Dear friends,

We really hope you enjoy the extra start-of-summer profundity that we’ve larded (excuse the expression) into this issue. We took advantage of the extra time afforded by the June 30^th leap second and the extra light generated that night by the once-in-two-millennia conjunction of Venus and Jupiter to squeeze in a family-sized portion of insight into this month’s issue.

And it all started with Morningstar.

Mania at the McCormick!

Morningstar’s annual investor conference is always a bit of a zoo. Two thousand people jam together in a building the size of a shopping mall, driven by a long schedule and alternating doses of caffeine (6:00 a.m. to 6:00 p.m.) and alcohol (thereafter). There are some dozens of presentations, ranging from enormously provocative to freakish, mostly by folks who have something to sell but, for the sake of decorum, are trying not to mention that fact.

Okay: the damned thing’s a lot bigger than any shopping mall except the Mall of America. MoA has about 4.2 million square feet total, McCormick is around 3.4 million. We were in the West Building, whose main ballroom alone runs to 100,000 square feet. 500,000 square feet of exhibition space, 250,000 of meeting space, with something like 60 meeting rooms. That building alone cost about $900 million, and McCormick has three others.

What follows are three sets of idiosyncratic observations: mine, Charles and Ed’s. I’ve linked to Morningstar’s video, where available. The key is that their videos auto-launch, which can be mightily annoying. Be ready for it.

Jeremy Grantham: The World Will End, You’ve Just Got to be Patient for a Bit

Grantham, one of the cofounders of GMO, a highly respected institutional investment firm originally named Grantham, Mayo, van Otterloo, is regularly caricatured as a perma-bear. He responds to the charge by asserting “I’m not a pessimist. You’re simply optimists.”

Grantham argues that we’re heading for a massive stock market crash (something on the order of a 60% fall), just not for a while yet. GMO’s study of asset bubbles found that asset prices regularly become detached from reality but they’re not subject to crashing until they exceed their normal levels by about two standard deviations.  Roughly speaking, that translates to asset prices that are higher than they are 95% of the time. Right now, we’re about 1.5 standard deviations above average. If current trends continue – and Grantham does expect stocks to follow the path of least resistance, higher – then we’ll reach the two standard deviation mark around the time of the presidential election.

Merely being wildly overvalued doesn’t automatically trigger a crash (in the UK, home prices reached a three standard deviation peak – 99.7% – before imploding) but it’s extremely rare for such a market not to find a reason to crash. And when the crash comes, the market typically falls at about twice the rate that it rose.

As an aside, Grantham also notes that no stock market crash has occurred until after average investors have been dragged into the party’s frenzied last hours, too late to make much money but just in time to have their portfolios gutted (again). While optimism, measured by various investor attitude surveys, is high, it’s not manic. Yet.

So, we’ve got a bit to savor ill-garnered gains and to reassure ourselves that this time we’ll be sharp, discerning and well on our way to safety ere the crash occurs.

Oddly, Grantham expects a crash because capitalism does work, but regulation (mostly) does not. Under capitalism, capital flows to the area of greatest opportunity: if your lemonade stand is able to draw a million in revenue today, you can be pretty much guaranteed that there will be a dozen really cool lemonade stands in your neighborhood within the week. As a result, your profit will decline. More stands will be built, and profits will continue declining, until capitalists conclude that there’s nothing special in the lemonade stand biz and they resume the search for great opportunities. Today’s record corporate profit margins must draw new competitors in to drive those excess profits down, or capitalism is failing.

Grantham argues that capitalism is failing for now. He blames the rise of “stock option culture” and a complicit U.S. fed for the problem. Up to 80% of executive compensation now flows from stock options, which are tied to short-term performance of a company’s stock rather than long-term performance of the company. People respond to the incentives they’re given, so managers tend toward those actions which increase the value of their stock options. Investing in the company is slow, uncertain and risky, and so capital expenditures (“capex”) by publicly-traded firms is falling. Buying back stock (overpriced or not) and issuing dividends is quick, clean and safe, and so that sort of financial engineering expands. Interest rates at or near zero even encourage the issuance of debt to fund buybacks (“Peter, meet Paul”). It would be possible to constrain the exercise of options, but we choose not to. And so firms are not moving capital into new ventures or into improving existing capabilities which, in the short run, continues to underwrite record profit margins.

David Marcus: We’re in the Bottom of the Third

All value investing starts with fundamentally, sometimes appallingly, screwed-up companies that have the potential to do vastly better than they’ve been doing. The question is whether anything will unleash those potential gains. That’s not automatically true; 50 to a hundred publicly-traded companies go bankrupt each year as do something like 30,000 private ones.

On whole, investors would prefer that the firms they invest in not go belly up. In the U.S., they’ve got great leverage to encourage corporate restructurings – spinoffs, mergers, acquisitions, division closures – which might serve to release that locked-up potential. We also have a culture that, for better and worse, endorses the notion of maximizing shareholder (rather than stakeholder or community) value.

Traditionally the U.S. has been one of the few places that countenanced, much less encouraged, frequent corporate dislocations. Europeans encourage a stakeholder model focused on workers’ interests and Asians have a tradition of intricately interwoven corporate interests where corporations share a web of directorships and reciprocal investments in each other.

David Marcus manages Evermore Global Value (EVGBX) and tries to do so in the spirit of his mentor, Michael Price. As one of Price’s Mutual Series managers, he specialized in “special situations” investing, a term that describes the whole array of “rotten company teetering between damnation and salvation” thing. Later, as a private investor in Europe, he saw the beginnings of a change in corporate culture; the first intimations that European managers were willing to make tentative moves toward a shareholder-focused culture. In December 2009, he launched the Evermore funds to exploit that unrecognized change.

The first three years were trying: his flagship fund lost 10% over the period and trailed 95% of its peers. When we spoke several years ago, Mr. Marcus was frustrated but patient: he likened his portfolio to a spring that’s already been compressed a lot but, instead of releasing, was getting compressed even more. In the past three years, the spring rebounded: top third relative returns, 15% annualized ones, with two stretches at the very top of the global equity heap.

Mr. Marcus’s portfolio remains Euro-centric, about 66% against his peers’ 30%, but he foresees a rotation. The 2008 financial meltdown provided an opportunity for European corporate insiders to pursue a reform agenda. International members started appearing on corporate boards, for instance, and managers were given leeway to begin reducing inefficiency. ThyssenKrupp AG, a German conglomerate, had 27 separate IT departments operating with inconsistent policies and often incompatible software. They’ve whittled that down to five and are pursuing the crazy dream of just one IT department. Such moves create a certain momentum: at first, restructuring seems impossible, then a minor restructuring frees up a billion in capital and managers begin to imagine additional work that might reap another billion and a half. As the great Everett Dirksen once reflected, “A billion here, a billion there, and pretty soon you’re talking about real money.” Mr. Marcus believes that Europeans are pursuing such reforms with greater vigor but without wasting capital “on crappy IPOs” that continue to dog the U.S. market.

A bigger change might be afoot in Asia and, in particular, in Japan. Corporate executives are, for the first time, beginning to unwind the complex web of cross-ownership which had traditionally been a one-way move: you invest in another corporation but never, ever sell your stake. Increasingly, managers see those investments as “cash cows,” the source of additional capital that might be put to better use.

Ironically, the same social forces that once held capital captive might now be working to free it. Several new Japanese stock indexes attempt to recognize firms that are good stewards of shareholder capital. The most visible is the Nikkei 400 ROE index, which tracks companies “with high appeal for investors, which meet requirements of global investment standards, such as efficient use of capital and investor-focused management perspectives.” Failure to qualify for inclusion has been deeply embarrassing for some management teams, which subsequently reoriented their capital allocations. Nomura Securities launched a competing index focusing on companies that use dormant cash to repurchase shares, though the effects of that are not yet known.

Mr. Marcus’s sense that the ground might be shifting is shared by several outstanding managers. Andrew Foster of Seafarer (SFGIX) has speculated that conditions favorable to value investing (primarily institutions that might serve as catalysts to unlock value) are evolving in the emerging markets. Messrs. Lee and Richyal at JOHCM International Select Fund (JOHAX) have directly invoked the significance of the Nikkei ROE Index in their Japan investing. Ralf Scherschmidt at Oberweis International Opportunities (OBIOX) has made a career of noticing that investors fail to react promptly to such changes; he tries to react to news promptly then wait patiently for others to begin believing that change is really. All three are five-star funds.

I’ll continue my reviews in August. For now, here are Charles’s quick takes.

Morningstar Investment Conference 2015 Notes

In contrast to the perfect pre-autumnal weather of last year’s ETF conference, Chicago was hot and muggy this past week, where some 2000 attendees gathered for Morningstar’s Investment Conference located at the massive, sprawling, and remote McCormick Place.

Morningstar does a great job of quickly publishing conference highlights and greatly facilitates press … large press room wired with high-speed internet, ample snacks and hot coffee, as well as adjacent media center where financial reporters can record fund managers and speakers then quickly post perspectives, like Chuck Jaffe’s good series of audio interviews.

On the MFO Discussion Board, David attempts to post nightly his impressions and linkster Ted relays newly published conference articles. To say the event is well covered would be a colossal understatement.

Nonetheless, some impressions for inclusion in this month’s commentary …

If you are a financial adviser not catering to women and millennials, your days are numbered.

On women. Per Sallie Krawcheck, former president of BAC’s Global Wealth division and currently chair of the Ellevate network, which is dedicated to economic engagement of women worldwide, women live six to eight years longer than men … 80% of men die married, while 80% of women die unmarried … 70% of widows leave their financial advisers within a year of their husband’s death.

While women will soon account for majority of US millionaires, most financials advisors don’t include spouses in the conversation. The issue extends to the buy side as well. In a pre-conference session entitled, “Do Women Investors Behave Differently Than Men,” panels cited that women control 51% investable wealth and currently account for 47% of high net worth individuals, yet professional women money managers account for only 5% of assets under management. How can that be?

The consequence of this lack of inclusion is “lack of diversification, higher risk, and money left on table.” Women, they state, value wealth preservation many times more than men. One panelist actually argues that women are better suited to handle the stress hormone cortisol since they need not suffer adverse consequences of interaction with testosterone.

While never said explicitly, I could not help but wonder if the message or perhaps question here is: If women played a greater role in financial institutions and at the Fed in years leading up to 2007, would we have avoided the financial or housing crises?  

On millennials. Per Joel Brukenstein of Financial Planning Magazine and creator of Technology Tools for Today website, explains that the days of financial advisors charging 1% annual fee for maintaining a client portfolios of four or five mutual funds are no longer sustainable … replaced with a proliferation of robo-advisors, like Schwab Intelligent Portfolios, which charges “no advisory fees, no account service fees, no commissions, period.”

Ditto, if your services are not available on a smart phone. Millennials are beyond internet savvy and mobile … all data/tools must be accessible via the cloud.

Mr. Brukenstein went so far as to suggest that financial advisors not offering services beyond portfolio management should consider exiting the business.

Keynote highlights. Jeremy Grantham, British-born co-founder of Boston-based asset management firm GMO, once again reiterated his belief that US stocks are 30 – 60% overvalued, still paying for overvaluation sins of our fathers … the great bull run of 1990, which started in 1987, finished in 2000, and was right on the heels of the great bull run of the 1980s. No matter that investors have suffered two 50% drawdowns the past 15 years with the S&P 500 and only received anemic returns, “it will take 25 years to get things right again.” So, 10 more years of suffering I’m afraid.

He blames Greenspan, Bernanke, and Yellen for distorting valuations, the capital markets, the zero interest rate policy … leading to artificially inflated equity prices and a stock-option culture that has resulted in making leaders of publically traded companies wealthy at the expense of capital investment, which would benefit the many. “No longer any room for city or community altruism in today’s capitalism … FDR’s social contract no more.”

All that said he does not see the equity bubble popping just yet … “no bubble peaks before abnormal buyers and deals come to market.” He predicts steady raise until perhaps coming presidential election.

Mr. Grantham is not a believer in efficient market theory. He views the cycles of equity expansion and contraction quite inefficiently driven by career risk (never be wrong on your own …), herding, momentum, extrapolation, excursions from replacement value, then finally, arbitrage and mean reversion at expense of client patience. Round and round it goes.

David Kelly, JP Morgan’s Chief Global Strategist whose quarterly “Guide To Markets” now reaches 169 thousand individuals in 25 countries, also does not see a bear market on horizon, which he believes would be triggered by one or more of these four events/conditions: recession, commodity spike, aggressive fed tightening, and/or extreme valuation. He sees none of these.

He sees current situation in Greece as a tragedy … Germany was too tough during recession. Fortunately, 80% of Greek debt is held by ECB, not Euro banks, so he sees no lasting domino effect if it defaults.

On the US economy, he sees it “not booming, but bouncing back.” Seven years into recovery, which represents the fourth longest expansion dating back to 1900. “Like a Yankees/Red Sox game … long because it is slow.”

He disputes Yellen’s position that there is slack in the economy, citing that last year 60 million people were hired … an extraordinary amount. (That is the gross number; subtract 57 million jobs left, for a net of 3 million.) The biggest threat to continued expansion is lack of labor force, given retiring baby boomers, 12.5% of population with felony convictions, scores addicted to drug, and restrictions on foreign nationals, which he calls the biggest tragedy: “We bring them in. They want to be here. We educate them. They are top of class. Then, we send them home. It’s crazy. We need immigration reform to allow skilled workers to stay.”

Like Grantham, he does see QE helping too much of the wrong thing at this point: “Fertilizer for weeds.”

On oil, which he views like potatoes – a classic commodity: “$110 is too much, but $40 is too low.” Since we have “genetically evolved to waste oil,” he believes now is good time to get in cause “prices have stabilized and will gradually go up.”

Like last fall, he continues to see EM cheap and good long term opportunity. Europe valuations ok … a mid-term opportunity.

He closed by reminding us that investors need courage during bear markets and brains during bull markets.

Breakout sessions. Wasatch’s Laura Geritz was stand-out panelist in break-out session “Are Frontier Markets Worth Pursuing?” She articulates her likes (“Active manager’s dream asset class … capital held dear by phenomenal FM management teams … investments by strong subsidiaries, like Nestle … China’s investment in FM … ”) and dislikes (“No practical index … current indices remain too correlated due to lack of diversification … lack of market liquidity …”). She views FM as strictly long-term investment proposition with lots of ups and downs, but ultimately compelling. If you have not listened to her interview with Chuck Jaffe, you should.

Another break-out session, panelists discussed the current increasing popularity of “ESG Investing.” (ESG stands for environmental, social, and governance. ESG funds, currently numbering more than 200, apply these criteria in their investments.) “Ignore increasingly at your own peril … especially given that women and millennials represent the biggest demographic on horizon.” Interestingly, data suggest such funds do just as well if not slightly better than the overall market.

Lengthening Noses

By Edward Studzinski

“A sign of celebrity is that his name is often worth more than his services.”

Daniel J. Boorstin

So the annual Morningstar Conference has come and gone again, with couple thousand attendees in town hoping to receive the benefit of some bit of investment or business wisdom. The theme of this year’s conference appears to have been that the world of investors now increasingly is populated by and belongs to “Gen X’ers” and “Millennials.” Baby Boomers such as yours truly, are a thing of the past in terms of influence as well as a group from whom assets are to be gathered. Indeed, according to my colleagues, advisors should be focused not on the current decision maker in a client family but rather the spouse (who statistically should outlive) or the children. And their process of decision making will most likely be very different than that of the patriarch. We can see that now, in terms of how they desire to communicate, which is increasingly less by the written word or in face to face meetings.

In year’s past, the conference had the flavor of being an investment conference. Now it has taken on the appearance of a marketing and asset allocation advice event. Many a person told me that they do not come to attend the conference and hear the speakers. Rather, they come because they have conveniently assembled in one place a large number of individuals that they have been interested either in meeting or catching up with. My friend Charles’ observation was that it was a conference of “suits” and “skirts” in the Exhibitors’ Hall. Unfortunately I have the benefit of these observations only second and third hand, as for the first part of the week I was in Massachusetts and did not get back to Chicago until late Wednesday evening. And while I could have made my way to events on Thursday afternoon and Friday morning, I have found it increasingly difficult to take the whole thing seriously as an investment information event (although it is obviously a tremendous cash cow for Morningstar). Given the tremendous success of the conference year in and year out, one increasingly wonders what the correct valuation metric is to be applied to Morningstar equity. Is it the Google of the investment and financial services world? Nonetheless, given the focus of many of the attendees on the highest margin opportunities in the investment business and the way to sustain an investment management franchise, I wonder if, notwithstanding how she said it, whether Senator Elizabeth Warren is correct when she says that “the game is rigged.”

Friday apparently saw two value-oriented investors in a small panel presenting and taking Q&A. One of those manages a fund with $20 Billion in assets, which is a larger amount of money than he historically has managed. Charging a 1% fee on that $20B, his firm is picking up $200 Million in revenue from that one fund alone, notwithstanding that they have other funds. Historically he has been more of a small-midcap manager, with a lot of special situations but not to worry, he’s finding lots of things to invest in, albeit with 40% or so in cash or cash equivalents. The other domestic manager runs two domestic funds as the lead manager, with slightly more than $24 Billion in assets, and for simplicity’s sake, let’s call it a blended rate of 90 basis points in fees. His firm is seeing than somewhat in excess of $216 Million in revenue from the two funds. Now let me point out that unless the assets collapse, these fees are recurring, so in five years, there has been a billion dollars in revenue generated at each firm, more than enough to purchase several yachts. The problem I have with this is it is not a serious discussion of the world we are in at present. Valuation metrics for stocks and bonds are at levels approaching if not beyond the two standard deviation warning bells. I suppose some of this is to be expected, as if is a rare manager who is going to tell you to keep your money. However, I would be hard pressed at this time if running a fund, to have it open. I am actually reminded of the situation where a friend sent me to her family’s restaurant in suburban Chicago, and her mother rattled off the specials of the evening, one of which was Bohemian style duck. I asked her to go ask the chef how the duck looked that night, and after a minute she came back and said, “Chef says the duck looks real good tonight.” At that point, one of the regulars at the bar started laughing and said, “What do you think? The chef’s going to say, oh, the duck looks like crap tonight?”

Now, if I could make a suggestion in Senator Warren’s ear, it would be that hearings should be held about what kind of compensation in the investment management field is excessive. When the dispersion between the lowest paid employee and the highest results in the highest compensated being paid two hundred times more than the lowest, it seems extreme. I suppose we will hear that not all of the compensation is compensation, but rather some reflects ownership and management responsibilities. The rub is that many times the so-called ownership interests are artificial or phantom.

It just strikes that this is an area ripe for reform, for something in the nature of an excess profits tax to be proposed. After all, nothing is really being created here that redounds to the benefit of the U.S. economy, or is creating jobs (and yes Virginia, carried interest for hedge funds as a tax advantage should also be eliminated).

We now face a world where the can increasingly looks like it cannot be kicked down the road financially for either Greece or Puerto Rico. And that doesn’t even consider the states like Illinois and Rhode Island that have serious underfunded pension issues, as well as crumbling infrastructures. So, I say again, there is a great deal of risk in the global financial system at present. One should focus, as an investor, in not putting any more at risk than one could afford to write off without compromising one’s standard of living. Low interest rates have done more harm than good, for both the U.S. economy and the global economy. And liquidity is increasingly a problem, especially in the fixed income markets but also in stocks. Be warned! Don’t be one of the investors who has caught the disease known as FOMO or “Fear of Missing Out.”

