by talking heads to explain January’s turbulence. Those same sages have offered prognostications for the year ahead, ranging from a “cataclysmic” 40% decline and advice to “sell everything” to 7-11% gains, the latter from folks who typically foresee 7-11% gains.

As I drove to campus the other day, watching a huge flock of birds take wing and wheel and listening to financial analysis, it occurred to me that these guys had about as much prospect of understanding the market as they do of understanding the birds’ ballet.

Open confession is good for the soul.

I have two confessions.

First, I can’t find the source of the quotation that serves as the title of this essay. I keep hitting a wall as “Scottish proverb,” with no further discussion. All too often that translates to “some hack at The Reader’s Digest in 1934 made it up and added ‘Scottish proverb’ to dignify the insight.”

Second, until I began this essay, I had only the vaguest idea of how my portfolio had done in 2015. I preach a single doctrine: make a good plan, execute the plan, get on with your life.

Make a good plan: My retirement portfolio is largely hostage to Augustana College. As part of a Retirement Plan Redesign task force a few years ago, we discovered that the college’s plan was too complicated (it offered over 800 funds) and too lax (under 30% of our employees contributed anything beyond the college’s 10% contribution).  The research was clear and we followed it: we dramatically reduced the fund of investment choices so that in each asset class folks had one active fund and one passive fund, installed a lifecycle fund as the default option, the college went from a flat contribution to a modestly more generous one based on a matching system, we auto-enrolled everyone in a payroll deduction which started at 4%, and automatically escalated their contributions annually until they reached 10%. It was, of course, possible to opt out but we counted on the same laziness that kept folks from opting in to keep them from opting out.

We were right. Ninety-some percent of employees now contribute to their own retirements, the amount of money sitting in money markets for years is dramatically reduced, the savings rate is at a record and more accounts seem to contain a mix of assets.

Yay for everyone but me! In pursuit of the common good, I helped strip out my own access to the Fidelity and T. Rowe Price funds that were central to my plan. Those funds are now in a “can’t add more” account and continue to do quite well. Both growth funds (Fidelity Growth Discovery, T. Rowe Price Blue Chip Growth) and international small caps (Fidelity Japan Smaller Companies, T. Rowe Price International Discovery) were thriving, while my substantial emerging markets exposure and a small inflation hedge hurt. In these later years of my career at the college, the vast bulk of my retirement contributions are going into a combination of the CREF Stock Account (60% of my portfolio, down 0.9% in 2015, up 10.5% annually over the past three years), TIAA Real Estate Account (25% of my portfolio, up 8% in 2015, up 10% annually over the past three years) and a TIAA-CREF Retirement Income fund (15% of the portfolio, flat in 2015, up 4.5% over three years) for broad-based fixed income exposure.

My non-retirement account starts with a simple asset allocation:

• 50% growth / 50% income
• Within growth, 50% domestic equities, 50% foreign
• Within domestic, 50% smaller companies, 50% larger
• Within foreign, 50% developed, 50% emerging
• Within income, 50% conservative, 50% venturesome.

I know that I could optimize the allocation by adjusting the exact levels of exposure to each class, but I don’t need the extra complexity in my life. In most of my funds, the managers have some wiggle room so that they’re not locked into a single narrow asset class. That makes managing the overall asset allocation a bit trickier, but manageable.

The roster of funds, ranked from my largest to smallest positions:

FPA Crescent FPACX	A pure play on active management.  Mr. Romick is willing to go anywhere and frequently does. He’s been making about 6% a year and has done exceptionally well mitigating down markets. The fund lost 2% in 2015, its third loss in 20 years.
T. Rowe Price Spectrum Income RPSIX	A broadly diversified fund of income funds. Low cost, low drama. It’s been making about 4% in a low-rate environment. The fund lost 2% in 2015, its third loss, and its second-worst, in a quarter century.
Artisan International Value ARTKX	A fund that I’ve owned since inception and one of my few equity-only funds. It’s made about 7% a year and its long-term performance is in the top 1% of its peer group. Closed to new investors.
RiverPark Short-Term High Yield RPHYX	An exceedingly conservative cash-substitute for me. I’m counting on it to beat pure cash by 2-3% a year, which it has regularly managed. Up about 1% in 2015. Closed to new investors.
Seafarer Overseas Growth & Income SFGIX	An outstanding EM equity fund that splits its exposure between pure EM stocks and firms domiciled in developed markets but serving emerging ones. Up about 10% since launch while its peers are down 18%. Down 4% in 2015 while its peers were down 14%.
Artisan Small Cap Value ARTVX	(sigh) More below.
Matthews Asian Growth & Income MACSX	Traditionally one of the least volatile ways to invest in the world’s most dynamic economies. I started here when Mr. Foster, Seafarer’s manager, ran the fund. When he launched Seafarer, I placed half of my MACSX position in his new fund. MACSX has continued to be a top-tier performer but might fall victim to a simplification drive.
RiverPark Strategic Income RSIVX	Mr. Sherman, the RPHYX manager, positions this as “one step out the risk-return spectrum” from his flagship fund. His expectation was to about double RPHYX’s return. He was well on his way to do exactly that until three bad investments and some market headwinds derailed performance over the past six months. Concern is warranted.
Matthews Asian Strategic Income MAINX	The argument here is compelling: the center of the financial universe is shifting to Asia but most investors haven’t caught up with that transition. Matthews is the best Asia-centered firm available in the US retail market and Ms. Kong, the manager, is one of their brightest stars. The fund made a lot of money in its first year but has pretty much broken even over the next three. Sadly, there’s no clear benchmark to help answer the question, “is that great or gross?”
Grandeur Peak Global Reach GPROX	The flagship fund for Grandeur Peak, a firm specializing in global small and microcap growth investing.  The research is pretty clear that this is about the only place where active managers have a persistent edge, and none have had greater success than G.P. The fund was up 8% in 2014 and down 0.6% in 2015, outstanding and respectable performances, respectively.
Northern Global Tactical Asset Allocation BBALX	Northern aspires to be a true global hybrid fund offering low-cost access to global stocks, bonds and alternatives. It looks terrible benchmarked against its US-centered peers but I’m not sure that’s an argument against it.
Grandeur Peak Global Microcap GPMCX	This was simply too intriguing to pass up: G.P. wanted  a tiny fund to invest in the world’s tiniest companies, potentially explosive firms that would need to grow a lot even to become microcaps. It was open by subscription only to current GP shareholders and hard-closed at $27.5 million even before it opened.
ASTON/River Road Long Short ARLSX	This is a very small position, started mostly because I like the guys’ clear thinking and disciplined approach. Having even a small amount in a fund lends me to pay more attention to it, which was the goal. Other than for 2014, it typically finishes in the top third of L/S funds.

