Category Archives: Funds

Homestead Growth (HNASX), March 2017

By David Snowball

Objective and strategy

The fund seeks long-term capital appreciation by investing, primarily, in domestic large cap growth stocks. The portfolio is diversified (typically 60-75 names) but not sprawling. Direct foreign investment is currently about 5.6%, which is modest but also above-average for its Morningstar peer group.

In general, the fund’s subadvisor T. Rowe Price targets:

companies with characteristics that support sustainable double-digit earnings growth and
high-quality earnings, strong free cash flow growth, shareholder-oriented management, and rational competitive environments

Their preference is for firms with a lucrative and defensible niche which allows them to Continue reading →

Pin Oak Equity (POGSX), March 2017

By David Snowball

Objective and strategy

Pin Oak is a concentrated, all-cap fund. The portfolio currently holds 35 securities with much more exposure to small- and mid-cap stocks than its peers Portfolio construction begins with macro-level assessments of the economy, proceeds to analyses of industries and sectors, and then ends by buying and holding the most attractive stocks in the most attractive sectors. Oak Associates has a long and adamant tradition in favor of buying-and-holding just a few best-of-class stocks, so turnover is generally below 20%. Half of the portfolio’s 35 current stocks have been there for between five and 15 years.

Adviser

Oak Associates, ltd. Founded in 1985 and headquartered in Continue reading →

Sunbridge Capital Emerging Markets (formerly Fiera Capital Emerging Markets Fund), (RIMIX, CNRYX), October 2016

By Dennis Baran

At the time of publication, this fund was named City National Rochdale Emerging Markets Fund.
This fund was formerly named Fiera Capital Emerging Markets Fund.

This fund has been liquidated as of February 10, 2023.

Objective and strategy

The fund seeks to provide long-term capital appreciation primarily by investing in locally listed large, medium, and small quality companies broadly accessible to U.S. investors within Asian Emerging Markets. The Adviser conducts on-the-ground research to provide direct insight into these companies using its domain expertise in the region, and while it may invest in companies from any emerging market country, it expects to focus its investments in Asia.

The fund is intended for long-term investors who have a time horizon of at least 5 years but preferably 7-10. It was first mentioned in the April 2015 edition of MFO as Continue reading →

Mairs and Power Small Cap Fund (MSCFX), September 2016

By David Snowball

Objective and strategy

The fund seeks “above-average” long-term capital appreciation by investing in 40-45 small cap stocks. For their purposes, “small caps” have a market capitalization under $3.4 billion at the time of purchase. The manager is authorized to invest up to 25% of the portfolio in foreign stocks and to invest, without limit, in convertible securities (but he plans to do neither). Across all their portfolios, Mairs & Power invests in “carefully selected, quality growth stocks” purchased “at reasonable valuation levels.” Continue reading →

Otter Creek Long Short Opportunity (OTCRX), April 2016

By David Snowball

Objective and strategy

The Otter Creek Long/Short Opportunity Fund seeks long-term capital appreciation. They take long positions in securities they believe to be undervalued and short positions in the overvalued. Their net market exposure will range between (-35%) and 80%. They can place up to 20% in MLPs, 30% in REITs, and 30% in fixed income securities, including junk bonds. They use a limited amount of leverage. The fund is unusually concentrated with about 30 long and 30 short positions.

Adviser

Otter Creek Advisors. Otter Creek Advisors was formed for the special purpose of managing this mutual fund and giving Messrs. Walling and Winter, the two primary managers, a substantial equity stake in the operation. That arrangement is part of a “succession plan to provide equity ownership to the next generation of portfolio managers: Mike Winter and Tyler Walling.” Otter Creek Advisers has about $280 million in assets under management.

Managers

R. Keith Long, Tyler Walling and Michael Winter. Mr. Long has a long and distinguished career in the financial services industry, dating back to 1973. Mr. Walling joins Otter Creek in 2011 after a five-year stint as an equity analyst for Goldman Sachs. Mr. Winter joined Otter Creek in 2007. Prior to Otter Creek, he worked for a long/short equity hedge fund and, before that, for Putnam Investment Management.

Strategy capacity and closure

Somewhere “north of a billion” the team would consider a soft close. They were pretty emphatic that they didn’t want to become an asset sponge and that they were putting an enormous amount of care into attracting compatible investors.

Management’s stake in the fund

Mr. Long has invested more than $1,000,000 in the fund, Mr. Winter and Mr. Walling each have $500,000-$1,000,000. Those are substantial commitments for 30-something managers to make. Sadly, as of December 30, 2015, no member of the fund’s board of trustees had chosen to invest in it.

Opening date

December 30, 2013.

Minimum investment

$2,500, reduced to $1,000 for accounts established with an automatic investment plan.

Expense ratio

2.63% for the Investor class, on assets of $153.3 million (as of July 2023).

Comments

In its first two-plus years of operation, Otter Creek Opportunity has been a very, very good long/short fund. Three observations lie behind that judgment.