It’s finally easy being green

The most widely accepted solution to Americans’ “retirement crisis” – our lifelong refusal to forego the joy of stuff now in order to live comfortably later – is pursuing a second (or third or fifth) career after we’ve nominally retired. Some of us serve as school crossing guards, greeters, or directors of mutual fund boards, others as consultants, carpenters and writers. Honorable choices, all.

But what if you could make more money another way, by selling cigarettes directly to adolescents in poor countries?  There’s a booming market, the U.S. Chamber of Commerce is working globally to be sure that folks keep smoking, and your customers do get addicted. A couple hours a day with a stand near a large elementary school or junior high and you’re golden.

Most of us would say “no.” Many of us would say “HELL NO.” The thought of imperiling the lives and health of others to prop up our own lifestyle just feels horribly wrong.

The question at hand, then, is “if you aren’t willing to participate directly in such actions, why are you willing to participate indirectly in them through your investments?” Your decision to invest in, for example, a tobacco company lowers their cost of capital, increases their financial strength and furthers their business. There’s no real dodging the fact: you become a part-owner of the corporation, underwrite its operations and expect to be well compensated for it.

And you are doing it. In the case of Phillip Morris International (PM), for example, 30% of the firm’s stock is owned by ten investment companies:

Capital World & Capital Research are the advisors to the American Funds. Barrow sub-advises funds for, among others, Vanguard and Touchstone.

That exercise can be repeated with a bunch of variations: what role would you like to play in The Sixth Great Extinction, the impending collapse of the Antarctic ice sheet, or the incineration of young people in footwear factories? In the past, many of us defaulted to one of two simple positions: I don’t have a choice or I can’t afford to be picky.

The days when socially-responsible investing was the domain of earnest clergy and tree-hugging professors are gone. How gone?  Here’s a quick quiz to help provide context: how many dollars are invested through socially-screened investment vehicles?

1. A few hundred million
2. A few billion
3. A few tens of billions
4. A few hundred billion
5. A few trillion
6. Just enough to form a really satisfying plug with which to muffle The Trump.

The answer is “E” (though I’d give credit, on principle, for “F”). ESG-screened investments now account for about one-sixth of all of the money invested in the U.S. —over $6.5 trillion— up by 76% since 2012. In the U.S. alone there are over 200 open-end funds and ETFs which apply some variety of environmental, social and governance screens on their investors’ behalf.

There are four reasons investors might have for pursuing, or avoiding, ESG-screened investments. They are, in brief:

1. It changes my returns. The traditional fear is that by imposing screening costs and limiting one’s investable universe, SRI funds were a financial drag on your portfolio. There have been over 1200 academic and professional studies published on the financial effects, and a dozen or so studies of the studies (called meta-analyses). The uniform conclusion of both academic and professional reviews is that SRI screens do not reduce portfolio returns. There’s some thin evidence of improved performance, but I wouldn’t invest based on that.
2. It changes my risk profile. The traditional hope is that responsible firms would be less subject to “headline risk” and less frequently involved in litigation, which might make them less risky investments. At least when examining SRI indexes, that’s not the case. TIAA-CREF examined a quarter century’s worth of volatility data for five widely used indexes (Calvert Social Index, Dow Jones Sustainability U.S. Index, FTSE4Good US Index, MSCI KLD 400 Social Index, and MSCI USA IMI ESG Index) and concluded that there were no systematic differences between ESG-screened indexes and “normal” ones.
3. It allows me to foster good in the world. The logic is simple: if people refuse to invest in a company, its cost of doing business rises, its products become less economically competitive and fewer people buy them. Conversely, if you give managers access to lots of capital, their cost of capital falls and they’re able to do more of whatever you want them to do. In some instances, called “impact investing,” you actually direct your manager to put money to work for the common ground through microfinance, underwriting housing construction in economically-challenged cities and so on.
4. It’s an expression of an important social value. In its simplest form, it’s captured by the phrase “I’m not giving my money to those bastards. Period.” Some critics of SRI have made convoluted arguments in favor of giving your money to the bastards on economic grounds and then giving other money to social causes or charities. The argument for investing in line with your beliefs seems to have resonated most strongly with Millennials (those born in the last two decades of the 20^th century) and with women. Huge majorities in both groups want to align their portfolio with their desires for a better world.

Our bottom line is this: you can invest honorably without weakening your future returns. There is no longer any credible doubt about it. The real problems you face are (1) sorting through the welter of funds which might impose both positive and negative screens on a conflicting collection of 20 different issues and (2) managing your investment costs.

We’ve screened our own data to help you get started. We divided funds into two groups: ESG Stalwarts, funds with long records and stable teams, and Most Intriguing New ESG Funds, those with shorter records, smaller asset bases and distinctly promising prospects. We derived those lists by looking for no-load options open to retail investors, then looking for folks with competitive returns, reasonable expenses and high Sharpe ratios over the full market cycle that began in October 2007.

In addition, we recommend that you consult the exceedingly cool, current table of SRI funds maintained by the Forum for Sustainable and Responsible Investment. The table, which is sadly not sortable, provides current performance data and screening criteria for nearly 200 SRI funds. In addition, it has a series of clear, concise summaries of each fund on the table.

ESG Stalwarts

Most intriguing new ESG funds

In the wings, socially responsible funds still in registration with the Securities and Exchange Commission which will be available by early autumn include:

Thornburg Better World Fund will seek long-term capital growth. The plan is to invest in international “companies that demonstrate one or more positive environmental, social and governance characteristics.” Details in this month’s Funds in Registration feature.

TIAA-CREF Social Choice International Equity Fund will seek a favorable long-term total return, reflected in the performance of ESG-screened international stocks. MSCI will provide the ESG screens and the fund will target developed international markets. This fund, and the next, will be managed by Philip James (Jim) Campagna and Lei Liao. The managers’ previous experience seems mostly to be in index funds.

TIAA-CREF Social Choice Low Carbon Equity Fund will seek a favorable long-term total return, reflected in the performance of ESG-screened US stocks. MSCI will provide the ESG screens, which will be supplemented by screens looking for firms with “demonstrate leadership in managing and mitigating their current carbon emissions and (2) have limited exposure to oil, gas, and coal reserves.”

Trillium All Cap Fund will seek long term capital appreciation by investing in an all-cap portfolio of “stocks with high quality characteristics and strong environmental, social, and governance records.” Up to 20% of the portfolio might be overseas. The fund will be managed by Elizabeth Levy and Stephanie Leighton of Trillium Asset Management. Levy managed Winslow Green Large Cap from 2009-11, Leighton managed ESG money at SunLife of Canada and Pioneer.

Trillium Small/Mid Cap Fund will seek long term capital appreciation by investing in a portfolio of small- to mid-cap “stocks with high quality characteristics and strong environmental, social, and governance records.” Small- to mid- is defined as stocks comparable in size to those in the S&P 1000, a composite of the S&P’s small and mid-cap indexes. Up to 20% of the portfolio might be overseas. The fund will be managed by Laura McGonagle and Matthew Patsky of Trillium Asset Management. Trillium oversees about $2.2 billion in assets. McGonagle was previously a research analyst at Adams, Harkness and Hill and is distantly related to Professor Minerva McGonagall. Patsky was Director of Equity Research for Adams, Harkness & Hill and a manager of the Winslow Green Solutions Fund.

We, now more than ever in human history, have a chance to make a difference. Indeed, we can’t avoid making a difference, for good or ill. In our daily lives, that might translate to helping our religious community, coaching youth sports, serving meals at a center for the marginally secure or turning our backs on that ever-so-manly Cadillac urban assault vehicle, the Escalade.

That’s all inconvenient, a bit limiting and utterly right, and so we do it. ESG advocates argue that we’ve reached the point where we can do the same things with our portfolios: we can make a difference, encourage good behavior and affirm important personal values, all with little or no cost to ourselves. It seems like a deal worth considering.

The league’s top rebounders

Even the best funds decline in value during either a correction or a bear market. Indeed, many of the best decline more dramatically than their peers because the high conviction, high independence portfolios that are signs of their distinction also can leave them exposed when things turn bad. The disastrous performance of the Dodge & Cox funds during the 2007-09 crash is a case in point.

The real question isn’t “will it fall?” We know the answer. The real question is “will the fall be so bad that I’ll get stupid and insist on selling at a painful loss (again), probably just before a rebound?” Two rarely discussed statistics address that question. The first is recovery time, which simply measures the number of months that it’s taken each fund to recover from its single worst drawdown. The second is the Ulcer Index, one of Charles’s favorite metrics if only because of the name, which was designed by Peter Martin to factor–in both the depth and duration of a fund’s drawdown.

For those casting about for tummy-calming options, we screened for funds that had been around for a full market cycle, then looked at funds which have the shortest recovery times and, separately, the lowest Ulcer Indexes over the current market cycle. That cycle started in October 2007 when the broad market peaked and includes both the subsequent brutal crash and ferocious rebound. Our general sense is that looking at performance across such a cycle is better than focusing on some arbitrary number of years (e.g., 5, 10 or 15 year results).

The first table highlights the funds with the fastest rebounders in each of six popular categories.

The rebound or recovery time doesn’t directly account for the depth of the drawdown. It’s possible, after all, for an utterly nerve-wracking fund to power dive then immediately rocket skyward again, leaving your stomach and sleep behind.  The Ulcer Index figures that in: two funds might each dive, swoop and recover in two months but the one dove least earned a better (that is, lower) Ulcer Index score.

Again, these calculations are looking at performance over the course of the current market cycle only.

How much difference does paying attention to risk make? Fully half of all international large cap funds are still underwater; 83 months after the onset of the crash, they have still not made their investors whole. That roster includes all of the funds indexed to the MSCI EAFE, the main index of large cap stocks in the developed world, as well as actively-managed managed funds from BlackRock, Goldman Sachs, Janus, JPMorgan and others.

In domestic large caps, both the median fund on the list and all major market index funds took 57 months to recover.

Bottom Line: the best time to prepare for the rain is while the sun is still shining. While you might not feel that a portfolio heavy on cash or short-term bonds meets your needs, it makes sense for you to investigate – within whatever asset classes you choose to pursue – funds likely to inflict only manageable amounts of pain. Metrics like recovery time and Ulcer Index should help guide those explorations.

FPA Perennial: Time to Go.

FPA Perennial (FPPFX) closed to new investors on June 15, 2015. The fund that re-opens to new investors at the beginning of October will bear no resemblance to it. If you are a current Perennial shareholder, you should leave now.

Perennial and its siblings, FPA Paramount (FPRAX) and the closed-end Source Capital (SOR), were virtual clones, managed by Steve Geist and Eric Ende. While the rest of FPA were hard-core absolute value guys, G&E ran splendid small- to mid-cap growth funds, fully invested in very high-quality companies, negligible turnover, drifting between small and mid, growth and blend. Returns were consistent and solid. Greg Herr was added to the team several years ago.

In 2013, FPA made the same transition at Paramount that’s envisaged here: the managers left, a new strategy was imposed and the portfolio was liquidated. Domestic growth became global value. Only the name remained the same.

With Perennial, not even the name will remain.

1. All of the managers are going. Mr. Geist retired in 2014 and Ende, at age 70, is moving toward the door. Mr. Herr is leaving to focus on Paramount. They are being replaced by Greg Nathan. Mr. Nathan is described as “the longest serving analyst for the Contrarian Value Strategy, including FPA Crescent Fund (FPACX).”
2. The strategy is going. Geist and Ende were small- to mid-cap growth. The new fund will be all-cap value. It will be the US equity manifestation of the stock-picking strategy used in Crescent, Paramount and International Value. It is a perfectly sensible strategy, but it bears no resemblance to the one for which the fund is known.
3. The portfolio is going. FPA warns that the change “will result in significant long-term capital gains.” Take that warning seriously.  Morningstar calculates your potential capital gains exposure at 63%, that is, 63% of the fund’s NAV is a result of so far untaxed capital gains. If the portfolio is liquidated, you could see up to $36/share in taxable distributions.  

   How likely is a hit of that magnitude? We can compare Paramount’s portfolio before and after the 2013 transition. Of the 31 stocks in Paramount’s portfolio:

   27 positions were entirely eliminated
   2 positions (WABCO and Zebra Technologies) were dramatically reduced
   1 position (Aggreko plc) was dramatically expanded
   1 position (Maxim Integrated Products) remained roughly equal

   During that transition, the fund paid out about 40% of its NAV in taxable gains including two large distributions over the course of two weeks at year’s end.

   Certainly the tax hit will vary based on your cost basis, but if your cost basis is high – $35/share or more – you might be better getting out before the big tax hit comes.

4. The name is going. The new fund will be named FPA S. Value Fund.

I rather like FPA’s absolute value orientation and FPA U.S. Value may well prove itself to be an excellent fund in the long-term. In the short term, however, it’s likely to be a tax nightmare led in an entirely new direction by an inexperienced manager. If you bought FPPFX because you likely want what Geist & Ende did, you might want to look at Motley Fool Great America (TMFGX). It’s got a similar focus on quality growth, low turnover and small- to mid-cap domestic stocks. It’s small enough to be nimble and we’ve identified it as a Great Owl Fund for its consistently excellent risk-adjusted returns.

The mills of justice turn slowly, but grind exceedingly fine.

The SEC this month announced sanctions against two funds for misdeeds that took place five to seven years ago while a third fund worked to get ahead of SEC concerns about its advisor.

On June 17, 2015, the SEC issued penalties to Commonwealth Capital Management and three former three independent members of its mutual fund board. The basic argument is that, between 2008 and 2010, the adviser fed crap to the board and they blindly gobbled it up. (Why does neither half of their equation surprise me?) The SEC’s exact argument is that the board provided misleading information about the fund to the directors and the independent directors failed to exercise reasonable diligence in examining the evidence before approving a new investment contract. The fund in question was small and bad; it quickly added “extinct” to its list of attributes.

On June 22, 2015, the Board of Trustees of the Vertical Capital Income Fund (VCAPX) terminated the investment advisory agreement with Vertical Capital Asset Management, LLC. The fund’s auditor has also resigned. The Board’s vaguely phrased concern is that VCAM “lacks sufficient resources to meet its obligations to the Fund, and failed to adequately monitor the actions of its affiliate Vertical Recovery Management in its duties as the servicing agent of the mortgage notes held by the Fund.”

On June 23, 2015, the SEC reached a settlement with Pekin Singer Strauss Asset Management (PSS), advisor to the Appleseed Fund (APPLX) and portfolio managers William Pekin and Joshua Strauss.  The SEC found “that the securities laws were violated in 2009 and 2010 when PSS did not conduct timely internal annual compliance reviews or implement and enforce certain policies and procedures.” PSS also failed to move clients from the higher-cost investor shares to the lower-cost institutional ones. No one admits or denies anything, though PSS were the ones who detected and corrected the share class issue on their own.

Morningstar, once a fan of the fund, has placed them “under review” as they sort out the implications. That’s got to sting since Appleseed so visibly positions itself as a socially-responsible fund.

Top developments in fund industry litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized, searchable, and filtered as never before. For the complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

Order

• The court gave its final approval to a $9.475 million settlement in the ERISA class action that challenged MassMutual‘s receipt of revenue-sharing payments from third-party mutual funds. (Golden Star, Inc. v. Mass Mut. Life Ins. Co.)

Briefs

• Calamos filed a motion to dismiss excessive-fee litigation regarding its Growth Fund. Brief: “Plaintiffs advance overwrought policy critiques of the entire mutual fund industry, legally inapt comparisons between services rendered to a retail mutual fund (such as the [Growth] Fund) and those provided to an institutional account or as sub-adviser, and conclusory assertions that the Fund grew over time but did not reduce its fees that are just the sort of allegations that courts in this Circuit have consistently dismissed for more than 30 years.” (Chill v. Calamos Advisors LLC.)
• Parties filed dueling motions for summary judgment in fee litigation regarding eight Hartford mutual funds. Plaintiffs’ section 36(b) claims, first filed in 2011, previously survived Hartford’s motion to dismiss. The summary judgment briefs are unavailable on PACER. (Kasilag v. Hartford Inv. Fin. Servs. LLC; Kasilag v. Hartford Funds Mgmt. Co.)
• New York Life filed a motion to dismiss excessive-fee litigation regarding four of its MainStay funds. Brief: Plaintiffs’ complaint “asserts in conclusory fashion that Defendant New York Life Investment Management LLC (‘NYLIM’) received excessive fees for management of four mutual funds, merely because NYLIM hired subadvisors to assist with its duties and paid them a portion of the total management fee. But NYLIM’s employment of this manager/subadvisor structure—widely utilized throughout the mutual fund industry and endorsed by NYLIM’s regulator—cannot itself constitute a breach of NYLIM’s fiduciary duty under Section 36(b) of the Investment Company Act . . . .” (Redus-Tarchis v. N.Y. Life Inv. Mgmt., LLC.)

The Alt Perspective: Commentary and news from DailyAlts.

Survey Says…

The spring is the season for surveys and big opinion pieces. Perhaps it is the looming summer vacations of readers that prompt companies to survey the market for opinions and views on particular topics before everyone heads out of the office for a long break. Regardless, the survey results are in, the results have been tallied and in the world of liquid alternatives, it appears that the future looks good.

Two industry surveys that were completed recently are cited in the articles below. The first provides the results of a survey of financial advisors about their allocations to alternative investments, and notes that more than half of the financial advisors surveyed think that their clients should allocate between 6% and 15% to alternative investments – a significant increase from today’s levels.

The second report below provides big picture industry thinking from Citi’s Business Advisory Services unit, and projects the market for liquid alternatives to double over the next five years, increasing to more than $1.7 trillion in assets.

• Majority of Advisors Plan to Continue Recommending Alternatives
• Citi Sees Boom in Unconstrained Long, Smart Beta and Liquid Alts

While industry surveys and big picture industry reports can often over-project the optimism and growth of a particular product group, the directional trends are important to watch. And in this case, the trends continue to be further growth of the liquid alternatives market, both here in the U.S. and abroad.

Monthly Liquid Alternative Flows

Consistent with the reports above, investors continued to allocate to alternative mutual funds and ETFs in May of this year. Investors allocated a net total of $2 billion to the space in May, a healthy increase from April’s level of $723 million, and a return to levels we saw earlier in the year.

While only two categories had positive inflows last month, this month has four categories with positive inflows. Once again, multi-alternative funds that combine multiple styles of investing, and often multiple asset managers, all into a single fund had the most significant inflows. These funds pulled in $1.8 billion in net new assets. Managed futures are once again in second place with just over $520 million in new inflows.

While the outflows from long/short equity funds have moved closer to $0, they have yet to turn positive this year. With equity market conditions as they are, this has the potential to shift to net inflows over the coming months. Commodity funds continued to struggle in May, but investors kicked it up a notch and increased the net outflows to more than $1.5 billion, more than a double from April’s level.

