Author Archives: Editor

Centaur Total Return Fund (TILDX)

By Editor 

This profile has been updated. Find the new profile here.

Objective

The fund seeks “maximum total return” through a combination of capital appreciation and income. The fund invests in undervalued securities, included (mostly domestic) high dividend large cap stocks, REITs, master limited partnerships, royalty trusts and convertibles. The manager invests in companies “that it understands well.” The managers also generate income by selling covered calls on some of their stocks.

Adviser

T2 Partners Management, LP. T2, named for founders Whitney Tilson and Glenn Tongue, manages about $150 million through its two mutual funds (the other is Tilson Focus TILFX) and three hedge funds (T2 Accredited, T2 Qualified and Tilson Offshore). These are Buffett-worshippers, in the Warren rather than Jimmy sense. The adviser was founded in 1998.

Manager

Zeke Ashton, founder, managing partner, and a portfolio manager of Centaur Capital Partners L.P., has managed the fund since inception. Mr. Ashton is the the Sub-Advisor. Before founding Centaur in 2002, he spent three years working for The Motley Fool where he developed and produced investing seminars, subscription investing newsletters and stock research reports in addition to writing online investing articles. He graduated from Austin College, a good liberal arts college, in 1995 with degrees in Economics and German.

Management’s Stake in the Fund

Somewhere between $100,000 and $500,000 as of October 2009.

Opening date

March 16, 2005

Minimum investment

$1,500 for regular and tax-advantaged accounts, reduced to $1000 for accounts with an automatic investing plan

Expense ratio

2.00% after waivers on an asset base of $40 million, plus a 2% redemption fee on shares held less than a year.

Comments

Tilson Dividend presents itself as an income-oriented fund. The argument for that orientation is simple: income stabilizes returns in bad times and adds to them in good. The manager imagines two sources of income: (1) dividends paid by the companies whose stock they own and (2) fees generated by selling covered calls on portfolio investments.

The core of the portfolio are a limited number (currently about 25) of high quality stocks. In bad markets, such stocks benefit from the dividend income – which helps support their share price – and from a sort of “flight to quality” effect, where investors prefer (and, to an extent, bid up) steady firms in preference to volatile ones. About three-quarters of those stocks are domestic, and one quarter represent developed foreign markets.

The manager also sells covered calls on a portion of the portfolio. At base, he’s offering to sell a stock to another investor at a guaranteed price. “If GM hits $40 a share within the next six months, we’ll sell it to you at that price.” Investors buying those options pay a small upfront price, which generates income for the fund. As long as the agreed-to price is approximately the manager’s estimate of fair value, the fund doesn’t lose much upside (since they’d sell anyway) and gains a bit of income. The profitability of that strategy depends on market conditions; in a calm market, the manager might place only 0.5% of his assets in covered calls but, in volatile markets, it might be ten times as much.

The fund currently generates a lot of income but the reported yield is low because the fund’s expenses are high, and covering operating expenses has the first call on income flow. While it has a high cash stake (about 20%), cash is not current generating appreciable income.

The fund’s conservative approach is succeeded (almost) brilliantly so far. At the fund’s five year anniversary (March 2010), Lipper ranked it as the best performing equity-income fund for the trailing three- and five-year periods. At that same point, Morningstar ranked it in the top 1% of mid-cap blend funds. It’s maintained that top percentile rank since then, with an annualized return of 9.3% from inception through late November 2010.

The fund has achieved those returns with remarkably muted volatility. Morningstar rates its risk as “low” (and returns “high”) and the fund’s five-year standard deviation (a measure of volatility) is 15, substantially below its peers score of 21.

And, on top of it all, the fund has substantially outperformed its more-famous stable-mate. Tilson Focus (TILFX), run by value investing guru Whitney Tilson, has turned a $10,000 investment at inception into $13,100 (good!). Tilson Dividend turned that same investment into $16,600 (better! Except for that whole “showing up the famous boss” issue).

Bottom Line

There are risks with any investment. In this case, one might be concerned that the manager has fine-tuned his investment discipline to allow in a greater number of non-income-producing investments. That said, the fund earned a LipperLeader designation for total returns, consistency and preservation of gains, and a five-star designation from Morningstar. For folks looking to maintain their stock exposure, but cautiously, this is an awfully compelling little fund.

Fund website

Tilson mutual funds website 

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact David@MutualFundObserver.com.

First Trust/Aberdeen Emerging Opportunity Fund (FEO), April 2011

By Editor

*The fund has terminated in December 2022*

Objective

To provide a high level of total return by investing in a diversified portfolio of emerging market equity and fixed-income securities. The fund does not short anything but they may use derivatives to hedge their risks.

Adviser

First Trust Advisors, L.P., in suburban Chicago. First Trust is responsible for 29 mutual funds and a dozen closed-end funds. They tend to be responsible for picking sub-advisers, rather than for running the funds on their own.

Manager

A large team from Aberdeen Asset Management, Inc., which is a subsidiary of Aberdeen Asset Management PLC. The parent firm manages $250 billion in assets, as of mid-210. Their clients include a range of pension funds, financial institutions, investment trusts, unit trusts, offshore funds, charities and rich folks, in addition to two dozen U.S. funds bearing their name. The management team is led by Devan Kaloo, Head of Emerging Markets Equity, and Brett Diment, Head of Emerging Market Debt for the Aberdeen Group.

Management’s Stake in the Fund

I can’t determine this. The reporting requirements for closed-end funds seem far more lax than for “regular” mutual funds, so the most recent Statement of Additional Information on file with the SEC appears to be four years old.

Opening date

August 28, 2006

Minimum investment

Like stocks and ETFs, there is no minimum purchase established by the fund though you will need to pay a brokerage fee.

Expense ratio

1.80% on assets of $128 million. This calculation is a bit deceiving, since it ignores the possibility of buying shares of the fund at a substantial discount to the stated net asset value.

Comments

In my September 2010 cover essay, I offered a quick performance snapshot for “the best fund that doesn’t exist.” $10,000 invested in a broad measure of the U.S. stock market in 2000 would have been worth $9,700 by the decade’s end. The same investment in The Best Fund That Doesn’t Exist (TBFTDE) would be worth $30,500, a return that beats the socks off a wide variety of superstar funds with flexible mandates.

TBFTDE is an emerging markets hybrid fund; that is, one that invests in both e.m. stocks and bonds. No mutual fund or exchange-traded fund pursues the strategy which is odd, since many funds pursue e.m. stock or e.m. bond strategies separately. There are, for example, eight e.m. bond funds and 32 e.m. stock funds each with over a billion in assets. Both asset classes have offered healthy (10-11% annually over the past decade) returns and are projected to have strong returns going forward (see GMO’s monthly “asset class return forecasts” for details), yet are weakly correlated with each other. That makes for a natural combination in a single fund.

Sharp-eyed FundAlarm readers (you are a remarkable bunch) quickly identified the one option available to investors who don’t want to buy and periodically rebalanced separate funds. That option is a so-called “closed end” fund, First Trust/Aberdeen Emerging Opportunity (FEO).

