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 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.  As of April 5, 2011, Mr. Dodson and his family owned about 75% of the fund’s shares.

Opening date

September 30, 2010.

Minimum investment

$5000 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

1.5% on $3 million in assets.

Comments

Mr. Dodson is an experienced investment professional, pursuing a simple discipline.  He wants to buy deeply discounted stocks, but not a lot of them.  Where some funds tout a “best ideas” focus and then own dozens of the same large cap stocks, Bretton seems to mean it when he says “just my best.”

As of 9/30/11, the fund held just 15 stocks.  Of those, six were large caps, three mid-caps and six small- to micro-cap.  His micro-cap picks, where he often discerns the greatest degree of mispricing, are particularly striking.  Bretton is one of only a handful of funds that owns the smaller cap names and it generally commits ten or twenty times as much of the fund’s assets to them.

In addition to being agnostic about size, the fund is also unconstrained by style or sector.  Half of the fund’s holdings are characterized as “growth” stocks, half are not.   The fund offers no exposure at all in seven of Morningstar’s 11 industry sectors, but is over weighted by 4:1 in financials.

This is the essence of active management, and active management is about the only way to distinguish yourself from an overpriced index.  Bretton’s degree of concentration is not quite unprecedented, but it is remarkable.  Only six other funds invest with comparable confidence (that is, invests in such a compact portfolio), and five of them are unattractive options.

Biondo Focus (BFONX) holds 15 stocks and (as of January 2012) is using leverage to gain market exposure of 130%.  It sports a 3.1% e.r.  A $10,000 investment in the fund on the day it launched was worth $7800 at the end of 2011, while an investment in its average peer for the same period would have grown to $10,800.

Huntington Technical Opportunities (HTOAX) holds 12 stocks (briefly: it has a 440% portfolio turnover), 40% cash, and 10% S&P index fund.  The expense ratio is about 2%, which is coupled with a 4.75% load.  From inception, $10,000 became $7200 while its average peer would be at $9500.

Midas Magic (MISEX).  The former Midas Special Fund became Midas Magic on 4/29/2011.  Dear lord.  The ticker reads “My Sex” and the name cries out for Clara Peller to squawk “Where’s The Magic?”  The fund reports 0% turnover but found cause to charge 3.84% in expenses anyway.  Let’s see: since inception (1986), the fund has vastly underperformed the S&P500, its large cap peer group, short-term bond funds, gold, munis, currency . . . It has done better than the Chicago Cubs, but that’s about it.  It holds 12 stocks.

Monteagle Informed Investor Growth (MIIFX) holds 12 stocks (very briefly: it reports a 750% turnover ratio) and 20% cash.  The annual report’s lofty rhetoric (“The Fund’s goal is to invest in these common stocks with demonstrated informed investor interest and ownership, as well as, solid earnings fundamentals”) is undercut by an average holding period of six weeks.  The fund had one brilliant month, November 2008, when it soared 36% as the market lost 10%.  Since then, it’s been wildly inconsistent.

Rochdale Large Growth (RIMGX) holds 15 stocks and 40% cash.  From launch through the end of 2011, it turned $10,000 to $6300 while its large cap peer group went to $10,600.

The Cook & Bynum Fund (COBYX) is the most interesting of the lot.  It holds 10 stocks (two of which are Sears and Sears Canada) and 30% cash.  Since inception it has pretty much matched the returns of a large-value peer group, but has done so with far lower volatility.

And so fans of really focused investing have two plausible candidates, COBYX and BRTNX.  Of the two, Bretton has a far more impressive, though shorter, record.  From inception through the end of 2011, $10,000 invested in Bretton would have grown to $11,500.  Its peer group would have produced an average return of $10,900. For 2011 as a whole, BRTNX’s returns were in the top 2% of its peer group, by Morningstar’s calculus.   Lipper, which classifies it as “multi-cap value,” reports that it had the fourth best record of any comparable fund in 2011.  In particular, the fund outperformed its peers in every month when the market was declining.  That’s a particularly striking accomplishment given the fund’s concentration and micro-cap exposure.