Diversification and one stop shopping continue to be an important theme for investors. Multi-alternative fund and managed futures funds provide both. Expect asset flows to liquid alternatives to continue on their current course of strong single-digit to low double-digit growth. Should the current Greek debt crisis or other global events cause the markets to falter, investors will look to allocate more to liquid alternatives.

New Fund Launches

We have seen 66 new funds launched this year, up from 53 at the end of April. This includes alternative beta funds as well as non-traditional bond funds, both of which provide investors with differentiated sources of return. In May, we logged 13 new funds, with nearly half being alternative beta funds. The remaining funds cut across multi-alternative, non-traditional bonds and hedged equity.

Two of the funds that were launched in May were unconstrained bond funds, one of the more popular categories for asset inflows in 2014. This asset category is meant to shield investors from the potential rise in interest rates and the related negative impact of bond prices. Both Virtus and WisdomTree placed a bet on the space in May with their new funds that give the portfolio managers wide latitude to invest across nearly all areas of the global fixed income market on a long and short basis.

While significant assets have flowed into this category of funds over the past several years, the rise in interest rates has yet to occur. This may change come September, and at that point we will find out if the unconstrained nature of these funds is helpful.

For more details on new fund launches, you can visit our New Funds 2015 page.

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. 

Eventide Healthcare & Life Sciences (ETNHX): Morningstar’s 2015 conference included a laudatory panel celebrating “up and coming” funds, including the five star, $2 billion Eventide Gilead. At yet as I talked with the Eventide professionals the talk kept returning to the fund that has them more excited, Healthcare. The fund looks fascinating and profitable. Unfortunately, we need answers to two final questions before publishing the profile. We’re hopeful of having those answers in the first couple days of July; we’ll notify the 6000 members of our mailing list as soon as the profile goes live

Launch Alert

Thornburg Developing World (THDAX) is one of the two reasons for being excited about Artisan Developing World (ARTYX). Artisan’s record for finding and nurturing outstanding management teams is the other.

Lewis Kaufman managed Thornburg Developing World from inception through early 2015. During that time, he amassed a remarkable record for risk-sensitive performance.  A $10,000 investment at inception would have grown to $15,700 on the day of Mr. Kaufman’s departure, while his peers would have earned $11,300. Morningstar’s only Gold-rated emerging markets fund (American Funds New World Fund NEWFX) would have clocked in at $13,300, a gain about midway between mediocre and Mr. Kaufmann.

By all of the risk and risk/return measures we follow, he achieved those gains with lower volatility than did his peers.

Mr. Kaufman pursues a compact, primarily large-cap portfolio. He’s willing to invest in firms tied to, but not domiciled in, the emerging markets. And he has a special interest in self-funding companies; that is, firms that generate free cash flow sufficient to cover their operating and capital needs. That allows the firms insulate themselves from both the risk of international capital flight and dysfunctional capital markets that are almost a defining feature of the emerging markets. Andrew Foster of Seafarer Overseas Growth & Income (SFGIX) shares that preference for self-funding firms and it has been consistently rewarding.

There are, of course, two caveats. First, Thornburg launched after the conclusion of the 2007-09 market crisis. That means that it only dealt with one sharply down quarter (3Q2011) and it trailed the pack then. Second, Thornburg’s deep analyst core doubtless contributed to Mr. Kaufmann’s success. It’s unclear how reliance on a smaller team will affect him.

In general, Artisan’s new funds have performed exceptionally well (the current E.M. product, which wasn’t launched in the retail market, is the exception). Artisan professes only ever to hire “category killers,” then gives them both great support and great autonomy. That process has worked exceptionally well. I suggested on our discussion board “that immediately upon launch, our short-list of emerging markets funds quite worth your money’ will grow by one.” I’m pretty comfortable with that prediction.

Artisan Developing World (ARTYX) has a 1.5% initial expense ratio and a $1,000 investment minimum.

Funds in Registration

There are eight new funds in registration this month. Funds in registration with the SEC are not available for sale to the public and the advisors are not permitted to talk about them, but a careful reading of the filed prospectuses gives you a good idea of what interesting (and occasionally appalling) options are in the pipeline. Funds currently in registration will generally be available for purchase in September or early October.

Two funds sort of pop out:

RiverNorth Marketplace Lending Fund will invest in loans initiated by peer-to-peer lenders such as LendingClub and Prosper.com. It’s structured as a non-listed closed-end fund which will likely offer only periodic liquidity; that is, you might be able to get out just once a month or so. The portfolio’s characteristics should make it similar to high-yield bonds, offering the chance for some thrills and interest rate insulation plus high single-digit returns. It’s a small market; about $7 billion in loans were made last year, which makes it most appropriate to a specialist boutique firm like RiverNorth.

Thornburg Better World will be an international fund with strong ESG screens. Thornburg’s international funds are uniformly in the solid-to-outstanding range, though the departure of Lewis Kaufmann and some of his analysts for Artisan certainly make a dent. That said, Thornburg’s analyst core is large and well-respected and socially-responsible investing has established itself as an entirely mainstream strategy.

Manager Changes

This month there were only 38 funds reporting partial or complete changes in their management teams. This number is slightly inflated by the departure of Wayne Crumpler from eleven American Beacon funds. The most notable changes include Virginie Maisonneuve’s departure from another PIMCO fund, and Thomas Huber stepping down from T. Rowe Price Growth & Income. The good news is that he’s remaining at T. Rowe Price Dividend Growth where he’s had a longer record and more success.

Updates

In May we ran The Dry Powder Gang, a story highlighting successful funds that are currently holding exceptionally high levels of cash. After publication, we heard from two advisors who warned that their funds’ cash levels were dramatically lower than we’d reported: FMI International (FMIJX) and Tocqueville International Value (TIVFX).

The error came from, and remains in, the outputs from Morningstar’s online fund screener.  Here is Morningstar’s report of the most cash-heavy international funds, based on a June 30 2015 screening:

Cool, except for the fact the Brown is 9% cash, not 66%; FMI is 20%, not 62%; AQR is 7%, not 56% … down to Tocqueville which is 6%, not 38%.

Where do those lower numbers come from? Morningstar, of course, on the funds’ “quote” and “portfolio” pages.

We promptly corrected our misreport and contacted Morningstar. Alexa Auerbach, a kind and crafty wizard there, explained the difficulty: the cash levels reported in the screener are “long rescaled” numbers. If a fund has both long and short positions, which is common in international funds which are hedging their currency exposures, Morningstar recalculates the cash position as a percentage of the fund’s long portfolio. “So,” I asked, “if a fund was 99% short and 1% long, including a 0.3% cash position, the screener would report a 30% cash stake?” Yep.

When I mentioned that anomaly to John Rekenthaler, Morningstar’s resident thunderer and former head of research, he was visibly aroused. “Long-rescaled? I thought I’d killed that beast five years ago!” And, grabbing a cudgel, he headed off again in the direction of IT.

I’ll let you know how the quest goes. In the interim, we will, and you should be a bit vigilant in checking curious outputs from the software.

Trust but Verify

On December 9, 2014, BlackRock president Larry Fink told a Bloomberg TV interviewer, “I am absolutely convinced we will have a day, a week, two weeks where we will have a dysfunctional market. It’s going to create some sort of panic, create uncertainty again.” That’s pretty much the argument that Ed and I have made, in earlier months, about ongoing liquidity constraints and an eventual crisis. It’s a reasonably widespread topic of conversation about serious investment professionals, as well as the likes of us.

Fink’s solution was electronic bond trading and his fear was not the prospect of the market crisis but, rather, of regulators reacting inappropriately. In the interim, BlackRock applied for permission to do inter-fund lending: if one of their mutual funds needed cash to meet redemptions, they could take a short-term loan from a cash-rich BlackRock fund in lieu of borrowing from the banks or hastily selling part of the portfolio. It is a pretty common provision.

Which you’d never know from one gold bug’s conclusion that Fink sounded “BlackRock’s Warning: Get Your Money Out Of All Mutual Funds.” It’s the nature of the web that that same story, generally positioned as “What They Don’t Want You to Know,” appeared on a dozen other websites, some with remarkably innocuous names. Those stories stressed that the problem would last “days or even weeks,” which is not what Fink said.

Briefly Noted . . .

On June 4, 2015, John L. Keeley, Jr., the president and founder of Keeley Asset Management and a portfolio manager to several of the Keeley funds passed away at a still-young 75. He’s survived by his wife of 50+ years and a large family. His rich life, good works and premature departure remind us all of the need to embrace our lives while we can, rather than dully plodding through them.

Conestoga SMid Cap Fund (CCSMX) just gained, with shareholder approval, a 12(b)1 fee. (Shareholders are a potentially valuable source of lanolin.) Likewise, the Hennessy Funds are asking shareholders to raise their costs via a 12(b)1 fee on the Investor Class of the Hennessy Funds.

In the “let’s not be too overt about this” vein, Janus quietly added a co-manager to Janus Unconstrained Global Bond (JUCAX).  According to the WSJ, Janus bought the majority stake in an Australian bond firm, Kapstream Capital Pty Ltd., then appointed Kapstream’s founder to co-manage Unconstrained Bond.  Kumar Palghat, the co-manager in question, is a former PIMCO executive who managed a $22 billion bond portfolio for PIMCO’s Australian division. He resigned in 2006, reportedly to join a hedge fund.

It’s intriguing that Gross, who once managed $1.8 trillion, is struggling with one-tenth of one percent of that amount. Janus Unconstrained is volatile and underwater since launch. Its performance trails that of PIMCO Unconstrained (PFIUX), the BarCap Aggregate, its non-traditional bond peer group, and most other reasonable measures.

PIMCO has announced reverse share-splits of 2:1 or 3:1 for a series of its funds: PIMCO Commodity Real Return Strategy Fund (PCRAX), PIMCO RAE Fundamental Advantage PLUS Fund (PTFAX), PIMCO Real Estate Real Return Strategy Fund (PETAX) and PIMCO StocksPLUS Short Fund (PSSAX). Most of the funds have NAVs in the neighborhood of $2.50-4.00. At that level, daily NAV changes of under 0.25% don’t get reflected (they round down to zero) until a couple consecutive unreported changes pile up and trigger an unusually large one day move.

O Canada! Your home and native land!! Vanguard just noticed that Canada exists and that it is (who knew?) a developed market. As a result, the Vanguard Developed Markets Index Fund will now track the FTSE Developed All Cap ex US Index rather than the FTSE Developed ex North America Index. The board has also approved the addition of the Canadian market to the Fund’s investment objective. Welcome, o’ land of pines and maples, stalwart sons and gentle maidens!

Vanguard’s Emerging Markets, Pacific and European stock index funds will also get new indexes, some time late in 2015. Vanguard’s being intentionally vague on the timing of the transition to try to prevent front-running by hedge funds and others. In each case, the new index will include a greater number of small- to mid-cap names. The Emerging Markets index will, in addition, include Chinese “A” shares. One wonders if recent events are causing them to reconsider?

Villere Balanced Fund (VILLX) and Villere Equity Fund (VLEQX) may, effective immediately, lend securities – generally, that means “to short sellers” – “in order to generate return.”

SMALL WINS FOR INVESTORS

AMG Yacktman (YACKX) and AMG Yacktman Focused (YAFFX) both reopened to new investors on June 22, 2015. The reopening engendered a lively debate on our discussion board. One camp pointed out that these are top 1% performers over the past 10- and 15-year periods. The other mentioned that they’re bottom 10% performers over the past 3- and 5-year periods. The question of asset bloat (about $20 billion between them) came up as did the noticeable outflows ($4 billion between them) in the last several years. There was a sense that the elder Mr. Yacktman was brilliant and a phenomenally decent man but, really, moving well into the “elder” ranks. Son Steve, who has been handling the funds’ day-to-day operations for 15 years is … hmmm, well, a piece of work.

The Barrow Funds, Barrow Value Opportunity Fund (BALAX/BALIX) and Barrow Long/Short Opportunity Fund (BFLSX/BFSLX) are converting from two share classes to one. The investor share class closed to new purchases on June 2 and merged into the institutional share class on June 30. At that same time, the minimum investment requirement for the institutional shares dropped from $250,000 to $2,500.  The net effect is that Barrow gets administrative simplicity and their investors, current and potential, get a price break.

Effective immediately, the name of the Hatteras Hedged Strategies Fund has changed to Hatteras Alternative Multi-Manager Fund (HHSIX).  Here’s the “small wins” part: they’ve sliced their minimum initial investment from $150 million to $1 million! Woo hoo! And here’s the tricky part: the fund has only $97 million in assets which implies that the exalted minimum was honored mostly in the breach.

The Royce Funds reduced their advisory fees for their European Smaller-Companies Fund, Global Value, International Smaller-Companies, International Micro-Cap and International Premier funds on July 1, 2015. The reductions are about 15 basis points, which translates to a drop in the funds’ expense ratios of about 10%.

Nota bene: the Royce Funds make me crazy. After a series of liquidations in April, there are 22 funds left which will drop to 21 in a couple of months. Of those, two have above average returns for the past five years while 16 trail at least 80% of their peers. The situation over the past decade is better, but not much. If you screen out the sucky, high risk and economically unviable Royce funds, you get down to about five: Global Financial Services and a bunch that existed before Legg Mason bought the firm and got them to start churning out new funds.

Effective June 1, 2015, the Schroder U.S. Opportunities Fund (SCUIX), which had been closed to new investors, will become available for purchase by investors generally. Actually with a $250,000 investment minimum, it “became available for purchase by really rich investors generally.”

CLOSINGS (and related inconveniences)

Effective as of the close of business on July 15, 2015, Brown Advisory Small-Cap Fundamental Value Fund (BIAUX) will stop accepting new purchases through most broker-dealer firms.

Eaton Vance Atlanta Capital Horizon Growth Fund (EXMCX) announced its plan to close to new investors on July 13, 2015. I wouldn’t run for your checkbook just yet. The fund has only $34 million in assets and has trailed pretty much everybody in its peer group, pretty much forever:

INTECH U.S. Core Fund (JDOAX) closed to new investors on June 30, 2015. Why, you ask? Good question. It’s a small fund that invests in large companies with a doggedly mediocre record. Not “bad,” “mediocre.” Over the past decade, it’s trailed the S&P 500 by 0.11% annually with no particular reduction of volatility. The official reason: “because Janus Capital and the Trustees believe continued sales are not in the best interests of the Fund.”

OLD WINE, NEW BOTTLES

The Calvert Social Index Fund is now Calvert U.S. Large Cap Core Responsible Index Fund (CSXAX). At the same time, the adviser reduced the fund’s expense ratio by nearly one-third, from 0.75% down to 0.54% for “A” shares.  

Effective June 2, 2015, Columbia LifeGoal Growth Portfolio, a fund of funds, became Columbia Global Strategic Equity Fund (NLGIX). At the same time the principal investment strategies were revised (good plan! It trails 90% of its peers over the past 1, 3 and 5 years) to eliminate a lot of the clutter about how much goes into which Columbia fund. The proviso that the fund will invest at least “40% of its net assets in foreign currencies, and equity and debt securities” implies a currency-hedged portfolio.

FPA Perennial (FPPFX) has closed for a few months while it becomes an entirely different fund using the same name.

Effective immediately, the name of the Hatteras Hedged Strategies Fund has changed to Hatteras Alternative Multi-Manager Fund (HHSIX). 

On August 31, 2015: iShares MSCI USA ETF (EUSA) becomes iShares MSCI USA Equal Weighted ETF. We’ll leave it to you to figure out how they might be changing the portfolio.

Natixis Diversified Income Fund (IIDPX) becomes Loomis Sayles Multi-Asset Income Fund on August 31, 2015. The investment strategy gets tweaked accordingly.

-er, don’t panic! A handful of Royce funds have lost their –ers. On June 15, Royce International Smaller-Companies Fund became Royce International Small-Cap Fund (RYGSX), European Smaller-Companies Fund became European Small-Cap Fund (RISCX) and Royce Financial Services Fund became Royce Global Financial Services Fund (RYFSX). In the former two cases, the managers wanted to highlight the fact that they focused on a stock’s capitalization rather than the size of the underlying firm. In the latter case, RYFSX has about five times the international exposure of its peers. Given that excellent performance (top 2% over the past decade) and a distinctive portfolio (their market cap is one-twentieth of their peers) hasn’t drawn assets, I suppose they’re hoping that a new name will. At the very least, with eight funds – over a third of their lineup – renamed in the past three months, that’s the way they’re betting.

Oppenheimer Flexible Strategies Fund (QVOPX) becomes Oppenheimer Fundamental Alternatives Fund on August 3, 2015. There’s no change in the fund’s operation, so apparently “strategies” are “alternatives,” just not trendy alternatives.

On June 22, 2015, the Sterling Capital Strategic Allocation Conservative Fund (BCGAX) morphed into Sterling Capital Diversified Income Fund. Heretofore it’s been a fund of Sterling funds. With the new name comes the ability to invest in other funds as well.

In case you hadn’t noticed, on June 18, 2015, the letters “TDAM” were replaced by the word “Epoch” in the names of a bunch of funds: Epoch U.S. Equity Shareholder Yield Fund, Epoch U.S. Large Cap Core Equity Fund, Epoch Global Equity Shareholder Yield Fund, Epoch Global All Cap Fund, and Epoch U.S. Small-Mid Cap Equity Fund. The funds, mostly bad, have two share classes each and have authorization to launch eight additional share classes. Except for U.S. Small-Mid Cap, they have $3-6 million in assets.

Effective July 31, 2015 Virtus Global Dividend Fund (PGUAX), a perfectly respectable fund with lots of global infrastructure exposure, becomes Virtus Global Infrastructure Fund.

Effective August 28, 2015, the West Shore Real Return Income Fund (NWSFX) becomes West Shore Real Return Fund. They’re also changing their objective from “capital growth and current income” to “preserving purchasing power.” They’ve pretty much completely rewritten their “principal strategies” text so that it’s hard to know how exactly the portfolio will change, though the addition of a risk statement concerning the use of futures and other derivatives does offer a partial answer. I’ve been genially skeptical of the fund for a long while. Their performance chart doesn’t materially reduce that skepticism:

At a reader’s behest, I spoke at length with one of the managers whose answers seemed mostly circular and who was reluctant to share information about the fund. He claimed that they have a great record as a private strategy, that they’ve shown to the board, but that they’re not interested in sharing with others. His basic argument was: “we don’t intend to make information about the fund, our strategies or insights available on the web. Our website is just a pick-up point for the prospectus. We expect that people will either know us already or will follow our success and be drawn.” At the end of the call, he announced that he and co-manager James Rickards were mostly the public faces of the fund and that the actual work of managing it fell to the third member of the trio. Mr. Rickards has since left to resume his career as doom-sayer.

OFF TO THE DUSTBIN OF HISTORY

Aftershock Strategies Fund (SHKIX/SHKNX) has closed and will discontinue its operations effective July 6, 2015.

You’ll need to find an alternative to AMG FQ Global Alternatives Fund (MGAAX), which is in the process of liquidating. Apparently they’re liquidating (or solidifying?) cash:

Final shutdown should occur by the end of July.