Closed-end funds represent a large, well-established channel for sophisticated investors. There are two central distinctions between CEFs and regular funds. First, CEFs issue a limited number of shares (5.8 million in the case of this fund) while open-ended funds create new shares constantly in response to investor demand. That’s important. If you want shares of a mutual fund, you can buy them – directly or indirectly – from the fund company that simply issues more shares to meet investor interest. Buying shares of a CEF requires that you find someone who already owns the shares and who is willing to sell them to you. Depending on the number of potential buyers and the motivation of potential sellers, it’s possible for shares of CEFs to trade at substantial discounts to the fund’s net asset value. That is, there will be days when you’re able to buy $100 worth of assets for $80. That also implies there are days when you’ll only be able to get $80 when you try to sell $100 in assets. The opposite is also true: some funds sell at a double-digit premium to their net asset values.

Second, since you need to purchase the shares from an existing shareholder, you need to work through a broker. As a result, each purchase and sale will engender brokerage fees. In general, those are the same as the fees the broker charges for selling an equivalent amount of common stock.

The systemic upside is CEFs is that they’re easier to manage, especially in niche markets, than are open-end funds. Mass redemptions, generally sell orders arriving at the worst possible moment during a market panic, are the bane of fund managers’ existence. At the exact moment they need to think long term and pursue securities available at irrational discounts, they’re forced to think short term and liquidate parts of their own portfolios to meet shareholder redemptions. Since CEF are bought and sold from other investors, your greed (or panic) is a matter of concern for you and some other investor. The fund manager is insulated from it. That makes CEF popular instruments for using risky strategies (such as leverage) in niche markets.

What are the arguments for considering an investment in FEO particularly? First, the management team is large and experienced. Aberdeen boasts 95 equity and 130 global fixed income professionals. They handle hundreds of billions of assets, including about $30 billion in emerging markets stocks and bonds. Their Emerging Markets Institutional (ABEMX) stock fund, run by the same equity team that runs FEO, has beaten 99% of its peers over the past three years (roughly the period since inception). Their global fixed income funds are only “okay” while their blended asset-allocation funds are consistently above average. Given that FEO’s asset allocation shifts, the success of those latter funds is important to predicting FEO’s success.

Second, the fund has done well in its short existence. Here’s a quick comparison on the fund’s performance over the past three years. The net asset value performance is a measure of the managers’ skill, the market performance reflects the willingness of investors to buy or sell as a discount (or premium) to NAV, while the FundAlarm Emerging Markets Hybrid returns represent a simple 50/50 split between T. Rowe Price Emerging Market Stock fund and Emerging Markets Bond.

  FEO at NAV FEO at market price FundAlarm E.M. Hybrid
2007 12.8 15.6 24
2008 (41) (34) (40)
2009 94 70 60
2010 29.5 23.5 15

FEO’s three-year return, through October 2010, is either 15.4% (at NAV) or 10.4% (at market price). That huge gap represents a huge opportunity, since shares in the fund have been available for discounts of as much as 30%, far above the 3-4% seen in calmer times. And both of those returns compare favorably to the performance of Matthews Asian Growth and Income (MACSX), a phenomenal long-term hybrid Asian investment, which returned only 3.5% in the same period.

Bottom Line

I would really prefer to have access to an open-end fund or ETF since I dislike brokerage fees and the need to fret about “discounts” and “entry points.” That said, for long-term investors looking for risk-moderated emerging markets exposure, and especially those with a good discount broker, this really should be on your due diligence list.

Fund website

First Trust/Aberdeen Emerging Opportunity

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact David@MutualFundObserver.com.

Fairholme Allocation (formerly Fairholme Asset Allocation), (FAAFX), April 2011

By Editor 

At the time of publication, this fund was named Fairholme Asset Allocation.

Objective

The fund seeks long-term total return from capital appreciation and income by investing opportunistically and globally in a focused portfolio of stocks, bonds, and cash.

Adviser

Fairholme Capital Management. Fairholme runs the three Fairholme funds and oversees about 800 separate accounts. Its assets under management total about $20 billion, with a good 90% of that in the funds.

Manager(s)

Bruce Berkowitz.

Mr. Berkowitz was Morningstar’s Fund Manager of the Decade for 2000-2010, a distinction earned through his management of Fairholme Fund (FAIRX). He was also earning his B.A. at UMass-Amherst at the same time (late 1970s) I was earning my M.A. there. (Despite my head start, he seems to have passed me somehow.) 

Management’s Stake in the Fund

None yet reported. Each manager has a huge investment (over $1 million) in each of his other funds, and the Fairholme employees collectively have over $300 million invested in the funds.

Opening date

December 30, 2010.

Minimum investment

$25,000 (gulp) for accounts of all varieties.

Expense ratio

1.01% on assets of $51.4 million, as of July 2023. 

Comments

Fairholme Fund (FAIRX) has the freedom to go anywhere. The prospectus lists common and preferred stock, partnerships, business trust shares, REITs, warrants, US and foreign corporate debt, bank loans and participations, foreign money markets and more. The manager uses that flexibility, making large, focused investments in a wide variety of assets.

Fairholme’s most recent portfolio disclosure (10/28/10) illustrates that flexibility:

62% Domestic equity, with a five-year range of 48-70%
10% Commercial paper (typical of a money market fund’s portfolio)
6% Floating rate loans
6% Convertible bonds
5 % T-bills
3% Domestic corporate bonds
1% Asset backed securities (uhh… car loans?)
1% Preferred stock
1% Foreign corporate bonds
.3% Foreign equity (three months later, that’s closer to 20%)

On December 30, Fairholme launched its new fund, Fairholme Allocation (FAAFX). The fund will seek “long-term total return from capital appreciation and income” by “investing opportunistically” in equities, fixed-income securities and cash. Which sounds a lot like Fairholme fund’s mandate. The three small differences in the “investment strategies” section of their prospectuses are: the new fund targets “total return” while Fairholme seeks “long term growth of capital.” The new fund invests opportunistically, which Fairholme does but which isn’t spelled out. And the new fund includes “and income” as a goal.

And, oh by the way, the new fund charges $25,000 to get in but only 0.75% (after waivers) to stay in.

The question is: why bother? In a conversation with me, Mr. Berkowitz started by reviewing the focus for Fairholme (equity) and Fairholme Focus Income (income) and allowed that the new fund “could do anything either of the other two could do.” Which is, I argued, also true of Fairholme itself. I suggested that the “total return” and “and income” provisions of the prospectus might suggest a more conservative, income-oriented approach but Mr. B. dismissed the notion. He clearly did not see the new fund as intrinsically more conservative and warned that it might be more volatile. He also wouldn’t speculate on whether the one fund’s asset allocation decisions (e.g., to move Fairholme 100% to cash) would be reflected in the other fund’s. He suggested that if his two best investment ideas were a $1 billion stock investment and a $25 million floating rate loan, he’d likely pursue one for Fairholme and the other for Allocation.