Bottom Line

Bretton has the courage of its convictions.  Those convictions are grounded in an intelligent reading of the investment literature and backed by a huge financial commitment by the manager and his family.  It’s a fascinating vehicle and deserves careful attention.

Fund website

Bretton Fund

[cr2012]

This profile has been updated since it was originally published. The updated profile can be found at http://www.mutualfundobserver.com/2012/09/northern-global-tactical-asset-allocation-fund-bbalx-september-2011-updated-september-2012/

Objective

The fund seeks a combination of growth and income. Northern’s Investment Policy Committee develops tactical asset allocation recommendations based on economic factors such as GDP and inflation; fixed-income market factors such as sovereign yields, credit spreads and currency trends; and stock market factors such as domestic and foreign earnings growth and valuations.  The managers execute that allocation by investing in other Northern funds and outside ETFs.  As of 6/30/2011, the fund holds 10 Northern funds and 3 ETFs.

Adviser

Northern Trust Investments.  Northern’s parent was founded in 1889 and provides investment management, asset and fund administration, fiduciary and banking solutions for corporations, institutions and affluent individuals worldwide.  As of June 30, 2011, Northern Trust Corporation had $97 billion in banking assets, $4.4 trillion in assets under custody and $680 billion in assets under management.  The Northern funds account for about $37 billion in assets.  When these folks say, “affluent individuals,” they really mean it.  Access to Northern Institutional Funds is limited to retirement plans with at least $30 million in assets, corporations and similar institutions, and “personal financial services clients having at least $500 million in total assets at Northern Trust.”  Yikes.  There are 51 Northern funds, seven sub-advised by multiple institutional managers.

Managers

Peter Flood and Daniel Phillips.  Mr. Flood has been managing the fund since April, 2008.  He is the head of Northern’s Fixed Income Risk Management and Fixed Income Strategy teams and has been with Northern since 1979.  Mr. Phillips joined Northern in 2005 and became co-manager in April, 2011.  He’s one of Northern’s lead asset-allocation specialists.

Management’s Stake in the Fund

None, zero, zip.   The research is pretty clear, that substantial manager ownership of a fund is associated with more prudent risk taking and modestly higher returns.  I checked 15 Northern managers listed in the 2010 Statement of Additional Information.  Not a single manager had a single dollar invested.  For both practical and symbolic reasons, that strikes me as regrettable.

Opening date

Northern Institutional Balanced, this fund’s initial incarnation, launched on July 1, 1993.  On April 1, 2008, this became an institutional fund of funds with a new name, manager and mission and offered four share classes.  On August 1, 2011, all four share classes were combined into a single no-load retail fund but is otherwise identical to its institutional predecessor.

Minimum investment

$2500, reduced to $500 for IRAs and $250 for accounts with an automatic investing plan.

Expense ratio

0.68%, after waivers, on assets of $18 million. While there’s no guarantee that the waiver will be renewed next year, Peter Jacob, a vice president for Northern Trust Global Investments, says that the board has never failed to renew a requested waiver. Since the new fund inherited the original fund’s shareholders, Northern and the board concluded that they could not in good conscience impose a fee increase on those folks. That decision that benefits all investors in the fund. Update – 0.68%, after waivers, on assets of nearly $28 million (as of 12/31/2012.)

Comments

The case for this fund can be summarized easily.  It was a perfectly respectable institutional balanced fund which has become dramatically better as a result of two sets of recent changes.

Northern Institutional Balanced invested conservatively and conventionally.  It held about two-thirds in stocks (mostly mid- to large-sized US companies plus a few large foreign firms) and one-third in bonds (mostly investment grade domestic bonds).   Northern’s ethos is very risk sensitive which makes a world of sense given their traditional client base: the exceedingly affluent.  Those folks didn’t need Northern to make a ton of money for them (they already had that), they needed Northern to steward it carefully and not take silly risks.  Even today, Northern trumpets “active risk management and well-defined buy-sell criteria” and celebrates their ability to provide clients with “peace of mind.”  Northern continues to highlight “A conservative investment approach . . . strength and stability . . .  disciplined, risk-managed investment . . . “

As a reflection of that, Balanced tended to capture only 65-85% of its benchmark’s gains in years when the market was rising but much less of the loss when the market was falling.  In the long-term, the fund returned about 85% of its 65% stock – 35% bond benchmark’s gains but did so with low volatility.