Execute the plan. So what did I do in 2015? Added Grandeur Peak Global Microcap and set up a monthly auto-invest. I also (finally!) transferred my Seafarer holdings from Scottrade directly to Seafarer where I took advantage of their offer to make lower-cost institutional shares available to retail investors who met the retail minimum and established an auto-investing plan. Otherwise, it was mostly stay the course and invest monthly.

What’s up for 2016? Artisan Small Cap Value is on the chopping block. Assets in the fund are down nearly 90% from peak, reflecting year after wretched year of underperformance. This is one of my oldest holdings, I’ve owned it since the late 1990s and have substantial embedded capital gains. Three issues are pushing me toward the door:

1. The managers seem to have fallen into a value trap. Their discipline is explicitly designed to avoid “value traps,” but their dogged commitments to energy and industrials seem to have ensnared them.
2. They don’t seem to be able to get out. Perhaps I’m jaundiced, but their shareholder communications haven’t been inspiring. The theme is “we’re not going to change our discipline just because it’s not working right now.” My fear is that “disciplined” transitions too easily into “bunkered down.” I experienced something similar with Ron Muhlenkamp of Muhlenkamp Fund (MUHLX), which was brilliant for 15 years then rigidly rotten for a decade. Mr. Muhlenkamp’s mantra was “we’re not sacrificing our long-term discipline for short-term gains” which sounded grand and worked poorly. I know of few instances where once-great funds rebound from several consecutive years in the basement. The question was examined closely by Leigh Walzer of Trapezoid in his December 2015 essay, When Good Managers Go Bad.
3. Lead manager Scott Satterwhite is retiring in October. The transition has been underway for a long while now but (a) it’s still epochal and (b) performance during the transition has not been noticeable better.

I may surrender to Ed’s desire to have me simplify my portfolio. (Does he simplify his? No, not so far as I can tell.) That might mean moving the MACSX money into Seafarer. Maybe closing out a couple smaller holdings because they’re not financially consequential. My asset allocation is a bit overweight in international stocks right now, so I’m probably going to move some into domestic smaller caps. (Yes, I know. I’ve read the asset class projections but my time horizon is still longer than five to seven years.) And making some progress in debt reduction (I took out a home equity loan to handle some fairly-pressing repairs) would be prudent.

Get on with life. I’m planning on resuming my War on Lawns this spring. I’m having a Davenport firm design a rain garden, an area designed to slow the rush of water off my property during storms, for me and I’ll spend some weeks installing it. I’ll add a bunch of native plants, mostly pollinator-friendly, to another corner once overrun by lawn. Together, I think they’ll make my space a bit more sustainable. Baseball season (which my son interprets as “I need expensive new stuff” season) impends. I really need to focus on strengthening MFO’s infrastructure, now that more people are depending on it. And my academic department continues to ask, “how can we change our teaching to help raise diverse, first-generation college students to that same level of achievement that we’ve traditionally expected?” That’s exhausting but exciting because I think, done right, we can make a huge difference in the lives of lots of bright kids who’ve been poorly served in some of their high schools. As a kid whose parents never had the opportunity to finish high school (World War Two interrupted their teen years), my faith in the transformative power of teaching remains undimmed.

It’ll be a good year.

Emerging markets: About as cheap as it gets

In the course of our conversation about Leuthold Core Investment (LCORX), Doug Ramsay shared the observation that emerging markets stocks are painfully cheap. Leuthold’s chart, below, shows the price/earnings ratio based on five-year normalized earnings for E.M. stocks from 2004 to now. Valuations briefly touched a p/e of 31 in 2007 then fell to 8 within a year. As we end January 2016, prices for E.M. stocks hover within a point of their market-crisis lows.

And still Leuthold’s not investing in them. Their E.M. exposure in Core and Global (GLBLX) are both near all-time lows because their analytics don’t (yet) show signs of a turnaround. Still, Mr. Ramsay notes, “they look impossibly cheap.”

Investing in five-star funds? It’s not as daft as you’d think

We asked the good folks at Morningstar if they’d generate a list of all five-star funds from ten years ago, then update their star ratings from five years ago and today. I’d first seen this data several years ago when it had been requested by a Wall Street Journal reporter and shared with us. The common interpretation is “it’s not worth it, since five-star funds aren’t likely to remain five-star funds.”

I’ve always thought that was the wrong concern. Really, I’m less concerned about whether my brilliant manager remains absolutely brilliant than whether he turns wretched. Frankly, if my funds kept bouncing between “reasonable,” “pretty good” and “really good,” I’d be thrilled. That is, if they stay in the three- to five-star range over time, that’s perfectly respectable.

Chip took the data and converted it into a pivot table. (Up until then, I thought “pivot table” was just another name for a “lazy Susan.” Turns out it’s actually a data visualization tool. Who knew?)

Here’s how to read it. There were 354 five-star funds in 2005. Of those, only 16 fell to one-star by 2010. You can see that in the top-center box. Of those 16 one-star funds, none rebounded to five stars by 2015 and only two made it back to four stars. On the upside, 187 of the original 354 remained four- or five-star funds across the whole time period and 245 of 354 never dropped below three stars.

We clearly need to do some refinement of the data to see whether a few categories are highly resilient (for example, single-state muni bond funds might never change their star ratings) and, thus, skewing the results. On whole, though, it seems clear that “first to worst” is a pretty low probability outcome and “first to kinda regrettable” isn’t hugely more likely.

The original spreadsheet is in the Commentary section at MFO Premium, for what interest that holds.

This Time It Really Is Different!

“Every revolution evaporates and leaves behind only the slime of a new bureaucracy.”

 Kafka

So, time now for something of a follow-up to my suggestion of a year ago that a family unit should own no more than ten mutual funds. As some will recall, I was instructed by “She Who Must Be Obeyed” to follow my own advice and get our own number of fund investments down from the more than twenty-five where it had been. We are now down to sixteen, which includes money market funds. My first observation would be that this is not as easy to do as I thought it would be, especially when you are starting from something of an ark approach (one of these, two of those). It is far easier to do when you start to build your portfolio from scratch, when you can be ruthless about diversification. That is, you don’t really need two large cap growth or four value funds. You may only add a new fund if you get rid of an old fund. You are quite specific about setting out the reasons for investing in a fund, and you are equally disciplined about getting rid of it when the reasons for owning it change, e.g. asset bloat, change in managers, style drift, no fund managers who are in Boston, etc., etc.

Which brings me to a point that I think will be controversial – for most families, mutual fund ownership should be concentrated in tax-exempt (retirement accounts) if taxes matter. And mutual fund ownership in retirement accounts should emphasize passive investments to maximize the effects of lower fees on compounding. It also lessens the likelihood of an active manager shooting himself or herself in the foot by selling the wrong thing at the wrong time because of a need to meet redemptions, or dare I suggest it, panic or depression overwhelm the manager’s common sense in maintaining an investment position (which often hits short seller specialists more than long only investors, but that is another story for another day).