In the end , the argument was simply size. While “bigger is better” in the current global environment, “smaller” can mean “more degrees of freedom.” The Fairholme team discovers a number of “small quantity ideas,” potentially great investments which are too small “to move the needle” for a vehicle as large as Fairholme (roughly $20 billion). A $50 million opportunity which has no place in Fairholme’s focus (Fairholme owns over $100 million in 17 of its 22 stocks) might be a major driver for the Allocation fund.

Finally, he meant the interesting argument that Allocation would be able to ride on Fairholme’s coattails. Fairholme’s bulk might, as I mentioned in the first Berkowitz piece, give the firm access to exclusive opportunities. Allocation might then pick up an opportunity not available to other funds its size.

Bottom Line

Skeptics of Fairholme’s bulk are right. The fund’s size precludes it from profiting in some of the investments it might have pursued five years ago. Allocation, with a similarly broad mandate and even lower expense ratio, gives Berkowitz a tool with which to exploit those opportunities again. Having generated nearly $200 million in investor assets in two months, the question is how long that advantage will persist. Likely, the $25,000 minimum serves to slow inflows and help maintain a relatively smaller asset base.

Fund website

Fairholme Funds, click on “public.”

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact David@MutualFundObserver.com.

Aston/River Road Independent Value Fund (ARIVX) – updated September 2012

By Editor

This profile was updated in September 2012. You will find the updated profile at http://www.mutualfundobserver.com/2012/09/astonriver-road-independent-value-fund-arivx-updated-september-2012/

Objective and strategy

The fund seeks to provide long-term total return by investing in common and preferred stocks, convertibles and REITs. The manager attempts to invest in high quality, small- to mid-cap firms (those with market caps between $100 million and $5 billion). He thinks of himself as having an “absolute return” mandate, which means an exceptional degree of risk-consciousness. He’ll pursue the same style of investing as in his previous charges, but has more flexibility than before because this fund does not include the “small cap” name.

Adviser

Aston Asset Management, LP. It’s an interesting setup. As of June 30, 2012, Aston is the adviser to twenty-seven mutual funds with total net assets of approximately $10.5 billion and is a subsidiary of the Affiliated Managers Group. River Road Asset Management LLC subadvises six Aston funds; i.e., provides the management teams. River Road, founded in 2005, oversees $7 billion and is a subsidiary of the European insurance firm, Aviva, which manages $430 billion in assets. River Road also manages five separate account strategies, including the Independent Value strategy used here.

Manager

Eric Cinnamond. Mr. Cinnamond is a Vice President and Portfolio Manager of River Road’s independent value investment strategy. Mr. Cinnamond has 19 years of investment industry experience. Mr. Cinnamond managed the Intrepid Small Cap (ICMAX) fund from 2005-2010 and Intrepid’s small cap separate accounts from 1998-2010. He co-managed, with Nola Falcone, Evergreen Small Cap Equity Income from 1996-1998.  In addition to this fund, he manages six smallish (collectively, about $50 million) separate accounts using the same strategy.

Management’s Stake in the Fund

As of October 2011, Mr. Cinnamond has between $100,000 and $500,000 invested in his fund.  Two of Aston’s 10 trustees have invested in the fund.  In general, a high degree of insider ownership – including trustee ownership – tends to predict strong performance.  Given that River Road is a sub-advisor and Aston’s trustees oversee 27 funds each, I’m not predisposed to be terribly worried.

Opening date

December 30, 2010.

Minimum investment

$2,500 for regular accounts, $500 for various sorts of tax-advantaged products (IRAs, Coverdells, UTMAs).

Expense ratio

1.42%, after waivers, on $616 million in assets.

Update

Our original analysis, posted February, 2011, appears just below this update.  It describes the fund’s strategy, Mr. Cinnamond’s rationale for it and his track record over the past 16 years.

September, 2012
2011 returns: 7.8%, while his peers lost 4.5%, which placed ARIVX in the top 1% of comparable funds.  2012 returns, through 8/30: 5.3%, which places ARIVX in the bottom 13% of small value funds.
Asset growth: about $600 million in 18 months, from $16 million.  The fund’s expense ratio did not change.
What are the very best small-value funds?  Morningstar has designated three as the best of the best: their analysts assigned Gold designations to DFA US Small Value (DFSVX), Diamond Hill Small Cap (DHSCX) and Perkins Small Cap Value (JDSAX).  For my money (literally: I own it), the answer has been Artisan Small Cap(ARTVX).And where can you find these unquestionably excellent funds?  In the chart below (click to enlarge), you can find them where you usually find them.  Well below Eric Cinnamond’s fund.

fund comparison chart

That chart measures only the performance of his newest fund since launch, but if you added his previous funds’ performance you get the same picture over a longer time line.  Good in rising markets, great in falling ones, far steadier than you might reasonably hope for.

Why?  His explanation is that he’s an “absolute return” investor.  He buys only very good companies and only when they’re selling at very good prices.  “Very good prices” does not mean either “less than last year” or “the best currently available.”  Those are relative measures which, he says, make no sense to him.

His insistence on buying only at the right price has two notable implications.

He’s willing to hold cash when there are few compelling values.  That’s often 20-40% of the portfolio and, as of mid-summer 2012, is over 50%.  Folks who own fully invested small cap funds are betting that Mr. Cinnamond’s caution is misplaced.  They have rarely won that bet.

He’s willing to spend cash very aggressively when there are many compelling values.  From late 2008 to the market bottom in March 2009, his separate accounts went from 40% cash to almost fully-invested.  That led him to beat his peers by 20% in both the down market in 2008 and the up market in 2009.

This does not mean that he looks for low risk investments per se.  It does mean that he looks for investments where he is richly compensated for the risks he takes on behalf of his investors.  His July 2012 shareholder letter notes that he sold some consumer-related holdings at a nice profit and invested in several energy holdings.  The energy firms are exceptionally strong players offering exceptional value (natural gas costs $2.50 per mcf to produce, he’s buying reserves at $1.50 per mcf) in a volatile business, which may “increase the volatility of [our] equity holdings overall.”  If the market as a whole becomes more volatile, “turnover in the portfolio may increase” as he repositions toward the most compelling values.

The fund is apt to remain open for a relatively brief time.  You really should use some of that time to learn more about this remarkable fund.

Comments

While some might see a three-month old fund, others see the third incarnation of a splendid 16 year old fund.

The fund’s first incarnation appeared in 1996, as the Evergreen Small Cap Equity Income fund. Mr. Cinnamond had been hired by First Union, Evergreen’s advisor, as an analyst and soon co-manager of their small cap separate account strategy and fund. The fund grew quickly, from $5 million in ’96 to $350 million in ’98. It earned a five-star designation from Morningstar and was twice recognized by Barron’s as a Top 100 mutual fund.

In 1998, Mr. Cinnamond became engaged to a Floridian, moved south and was hired by Intrepid (located in Jacksonville Beach, Florida) to replicate the Evergreen fund. For the next several years, he built and managed a successful separate accounts portfolio for Intrepid, which eventually aspired to a publicly available fund.

