This fund has been liquidated.

Objective and Strategy

The fund seeks maximum long-term capital growth by investing in a compact portfolio of global small cap stocks. In general they pursue “high-quality companies that typically have a sustainable competitive advantage, a superior business model and a high-quality management team.” “Small caps” are stocks with a capitalization under $4 billion at time of purchase. The fund holds about 40 stocks. No more than 50% of the portfolio will be investing in emerging markets and the managers do not expect to hold more than 10%.

Adviser

Artisan Partners, L.P. Artisan is a remarkable operation. They advise the 13 Artisan funds (the 12 funds with a retail share class plus an institutional emerging markets fund), as well as a number of separate accounts. The firm has managed to amass over $105 billion in assets under management, of which approximately $45 billion are in their mutual funds. Despite that, they have a very good track record for closing their funds and, less visibly, their separate account strategies while they’re still nimble. Seven of the firm’s funds are closed to new investors, as of February 2014. Their management teams are stable, autonomous and invest heavily in their own funds.

Manager

Mark Yockey, Charles-Henri Hamker and David Geisler. Mr. Yockey joined Artisan in 1995 and has been repeatedly recognized as one of the industry’s premier international stock investors. He is a portfolio manager for Artisan International, Artisan International Small Cap and Artisan Global Equity Funds. He is, Artisan notes, fluent in French. Charles-Henri Hamker is an associate portfolio manager on Artisan International Fund, and a portfolio manager with Artisan International Small Cap and Artisan Global Equity Funds. He is fluent in French and German. (Take that, Yockey.)  Messrs Yockey and Hamker manage rather more than $10 billion in other assets and were nominated as Morningstar’s international-stock fund managers of the year in both 2012 and 2013. Mr. Yockey won the honor in 1998. Mr. Geisler joined Artisan as an analyst in 2007 after working for Cowen and Company. This is his first portfolio management assignment.

Strategy capacity and closure

Between $1 – 2 billion, depending on how quickly money is flowing in and the state of the market.  Artisan has an exceptional record for closing funds before they become overly large – seven of their 12 retail funds are, or imminently will be, closed to new investors and Artisan International Small Cap closed in 2003 with about $500 million in assets. As a result, closing the fund well before it hits the $2 billion cap seems likely.

Management’s Stake in the Fund

Mr. Yockey has over $1 million in the fund, Mr. Geisler has between $50,000 – 100,000 and Mr. Hamker has no investment in it. Only one of the funds five independent directors has an investment in the fund; in general, the Artisan directors have invested between hundreds of thousands to millions of their own dollars in the Artisan complex.

Opening date

June 23, 2013

Minimum investment

$1,000

Expense ratio

1.50% after waivers on assets of $53 million, as of January 2014.

Comments

There is a real question about whether early 2014 is a good time to begin investing in small cap stocks. The Leuthold Group reports that small cap stocks are selling at record or near-record premiums to large caps and manager David Geisler concurs that “U.S. small caps are close to peak valuations.” The managers have added just one or two names to the portfolio in recent months; they are not, Mr. Geisler reports, “on a buying strike but we try to be thoughtful.”  Perhaps in recognition of those factors, Mike Roos, a vice president and managing director at Artisan (also a consistently thoughtful, articulate guy), reports that Artisan will do no marketing of the fund.  “We look forward to organic growth of the fund, but we’re simply not pushing it.”

If you decide that you want to increase your exposure to global small caps, though, there are few safer bets than Artisan. Artisan’s managers are organized into six autonomous teams, each with responsibility for its own portfolios and personnel. The teams are united by four characteristics:

• pervasive alignment of interests with their shareholders – managers, analysts and directors are all deeply invested in their funds, the managers have and have frequently exercised the right to close funds and other manifestations of their strategies, the partners own the firm and the teams are exceedingly stable.
• price sensitivity – while it’s not exclusively a GARP shop, it’s clear that neither the value guys nor the growth guys pursue stocks with extreme valuations.
• a careful, articulate strategy for portfolio weightings – the funds generally have clear criteria for the size of initial positions in the portfolio, the upsizing of those positions with time and their eventual elimination, and
• uniformly high levels of talent.  Artisan interviews a lot of potential managers each year, but only hires managers who they believe will be “category killers.” 

Those factors have created a tradition of consistent excellence across the Artisan family.  By way of illustration:

• Eleven of Artisan’s 12 retail funds are old enough to have Morningstar ratings.  Ten of those 11 funds have earned four- or five-stars. 
• Ten of the 11 have been recognized as “Silver” or “Gold” funds by Morningstar’s analysts. 
• Nine of the 11, including all of the international and global funds, are Lipper Leaders for Total Return. 
• Six are MFO Great Owl funds, as well.
• Artisan teams have been nominated for Morningstar’s “manager of the year” award nine times in the past 15 years; they’ve won four times.

And none are weak funds, though some do get out of step with the market from time to time.  The managers are finding far better values outside of the US than in it: about 12% of the most recent portfolio are US-domiciled firms, about the same as its UK and China exposure. Despite popular panic about the emerging markets, E.M. stocks are 33% of the portfolio. The average global fund is 50% US, 80% large caps and just 7% EM. That independence is reflected in the fund’s active share: 99.6%. 

Bottom Line

You might imagine Global Small Cap as representing the subset of stocks which lies at the intersection of the team’s International Fund (which has had one sub-par year in a decade), it’s International Small Cap fund (which has had two sub-par years in a decade) and its Global Equity fund (which has not yet had a below-average year, though it’s just a bit over three). On face, that’s a very good place to be.

Fund website

Artisan Global Small Cap

By way of disclosure: while the Observer has no financial relationship with or interest in Artisan, I do own shares of two of the Artisan funds (Small Cap Value ARTVX and International Value ARTKX) and have done so since the funds’ inception.

[cr2014]

Objective and Strategy

The FPA Global Value Strategy will seek to provide above-average capital appreciation over the long term while attempting to minimize the risk of capital losses by investing in well-run, financially robust, high-quality businesses around the world, in both developed and emerging markets.

Adviser

FPA, formerly First Pacific Advisors, which is located in Los Angeles.  The firm is entirely owned by its management which, in a singularly cool move, bought FPA from its parent company in 2006 and became independent for the first time in its 50 year history.  The firm has 28 investment professionals and 72 employees in total.  Currently, FPA manages about $25 billion across four equity strategies and one fixed income strategy.  Each strategy is manifested in a mutual fund and in separately managed accounts; for example, the Contrarian Value strategy is manifested in FPA Crescent (FPACX), in nine separate accounts and a half dozen hedge funds.  On April 1, 2013, all FPA funds became no-loads.

Managers

Pierre O. Py and Greg Herr.  Mr. Py joined FPA in September 2011. Prior to that, he was an International Research Analyst for Harris Associates, adviser to the Oakmark funds, from 2004 to 2010.  Mr. Py has managed FPA International Value (FPIVX) since launch. Mr. Herr joined the firm in 2007, after stints at Vontobel Asset Management, Sanford Bernstein and Bankers Trust.  He received a BA in Art History at Colgate University.  Mr. Herr co-manages FPA Perennial (FPPFX) and the closed-end Source Capital (SOR) funds with the team that used to co-manage FPA Paramount.  Py and Herr will be supported by the two research analysts, Jason Dempsey and Victor Liu, who also contribute to FPIVX.