The reasons for this will become clearer as holdings come out for 12/31 and 3/31, as well as asset levels (which will let you know what redemptions are – the rumor is that they are large). It will also become pretty clear as you look at your tax forms from your taxable fund accounts and are wondering where the money will come from to pay the capital gains that were triggered by the manager’s need to raise funds (actually they probably didn’t need to sell to meet redemptions as they all have bank lines of credit in place to cover those periods when redemptions exceed cash on hand, but …..).

The other thing to keep in mind about index funds that are widely diversified (a total market fund for instance) – yes, it will lag on the upside against a concentrated fund that does well. But it will also do better on the downside than a concentrated fund that does not do well. Look at it this way – a fifty stock portfolio that has a number of three and four per cent positions, especially in the energy or energy services sector this past year, that has seen those decline by 50% or more, has a lot of ground to make up. A total stock market portfolio that has a thousand or more positions – one or two or twenty or thirty bad stocks, do not cripple it. And in retirement accounts, it is the compounding effect that you want. The other issue of course is that the index funds will stay fully invested in the indices, rather than be caught out underinvested because they were trying to balance out exiting positions with adding positions with meeting redemptions. The one exception here would be for funds where the inefficiencies of an asset class can lead to a positive sustainable alpha by a good active manager – look for that manager as one to invest with in either taxable or tax-exempt accounts.

China, China, China, All the Time

In both the financial print press and the financial media on television and cable, much of the “blame” for market volatility is attributed to nervousness about the Chinese economy, the Chinese stock market, in fact everything to do with China. There generally appear to be two sorts of stories about China these days. One recurring theme is that they are novices at capital markets, currencies, as well as dealing with volatility and transparency in their markets, and that this has exacerbated trends in the swings in the Shanghai market, which has spread to other emerging markets. Another element of this particular them is that China’s economy is slowing and was not transparent to begin with, and that lack of growth will flow through and send the rest of the world into recession. Now, mind you, we are talking about economic growth that by most accounts, has slowed from high single digits recently (above 7%) to what will be a range going forward of low to still mid-single digits (4 – 7%).

I think a couple of comments are in order about this first theme. One, the Shanghai market has very much been intended as a punter’s market, where not necessarily the best companies are listed (somewhat like Vancouver in Canada twenty-odd years ago). The best companies in China are listed on the Hong Kong market – always have been, and will continue to be for the foreseeable future. The second thing to be said is that if you think things happen in China by accident or because they have lost control, you don’t understand very much about China and its thousands of years of history. Let’s be realistic here – the currency is controlled, interest rates are controlled, the companies are controlled, the economy is controlled – so while there may be random events and undercurrents going on, they are probably not the ones we are seeing or are worried about.

This brings me to the second different theme you hear about China these days, which is that China and the Chinese economy have carried the global economy for the last several years, and that even last year, their contribution to the world economy was quite substantial. I realize this runs counter to stories that you hear emanating from Washington, DC these days, but much that you hear emanating from Washington now is quite surreal. But let’s look at a few things. China still has $3 trillion dollars of foreign exchange reserves. China does not look to be a debtor nation. China has really not a lot of places left to spend money domestically since they have a modern transportation infrastructure and, they have built lots of ghost cities that could be occupied by a still growing population. And while China has goods that are manufactured that they would like to export, the rest of the world is not in a buying mood. A rumor which I keep hearing, is that they have more than 30,000 metric tons of gold reserves with which to back their currency, should they so choose (by comparison, the US as of October 2014 was thought to have about 4,200 metric tons in Fort Knox).

For those familiar with magic shows and sleight of hand tricks, I think this is what we are seeing now. Those who watch the cable financial news shows come away with the impression that the world is ending in the Chinese equity markets, and that will cause the rest of the world to end as well. So while you are watching that, let’s see what you are missing. We have a currency that has become a second reserve currency to the world, supplanting the exclusive role of the U.S. dollar as countries that are commodity economies now price their commodities and do trade deals in Chinese currency. And, notwithstanding that, the prices of commodities have fallen considerably, we continue to see acquisition and investment in the securing of commodities (at fire sale prices) by China. And finally, we have a major expansion by China in Africa, where it is securing arable land to provide another bread basket for itself for the future, as well as an area to send parts of it population.

And let me suggest in passing that the one place China could elect to spend massively in their domestic economy is to build up their defense establishment far beyond what they have done to date. After all, President Reagan launched a massive arms build-up by the US during his terms in office, which in effect bankrupted the Soviets as they tried to keep up. One wonders whether we would or could try to keep up should China elect to do the same to us at this point.

So, dear readers, I will leave it to you to figure out which theme you prefer, although I suspect it depends on your time horizon. But let me emphasize again – looking at the equity markets in China means looking at the wrong things. By the end of this year, we should have a better sense of whether the industrial economy is China has undergone a rather strong recovery, driven by the wealth of a growing middle class (which is really quite entrepreneurial, and which to put it into context, should be approaching by the end of this year, 400M in size). And it will really also become clear that much of the capital that has been rumored to be “fleeing” China has to be split out to account for that which is investment in other parts of the world. Paying attention to those investment outflows will give you some insight as to why China still thinks of and refers to itself as, “The Middle Kingdom.”

— by Edward A. Studzinski

Looking for Bartolo Colon

by Leigh Walzer

Bartolo Colon is a baseball pitcher; he is the second oldest active major leaguer.  Ten years ago he won the coveted Cy Young award. Probably no investment firm has asked Colon for an endorsement but maybe they should. More on this shortly.

FROM THE MAILBAG:

A reader in Detroit who registered but has not yet logged into www.Fundattribution.com  writes: “We find little use for back tested or algorithmic results [and prefer an] index-based philosophy for clients.” 

Index funds offer a great approach for anyone who lacks the time or inclination to do their homework. We expect they will continue to gain share and pressure the fees of active managers.

Trapezoid does not advocate algorithmic strategies, as the term is commonly used. Nor do we oppose them. Rather, we rigorously test portfolio managers for skill. Our “null hypothesis” is that a low-cost passive strategy is best. We look for managers which demonstrate their worth, based on skill demonstrated over a sufficient period of time. Specifically, Honor Roll fund classes must have a 60% chance of justifying their expenses. Less than 10% of the fund universe satisfies this test.  Trapezoid does rate some quantitative funds, and we wrote in the November edition of Mutual Fund Observer about some of the challenges of evaluating them.

We do rely on quantitative methods, including back testing, to validate our tests and hone our understanding of how historic skill translates into future success.