The fund’s second incarnation appeared in 2005, with the launch of Intrepid Small Cap (ICMAX). In his five years with the fund, Mr. Cinnamond built a remarkable record which attracted $700 million in assets and earned a five-star rating from Morningstar. If you had invested $10,000 at inception, your account would have grown to $17,300 by the time he left. Over that same period, the average small cap value fund lost money. In addition to a five star rating from Morningstar (as of 2/25/11), the fund was also designated a Lipper Leader for both total returns and preservation of capital.

In 2010, Mr. Cinnamond concluded that it was time to move on. In part he was drawn to family and his home state of Kentucky. In part, he seems to have reassessed his growth prospects with the firm.

The fund’s third incarnation appeared on the last day of 2010, with the launch of Aston / River Road Independent Value (ARIVX). While ARIVX is run using the same discipline as its predecessors, Mr. Cinnamond intentionally avoided the “small cap” name. While the new fund will maintain its historic small cap value focus, he wanted to avoid the SEC stricture which would have mandated him to keep 80% of assets in small caps.

Over an extended period, Mr. Cinnamond’s small cap composite (that is, the weighted average of the separately managed accounts under his charge over the past 15 years) has returned 12% per year to his investors. That figure understates his stock picking skills, since it includes the low returns he earned on his often-substantial cash holdings. The equities, by themselves, earned 15.6% a year.

The key to Mr. Cinnamond’s performance (which, Morningstar observes, “trounced nearly all equity funds”) is achieved, in his words, “by not making mistakes.” He articulates a strong focus on absolute returns; that is, he’d rather position his portfolio to make some money, steadily, in all markets, rather than having it alternately soar and swoon. There seem to be three elements involved in investing without mistakes:

  • Buy the right firms.
  • At the right price.
  • Move decisively when circumstances demand.

All things being equal, his “right” firms are “steady-Eddy companies.” They’re firms with look for companies with strong cash flows and solid operating histories. Many of the firms in his portfolio are 50 or more years old, often market leaders, more mature firms with lower growth and little debt.

Like many successful managers, Mr. Cinnamond pursues a rigorous value discipline. Put simply, there are times that owning stocks simply aren’t worth the risk. Like, well, now. He says that he “will take risks if I’m paid for it; currently I’m not being paid for taking risk.” In those sorts of markets, he has two options. First, he’ll hold cash, often 20-30% of the portfolio. Second, he moves to the highest quality companies in “stretched markets.” That caution is reflected in his 2008 returns, when the fund dropped 7% while his benchmark dropped 29%.

But he’ll also move decisively to pursue bargains when they arise. “I’m willing to be aggressive in undervalued markets,” he says. For example, ICMAX’s portfolio went from 0% energy and 20% cash in 2008 to 20% energy and no cash at the market trough in March, 2009. Similarly, his small cap composite moved from 40% cash to 5% in the same period. That quick move let the fund follow an excellent 2008 (when defense was the key) with an excellent 2009 (where he was paid for taking risks). The fund’s 40% return in 2009 beat his index by 20 percentage points for a second consecutive year. As the market began frothy in 2010 (“names you just can’t value are leading the market,” he noted), he let cash build to nearly 30% of the portfolio. That meant that his relative returns sucked (bottom 10%), but he posted solid absolute returns (up 20% for the year) and left ICMAX well-positioned to deal with volatility in 2011.

Unfortunately for ICMAX shareholders, he’s moved on and their fund trailed 95% of its peers for the first couple months of 2011. Fortunately for ARIVX shareholders, his new fund is leading both ICMAX and its small value peers by a comfortable early margin.

The sole argument against owning is captured in Cinnamond’s cheery declaration, “I like volatility.” Because he’s unwilling to overpay for a stock, or to expose his shareholders to risk in an overextended market, he sidelines more and more cash which means the fund might lag in extended rallies. But when stocks begin cratering, he moves quickly in which means he increases his exposure as the market falls. Buying before the final bottom is, in the short term, painful and might be taken, by some, as a sign that the manager has lost his marbles. He’s currently at 40% cash, effectively his max, because he hasn’t found enough opportunities to fill a portfolio. He’ll buy more as prices on individual stocks because attractive, and could imagine a veritable buying spree when the Russell 2000 is at 350. At the end of February 2011, the index was close to 700.

Bottom Line

Aston / River Road Independent Value is the classic case of getting something for nothing. Investors impressed with Mr. Cinnamond’s 15 year record – high returns with low risk investing in smaller companies – have the opportunity to access his skills with no higher expenses and no higher minimum than they’d pay at Intrepid Small Cap. The far smaller asset base and lack of legacy positions makes ARIVX the more attractive of the two options. And attractive, period.

Fund website

Aston/River Road Independent Value

[cr2012]

Vulcan Value Partners Small Cap Fund (VVPSX), April 2011

By Editor

Objective

Seeks to achieve long-term capital appreciation by investing primarily in publicly traded small-capitalization U.S. companies – the Russell 2000 universe – believed to be both undervalued and possessing a sustainable competitive advantage. They look for businesses that are run by ethical, capable, stockholder-oriented management teams that also are good at allocating their capital. The manager determines the firm’s value, compares it to the current share price, and then invests greater amounts in the more deeply-discounted stocks.

Adviser

Vulcan Value Partner. C.T. Fitzpatrick founded Vulcan Value Partners in 2007 to manage his personal wealth. Vulcan manages two mutual funds and oversees four strategies (Large Cap, Small Cap, Focus and Focus Plus) for its separate accounts. Since inception, all four strategies have peer rankings in the top 5% of value managers in their respective categories.

Manager

C.T. Fitzpatrick, Founder, Chief Executive Officer, Chief Investment Officer, and Chief Shareholder. Before founding Vulcan, Mr. Fitzpatrick worked as a principal and portfolio manager at Southeastern Asset Management, adviser to the Longleaf funds. He co-managed the relatively short-lived Longleaf Partners Realty fund. During his 17 year tenure (1990-2007), the team at Southeastern Asset Management achieved double digit returns and was ranked in top 5% of money managers over five, ten, and twenty year periods according to Callan and Associates.

Management’s Stake in the Fund

Mr. Fitzpatrick has over $1 million in each of Vulcan’s two funds. He also owns a majority of the Adviser. All of Vulcan Value’s employees make all of their investments either through the firm’s funds or its separate accounts.

Opening date

12/30/2009

Minimum investment

$5000, reduced to $500 for college savings accounts.

Expense ratio

1.25% on assets of $423 million, as of July 2023. There is no redemption fee. 