Management’s Stake in the Fund

As of the last SAI (September 30, 2012), Mr. Herr had invested between $1 and $10,000 in the fund and Mr. Py had no investment in it.  Mr. Py did have a very large investment in his other charge, FPA International Value.

Opening date

September 8, 1958.

Minimum investment

$1,500, reduced to $100 for IRAs or accounts with automatic investing plans.

Expense ratio

0.94% on $323 million in assets, as of August 2013.

Comments

We’ve never before designated a 55-year-old fund as a “most intriguing new fund,” but the leadership and focus changes at FPRAX warrant the label.

I’ve written elsewhere that “Few fund companies get it consistently right.  By “right” I don’t mean “in step with current market passions” or “at the top of the charts every year.”  By “right” I mean two things: they have an excellent investment discipline and they treat their shareholders with profound respect.

FPA gets it consistently right.

FPA has been getting it right with the two funds overseen by Eric Ende and Stephen Geist: FPA Paramount (since March 2000) and FPA Perennial (since 1995 and 1999, respectively).   Morningstar designates Paramount as a five-star world stock fund and Perennial as a three-star domestic mid-cap growth fund (both as of August, 2013).  That despite the fact that there’s a negligible difference in the fund’s asset allocation (cash/US stock/international stock) and no difference in their long-term performance.  The chart below shows the two funds’ returns and volatility since Geist and Ende inherited Paramount.

To put it bluntly, both have consistently clubbed every plausible peer group (mid-cap growth, global stock) and benchmark (S&P 500, Total Stock Market, Morningstar US Growth composite) that I compared them to.  By way of illustration, $10,000 invested in either of these funds in March 2000 would have grown to $35,000 by August 2013.  The same amount in the Total Stock Market index would have hit $16,000 – and that’s the best of any of the comparison groups.

To be equally blunt, the funds mostly post distinctions without a difference.  In theory Paramount has been more global than Perennial but, in practice, both remained mostly focused on high-quality U.S. stocks. 

FPA has decided to change that.  Geist and Ende will now focus on Perennial, while Py and Herr reshape Paramount.  There are two immediately evident differences:

1. The new team is likely to transition toward a more global portfolio.  We spoke with Mr. Py after the announcement and he downplayed the magnitude of any immediate shifts.  He does believe that the most attractive valuations globally lie overseas and the most attractive ones domestically lie among large cap stocks.  That said, it’s unlikely the case that FPA brought over a young and promising international fund manager with the expectation that he’ll continue to skipper a portfolio with only 10-15% international exposure.
2. The new team is certain to transition toward a more absolute value portfolio.  Mr. Py’s investment approach, reflected in the FPIVX prospectus, stresses “Low Absolute Valuation. The Adviser only purchases shares when the Adviser believes they offer a significant margin of safety (i.e. when they trade at a significant discount to the Adviser’s estimate of their intrinsic value).”  In consequence of that, “the limited number of holdings in the portfolio and the ability to hold cash are key aspects of the portfolio.”  At the last portfolio report, International Value held 24 stocks and 38% cash while Paramount held 31 and 10%.  Given that the investment universe here is broader than International’s, it’s unlikely to hold huge cash stakes but likely that it might drift well north of its current level at times.

Bottom Line

Paramount is apt to become a very solid, but very different fund under its new leadership.  There will certainly be a portfolio restructuring and there will likely be some movement of assets as investors committed to Ende and Geist’s style migrate to Perennial.  The pace of those changes will dictate the magnitude of the short-term tax burden that shareholders will bear. 

Fund website

FPA Paramount Fund

2013 Q3 Report and Commentary

Fact Sheet

[cr2013]

Objective and Strategy

The Fund aims to preserve capital while delivering above-market returns and managing volatility.  They invest, long and short, in a domestic equity portfolio.  The portfolio is driven by intensive company research and risk management protocols. The long portfolio is typically 30-50 names, though as of mid-2013 it was closer to 70.  The short portfolio is also 30-50 names.  The average long position persists for 12-24 months while the average short position is closed after 3-6.  The fund averages about 50% net long, though at any given point it might be 20-70% long.  The fund’s target standard deviation is eight.

Adviser

Long Short Advisors, LLC.   LSA launched the LS Opportunity Fund to offer access to Independence Capital Asset Partners’ long/short equity strategy. ICAP is a Denver-based long/short equity manager with approximately $500 million in assets under management.

Manager

James A. Hillary, Chief Executive Officer, Chief Investment Officer, and Portfolio Manager at ICAP.  Mr. Hillary founded Independence Capital Asset Partners (ICAP) in 2004. From 1997-2004, Mr. Hillary was a founding partner and portfolio manager at Marsico Capital Management.  While there he managed the 21^st Century Fund (MXXIX) and co-managed several other products. Morningstar noted that during Mr. Hillary’s tenure “the fund [MXXIX] has sailed past the peer-group norm by a huge margin.” Bank of America bought Marsico in 2000, at which time Mr. Hillary received a substantial payout.  Before Marsico, he managed a long/short equity fund for W.H. Reaves. Effective June 1, 2013, Mr. Chris Hillary was added as a co-portfolio manager of the Fund. Messrs Hillary are supported by seven other investment professionals.

Strategy capacity and closure

The strategy, which is manifested in the mutual fund, a hedge fund (ICAP QP Absolute Return Fund), a European investment vehicle (Prosper Stars and Stripes, no less) and separate accounts, might accommodate as much as $2 billion in assets but the advisor will begin at about $1 billion to look at the prospect of soft closing the strategy.

Management’s Stake in the Fund

The senior Mr. Hillary has between $100,000 and 500,000 in the fund.  Most of his investable net wealth is invested here and in other vehicles using this strategy.  The firm’s principals and employees account for about 14% of ICAP’s AUM, though the fund’s trustees have no investment in the fund.

Opening date

September 9, 2010, though the hedge fund which runs side-by-side with it was launched in 2004.

Minimum investment

$5,000

Expense ratio

1.95% on fund assets of $40 million.  The limit was reduced in early 2013 from 2.50%.

Comments

In 2004, Jim Hillary had a serious though delightful problem.  As one of the co-founders of MCM, he had received a rich payout from the Bank of America when they purchased the firm.  The problem was what to do with that payout.

He had, of course, several options.  He might have allowed someone else to manage the money, though I suspect he would have found that option to be laughable.  In managing it himself, he might reasonably have chosen a long-only equity portfolio, a long-short equity portfolio or a long equity portfolio supplemented by some sort of fixed-income position.  He had success in managing both of the first two approaches and might easily have pursued the third.

The decision that Mr. Hillary made was to pursue a long-short equity strategy as the most prudent and sustainable way to manage his own and his family’s wealth.  That strategy achieved substantial success, measured both by its ability to achieve sustainable long-term returns (about 9% annually from 2004) and to manage volatility (a standard deviation of about 12, both better than the Total Stock Market’s performance). 

Mr. Hillary’s success became better known and he chose, bit by bit, to make the strategy available to others.  One manifestation of the strategy is that ICAP QP Absolute Return L.P. hedge fund, a second is the European SICAV Prosper Star & Stripes, and a third are separately managed accounts.  The fourth and newest manifestation, and the only one available to retail investors, is LS Opportunity Fund.  Regardless of which vehicle you invest in, you are relying on the same strategy and the portfolio in which Mr. Hillary’s own fortune resides.

Mr. Hillary’s approach combines intensive fundamental research in individual equities, both long and short. 

There are two questions for potential investors:

• Does a long-short position make sense for me?
• Does this particular long-short vehicle make the most sense for me?