VULCAN MIND MELD

A wealth manager (and demo client) from Denver asks our view of his favorite funds, Vulcan Value Partners (VVPLX). Vulcan was incepted December 2009.Prior to founding Vulcan, the manager, C.T. Fitzpatrick, worked for many years at Southeastern under famed value investor O. Mason Hawkins.  Currently it is closed to new investors.

VVPLX has performed very well in its 6 years of history. By our measure, investors accumulated an extra 20% compared to index funds based on the managers’ stock selection skill alone. We mentioned it favorably in the October edition of MFO.

Vulcan’s expense structure is 1.08%, roughly 90bps higher than an investor would require to hold a comparable ETF. Think of that as the expense premium to hire an active manager. Based on data through October, we assigned VVPLX a 55% probability of justifying its active expense premium. (This is down from 68% based on our prior evaluation using data through July 2015 and places them outside the Honor Roll.)

The wealth manager questioned why we classify VVPLX as large blend?  Vulcan describes itself as a value manager and the portfolio is heavily weighted toward financial services.

VVPLX is classified as large blend because, over its history, it has behaved slightly more like the large blend aggregate than large value. We base this on comparisons to indices and active funds. One of our upcoming features identifies the peer funds, both active and passive, which most closely resemble a given fund. For a majority of our funds, we supplement this approach by looking at historic holdings. We currently consider factors like the distribution of forward P/E ratios over time. Our categorization and taxonomy do not always conform to services like Morningstar and Lipper, but we do consider them as a starting point, along with the manager’s stated objective.  We frequently change classifications and welcome all input. While categories may be useful in screening for managers, we emphasize that the classifications have no impact on skill ratings, since we rely 100% on objective criteria such as passive indices.

The client noted we identified a few managers following similar strategies to VVPLX who were assigned higher probabilities. How is this possible considering VVPLX trounced them over its six-year history?

Broadly speaking, there are three reasons:

• Some of the active managers who beat out VVPLX had slightly lower expenses.
• While VVPLX did very well since 2010, some other funds have proven themselves over much longer periods. We have more data to satisfy ourselves (and our algorithms) that the manager was skillful and not just lucky. 
• VVPLX’s stock selection skill was not entirely consistent which also hurts its case. From April to October, the fund recorded negative skill of approximately 4%. This perhaps explain why management felt compelled to close the fund 4/22/15.

Exhibit I

		Mgr. Tenure	sS*	sR*	Proj.  Skill (Gross)	Exp.	∆	±	Prob.
Boston Partners All-Cap Value Fund [c]	BPAIX	2005	1.4%	0.3%	0.88%	0.80%(b)	23	1.5%	56.1
Vulcan Value Partners Fund	VVPLX	2010	3.8%	1.5%	1.19%	1.08%	.25	1.8%	55.2

1. Annualized contribution from stock selection or sector rotation over manager tenure
2. Expenses increased recently by 10bps as BPAIX’s board curtailed the fee waiver
3. Closed to new investors

Exhibit II: Boston Partners All-Cap Value Fund

Exhibit I compares VVPLX to Boston Partners All-Cap Value Fund. BPAIX is on the cusp of value and blend, much like VVPLX. Our model sees a 56.1% chance that the fund’s skill over the next 12 months will justify its expense structure. According to John Forelli, Senior Portfolio Analyst, the managers screen from a broader universe using their own value metrics. They combine this with in-depth fundamental analysis. As a result, they are overweight sectors like international, financials, and pharma relative to the Russell 3000 (their avowed benchmark.) Boston Partners separately manages approximately $10 billion of institutional accounts which closely tracks BPAIX.

Any reader with the www.fundattribution.com demo can pull up the Fund Analysis for VVPLX.  The chart for BPAIX is not available on the demo (because it is categorized in Large Value) so we present it in Exhibit II.  Exhibit III presents a more traditional attribution against the Russell 3000 Value Fund. Both exhibits suggest Boston Partners are great stock pickers. However, we attribute much less skill to Allocation because our “Baseline Return” construes they are not a dyed-in-the-wool value fund.

VVPLX has shown even more skill over the manager’s tenure than BPAIX and is expected to have more skill next year^[1]. But even if VVPLX were open, we would prefer BPAIX due to a combination of cost and longer history. (BPAIX investors should keep an eye on expenses: the trustees recently reduced the fee waiver by 10bps and may move further next year.)

Trapezoid has identified funds which are more attractive than either of these funds. The Trapezoid Honor Roll consists of funds with at least 60% confidence. The methodology behind these findings is summarized at here.

^[1] 12 months ending November 2016.

VETERAN BENEFITS

Our review of VVPLX raises a broader question. Investors often have to choose between a fund which posted stellar returns for a short period against another whose performance was merely above average over a longer period.

For those of you who watched the World Series a few months ago, the NY Mets had a number of very young pitchers with fastballs close to 100 miles per hour.  They also had some veteran pitchers like John Niese and the 42-year-old ageless wonder Bartolo Colon who couldn’t muster the same heat but had established their skill and consistency over a long period of time. We don’t know whether Bartolo Colon drank from the fountain of youth; he served a lengthy suspension a few years ago for using a banned substance. But his statistics in his 40s are on par with his prime ten year ago.  

Unfortunately, for every Bartolo Colon, there is a Dontrelle Willis. Willis was 2003 NL Rookie of the year for the Florida Marlins and helped his team to a World Series victory. He was less effective his second year but by his third year was runner up for the Cy Young award. The “D-Train” spent 6 more years in the major leagues; although his career was relatively free of injuries, he never performed at the same level.

Extrapolating from a few years of success can be challenging. If consistency is so important to investors, does it follow that a baseball team should choose the consistent veterans over the promising but less-tested young arms?

Sometimes there is a tradeoff between expected outcome (∆) and certitude (±).  The crafty veteran capable of keeping your team in the game for five innings may not be best choice in the seventh game of the World Series; but he might be the judicious choice for a general manager trying to stretch his personnel budget. The same is true for investment managers. Vulcan may have the more skillful management team. But considering its longevity, consistency, and expense Boston Partners is the surer bet.

HOW MUCH IS ENOUGH

How long a track record is needed before an investor can bet confident in a portfolio manager? This is not an easy question to answer.

In the December edition of MFO (When_Good_Managers_Go_Bad) we profiled the Clearbridge Aggressive Growth fund which rode one thesis successfully for 20 years. Six years of data might tell us less about them than a very active fund.   

Here is one stab at answering the question.  We reviewed the database to see what percentage of fund made the Trapezoid Honor Roll as a function of manager tenure. 