First, it has made much more money than its generally sad sack peer group. From inception from the end of February, 2016, OTCRX posted annual returns of 10.2%. Its average peer lost 1% annually in the same period. During that stretch, it bested the S&P 500 in 15 of 25 calendar months and beat its peers in 17 of 25 months.

Second, it has provided exceptional downside protection. It outperformed the S&P 500 in 10 of the 11 months in which the index declined and consistently stayed in the range of tiny losses to modest gains in periods when the S&P 500 was down 3% or more.

ottrx

It also outperformed its long/short peers in nine of the 11 months in which the S&P 500 dropped. Since launch, the fund’s downside deviation has been only 40% of its peers and its maximum drawdown has been barely one-fourth as great as theirs.

Third, it has negligible correlation to the market. To date, its correlation to the S&P 500 is 0.05. In practical terms, that means that there’s no evidence that a decline in the stock market will be consistently associated with a decline in Otter Creek.

What accounts for their very distinctive performance?

At base, the managers believe it’s because they focus. They focus, for example, on picking exceptional stocks. They are Graham and Dodd sorts of investors, looking for sustainably high return-on-equity, growing dividends, limited financial leverage and dominant market positions. They use a “forensic accounting approach to financial statement analysis” to help identify not only attractive firms but also the places within the firm’s capital structure that holds the best opportunities. They tend to construct a focused portfolio around 30 or so long and short positions. On the flip side, they short firms that use aggressive accounting, weak balance sheets, wretched leadership and low quality earnings.

Which is to say, yes, they were shorting Valeant in 2015.

Their top ten long and short positions, taken together, account for about 70% of the portfolio. They’re both more concentrated and more patient, measured by turnover, than their peers.

They also focus on the portfolio, rather than just on individual names for the portfolio. They’ve created a series of rules, drawing on their prior work with their firm’s hedge fund, to limit mishaps in their short portfolio. If, for example, a short position begins to get “crowded,” that is, if other investors start shorting the same names they do, they’ll reduce their position size to avoid the risk of a short squeeze. Likewise they substantially reduce or eliminate any short that moves against the portfolio by 25% or more over the course of six months.

Bottom Line

Messrs. Walling and Winter bear watching. They’ve got a healthy attitude and have done a lot right in a short period. As of mid-February, they had a vast performance advantage over the S&P 500 and their peers. Even after the S&P’s furious six-week rally, they are still ahead – and vastly ahead if you take the effects of volatility into account. It’s clear that they see this fund as a long-term project, they’re excited by it and they’re looking for the right kind of investors to join in with them. If you’re looking to partner with investors who don’t like volatility and detest losing their shareholders money, you might reasonably add OTCRX to your short-list of funds to investigate.

Fund website

Otter Creek Long/Short

[cr2016]

AQR Equity Market Neutral (QMNIX), AQR Long-Short Equity (QLEIX), April 2016

By Samuel Lee

Objective and strategy

AQR offers its absolute return equity strategy in two mutual fund flavors: AQR Equity Market Neutral and AQR Long-Short Equity. Equity Market Neutral, or EMN, goes long global stocks that score well on proprietary composite measures and shorts global stocks that score poorly. AQR groups these measures into six broad “themes”:

Value is the strategy of buying stocks that are cheap on fundamental measures such as book value, earnings, dividends and cash flow.
Momentum is the strategy of buying stocks with strong recent relative performance according to measures such as price returns, abnormal returns after earnings announcements (earnings surprises), abnormal risk-adjusted returns (residual momentum), and returns of economically linked firms (indirect momentum).
Earnings quality is the strategy of buying stocks with reported earnings that are more reliable indicators of future earnings, according to measures such as accruals.
Stability is the strategy of buying stocks with defensive characteristics, such as low volatility, low beta, and low leverage.
Investor sentiment is the strategy of buying stocks with wide agreement by “smart money”, according to measures such as low short interest as a percentage of market capitalization and high commonality of holdings by elite hedge funds.
Management signaling is the strategy of buying stocks where management engages in actions that indicate financial strength or cheapness, such as debt retirement and share repurchases.

Stocks are ranked by these measures within each industry. The stocks with the highest composite scores are bought and the stocks with the lowest composite scores are shorted. Industry neutrality improves risk-adjusted returns on a wide variety of stock selection signals, perhaps because it removes persistent industry bets.

In addition, the strategy engages in country-industry pairs selection using the same six sets of signals and industry selection using only value and momentum. Because AQR dislikes concentrated bets, the country-industry pairs and industry selection strategies are allotted a smaller portion of the strategy’s overall risk than the stock-selection strategy.