The argument for long-short investing is complicated by the fact that there are multiple types of long-short funds which, despite having similar names or the same peer group assigned by a rating agency, have strikingly different portfolios and risk/return profiles.  A fund which combines an ETF-based long portfolio and covered calls might, for example, offer far more income but far fewer opportunities for gain than a “pure” long/short strategy such as this one.

The argument for pure long/short is straightforward: investors cannot stomach the volatility generated by unhedged exposure to the stock market.  That volatility has traditionally been high (the standard deviation for large cap stocks this century has been over 16 while the mean return has been 4; the translation is that you’ve been averaging a measly 4% per year while routinely encountering returns in the range of minus-12 to plus-20 with the occasional quarterly loss of 17% and annual loss of 40% thrown in) and there’s no reason to expect it to decline.   The traditional hedge has been to hold a large bond position, which worked well during the 30-year bond bull market just ended.  Going forward, asset allocation specialists expect the bond market to post negative real returns for years.  Cash, which is also posting negative real returns, is hardly an attractive option.

The alternative is a portfolio which offsets exposure to the market’s most attractive stocks with bets against its least attractive ones.  Research provided by Long Short Advisors makes two important points:

• since 1998, an index of long/short equity hedge funds has outperformed a simple 60/40 allocation with no material change in risk and
• when the market moves out of its panic mode, which are periods in which all stocks move in abnormal unison, both the upside and downside advantages of a hedged strategy rises in comparison to a long-only portfolio.

In short, a skilled long-short manager can offer more upside and less downside than either a pure stock portfolio or a stock/bond hybrid one.

The argument for LS Opportunity is simpler.  Most long/short managers have limited experience either with shorting stocks or with mutual funds as an investment vehicle.  More and more long/short funds are entering the market with managers whose ability is undocumented and whose prospects are speculative.  Given the complexity and cost of the strategy, I’d avoid managers-with-training-wheels.

Mr. Hillary, in contrast, has a record worth noticing.  He’s managed separate accounts and hedge funds, but also has a fine record as a mutual fund manager.  He’s been working with long/short portfolios since his days at W.H. Reaves in the early 1990s.  The hedge fund on which LS Opportunity is based has survived two jarring periods, including the most traumatic market since the Great Depression.  The mutual fund itself has outperformed its peers since launch and has functioned with about half of the market’s volatility.

Bottom Line

This is not a risk-free strategy.  The fund has posted losses in 15 of its first 34 months of operation.  Eight of those losses have come in months when the S&P500 rose.  The fund’s annualized return from inception through the end of June 2013 is 6.32% while the S&P moved relentlessly and, many fear, irrationally higher.  In the longer term, the strategy has worked to both boost returns and mute volatility.  And, with his personal fortune and professional reputation invested in the strategy, you’d be working with an experienced team which has committed “our lives, our fortunes, and our sacred honor” to making it work.  It’s worth further investigation.

Fund website

LS Opportunity Fund

3Q 2013 Fact Sheet

[cr2013]

This fund has been liquidated.

Objective and Strategy:

The fund seeks high current income and some stability of principal by investing in an array of other Forward Funds and cash.  The portfolio has a target volatility designation (a standard deviation of 6.5%) and it is rebalanced monthly to generate as much income as possible consistent with that risk goal. 

Adviser:

Forward Management, LLC.  Forward specializes in alternative investment classes.  As of March 2013, Forward had $6.1 billion in assets under management in their “alternative and niche” mutual funds and in separately managed accounts.

Managers:

All investment decisions are made jointly by the team of Nathan Rowader, Director of Investments and Senior Market Strategist; Paul Herber, Portfolio Manager; Paul Broughton, Assistant Portfolio Manager; and Jim O’Donnell, CIO. Between them, the team has over 70 years of investment experience.

Management’s Stake in the Fund:

As of May 1^st, Messrs. Rowader and Broughton had not invested in the fund. Messrs. Herber and O’Donnell each had a small stake, of less than $10,000, invested.

Opening date:

December 27, 2000.  Prior to May 1, 2012, it was known as the Forward Income Allocation Fund.

Minimum investment:

There’s a $4,000 minimum initial investment, lowered to $2,000 for Coverdell and eDelivery accounts, further lowered to $500 for automatic investment plans.

Expense ratio:

1.96% on assets of $21.2 million.

Comments:

Forward Income Builder is different.  It’s different than what it used to be.  It’s different than other funds, income-oriented or not.  So far, those differences have been quite positive for investors.

Income Builder has always been a fund-of-funds.  From launch in 2000 to May 2012, it had an exceedingly conservative mandate: it “uses an asset allocation strategy designed to provide income to investors with a low risk tolerance and a 1-3 year investment time horizon.”  In May 2012, it shifted gears.  The corresponding passage now read: it “uses an asset allocation strategy designed to provide income to investors with a lower risk tolerance by allocating the Fund’s investments to income producing assets that are exhibiting a statistically higher yield relative to other income producing assets while also managing the volatility of the Fund.” The first change is easy to decode: it targets investors with a “lower” rather than “low risk tolerance” and no longer advertises a 1- 3 year investment time horizon.

The second half is a bit trickier.  Many funds are managed with an eye to returns; Income Builder is managed with an eye to risk (measured by standard deviation) and yield.  It’s goal is to combine asset classes in such a way that it generates the maximum possible return from a portfolio whose standard deviation is 6.5%.  They calculate forward-looking standard deviations for 11 asset classes for the next 30 days.  They then calculate which combination of asset classes will generate high yield with no more than 6.5% standard deviation.  The rebalance the portfolio monthly to maintain that profile.

Why might this interest you?  Forward is responding to the end of the 30 year bull market in bonds.  They believe that income-oriented investors will need to broaden their opportunity set to include other assets (dividend-paying stocks, REITs, preferred shares, emerging markets corporate debt and so on).  At the same time, they can’t afford wild swings in the value of their portfolios.  So Forward builds backward from an acceptable level of volatility to the mix of assets which have the greatest excess return possibilities.

The evidence so far available is positive.  A $10,000 investment in the fund on May 1, 2012, when its mandate changed, was worth $10,800 by the end of June, 2012.  The same investment in its average peer was worth $10,500.  The portfolio’s stocks are yielding a 6.1% dividend, their income is higher than their peers and their standard deviation has been lowered (4.1%) than their target.  The portfolio yield is 4.69%.  By comparison, T. Rowe Price Spectrum Income (RPSIX), another highly regarded fund-of-funds with about 15% equity exposure, has a yield of 3.65%.

There are three issues that prospective investors need to consider:

1. The fund is expensive. It charges 1.96%, including the expenses of its underlying funds.
2. During the late May – June market turbulence, it dropped substantially more than its multi-sector bond peers.  The absolute drop was small – 2.2% – but still greater than the 1.2% suffered by its peers.  Nonetheless, its YTD and TTM returns, through the end of June 2013, place it in the top tier of its peer group.
3. The managers have, by and large, opted not to make meaningful investments in the fund.  On both symbolic and practical grounds, that’s a regrettable decision.

Bottom Line:

Forward Income Builder will for years drag the tepid record occasioned by its former strategy.  That will likely deter many new investors.  For income-oriented investors who accept the need to move beyond traditional bonds and are willing to look at the new strategy with fresh eyes, it has a lot to offer.

Fund website:

www.forwardinvesting.com

[cr2013]

This fund is now the Carillon Reams Low Duration Bond Fund.