That was perfectly respectable.

Since then, two sets of changes have made it dramatically better.  In April 2008, the fund morphed from conservative balanced to a global tactical fund of funds.  At a swoop, the fund underwent a series of useful changes.

The asset allocation became fluid, with an investment committee able to substantially shift asset class exposure as opportunities changed.

The basic asset allocation became more aggressive, with the addition of a high-yield bond fund and emerging markets equities.

The fund added exposure to alternative investments, including gold, commodities, global real estate and currencies.

Those changes resulted in a markedly stronger performer.  In the three years since the change, the fund has handily outperformed both its Morningstar benchmark and its peer group.  Its returns place it in the top 7% of balanced funds in the past three years (through 8/25/11).  Morningstar has awarded it five stars for the past three years, even as the fund maintained its “low risk” rating.  Over the same period, it’s been designated a Lipper Leader (5 out of 5 score) for Total Returns and Expenses, and 4 out of 5 for Consistency and Capital Preservation.

In the same period (04/01/2008 – 08/26/2011), it has outperformed its peer group and a host of first-rate balanced funds including Vanguard STAR (VGSTX), Vanguard Balanced Index (VBINX), Fidelity Global Balanced (FGBLX), Leuthold Core (LCORX), T. Rowe Price Balanced (RPBAX) and Dodge & Cox Balanced (DODBX).

In August 2011, the fund morphed again from an institutional fund to a retail one.   The investment minimum dropped from $5,000,000 to as low as $250.  The expense ratio, however, remained extremely low, thanks to an ongoing expense waiver from Northern.  The average for other retail funds advertising themselves as “tactical asset” or “tactical allocation” funds is about 1.80%.

Bottom Line

Northern GTA offers an intriguing opportunity for conservative investors.  This remains a cautious fund, but one which offers exposure to a diverse array of asset classes and a price unavailable in other retail offerings.  It has used its newfound flexibility and low expenses to outperform some very distinguished competition.  Folks looking for an interesting and affordable core fund owe it to themselves to add this one to their short-list.

Fund website

Northern Global Tactical Asset Allocation

Update – 3Q2011 Fact Sheet

Fund Profile, 2nd quarter, 2012

[cr2012]

This profile has been updated since it was originally published. The updated profile can be found at http://www.mutualfundobserver.com/2012/09/riverpark-short-term-high-yield-fund-rphyx-july-2011-updated-october-2012/

Objective

The fund seeks high current income and capital appreciation consistent with the preservation of capital, and is looking for yields that are better than those available via traditional money market and short term bond funds.  They invest primarily in high yield bonds with an effective maturity of less than three years but can also have money in short term debt, preferred stock, convertible bonds, and fixed- or floating-rate bank loans.

Adviser

RiverPark Advisers.  Executives from Baron Asset Management, including president Morty Schaja, formed RiverPark in July 2009.  RiverPark oversees the five RiverPark funds, though other firms manage three of the five.  Until recently, they also advised two actively-managed ETFs under the Grail RP banner.  A legally separate entity, RiverPark Capital Management, runs separate accounts and partnerships.  Collectively, they have $90 million in assets under management, as of May 2011.

Manager

David Sherman, founder and owner of Cohanzick Management of Pleasantville (think Reader’s Digest), NY.  Cohanzick manages separate accounts and partnerships.  The firm has more than $320 million in assets under management.  Since 1997, Cohanzick has managed accounts for a variety of clients using substantially the same process that they’ll use with this fund. He currently invests about $100 million in this style, between the fund and his separate accounts.  Before founding Cohanzick, Mr. Sherman worked for Leucadia National Corporation and its subsidiaries.  From 1992 – 1996, he oversaw Leucadia’s insurance companies’ investment portfolios.  All told, he has over 23 years of experience investing in high yield and distressed securities.  He’s assisted by three other investment professionals.

