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Recently published research laments the fact that actively-managed funds have become steadily less active and more index-like over time.

The changing imperatives of the fund industry have led many managers to become mediocre by design. Their response is driven by the anxious desire for so-called “sticky” assets. The strategy is simple: design a product to minimize the risk that it will ever spectacularly trail its peer group. If you make your fund very much like its benchmark, you will never be a singular disaster and so investors (retirement plan investors, particularly) will never to motivated to find something better The fact that you never excel is irrelevant. The result is a legion of large, expensive, undistinguished funds who seek safety in the herd.

The Cook and Bynum Fund (COBYX) strikes me as the antithesis of those. Carefully constructed, tightly focused, and intentionally distinct. On Tuesday, March 5, we spoke with Richard Cook and Dowe Bynum in the first of three conversations with distinguished managers who defy that trend through their commitment to a singular discipline: buy only the best. For Richard and Dowe, that translates to a portfolio with only seven holdings and a 34% cash stake. Since inception (through early March, 2013), they managed to capture 83% of the market’s gains with only 50% of its volatility; in the past twelve months, Morningstar estimates that they captured just 7% of the market’s downside.

Among the highlights of the call for me:

1. The guys are willing to look stupid. There are times, as now, when they can’t find stocks that meet their quality and valuation standards. The rule for such situations is simply: “When compelling opportunities do not exist, it is our obligation not to put capital at risk.” They happily admit that other funds might well reap short-term gains by running with the pack, but you “have to be willing to look stupid.” Their current cash stake is about 34%, “the highest cash level ever in the fund.” That’s not driven by a market call; it’s a simple residue of their inability to find great opportunities.
2. The guys are not willing to be stupid. Richard and Dowe grew up together and are comfortable challenging each other. Richard knows the limits of Dowe’s knowledge (and vice versa), “so we’re less likely to hold hands and go off the cliff together.” In order to avoid that outcome, they spend a lot of time figuring out how not to be stupid. They relegate some intriguing possibilities to the “too hard pile,” those businesses that might have a great story but whose business model or financials are simply too hard to forecast with sufficient confidence. They think about common errors (commitment bias, our ability to rationalize why we’re not going to stop doing something once we’ve started, chief among them) and have generated a set of really interesting tools to help contain them. They maintain, for example, a list all of the reasons why they don’t like their current holdings. In advance of any purchase, they list all of the conditions under which they’d quickly sell (“if their star CEO leaves, we do too”) and keep that on top of their pile of papers concerning the stock.
3. They’re doing what they love. Before starting Cook & Bynum (the company), both of the guys had high-visibility, highly-compensated positions in financial centers. Richard worked for Tudor Investments in Stamford, CT, while Dowe was with Goldman, Sachs in New York. The guys believe in a fundamental, value- and research-driven, stock-by-stock process. What they were being paid to do (with Tudor’s macro event-driven hedge fund strategies for Richard) was about as far from what they most wanted as they could get. And so they quit, moved back to Alabama and set up their own shop to manage their own money and the investments of high net-worth individuals. They created Cook & Bynum (the fund) in response to an investor’s request for a product accessible to family and friends. The $250 million invested with them (about $100 million in the fund) includes 100% of their own liquid net worth, with their investment split between the fund and the partnerships. Since both sets of vehicles use the same fees and structure, there’s no conflict between the two.
4. They do prodigious research without succumbing to the “gotta buy something” impulse. While they spend the majority of their time in their offices, they’re also comfortable with spending two or three weeks at a time on the road. Their argument is that they’ve got to understand the entire ecosystem in which a firm operates – from the quality of its distribution network to the feelings of its customers – which they can only do first-hand. Nonetheless, they’ve been pretty good at resisting “deal momentum.” They spent, for example, some three weeks traveling around Estonia, Poland and Hungary. Found nothing compelling. Traveled Greece and Turkey and learned a lot, including how deeply dysfunctional the Greek economy, is but bought nothing.
5. They’re willing to do what you won’t. Most of us profess a buy low / buy the unloved / break from the herd / embrace our inner contrarian ethos. And most of us are deluded. Cook and Bynum seem rather less so: they’re holding cash now while others buy stocks after the market has doubled and profits margins hit records but in the depth of the 2008 meltdown they were buyers. (They report having skipped Christmas presents in 2008 in order to have extra capital to invest.) As the market bottomed in March 2009, the fund was down to 2% cash.