Objective and Strategy

The fund seeks a high level of total return consistent with the preservation of capital.  The managers may invest in a wide variety of income-producing securities, including bonds, debt securities, derivatives and mortgage- and asset-based securities.  They may invest in U.S. and non-U.S. securities and in securities issued by both public and private entities.  Up to 25% of the portfolio may be invested in high yield debt.  The investment process combines top-down interest rate management (determining the likely course of interest rates and identifying the types of securities most likely to thrive in various environments) and bottom-up fixed income security selection, focusing on undervalued issues in the fixed income market. 

Adviser

Scout Investments, Inc. Scout is a wholly-owned subsidiary of UMB Financial, both are located in Kansas City, Missouri. Scout advises the nine Scout funds. As of January 2013, they managed about $25 billion.  Scout’s four fixed-income funds are managed by its Reams Asset Management division, including Low-Duration Bond (SCLDX), Unconstrained Bond (SUBYX), Core Bond (SCCYX, four stars) and Core Plus Bond (SCPZX, retail shares were rated four star and institutional shares five star/Silver by Morningstar, as of May, 2013).

Manager

Mark M. Egan is the lead portfolio manager for all their fixed income funds. His co-managers are Thomas Fink, Todd Thompson and Stephen Vincent.  From 1990 to 2010, Mr. Egan was a portfolio manager for Reams Asset Management.  In 2010, Reams became the fixed-income arm of Scout.  His team worked together at Reams.  In 2012, they were finalists for Morningstar’s Fixed-Income Manager of the Year honors.   

Management’s Stake in the Fund

None yet reported.  Messrs. Egan, Fink and Thompson have each invested over $1,000,000 in their Unconstrained Bond fund while Mr. Vincent has between $10,000 – 50,000 in it.  

Opening date

August 29, 2012.

Minimum investment

$1,000 for regular accounts, reduced to $100 for IRAs or accounts with AIPs.

Expense ratio

0.40%, after waivers, on assets of $32 million (as of May 2013).  The fund’s assets are growing briskly.  The Low Duration Strategy on which this fund operates was launched July 1, 2002 and has $2.9 billion in it.

Comments

The simple act of saving money is not supposed to be a risky activity.  Recent Federal Reserve policy has made it so.  By driving interest rates relentlessly down in support of a feeble economy, the Fed has turned all forms of saving into a money losing proposition.  Inflation in the past couple years has average 1.5%.  That’s low but it’s also 35-times higher than the rate of return on the Vanguard Prime Money Market fund, which paid 0.04% in each of the past two years.  The average bank interest rate sits at 0.21%.  In effect, every dollar you place in a “safe” place loses value year after year.

Savers are understandable irate and have pushed their advisers to find alternate investments (called “funky bonds” by The Wall Street Journal) which will offer returns in excess of the rate of inflation.  Technically, those are called “positive real returns.”  Combining a willingness to consider unconventional fixed-income securities with a low duration portfolio offers the prospect of maintaining such returns in both low and rising interest rate environments.

That impulse makes sense and investors have poured hundreds of billions into such funds over the past three years.  The problem is that the demand for flexible fixed-income management exceeds the supply of managers who have demonstrated an ability to execute the strategy well, across a variety of markets.

In short, a lot of people are handing money over to managers whose credentials in this field are paper thin.   That is unwise.

We believe, contrarily, that investing with Mr. Egan and his team from Reams is exceptionally wise.  There are four arguments to consider:

1. This strategy is quite flexible.

   The fund can invest globally, in both public and private debt, in investment grade and non-investment grade, and in various derivatives.  All of the Scout/Reams funds, according to Mr. Egan, use “the same proven philosophy and process.”  While he concedes that “due to the duration restrictions the opportunity set is slightly smaller for a low duration fund …  the ability to react to value when it is created in the capital markets is absolutely available in the low duration fund.  This includes sector decisions, individual security selection, and duration/yield curve management.”

2. The managers are first-rate.

   Reams was nominated as one of Morningstar’s fixed-income managers of the year in 2012.  They were, at base, recognized as one of the five best teams in existence In explaining their nomination of Reams as fixed-asset manager of the year, Morningstar explained:

   Mark Egan and crew [have delivered] excellent long-term returns here. Reams isn’t a penny-ante player, either: The firm has managed close to $10 billion in fixed-income assets, mainly for institutions, for much of the past decade.

   Like some of its fellow nominees, the team followed up a stellar showing in 2011 with a strong 2012, owing much of the fund’s success this year to decisions made amid late 2011’s stormy climate, including adding exposure to battered U.S. bank bonds and high-yield. Unlike the other nominees, however, the managers have pulled in the fund’s horns substantially as credit has rallied this year. That’s emblematic of what they’ve done for more than a decade. When volatility rises, they pounce. When it falls, they protect. That approach has taken a few hits along the way, but the end result has been outstanding.

3. They’ve succeeded over time.

   While the Low Duration fund is new, the Low Duration strategy has been used in separately managed accounts for 11 years.  They currently manage nearly $3 billion in low duration investments for high net-worth individuals and institutions.  For every trailing time period, Mr. Egan has beaten both his peer group.  His ten year returns have been 51% higher than his peers:

   	1 Yr.	3 Yrs.	5 Yrs.	10 Yrs.
   Low Duration Composite (net of fees)	3.76%	3.72%	5.22%	4.73%
   Vanguard Short-Term Bond Index fund (VBISX)	1.70	2.62	3.12	3.51
   Average short-term bond fund	2.67	2.81	3.22	3.13
   Reams performance advantage over peers	41%	32%	62%	51%

   Annualized Performance as of March 31, 2013.  The Low Duration Fixed Income Composite was created July 1, 2003.

   The pattern repeats if you look year by year: he has outperformed his peers in six of the past six years and is doing so again in 2013, through May.  While he trails the Vanguard fund above half the time, the magnitude of his “wins” over the index fund is far greater than the size of his losses.

   	2007	2008	2009	2010	2011	2012
   Low Duration Composite (net of fees)	7.02	1.48	13.93	5.02	2.62	5.06
   Vanguard Short-Term Bond Index fund (VBISX)	7.22	5.43	4.28	3.92	2.96	1.95
   Average short-term bond fund	4.29	(4.23)	9.30	4.11	1.66	3.67

   Annualized Performance as of March 31, 2013.  The Low Duration Fixed Income Composite was created July 1, 2003.

4. They’ve succeeded when you most needed them.

   The fund made money during the market meltdown that devastated so many investors.  Supposedly ultra-safe ultra-short bond funds imploded and the mild-mannered short-term bond group lost about 4.2% in 2008.  When we asked Mr. Egan about why he managed to make money when so many others were losing it, his answer came down to a deep-seated aversion to suffering a loss of principle.

   One primary reason we outperformed relative to many peers in 2008 was due to our investment philosophy that focuses on downside risk protection.  Many short-term bond funds experienced negative returns in 2008 because they were willing to take on what we view as unacceptable risks in the quest for incremental yield or income.  This manifested itself in many forms: a junior position in the capital structure, leveraged derivative credit instruments, or securities backed by loans of questionable underwriting and payer quality.   Specifically, many were willing to purchase and hold subprime securities because the higher current yield was more important to them then downside protection.  When the credit crisis occurred, the higher risks they were willing to accept produced significant losses, including permanent impairment.  We were able to side-step this damage due to our focus on downside risk protection.  We believe that true risk in fixed income should be defined as a permanent loss of principle.  Focusing on securities that are designed to avoid this type of risk has served us well through the years.