Comments

Mr. Fitzpatrick is a disciplined, and bullish, value investor. He spent 17 years at Southeastern Asset Management, which has a great tradition of skilled, shareholder-friendly management. He left, he says, because life simply got too hectic as SAM grew to managing $40 billion and he found himself traveling weekly to Europe. (The TSA pat downs alone would cause me to reconsider the job.) While he was not one of the Longleaf Small Cap co-managers, he knows the discipline and has imported chunks of it. Like Longleaf, Vulcan runs a very compact portfolio of 20-30 stocks while many of the small-to-midcap peers holds 50-150 names. Both firms profess a long-term perspective, and believe that a five-year perspective gives them a competitive advantage when dealing with competitors who have trouble imagining “committing” to a stock for five months. Mr. Fitzpatrick’s description is that “We buy 900-pound gorillas priced like 98-pound weaklings. We have a five-year time horizon. Usually, our investments are out of favor for short-term reasons but their long-term fundamentals are sound.” They continue to hold stocks which have grown beyond the small cap realm, so long as those stocks continue to have a favorable value profile. As a result, both firms hold more midcap than small cap stocks in their small cap funds. Neither firm is a “deep value” purist, so the portfolios contain a number of “growth” stocks. And both firms require that everyone’s interests are aligned with their shareholders; the only investment that employees of either firm are allowed to make are in the firms’ own products. That discipline seems to work. It works for Longleaf, which has 20 years of top decile returns. It’s worked for Vulcan’s separate accounts, whose small cap composite outperformed their benchmark by index by 900 basis points a year; gaining 4% which the Russell Value index dropped 5%. And it’s worked so far for the Vulcan fund, which gained nearly 23% over the first 11 months of 2010. That easily outpaces both its small- and mid-cap peer groups, placing it in the top 10% of the former.

Bottom Line

Mr. Fitzpatrick is bullish on stocks, largely because so few other people are. Money is flowing out of equities, at the same time that corporate balance sheets are becoming exceptionally strong and bonds exceptionally unattractive. In particular, he finds the highest quality companies to be the most undervalued. That creates fertile ground for a disciplined value investor. For folks venturesome enough to pursue high quality small companies, Vulcan offers the prospects of a solid, sensible, profitable vehicle.

Fund website

Vulcan Value Partners Small Cap. You might browse through the exceptionally detailed discussion of their small cap separate accounts, of which the mutual fund is a clone. There’s a fair amount of interesting commentary attached to them.

Fact Sheet

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact David@MutualFundObserver.com.

RiverNorth DoubleLine Strategic Income (RNDLX), April 2011

By Editor

Objective

To provide both current income and total return. The fund has three distinct strategies, two overseen by DoubleLine, among which it allocates assets based on the advisor’s tactical judgment. The fund aims to be less volatile than the broad fixed-income market.

Adviser

RiverNorth Capital Management, LLC. RiverNorth, founded in 2000, specializes in quantitative and qualitative closed-end fund trading strategies and advises the RiverNorth Core Opportunity Fund (RNCOX) and a several hedge funds. They manage nearly $700 million for individuals and institutions, including employee benefit plans.

Manager

Patrick W. Galley and Stephen A. O’Neill, both of RiverNorth Capital and co-managers of the five-star RiverNorth Core Opportunity fund (RNCOX), and Jeffrey E. Gundlach. Mr. Gundlach ran TCW Total Return (TGLMX) from 1993 through 2009. For most trailing periods at the time of his departure, his fund had returns in the top 1% of its peer group. He was Morningstar’s fixed-income manager of the year in 2006 and a nominee for fixed income manager of the decade in 2009. Most of the investment staff from TCW moved to DoubleLine with him.

Management’s Stake in the Fund

None yet reported since the latest Statement of Additional Information precedes the fund’s launch. Mr. Galley owns more than 25% of the adviser and has between $100,000 and $500,000 in his Core Opportunity fund. Mr. Galley reports that “100% of our employees’ 401k assets [and] over 85% of the portfolio managers’ liquid net worth [is] invested in our own products.”

Opening date

December 30, 2010.

Minimum investment

$5000, reduced to $1000 for IRAs.

Expense ratio

1.28% on assets of about $1.3 Billion, as of July 2023. 

Comments

Many serious analysts expect a period of low returns across a whole variety of asset classes. GMO, for example, forecasts real returns of nearly zero on a variety of bond classes over the next five years. Forecasts for equity returns seem to range from “restrained” to “disastrous.”

If true, the received wisdom — invest in low cost, broadly diversified index funds or ETFs — will produce reasonable relative returns and unreasonable absolute ones. A popular alternative — be bold, make a few big bets — might produce better returns, but will certainly produce gut-wrenching periods. And, in truth, we’re not wired to embrace volatility.

The folks at RiverNorth propose an alternative of a sort of “core and explore” variety. RiverNorth DoubleLine Strategic Income has three “sleeves,” or distinct components in its portfolio:

  • Core Fixed Income, run by fixed-income superstar Jeff Gundlach & co., will follow the same strategy as the DoubleLine Core Fixed Income (DLFNX) fund though it won’t be a clone of the fund. As the name implies, this strategy will be the core of the portfolio. With it, Gundlach is authorized to invest globally in a wide variety of fixed-income assets. The asset allocation within this sleeve varies, based on Mr. G’s judgment.
  • Opportunistic Income, also run by Mr. G., will specialize in mortgage-backed securities. Most analysts argue that this is DoubleLine’s area of core competence, and that it’s contributed much of the alpha to his earlier TCW funds.
  • Tactical Closed-end Fund Income, run by Patrick Galley and the team at RiverNorth, invests in closed-end income funds when (1) they fit into the team’s tactical asset allocation model and (2) they are selling at an unsustainable discount. As investors in the (five-star) RiverNorth Core Opportunity (RNCOX) fund know, CEFs often sell at irrational discounts to their net asset value; that is, you might briefly be able to buy $100 worth of bonds for $80 or less. RiverNorth monitors both sectors and individual fund discounts. It buys funds when the discount is irrational and sells as soon as it returns to a rational level, looking in an arbitrage gain which is largely independent of the overall moves in the market. Ideally, the combination of opportunism and cognizance of volatility and concentration risk will allow the managers to produce a better risk adjusted return (i.e., a higher Sharpe ratio) than the Barclays Aggregate.

The fund’s logic is this: Gundlach’s Core Fixed Income sleeve is going to be rock-solid. If either Gundlach or Galley sees a high-probability, high-alpha opportunity in their respective areas of expertise, they’ll devote a portion of the portfolio to locking in those gains. If they see nothing special, a larger fraction of the fund will remain in the core portfolio. While most of us detest market volatility, Galley and Gundlach seem to be waiting anxiously for it since it gives them an opportunity to reap exceptional profits from the irrationality of other investors. The managers report that their favorite time to buy is “when your hand is shaking [as] you are going to write the check.” The ability to move assets out of Core and into one of the other sleeves means the managers will have the money available to exploit market panics, even if investor panic means the fund isn’t receiving new cash.

The CEF strategy is distinguished from the RNCOX version, which slides between CEFs (when pricing is irrational) and ETFs (when pricing is rational). Based on the managers’ judgment that Mr. Gundlach can consistently add alpha over what comparable ETFs might offer (both in sector and security selection), Mr. Galley will slide his resources between CEFs (when pricing is irrational) and Core Fixed Income (when pricing isn’t).

While there’s no formal “neutral allocation” for the fund, the managers can imagine a world in which about half of the fund is usually in Core Fixed Income and the remainder split between the two alpha-generating strategies. Since the three strategies are uncorrelated, they offer a real prospect of damping the portfolio’s overall volatility while adding alpha. How much alpha? In early February, the managers estimated that their strategies were yielding between the mid single digits (in two sleeves) and low double-digits (in the other).