The balance of the long and short sleeves is managed to produce returns uncorrelated with the MSCI World Index, a market-weighted benchmark of developed market stocks. This does not mean each sleeve has the same notional size. The long sleeve tends to exhibit lower volatility for each unit of notional exposure than the short sleeve. In order to balance them, the strategy must own more dollars of the long sleeve, creating the impression that it has net long equity exposure. The gross exposure for each sleeve has a floor of 100% NAV and a cap of 250% NAV, meaning the strategy’s gross exposure can range from 2x to 5x the net asset value of the fund. As of February end, AQR Equity Market Neutral had 190% notional long exposure and 173% notional short exposure, for a total gross notional exposure of 363%.

AQR takes steps to mitigate the risks of leverage. First, the strategy is well diversified, with over 1700 stock positions, most of them under 0.5% notional exposure and the biggest at a little under 1.7%. Single-stock concentration goes against every bone in AQR. Like most quant investors, AQR goes for seconds and thirds when it comes to the “free lunch” of diversification.

Second, AQR has a 6% annualized volatility target for the strategy, which means AQR will likely reduce gross leverage if its positions behave erratically. This is a trend-following strategy as periods of high volatility usually coincide with bad returns. For reference, the volatility target is about a third of the historical volatility of the U.S. stock market and roughly the same as the historical volatility of the Barclays Aggregate Bond Index (though in recent years the bond index’s volatility has dropped to about 3%).

Finally, the strategy applies what AQR calls a “drawdown control system”, a methodology for cutting risk when the strategy loses money and adding it back as it recoups its losses (or enough time lapses since a drawdown). The drawdown control system can cut the fund’s target volatility by up to half in the worst circumstances. AQR’s use of volatility targeting and drawdown control are common practices among quantitative investors. As a group these investors tend to cut and add risks at the same time. It is unclear whether they are influential enough to alter the nature of markets and perhaps render these methods obsolete or even harmful (think of portfolio insurance and its contribution to Black Monday in 1987, when the Dow Jones Industrial Average fell 22.6%). My guess is quantitative investors aren’t yet big enough because many more investors are counter-cyclical rebalancers over the short-run, particularly institutions. This is speculation, of course. The market is a big and wild herd that will sometimes stampede in a direction it had never gone before—a lesson AQR itself learned at least twice: during the madness of the dot-com bubble and during the great quant meltdown of 2007.

—

Long-Short Equity, or LSE, takes the EMN strategy (though they’re not exact clones if we’re to judge by their holdings and position sizes) and overlays a tactical equity strategy that targets an average 50% exposure to the MSCI World Index, with the ability to adjust its exposure by +/- 20% based largely on valuation and momentum. The equity exposure is obtained through futures.

In a back-test of a simplified version of the strategy, the market-timing component did not add much to the strategy’s performance while it worsened the drawdown during the financial crisis.

Adviser

AQR Capital Management, LLC, was founded in 1998 by a team of ex-Goldman Sachs quant investors led by Clifford S. Asness, David G. Kabiller, Robert J. Krail, and John M. Liew. (Krail is no longer with the firm.) AQR stands for Applied Quantitative Research. Asness, Krail and Liew met each other at the University of Chicago’s finance PhD program. The firm’s bread and butter has long been trading value and momentum together, an idea Asness studied in his dissertation under Eugene Fama, father of modern finance and one of the co-formulators of the efficient market hypothesis.

AQR is mostly owned by AQR Group LP, which in turn is owned by employees of the firm. AMG, a publicly traded asset manager, has owned a stake in AQR since 2004 and in 2014 it increased it, but remains a minority shareholder (terms of both transactions have not been disclosed). AMG largely leaves its investees to run themselves, so I am not concerned about the firm pushing AQR to do stupid things to meet or beat a quarterly target. Though the implosion of Third Avenue, an investee, may spur AMG to more actively monitor its portfolio companies, I doubt Asness and his partners gave AMG much power to meddle in AQR’s affairs.

AQR’s mutual fund business has grown rapidly in size and sophistication since 2009, when it launched arbitrage and equity momentum funds. It competes with DFA for the mantle of academic “thought leadership” among advisors, its main clients. This has put Asness in the awkward position of competing with his former mentor Fama, who is a significant shareholder in DFA and the chief intellectual architect of its approach. Like DFA, AQR emphasizes the primacy of factors in managing portfolios.

—

When AQR started up, it was hot. It had one of the biggest launches of any hedge-fund up to that point. Then the dot-com bubble inflated. The widening gap in valuations between value and growth stocks almost sunk AQR. According to Asness, had the bubble lasted six more months, he would have been out of business. When the bubble burst, the firm’s returns soared and so did its assets. The good times rolled on and the firm was on the verge of an IPO by late 2007. According to the New York Post, AQR had to shelve it as the subprime crisis began roiling the markets. The financial crisis shredded its returns, with its flagship Absolute Return fund falling more than 50 percent from the start of 2007 to the end of 2008. Firm-wide assets from peak-to-trough went from $39.1 billion to $17.2 billion. The good times are back: As of December-end, AQR had $142.2 billion in net assets under management.