Bottom Line

Mr. Egan’s team has been at this for a long time.  Their discipline is clear, has worked under a wide variety of conditions, and has worked with great consistency.  For investors who need to take one step out on the risk spectrum in order to escape the trap of virtually guaranteed real losses in money markets and savings accounts, there are few more compelling options.

Fund website

Scout Low Duration Bond

Commentary

Fact Sheet

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This fund has been liquidated.

Objective and Strategy

The fund will seek long term capital appreciation.  While the prospectus notes that “the Fund will invest primarily in U.S. equity securities,” the managers view it as more of a go-anywhere operation, akin to the Oakmark Global and Acorn funds.  They can invest in common and preferred stocks, warrants, ETFs and ADRs.  The managers are looking for investments with three characteristics:

• High quality businesses in healthy industries
• Compelling valuations
• Evidence that management’s interests are aligned with shareholders

They are hopeful of holding their investments for three to five years on average, and are intent on exploiting short-term market turbulence.  The managers do have the option to using derivatives, primarily put options, to reduce volatility and strengthen returns.

Adviser

Jackson Park Capital, LLC was founded in late 2012 by Greg Jackson and John Park. The firm is based in Park City, Utah.  The founders claim over 40 years of combined investment experience in managing mutual funds, hedge funds, and private equity funds.

Managers

Gregory L. Jackson and John H. Park.  Mr. Jackson was a Partner at Harris Associates and co-manager of Oakmark Global (OAKGX) from 1999 – 2003.  Prior to that, he works at Yacktman Asset Management and afterward he and Mr. Park were co-heads of the investment committee at the private equity firm Blum Capital.  Mr. Park was Director of Research at Columbia Wanger Asset Management, portfolio manager of the Columbia Acorn Select Fund (LTFAX) from inception until 2004 and co-manager of the Columbia Acorn Fund (LACAX) from 2003 to 2004.  Like Mr. Jackson, he subsequently joined Blum Capital.  The Oakmark/Acorn nexus gave rise to the Oakseed moniker.

Management’s Stake in the Fund

Mr. Park estimates that the managers have $8-9 million in the fund, with plans to add more when they’re able to redeem their stake in Blum Capital.  Much of the rest of the money comes from their friends, family, and long-time investors.  In addition, Messrs. Jackson and Park own 100% of Jackson Park. 

Opening date

December 31, 2012.

Minimum investment

$2500 for regular accounts, $1000 for various tax-deferred accounts and $100 for accounts set up with an AIP.

Expense ratio

1.41% after waivers on assets of $40 million (as of March, 2013).  Morningstar inexplicably assigns the fund an expense ratio of 0.00%, which they correctly describe as “low.”

Comments

If you’re fairly sure that creeping corporatism – that is, the increasing power of marketers and folks more concerned with asset-gathering than with excellence – is a really bad thing, then you’re going to discover that Oakseed is a really good one.

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

It’s entirely plausible that Messrs. Park and Jackson will be able to accomplish that goal. 

Why does that seem likely?  Two reasons.  First, they’ve done it before.  Mr. Park managed Columbia Acorn Select from its inception through 2004. Morningstar analyst Emily Hall’s 2003 profile of the fund was effusive about the fund’s ability to thrive in hard times:

This fund proved its mettle in the bear market. On a relative basis (and often on an absolute basis), it was a stellar performer. Over the trailing three years through July 22 [2003], its 7.6% annualized gain ranks at the top of the mid-growth category.

Like all managers and analysts at Liberty Acorn, this fund’s skipper, John Park, is a stickler for reasonably priced stocks. As a result, Park eschews expensive, speculative fare in favor of steadier growth names. That practical strategy was a huge boon in the rough, turn-of-the-century environment, when investors abandoned racier technology and health-care stocks. 

They were openly mournful of the fund’s prospects after his departure.  Their 2004 analysis began, “Camel, meet straw.”  Greg Jackson’s work with Oakmark Global was equally distinguished, but there Morningstar saw enough depth in the management ranks for the fund to continue to prosper.  (In both cases they were right.)  The strength of their performance led to an extended recruiting campaign, which took them from the mutual fund work and into the world of private equity funds, where they (and their investors) also prospered.

Second, they’re not all that concerned about attracting more money.  They started this fund because they didn’t want to do marketing, which was an integral and time consuming element of working with a private equity fund.  Private equity funds are cyclical: you raise money from investors, you put it to work for a set period, you liquidate the fund and return all the money, then begin again.  The “then begin again” part held no attraction to them.  “We love investing and we could be perfectly happy just managing the resources we have now for ourselves, our families and our friends – including folks like THOR Investment who have been investing with us for a really long time.”  And so, they’ve structured their lives and their firm to allow them to do what they love and excel at.  Mr. Park described it as “a virtual firm” where they’ve outsourced everything except the actual work of investing.  And while they like the idea of engaging with prospective investors (perhaps through a summer conference call with the Observer’s readers), they won’t be making road trips to the East Coast to rub elbows and make pitches.  They’ll allow for organic growth of the portfolio – a combination of capital appreciation and word-of-mouth marketing – until the fund reaches capacity, then they’ll close it to new investors and continue serving the old.

A quirk of timing makes the fund’s 2013 returns look tepid: my Morningstar’s calculation (as of April 30), they trail 95% of their peers.  Look closer, friends.  The entire performance deficit occurred on the first day of the year and the fund’s first day of existence.  The market melted up that day but because the fund’s very first NAV was determined after the close of business, they didn’t benefit from the run-up.  If you look at returns from Day Two – present, they’re very solid and exceptional if you account for the fund’s high cash stake and the managers’ slow, deliberate pace in deploying that cash.

Bottom Line

This is going to be good.  Quite possibly really good.  And, in all cases, focused on the needs of its investors and strengths of its managers.  That’s a rare combination and one which surely warrants your attention.

Fund website

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

Update: In our original article, we noted that the Oakseed website was distressingly Spartan. After a round of good-natured sparring, the guys launched a highly functional, visually striking new site. Nicely done

Fact Sheet

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Objective and Strategy

The fund seeks to provide investors with a positive return regardless of the direction and fluctuations of the U.S. equity markets by creating a market neutral portfolio designed to exploit inefficiencies in the markets. While they can invest in stocks of any size, they anticipate a small- to mid-cap bias. The managers advertising three reasons to consider the fund:

Downside Management: they seek to limit exposure to downside risk by running a beta neutral portfolio (one with a target beta of 0.2 to minus 0.2 which implies a net equity exposure of 20% to minus 20%) designed to capitalize on arbitrage opportunities in the equity markets.

Portfolio Diversification: they seek to generate total return that is not correlated to traditional asset classes and offers portfolio diversification benefits.

Experienced, Talented Investment Team: The team possess[es] decades of experience investing in long short equity strategies for institutional investors.

Morningstar analysis of their portfolio bears no resemblance to the team’s description of it (one short position or 198? 65% cash or 5%?), so you’ll need to proceed with care and vigilance.  Unlike many of its competitors, this is not a quant fund.

Adviser

Whitebox Advisors LLC, a multi-billion dollar alternative asset manager founded in 2000.  Whitebox manages private investment funds (including Credit Arbitrage, Small Cap L/S Equity, Liquid L/S Equity, Special Opportunities and Asymmetric Opportunities), separately managed accounts and the two (soon to be three) Whitebox funds. As of January 2012, they had $2.3 billion in assets under management (though some advisor-search sites have undated $5.5 billion figures).