Recall the Trapezoid Honor Roll consists of fund classes for which we have 60% confidence that future skill will justify expense structure.  In Exhibit IV the Honor Roll fund classes are shown in blue while the funds we want no part of are in yellow.  16% of those fund classes where the manager has been on the job for twenty-five years make the Honor Roll compared with just 2% for those on the job less than three years.  The relationship is not a smooth line, but generally managers with more longevity give us more data points allowing us to be more confident of their skill.. or more likely persuade us they lack sufficient skill. 

There is an element of “survivorship” bias in this analysis. Every year 6% of funds disappear; generally, they are the smallest or worst performers. “All-stars” managers are more likely to survive for 20 years. But surprisingly a lot of “bad” managers survive for a long time. The percentage of yellow funds increases just as quickly as the blue.

It seems reasonable to ask why so many “bad” managers survive in a Darwinian business. We surveyed the top 10. (Exhibit V) We find that in the aggregate they have a modicum of skill, but nowhere sufficient to justify what they charge.  We can say with high confidence all these investors would be better off in index funds or (ideally) the active managers on the Trapezoid honor roll.

We haven’t distinguished between a new manager who takes over an old fund and a brand new fund. Should investors abandon all their confidence when a good manager retires and passes the baton? Should investors give the fund a mulligan when a poor performer is replaced?  Probably not.  From a review of 840 manager changes with sufficient data (Exhibit VI), strong performers tend to remain strong which suggests we may gain confidence by considering the track record of the previous manager.

The “rookie confidence” problem is a challenge for investors. The average manager tenure is about six years and only a quarter of portfolio managers have been on the job longer than 10 years. It is also a challenge for asset managers marketing a new fund or a new manager of an existing fund.  Without a long track record, it is hard to tell if a fund is good – investors have every incentive to stick with the cheaper index fund.  Asset managers incubate funds to give investors a track record but studies suggest investors shouldn’t take much comfort from incubated track records. (Richard Evans, CFA Digest, 2010.) We see many sponsors aggressively waiving fees for their younger funds.  Investors will take comfort when the individuals have a prior track record at another successful fund.  C.T. Fitzpatrick’s seventeen years’ experience under Mason Hawkins seems to have carried over to Vulcan.

BOTTOM LINE:  It is hard to gain complete trust that any active fund is better than an index fund. It is harder when a new captain takes the helm, and harder yet for a brand new fund. The fund with the best five-year record is not necessarily the best choice. Veteran managers are over represented in the Trapezoid Honor Roll — for good reason.

Unlike investing, baseball will always have rookies taking jobs from the veterans. But in 2016 we can still root for Bartolo Colon.

Why are investors so bad at picking alternatives?

By Sam Lee, principal of Severian Asset Management and former editor of Morningstar ETF Investor.

Gateway (GATEX) is the $8 billion behemoth of the long-short equity mutual fund category, and one of the biggest alternative mutual funds. I’ve long marveled at this fund’s size given its demonstrable lack of merit as a portfolio diversifier. Over the past 10 years the fund has behaved like an overpriced, underperforming 40% stock, 60% cash portfolio. Its R-squared over this period to the U.S. stock market index is 0.85.

Not only is its past performance damning, but little in the substance of the strategy suggests performance will radically change. Gateway owns a basket of stocks designed to track the S&P 500, with a slight dividend tilt. On this portfolio the managers sell calls on the S&P 500, capping the potential upside of the fund in exchange for a premium up front, and simultaneously buy puts, capping the potential downside of the fund at the cost of a premium up front. By implementing this “collar” strategy, the managers protect the portfolio from extreme ups and downs.

There is another way to soften volatility: Own less equities and more cash—which is pretty much what this fund achieves in a roundabout manner.

Portfolio theory says that an investment is only attractive to the extent that it improves the risk-adjusted return of a portfolio. That means three things matter for each asset: expected return, expected volatility, and expected correlation with other assets in the portfolio. The first two are intuitive, but many investors neglect the correlation piece. A low return, high volatility asset can be an excellent investment if it has a low enough correlation with the rest of the portfolio.

Consider an asset that’s expected to return 0% with stock-like volatility and a perfectly negative correlation to the stock market (meaning it moves in the opposite direction of the market without fail). Many investors, looking at the asset’s standalone returns and volatility, would be turned off. Someone fluent in portfolio theory would salivate. Assume the expected excess return of the stock market is 5%. If you own the stock market and the negatively correlated asset in equal measure, the portfolio’s expected excess return halves to 2.5% and its expected volatility drops to 0%. Apply some leverage to double the portfolio’s return and you end up with a 5% expected excess return with no volatility.

In practice, many investors do not assess assets from the portfolio perspective. They fixate on standalone return and volatility. Much of the time this is a harmless simplification. But it can go wrong when assessing alternatives, such as with Gateway. Judged by its Sharpe ratio and other risk-adjusted measures, Gateway looks like a reasonable investment. Judged by its ability to enhance a portfolio’s risk-adjusted return, it falls flat.

I don’t believe individual investors are responsible for Gateway’s size. If anything, institutional investors (particularly RIAs) are to blame. You would think that supposedly sophisticated investors would not fall into this trap. But they do. A large part of the blame belongs to committee-driven investment processes, which dominate institutional money management. When a committee is responsible for a portfolio, they often hire consultants. These consultants in turn promise to help members of the committee avoid getting fired or sued.

In this context, the consultants like to create model portfolios that have predefined allocations to investment types—X% in large growth, Y% in small-cap value, Z% in long-short equity, and so on—and then find suitable managers within those categories. When picking those managers, they tend to focus on return and volatility as well as performance relative to peers. If not done carefully, a fund like Gateway gets chosen, despite its utter lack of diversifying power.

 

Smallest, Shortest, Lowest

David invariably cuts to the chase when it comes to assessing mutual funds. It’s a gift he shares with us each month.

So, in evolving the MFO Premium site, he suggested we provide lists of funds satisfying interesting screening criteria to help users get the most from our search tools.

Last month we introduced two such lists: “Best Performing Rookie Funds” and “Dual Great Owl & Honor Roll Funds.”

This month our MultiSearch screener incorporates three more: “Smallest Drawdown Fixed Income Funds,” “Shortest Recovery Time Small Caps,” and “Lowest Ulcer Moderate Allocation Funds.”

Smallest Drawdown Fixed Income Funds generates a list of Fixed Income (e.g., Bond, Muni) funds that have experienced the smallest levels of Maximum Drawdown (MAXDD) in their respective categories. More specifically, they are in the quintile of funds with smallest MAXDD among their peers.

Looking back at performance since the November 2007, which represents the beginning of the current full market cycle, we find 147 such funds. Two top performing core bond funds are TCW Core Fixed-Income (TGCFX) and RidgeWorth Seix Total Return (SAMFX). The screen also uncovered notables like First Pacific Advisors’ FPA New Income (FPNIX) and Dan Ivascyn’s PIMCO Income (PIMIX).