Elessar SCV Fund has morphed into the Emerald Small Cap Value Fund (ELASX)

Franklin Templeton has delayed by a bit the liquidation of Franklin Global Allocation Fund (FGAAX). The original date of execution was June 30 but “due to delays in liquidating certain portfolio securities,” they anticipate waiting until October 23. That’s a fascinating announcement since it implies liquidity problems though that’s not listed as an investment risk in the prospectus.

Guggenheim Enhanced World Equity Fund “ceased operations, liquidated its assets, and distributed the liquidation proceeds to shareholders of record at the close of business on June 26, 2015.”

Salient recently bought the Forward Funds complex “in an effort to build scale in the rapidly growing liquid alternatives space.” The brilliance of the deal is debatable (Forward favors liquid alts investing, but only three of its 30 funds – Select Emerging Markets Dividend, Credit Analysis Long/Short (whose founding managers were sacked a year ago) and High Yield Bond – have outperformed their peers since inception). As it turns out, Forward Small Cap Equity Fund (FFSCX) and Forward Income & Growth Allocation Fund (AOIAX) fell into neither of those camps: good or alternative. Both are scheduled to be liquidated on August 12, 2015.

HSBC RMB Fixed Income Fund (HRMBX), an exceptionally strong EM bond fund with no investors, will be liquidated on or about July 21, 2015.

MainStay ICAP Global Fund (ICGLX) will be liquidated on or about September 30, 2015. Small, middling performer, culled from the herd.

Sometimes a picture is worth a thousand words. Other times a picture leaves me speechless. Such is the case with the YTD price chart for Merk Currency Enhanced U.S. Equity Fund (MUSFX).

Yuh. That’s a one-day spike of about 60%, followed by a 60% fall the next day for a net loss of a third over two days, at which point the fund was no longer “pursuing its investment objective.” The fund is scheduled to be liquidated July 15.

Montibus Small Cap Growth Fund (SGWAX) joins the legion of the dearly departed on August 24, 2015.

Nationwide HighMark Balanced Fund (NWGDX) will, pending shareholder approval, vanish on or about October 23, 2015. At about the same time Nationwide HighMark Large Cap Growth (NWGLX) is slated to merge into Nationwide Large Cap Core Equity while Nationwide HighMark Value (NWGTX) gets swallowed by Nationwide Fund (NWFAX). The latter has been rallying after getting a new manager in 2013, so we’ll be hopeful that this is a gain for shareholders.

At the end of July, shareholders will vote on a proposal to merge the small and sad Royce Select Fund (RYSFX) into the much larger and sadder Royce 100 (RYOHX). The proxy assures investors that “the Funds have identical investment objectives, employ substantially similar principal investment strategies to pursue those investment objectives, and have the same portfolio managers,” which raises the question of why they launched Select in the first place.

The previously announced liquidation of the half million dollar Rx Tax Advantaged Fund (FMERX) has been delayed until July 31, 2015. 

On or about August 25, 2015, the Vantagepoint Model Portfolio All-Equity Growth Fund (VPAGX) becomes Vantagepoint Model Portfolio Global Equity Growth Fund and increases its equity exposure to non-U.S. securities by adding an international index fund to its collection. The fund has about a billion in assets. Who knew?

Relationships come and relationships go. One of the few proprieties that my students observe is, if you’ve actually met and gone out in person, you should be willing to break up in person. Breaking up by text is, they agreed, cruel and cowardly. I suspect that they’re unusually sympathetic with the managers of Wells Fargo Advantage Emerging Markets Local Bond Fund (WLBAX) and Wells Fargo Advantage Emerging Markets Equity Select Fund (WEMTX). “At a telephonic meeting held on June 15, 2015, the Board of Trustees unanimously approved the liquidation of the Funds.” Cold, dude. If you’d like to extend your sympathies, best send the text before July 17, 2015.

Wilmington Mid-Cap Growth Fund (AMCRX) will liquidate on or about August 3, 2015. Being “not very good” (they’ve trailed two-thirds of their peers for the past five and ten years) didn’t stop them from accumulating a quarter billion in assets but somehow the combination wasn’t enough to keep them around. Wilmington Small-Cap Strategy Fund (WMSIX), a small institutional fund with a pretty solid record and stable management, goes into the vortex that same day.

In Closing . . .

Thank you, once again, to those whose support keeps the lights on at the Observer. To Diane & Tom, Allen & Cleo, Hjalmar, Ed (cool and mysterious email address, sir!): we appreciate you!  A great, big thanks to those who use the Observer’s Amazon link for all their Amazon purchases. Your consistency, and occasional exuberant purchase, continues to help us beat our normal pattern of declining revenue in the summer months. We’d also be remiss if we forgot to thank the faithful Deborah and Greg, our honorary subscribers and PayPal monthly contributors. Many thanks to you both.

Lots to do for August. We’ve been watching the folks at the Turner Funds thrash about, both in court and in the marketplace. We’ll try to give you some perspective on what some have called The Fall of the House of Turner. In addition, we’d like to look at the question, “where should you start out?” That is, if you or a young friend of yours is a 20-something with exceedingly modest cash flow but a determination to build a sensible, durable foundation, which funds might serve as your (or their) best first investment: conservative, affordable, sensible.

And, too, I’ve got to prepare for a couple presentations: a talk with some of the young analysts at Edward Jones in St. Louis and with the folks attending Ultimus Fund Solution’s client conference at the end of August and beginning of September. If I find something fun, you’ll be the second to know!

As ever,

Dear friends,

They’re gone. Five hundred and twenty-six Augie students who we’ve jollied, prodded, chided, praised, despaired of and delighted in for the past four years have been launched on the rest of you. They’re awfully bright-eyed, occasionally in reflection of the light coming from their cell phone screens. You might suspect that they’re not listening, but if you text them, they’ll perk right up.

This is usually the time for graduation pictures but I’ve never found those engaging since they reflect the dispersion of our small, close-knit community. I celebrate rather more the moments of our cohesion; the times when small and close were incredibly powerful.

Augie’s basketball team finished second in the nation in 2015, doing rather better in our division than the Kentucky Mildcats did in theirs, eh? We did not play in a grand arena but instead in a passionate one: Carver Gymnasium, home of the Carver Crazies. It was a place where the football team (the entire football team) jammed the sidelines of every game, generally shoulder to shoulder with the women’s basketball team and the choir, all shouting … hmmm, deprecations at opposing players.

When the team boarded buses at 5:00 a.m. for the trip east to compete in the Final Four, they were cheered off by hundreds of students and staff who stood in happy gaggles in the dark. A day later, hundreds more boarded buses and jammed in cars to follow them east. And when they came home, one win shy of a championship, they were greeted with the sound of trumpets and cheers.

And while the basketball players won’t go to the NBA, a fair number – over half of our juniors – will go to med school. And so perhaps we’ll yet meet the Kentuckians at an NBA contest as our guys patch together theirs.

I rather like kids, maddened though we make each other.

MFO on FOMO

No, FOMO is not that revolutionary white spray foam that’s guaranteed to remove the toughest pet stains from your carpet; neither is it a campaign rallying cry (“FOMO years! FOMO years!”).

FOMO is “fear of missing out” and it’s one of the more plausible explanations for the market’s persistent rise. There’s an almost-universal agreement that financial assets are, almost without exception, overpriced. Some (bonds) are more badly overpriced than others (small Japanese stocks), but that’s about the best defense that serious investors make of current conditions: they’re finding pockets of relative value rather than much by way of absolute value.

The question is: why are folks hanging around when they know this is going to end badly (again)? The surprising answer is, because everyone else is hanging around. It’s a logic reminiscent of those anxious moments back in our early high school years. We’d get invited to a party (surprise!), it would be great for a while then it would begin to drag. But really, you couldn’t be the first kid to leave. First off, everyone would notice and brand you as a wuss, or worse. Second, while it was late, all the cool kids were still around and that meant, you know, that something cool might happen.

And so you lingered until just after that kid from the football team threw up near the food, one of the girls used “the F word” kinda in your face and someone – no one knows who – knocked over the nice table lamp which really pissed off Emily’s dad. Then everyone was anxious to squeeze as quickly through the door as possible. On whole, the night would have been a lot better if you’d left just a little earlier but still …

It’s like that for professional investors, too. Reuters columnist James Saft points to research that shows professionals falling victim to the same pressures:  

Call it status anxiety, call it greed or just call it clever momentum trading, but the fear of missing out is an under-appreciated force in financial markets. No one likes to miss out on a good thing, especially when they see their friends, neighbors and rivals cashing in.

Much of this may be driven by concerns about relative wealth, or how much you have compared to those in your group, a force explored in a 2007 paper by Peter DeMarzo and Ilan Kramer of Stanford University and Ron Kaniel of Duke University. They found that even when traders understand that prices are too high they may stay in the market because they fear losing out as the overvaluation persists and extends.

Investors want to keep pace with their peers, and fear not having as much wealth. That raises, in a certain way, the risk of selling into a bubble. That status and group-motivated anxiety can blind investors towards other, seemingly obvious risks. (“The power of the fear of missing out,” 05/29/2015.)

You might think of it as a financial manifestation of Newton’s first law of motion: “unless acted upon by an outside force, an object in motion tends to stay in motion in the same direction and speed.” It’s sometimes called “the law of inertia.” One technical analyst, looking at the “pattern we have seen for much of 2015, namely choppy with a slight upward bias,” opined that despite “an increasing number of clouds gathering on the horizon  …  the path of least resistance likely remains to the upside.”

And so the smart money people remain, anxiously, present. Business Insider reporter Linette Lopez, covering the huge SALT Las Vegas hedge fund conference, observes that leading hedge fund strategists:

Across the board … believe asset prices are too high. Mostly bonds, sometimes stocks. Still, everyone is long the market. No one wants to be the first person out of the market as long as they’re making money. This is a huge issue on Wall Street, and everyone at this conference is now looking for a warning signal. (“We’ve already seen the beginning of the quake that could be coming,” 05/06/2015) – didn’t discuss h.f. fees (steadily rising) or h.f. performance (steadily lagging)…

In the same week that the hedgies were meeting in Las Vegas, the Buffett Believers gathered in Omaha. There renowned value investors, such as Jean-Marie Eveillard, now a senior advisor to First Eagle funds, fret that the market was overvalued, kept alive by artificial stimulus that’s coming to an end. Eveillard says investors don’t seem to be factoring that in. “Either everyone is thinking I will just keep dancing until the music stops, or they don’t see the risks that I do.” (“At Berkshire annual meeting, Warren Buffett hosts cautious investors,” 05/02/2015.)

In an interview with Reuters, Joel Tillinghast – one of Fidelity’s two best managers – captured the yin and yang of it:

“I think [the level of the financial markets are] colossally artificial, but I don’t see it ending. How long can we party with our bad selves?” Mr. Tillinghast asked. “You want to know so you can party on until five minutes before it ends.” (“Top Fidelity stockpicker: Financial markets are ‘colossally artificial,’” 05/26/2015)

We raised last month the notion of a “roach motel,” where getting in is easy and getting out is impossible. In the case of bugs, the problem is stickum. In the case of investors, it’s liquidity. At base, you may find that there’s no one willing to pay anything even vaguely like what you think your holdings are worth. Kevin Kinsella, president of a venture capital firm, notes that investors have been making 30% per quarter on privately traded shares, like Uber.

Given the various stratospheric private valuations some of these unicorn companies are reaching, there will be no trade buyers, and it is doubtful whether a sane investment bank would take such companies public at these market caps.

Investors historically delude themselves by concocting rationales as to why the insanity will continue, why it is completely reasonable and why an implosion won’t happen to them. They are always wrong. 

How will it end? When interest rates ultimately start to tick up and vast pools of capital begin to shift toward fixed income away from equities. It’s a historic cyclical shift. When the music stops and everyone needs to scramble for their chair, there will be a lot of fannies left hanging out there.

Predicting that this will happen is easy; predicting exactly when, not so easy. But my prediction is that it is not far off. (“Tech Boom 2015: What’s Driving Investor Insanity?” Forbes, 05/21/2015)

Michael Novogratz, head of the $67 billion Fortress hedge fund operation, shared that concern at the SALT gathering:

“I’m going to argue that I think something has fundamentally changed.” He is worried because even though managers know assets are expensive, they are still long. This is a recipe for a difficult exit once all they want to close their positions. The liquidity will disappear and assets will reprice. As legendary trader Stanley Druckenmiller said, assets need a lot of volume and money to go up and much less to crash.  (Michael Novogratz CEO of Fortress Investments Is Worried About The Markets)

The question is, what’s a fund investor to do? Five things come to mind:

1. Do a quick check on your asset allocation and risk exposure. Any idea of how long a core equity fund might remain underwater; that is, how many months it takes for a fund to rebound from a bad decline? I scanned MFO’s premium fund screener for large-cap core funds that had been around 10 years or more. The five best funds took, on average, over two years to rebound. The average large cap fund took 58 months, on average, to recover from their maximum drawdown. Here’s the test: look at your portfolio value today and ask whether you’re capable of waiting until April, 2020 to ever see a number that high again. That’s the worst case for a large cap stock portfolio. For a conservative asset allocation, the recovery time is a year or two. For a moderate portfolio, three or so years. At base, decide now how long you can wait and adjust accordingly.
2. Join the Dry Powder Gang. We profiled, last month, a couple dozen entirely admirable funds that are holding substantial cash stakes. Some have been badly punished for their caution, both by investors and raters, but all have strong, stable management teams, coherent strategies and a record of deploying cash when prices get juicy.
3. Allocate some to funds that have won in up and down markets. They’re rare. Daren Fonda at Barron’s recommends “[f]unds such as FPA Crescent (FPACX) and First Eagle Global (SGENX) have flexible strategies and defensive-minded managers.”  Charles identified a handful of long-term stalwarts in his April 2015 essay “Identifying Bear-Market Resistant Funds During Good Times.” Among the notable funds (not all open to new investors) he highlighted:
   
4. Cautiously approach the alt-fund space. There are some alt funds which have a plausible claim to thrive on volatility. We’ve profiled RiverPark Structural Alpha (RSAFX), for instance, and our colleagues at DailyAlts.com regularly highlight intriguing options.
5. Try to leave when everyone else heads out, too. The Latin word for those massive exits was “vomitaria” which would make you …

Liquidity Problem – What Liquidity Problem?

By Edward A. Studzinski

“Moon in a barrel: you never know just when the bottom will fall out.”

 Mabutsu

So as David Snowball mentioned in his May commentary, I have been thinking about the potential consequences of illiquidity in the fixed income market. Obviously, if you have a portfolio in U.S. Treasury issues, you assume you can turn it into cash overnight. If you can’t, that’s a potential problem. That appears to be a problem now – selling $10 or $20 million in Treasuries without moving the market is difficult. Part of the problem is there are not a lot of natural buyers, especially at these rates and prices. QE has given the Federal Reserve their fill of them. Banks have to hold them as part of the Dodd-Frank capital requirements, but are adding to their holdings only when growing their assets. And those people who always act in the best interests of the United States, namely the Chinese, have been liquidating their U.S. Treasury portfolio. Why? As they cut rates to stimulate their economy, they are trying to sterilize their currency from the effects of those rate cuts by selling our bonds, part of their foreign reserve holdings. Remember, the goal of China is to supplant, with their own currency, the dollar as a reserve currency, especially in Asia and the developing world. And our Russian friends have similarly been selling their Treasury holdings, but in that instance using the proceeds to purchase gold bullion to add to their reserves.

Who is there to buy bonds today? Bond funds? Not likely. If you are a fund manager and thought a Treasury bond was a cash equivalent, it is not. But if there are redemptions from your fund, there is a line of credit to use until you can sell securities to cover the redemptions, right? And it is a committed line of credit, so the bank has to lend on it, no worries! In the face of a full blown market panic, with the same half dozen banks in the business of providing lines of credit to the fund industry, where will your fund firm fall in the pecking order of mutual fund holding companies, all of whom have committed lines of credit? It now becomes more understandable why the mutual fund firms with a number of grey hairs still around, have been raising cash in their funds, not just because they are running out of things to invest in that meet their parameters. It also gives you a sense as to who understands their obligations to their shareholder investors.

We also saw this week, through an article in The Wall Street Journal, that there is a liquidity problem in the equity markets as well. There are trading volumes at the open. There are trading volumes, usually quite heavy, at the end of the day. The rest of the time – there is no volume and no liquidity. So if you thought you had protected yourself from another tsunami by having no position in your fund composed of more than three days average volume of a large or mega cap stock, surprise – you have again fought the last war. And heaven help you if you decide to still sell a position when the liquidity is limited and you trigger one or more parameters for the program and quant traders.

As Lenin asked, “What is to be done?” Jason Zweig, whom I regard as the Zen Philosopher King of financial columnists, wrote a piece in the WSJ on May 23, 2015 entitled “Lessons From A Buffett Believer.” It is a discussion about the annual meeting of Markel Corporation and the presentation given by its Chief Investment Officer, Tom Gayner. Gayner, an active manager, has compiled a wonderful long-term investment record. However, he also has a huge competitive advantage. Markel is a property and casualty company that consistently underwrites at a profitable combined ratio. Gayner is always (monthly) receiving additional capital to invest. He does not appear to trade his portfolio. So the investors in Markel have gotten a double compounding effect both at the level of the investment portfolio and at the corporation (book value growth). And it has happened in a tax-efficient manner and with an expense ratio in investing that Vanguard would be proud of in its index funds.

I recently was speaking with a friend in Japan, Alex Kinmont, who has compiled a very strong record as a deep value investor in the Japanese market, in particular the small cap end of the market. We were discussing the viability of a global value fund and whether it could successfully exist with an open-ended mutual fund as its vehicle. Alex reminded me of something that I know but have on occasion forgotten in semi-retirement, which is that our style of value can be out of favor for years. Given the increased fickleness today of mutual fund investors, the style may not fit the vehicle. Robert Sanborn used to say the same thing about those occasions when value was out of favor (think dot.com insanity). But Robert was an investment manager who was always willing to put the interests of his investors above the interests of the business.

Alex made another point which is more telling, which is that Warren Buffett has been able to do what is sensible in investing successfully because he has permanent capital. Not for him the fear of redemptions. Not for him the need to appear at noon on the Gong Show on cable to flog his investment in Bank America as a stroke of genius. Not for him the need to pander to colleagues or holding company managers more worried about their bonuses than their fiduciary obligations. Gayner at Markel has the same huge competitive advantage. Both of them can focus on the underlying business value of their investments over the long term without having to worry about short-term market pricing volatility.

What does this mean for the average fund investor? You have to be very careful, because what you think you are investing in is not always what you are getting. You can see the whole transformation of a fund organization if you look carefully at what Third Avenue was and how it invested ten years ago. And now look at what its portfolios are invested in with the departure of most of the old hands.

The annual Morningstar Conference happens in a few weeks here in Chicago. Steve Romick of FPA Advisors and the manager of FPA Crescent will be a speaker, both at Morningstar and at an Investment Analysts Society of Chicago event. Steve now has more than $20B in assets in Crescent. If I were in a position to ask questions, one of them would be to inquire about the consequences of style drift given the size of the fund. Another would be about fees, where the fee breakpoints are, and will they be adjusted as assets continue to be sought after.