Bottom Line: the guys seem to be looking for two elusive commodities. One is investments worth pursuing. The other is investing partners who share their passion for compelling investments and their willingness to let other investors charge off in a herd. Neither is as common as you might hope. 

The conference call (When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded.)

The profile:

It’s working.  Cook and Bynum might well be among the best.  They’re young.  The fund is small and nimble.  Their discipline makes great sense.  It’s not magic, but it has been very, very good and offers an intriguing alternative for investors concerned by lockstep correlations and watered-down portfolios.

The Mutual Fund Observer profile of COBYX, April 2013.

 The COBYX audio profile

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The Cook & Bynum Fund website

The Cook and Bynum Fact Sheet

Fund Focus: Resources from other trusted sources

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On February 19^th, about 50 people phoned-in to listen to our conversation with Andrew Foster, manager of Seafarer Overseas Growth * Income Fund (SFGIX and SIGIX).   The fund has an exceptional first year: it gathered $35 million in asset and returned 18% while the MSCI emerging market index made 3.8%. The fund has about 70% of its assets in Asia, with the rest pretty much evenly split between Latin America and Emerging Europe.   Their growth has allowed them to institute two sets of expense ratio reductions, one formal and one voluntary. 

Among the highlights of the call, for me:

1. China has changed.   Andrew offered a rich discussion about his decision to launch the fund. The short version: early in his career, he concluded that emergent China was “the world’s most under-rated opportunity” and he really wanted to be there. By late 2009, he noticed that China was structurally slowing. That is, it was slow because of features that had no “easy or obvious” solution, rather than just slowly as part of a cycle. He concluded that “China will never be the same.” Long reflection and investigation led him to begin focusing on other markets, many of which were new to him, that had many of the same characteristics that made China exciting and profitable a decade earlier. Given Matthews’ exclusive and principled focus on Asia, he concluded that the only way to pursue those opportunities was to leave Matthews and launch Seafarer.
2. It’s time to be a bit cautious. As markets have become a bit stretched – prices are up 30% since the recent trough but fundamentals have not much changed – he’s moved at the margins from smaller names to larger, steadier firms.
3. There are still better opportunities in equities than fixed income; hence he’s about 90% in equities.
4. Income has important roles to play in his portfolio.  (1) It serves as a check on the quality of a firm’s business model. At base, you can’t pay dividends if you’re not generating substantial, sustained free cash flow and generating that flow is a sign of a healthy business. (2) It serves as a common metric across various markets, each of which has its own accounting schemes and regimes. (3) It provides as least a bit of a buffer in rough markets. Andrew likened it to a sea anchor, which won’t immediately stop a ship caught in a gale but will slow it, steady it and eventually stop it.

The conference call (When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded.)

The profile:

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.

The Mutual Fund Observer profile of SFGIX, Updated March 2013.

 The SFGIX audio profile

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Seafarer Overseas Growth and Income Fund website

Shareholder Conference Call

2013 Q3 Report

Fund Focus: Resources from other trusted sources

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We spent an hour on Tuesday, January 22, talking with Teresa Kong of Matthews Asia Strategic Income. The fund is about 14 months old, has about $40 million in assets, returned 13.6% in 2012 and 11.95% since launch (through Dec. 31, 2012).

Highlights include:

1. this is designed to offer the highest risk-adjusted returns of any of the Matthews funds. 
2. the manager describes the US bond market, and most especially Treasuries, as offering “asymmetric risk” over the intermediate term. Translation: more downside risk than upside opportunity. 
3. given some value in having a fixed income component of one’s portfolio, Asian fixed-income offers two unique advantages in uncertain times. First, the fundamentals of the Asian fixed-income market are very strong. Second, Asian markets have a low beta relative to US intermediate-term Treasuries. 
4. MAINX is one of the few funds to have positions in both dollar-denominated and local currency Asian debt (and, of course, equities as well). 
5. in equities, Matthews looks for stocks with “bond-like characteristics.” 
6. most competitors don’t have the depth of expertise necessary to maximize their returns in Asia. 
7. TK said explicitly that they have no neutral position or target bands of allocation for anything, i.e., currency exposure, sovereign vs. corporate, or geography. They try to get the biggest bang for the level of risk across the portfolio as a whole, with as much “price stability” (she said that a couple of times) as they can muster.

The conference call (When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded.)

The profile:

MAINX offers rare and sensible access to an important, under-followed asset class. The long track record of Matthews’ funds suggests that this is going to be a solid, risk-conscious and rewarding vehicle for gaining access to that class.