Management’s Stake in the Fund

30% of the fund’s investments come from RiverPark or Cohanzick.  However, if you include friends and family in the equation, the percentage climbs to about 50%.

Opening date

September 30, 2010.

Minimum investment

$1,000.

Expense ratio

1.25% after waivers on $20.5 million in assets.  The prospectus reports that the actual cost of operation is 2.65% with RiverPark underwriting everything above 1.25%.  Mr. Schaja, RiverPark’s president, says that the fund is very near the break-even point. Update – 1.25%, after waivers, on $53.7 million in assets (as of 12/31/2011.)

Comments

The good folks at Cohanzick are looking to construct a profitable alternative to traditional money management funds.  The case for seeking an alternative is compelling.  Money market funds have negative real returns, and will continue to have them for years ahead.  As of June 28 2011, Vanguard Prime Money Market Fund (VMMXX) has an annualized yield of 0.04%.  Fidelity Money Market Fund (SPRXX) yields 0.01%.  TIAA-CREF Money Market (TIRXX) yields 0.00%.  If you had put $1 million in Vanguard a year ago, you’d have made $400 before taxes.  You might be tempted to say “that’s better than nothing,” but it isn’t.  The most recent estimate of year over year inflation (released by the Bureau of Labor Statistics, June 15 2011) is 3.6%, which means that your ultra-safe million dollar account lost $35,600 in purchasing power.  The “rush to safety” has kept the yield on short term T-bills at (or, egads, below) zero.  Unless the U.S. economy strengths enough to embolden the Fed to raise interest rates (likely by a quarter point at a time), those negative returns may last through the next presidential election.

That’s compounded by rising, largely undisclosed risks that those money market funds are taking.  The problem for money market managers is that their expense ratios often exceed the available yield from their portfolios; that is, they’re charging more in fees than they can make for investors – at least when they rely on safe, predictable, boring investments.  In consequence, money market managers are reaching (some say “groping”) for yield by buying unconventional debt.  In 2007 they were buying weird asset-backed derivatives, which turned poisonous very quickly.  In 2011 they’re buying the debt of European banks, banks which are often exposed to the risk of sovereign defaults from nations such as Portugal, Greece, Ireland and Spain.  On whole, European banks outside of those four countries have over $2 trillion of exposure to their debt. James Grant observed in the June 3 2011 edition of Grant’s Interest Rate Observer, that the nation’s five largest money market funds (three Fidelity funds, Vanguard and BlackRock) hold an average of 41% of their assets in European debt securities.

Enter Cohanzick and the RiverPark Short Term High Yield fund.  Cohanzick generally does not buy conventional short term, high yield bonds.  They do something far more interesting.  They buy several different types of orphaned securities; exceedingly short-term (think 30-90 day maturity) securities for which there are few other buyers.

One type of investment is redeemed debt, or called bonds.  A firm or government might have issued a high yielding ten-year bond.  Now, after seven years, they’d like to buy those bonds back in order to escape the high interest payments they’ve had to make.  That’s “calling” the bond, but the issuer must wait 30 days between announcing the call and actually buying back the bonds.  Let’s say you’re a mutual fund manager holding a million dollars worth of a called bond that’s been yielding 5%.  You’ve got a decision to make: hold on to the bond for the next 30 days – during which time it will earn you a whoppin’ $4166 – or try to sell the bond fast so you have the $1 million to redeploy.  The $4166 feels like chump change, so you’d like to sell but to whom?

In general, bond fund managers won’t buy such short-lived remnants and money market managers can’t buy them: these are still nominally “junk” and forbidden to them.  According to RiverPark’s president, Morty Schaja, these are “orphaned credit opportunities with no logical or active buyers.”  The buyers are a handful of hedge funds and this fund.  If Cohanzick’s research convinces them that the entity making the call will be able to survive for another 30 days, they can afford to negotiate purchase of the bond, hold it for a month, redeem it, and buy another.  The effect is that the fund has junk bond like yields (better than 4% currently) with negligible share price volatility.