I believe in 2010, Steve’s colleague Bob Rodriguez did a well-deserved victory lap as a keynote speaker at Morningstar and also as well at another Investment Analysts Society of Chicago meeting. And what I heard then, both in the presentation and in the q&a by myself and others then has made me wonder, “What’s changed?” Of course, this was just before Bob was going on a year’s sabbatical, leaving the business in the hands of others. But, he said we should not expect to see FPA doing conference calls, or having a large marketing effort. And since all of their funds at that time, with the exception of Crescent, were load funds I asked him why they kept them as load funds? Bob said that that distribution channel had been loyal to them and they needed to be loyal to it, especially since it encouraged the investors to be long term. Now all the FPA Funds are no load, and they have marketing events and conference calls up the wazoo. What I suspect you are seeing is the kind of generational shift that occurs at organizations when the founders die or leave, and the children or adopted children want to make it seem like the success of the organization and the investment brilliance is solely due to them. For those of us familiar with the history of Source Capital and FPA, and the involvement of Charlie Munger, Jim Gipson, and George Michaelis, this is to say the least, disappointing.

Does Your Fund Manager Consistently Beat the Stock Market?

I saw the headline at Morningstar and had two immediate thoughts: (1) uhh, no, and (2) why on earth would I care since “beating the stock market” is not one of my portfolio objectives?

Then I read the sub-title: “Probably not–but you shouldn’t much care.”

“Ah! Rekenthaler!” I thought. And I was right.

John recounts a column by Chuck Jaffe, lamenting the demise of the star fund manager.  Rekenthaler’s questions are (1) are they actually gone? And (2) should you care? The answers are “yes” and “no, not much,” respectively.

Morningstar researchers looked to determine how long “winning streaks” last; that is, for how many consecutive years might a fund manager beat his or her benchmark. Over the past 10 years, none of the 1000 U.S. stock funds have beaten the S&P500 for more than six years. Ten funds managed six year streaks, but four of those were NASDAQ 100 index funds. Worse yet, active managers performed worse than simple luck would dictate.

Outliers

“At the extreme outer edge of what is statistically plausible” is how Malcom Gladwell defines an outlier in his amazing book, Outliers: The Story of Success (2008).

The MFO Rating System ranks funds based on risk adjusted return within their respective categories across various evaluation periods. The rankings are by quintile. Those in the top 20 percentile are assigned a 5, while those in the bottom 20 percentile are assigned a 1.

The percentile is not determined from simple rank ordering. For example, say there are 100 funds in the Large Growth category. The 20 funds with the highest risk adjusted return may not necessarily all be given a 5. That’s because our methodology assumes fund performance will be normally distributed across the category, which means terms like category mean and standard deviation are taken into account.

It’s similar to grading tests in school using a bell curve and, rightly or wrongly, is in deference to the random nature of returns. While not perfect, this method produces more satisfactory ranking results than the simple rank order method because it ensures, for example, that the bottom quintile funds (Return Group 1) have returns that are so many standard deviations below the mean or average returning funds (Return Group 3). Similarly, top quintile funds (Return Group 5) will have returns that are so many standard deviations above the mean.

All said, there remain drawbacks. At times, returns can be anything but random or “normally” distributed, which was painfully observed when the hedge fund Long-Term Capital Management (LTCM) collapsed in 1998. LTCM used quant models with normal distributions that underestimated the potential for extreme under performance. Such distributions can be skewed negatively, creating a so-called “left tail” perhaps driven by a market liquidity crunch, which means that the probability of extreme under-performance is higher than depicted on the left edge of the bell curve above.

Then there are outliers. Funds that over- or under-perform several standard deviations away from the mean. Depending on the number of funds in the category being ranked, these outliers can meaningfully alter the mean and standard deviation values themselves. For example, if a category has only 10 funds and one is an outlier, the resulting rankings could have the outlier assigned Return Group 5 and all others relegated to Return Group 1.

The MFO methodology removes outliers, anointing them if you will to bottom or top quintile, then recalculates rankings of remaining funds. It keeps track of the outliers across the evaluation periods ranked. Below please find a list of positive outliers, or extreme over-performers, based on the latest MFO Ratings of some 8700 funds, month ending April 2015.

The list contains some amazing funds and warrants a couple observations:

• Time mitigates outliers, which seems to be a manifestation of reversion to the mean, so no outliers are observed presently for periods beyond 205 or so months, or about 17 years.
• Outliers rarely repeat across different time frames, sad to say but certainly not unexpected as observed in In Search of Persistence.
• Outliers typically protect against drawdown, as evidenced by low Bear Decile score and Great Owl designations (highlighted in dark blue – Great Owls are assigned to funds that have earned top performance rank based on Martin for all evaluation periods 3 years or longer).

The following outliers have delivered extreme over-performance for periods 10 years and more (the tables depict 20 year or life metrics, as applicable):

Here are the outliers for periods 5 years and more (the tables depict 10 year or life metrics, as applicable):

Finally, the outliers for periods 3 years and more (the tables depict 5 year or life metrics, as applicable):

Top developments in fund industry litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized, searchable, and filtered as never before. For the complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

Order

The Tenth Circuit vacated a district court’s order that had granted class certification in the prospectus disclosure lawsuit regarding the Oppenheimer California Municipal Bond Fund, finding that “[t]he district court’s class certification order at issue here did not analyze either the Rule 23(a) or 23(b) factors.” Defendants include independent directors. (In re Cal. Mun. Fund.)

New Lawsuits

A new securities fraud class action targets four Virtus funds, alleging that defendants misrepresented the performance track record of the funds’ “AlphaSector” strategy (created by an unaffiliated sub-adviser). Defendants include independent directors. (Youngers v. Virtus Inv. Partners, Inc.)

A new antitrust lawsuit alleges that Waddell & Reed and Ivy Funds “financed and aided” Al Haymon’s illegal efforts to monopolize professional boxing. (Golden Boy Promotions LLC v. Haymon.)

Briefs

Davis filed a reply brief in support of its motion to dismiss fee litigation regarding its New York Venture Fund. (In re Davis N.Y. Venture Fund Fee Litig.)

PIMCO filed a reply brief in support of its motion to dismiss fee litigation regarding its Total Return Fund (Kenny v. Pac. Inv. Mgmt. Co.)

Having lost in district court, plaintiffs filed their opening appellate brief defending their state-law claims regarding investments of Vanguard mutual fund assets in foreign gambling businesses. Defendants include independent directors. (Hartsel v. Vanguard Group, Inc.)

Amended Complaint

Plaintiffs filed a second amended complaint in fee litigation regarding four MainStay funds issued by New York Life. (Redus-Tarchis v. N.Y. Life Inv. Mgmt., LLC.)

Answer

Having lost on appeal, Putnam filed an answer to fraud and negligence claims, filed by the insurer of a swap transaction, regarding Putnam’s collateral management services to a CDO. (Fin. Guar. Ins. Co. v. Putnam Advisory Co.)

The Alt Perspective: Commentary and news from DailyAlts

Every month Brian J. Haskin, founder, publisher and editor of DailyAlts shares news, perspective and commentary on the alt-space with the Observer’s readers. DailyAlts is the only website with a sole focus on liquid alternative investments.  They seek to provide a centralized source for high quality news, research and other information on one of the most dynamic and fastest growing segments of the investment industry. We’re always grateful for Brian’s commentary and he welcomes folks to drop by DailyAlts for more news in great depth. For now, the highlights:

The Access Revolution

There is an access revolution taking place in today’s investment world, especially with alternative investments. It started a number of years ago with platforms such as Kickstarter and Kiva, where everyday citizens could help others get their new idea off the ground. Today, individual investors can access a broad array of investments with just a few clicks of the mouse:

• Private equity via closed-end mutual funds
• Real estate lending and investing through crowdsourcing platforms
• Angel investing via online venture capital portals
• Private lending via online lending platforms

The list goes on, but the good news is that individual investors have far greater choice today than they did just a few years ago.

Much of the change taking place is due to changes in securities regulations that permit advertising and public promotion of private investment offerings. Other changes are driven by capital flowing to new technology-driven platforms and the broader use of existing investment vehicles.

Just this past month we had two new private equity offerings come to market in closed-end interval funds, one from Altegris / StepStone / KKR and the other from Pomona Capital / Voya:

• New Altegris Fund Gives Accredited Investors Exposure to Private Equity
• Pomona Capital and Voya Team Up on New Private Equity Fund

While these are not pure liquid alternatives (they don’t have daily liquidity, thankfully), they fall into the “near” liquid grouping. And furthermore, they give the mass-affluent access to investments that have never been available for as little as $25,000.

Expect to see more products such as these from the big name financial firms, as well as more access to alternatives through online investment portals. There is a revolution taking place.

Now, onto the liquid part of the alternatives market.

Monthly Liquid Alternative Flows

Investors allocated a total of $982 million to actively managed alternative mutual funds and ETFs in April, according to Morningstar’s most recent asset flows report, but pulled $259 million from passively managed alternative funds. Net flows totaled $723 million for the month, down from the healthy $2.8 billion of net new asset flows seen in March.

Interestingly, only two categories had positive flows in April: Multi-alternative funds and managed futures. Clearly a sign that advisors and investors are looking for either a one-stop shop for an alternatives allocation, or are looking to allocate to wholly uncorrelated strategies alongside equity and fixed income allocations. Managed futures strategies are generally expected to perform well during times of crisis, such as during the 2008 credit crisis, and when there are strong directional trends in markets, such as those we have seen in the past year with oil prices and the US dollar.

Last year was the year of non-traditional bonds, while 2015 is looking much stronger for several other strategies. Volatility based funds topped the charts for 12-month growth rates, with managed futures and multi-alternative funds not too far behind. And despite strong growth in 2014, non-traditional bond funds are only modestly keeping their head above water with a 12-month growth rate of 2.6%.

Based on growth rates and asset flows, diversification appears to be the primary focus of investors and allocators. In 2014, long/short equity fought against the $7.8 billion of outflows from the MainStay Marketfield Fund and still posted $6.4 billion of net inflows for the year. 2015 is looking quite different. Year-to-date, the long/short equity category is down $1.5 billion. While market neutral strategies can provide low levels of correlation with the equity markets, investors appear to be moving away from these strategies in favor of managed futures, volatility and multi-alternative funds.

Expect asset flows to liquid alternatives to continue on their current course of strong single-digit to low double-digit growth. Should markets falter, investors will look to allocate more to liquid alternatives.

New Fund Launches

We have seen 53 new funds launched this year, including alternative beta funds. In May, we logged 12 new funds, with nearly half being alternative beta funds. The remaining funds cut across multi-alternative, market neutral, non-traditional bonds, volatility and commodities. 

Two intriguing funds in the volatility space came to market in May:

• AccuShares Spot CBOE VIX Up Shares (VXUP)
• AccuShares Spot CBOE VIX Down Shares (VXDN)

These two funds are different because they provide direct exposure to the VIX Index, whereas other VIX related products are indexed to futures contracts on the VIX, and thus can have very high holding costs over the course of a month. Some time is needed on the new AccuShares ETFs, but if VIX is your game, these are worth keeping an eye on.

For more details, you can visit our New Funds 2015 page to see a full listing.

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.

JOHCM International Select II (JOHAX): it’s the single best performing international large growth fund in existence over the past 1, 3 and 5 years. It’s got five stars. It’s a Great Owl. You’ve probably never heard of it and it’s closing in mid-July. Now does any of that offer a compelling reason to add it to your portfolio?

Elevator Talk: Jon Angrist, Cognios Market Neutral Large Cap

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.

Market-neutral funds are, on whole, dumb investments. They’re funds with complex strategies, high expenses and low returns which provide questionable protection for their investors. By way of simple illustration, the average market-neutral fund charges 1.70% while returning 1.25% annually over the past five years. Right: 60% of the portfolio’s (modest) returns go to the adviser in the form of fees, 40% go to you.

About the best you can say for them is that, as a group, they lost only a little money in 2008: about 0.3%. The worst you can say is that they also lost a little money in 2009. And then a little more in 2010. And yet again in 2011 before their … uh, ferocious rebound led to a 0.18% gain in 2012.

Into the mess steps Jon Angrist, Brian J. Machtley and the folks at Cognios Capital. In 2008, Messrs. Angrist and Machtley co-founded Cognios (from the Latin for “to learn” or “to inquire”) which manages about $325 million, mostly for high net worth individuals. Mr. Angrist, the lead manager, has experience managing investments through limited partnerships (Helzberg Angrist Capital), private equity firms (Harvest Partners) and mutual funds (Buffalo Microcap Fund, now called Buffalo Emerging Opportunities BUFOX).

Cognios argues that most market-neutral managers misconstruct their portfolios. Most managers simply balance their short and long books: if 5% gets invested in an attractively valued car company then another 5% is devoted to shorting an unattractively valued car company. The problem is that an over-priced company might well be more volatile than an underpriced one, which means that the portfolio ceases to be market-neutral. The twist at Cognios, then, is to use quant tools to construct an attractive large cap portfolio while changing the relative sizes of the long and short books to neutralize beta. Cognios Market Neutral Large Cap describes itself as providing a “beta-adjusted market neutral” portfolio.

In a Beta-adjusted market neutral portfolio the size of the short book can be larger or smaller than the size of the long book. If the Beta of the long book is higher than the Beta of the short book, the short book needs to be larger than the size of the long book in order to remove all of the market’s broad movements (i.e., to remove the market’s Beta) … Even though the portfolio will be net short on an absolute dollar basis in [this] example (i.e., more shorts than longs) … [it] both would be market neutral on a Beta-adjusted basis.

So far, this seems to be a profitable strategy. Below is the comparative performance of Cognios (blue line) since inception, against its market neutral peer group.

Here are Jon’s 264 words on why this might become a standout strategy:

Brian and I have been working in value investing for most of our careers and about three years ago, as we looked at the mutual fund universe, we saw a huge gap in market neutral offerings for individual investors. Even today, there are less than 40 market neutral mutual funds (not share classes). In today’s market environment, I believe a market neutral allocation, beta market neutral in particular, is a critical diversification tool in an investor’s overall asset allocation as it is the only strategy that strives to remove the impact of the market and macro events from the return of the strategy. Unlike most market neutral strategies that target risk-free rates of return, our fund targets equity-like returns over full market cycles because, in my opinion, if an investor wants Treasury-like returns why wouldn’t he/she just buy Treasuries?

There was a real need in the market for which our strategy could provide a solution if packaged in a mutual fund wrapper and because we only invest in large, liquid companies in the S&P 500, we didn’t have to change our strategy in order to deploy it in a mutual fund. Investors and their advisors are looking for strategies that seek to reduce volatility, standard deviation and downside risk in a portfolio, which is the primary objective of our fund. This fund has made it possible for a wide range of investors to access the same strategy that we provide to our institutional clients in other structures. As investors in our own fund, we have a very strong conviction about what we are doing.

Cognios Market Neutral Large Cap (COGMX/COGIX) has a $1000 minimum initial investment for its retail class and $100,000 for the institutional class. Both are modest in comparison to the $25 million minimum for a separately managed account. Expenses are capped at 1.95% on the investor shares, at least through early 2016. The fund has about gathered about $16 million in assets since its December 2012 launch. More information can be found at the fund’s homepage. There’s also a quick slideshow on a third-party website that walks through the basics of the fund’s strategy.

Funds in Registration

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

Funds in registration this month are eligible to launch in July or August and some of the prospectuses do highlight that date.

This month our research associate David Welsch tracked down eight no-load retail funds in registration, which represents our core interest. Of those, four carry ESG screens (two from TIAA-CREF and two from Trillium) and three represent absolute value or absolute return strategies, while one is a short-term bond index. Interesting cluster of interests.

Manager Changes

This month 66 funds reported partial or complete changes in their management teams, a number slightly inflated by a dozen partial team changes in the AB (formerly AllianceBernstein) retirement date funds. The most striking were the imminent departures of PIMCO’s global equities CIO Virginie Maisonneuve plus several equity managers and analysts as PIMCO pulls back on their attempt to make a mark in pure equity investing. There was, in addition, announcement of the planned departure of Robert Mohn, Domestic Chief Investment Officer of Columbia Wanger Asset Management and Vice President of Wanger Advisors Trust who will step down in the fourth quarter of 2015. The change was announced for Wanger USA (WUSAX) but will presumably ripple through a series of Columbia Acorn funds eventually. In addition, Matt Paschke of the Leuthold Funds is taking a leave of absence to pursue personal interests for a bit. He’s a good and level-headed guy and we wish him well.

Updates

Andrew Foster, manager of Seafarer Overseas Growth & Income (SFGIX), was the guest on a sort-of video interview with Morningstar’s Jason Stipp in mid-May. The interview, entitled “Seeking Sustainable Growth in Emerging Markets,” covers much of the same ground as our recent conference call with Mr. Foster. One difference is that he spoke at greater length about China in his conversation with Mr. Stipp. I’ve designed it as a “sort of” video call because Jason was on-camera while Andrew was on a phone, with his picture superimposed on the screen.

Seafarer, with a three year record and five star rating, seems to have found its footing in the marketplace. The fund now boasts over a quarter billion in well-deserved assets.

Briefly Noted . . .

Ted, The Linkster and long-time stalwart of our discussion board, cheers for Dodge & Cox shareholders. He shared a USA Today story “3 AOL Investors Bag a Quick $200M” that calculates the gain to D&C shareholders from Verizon’s bid to acquire AOL. The Dodge & Cox funds own 15% of the outstanding shares of AOL, which netted them $95,000,000 in a single day. Sadly, the D&C funds are so big that AOL contributed just a fraction of a percent to returns that day. Iridian Asset Management and BlackRock finished second and third in total gains.

Ted also reports that the famously frugal Vanguard Group decided to chuck $200,000 at Bill Clinton in exchange for a 2012 speech for Vanguard’s institutional clients. That’s not an exceptional amount to hear from the former First Saxophonist; The Washington Post shows Bill pocketing $105 million for 542 speeches from the time he left the White House until the time Hilary Rodham-Clinton left the State Department. That comes to an average of $194,000 which suggests that Vanguard might have gotten just a bit flabby on their cost containment with this talk. The record might have been $300,000 paid by Dell that same year.

SMALL WINS FOR INVESTORS

Hmmm … does “nothing really bad has happened yet” qualify as a win? Other than that, we’ve got the reopening of BlackRock Event Driven Equity Fund (BALPX) on or about July 27, 2015. Bad news: BALPX is tiny, expensive and sucks. Good news: they brought in a new manager in early May, 2015. Mark McKenna left Harvard’s endowment team and joined BlackRock last year to run an event-driven hedge fund. He’s now been moved here. The other bad news: Harvard’s performance was surprisingly poor during McKenna’s tenure, which doesn’t say McKenna was responsible for the poor performance, just that he didn’t live up to the vaunted Harvard standard. As a result, this is a small win.

CLOSINGS (and related inconveniences)

American Century Small Cap Value Fund sort of closed on May 1. In an increasingly common move, the adviser left the door open for those who invest directly with the fund and for “certain financial intermediaries selected by American Century.”

ASTON/River Road Dividend All Cap Value Fund (ARDEX) and ASTON/Fairpointe Mid Cap Fund (CHTTX) have each been soft-closed. Each management team has a second fund still open.