Here are some risk/return metrics for these Fixed Income funds (click on images to enlarge):

TCW Core Fixed-Income (TGCFX) and RidgeWorth Seix Total Return (SAMFX)

First Pacific Advisors’ FPA New Income (FPNIX)

PIMCO Income (PIMIX)

Shortest Recovery Time Small Caps generates a list of Small Cap (Small Core, Small Value, Small Growth) funds that have incurred shortest Recovery Times (number of months a fund retracts from previous peak) in their respective categories.

For Full Cycle 5, this screen produces 62 such funds through December 2015. Among the best performing funds with shortest Recovery Times, under 30 months, only one remains open and/or accessible: Queens Road Small Cap Value (QRSVX). It was profiled by David in April 2015.

Here’s a short list and risk/return numbers for QRSVX across various timeframes:

Queens Road Small Cap Value (QRSVX)

Lowest Ulcer Moderate Allocation Funds generates a list of Mixed Asset Moderate Allocation funds that have incurred the lowest Ulcer Indices in their respective categories. 

Topping the list (fund with lowest UI) is James Balanced: Golden Rainbow (GLRBX), profiled last August :

The Alt Perspective: Commentary and news from DailyAlts.

We can all be thankful that January 2016 is over. I am at a point in my life where I don’t really enjoy rollercoaster rides, of any sort, as much as I did when I was younger. And this past month has been nothing short of a financial rollercoaster. In many ways, however, it shouldn’t have been a surprise that investors decided to take some air out of the balloon.

In a grand experiment, the central banks around the world have been pumping hot air into the global market balloon since November 2008. But the U.S. Fed officially took its foot off the gas pedal and applied a bit of light pressure to the brakes with its scant rate rise in December. And on top of that, China’s slowdown has raised concerns of contagion, and its equity markets have taken the brunt of that concern.

With all of the re-adjustments of market expectations and valuations currently taking place, 2016 may turn out to be quite a good year to be invested in alternatives.

Performance Review

Let’s start with traditional asset classes for the month of January 2015, where the average mutual fund for all of the major equity markets (per Morningstar) delivered negative performance in the month:

• Large Blend U.S. Equity: -6.95%
• Small Blend U.S. Equity: -9.18%
• Foreign Equity Large Blend: -7.32%
• Diversified Emerging Markets: -6.46%
• Intermediate Term Bond: 0.94%
• World Bond: -0.03%
• Moderate Allocation: -4.36%

Now a look at the liquid alternative categories, per Morningstar’s classification. Only Managed Futures and Bear Market funds generated positive returns in January, as one would expect. Long/Short Equity was down more than expected, but with small cap stocks being down just over 9%, it is not a surprise. Multi-alternative funds held up well, as did market neutral funds.

• Long/Short Equity: -4.18%
• Non-Traditional Bonds: -1.15%
• Managed Futures: 2.34%
• Market Neutral: -0.22%
• Multi-Alternative: -1.65%
• Bear Market: 11.92%

And a few non-traditional asset classes, where none escaped January’s downdraft:

• Commodities: -3.01%
• Multi-Currency: -0.49%
• Real Estate: -5.16%
• Master Limited Partnerships: -9.77%

Overall, a mixed bag for January.

Asset Flows

One of the more surprising aspects of 2015 was the concentration of asset flows into multi-alternative funds and managed futures funds. All other categories of funds, except for volatility funds, experienced outflows over the full twelve months of 2015, as documented in the below chart:

And despite the massive outflows from non-traditional bonds, the category remains the largest with more than $135 billion in assets. This compares to commodities at $67 billion and multi-alternative at $56 billion.

Hot Topics

Only six new liquid alternative funds were launched in January – four were long/short equity funds, one was a managed futures fund and the sixth was a non-traditional bond fund. Of the six funds, two were ETFs, and fairly innovative ETFs at that. We wrote about their structure in an article titled, Reality Shares Builds Suite of Dividend-Themed ETFs.

On the research front, we published summaries of two important research papers in January, both of which have been popular with readers:

• Using Active Share to Evaluate High-Yield Bond Portfolios – An interesting look at how to use active share to evaluate fixed income portfolios.
• Using Momentum and Hedge Funds to Build a Better Portfolio – It is often documented how hedge funds can help a traditionally allocated portfolio, but this article takes a look at a research paper that proposes something a bit different.

If you would like to keep up with all the news from DailyAlts, feel free to sign up for our daily or weekly newsletter.

I’ll be back next month, and until then, let’s hope the rollercoaster ride that started in January has come to an end.

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.

Cognios Market Neutral Large Cap (COGMX): this tiny fund does what its category is supposed to do, but never has. It makes good money even when the market stinks.

Leuthold Core Investment (LCORX): We celebrate the 20^th anniversary of Leuthold Core, a singularly disciplined and adaptive fund. Just one more year and it will be old enough to drink! We’re hopeful that the markets don’t give it, or us, reason to.

RiverNorth Opportunities (RIV): This is the closed-end fund for serious investors who know there’s a lot of money to be made in the irrational pricing of closed-end funds, but who don’t have the time or expertise to construct such a portfolio on their own.

Launch Alert: Davenport Balanced Income (DBALX)

Most folks haven’t heard of the Davenport Funds, which is understandable but also too bad. Davenport & Company is an employee-owned investment adviser that’s headquartered in Richmond, VA. They’ve been around since 1863 and now “custodies more than $20 billion in assets.” They manage five no-load funds, all somewhere in the solid-to-excellent range. Their newest fund, Davenport Balanced Income, launched on December 30, 2015.

Three things worth knowing:

1. The equity portion of the portfolio mirrors the holdings of the Davenport Value and Income Fund (DVIPX). All Davenport funds target firms with exceptionally high levels of insider equity ownership. Value & Income, in particular, targets three investment themes: Dividend Aristocrats, High Yielders with Capital Appreciation Potential and deep-value Contrarian/Special Situations.
2. Value and Income has performed exceedingly well. The fund just celebrated its fifth anniversary. Morningstar places it in the top 4% of all large value funds since inception. Perhaps more importantly, it significantly outperformed its peers in 2015 and again in 2016’s choppy first month. Since inception, its returns have been about a third higher than its equity income peers while all measures of its volatility have been lower. Based on the conventional measures of risk-adjusted return (Sharpe, Martin and Sortino ratios or Ulcer Index), it’s a Top 20 equity income fund.
3. The equity allocation is fluid, ranging from 25 to 75% of assets. The balance between the two sleeves is determined by the managers’ analysis of “economic trends, changes in the shape of the yield curve and sector analysis.” The income portion of the portfolio is invested for stability rather than appreciation.