Redeemed debt (which represents 33% of the June 2011 portfolio) is one of five sorts of investments typical of the fund.  The others include

• Corporate event driven (18% of the portfolio) purchases, the vast majority of which mature in under 60 days. This might be where an already-public corporate event will trigger an imminent call, but hasn’t yet.  If, for example, one company is purchased by another, the acquired company’s bonds will all be called at the moment of the merger.
• Strategic recapitalization (10% of the portfolio), which describes a situation in which there’s the announced intention to call, but the firm has not yet undertaken the legal formalities.  By way of example, Virgin Media has repeatedly announced its intention to call certain bonds in August 2011. The public announcements gave the manager enough comfort to purchase the bonds, which were subsequently called less than 2 weeks later.  Buying before call means that the fund has to post the original maturities (five years) despite knowing the bond will cash out in (say) 90 days.  This means that the portfolio will show some intermediate duration bonds.
• Cushion bonds (14%), refers to a bond whose yield to maturity is greater than its current yield to call.  So as more time goes by (and the bond isn’t called), the yield grows. Because I have enormous trouble in understanding exactly what that means, Michael Dekler of Cohanzick offered this example:

A good example is the recent purchase of the Qwest (Centurylink) 7.5% bonds due 2014.  If the bonds had been called on the day we bought them (which would have resulted in them being redeemed 30 days from that day), our yield would only have been just over 1%.  But since no immediate refinancing event seemed to be in the works, we suspected the bonds would remain outstanding for longer.  If the bonds were called today (6/30) for a 7/30 redemption date, our yield on the original purchase would be 5.25%.  And because we are very comfortable with the near-term credit quality, we’re happy to hold them until the future redemption or maturity.

• Short term maturities (25%), fixed and floating rate debt that the manager believes are “money good.”

What are the arguments in favor of RPHYX?

• It’s currently yielding 100-400 times more than a money market.  While the disparity won’t always be that great, the manager believes that these sorts of assets might typically generate returns of 3.5 – 4.5% per year, which is exceedingly good.
• It features low share price volatility.  The NAV is $10.01 (as of 6/29/11).  It’s never been higher than $10.03 or lower than $9.97.  Almost all of the share price fluctuation is due to their monthly dividend distributions.    A $0.04 cent distribution at the end of June will cause the NAV will go back down to about $9.97. Their five separately managed accounts have almost never shown a monthly decline in value.  The key risk in high-yield investing is the ability of the issuer to make payments for, say, the next decade.  Do you really want to bet on Eastman Kodak’s ability to survive to 2021?  With these securities, Mr. Sherman just needs to be sure that they’ll survive to next month.  If he’s not sure, he doesn’t bite.  And the odds are in his favor.  In the case of redeemed debt, for instance, there’s been only one bankruptcy among such firms since 1985.
• It offers protection against rising interest rates.  Because most of the fund’s securities mature within 30-60 days, a rise in the Fed funds rate will have a negligible effect on the value of the portfolio.
• It offers experienced, shareholder-friendly management.  The Cohanzick folks are deeply invested in the fund.  They run $100 million in this style currently and estimate that they could run up to $1 billion. Because they’re one of the few large purchasers, they’re “a logical first call for sellers.  We … know how to negotiate purchase terms.”  They’ve committed to closing both their separate accounts and the fund to new investors before they reach their capacity limit.

Bottom Line

This strikes me as a fascinating fund.  It is, in the mutual fund world, utterly unique.  It has competitive advantages (including “first mover” status) that later entrants won’t easily match.  And it makes sense.  That’s a rare and wonderful combination.  Conservative investors – folks saving up for a house or girding for upcoming tuition payments – need to put this on their short list of best cash management options.