Effective June 12, 2015, $4.2 billion Diamond Hill Long-Short Fund (DIAMX) will close to most new investors. The fund has exceptional returns for an exceptional period. Its 3-, 5- and 10-year records cluster around the 25^th percentile of all long-short funds. Potential investors need to take two factors into consideration when deciding whether to jump in: (1) performance is driven primarily by the strength of its long portfolio and (2) the lead manager for the long portfolio, Chuck Bath, is stepping aside. He’ll remain as a sort of backup manager but wants to focus his attention on Diamond Hill Large Cap. There’s no easy way of guessing how much his reorientation will cost the fund, so proceed thoughtfully if at all.

Effective as of the close of business on July 15, 2015, the $2.8 billion, five-star JOHCM International Select Fund (JOHIX) will be soft-closed. As friend Marjorie Pannell points out, the fund is an MFO Great Owl with eye-popping performance:

1 year – top 1% – (1 out of 339 funds) 
3 year – top 1% – (1 out of 293 funds) 
5 year – top 1% – (1 out of 277 funds)

Vulcan Value Partners (VVLPX) closed on June 1, rather later than originally planned. Out of respect for manager C.T. Fitzpatrick’s excellent long-term record here and at the Longleaf Funds, we sent out a notice of the extended window of opportunity to the 6000 or so folks on our email list.The $14 billion T. Rowe Price Health Sciences Fund (PRHSX) closed to new investors on June 1, 2015. Morningstar covered the fund avidly until the departure of star manager Kris Jenner. Over 13 years, Jenner nearly doubled the annualized returns of his benchmark. He left with two analysts, leaving the remaining analyst to take the reins. There was about $6 billion in the fund when Jenner (and Morningstar) left. Since then the fund has been much more T. Rowe Price-like: it has converted consistent, modest outperformance and risk consciousness into a fine record under manager Taymour Tamaddon.

OLD WINE, NEW BOTTLES

Barrow All-Cap Core Fund (BALAX) is now Barrow Value Opportunity Fund and Barrow All-Cap Long/Short Fund (BFLSX) has been renamed Barrow Long/Short Opportunity Fund. Morningstar hasn’t caught up with the change yet.

Brown Capital Management Mid-Cap Fund is now Brown Capital Management Mid Company Fund (BCSMX). Rather than investing in mid-cap stocks, the fund will target mid-sized companies: those with total operating revenues of $500 million to $10 billion.

Catalyst Absolute Total Return Fund, will undergo a name and objective change to Catalyst Intelligent Alternative Fund in July.

Over the course of the past month, The Hartford Emerging Markets Research Fund (HERAX) was … uhh, tweaked a bit so that it has a new investment mandate, lower management fee (though no break on the bottom line expense ratio), new manager (Cheryl Duckworth is out, David Elliott of Wellington is in) and new name, Hartford Emerging Markets Equity Fund. One striking element of the change was the introduction of a new “related accounts performance” table, which shows how Mr. Elliott’s other EM porfolios perform before and after deductions for Hartford’s sales charges and expenses. Since inception, Elliott’s portfolio has returned 6.9% which crushes his benchmark’s 3.6%. Deduct sales charges and expenses and investors would pocket only 3.9%. That is, 56% of the manager’s raw performance gets routed to The Hartford and 44% goes to his investors. Other than for that, it was pretty much status quo in Hartford.

Roxbury/Mar Vista Strategic Growth Fund was recently rechristened as the Mar Vista Strategic Growth Fund (MVSGX) while Roxbury/Hood River Small-Cap Growth Fund became Hood River Small-Cap Growth Fund (HRSMX). Both are tiny but have really solid records. Heck, in Hood River’s case, it has a top tier 3-, 5- and 10 year record

On July 1, 2015, the T. Rowe Price Strategic Income Fund (PRSNX) will change its name to the T. Rowe Price Global Multi-Sector Bond Fund.

Effective May 30, 2015, the name of Turner Spectrum Fund was changed to Turner Titan II Fund. . Under its new dispensation, the fund “invests primarily in equity securities of companies with large capitalization ranges across major industry sectors using a long/short strategy in seeking to capture alpha, reduce volatility, and preserve capital in declining markets.”

On May 1, 2015, the European Equity Fund (VEEEX) became the Global Strategic Income Fund. Morningstar continues its membership in the European equity peer group despite the fact that, well, it ain’t.

OFF TO THE DUSTBIN OF HISTORY

It was a bad month for both alternative strategy and bond funds. Of the 23 funds that went extinct this month, five pursued alternative strategies, four were fixed-income funds – mostly international – and two were stock/bond hybrids.

361 Market Neutral Fund (ALSQX) underwent “termination, liquidation and dissolution” on May 29, 2015. The fund had an all-star management team, spotty record and trivial asset base.

As of March 9, 2015, AllianzGI Opportunity Fund merged into AllianzGI Small-Cap Blend Fund (AZBAX). The topic came up in a mid-May SEC filing, so I thought I’d mention.

Ancora Equity Fund (ANQIX) will be liquidated and dissolved on or about June 26, 2015.

Ave Maria Opportunity Fund (AVESX), a tiny small-value fund with a lot of faith in energy stocks, will merge into Ave Maria Catholic Values Fund (AVEMX) at the end of July.

Catalyst Event Arbitrage Fund (CEAAX), which was a good hedge fund and a bad mutual fund, will be liquidated on June 15, 2015.

Clear River Fund (CLRVX) will liquidate on June 30, 2015. No, I’ve never heard of it, either. The closest to a fun fact about the fund is that it never managed to finish any calendar year with above-average returns relative to its Morningstar peer group.

A new speed record: The Trustees of Context Capital Funds launched the Context Alternative Strategies Fund (CALTX) with two managers and seven sub-advisers in March, 2014. Performance started out as mediocre but by December turned ugly. Having been patient for more than a year(!), the Trustees dismissed their two managers on May 18, then filed a prospectus supplement on Friday, May 29, 2015 that announced the liquidation of the fund on the next business day, Monday, June 1, 2015. That liquidation leaves Context with one fund, Context Macro Opportunities (CMOTX), which nominally launched in December, hasn’t traded yet, has $100,000 in assets and a $1,000,000 minimum.

Encompass Fund (ENCPX) liquidated on May 27, 2015. They launched about seven years ago, convinced that it was time to focus on materials stocks. They were right, then they were very wrong; the fund tended to finish in the top 1% or the bottom 1% of its noticeably volatile natural resources peer group. At the end, they had $2 million in AUM and were dead last in their peer group. The managers and trustees, to their great credit if not to their personal gain, held about half of the fund’s total assets.

That said, the managers wrote a thoughtful and appropriate eulogy for the fund in their last letter to shareholders.

We want the shareholders to know that we resigned with a keen sense of disappointment. After posting exceptional returns in 2009 and 2010, we were optimistic that the Fund’s overweight in precious and industrial metals would continue to enable Encompass to excel. However, the last 4 years were difficult ones for resource companies and the Fund has underperformed. We did increase exposure to the energy sector in late 2013 and early 2014. Those stocks performed very well until oil prices shocked investors by declining more than 50% in the second half of 2014.

More recently we increased the Fund’s exposure to the health care, cybersecurity and airline industries with good results. However, the resource companies have continued to weigh on overall portfolio performance even though exposure to metals has been significantly reduced.

When we launched Encompass in mid-2006, we believed the time was right for a diversified mutual fund that emphasized resource companies. For several years we were proven right, but despite fundamentals that historically have been good for metals companies, the last few years have been very challenging. The Fund has not been able to grow and thus we came to the very difficult decision that we should resign as Manager. The Fund’s independent Trustees considered various alternatives and concluded that the Fund should be liquidated.

We have begun liquidating the Fund’s holdings, and intend to complete the process in the next couple of weeks. Of course, we are attempting to maximize the proceeds for the benefit of shareholders.

Guggenheim Enhanced World Equity Fund (GEEWX) will liquidate on June 26, 2015. $6 million in assets with a 600% annual turnover which, I presume, is the “enhancement” implied by the name.

Innealta Capital Global All Asset Opportunity Fund (ROMAX) will discontinue operations on June 19^th. The fund managed to rake in just about $3 million in its two years of high expense/high turnover/low returns operations.

In mid-July, Jamestown Balanced Fund (JAMBX) will ask its shareholders for permission to merge into Jamestown Equity Fund (JAMEX). The rationale is that the funds have “similar investment objectives, investment strategies and risk factors,” which is true give or take the nearly 50% higher volatility that investors in the equity fund experience over investors in the balanced one.

The trustees of the fund have authorized the liquidation of the Pioneer Emerging Markets Local Currency Debt Fund (LCEMX) which will occur on August 7, 2015. To put the decision in context: over the past couple years, investing in emerging markets bonds (the orange line) has been a bad idea, investing in EM bonds denominated in local currencies (green) has been a worse idea and investing in the Pioneer fund (blue) has been a thorough disaster.

On the upside, with only $10 million in assets, no one much was hurt. As of the last SAI, the manager hadn’t invested a single dinar, rupee or pataca in the fund so his portfolio was pretty much unscathed.

The Listed Private Equity Plus Fund become unlisted on May 18, 2015.

On May 15, 2015, the Loomis Sayles International Bond Fund was liquidated. A subsequent SEC filing helpfully notes: “The Fund no longer exists, and as a result, shares of the Fund are no longer available for purchase or exchange.”

PIMCO is retreating from the equity business with the liquidation of PIMCO Emerging Multi-Asset (PEAAX), PIMCO EqS^® Emerging Markets (PEQAX) and PIMCO EqS Pathfinder (PATHX) funds, all on July 14, 2015. Pathfinder, with nearly $900 million in assets, was supposed to be a vehicle to showcase the talents of two Franklin Mutual Series managers who defected to PIMCO. That didn’t play out during the fund’s five year history, arguably because it was better positioned for down markets than for rising ones. PEAAX was a small, sucky fund of PIMCO funds. PEQAX was a slightly less small, slightly less sucky fund that was supposed to be the star vehicle for an imported GSAM team. Oops.

Rx Tax Advantaged Fund (FMERX) will liquidate soon. It managed to parlay high expenses and a low-return asset class (muni bonds) into a tiny, money-losing proposition.

Templeton Constrained Bond Fund (FTCAX) goes the way of the dodo bird on August 27, 2015 which “may be delayed if unforeseen circumstances arise.” I can’t for the life of me figure out what the “constraint” in the fund name referred to. The prospectus announces:

Under normal market conditions, the Fund invests at least 80% of its net assets in “bonds.” Bonds include debt obligations of any maturity, such as bonds, notes, bills and debentures.

The constraint is that the bond fund must buy “bonds”? The last portfolio report shows them at 90% cash in a $10 million portfolio.

Touchstone International Fixed Income Fund (TIFAX), in recognition of “its small size and limited growth potential,” will liquidate on July 21, 2015. “An overweight to peripheral and speculative issuers” helped performance, right up to the moment when it didn’t:

Okay, they really, really mean it this time: The Turner Funds determined to close and liquidate the Turner Titan Fund (TTLFX), effective on or about June 19, 2015. The Fund had previously been scheduled to close and liquidate on or about June 1, 2015. That’s followed its closure at the end of 2014 and previously announced plans to liquidate in mid-March and late April.

V2 Hedged Equity Fund (VVHEX/VVHIX), responding to “an anticipated decline in Fund assets,” liquidated in early May.

I appreciate thoroughness: “Effective April 30, 2015, the Virtus Global Commodities Stock Fund … was liquidated. The Fund has ceased to exist and is no longer available for sale. Accordingly, the prospectus and SAI are no longer valid.” Any questions?

In Closing . . .

Thanks, as always, to the folks who support the Observer. To Binod, greetings and good luck with the rising waters in Houston. We feel for you! Thanks to Joe for the thumbs-up on our continuing redesign of the Observer’s site; it’s always good to get an endorsement from a pro! Tom, thank you, we’re so glad that you find our site useful. Thanks, finally, to the folks who’ve bookmarked the Observer’s link to Amazon. Normally our Amazon revenue tails off dramatically at mid-year. So far this season, it’s held up reasonably well and we’re grateful.

We’ll look for you at Morningstar. I’ll be the one dressed like a small oak. It’s a ploy! John Rekenthaler (Bavarian for “thunder talker,” I think) recently mused “I don’t actually get invited to parties, but if I did, I’d be chatting with the potted plants.” I figure that with proper foliage I might lure the Great Man into amiable conversation.

If any of you would like to join Hedda, Jake, (maybe) Tadas and the good folks from the Queens Road funds (they’ve promised me fresh peanuts) in diverting my attention and saving John from my interminable prattle, please do drop us a note and we’ll set up a time to meet. The Observer folks should be around the conference from early Wednesday until well past its Friday close.

As always, we’ll post daily conference highlights on MFO’s discussion board. (No, I don’t tweet and you can’t make me.) If you miss them there, we’ll share them in our July issue. In addition, we have profiles of some new ESG/green funds – equity, income and hybrid – on tap. We’ll explain why in July!

As ever,

Dear friends,

It’s May, a sweet and anxious time at college. The End is tantalizingly close; just two weeks remain in the academic year and, for many, in their academic career.  Both the trees on the Quad and summer wardrobes are bursting out. The days remaining and the brain cells remaining shrink to a precious few. We all wonder where another year (my 31^st here) went, holding on to its black-robed closing days even as we long for the change of pace and breathing space that summer promises.

For investors too summer holds promise, for days away and for markets unhinged. Perhaps thinking a bit ahead while the hinges remain intact might be a prudent course and a helpful prologue to lazy, hazy and crazy.

The Dry Powder Crowd

A bunch of fundamentally solid funds have been hammered by their absolute value orientation; that is, their refusal to buy stocks when they believe that the stock’s valuations and the underlying corporation’s prospects simply do not offer a sufficient margin of safety for the risks they’re taking, much less compelling opportunities. The mere fact that a fund sports just one lonely star in the Morningstar system should not disqualify it from serious consideration. Many times a low star rating reflects the fact that a particular style or perspective is out-of-favor, but the managers were unwilling to surrender their discipline to play to what’s popular.

That strikes us as admirable.

Sometimes a fund ends up with a one-star rating simply because it’s too independent to fit into one of Morningstar’s or Lipper’s predetermined boxes.

We screened for one-star equity funds with over 20% cash. From that list we looked for solid, disciplined funds whose Morningstar ratings have taken a pounding. Those include:

Frankly, any one of the funds above has the potential to be the best performer in your portfolio over the next five years especially if interest rates and valuations begin to normalize.

The challenge of overcoming cash seems so titanic that it’s worth noting, especially, the funds whose managers have managed to marry substantial cash strong with ongoing strong absolute and relative returns. These funds all have at least 20% cash and four- or five-star ratings from Morningstar, as of April 2015.

Fans of large funds (or Goodhaven) might want to consult Morningstar’s recommended list of “Cash-Heavy Funds for the Cautious Investor” which includes five names:

It’s time for an upgrade

The story was all over the place on the morning of April 20^th:

• Reuters: “Carlyle to shutter its two mutual funds”
• Bloomberg: “Carlyle to close two mutual funds in liquid alts setback”
• Ignites: “Carlyle pulls plug on two mutual funds”
• ValueWalk: “Carlyle to liquidate a pair of mutual funds”
• Barron’s: “Carlyle closing funds, gold slips”
• MFWire dutifully linked to three of them in its morning link list

Business Insider gets it closest to right: “Private equity giant Carlyle Group is shutting down the two mutual funds it launched just a year ago,” including Carlyle Global Core Allocation Fund.

What’s my beef? 

1. Carlyle doesn’t have two mutual funds, they have one. They have authorization to launch the second fund, but never have. It’s like shuttering an unbuilt house. Reuters, nonetheless, solemnly notes that the second fund “never took off [and] will also be wound down,” implying that – despite Carlyle’s best efforts, it was just an undistinguished performer.
2. The fund they have isn’t the one named in the stories. There is no such fund as Carlyle Global Core Allocation Fund, a fund mentioned in every story. Its name is Carlyle Core Allocation Fund(CCAIX/CCANX). It’s rather like the Janus Global Unconstrained Bond Fund that, despite Janus’s insistence, didn’t exist at the point that Mr. Gross joined the team. “Global” is a description but not in the name.
3. The Carlyle fund is not newsworthy. It’s less than one year old, it has a trivial asset base ($50 million) and has not yet made a penny ($10,000 at inception is now $9930).

If folks wanted to find a story here, a good title might be “Another big name private investor trawls the fund space for assets, doesn’t receive immediate gratification and almost immediately loses interest.” I detest the practice of tossing a fund into the market then shutting it in its first year; it really speaks poorly of the adviser’s planning, understanding and commitment but it seems distressingly common.

What’s my solution?

Upgrade. Most news outlets are no longer capable of doing that for you; they simply don’t have the resources to do a better job or to separate press release from self-serving bilge from news so you need to do it for yourself.

Switch to Bloomberg TV from, you know, the screechy guys. If it’s not universally lauded, it does seem broadly recognized as the most thoughtful of the financial television channels.

Develop the habit of listening to Marketplace, online or on public radio. It’s a service of American Public Media and I love listening to Kai Ryssdal and crew for their broad, intelligent, insightful reporting on a wide range of topics in finance and money.

Read the Saturday Wall Street Journal, which contains more sensible content per inch than any other paper that lands on my desk. Jason Zweig’s column alone is worth the price of admission. His most recent weekend piece, “A History of Mutual-Fund Doors Opening and Closing,” is outstanding, if only because it quotes me.  About 90% of us would benefit from less saturation with the daily noise and more time to read pieces that offer a bit of perspective.

Reward yourself richly on any day when your child’s baseball score comes immediately to mind but you can honestly say you have no earthly clue what the score of the Dow Jones is. That’s not advice for casual investors, that’s advice for professionals: the last thing on earth that you want is a time horizon that’s measured in hours, days, weeks or months. On that scale the movement of markets is utterly unpredictable and focusing on those horizons will damage you more deeply and more consistently than any other bad habit you can develop.

Go read a good book and I don’t mean financial porn. If your competitive advantage is seeing things that other people (uhh, the herd) don’t see, then you’ve got to expose yourself to things other people don’t experience. In a world increasingly dominated by six inch screens, books – those things made from trees – fit the bill. Bill Gates recommends The Bully Pulpit, by Doris Kearns Goodwin. Goodwin “studies the lives of America’s 26th and 27th presidents to examine a question that fascinates me: How does social change happen?” That is, Teddy Roosevelt and William Taft. Power down your phone while you’re reading. The aforementioned Mr. Zweig fusses that “you can’t spend all day reading things that train your brain to twitch” and offers up Daniel Kahneman’s Thinking, Fast and Slow. Having something that you sip, rather than gulp, does help turn reading from an obligation to a calming ritual. Nina Kallen, a friend, insurance coverage lawyer in Boston and one of the sharpest people we know, declares Roger Fisher and William Ury’s Getting to Yes: Negotiating Agreement Without Giving In to be “life-changing.” In her judgment, it’s the one book that every 18-year-old should be handed as part of the process of becoming an adult. Chip and I have moved the book to the top of our joint reading list for the month ahead. Speaking of 18-year-olds, it wouldn’t hurt if your children actually saw you reading; perhaps if you tell them they wouldn’t like it, they’d insist on joining you.