Bottom Line

In reviewing RiverNorth Core in 2009, I described the case for the fund as “compelling.” Absent a crushing legal defeat for Mr. Gundlach in his ongoing fight with former employer TCW, the same term seems to fit here as well.

I’ve been pondering a question, posed on the board, about a three fund portfolio; that is, if you could own three and only three funds over the long haul, which would they be? Given its reasonable expenses, the managers’ sustained successes, innovative design and risk-consciousness, this might well be one of the three on my list anyway.

Fund website

RiverNorth Funds

RiverNorth/DoubleLine Strategic Income

Fact Sheet

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact David@MutualFundObserver.com.

FPA Queens Road Value (formerly Queens Road Value), (QRVLX), April 2011

By Editor 

At the time of publication, this fund was named Queens Road Value.

Objective

The fund seeks capital appreciation by investing in the stocks or preferred shares of U.S. companies. They look for companies with strong balance sheets and experienced management, and stocks selling at discounted price/earnings and price-to-cash flow ratios. It used to be called Queens Road Large Cap Value, but changed its name to widen the range of allowable investments. Nonetheless, it continues to put the vast majority of its portfolio into large cap value stocks.

Adviser

Bragg Financial Advisors, headquartered in Charlotte, NC. In particular, their offices are on Queens Road. Bragg has been around since the early 1970s, provides investment services to institutions and individuals, and has about $400 million in assets under management. It’s now run by the second generation of the Bragg family.

Manager

Steven Scruggs, CFA. Mr. Scruggs has worked for BFA since 2000 and manages this fund and Queens Road Small Cap Value (QRSVX). That’s about it. No separate accounts, hedge funds or other distractions. On the other hand, he has no research analysts to support him.

Management’s Stake in the Fund

As of the most recent Statement of Additional Information, Mr. Scruggs has invested between $10,000 and $50,000 in his fund. Though small in absolute terms, it’s described as “the vast majority of [his] investable assets.”

Opening date

June 13, 2002.

Minimum investment

$2500 for regular accounts, $1000 for tax-sheltered accounts.

Expense ratio

0.95% on assets of $19 million.

Comments

Steven Scruggs, and his investing partner Benton Bragg, are trying to do a simple, sensible thing well. By their own description, they’re trying to tune out the incessant noise – the market’s down, gold is up, it’s the “new normal,” no, it isn’t, Glenn Beck has investing advice, the Hindenburg’s been spotted, volumes are thin – and focus on what works: “over long periods of time companies are worth the amount of economic profits they earn for their shareholders.” They’re not trying to out-guess the market or make top-down calls. They’re mostly trying to find companies that will make more money over the next five years than they’re making now. When the stocks of those companies are unreasonably cheap, they buy them and hold them for something like 5-7 years. When they don’t find stocks that are unreasonably cheap given their companies’ prospects, they let cash (or gold, a sort of cash substitute) accumulate. As of the last portfolio disclosure, gold is about 3% and cash about 11% of the portfolio. The fund typically holds 50 or so names, which is neither terribly focused nor terribly dilute. He’s been avoiding big banks in favor of insurers. He’s overweighted technology, because many of those companies have remarkably solid financials right now. The manager anticipates slow growth and, it seems, mostly imprudent government intervention. As a result, he’s being cautious in his attempts to find high quality companies with earnings growth potential. All of this has produced a steady ride for the fund’s investors. The fund outperformed its peer group in every quarter of the 2007-09 meltdown and performed particularly well during the market drops in June and August 2010. And it tends to post competitive returns in rising markets. Its ability to handle poor weather places the fund near the top of its large-value cohort for the past one, three and five-year periods, as well as the eight-year period since inception.

Bottom Line

A fund for the times, or for the timid? It might be either. It’s clear that most retail investors have long patience (or courage) and are not willing to embrace high volatility investments. Mr. Scruggs ongoing skepticism about the market and economy, his attention to financially solid firms, and willingness to hold cash likely will serve such investors well.

Fund website

Queens Road Value Fund

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact David@MutualFundObserver.com.

Prospector Capital Appreciation (PCAFX), April 2011

By Editor

Objective

Seeks capital appreciation by investing globally in a combination of stocks and “equity-related securities,” though they have latitude to invest in a broad array of distressed debt. Their activities are limited to the U.S. “and other developed markets.” They look for firms with good long-term prospects for generating total return (appreciation plus dividends), good managers, good products and some evidence of a catalyst for unlocking additional value.

Adviser

Prospector Partners Asset Management, LLC . Prospector was founded in 1997 and manages about $2 billion in assets, including $70 million in its two mutual funds.

Managers

John Gillespie, Richard Howard and Kevin O’Brien. Mr. Howard, the lead manager, was the storied manager of the storied T. Rowe Price Capital Appreciation Fund (PRWCX, 1989-2001). Mr. Gillespie spent a decade at T. Rowe Price, including a stint as manager of Growth Stock (PRGFX, 1994-96) and New Media (1993-1997). Mr. O’Brien comanaged Neuberger Berman Genesis (NBGNX). All three have extensive experience at White Mountain Insurance, whose investment division has Buffett-like credentials.

Management’s Stake in the Fund

Each of the managers has over $100,000 invested in the fund and into their other charge, Prospector Opportunity, as well. The fund’s officers and board own 17% of the shares of PCAFX. Mr. Gillespie and his family own 20% and Mr. Howard owns almost 7%. They also own a majority of the advisor.

Opening date

9/27/2007

Minimum investment

$10,000 across the board.

Expense ratio

1.26% after waivers on assets of $28.3 million, plus a 2% redemption fee on shares held fewer than 60 days.