Financial disclosure: I intend to shift $1000 from the TIAA-CREF money market to RPHYX about one week after this profile is posted (July 1 2011) and establish an automatic investment in the fund.  That commitment, made after I read an awful lot and interviewed the manager, might well color my assessment.  Caveat emptor.

Note to financial advisers: Messrs Sherman and Schaja seem committed to being singularly accessible and transparent.  They update the portfolio monthly, are willing to speak individually with major investors and plan – assuming the number of investors grows substantially – to offer monthly conference calls to allow folks to hear from, and interact with, management.

Fund website

RiverPark Short Term High Yield

Update: 3Q2011 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.

Objective

The fund pursues long-term growth by investing in 30-50 undervalued global stocks.  Generally it avoids small cap caps, but can invest up to 30% in emerging and less developed markets.   The managers look for four characteristics in their investments:

1. A high quality business
2. With a strong balance sheet
3. Shareholder-focused management
4. Selling for less than it’s worth.

The managers can hedge their currency exposure, though they did not do so until they confronted twin challenges to the Japanese yen: unattractive long-term fiscal position plus the tragedies of March 2011. The team then took the unusual step of hedging part of their exposure to the Japanese yen.

Adviser

Artisan Partners of Milwaukee, Wisconsin.   Artisan has five autonomous investment teams that oversee twelve distinct U.S., non-U.S. and global investment strategies. Artisan has been around since 1994.  As of 3/31/2011 Artisan Partners had approximately $63 billion in assets under management (March 2011).  That’s up from $10 billion in 2000. They advise the 12 Artisan funds, but only 6% of their assets come from retail investors. Update – Artisan Partners had approximately $57.1 billion in assets under management, as of 12/31/2011.

Manager

Daniel J. O’Keefe and David Samra, who have worked together since the late 1990s.  Mr. O’Keefe co-manages this fund, Artisan International Value (ARTKX) and Artisan’s global value separate account portfolios.  Before joining Artisan, he served as a research analyst for the Oakmark international funds and, earlier still, was a Morningstar analyst.  Mr. Samra has the same responsibilities as Mr. O’Keefe and also came from Oakmark.  Before Oakmark, he was a portfolio manager with Montgomery Asset Management, Global Equities Division (1993 – 1997).  Messrs O’Keefe, Samra and their five analysts are headquartered in San Francisco.  ARTKX earns Morningstar’s highest accolade: it’s an “analyst pick” (as of 04/11).

Management’s Stake in the Fund

Each of the managers has over $1 million here and over $1 million in Artisan International Value.

Opening date

December 10, 2007.

Minimum investment

$1000 for regular accounts, reduced to $50 for accounts with automatic investing plans.  Artisan is one of the few firms who trust their investors enough to keep their investment minimums low and to waive them for folks willing to commit to the discipline of regular monthly or quarterly investments.

Expense ratio

1.5%, after waivers, on assets of $57 million (as of March 2011). Update – 1.5%, after waivers, on assets of $91 million (as of December 2011).

Comments

Artisan Global Value is the first “new” fund to earn the “star in the shadows” designation.  My original new fund profile of it, written in February 2008, concluded: “Global is apt to be a fast starter, strong, disciplined but – as a result – streaky.”  I have, so far, been wrong only about the predicted streakiness.  The fund’s fast, strong and disciplined approach has translated into consistently superior returns from inception, both in absolute and risk-adjusted terms.  Its shareholders have clearly gotten their money’s worth, and more.

What are they doing right?

Two things strike me.  First, they are as interested in the quality of the business as in the cost of the stock.  O’Keefe and Samra work to escape the typical value trap (“buy it!  It’s incredibly cheap!”) by looking at the future of the business – which also implies understanding the firm’s exposure to various currencies and national politics – and at the strength of its management team.  One of the factors limiting the fund’s direct exposure to emerging markets stocks is the difficulty of finding sufficiently high quality firms and consistently shareholder-focused management teams.  If they have faith in the firm and its management, they’ll buy and patiently wait for other investors to catch up.