How Good Is Your Fund Family? An Update…

Baseball season has started. MLB.TV actually plays more commercials than it used to, which sad to say I enjoy more than the silent “Commercial Break In Progress” screen, even if they are repetitive.

One commercial is for The Hartford Funds. The company launched a media campaign introducing a new tagline, “Our benchmark is the investor℠,” and its focus on “human-centric investing.”

Its website touts research they have done with MIT on aging, and its funds are actually sub-advised by Wellington Management.

A quick look shows 66 funds, each with some 6 share classes, and just under $100B AUM. Of the 66, most charge front loads up to 5.5% with an average annual expense ratio of just over 1%, including 12b-1 fee. And, 60 have been around for more than 3 years, averaging 15 years in fact.

How well have their funds performed over their lifetimes? Just average … a near even split between funds over-performing and under-performing their peers, including expenses.

We first started looking at fund family performance last year in the piece “How Good Is Your Fund Family?” Following much the same methodology, with all the same qualifications, below is a brief update. Shortly, we hope to publish an ongoing tally, or “Fund Family Score Card” if you will, because … during the next commercial break, while watching a fund family’s newest media campaign, we want to make it easier for you to gauge how well a fund family has performed against its peers.

The current playing field has about 6200 US funds packaged and usually marketed in 225 families. For our tally, each family includes at least 5 funds with ages 3 years or more. Oldest share class only, excluding money market, bear, trading, and specialized commodity funds. Though the numbers sound high, the field is actually dominated by just five families, as shown below:

It is interesting that while Vanguard represents the largest family by AUM, with nearly twice its nearest competitor, its average annual ER of 0.22% is less than one third either Fidelity or American Funds, at 0.79% and 0.71%, respectively. So, even without front loads, which both the latter use to excess, they are likely raking in much more in fees than Vanguard.

Ranking each of the 225 families based on number of funds that beat their category averages produces the following score card, by quintile, best to worst:

Of the five families, four are in top two quintiles: Vanguard, American Funds, Fidelity, and T. Rowe Price.  In fact, of Vanguard’s 145 funds, 119 beat their peers. Extraordinary. But BlackRock is just average, like Hartford.

The difference in average total return between top and bottom fund families on score card is 3.1% per year!

The line-ups of some of the bottom quintile families include 100% under-performers, where every fund has returned less than its peers over their lifetimes: Commonwealth, Integrity, Lincoln, Oak Associates, Pacific Advisors, Pacific Financial, Praxis, STAAR. Do you think their investors know? Do the investors of Goldman Sachs know that their funds are bottom quintile … written-off to survivorship bias possibly?

Visiting the website of Oberweis, you don’t see that four of its six funds under-performed. Instead, you find: TWO FUNDS NAMED “BEST FUND” IN 2015 LIPPER AWARDS. Yes, its two over-performers.

While the line-ups of some top quintile families include 100% over-performers: Cambiar, Causeway, Dodge & Cox, First Eagle, Marsico, Mirae, Robeco, Tocqueville.

Here is a summary of some of the current best and worst:

While not meeting the “five funds” minimum, some other notables: Tweedy Browne has 4 of 4 over-performers, and Berwyn, FMI, Mairs & Power, Meridian, and PRIMECAP Odyssey all have 3 of 3.

(PRIMECAP is an interesting case. It actually advises 6 funds, but 3 are packaged as part of the Vanguard family. All 6 PRIMECAP advised funds are long-term overperformers … 3.4% per year across an average of 15 years! Similarly with OakTree. All four of its funds beat their peers, but only 2 under its own name.)

As well as younger families off to great starts: KP, 14 of 14 over-performers, Rothschild 7 of 7, Gotham 5 of 5, and Grandeur Peak 4 of 4. We will find a way to call attention to these funds too on the future “Fund Family Score Card.”

Ed is on assignment, staking out a possible roach motel

Our distinguished senior colleague Ed Studzinski is a deep-value investor; his impulse is to worry more about protecting his investors when times turn dark than in making them as rich as Croesus when the days are bright and sunny. He’s been meditating, of late, on the question of whether there’s anything a manager today might do that would reliably protect his investors in the case of a market crisis akin to 2008.

Ed is one of a growing number of investors who are fearful that we might be approaching a roach motel; that is, a situation where it’s easy to get into a particular security but where it might be impossible to get back out of it when you urgently want to.

Structural changes in the market and market regulations have, some fear, put us at risk for a liquidity crisis. In a liquidity crisis, the ability of market makers to absorb the volume of securities offered for sale and to efficiently match buyers and sellers disappears. A manager under pressure to sell a million dollars’ worth of corporate bonds might well find that there’s only a market for two-thirds of that amount, the remaining third could swiftly become illiquid – that is, unmarketable – securities.

David Sherman, president of Cohanzick Asset Management and manager of two RiverPark’s non-traditional bond funds addressed the issue in his most recent shareholder letter. I came away from it with two strong impressions:

There may be emerging structural problems in the investment-grade fixed-income market. At base, the unintended consequences of well-intended reforms may be draining liquidity from the market (the market makers have dramatically less cash and less skin in the game than they once did) and making it hard to market large fixed-income sales. An immediate manifestation is the problem in getting large bond issuances sold.

Things might get noticeably worse for folks managing large fixed-income portfolios. His argument is that given the challenges facing large bond issues, you really want a fund that can benefit from small bond issues. That means a small fund with commitments to looking beyond the investment-grade universe and to closing before size becomes a hindrance.

Some of his concerns are echoed on a news site tailored for portfolio managers, ninetwentynine.com. An article entitled “Have managers lost sight of liquidity risk?” argues:

A liquidity drought in the bond space is a real concern if the Fed starts raising rates, but as the Fed pushes off the expected date of its first hike, some managers may be losing sight of that danger. That’s according to Fed officials, who argue that if a rate hike catches too many managers off their feet, the least they can expect is a taper tantrum similar to 2013, reports Reuters. The worst-case-scenario is a full-blown liquidity crisis.

The most recent investor letter from the managers of Driehaus Active Income Fund (LCMAX) warns that recent structural changes in the market have made it increasingly fragile:

Since the end of the credit crisis, there have been a number of structural changes in the credit markets, including new regulations, a reduced size of broker dealer trading desks, changes in fund flows, and significant growth of larger index-based mutual funds and ETFs. The “new” market environment and players have impacted nearly all aspects of the market, including trading liquidity. The transfer of risk is not nearly as orderly as it once was and is now more expensive and volatile … one thing nearly everyone can agree on is that liquidity in the credit markets has decreased materially since the credit crisis.

The federal Office of Financial Research concurs: “Markets have become more brittle because liquidity may be less available in a downturn.” Ben Inker, head of GMO’s asset allocation group, just observed that “the liquidity in [corporate credit] markets has become shockingly poor.”

More and more money is being stashed in a handful of enormous fixed income funds, active and passive. In general, those might be incredibly regrettable places to be when liquidity becomes constrained:

Generally speaking, you’re going to need liquidity in your bond fund when the market is stressed. When the market is falling apart, the ETFs are the worst place to be, as evidenced by their underperformance to the index in 2008, 2011 and 2013. So yes, you will have liquidity, but it will be in something that is cratering.

What does this mean for you?

1. Formerly safe havens won’t necessarily remain safe.
2. You need to know what strategy your portfolio manager has for getting ahead of a liquidity crunch and for managing during it. The Driehaus folks list seven or eight sensible steps they’ve taken and Mr. Sherman walks through the structural elements of his portfolio that mitigate such risks.
3. If your manager pretend not to know what the concern is or suggests you shouldn’t worry your pretty little head about it, fire him.

In the interim, Mr. Studzinski is off worrying on your behalf, talking with other investors and looking for a safe(r) path forward. We’re hoping that he’ll return next month with word of what he’s found.

Top developments in fund industry litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before. For the complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

Orders

• The SEC charged BlackRock Advisors with breaching its fiduciary duty by failing to disclose a conflict of interest created by the outside business activity of a top-performing portfolio manager. BlackRock agreed to settle the charges and pay a $12 million penalty.
• In a blow to Putnam, the Second Circuit reinstated fraud and negligence-based claims made by the insurer of a swap transaction. The insurer alleges that Putnam misrepresented the independence of its management of a collateralized debt obligation. (Fin. Guar. Ins. Co. v. Putnam Advisory Co.)

New Appeals

• Plaintiffs have appealed the lower court’s dismissal of an ERISA class action regarding Fidelity‘s practices with respect to the so-called “float income” generated from plan participants’ account transactions. (In re Fid. ERISA Float Litig.)

Briefs

• Plaintiffs filed their opposition to Davis‘s motion to dismiss excessive-fee litigation regarding the New York Venture Fund. Brief: “Defendants’ investment advisory fee arrangements with the Davis New York Venture Fund . . . epitomize the conflicts of interest and potential for abuse that led Congress to enact § 36(b). Unconstrained by competitive pressures, Defendants charge the Fund advisory fees that are as much as 96% higher than the fees negotiated at arm’s length by other, independent mutual funds . . . for Davis’s investment [sub-]advisory services.” (In re Davis N.Y. Venture Fund Fee Litig.)
• Plaintiffs filed their opposition to PIMCO‘s motion to dismiss excessive-fee litigation regarding the Total Return Fund. Brief: “In 2013 alone, the PIMCO Defendants charged the shareholders of the PIMCO Total Return Fund $1.5 billion in fees, awarded Ex-head of PIMCO, Bill Gross, a $290 million bonus and his second-in-command a whopping $230 million, and ousted a Board member who dared challenge Gross’s compensation—all this despite the Fund’s dismal performance that trailed 70% of its peers.” (Kenny v. Pac. Inv. Mgmt. Co.)
• In the purported class action regarding alleged deviations from two fundamental investment objectives by the Schwab Total Bond Market Fund, the Investment Company Institute and Independent Directors Council filed an amici brief in support of Schwab’s petition for rehearing (and rehearing en banc) of the Ninth Circuit’s 2-1 decision allowing the plaintiffs’ state-law claims to proceed. Brief: “The panel’s decision departs from long-standing law governing mutual funds and creates confusion and uncertainty nationwide.” Defendants include independent directors. (Northstar Fin. Advisors, Inc. v. Schwab Invs.)

Amended Complaint

• Plaintiffs filed a new complaint in the fee litigation against New York Life, adding a fourth fund to the case: the MainStay High Yield Opportunities Fund. (Redus-Tarchis v. N.Y. Life Inv. Mgmt., LLC.)

Answer

• P. Morgan filed an answer in an excessive-fee lawsuit regarding three of its bond funds. (Goodman v. J.P. Morgan Inv. Mgmt., Inc.)

The Alt Perspective: Commentary and News from Daily Alts

The spring has brought new life into the liquid alternatives market with both March and April seeing robust activity in terms of new fund launches and registrations, as well as fund flows. Touching on new fund flows first, March saw more than $2 billion of new asset flow into alternative mutual funds and ETFs, while US equity mutual funds and ETFs had combined outflows of nearly $6 billion.

At the top of the inflow rankings were international equity and fixed income, which provides a clear indication that investors were seeking both potentially higher return equity markets (non-US equity) and shelter (fixed income and alternatives). With increased levels of volatility in the markets, I wouldn’t be surprised to see this cash flow trend continue on into April and May.

New Funds Launched in April

We logged eight new liquid alternative funds in April from firms such as Prudential, Waycross, PowerShares and LoCorr. No particular strategy stood out as being dominant among the eight funds as they ranged from long/short equity and alternative fixed income strategies, to global macro and multi-strategy. A couple highlights are as follows:

1) LoCorr Multi-Strategy Fund – To date, LoCorr has done a thoughtful job of brining high quality managers to the liquid alts market, and offers funds that cover managed futures, long/short commodities, long/short equity and alternative income strategies. In this new fund, they bring all of these together in a single offering, making it easier for investors to diversify with a single fund.

2) Exceed Structured Shield Index Strategies Fund – This is the first of three new mutual funds that provide investors with a structured product that is designed to protect downside volatility and provide a specific level of upside participation. The idea of a more defined outcome can be appealing to a lot of investors, and will also help advisors figure out where and how to use the fund in a portfolio.

New Funds Registered in April

Fund registrations are where we see what is coming a couple months down the road – a bit like going to the annual car show to see what the car manufacturers are going to be brining out in the new season. And at this point, it looks like June/July will be busy as we counted 9 new alternative fund registration in April. A couple interesting products are listed below:

1) Hatteras Market Neutral Fund – Hatteras has been around the liquid alts market for quite some time, and with this fund will be brining multiple managers in as sub-advisors. Market neutral strategies are appealing at times when investors are looking to take risk off the table yet generate returns that are better than cash. They can also serve as a fixed income substitute when the outlook is flat to negative for the fixed income market.

2) Franklin K2 Long Short Credit Fund – K2 is a leading fund of hedge fund manager that works with large institutional investors to invest in and manage portfolios of hedge funds. The firm was acquired by Franklin Templeton back in 2012 and has so far launched one alternative mutual fund. The fund will be managed by multiple sub-advisors and will allocate to several segments of the fixed income market. 

Debunking Active Share

High active share does not equal high alpha. I’ll say that again. High active share does not equal high alpha. This is the finding in a new AQR white paper that essentially proves false two of the key tenents of a 2009 research paper (How Active is Your Fund Manager? A New Measure That Predicts Performance) by Martijn Cremers and Antti Petajisto. These two tenents are:

1) Active Share predicts fund performance: funds with the highest Active Share significantly outperform their benchmarks, both before and after expenses, and they exhibit strong performance persistence.

2) Non-index funds with the lowest Active Share underperform their benchmarks.

AQR explains that other factors are in play, and those other factors actually explain the outperformance that Cremers and Petajisto found in their work. You can read more here: AQR Deactivates Active Share in New White Paper.

And finally, for anyone considering the old “Sell in May and Go Away” strategy this month, be sure to have a read of this article, or watch this video. Or, better yet, just make a strategic allocation to a few solid alternative funds that have some downside protection built into them.

Feel free to stop by DailyAlts.com for more coverage of liquid alternatives.

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.

Seafarer Overseas Growth & Income (SFGIX/SIGIX): Our contention has always been that Seafarer represents one of the best possible options for investors interested in approaching the emerging markets. A steadily deepening record and list of accomplishments suggests that we’re right.

Towle Deep Value Fund (TDVFX): This fund positions itself a “an absolute value fund with a strong preference for staying fully invested.” For the past 33 years, Mr. Towle & Co. have been consistently successful at turning over more rock – in under covered small caps and international stocks alike – to find enough deeply undervalued stocks to populate the portfolio and produce eye-catching results.

Conference Call Highlights: Seafarer Overseas Growth & Income

Here are some quick highlights from our April 16^th conversation with Andrew Foster of Seafarer.

Seafarer’s objective: Andrew’s hope is to outperform his benchmark (the MSCI EM index) “slowly but steadily over time.” He describes the approach as a “relative return strategy” which pursues growth that’s more sustainable than what’s typical in developing markets while remaining value conscious.

Here’s the strategy: you need to start by understanding that the capital markets in many EM nations are somewhere between “poorly developed” and “cruddy.” Both academics and professional investors assume that a country’s capital markets will function smoothly: banks will make loans to credit-worthy borrowers, corporations and governments will be able to access the bond market to finance longer-term projects and stocks will trade regularly, transparently and at rational expense.

None of that may safely be assumed in the case of emerging markets; indeed, that’s what might distinguish an “emerging” market from a developed one. The question becomes: what are the characteristics of companies that might thrive in such conditions.

The answer seems to be (1) firms that can grow their top line steadily in the 7-15% per annum range and (2) those that can finance their growth internally. The focus on the top line means looking for firms that can increase revenues by 7-15% without obsessing about similar growth in the bottom line. It’s almost inevitable that EM firms will have “stumbles” that might diminish earnings for one to three years; while you can’t ignore them, you also can’t let them drive your investing decisions. “If the top line grows,” Andrew argues, “the bottom line will follow.” The focus on internal financing means that the firms will be capable of funding their operations and plans without needing recourse to the unreliable external sources of capital.

Seafarer tries to marry that focus on sustainable moderate growth “with some current income, which is a key tool to understanding quality and valuation of growth.” Dividends are a means to an end; they don’t do anything magical all by themselves. Dividends have three functions. They are:

An essential albeit crude valuation tool – many valuation metrics cannot be meaningfully applied across borders and between regions; there’s simply too much complexity in the way different markets operate. Dividends are a universally applicable measure.

A way of identifying firms that will bounce less in adverse market conditions – firms with stable yields that are just “somewhat higher than average” tend to be resilient. Firms with very high dividend yields are often sending out distress signals. 

A key and under-appreciated signal for the liquidity and solvency of a company – EMs are constantly beset by liquidity and credit shocks and unreliable capital markets compound the challenge. Companies don’t survive those shocks as easily as people imagine. The effects of liquidity and credit crunches range from firms that completely miss their revenue and earnings forecasts to those that drown themselves in debt or simply shutter. Against such challenges dividends provide a clear and useful signal of liquidity and solvency.

It’s certainly true that perhaps 70% of the dispersion of returns over a 5-to-10 year period are driven by macro-economic factors (Putin invades-> the EU sanctions-> economies falter-> the price of oil drops-> interest rates fall) but that fact is not useful because such events are unforecastable and their macro-level impacts are incalculably complex (try “what effect will European reaction to Putin’s missile transfer offer have on shadow interest rates in China?”). 

Andrew believes he can make sense of the ways in which micro-economic factors, which drive the other 30% of dispersion, might impact individual firms. He tries to insulate his portfolio, and his investors, from excess volatility by diversifying away some of the risk, imagining a “three years to not quite forever” time horizon for his holdings and moving across a firm’s capital structure in pursuit of the best risk-return balance.

While Seafarer is classified as an emerging markets equity fund, common stocks have comprised between 70-85% of the portfolio. “There’s way too much attention given to whether a security is a stock or bond; all are cash flows from an issuer. They’re not completely different animals, they’re cousins. We sometimes find instruments trading with odd valuations, try to exploit that.” As of January 2015, 80% of the fund is invested directly in common stock; the remainder is invested in ADRs, hard- and local-currency convertibles, government bonds and cash. The cash stake is at a historic low of 1%.

Thinking about the fund’s performance: Seafarer is in the top 3% of EM stock funds since launch, returning a bit over 10% annually. With characteristic honesty and modesty, Andrew cautions against assuming that the fund’s top-tier rankings will persist in the next part of the cycle:

We’re proud of performance over the last few years. We have really benefited from the fact that our strategy was well-positioned for anemic growth environments. Three or four years ago a lot of people were buying the story of vibrant growth in the emerging markets, and many were willing to overpay for it. As we know, that growth did not materialize. There are signs that the deceleration of growth is over even if it’s not clear when the acceleration of growth might begin. A major source of return for our fund over 10 years is beta. We’re here to harness beta and hope for a little alpha.

That said, he does believe that flaws in the construction of EM indexes makes it more likely that passive strategies will underperform:

I’m actually a fan of passive investing if costs are low, churn is low, and the benchmark is soundly constructed. The main EM benchmark is disconnected from the market. The MSCI EM index imposes filters for scalability and replicability in pursuit of an index that’s easily tradable by major investors. That leads it to being not a really good benchmark. The emerging markets have $14 trillion in market capitalization; the MSCI Core index captures only $3.8 trillion of that amount and the Total Market index captures just $4.2 trillion. In the US, the Total Stock Market indexes capture 80% of the market. The comparable EM index captures barely 25%.