The two near-death experiences have instilled in AQR a fear of concentrated business risks. In 2009, AQR began to diversify away from its flighty institutional clientele by launching mutual funds to entice stickier retail investors. The firm has also launched new strategies at a steady clip, including managed futures, risk parity, and global macro.

AQR has a strong academic bent. Its leadership is sprinkled with economics and finance PhDs from top universities, particularly the University of Chicago. The firm has poached academics with strong publishing records, including Andrea Frazzini, Lasse Pedersen, and Tobias Moskowitz. Its researchers and leaders are still active in publishing papers.

The firm’s principals are critical of hedge funds that charge high fees on strategies that are largely replicable. AQR’s business model is to offer up simplified quant versions of these strategies and charge relatively low fees.

Managers

Both the Equity Market Neutral and Long-Short Equity strategies are run by Jacques A. Friedman, Andrea Frazzini, and Michele L. Aghassi. Ronen Israel helps manage EMN. Hoon Kim helps manage LSE. All five are principals, or partners, in the firm.

Friedman heads AQR’s Global Stock Selection team. Prior to joining AQR at its inception in 1998, he developed quantitative stock selection strategies at Goldman Sachs. He is the principal portfolio manager and supervises Frazzini, Aghassi and Kim.

Israel heads AQR’s Global Alternative Premia Group. Prior to joining AQR in 1999, he was a senior analyst at Quantitative Financial Strategies, Inc.

Frazzini researches global stock-selection strategies. Prior to joining AQR in 2008 he was a star finance professor at the University of Chicago.

Aghassi is co-head of research of AQR’s Global Stock Selection team. Prior to joining AQR in 2005, she obtained her PhD in operations research at MIT.

Kim is the head of equity portfolio management in AQR’s Global Stock Selection team. Prior to joining AQR in 2005, he was head of quantitative equity research at Mellon Capital Management.

Israel and Friedman have master’s degrees in mathematics. Frazzini, Aghassi and Kim have PhDs.

Strategy capacity and closure

The EMN and LSE funds together have over $1.6 billion in assets. However, AQR runs hedge funds, institutional separate accounts, and foreign funds, and re-uses the same signals in different formats, such as long-only funds. The effective dollars dedicated to the signals use by the funds are almost certainly much higher than reported by the aggregate net asset values of the mutual funds.

Fortunately, AQR has a history of closing funds and ensuring its assets don’t overwhelm the capacity of its strategies. When the firm launched in 1998, it could have started with $2 billion but chose to manage only half that, according to founding partner David Kabiller. Of its mutual funds, AQR has already closed its Multi-Strategy Alternative, Diversified Arbitrage and Risk Parity mutual funds. Soon after I wrote about AQR Style Premia Alternative QSPIX and AQR Style Premia LV QSLIX in the September 2015 edition of MFO, AQR announced a soft close of the funds. It went into effect on March 31, 2016. AQR will meet additional demand by launching funds that are tweaked to have more capacity.

Management’s stake in the funds

As of December 31, 2014, the funds’ managers had relatively low investments in the mutual funds.

Friedman had $50,001 to $100,000 in the EMN fund and $100,001 to $500,000 in the LSE fund.
Israel had no investment in the EMN fund.
Frazzini had $10,001 to $50,000 in both funds.
Aghassi had no investments in either fund.
Kim had no investment in the LSE fund.

The low levels of investment should not be held against the managers. It is cheaper and more tax efficient for them to invest in the strategies through AQR’s hedge funds. They also have a direct interest in the success of the firm. Unlike many other hedge funds, AQR does not compensate partners and employees largely based on the profits attributable to them. The team-based nature of AQR’s quantitative process means profits cannot be cleanly attributable to a given employee. Moreover, there is a huge element of luck in the performance of a given strategy and AQR rightly does not want to overwhelmingly tie compensation to it. All the portfolio managers of the funds are partners and so earn a payout based on the firm’s earnings and their relative ownership stakes. AQR grants ownership stakes based on “cumulative research, leadership and other contributions.”

I expect that over time the managers’ stakes will rise as a matter of window-dressing for consultants who take a check-the-box approach to due diligence (most of them). There is evidence that window-dressing has occurred: Some of AQR’s principals own both the low- and high-volatility versions of the same strategy, which is strange because it is costlier to own the low-volatility version per unit of exposure.

Opening date

AQR Long-Short Equity started on July 16, 2013. AQR Equity Market Neutral started on October 7, 2014. AQR has been running long-short stock-selection strategies since its 1998 founding.

Minimum investment

$1 million for the N shares, $5 million for the I shares. The minimums are waived at certain brokerages. Fidelity, for example, allows investments as small as $2500 in IRAs. Fee-only financial advisors have no investment minimums.

Expense ratio

QMNIX shares are 1.50% with $208 million in assets and QLEIX shares are 1.36% with $597 million in assets, as of June 2023.

Comments

Both funds have been closed to new investors as of 2017.