John Ackerly, one of Davenport’s directors, claims they have “a long history of developing funds that manage downside risk and produce positive returns … over full market cycles.” The equity portion of the fund is managed by Davenport’s Investment Policy Committee; the fixed-income portion by two of the guys who manage their fixed-income separate accounts. Their managers have, on average, 30 years of experience. Expenses are capped at 1.25%. The minimum initial investment is $5,000 for regular accounts and $2,000 for tax-advantaged ones. More details are at Davenport Asset Management, with the funds linked under the Strategies tab.

Manager Changes

There’s always churn in the manager ranks. This month we tracked down changes at 67 equity or balanced funds. While no cry out “sea change!”, three fairly well-known Fidelity managers – Peter Saperstone, Adam Kutas and Charles Myers – are having their responsibilities changed. Mr. Kutas drops Latin America to focus on EMEA. Mr. Myers takes a six-month leave of absence starting in March. Mr. Saperstone has been steadily moving away for months. I also discovered that I don’t recognize the names of any of the Janus managers (except, of course, Mr. Gross).

Updates

Speaking of Mr. Gross, his Janus Unconstrained Bond (JUCAX) fund’s performance chart looks like this:

So far the fund has been above water for about one month, April 2015, since Mr. Gross came on board. That said, it certainly shows a dogged independence compared to its nontraditional bond peers (the orange line). And it does look a lot better than Miller Income Opportunity Fund (LMCJX), Legg Mason’s retirement gift to former star Bill Miller. Mr. Miller co-manages the fund with his son. Together they’ve managed to lose about 24% for their investors in the same period that Mr. Gross dropped two or three.

Briefly Noted . . .

There was a great thread on our discussion board about the fate of the Berwyn Funds. The Berwyn funds are advised by The Killen Group. The founder, Robert E. Killen, turned 75 and has chosen to sell his firm to the Chartwell Investment Partners. The fear is that Chartwell will use this as an opportunity to vacuum up assets. Their press release on the acquisition reads, in part:

“This transaction creates an investment management firm with annual revenues approaching $50 million and more than $10 billion in assets under management, as part of our well-defined strategy for growing our Chartwell Investment Partners business into a world-class asset manager,” TriState Capital Chief Executive Officer James F. Getz said. “We have an exceptional opportunity to combine Killen’s highly credible investment performance, particularly by the Morningstar five-star rated Berwyn Income Fund, with our proven national financial services distribution model to meaningfully accelerate growth in client assets….”

The fate of Berwyn’s small no-load shareholders seems unresolved.

Thanks, in passing but as always, to The Shadow, the indomitable Ted and the folks on our discussion board. They track down more cool stuff, and think more interesting thoughts, than about any group I know. I browse their work daily and learn a lot.

GoodHaven Fund (GOODX) is reorganizing itself. The key change is that it will have a new board of trustees, rather than relying on a board provided by the Professionally Managed Portfolios trust.

Effective at the end of January, 2016, the Innealta Capital Country Rotation (ICCNX) and Capital Sector Rotation (ICSNX) funds no longer include “consistent with the preservation of capital” as part of their investment objectives.

Manning & Napier has agreed to acquire a majority interest in Rainier Investment Management, the investment adviser to the Rainier Funds. 

Effective February 1, 2016, the T. Rowe Price Mid-Cap Index Fund and the T. Rowe Price Small-Cap Index Fund were added as options for all of the T. Rowe Price Retirement Fund. 

SMALL WINS FOR INVESTORS

Buffalo Emerging Opportunities Fund (BUFOX) and the Buffalo Small Cap Fund (BUFSX) have re-opened to new investors. They were closed for three and six years, respectively. Both funds posted wretched performance in 2014 and 2015 which might be a sign of disciplined investors out of step with an undisciplined market.

The Fairholme Focused Income (FOCIX) and Allocation (FAAFX) funds have reduced their minimum initial investment from $25,000 to $10,000.

Effective January 29, 2016, the redemption fee for the TCM Small Cap Growth Fund (TCMSX) was removed and the fund reduced its minimum initial investment from $100,000 to $2,500. It’s actually a pretty solid little small-growth fund.

Tweedy, Browne Global Value Fund II -Currency Unhedged (the “Fund”) reopened to new investors on February 1, 2016.

Effective as of January 1, 2016, the Valley Forge Fund’s (VAFGX) advisor, Boyle Capital Management, LLC, has voluntarily agreed to waive the full amount of its management fee. The voluntary waiver may be discontinued at any time. It was always a cute, idiosyncratic little fund run by a guy named Bernie Klawans. The sort of fund that had neither a website nor an 800 number. Bernie passed away at age 90, having run the fund until the last six months of his life. His handpicked successor died within the year. The Board of Trustees actually ran the fund for six months. Their eventual choice for a new manager did okay for a year, then performance fell off a cliff in the middle of 2014.

It’s never recovered and the fund is down to $7 million in assets, down by two-thirds since Mr. Klawan’s passing.

Vanguard Treasury Money Market Fund (VUSXX) has re-opened to all investors without limitations. It’s been charging four basis points and returning one basis point a year for the past three.

CLOSINGS (and related inconveniences)

AQR Style Premia Alternative Fund and AQR Style Premia Alternative LV Fund will both close to new investors on March 31, 2016. AQR’s Diversified Arbitrage Risk Parity and Multi-Strategy Alternative funds closed in 2012 and 2013. Sam Lee did a really strong analysis of the two Style Premia funds in our September 2015 issue.

Ziegler Strategic Income Fund (ZLSCX) has liquidated its Investor share class and has converted the existing Investor Class accounts into institutional accounts.

OLD WINE, NEW BOTTLES

The American Independence funds announced five name changes, including shortening American Independence to AI.

Old Name	New Name
American Independence JAForlines Risk-Managed Allocation	AI JAForlines Risk-Managed Allocation
American Independence International Alpha Strategies	AI Navellier International
American Independence Boyd Watterson Core Plus	AI Boyd Watterson Core Plus
American Independence Kansas Tax-Exempt Bond	AI Kansas Tax-Exempt Bond
American Independence U.S. Inflation-Indexed	AI U.S. Inflation-Protected

Aston Small Cap Fund (ATASX) – formerly Aston TAMRO Small Cap – is soon-to-be AMG GW&K Small Cap Growth Fund.

On January 28, 2016, Centre Global Select Equity Fund became Centre Global ex-U.S. Select Equity Fund (DHGRX). Not entirely sure why “Global ex-US” isn’t “International,” but maybe they had some monogrammed stationery that they didn’t want to throw out.

Effective on February 19, 2016, Columbia Intermediate Bond Fund (LIBAX) becomes Columbia Total Return Bond Fund. 