Comments

Most investors folks on two sorts of securities — stocks and bonds. The former provides an ownership stake in a firm, the latter provides the opportunity to lend money to the firm with the prospect of repayment with interest. There are, however, other options. One, called convertible securities, are a sort of hybrid. They have bond-like characteristics (fairly high payouts, fairly low volatility) but they are convertible under certain characteristics into shares of company stock. That conversion possibility then creates a set of equity-linked characteristics: because investors know that these things can become stock, their value risks when the value of the firm’s stock rises. As a result, you buy a fraction of the stock’s upside and a fraction of its downside with steady income to boot. The trick, of course, is making sure that the “fraction of upside” is greater than the “fraction of downside.” That is, if you can capture 90% of a stock’s potential gains with only half of its potential losses, you win. Successful convertibles investing is a tricky business, undertaken by durn few funds. The few that do it well have accumulated spectacular risk-adjusted records for their investors. These include Matthews Asian Growth & Income (MACSX), a singularly excellent play on Asian investing, T. Rowe Price Capital Appreciation (PRCWX), which consistently beats 98% of its peers over longer time frames, and, to a lesser extent, FPA Crescent (FPACX). You can now add Prospector Capital Appreciation to that list. Prospector’s prime charms are two: first, it has a sensible strategy for the use of convertibles. The fund starts its investment process by looking at the firm, then seeking convertibles which can offer a large fraction of the gains made by a firm’s stock with substantial downside protection. It buys common stock only if the firm is attractive but no convertible shares are to be had. Six of 10 largest buys in the first half of 2010 were convertibles. Because the market lately has favored lower-quality over higher-quality stocks, the fund has been able to add blue chip names, an occurrence which seems to leave him slightly dumb-struck: “we continue adding recognized high quality stocks to the portfolio . . . this seems almost surreal. We are used to buying mediocre companies that are getting better or good companies that few have heard of, not recognized quality.” At the moment (late 2010) about a quarter of the portfolio is in convertibles, about 13% in international stocks, a bit in bonds and cash, and the remainder in US stocks. The manager’s value orientation led him to include three gold miners in the top ten holdings but to avoid, almost entirely, tech names. The second attraction is the fund’s lead manager, Richard Howard. Mr. Howard guided T. Rowe Price Capital Apprecation is a spectacular performance over 12 years. He turned a $10,000 initial investment into $42,000, which dwarfed his peers’ performance (they averaged $32,000) and gave him one of the best records for any fund in Morningstar’s old “domestic hybrid” category. For much of that time, he kept pace with the hard-charging S&P500, lagging it in the bubble of the late 90s and making up much of the ground before his departure in August 2001. He posted only one small calendar-year losses in 12 years of management. He seems not to have lost his touch. The fund just passed its third anniversary and earned a five star rating from Morningstar, posting “high” returns for “average” risk. Moreover, he’s outperformed his old fund by about a third, lost noticeably less in 2008 and has done so with less volatility.

Bottom Line

Conservative equity investors should look seriously at funds, such as this, which seem to have mastered the use of convertible securities as a tool of risk management and enhanced returns. The investment minimum here is regrettably high and the expense ratio is understandably high. The primary appeal over Price Cap App is two-fold: Mr. Howard’s skills and the tiny asset base, which should give him the availability to establish meaningful positions in securities too small to profit the Price fund.

Fund website

Prospector Capital Appreciation homepage

Fact Sheet

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact David@MutualFundObserver.com.

Hussman Strategic International Equity (HSIEX), April 2011

By Editor

Hussman Strategic International Equity Fund was liquidated in June, 2023. Information in this profile is provided purely for archival purposes.

Objective

The fund seeks long term capital growth, but with special emphasis on defensive actions during unfavorable market conditions. The portfolio is a mix of individual securities, ETFs (up to 30% of the portfolio) and hedges. In the near term, the hedging strategy will focus on shorting particular markets; the fund can short individual ETFs but “the fund does not intend to use these hedging techniques during the coming year.” The portfolio balance is determined by the manager’s macro-level assessments of world markets. The fund may be fully hedged (that is, the amount long exactly matches the amount short), but it will not be net short.

Adviser

Hussman Econometrics Advisors of beautiful Ellicott City, Maryland. The advisor was founded in 1989 by John Hussman, who is the firm’s President and sole shareholder. Hussman also advises the Hussman Strategic Growth and Hussman Strategic Total Return funds but does not advise any private accounts. Together, those funds hold about $9 billion in assets.

Manager

John Hussman and William Hester. Hussman has a Ph.D. in economics from Stanford, a Masters degree in education and social policy and a B.A. in economics from Northwestern University. Prior to managing the Hussman Funds, he was a adjunct assistant professor of economics and international finance at the University of Michigan and its business school, an options mathematician at the Chicago Board of Trade, and publisher (since ’88) of the Hussman Econometrics newsletter. Mr. Hester has been Hussman’s Senior Research Analyst since 2003, and this will be his first stint at co-managing a fund.

Management’s Stake in the Fund

“Except for a tiny percentage in money market funds, all of Dr. Hussman’s liquid assets are invested in the Hussman Funds,” which translates to over a million in each of his two funds, plus sole ownership of the advisor. Likewise, “The compensation of every member of our Board of Trustees is generally invested directly into the Funds. All of these investments are regular and automatic.”

Opening date

December 31, 2009, sort of. The fund ran for nine months of road-testing, with only the manager’s own money in the fund. It opened to purchases by the public on September 1, 2010.

Minimum investment

$1,000 for regular, $500 for IRA/UGMA accounts and $100 for automatic investing plans.

Expense ratio

Capped at 2.0% through the end of 2012. The fund’s actual operating expenses are around 5.0%, measured against an in-house asset base of $7.5 million. The Strategic Growth Fund, of which this is an offshoot, has expenses around 1%. There’s a 1.5% redemption fee on shares held fewer than sixty days.

Comments

Dr. Hussman’s funds have drawn huge inflows in the past several years. Strategic Total Return (HSTRX) grew from under $200 million in June 2007 to $2.3 billion by June 2010. Strategic Growth (HSGFX) grew from $2.7 billion to $6.7 billion in the same period. The reason’s simple: over the past five years, they’ve made money. Total Return posted a healthy profit in 2008 (7%) and over the entire period of the market crash (an 8% rise from 10/07 – 03/09). In a crash where the Total Stock Market index dropped nearly 50%, Strategic Growth’s 5% decline became phenomenally attractive. And so the money poured in.

Presumably that track record will quickly draw attention, and assets, here.

Mr. Hussman’s success has been driven by his ability to make macro-level assessments of markets and economies, and then to position his funds with varying degrees of defensiveness based on those assessments. He has frequently been right, though that merely means he’s mostly been bearish.

Before investing in the fund, one might consider several reservations:

  1. Mr. Hussman has relatively little experience, at least as measured by portfolio composition, in international investing. Non-U.S. stocks comprise only 5-6% of his other portfolios.
  2. The other Hussman funds could, if Mr. H. found the case compelling, provide substantially more international exposure. At the very least, Strategic Growth’s portfolio contains no explicit limitation on the extent of international exposure in the portfolio.
  3. Mr. Hussman himself is skeptical of the value of international investing. His argument in January 2009 was striking:

    . . . the correlation of returns across various markets increases during recessionary periods. As I noted in November 2007 . . . global diversification is least useful when it’s needed most. And this data shows that not only does the correlation between US and international markets rise during recessions, but that global returns trail US returns during these periods. Lower returns with higher correlation. This data implies that the benefits of international investing and diversification come predominantly during periods of global expansion, and not during bear markets induced by recessions.

  4. Assets under management are ballooning. $2 billion in new – read: “hot” – money in a single year is a lot for a small operation to handle (c.f. Van Wagoner funds), and there’s no immediate sign of a decrease. Encouraging still-more inflows comes at a cost.

Mr. Hussman has done good work. I’ve written, favorably and repeatedly, about his Strategic Total Return fund. I’ve invested in that fund. And I’ve been impressed with his concern about shareholder-friendly policies, including his own financial commitment to the funds. That said, Mr. Hussman has not – so far as I can find – made any public statements explaining the launch of, or reasons behind this new fund.

Bottom Line

I don’t know why you’d want to invest in this fund. The expenses are high, the existing funds can provide international exposure and the manager himself seems skeptical of the rationale for international investing. That’s not an argument that you should run away. It’s a simple observation that the particular advantages of this fund are still undefined.