Since its October 2014 inception, AQR Equity Market Neutral Fund I QMNIX has returned 18.6% annualized with a standard deviation of 7.0%, for a Sharpe ratio of 2.66. Since its July 2013 inception, AQR Long-Short Equity Fund I QLEIX has returned 14.4% above its benchmark (a 50-50 blend of the MSCI World Index and cash) with a standard deviation of 5.8%, for a Sharpe ratio of 2.46. Almost all of the abnormal returns were driven by the market-neutral equity stock selection sleeve; AQR’s tactical market timing in the LSE strategy contributed zilch to the fund’s returns from inception to the end of 2015.

These are not sustainable numbers. A more reasonable, conservative long-run Sharpe ratio is 0.5. Translated to a raw return, that’s 3% above cash for a market-neutral strategy that runs at a 6% volatility.

While AQR’s absolute return global stock selection strategy has done well, its long-only funds have not. Since the LSE fund launched in 2013, its active returns (that is, returns above its benchmark) have far outstripped the active returns of the AQR Multi-Style funds. In the chart below I plotted the cumulative active returns of AQR Long-Short Equity (which has a longer live track record than AQR Equity Market Neutral) against a sum of the active returns of AQR Large Cap Multi-Style I QCELX and AQR International Multi-Style I QICLX. The long-only funds have stagnated, while the long-short fund has consistently made lots of money. While I doubt this divergence will remain big and persistent, I’m confident that it’s well worth paying up for AQR’s long-short strategy.

chart

Bottom line

AQR’s long-short global stock-selection strategy is well worth the money and a better deal than its long-only stock funds.

Fund Website

AQR Equity Market Neutral

AQR Long-Short Equity

Sam Lee and Severian Asset Management

Sam is the founder of Severian Asset Management, Chicago. He is also former Morningstar analyst and editor of their ETF Investor newsletter. Sam has been celebrated as one of the country’s best financial writers (Morgan Housel: “Really smart takes on ETFs, with an occasional killer piece about general investment wisdom”) and as Morningstar’s best analyst and one of their best writers (John Coumarianos: “ Lee has written two excellent pieces [in the span of a month], and his showing himself to be Morningstar’s finest analyst”). He has been quoted by The Wall Street Journal, Financial Times, Financial Advisor, MarketWatch, Barron’s, and other financial publications. 

Severian works with high net-worth partners, but very selectively. “We are organized to minimize conflicts of interest; our only business is providing investment advice and our only source of income is our client fees. We deal with a select clientele we like and admire. Because of our unusual mode of operation, we work hard to figure out whether a potential client, like you, is a mutual fit. The adviser-client relationship we want demands a high level of mutual admiration and trust. We would never want to go into business with someone just for his money, just as we would never marry someone for money—the heartache isn’t worth it.” Sam works from an understanding of his partners’ needs to craft a series of recommendations that might range from the need for better cybersecurity or lower-rate credit cards to portfolio reconstruction.

[cr2016]

Intrepid Endurance (ICMAX), April 2016

By David Snowball

Objective and strategy

The fund pursues long-term capital appreciation by investing in high quality small cap equities, which they’ll only buy and hold when they’re undervalued. “Small stocks” are stocks comparable in size to those in common indexes like the Russell 2000; currently, that means a maximum cap of $6.5 billion. The fund can hold domestic and international common stocks, preferred stocks, convertible preferred stocks, warrants, and options. They typically hold 15-50 securities. High quality businesses, typically, are “internally financed companies generating cash in excess of their business needs, with predictable revenue streams, and in industries with high barriers to entry.” The managers calculate the intrinsic value of a lot of small companies, though very few are currently selling at an acceptable discount to those values. As a result, the fund has about two-thirds of its portfolio in cash (as of March 2016). When opportunities present themselves, though, the managers deploy their cash quickly; in 2011, the fund moved from 40% cash down to 20% in the space of two weeks.

Adviser

Intrepid Capital Management. Intrepid was founded in 1994 by the father and son team of Forrest and Mark Travis. It’s headquartered in Jacksonville, Florida; the location is part of a conscious strategy to distance themselves from Wall Street’s groupthink. Rather distinctively, their self-description stresses the importance of the fact that their managers have rich, active lives (“some of us surf … others spend weekends at kids’ football games”) outside of work. That focus “makes us a better company and better managers.” They are responsible for “approximately $800 million for individuals and institutional investors through a combination of separately managed accounts, no-load mutual funds, and a long/short hedge fund.” They advise six mutual funds.