Highlights from the questions:

As a practical matter, a 4-5% position is “huge for us” though he has learned to let his winners run a little longer than he used to, so the occasional 6% position wouldn’t be surprising.

A focus on dividend payers does not imply a focus on large cap stocks. There are a lot of very stable dividend-payers in the mid- to small-cap range; Seafarer ranges about 15-20% small cap and 35-50% midcap.

The fundamental reason to consider investing in emerging markets is because “they are really in dismal shape, sometimes the horrible things you read about them are true but there’s an incredibly powerful drive to give your kids a better life and to improve your life. People will move mountains to make things better. I followed the story of one family who were able to move from a farmhouse with a dirt floor to a comfortable, modern townhouse in one lifetime. It’s incredibly inspiring, but it’s also incredibly powerful.”

With special reference to holdings in Eastern Europe, you need to avoid high-growth, high-expectation companies that are going to get shell-shocked by political turmoil and currency devaluation. It’s important to find companies that have already been hit and that have proved that they can survive the shock.

Bottom line: Andrew has a great track record built around winning by not losing. His funds have posted great relative returns in bad markets and very respectable absolute returns in frothy ones. While he is doubtless correct in saying that the fund was unique well-suited to the current market and that it won’t always be a market leader, it’s equally correct to say that this is one of the most consistently risk-conscious, more consistently shareholder-sensitive and most consistently rewarding EM funds available. Those are patterns that I’ve found compelling.

We’ve also updated our featured fund page for Seafarer.

Funds in Registration

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

Funds in registration this month are eligible to launch in late June and some of the prospectuses do highlight that date.

This month our research associate David Welsch tracked down 14 no-load retail funds in registration, which represents our core interest. By far the most interest was stirred by the announcement of three new Grandeur Peak funds:

• Global Micro Cap
• International Stalwarts
• Global Stalwarts

The launch of Global Micro Cap has been anticipated for a long time. Grandeur Peak announced two things early on: (1) that they had a firm wide strategy capacity of around $3 billion, and (2) they had seven funds in the works, including Global Micro, which were each allocated a set part of that capacity. Two of the seven projected funds (US Opportunities and Global Value) remain on the drawing board. President Eric Huefner remarks that “Remaining nimble is critical for a small/micro cap manager to be world-class,” hence “we are terribly passionate about asset capping across the firm.” 

The surprise comes with the launch of the two Stalwarts funds, whose existence was previously unanticipated. Folks on our discussion board reacted with (thoughtful) alarm. Many of them are GP investors and they raised two concerns: (1) this might signal a change in corporate culture with the business managers ascendant over the asset managers, and (2) a move into larger capitalizations might move GP away from their core area of competence.

Because they’re in a quiet period, Eric was not able to speak about these concerns though he did affirm that they’re entirely understandable and that he’d be able to address them directly after launch of the new funds.

Mr. Gardiner, Guardian Manager, at work

While I am mightily amused by the title GUARDIAN MANAGER given to Robert Gardiner to explain his role with the new funds, I’m not immediately distressed by these developments. “Stalwarts” has always been a designation for one of the three sorts of stocks that the firm invests in, so presumably these are stocks that the team has already researched and invested in. Many small cap managers find an attraction in these “alumni” stocks, which they know well and have confidence in but which have outgrown their original fund. Such funds also offer a firm the ability to increase its strategy capacity without compromising its investment discipline. I’ll be interested in hearing from Mr. Heufner later this summer and, perhaps, in getting to tap of Mr. Gardiner’s shield.

Manager Changes

A lot of funds were liquidated this month, which means that a lot of managers changed from “employed” to “highly motivated investment professional seeking to make a difference.” Beyond that group, 43 funds reported partial or complete changes in their management teams. The most striking were:

• The departure of Independence Capital Asset Partners from LS Opportunity Fund, about which there’s more below.
• The departure of Robert Mohn from both Columbia Acorn Fund (ACRNX) and Columbia Acorn USA (AUSAX) and from his position as their Domestic CIO. Mr. Mohn joined the fund in late 2003 shortly after the retirement of the legendary Ralph Wanger. He initially comanaged the fund with John Park (now of Oakseed Opportunity SEEDX) and Chuck McQuaid (now manager of Columbia Thermostat (CTFAX). Mr. Mohn is being succeeded by Zachary Egan, President of the adviser, and the estimable Fritz Kaegi, one of the managers of Columbia Acorn Emerging Markets (CAGAX). They’ll join David Frank who remained on the fund.

Updates

Centaur Total Return (TILDX) celebrated its 10-year anniversary in March, so I wish we’d reported the fact back then. It’s an interesting creature. Centaur started life as Tilson Dividend, though Whitney Tilson never had a role in its management. Mr. Tilson thought of himself (likely “thinks of himself”) as a great value investor, but that claim didn’t play out in his Tilson Focus Fund so he sort of gave up and headed to hedge fund land. (Lately he’s been making headlines by accusing Lumber Liquidators, a company his firm has shorted, of deceptive sales practices.) Mr. Tilson left and the fund was rechristened as Centaur.

Centaur’s record is worth puzzling over.  Morningstar gives it a ten-year ranking of five stars, a three-year ranking of one star and three stars overall. Over its lifetime it has modestly better returns and vastly lower risks than its peers which give it a great risk-adjusted performance.

Mostly it has great down market protection and reasonable upmarket performance, which works well if the market has both ups and downs. When the market has a whole series of strong gains, conservative value investors end up looking bad … until they look prescient and brilliant all over again.

There’s an oddly contrarian indicator in the quick dismissal of funds like Centaur, whose managers have proven adept and disciplined. When the consensus is “one star, bunch of worthless cash in the portfolio, there’s nothing to see here,” there might well be reason to start thinking more seriously as folks with a bunch of …

In any case, best anniversary wishes to manager Zeke Ashton and his team.

Briefly Noted . . .

American Century Investments, adviser to the American Century Funds, has elected to support the America’s Best Communities competition, a $10 million project to stimulate economic revitalization in small towns and cities across the country. At this point, 50 communities have registered first round wins. The ultimate winner will receive a $3 million economic development grant from a consortium of American firms.

In the interim, American Century has “adopted” Wausau, Wisconsin, which styles itself “the Chicago of the north.” (I suspect many of you think of Chicago as “the Chicago of the north,” but that’s just because you’re winter wimps.) Wausau won $35,000 which will be used to develop a comprehensive plan for economic revival and cultural enrichment. American Century is voluntarily adding another $15,000 to Wausau’s award and will serve as a sort of consultant to the town as they work on preparing a plan. It’s a helpful gesture and worthy of recognition.

LS Opportunity Fund (LSOFX) is about to become … well, something else but we don’t know what. The fund has always been managed by Independence Capital Asset Partners in parallel with ICAP’s long/short hedge fund. On April 23, 2015, the fund’s board terminated ICAP’s contract because of “certain portfolio management changes expected to occur within the sub-adviser.” On April 30, the board named Prospector Partners LLC has the fund’s interim manager, presumably with the expectation that they’ll be confirmed in June as the permanent replacement for ICAP. Prospector is described as “an investment adviser registered with the Securities and Exchange Commission with its principal offices [in] Guilford, CT. Prospector currently provides investment advisory services to corporations, pooled investment vehicles, and retirement plans.” Though they don’t mention it, Prospector also serves as the adviser to two distinctly unexciting long-only mutual funds: Prospector Opportunity (POPFX) and Prospector Capital Appreciation (PCAFX). LSOFX is a rated by Morningstar as a four-star fund with $170 million in assets, which makes the change both consequential and perplexing. We’ll share more as soon as we can.

Northern Global Tactical Asset Allocation Fund (BBALX) has added hedging via derivatives to the list of its possible investments: “In addition, the Fund also may invest directly in derivatives, including but not limited to forward currency exchange contracts, futures contracts and options on futures contracts, for hedging purposes.”

Gargoyle is on the move. RiverPark Funds is in the process of transferring control of RiverPark Gargoyle Hedged Value Fund (RGHVX) to TCW where it will be renamed … wait for it … TCW/Gargoyle Hedged Value Fund. It’s a solid five star fund with $73 million in assets. That latter number is what has occasioned the proposed move which shareholders will still need to ratify.

RiverPark CEO Morty Schaja notes that the strategy has spectacular long-term performance (it was a hedge fund before becoming a mutual fund) but that it’s devilishly hard to market. The fund uses two distinct strategies: a quantitatively driven relative value strategy for its stock portfolio and a defensive options overlay. While the options provide income and some downside protection, the fund does not pretend to being heavily hedged much less market neutral. As a result, it has a lot more downside volatility than the average long-short fund (it was down 34% in 2008, for example, compared with 15% for its peers) but also a more explosive upside (gaining 42% in 2009 against 10% for its peers). That’s not a common combination and RiverPark’s small marketing team has been having trouble finding investors who understand and value the combination. TCW is interested in developing a presence in “the liquid alts space” and has a sales force that’s large enough to find the investors that Gargoyle is seeking.

Expenses will be essentially unchanged, though the retail minimum will be substantially higher.

Zacks Small-Cap Core Fund (ZSCCX) has raised its upper market cap limit to $10.3 billion, which hardly sounds small cap at all.  That’s the range of stocks like Staples (SPLS) and L-3 Communications (LLL) which Morningstar classifies as mid-caps.

SMALL WINS FOR INVESTORS

Touchstone Merger Arbitrage Fund (TMGAX) has reopened to a select subset of investors: RIAs, family offices, institutional consulting firms, bank trust departments and the like. It’s fine as market-neutral funds go but they don’t go very far: TMGAX has returned under 2% annually over the past three years.  On whole, I suspect that RiverPark Structural Alpha (RSAFX) remains the more-attractive choice.

CLOSINGS (and related inconveniences)

Effective May 15, 2015, Janus Triton (JGMAX) and Janus Venture (JVTAX) are soft closing, albeit with a bunch of exceptions. Triton fans might consider Meridian Small Cap Growth, run by the team that put together Triton’s excellent record.

Effective at the close of business on May 29, 2015, MFS International Value Fund (MGIAX) will be closed to new investors

Effective June 1, 2015, the T. Rowe Price Health Sciences Fund (PRHSX) will be closed to new investors. 

Vulcan Value Partners (VVLPX) has closed to new investors. The firm closed its Small Cap strategy, including its small cap fund, in November of 2013, and closed its All Cap Program in early 2014. Vulcan closed, without advance notice, its Large Cap Programs – which include Large Cap, Focus and Focus Plus in late April. All five of Vulcan Value Partners’ investment strategies are ranked in the top 1% of their respective peer groups since inception.

OLD WINE, NEW BOTTLES

Effective April 30, 2015, American Independence Risk-Managed Allocation Fund (AARMX) was renamed the American Independence JAForlines Risk-Managed Allocation Fund. The objective, strategies and ticker remained the same. Just to make it unsearchable, Morningstar abbreviates it as American Indep JAFrl Risk-Mgd Allc A.

Effective on June 26, 2015 Intrepid Small Cap Fund (ICMAX) becomes Intrepid Endurance Fund and will no longer to restricted to small cap investing. It’s an understandable move: the fund has an absolute value focus, there are durned few deeply discounted small cap stocks currently and so cash has built up to become 60% of the portfolio. By eliminating the market cap restriction, the managers are free to move further afield in search of places to deploy their cash stash.

Effective June 15, 2015, Invesco China Fund (AACFX) will change its name to Invesco Greater China Fund.

Effective June 1, 2015, Pioneer Long/Short Global Bond Fund (LSGAX) becomes Pioneer Long/Short Bond Fund. Since it’s nominally not “global,” it’s no longer forced to place at least 40% outside of the U.S. At the same time Pioneer Multi-Asset Real Return Fund (PMARX) will be renamed Pioneer Flexible Opportunities.

As of May 1, 2015 Royce Opportunity Select Fund (ROSFX) became Royce Micro-Cap Opportunity Fund. For their purposes, micro-caps have capitalizations up to $1 billion. The Fund will invest, under normal circumstances, at least 80% of its net assets in equity securities of companies with stock market capitalizations up to $1 billion. In addition, the Fund’s operating policies will prohibit it from engaging in short sale transactions, writing call options, or borrowing money for investment purposes.

At the same time, Royce Value Fund (RVVHX) will be renamed Royce Small-Cap Value Fund and will target stocks with capitalizations under $3 billion. Royce Value Plus Fund (RVPHX) will be renamed Royce Smaller-Companies Growth Fund with a maximum market cap at time of purchase of $7.5 billion.

OFF TO THE DUSTBIN OF HISTORY

AlphaMark Small Cap Growth Fund (AMSCX) has been terminated; the gap between the announcement and the fund’s liquidation was three weeks. It wasn’t a bad fund at all, three stars from Morningstar, middling returns, modest risk, but wasn’t able to gain enough distinction to become economically viable. To their credit, the advisor stuck with the fund for nearly seven years before succumbing.

American Beacon Small Cap Value II Fund (ABBVX) will liquidate on May 12. The advisor cites a rare but not unique occurrence to explain the decision: “after a large redemption which is expected to occur in April 2015 that will substantially reduce the Fund’s asset size, it will no longer be practicable for the Manager to operate the Fund in an economically viable manner.”

Carlyle Core Allocation Fund (CCAIX) and Enhanced Commodity Real Return (no ticker) liquidate in mid-May.  

The Citi Market Pilot 2030 (CFTYX) and 2040 (CFTWX) funds each liquidated on about one week’s notice in mid-April; the decision was announced April 9 and the portfolio was liquidated April 17. They lasted just about one year.

The Trustees have voted to liquidate and terminate Context Alternative Strategies Fund (CALTX) on May 18, 2015.

Contravisory Strategic Equity Fund (CSEFX), a tiny low risk/low return stock fund, will liquidate in mid-May. 

Dreyfus TOBAM Emerging Markets Fund (DABQX) will be liquidated on or about June 30, 2015.

Franklin Templeton is thinning down. They merged away one of their closed-end funds in April. They plan to liquidate the $38 million Franklin Global Asset Allocation Fund (FGAAX) on June 30. Next the tiny Franklin Mutual Recovery Fund (FMRAX) is looking, with shareholder approval, to merge into the Franklin Mutual Quest Fund (TEQIX) likely around the end of August.

The Jordan Fund (JORDX) is merging into the Meridian Equity Income Fund (MRIEX), pending shareholder approval. The move is more sensible than it looks. Mr. Jordan has been running the fund for a decade but has little to show for it. He had five strong years followed by five lean ones and he still hasn’t accumulated enough assets to break even. Minyoung Sohn took over MRIEX last October but has only $26 million to invest; the JORDX acquisition will triple the fund’s size, move it toward financial equilibrium and will get JORDX investors a noticeable reduction in fees.

Leadsman Capital Strategic Income Fund (LEDRX) was liquidated on April 7, 2015, based on the advisor’s “representations of its inability to market the Fund and the Adviser’s indication that it does not desire to continue to support the Fund.” They lost interest in it? Okay, on the one hand there was only $400,005 in the fund. On the other hand, they launched it exactly six months before declaring failure and going home. I’m perpetually stunned by advisors who pull the plug after a few months or a year. I mean, really, what does that say about the quality of their business planning, much less their investment acumen?

I wonder if we should make advisers to new funds post bail? At launch the advisor must commit to running the fund for no less than a year (or two or three). They have to deposit some amount ($50,000? $100,000?) with an independent trustee. If they close early, they forfeit their bond to the fund’s investors. That might encourage more folks to invest in promising young funds by hedging against one of the risks they face and it might discourage “let’s toss it against the wall and see if anything sticks” fund launches.

Manning & Napier Inflation Focus Equity Series (MNIFX) will liquidate on May 11, 2015.

Merk Hard Currency ETF (formerly HRD) has liquidated. Hard currency funds are, at base, a bet against the falling value of the US dollar. Merk, for example, defines hard currencies as “currencies backed by sound monetary policy.” That’s really not been working out. Merk’s flagship no-load fund, Merk Hard Currency (MERKX), is still around but has been bleeding assets (from $280M to $160M in a year) and losing money (down 2.1% annually for the past five years). It’s been in the red in four of the past five years and five of the past ten. Here’s the three-year picture.

Presumably if investors stop fleeing to the safe haven of US Treasuries there will be a mighty reversal of fortunes. The question is whether investors can (or should) wait around until then. Can you say “Grexit”?

Effective May 1, 2015, Royce Select Fund I (RYSFX) will be closed to all purchases and all exchanges into the Fund in anticipation of the fund being absorbed into the one-star Royce 100 Fund (ROHHX). Mr. Royce co-manages both but it’s still odd that they buried a three-star small blend fund into a one-star one.

The Turner Funds will close and liquidate the Turner Titan Fund (TTLFX), effective on or about June 1, 2015. It’s a perfectly respectable long/short fund in which no one had any interest.

The two-star Voya Large Cap Growth Fund (ILCAX) is slated to be merged into the three-star Voya Growth Opportunities Fund (NLCAX). Same management team, same management fee, same performance: it’s pretty much a wash.

In Closing . . .

The first issue of the Observer appeared four years ago this month, May 2011. We resolved from the outset to try to build a thoughtful community here and to provide them with insights about opportunities and perspectives that they might never otherwise encounter. I’m not entirely sure of how well we did, but I can say that it’s been an adventure and a delight. We have a lot yet to accomplish and we’re deeply hopeful you’ll join us in the effort to help investors and independent managers alike. Each needs the other.

Thanks, as ever, to the folks – Linda, who celebrates our even temperament, Bill and James – who’ve clicked on our elegantly redesigned PayPal link. Thanks, most especially, to Deb and Greg who’ve been in it through thick and thin. It really helps.

A word of encouragement: if you haven’t already done so, please click now on our Amazon link and either bookmark it or set it as one of the start pages in your browser. We receive a rebate equivalent to 6-7% of the value of anything you purchase (books, music, used umbrellas, vitamins …) through that link. It costs you nothing since it’s part of Amazon’s marketing budget and if you bookmark it now, you’ll never have to think about it again.

We’re excited about the upcoming Morningstar conference. All four of us – Charles, Chip, Ed and I – will be around the conference and at least three of us will be there from beginning to end, and beyond. Highlights for me:

• The opportunity to dine with the other Observer folks at one of Ed’s carefully-vetted Chicago eateries.
• Two potentially excellent addresses – an opening talk by Jeremy Grantham and a colloquy between Bill Nygren and Steve Romick
• A panel presentation on what Morningstar considers off-the-radar funds: the five-star Mairs & Power Small Cap (MSCFX, which we profiled late in 2011), Meridian Small Cap Growth (MSGAX, which we profiled late in 2014) and the five-star Eventide Gilead Fund (ETAGX, which, at $1.6 billion, is a bit beyond our coverage universe).
• A frontier markets panel presented by some “A” list managers.
• The opportunity to meet and chat with you folks. If you’re going to be at Morningstar, as exhibitor or attendee, and would like a chance to chat with one or another of us, drop me a note and we’ll try hard to set something up. We’d love to see you.

As ever,