Manager

Andrew Redleaf, Jason E. Cross, Paul Karos and Kurt Winters.  Mr. Redleaf founded the advisor, has deep hedge fund experience and also manages Whitebox Tactical Opportunities.  Dr. Cross has a Ph.D. in Statistics, had a Nobel Laureate as an academic adviser and published his dissertation in the Journal of Mathematical Finance. Together they also manage a piece of Collins Alternative Solutions (CLLIX).  Messrs. Karos and Winters are relative newcomers, but both have substantial portfolio management experience.

Management’s Stake in the Fund

Not yet reported but, as of 12/31/12, Whitebox and the managers owned 42% of fund shares and the Redleaf Family Foundation owned 6.5%  Mr. Redleaf also owns 85% of the advisor.

Opening date

November 01, 2012 but The Fund is the successor to Whitebox Long Short Equity Partners, L.P., a private investment company managed by the Adviser from June, 2004 through October, 2012.

Minimum investment

$5000, reduced to $1000 for IRAs.

Expense ratio

1.95% after waivers on assets of $17 million (as of March, 2013).  The “Investor” shares carry a 4.5% front-end sales load, the “Advisor” shares do not.

Comments

Here’s the story of the Whitebox Long Short Equity fund, in two pictures.

Picture One, what you see if you include the fund’s performance when it was a hedge fund:

Picture Two, what you see if you look only at its performance as a mutual fund:

The divergence between those two graphs is striking and common.  There are lots of hedge funds – the progenitors of Nakoma Absolute Return, Baron Partners, RiverPark Long Short Opportunities – which offered mountainous chart performance as hedge funds but whose performance as a mutual fund was somewhere between “okay” and “time to turn out the lights and go home.”  The same has been true of some funds – for example, Auer Growth and Utopia Core – whose credentials derive from the performance of privately-managed accounts.  Similarly, as the Whitebox managers note, there are lots of markets in which their strategy will be undistinguished.

So, what do they do?  They operate with an extremely high level of quantitative expertise, but they are not a quant fund (that’s the Whitebox versus “black box” distinction).  We know that there are predictable patterns of investor irrationality (that’s the basis of behavioral finance) and that those investor preferences can shift substantially (for example, between obsessions with greed and fear).  Whitebox believes that those irrationalities continually generate exploitable mispricings (some healthy firms or sound sectors priced as if bankruptcy is imminent, others priced as if consumers are locked into an insane spending binge).  Whitebox’s models attempt to identify which factors are currently driving prices and they assign a factor score to stocks and sectors.

Whitebox does not, however, immediately act on those scores.  Instead, they subject the stocks to extensive, fundamental analysis.  They’re especially sensitive to the fact that quant outputs become unreliable in suddenly unstable markets, and so they’re especially vigilant in such markets are cast a skeptical eye on seemingly objective, once-reliable outputs.

They believe that the strengths of each approach (quant and fundamental, machine and human) can be complementary: they discount the models in times of instability but use it to force their attention on overlooked possibilities otherwise. 

They tend assemble a “beta neutral” portfolio, one that acts as if it has no exposure to the stock market’s volatility.  They argue that “risk management … is inseparable from position selection.”  They believe that many investors mistakenly seek out risky assets, expecting that higher risk correlates with higher returns.  They disagree, arguing that they generate alpha by limiting beta; that is, by not losing your money in the first place.  They’re looking for investments with asymmetric risks: downside that’s “relatively contained” but “a potentially fat tailed” upside.  Part of that risk management comes from limits on position size, sector exposure and leverage.  Part from daily liquidity and performance monitoring.

Whitebox will, the managers believe, excel in two sorts of markets.  Their discipline works well in “calm, stable markets” and in the recovery phase after “pronounced market turmoil,” where prices have gotten seriously out-of-whack.  The experience of their hedge fund suggests that they have the ability to add serious alpha: from inception, the fund returned about 14% per year while the stock market managed 2.5%.

Are there reasons to be cautious?  Yep.  Two come to mind:

1. The fund is expensive.  After waivers, retail investors are still paying nearly 2% plus a front load of 4.5%.  While that was more than offset by the fund’s past returns, current investors can’t buy past returns.
2. Some hedge funds manage the transition well, others don’t.  As I noted above, success as a hedge fund – even sustained success as a hedge fund – has not proven to be a fool-proof predictor of mutual fund success.  The fund’s slightly older sibling, Whitebox Tactical Opportunities (WBMAX) has provided perfectly ordinary returns since inception (12/2011) and weak ones over the past 12 months.  That’s not a criticism, it’s a caution.

Bottom Line

There’s no question that the managers are smart, successful and experienced hedge fund investors.  Their writing is thoughtful and their arguments are well-made.  They’ve been entrusted with billions of other people’s money and they’ve got a huge personal stake – financial and otherwise – in this strategy.  Lacking a more sophisticated understanding of what they’re about and a bit concerned about expenses, I’m at best cautiously optimistic about the fund’s prospects.

Fund website

Whitebox Market Neutral Equity Fund.  (The Whitebox homepage is just a bit grandiose, so it seems better to go straight to the fund’s page.)

Fact Sheet

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

Objective and Strategy

Seafarer seeks to provide long-term capital appreciation along with some current income; it also seeks to mitigate volatility. The Fund invests a significant amount – 20-50% of its portfolio – in the securities of companies located in developed countries. The remainder is investing in developing and frontier markets.  The Fund can invest in dividend-paying common stocks, preferred stocks, convertible bonds, and fixed-income securities. 

Adviser

Seafarer Capital Partners of San Francisco.  Seafarer is a small, employee-owned firm whose only focus is the Seafarer fund.

Managers

Andrew Foster is the lead manager.  Mr. Foster is Seafarer’s founder and Chief Investment Officer.  Mr. Foster formerly was manager or co-manager of Matthews Asia Growth & Income (MACSX), Matthews’ research director and acting chief investment officer.  He began his career in emerging markets in 1996, when he worked as a management consultant with A.T. Kearney, based in Singapore, then joined Matthews in 1998.  Andrew was named Director of Research in 2003 and served as the firm’s Acting Chief Investment Officer during the height of the global financial crisis, from 2008 through 2009.  Andrew is assisted by William Maeck and Kate Jaquet.  Mr. Maeck is the associate portfolio manager and head trader for Seafarer.  He’s had a long career as an investment adviser, equity analyst and management consultant.  Ms. Jaquet spent the first part of her career with Credit Suisse First Boston as an investment banking analyst within their Latin America group. In 2000, she joined Seneca Capital Management in San Francisco as a senior research analyst in their high yield group. Her responsibilities included the metals & mining, oil & gas, and utilities industries as well as emerging market sovereigns and select emerging market corporate issuers.

Management’s Stake in the Fund

Mr. Foster has over $1 million in the fund.  Both Maeck and Jaquet have between $100,000 and $500,000 invested.

Opening date

February 15, 2012

Minimum investment

$2,500 for regular accounts and $1000 for retirement accounts. The minimum subsequent investment is $500.

Expense ratio

1.40% after waivers on assets of $35 million (as of February 2013).  The fund has two fee waivers in place, a contractual waiver which is reflected in standard reports (such as those at Morningstar) but also a voluntary one which is not reflected elsewhere. The fund does not charge a 12(b)1 marketing fee but does have a 2% redemption fee on shares held fewer than 90 days.