Manager

Jayme Wiggins, Mark Travis and Greg Estes. Mr. Wiggins, whose first name is pronounced “Jay Mee,” is the lead manager and the guy responsible for the fund’s day-to-day operations. His career is just a bit complex: right after college, he joined Intrepid in 2002 where he worked as an analyst on the strategy before it even became a fund. In 2005 Jayme took over the high-yield bond strategy which, in 2007, was embodied in the new Intrepid Income Fund (ICMUX). In 2008, he left to pursue his MBA at Columbia. While he was away, Endurance’s lead manager Eric Cinnamond left to join River Road Asset Management. Upon his return in September 2010, Jayme became lead manager here. Mr. Travis is one of Intrepid’s founders and the lead manager on Intrepid Capital (ICMBX). Mr. Estes, who joined the firm in 2000, is lead manager of Intrepid Disciplined Value (ICMCX). Each member of the team contributes to each of the firm’s other funds.

Strategy capacity and closure

The managers would likely begin discussions about the fund’s assets when it approaches the $1 billion level, but there’s no firm trigger level. What they learned from the past was that too great a fraction of the fund’s assets represented “hot money,” people who got excited about the fund’s returns without ever becoming educated about the fund’s distinctive strategy. When the short-term returns didn’t thrill them, they fled. The managers are engaged now in discussions about how to attract more people who “get it.” Their assessment of the type of fund flows, as much as their amount, will influence their judgment of how and when to act.

Management’s stake in the fund

All of the fund’s managers have personal investments in it. Messrs. Travis and Wiggins have between $100,000 and $500,000 while Mr. Estes has between $10,000 and $50,000. The fund’s three independent directors also all have investments in the fund; it’s the only Intrepid fund where every director has a personal stake.

Opening date

The underlying small cap strategy launched in October, 1998; the mutual fund was opened on October 3, 2005.

Minimum investment

$2,500 for Investor shares, $250,000 for Institutional (ICMZX) shares.

Expense ratio

1.30%(Investor class) or 1.15%(Institutional class) on assets of approximately $53.3 million, as of July 2023.

Comments

Start with two investing premises that seem uncontroversial:

You should not buy businesses that you’ll regret owning. At base, you wouldn’t want to own a mismanaged, debt-ridden firm in a dying industry.
You should not pay prices that you’ll regret paying. If a company is making a million dollars a year, no matter how attractive it is, it would be unwise to pay $100 million for it.

If those strike you as sensible premises, then two conclusions flow from them:

You should not buy funds that invest in businesses regardless of their quality or price. Don’t buy trash, don’t pay ridiculous amounts even for quality goods.
You should buy funds that act responsibly in allocating money based on the availability of quality businesses at low prices. Identify high quality goods that you’d like to own, but keep your money in your wallet until they’re on a reasonable sale.

The average investor, individual and professional, consistently disregards those two principles. Cap-weighted index funds, by their very nature, are designed to throw your money at whatever’s been working recently, regardless of price or quality. If Stock A has doubled in value, its weighting in the index doubles and the amount of money subsequently devoted to it by index investors doubles. Conversely, if Stock B halves in value, its weighting is cut in half and so is the money devoted to it by index funds.

Most professional investors, scared to death of losing their jobs because they underperformed an index, position their “actively managed” funds as close to their index as they think they can get away with. Both the indexes and the closet indexers are playing a dangerous game.

How dangerous? The folks at Intrepid offer this breakdown of some of the hot stocks in the S&P 500:

Four S&P tech stocks—Facebook, Amazon, Netflix, and Google (the “FANGs”)—accounted for $450 billion of growth in market cap in 2015, while the 496 other stocks in the S&P collectively lost $938 billion in capitalization. Amazon’s market capitalization is $317 billion, which is bigger than the combined market values of Walmart, Target, and Costco. These three old economy retailers reported trailing twelve month GAAP net income of nearly $17 billion, while Amazon’s net income was $328 million.

As of late March, 2016, Amazon trades at 474 times earnings. The other FANG stocks sell for multiples of 77, 330 and 32. Why are people buying such crazy expensive stocks? Because everyone else is buying them.

That’s not going to end well.

The situation among small cap stocks is worse. As of April 1, 2016, the aggregate price/earnings ratio for stocks in the small cap Russell 2000 index is “nil.” It means, taken as a whole, those 2000 stocks had no earnings over the past 12 months. A year ago, the p/e was 68.4. In late 2015, the p/e ratios for the pharma, biotech, software, internet and energy sectors of the Russell 2000 were incalculable because those sectors – four of five are very popular sectors – have negative earnings.

“Small cap valuations,” Mr. Wiggins notes, “are pretty obscene. In historical terms, valuations are in the upper tier of lunacy. When that corrects, it’s going to get really bad for everybody and small caps are going to be ground zero.”

At the moment, just 50 of 2050 active U.S. equity mutual funds are holding significant cash (that is, 20% or more of total assets). Only nine small cap funds are holding out. That includes Intrepid Endurance whose portfolio is 67% cash.

Endurance looks for 30-40 high-quality companies, typically small cap names, whose prices are low enough to create a reasonable margin of safety. Mr. Wiggins is not willing to lower his standards – for example, he doesn’t want to buy debt-ridden companies just because they’re dirt cheap – just for the sake of buying something. You’ll see the challenge he faces as you consider the Observer’s diagram of the market’s current state and Endurance’s place in it.

venn

It wasn’t always that way. By his standards, “that small cap market was really cheap in ‘09 to fairly-priced in 2011 but since then it’s just become ridiculously expensive.”