Fund website

The Hussman Funds. Hussman’s 2009 critique of international investing is also available on his website.

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact David@MutualFundObserver.com.

GRT Absolute Return (GRTHX)

By Editor

Update: This fund has been liquidated.

Objective

The fund seeks total return by investing, long and short, in the entire investable universe. It starts with a sensible neutral asset allocation and tries to “add alpha around the edges.” The fund parallels the firm’s Topaz hedge fund. It can short stocks, to a maximum of 30%. Unlike other hedge funds, Topaz avoids extensive leverage and highly concentrated bets. The fund will do likewise.

Adviser

GRT Capital Partners. GRT was founded in 2001 by Gregory Fraser, Rudolph Kluiber and Timothy Krochuk. GRT offers investment management services to institutional clients and investors in its limited partnerships. As of 2/1/11, they had over $300 million in assets under management and were experiencing healthy inflows. They also manage GRT Value (GRTVX) and ten separate account strategies.

Manager

The aforementioned Gregory Fraser, Rudolph Kluiber and Timothy Krochuk. Mr. Fraser is the lead manager. He managed Fidelity Diversified International (FDIVX) from 1991 to 2001. Before that he analyzed stuff (shoes, steel, casinos) for Fidelity. Mr. Kluiber, from 1995 to 2001, ran State Street Research Aurora (SSRAX), a small cap value fund. Before that, he was a high yield analyst and assistant manager on State Street Research High Yield. Mr. Krochuk managed Fidelity TechnoQuant Growth Fund from 1996 to 2001 and Fidelity Small Cap Selector fund in 2000 and 2001. Since 2001, they’ve worked together on limited partnerships and separate accounts for GRT Capital. All three managers earned BAs from Harvard, where Mr. Kluiber and Mr. Fraser were roommates. Messrs Kluiber and Fraser have both earned MBAs from UCLA and Pennsylvania, respectively.

Management’s Stake in the Fund

Not yet reported. That said, the managers own the advisory firm, and Mr. Krochuk attsts that “all of our managers own shares in their products” and “most of our net worth is in those products.”

Opening date

December 8, 2010.

Minimum investment

$2500, reduced to $500 for IRAs.

Expense ratio

2.39% on assets of $10 million.

Comments

Investors are often panicked by the simple fact that virtually no asset class is attractively priced any longer. Cash is at zero. Bonds have a near zero real return, with the spread between the riskiest bonds and Treasuries collapsing to 4.6%. U.S. stocks have nearly doubled in under two years while emerging markets and REITs have risen by even more. Gold, a classic inflation hedge, has risen from $272 in 2000 to $1363 in February 2011.

The argument that no asset class is undervalued does not mean that it’s impossible to make money; just that you’re less likely to make it with a static asset allocation and exposure to market indexes. That, at least, is the argument advanced by Tim Krochuk and the good folks at GRT Capital Partners in support of their new absolute return fund. “Active management is,” he argues, “oversold while ETFs are screaming skyward.”

Mr. Krochuk’s argument is that managers need the flexibility to make gains wherever an uncertain market offers them, a strategy which requires the ability to invest both long and short, in a wide variety of asset classes.

GRT Absolute Return (GRTHX), launched in December, offers three distinctive features.

First, it has a sensible neutral allocation. By shifting the classic 60/40 split between stocks and bonds to a 55/35/10 split between stocks, bonds and cash, GRT produced a benchmark with great stability that outperformed the traditional allocation in 100% of the rolling five year periods they studied. From 2005 – 10, GRT’s neutral allocation returned 31% while a 60/40 split returned 20% and the S&P500 was in the red.

Second, it doesn’t try to over-promise or over-extend itself. GRT has a remarkably vibrant quant culture, and their studies conclude that “a little shorting goes a long way.” As a result, the fund won’t short more than 30%, which provides “major downside protection” as well as contributing alpha in some markets. How much downside protection? A 2004 asset allocation study, published by T. Rowe Price, gives a hint. They studied the effects of various broad asset allocations (100% stock, 80% stock/20% bonds, and so on). In general, reducing your stock exposure by 20% reduces the average down year loss by 4%. For example, a portfolio 80% in stocks lost an average of 10% in its down years. Dropping that to 60% stocks cut the average loss to 6.5%. There was surprisingly little loss in returns occasioned by easing up on stocks: a static 60% stock portfolio earned 9.3% per year over 50 years while 80% stocks earned 10%.

We can, Krochuk concludes, “add alpha by investing around the edges of a good allocation benchmark.” They also avoid leverage, which dramatically boosts returns — but only if you’re very right and have impeccable timing. The underlying portfolio will be well diversified, rather than making a series of hedge fund-like bets on a small basket of securities. They’ve found that they can use U.S. blue chip stocks (liquid and dividend paying) in lieu of a large cash stake. And the managers invest major amounts in their funds. The prospect of losing much of your life savings, Mr. Krochuk notes, has a wonderfully sobering effect on investor behavior.

Finally, the fund has Greg Fraser (and company). Mr. Fraser, the lead manager, performed brilliantly at Fidelity Diversified International (FDIVX) for a decade, outperforming in both rising and falling markets. In the five years before FDIVX, he was one of Fidelity’s top stock analysts. In the decade since FDIVX, he’s run both a long/short hedge fund and a natural resources hedge fund for GRT. As I noted in my profile of GRT Value (GRTVX) and my March 2011 cover essay, G, R & T represent a major pool of time-tested talent.

GRT employs another half dozen managers on their private accounts, and several of those have outstanding records as mutual fund managers. While those managers do not directly contribute to this fund, their presence strengthens the fund in at least two ways. First, there’s an ongoing flow of information between the managers; informally on a daily basis and formally at monthly meetings. Second, the advisor monitors the performance of each of its 10 strategies every day. Those strategies are, in normal times, uncorrelated. A spike in correlations has been a reliable sign of an impending market fall. That information is available only to GRT and allows them to anticipate events and adjust their portfolio positions.

Bottom Line

The price of entering the fund ($2500) is low, though the price of staying in is rather high (2.39% at the outset). That said, highly active, alternative-investment funds are pricey are a group (the $1.4 billion Wintergreen fund charges 2%, for example) and expenses are likely to fall as assets rise. As importantly, the managers have a record of earning their money. Beyond GRTVX’s strong performance, there’s also decades of great absolute and risk-adjusted returns posted by all three members of the management team. Ensconced now in a partnership of their own creation, with a sensible corporate structure and a cadre of managers whose work they respect, there’s good reason to believe the GRT will achieve their goal of becoming “a mini-Wellington.” That is, an exceedingly stable firm dedicated to providing strong, sustainable long-term gains for their clients.

Fund website

GRT Capital Partners, then click on “mutual funds” in the lower right. The funds portion of the site has minimal information (links to the prospectus, SAI and required reports but not a profile, holdings, commentary or performance). The rest of the site, though, has a fair amount of relevant information to help folks understand the management team and their approach.

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact David@MutualFundObserver.com.