Comments

Investors have latched on, perhaps too tightly, to the need for emerging markets exposure.  As of March 2013, e.m. funds had seen 21 consecutive weeks of asset inflows after years of languishing.  Any time there is that much enthusiasm for an asset class, prudent investors should pause.  But we also believe that prudent investors who want emerging markets exposure should start at Seafarer.  The case for Seafarer is straightforward: it’s going to be one of your best options for sustaining exposure to an important but challenging asset class.

There are four reasons to believe this is true.

First, Andrew Foster has been getting it right for a long time.  This is the quintessential case of “a seasoned manager at a nimble new fund.”  In addition to managing or co-managing Matthews Asian Growth & Income for eight years (2003-2011), he was a portfolio manager on Asia Dividend for six years and India Fund for five.  His hallmark piece, prior to Seafarer, indisputably was MACSX.  The fund’s careful risk management helped investors control the impulse to panic.  Volatility is the bane of most emerging markets funds (the group’s standard deviation is about 25, while developed markets average 15). The average emerging markets stock investor captured a mere 25 – 35% of their funds’ nominal gains. MACSX’s captured 90% over the decade that ended with Andrew’s departure and virtually 100% over the preceding 15 years.  The great debate surrounding MACSX during his tenure was whether it was the best Asia-centered fund in existence or merely one of the two or three best funds in existence. 

Second, Seafarer is independent.  Based on his earlier research, Mr. Foster believes that perhaps two-thirds of MACSX’s out-performance was driven by having “a more sensible” approach (for example, recognizing the strategic errors embedded in the index benchmarks which drive most “active” managers) and one-third by better security selection (driven by intensive research and over 1500 field visits).  Seafarer and its benchmarks focus on about 24 markets.  In 14 of them, Seafarer has dramatically different weightings than do the indexes (MSCI or FTSE) or his peers.  It’s striking, on a country-by-country level, how closely the average e.m. fund hugs its benchmark.  Seafarer dramatically underweights the BRICs and Korea, which represent 58% of the MSCI index but only 25% of Seafarer’s portfolio.  That’s made up for by substantially greater positions in Chile, Hong Kong, Japan, Poland, Singapore, Thailand and Turkey.  While the average e.m. fund seems to hold 100-250 names and index funds hold 1000, Seafarer focuses on 40.

Third, Seafarer is cautious. Andrew targets firms which are well-managed and capable of sustained growth.  He’s willing to sacrifice dramatic upside potential for the prospect of steady, long-term growth and income.  The stocks in his portfolio receive far high financial health and slightly lower growth scores from Morningstar than either indexed or actively managed e.m. funds as a group. Concern about stretched valuations led him to halve his small cap stake in 2012 and move into larger, steadier firms including those domiciled in developed markets. 

Combined with a greater interest in income in the portfolio, that’s given Seafarer noticeable downside protection.  E.M. funds as a group have posted losses in five of the past 12 months.  In those down months, their average loss is 2.9% per month.  In those same months, Seafarer posted an average loss of 1.3% (about 45% of the market’s).  In three of those five months, Seafarer made money.  That’s consistent with his long-term record.  During the global meltdown (10/07 – 03/09), his previous charge lost 34% but the average Asia fund dropped 58% and the average emerging markets fund dropped 59%.

Fourth Seafarer is rewarding.  In its first year, Seafarer returned 18% versus the MSCI emerging market index’s 3.8%.   It outperformed the only e.m. fund to receive Morningstar’s “Gold” designation, American Funds New World (NEWFX), the offerings from Vanguard, Price, Fidelity and PIMCO, its emerging markets peer group and First Trust/Aberdeen Emerging Opportunities (FEO), the best of the EM balanced funds.

Bottom Line

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

Fund website

Seafarer Overseas Growth and Income.  The website is remarkably rich, both with analyses of the fund’s portfolio and performance, and with commentary on broader issues.

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

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This is an update of the fund profile originally published in February 2012, and updated in March 2012. You can find that profile here. 

Objective and Strategy

MAINX seeks total return over the long term with an emphasis on income. The fund invests in income-producing securities including, but not limited to, debt and debt-related instruments issued by government, quasi-governmental and corporate bonds, dividend-paying stocks and convertible securities (a sort of stock/bond hybrid).  The fund may hedge its currency exposure, but does not intend to do so routinely.  In general, at least half of the portfolio will be in investment-grade bonds.  Equities, both common stocks and convertibles, will not exceed 20% of the portfolio.

Adviser

Matthews International Capital Management. Matthews was founded in 1991 and advises the 13 Matthews Asia funds.   As of December 31, 2012, Matthews had $20.9 billion in assets under management.  On whole, the Matthews Asia funds offer below average expenses.  They also publish an interesting and well-written newsletter on Asian investing, Asia Insight.

Manager(s)

Teresa Kong is the lead manager.  Before joining Matthews in 2010, she was Head of Emerging Market Investments at Barclays Global Investors (now BlackRock) and responsible for managing the firm’s investment strategies in Emerging Asia, Eastern Europe, Africa and Latin America. In addition to founding the Fixed Income Emerging Markets Group at BlackRock, she was also Senior Portfolio Manager and Credit Strategist on the Fixed Income credit team.  She’s also served as an analyst for Oppenheimer Funds and JP Morgan Securities, where she worked in the Structured Products Group and Latin America Capital Markets Group.  Kong has two co-managers, Gerald Hwang, who for three years managed foreign exchange and fixed income assets for some of Vanguard’s exchange-traded funds and mutual funds before joining Matthews in 2011, and Robert Horrocks, Matthews’ chief investment officer.

Management’s Stake in the Fund

As of the April 2012 Statement of Additional Information, Ms. Kong and Mr. Horrocks each had between $100,000 and 500,000 invested in the fund.  About one-third of the fund’s Investor class shares were held by Matthews.

Opening date

November 30, 2011.

Minimum investment

$2500 for regular accounts, $500 for IRAs for the retail shares.  The fund’s available, NTF, through Fidelity, Scottrade, TD Ameritrade, TIAA-CREF and Vanguard and a few others.

Expense ratio

1.40%, after waivers, on $50 million in assets (as of January, 2013).  There’s also a 2% redemption fee for shares held fewer than 90 days.  The Institutional share class (MINCX) charges 1.0% and has a $3 million minimum.

Comments

The events of 2012 only make the case for Matthews Asia Strategic Income more intriguing.  Our original case for MAINX had two premises:

1. Traditional fixed-income investments are failing. The combination of microscopic domestic interest rates with the slow depreciation of the U.S. dollar and the corrosive effects of inflation means that more and more “risk-free” fixed-income portfolios simply won’t meet their owners’ needs.  Surmounting that risk requires looking beyond the traditional.  For many investors, Asia is a logical destination for two reasons: the fundamentals of their fixed-income market is stronger than those in Europe or the U.S. and most investors are systematically underexposed to the Asian market.
2.  Matthews Asia is probably the best tool you have for gaining that exposure.  They have the largest array of Asia investment products in the U.S. market, the deepest analytic core and the broadest array of experience.  They also have a long history of fixed-income investing in the service of funds such as Matthews Asian Growth & Income (MACSX).   Their culture and policies are shareholder-friendly and their success has been consistent. 

Three developments in 2012 made the case for looking at MAINX more compelling.