For now, Mr. Wiggins is doing what he needs to do to protect his investors in the short term and enrich them in the longer term. He’s got 12 securities in the portfolio, in addition to the large cash reserve. He’s been looking further afield than usual because he’d prefer being invested to the alternative. Among his recent purchases are the common stock of Corus Entertainment, a small Canadian firm that’s Canada’s largest owner of women’s and children’s television networks, and convertible shares in EZcorp, an oddly-structured (hence mispriced) pawn shop operator in the US and Mexico.

While you might be skeptical of a fund that’s holding so much cash, it’s indisputable that Intrepid Endurance has been the single best steward of its shareholders’ money over the full market cycle that began in the fall of 2007. We track three sophisticated measures of a fund’s risk-return tradeoff: its Sharpe ratio, Sortino ratio and Martin ratio.

Endurance has the highest score on all three risk-return ratios among all small cap funds – domestic, global, and international, value, core and growth.

We track short-term pain by looking at a fund’s maximum drawdown, its Ulcer index which measures the depth and duration of a drawdown, its standard deviation and downside deviation.

Endurance has the best or second best record, among all small cap funds, on all of those risk measures. It also has the best performance during bear market months.

And it has substantially outperformed its peers. Over the full cycle, Endurance has returned 3.6% more annually than the average small-value fund. Morningstar’s Katie Reichart, writing in December 2010, reported that “the fund’s annualized 12% gain during [the past five years] trounced nearly all equity funds, thanks to the fund’s stellar relative performance during the market downturn.”

Bottom Line

Endurance is not a fund for the impatient or impetuous. It’s not a fund for folks who love the thrill of a rushing, roaring bull market. It is a fund for people who know their limits, control their greed and ask questions like “if I wanted to find a fund that I could trust to handle the next seven to ten years while I’m trying to enjoy my life, which would it be?” Indeed, if your preferred holding period for a fund is measured in weeks or months, the Intrepid folks would suggest you go find some nice ETF to speculate with. If you’re looking for a way to get ahead of the inevitable crash and profit from the following rebound, you owe it to yourself to spend some time reading Mr. Wiggins’ essays and doing your due diligence on his fund.

Fund website

Intrepid Endurance Fund

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Fidelity Total Emerging Markets (FTEMX), December 2015

By David Snowball

Objective and strategy

FTEMX seeks income and capital growth by investing in both emerging markets equities and emerging markets debt. White their neutral weighting is 60/40 between stocks/bonds, the managers adjust the balance between equity and debt based on which universe is most attractively positioned. In practice, that has ranged between 55% – 75% in equities. Within equities, sector and regional exposure are driven by security selection; they go where they find the best opportunities. The debt portfolio is distinctive; it tends to hold US dollar-denominated debt (a conservative move) but overweight frontier and smaller emerging markets (an aggressive one).

Adviser

Fidelity Investments. Fidelity has a bewildering slug of subsidiaries spread across the globe. Collectively they manage 575 mutual funds, over half of those institutional, and $2.1 trillion in assets.

Managers

John Carlson and a five person team of EM equity folks. Mr. Carlson has managed Fidelity’s EM bond fund, New Markets Income (FNMIX), since 1995. He added Global High Income (FGHIX) in 2011. He was Morningstar’s Fixed-Income Manager of the Year in 2011. He manages $7.8 billion and is supported by a 15 person team. The equity managers are Timothy Gannon, Jim Hayes, Sam Polyak, Greg Lee and Xiaoting Zhao. Gannon, Hayes and Polyak have been with the fund since inception, Lee was added in 2012 and Zhao in 2015. These folks have been responsible since 2014 for Emerging Markets Discovery (FEDDX), a four star fund with a small- to mid-cap bias. They also help manage Fidelity Series Emerging Markets (FEMSX), a four star fund that is only available to the managers of Fidelity funds-of-funds. The equity managers are each responsible for investing in a set of industries: Hayes (financials, telecom, utilities), Polyak (consumer and materials), Lee (industrials), Gannon (health care) and Zhao (tech). They help manage between $2 – 12 billion each.

Management’s stake in the fund

Messrs. Carlson, Gannon and Hayes have each invested between $100,000 and $500,000. Mr. Lee and Mr. Polyak have no investment in the fund. None of the fund’s 10 trustees have an investment in it. While they oversee Fidelity’s entire suite of EM funds, five of the 10 have no investment in any of the EM funds.

Opening date

November 1, 2011

Minimum investment

$2,500

Expense ratio

1.12% on assets of $229.7 million (as of 7/6/2023).

Comments

Simple, simple, simple.