On February 1, 2016, Ivy Global Real Estate Fund (IREAX) became Ivy LaSalle Global Real Estate Fund, and Ivy Global Risk-Managed Real Estate Fund changed to Ivy LaSalle Global Risk-Managed Real Estate Fund (IVRAX). For the past three years, both funds have been sub-advised by Lasalle Investment Management. IVRAX has performed splendidly; IREAX, not so much.

Silly reader. You thought it was Touchstone Small Cap Core Fund. Actually it’s just Touchstone Small Cap Fund (TSFAX). Now, anyway.

OFF TO THE DUSTBIN OF HISTORY

“Because of the difficulty encountered in distributing the Fund’s shares,” 1492 Small Cap Core Alpha Fund (FNTSX) will liquidate on February 26, 2016. The fact that it’s not very good probably contributed to the problem.

American Beacon Retirement Income and Appreciation Fund and American Beacon Treasury Inflation Protected Securities Fund ( ) will be liquidated and terminated on March 31, 2016. Presumably that’s part of the ongoing house-cleaning as American Beacon tries to reposition itself as a sort of alternatives manager.

Anfield Universal Fixed Income Fund (AFLEX) liquidated two of its share classes (A1 and R) on February 1, 2016. Rather than moving those investors into another share class, they received a check in the mail and a tax bill. Odd. 

ASTON/TAMRO International Small Cap Fund (AROWX) liquidated on February 1, 2016. On the one hand, it only had $2 million in assets. On the other, the adviser pulled the plug after just a year. The manager, Waldemar Mozes, is a bright guy with experience at Artisan and Capital Group. He jokingly described himself as “the best fund manager ever to come from Transylvania.” We wish him well.

Columbia Global Inflation-Linked Bond Plus Fund liquidated after very short notice, on January 29, 2016.

Gator Opportunities Fund (GTOAX) thought it had to hang on until March 21, 2016. The board has discovered that a swifter execution would be legal, and now it’s scheduled to disappear on February 15, 2016.

Hodges Equity Income Fund (HDPEX) will merge into Hodges Blue Chip Equity Income Fund (currently named the Hodges Blue Chip 25 Fund HDPBX) at the end of March, 2016.

Its board simultaneously announced new managers for, and liquidation of, KF Griffin Blue Chip Covered Call Fund (KFGAX). The former occurred on January 6, the latter is slated for February 16, 2016.

Madison Large Cap Growth Fund (MCAAX) merges into Madison Investors (MNVAX) on February 29, 2016,

Don’t blink: McKinley Non-U.S. Core Growth Fund (MCNUX) will be gone by February 5, 2016. It was an institutional fund with a minimum investment of $40 million and assets of $37 million, so ….

Midas Magic (MISEX) and Midas Perpetual Portfolio (MPERX) are both slated to merge into Midas Fund (MIDSX). In reporting their taxable distributions this year, Midas announced that “One of Midas’ guiding principles is that we will communicate with our shareholders and prospective investors as candidly as possible because we believe shareholders and prospective investors benefit from understanding our investment philosophy and approach.” That makes it ironic that there’s no hint about why they’ve folding a diversified equity fund and a tactical allocation fund into a gold portfolio with higher fees than either of the other two.

We previously noted the plan to merge the Royce European Small-Cap and Global Value funds into Royce International Premier, pending shareholder approval. The sheep baa’ed shareholders approved the mergers, which will be executed sometime in February, 2016.

On March 24, 2016, Sentinel Mid Cap Fund (SNTNX) will be absorbed by Sentinel Small Company Fund (SAGWX), which have “identical investment objectives and similar investment strategies.” That’s a clear win for the investors, give or take any actual interest in investing in mid-caps. At the same time, Sentinel Sustainable Mid Cap Opportunities Fund (WAEGX) will be absorbed into Sentinel Sustainable Core Opportunities Fund (MYPVX).

TeaLeaf Long/Short Deep Value Fund (LEFAX) closed on January 25 and liquidated on January 29, 2016.

I’m okay with the decision to liquidate UBS U.S. Equity Opportunity Fund (BNVAX): it’s a tiny fund that’s trailed 98% of its peers over the past decade. The UBS board decided you needed to hear their reasoning for the decision, which they included in a section entitled:

Rationale for liquidating the Fund

Based upon information provided by UBS Asset Management (Americas) Inc., the Fund’s investment advisor, the Board determined that “it is in the best interests of the Fund and its shareholders to liquidate and dissolve the Fund pursuant to a Plan of Liquidation (the “Plan”). To arrive at this decision, the Board considered factors that have adversely affected, and will continue to adversely affect, the ability of the Fund to conduct its business and operations in an economically viable manner.”

Quick note to the board: that’s not a rationale. It’s a conclusion (“it’s in your best interest”) and a cryptic passage about the process “we considered factors.”

The Board of Trustees of Monetta Trust has concluded “that it would be in the best interests of the Fund and its shareholders” to liquidate Varsity/Monetta Intermediate Bond Fund (MIBFX), which will occur on February 18, 2016.

Vivaldi Orinda Hedged Equity Fund (OHEAX) is victim of its advisor’s “strategic decision to streamline its product offerings.” The fund will liquidate on February 26, 2016.

Voya Emerging Markets Equity Dividend Fund (IFCAX) will liquidate on April 8, 2016.

In Closing . . .

Please do double-check to see if you’ve set our Amazon link as a bookmark or starting tab in your browser. From Christmas 2014 to Christmas 2015, Amazon’s sales rose 60% but our little slice of the pie fell by 15% in the same period. We try not to be too much of a pesterance on the subject, but the Amazon piece continues as a financial mainstay so it helps to mention it.

If you’re curious about how the Amazon Associates program works, here’s the short version: if you enter Amazon using our link, an invisible little piece of text (roughly: “for the benefit of MFO”) follows you. When you buy something, that tag is attached to your order and we receive an amount equivalent to 6% or so of the value of the stuff ordered. It’s invisible and seamless from your perspective, and costs nothing extra. Sadly the tag expires after a day so if you put something in your cart on Guy Fawkes Day and places the order on Mardi Gras, the link will have expired.

Thanks, too, to the folks whose ongoing support makes it possible for us to keep the lights on (and even to upgrade them to LEDs!). That includes the growing cadre of folks using MFO Premium but also Paul R and Jason B, our most faithful subscribers Deb and Greg, the good folks at Andrei Financial and Gardey Financial and Carl R. (generous repeat offenders in the “keep MFO going” realm).

We’re about 90% done on a profile of the “new” LS Opportunity Fund (LSOFX), so that’s in the pipeline for March. Readers and insiders both have been finding interesting options for us to explore which, with Augustana’s spring break occurring in February, I might actually have time to!

We’ll look for you.