1. Alarm about the state of developed credit markets is rising.  As of February 2013, Bill Gross anticipates “negative real interest rates approaching minus 2%” and warns “our credit-based financial markets and the economy it supports are levered, fragile and increasingly entropic – it is running out of energy and time.”  Templeton’s Dan Hasentab, “the man who made some of the boldest contrarian bets in the bond market last year has,” The Financial Times reported on January 30, “a new message for investors: get out of supposedly safe government debt now, before it is too late.” The 79 year old maestro behind Loomis Sayles Bond and Strategic Income, Dan Fuss, declares “This is the most overbought market I have ever seen in my life . . . What I tell my clients is, ‘It’s not the end of the world, but . . .”   

   Ms. Kong points to Asia as a powerful counterbalance to these concerns.  Its beta relative to US Treasuries bonds is among the lowest around: If, for example, the 5-year Treasury declines 1% in value, U.S. investment grade debt will decline 0.7%, the global aggregate index 0.5% and Asia fixed-income around 0.25%.

2. Strategic Income performed beautifully in its first full year.  The fund returned 13.62% in 2012, placing it in the top 10% of Morningstar’s “world bond” peer group.  A more telling comparison was provided by our collaborator, Charles Boccadoro, who notes that the fund’s absolute and risk-adjusted returns far exceeded those of its few Asia-centered competitors.

   

3. Strategic Income’s equity exposure may be rising in significance.  The inclusion of an equity stake adds upside, allows the fund to range across a firm’s capital structure and allows it to pursue opportunities in markets where the fixed-income segment is closed or fundamentally unattractive.  Increasingly, the top tier of strategists are pointing to income-producing equities as an essential component of a fixed-income portfolio.

Bottom Line

MAINX offers rare and sensible access to an important, under-followed asset class.  The long track record of Matthews Asia funds suggests that this is going to be a solid, risk-conscious and rewarding vehicle for gaining access to that class.  By design, MAINX will likely offer the highest Sharpe ratio (a measure of risk-adjusted returns) of any of the Matthews Asia funds. You really want to consider the possibility before the issue becomes pressing.

Fund website

Matthews Asia Strategic Income

Commentary

2013 Q3 Report

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Objective and Strategy

The fund seeks to maximize long-term capital growth.  They invest in a global, all-cap equity portfolio which may include common and preferred stocks, convertible securities and, to a limited extent, derivatives.  They’re looking for high-quality growth companies with sustainable growth characteristics.  Their preference is to invest in firms that benefit from long-term growth trends and in stocks which are selling at a reasonable price.  Typically they hold 60-100 stocks. No more than 30% of the portfolio may be invested in emerging markets.  In general they do not hedge their currency exposure but could choose to do so if they owned a security denominated in an overvalued currency.

Adviser

Artisan Partners of Milwaukee, Wisconsin with Artisan Partners UK LLP as a subadvisor.   Artisan has five autonomous investment teams that oversee twelve distinct U.S., non-U.S. and global investment strategies. Artisan has been around since 1994.  As of 9/30/2012, Artisan Partners had approximately $70 billion in assets under management.  That’s up from $10 billion in 2000. They advise the 12 Artisan funds, but only 5% of their assets come from retail investors.

Manager

Barry P. Dargan is lead portfolio manager and Mark L. Yockey is portfolio manager.  Dargan and Yockey are jointly responsible for management of the fund, they work together to develop investment strategies but Mr. Dargan generally exercises final decision-making authority.  Previously, Mr. Dargan worked for MFS, as an investment analyst from 1996 to 2001 and as a manager of MFS International Growth (MGRAX) from 2001 to 2010.  Mr. Yockey joined Artisan in 1995 and is the lead manager for Artisan International (ARTIX) and Artisan International Small Cap (ARTJX).  The fact that Mr. Dargan’s main charge handily outperformed ARTIX over nearly a decade might have helped convince Artisan to bring him on-board.

Management’s Stake in the Fund

Mr. Dargan has over $1 million invested with the fund, and Mr. Yockey has between $500,000 and $1 million invested.  As of December 31, 2011, the officers and directors of Artisan Funds owned 16.94% of Artisan Global Equity Fund.

Opening date

March 29, 2010

Minimum investment

$1,000, which Artisan will waive if you establish an account with an automatic investment plan.

Expense ratio

1.50%, after waivers, on assets of $16.7 million. There is a 2% redemption fee for shares held less than 90 days.

Comments

Q:   What do you get when you combine the talents of two supremely successful international stock managers, a healthy corporate culture and a small, flexible fund?

A:   Artisan Global Equity.

The argument for considering ARTHX is really straightforward.  First, both managers have records that are both sustained and excellent.  Mr. Dargan managed, or co-managed, six funds, including two global funds, while at MFS.  Those included funds targeting both U.S. and non-U.S. investors.  While I don’t have a precise calculation, it’s clear he was managing more than $3 billion.  Mr. Yockey has famously managed two Artisan international funds since their inception, was once recognized as Morningstar’s International Fund Manager of the Year (1998).  For most trailing time periods, his funds have top 10% returns.  International Small Cap received Morningstar’s highest accolade when it was designated as the only “Gold” fund in its peer group while International was recognized as a “Silver” fund.  Based on head-to-head comparisons from 2001-2010, Mr. Yockey is really first rate and Mr. Dargan might be better.  (Being British, it’s almost certain that he has a cooler accent.)

Second, Artisan is a good steward.  The firm’s managers are divided into five teams, each with a distinctive philosophy and portfolio strategy.  The Global Equity team has four members (including Associate Portfolio Managers Charles Hamker and Andrew Euretig who also co-manage International Small Cap) and their discipline grows from the strategies first employed in ARTIX then extended to ARTJX.  Artisan has a very good record for lowering expenses, being risk conscious, opening funds only when they believe they have the capacity to be category-leaders (and almost all are) and closing funds before they’re bloated.

Third, ARTHX is nimble.  Its mandate is flexible: all sizes, all countries, any industry.  The fund’s direct investment in emerging markets is limited to 30% of the portfolio, but their pursuit of the world’s best companies leads them to firms whose income streams are more diverse than would be suggested by the names of the countries where they’re headquartered.  The managers note:

Though we have outsized exposure to Europe and undersized exposure to the U.S., we believe our relative country weights are of less significance since the companies we own in these developed economies continually expand their revenue bases across the globe.

Our portfolio remains centered around global industry leading companies with attractive valuations. This has led to a significant overweight position in the consumer sectors where many of our holdings benefit from significant exposure to the faster growth in emerging economies.

Since much of the world’s secular (enduring, long-term) growth is in the emerging markets, the portfolio is positioned to give them substantial exposure to it through their Europe and US-domiciled firms.  While the managers are experienced in handling billions, here they’re dealing with only $17 million.

The results are not surprising.  Morningstar believes that their analysts can identify those funds likely to serve their shareholders best; they do this by looking at a series of qualitative factors on top of pure performance.  When they find a fund that they believe has the potential to be consistently strong in the future, they can name it as a “Gold” fund.   Here are ARTHX’s returns since inception (the blue line) against all of Morningstar’s global Gold funds:

Not to say that the gap between Artisan and the other top funds is large and growing, but it is.

Bottom Line

Artisan Global Equity is an outstanding small fund for investors looking for exposure to many of the best firms from around the global.  The expenses are reasonable, the investment minimum is low and the manager is first-rate.  Which should be no surprise since two of the few funds keeping pace with Artisan Global Equity have names beginning with the same two words: Artisan Global Opportunities (ARTRX) and Artisan Global Value (ARTGX).

Fund website

Artisan Global Equity

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