The Mutual Fund Observer profile of MAINX, updated March, 2012

The MAINX audio profile

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Matthews Asia Strategic Income Fund

Fact Sheet

2013 Q3 Report

Fund Commentary

Fund Focus: Resources from other trusted sources

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Highlights of the call:

In December 2012, we spoke with Matt and Dan about the River Road Long Short Strategy, which is also used in this fund. With regard to the strategy, they noted:

• they believe they can outperform the stock market by 200 bps/year over a full market cycle. 
• they believe they can keep beta at 0.3 to 0.5. They have a discipline for reducing market exposure when their long portfolio exceeds 80% of fair value. 
• risk management is more important than return management, so all three of their disciplines are risk-tuned. 
• River Road is committed to keeping the strategy open for at least 8 years.
• The fund might be considered an equity substitute. Their research suggests that a 30/30/40 allocation (long, long/short, bonds) has much higher alpha than a 60/40 portfolio.

The conference call (When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded.)

The profile:

Long/short investing makes great sense in theory but, far too often, it’s dreadful in practice.  After a year, ARLSX seems to be getting it right and its managers have a pretty cogent explanation for why that will continue to be the case.

The Mutual Fund Observer profile of ARLSX, dated June 2012.

The ARLSX audio profile

Web:

For information about the Aston mutual fund, subadvised by River Road, please see the following:

Aston Asset Management

2013 Q3 Report

Fact Sheet

ARLSX Profile Sheet

Fund Focus: Resources from other trusted sources

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

The call starts with Morty Schaja, RiverPark’s president, talking about the fund’s genesis and Mr. Rubin talking about its strategy.  After that, I posed five questions of Rubin and callers chimed in with another half dozen. I’d like to especially thank Bill Fuller, Jeff Mayer and Richard Falk for the half dozen really sharp, thoughtful questions that they posed during the closing segment.

Highlights of the conversation:

• Rubin believes that many long/short mutual fund managers (as opposed to the hedge fund guys) are too timid about using leverage.
• He believes long/short managers as a group are too skittish.  They obsess about short-term macro-events (the fiscal cliff) and dilute their insights by trying to bet for or against industry groups (by shorting ETFs, for example) rather than focusing on identifying the best firms in the best industries.
• RiverPark benefits from having followed many of their holdings for nearly two decades, following their trajectory from promising growth stocks (in which they invested), stodgy mature firms (which they’d sold) and now old firms in challenged industries (which they short).

The conference call (When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded.)

The profile:

All long-short funds have about the same goal: to provide a relatively large fraction of the stock market’s long-term gains with a relatively small fraction of its short-term volatility.  They all invest long in what they believe to be the most attractively valued stocks and invest short, that is bet against, the least attractively valued ones.  Many managers imagine their long portfolios as “offense” and their short portfolio as “defense.”

That’s the first place where RiverPark stands apart.  Mr. Rubin intends to “always play offense.”  He believes that RiverPark’s discipline will allow him to make money, “on average and over time,” on both his long and short portfolios.

The Mutual Fund Observer profile of RLSFX, dated August, 2012

The audio profile

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RiverPark Funds Website

2013 Q3 Report

RLSFX Fact Sheet

Fund Focus: Resources from other trusted sources

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For about an hour on September 13th, David Sherman of Cohanzick Management, LLC, manager of RiverPark Short Term High Yield (RPHYX) fielded questions from Observer readers about his fund’s strategy and its risk-return profile. Somewhere between 40-50 people signed up for the RiverPark call.

Highlights include:

1. they expect to be able to return 300 – 400 basis points more than a money market fund
2. they manage to minimize risk, not maximize return
3. they do not anticipate significant competition for these assets
4. expenses are unlikely to move much
5. NAV volatility is more apparent than real – by any measure other than a money market, it’s a very steady NAV. 

The conference call (When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded.)

The profile:

People are starting to catch on to RPHYX’s discrete and substantial charms.  Both the fund’s name and Morningstar’s assignment of it to the “high yield” peer group threw off some potential investors.  To be clear: this is not a high yield bond fund in any sense that you’d recognize.

The Mutual Fund Observer profile of RPHYX, updated October, 2012

The audio profile

Web:

RiverPark Funds Website

2013 Q3 Report

RPHYX Fact Sheet

Fund Focus: Resources from other trusted sources