The argument for considering an emerging markets fund is simple: they offer the prospect of being the world’s best performing asset class over the next 5 or 10 years. In October 2015, GMO estimated that EM stocks (4.0% real return) would be the highest returning asset class over the next 5-7 years, EM bonds (2.2%) would be second. Most other asset classes were projected to have negative real returns. At the same moment, Rob Arnott’s Research Affiliates was more optimistic, suggesting that EM stocks are priced to return 7.9% a year with high volatility compared with 1.1% in the US and 5.3% in the other developed markets. Given global demographics, it wouldn’t be surprising, give or take the wildcard effects of global warming, for them to be the best asset class over the next 50 or 100 years as well.

The argument against considering an emerging markets fund is simple: emerging markets are a mess. Their markets tend to be volatile. 30-60% drawdowns are not uncommon. National economies are overleveraged to commodity prices and their capital markets (banks, bond auctions, stock markets) can’t be relied upon; Andrew Foster, my favorite emerging markets manager and head of the Seafarer fund, argues that broken capital markets are almost a defining characteristic of the emerging markets. Investors yanked over a trillion dollars from emerging markets over the past 12 months.

The argument for investing in emerging markets through a balanced fund is simple: they combine higher returns and lower volatility than you can achieve through 100% equity exposure. The evidence here is a bit fragmentary (because the “e.m. balanced” approach is new and neither Morningstar nor Lipper have either a peer group or a benchmark) but consistent. The oldest EM balanced fund, the closed-end First Trust Aberdeen Emerging Opportunities Fund (FEO), reports that from 2006-2014 a blended benchmark returned 6.9% annually while the FTSE All World Emerging Market Equity Index returned 5.9%. From late 2011 to early 2015, Fidelity calculates that a balanced index returned 5.6% while the MSCI Emerging Markets Index returns 5.1%. Both funds have lower standard deviations and higher since-inception returns than an equity index. Simply rebalancing each year between Fidelity’s EM stock and bond funds so that you end up with a 60/40 weighting in a hypothetical balanced portfolio yields the same result for the past 10- and 15-year periods.

If balanced makes sense, does Fidelity make special sense?

Probably.

Two things stand out. First, the lead manager John Carlson is exceptionally talented and experienced. He’s been running Fidelity New Market Income (FNMIX), an emerging markets bond fund, since 1995. He’s the third longest-tenured EM bond manager and has navigated his fund through a series of crises initiated in Mexico, Asia and Russia. He earned Morningstar’s Fixed-Income Fund Manager of the Year in 2011. $10,000 entrusted to him when I took over FNMIX would have grown to $100,000 now while his average peer would be about $30,000 behind.

Second, it’s a sensible portfolio. Equity exposure has ranged from 55 – 73%. Currently it’s at the lowest in the fund’s history. Mr. Carlson says that “From an asset-allocation perspective, we believe shareholders can expect the sort of downside protection typically afforded by a balanced fund comprising both fixed-income and equity exposure.” He invests in dollar-denominated (so-called “hard currency”) EM bonds, which shields his investors from the effects of currency fluctuations. That makes the portfolio’s bond safety net extra safe. At the same time, he doesn’t hedge his stock exposure and is willing to venture into smaller emerging markets and frontier markets. At least in theory those are more likely to be mispriced than issues in larger markets, and they offer a bit more portfolio diversification. The manager says that “Based on about two decades of research, we found that frontier-markets debt performs much like EM equity.” In general the equity sub-portfolio’s returns are driven by individual security selection. It shows no unusual bias to any region, sector or market cap. “On the equity side, we take a sector-neutral approach that targets high active share, a measure of the percentage of holdings that differ from the index, which historically has offered greater potential for outperformance.”

Since inception in 2011, the strategy has worked. The fund has returned 2.9% a year in very rocky times while its all-equity peers lost money. Both measures of volatility, standard deviation and downside deviation, are noticeably lower than an EM equity fund’s.

ftemx

Bottom Line

I am biased in favor of EM investing. Despite substantial turmoil, it makes sense to me but only if you have a strategy for coping with volatility. Mr. Carlson has done a good job of it, making this the most attractive of the EM balanced funds on the market. There are other risk-conscious EM funds (most notable Seafarer Overseas Growth & Income SFGIX and the hedged Driehaus Emerging Markets Small Cap DRESX) but folks wanting even more of a buffer might reasonably start by looking here.

Fund website

Fidelity Total Emerging Markets

Disclosure: I own shares of FTEMX through my college’s 403b retirement plan and shares of SFGIX in my non-retirement portfolio.

Bretton Fund (BRTNX), Updated June 2013

By David Snowball

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

Objective and Strategy

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

Adviser

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

Manager

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

Management’s Stake in the Fund

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

Opening date

September 30, 2010.

Minimum investment

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

Expense ratio

1.35% on $67.7 million in assets.

Comments

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

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

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

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

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

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

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

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

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

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

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

Bottom Line

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

Fund website

Bretton Fund

Fund Documents

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