Second, the fund is sector agnostic.   Some funds, often closet indexes, formally attempt to maintain sector weights that mirror their benchmarks.  Others achieve the same effect by organizing their research and research teams by industry; that is, there’s a “tech analyst” or “an automotive analyst.”  Mr. O’Keefe argues that once you hire a financial industries analyst, you’ll always have someone advocating for inclusion of their particular sector despite the fact that even the best company in a bad sector might well be a bad investment.  ARTGX is staffed by “research generalists,” able to look at options across a range of sectors (often within a particular geographic region) and come up with the best ideas regardless of industry.  That independence is reflected in the fact that, in eight of ten industry sectors, ARTGX’s position is vastly different than its benchmark’s.  Too, it explains part of the fund’s excellent performance during the 2008 debacle. During the third quarter of 2008, the fund’s peers dropped 18% and the international benchmark plummeted 20%.  Artisan, in contrast, lost 3.5% because the fund avoided highly-leveraged companies, almost all banks among them.

Why, then, are there so few shareholders?

Manager Dan O’Keefe offered two answers.  First, advisors (and presumably many retail investors) seem uncomfortable with “global” funds.  Because they cannot control the fund’s asset allocation, such funds mess up their carefully constructed plans.  As a result, many prefer picking their international and domestic exposure separately.  O’Keefe argues that this concern is misplaced, since the meaningful question is neither “where is the firm’s headquarters” or “on which stock exchange does this stock trade” (the typical dividers for domestic/international stocks) but, instead, “where is this company making its money?”  Colgate-Palmolive (CL) is headquartered in the U.S. but generates less than a fifth of its sales here.  Over half of its sales come from its emerging markets operations, and those are growing at four times the rate of its domestic or developed international market shares.  (ARTGX does not hold CL as of 3/31/11.)  His hope is that opinion-leaders like Morningstar will eventually shift their classifications to reflect an earnings or revenue focus rather than a domicile one.

Second, the small size is misleading.  The vast majority of the assets invested in Artisan’s Global Value Strategy, roughly $3.5 billion, are institutional money in private accounts.  Those investors are more comfortable with giving the managers broad discretion and their presence is important to retail investors as well: the management team is configured for investing billions and even a tripling of the mutual fund’s assets will not particularly challenge their strategy’s capacity.

What are the reasons to be cautious?

There are three aspects of the fund worth pondering.  First, the expense ratio (1.50%) is above average even after expense waivers.  Even fully-grown, the fund’s expenses are likely to be in the 1.4% range (average for Artisan).  Second, the fund offers limited direct exposure to emerging markets.  While it could invest up to 30%, it has never invested more than 9% and, since late-2009, has had zero.  Many of the multinationals in its portfolio do give it exposure to those economies and consumers.  Third, the fund offers no exposure to small cap stocks.  Its minimum threshold for a stock purchase is a $2 billion market cap.  That said, the fund does have an unusually high number of mid-cap stocks.

Bottom Line

On whole, Artisan Global Value offers a management team that is as deep, disciplined and consistent as any around.  They bring an enormous amount of experience and an admirable track record stretching back to 1997.  Like all of the Artisan funds, it is risk-conscious and embedded in a shareholder-friendly culture.  There are few better offerings in the global fund realm.

Fund website

Artisan Global Value fund

Update – December 31, 2011 (4Q) – Fact Sheet (pdf)

© 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.

[fa_archives]

February 1, 2010

FundAlarm Annex – Fund Report

Objective

The fund seeks long-term capital appreciation by investing, mostly, in US stocks of various sizes, though it is likely to hold small and mid-cap stocks more frequently than large cap ones. The fund may also invest in “other equity-like instruments.”  The manager looks for companies with good management teams (those with “a history of treating public shareholders like partners”), little reliance on debt markets and above-average returns on equity.  Once they find such companies, they wait until the stock sells at a discount to “a conservative estimate of the company’s intrinsic value.”  The Fund is non-diversified, with both a compact portfolio (25 or so names) and a willingness to put a lot of money (often three or four times more than a “neutral weighting” would suggest) in a few sectors.

Adviser

Akre Capital Management, LLC, an independent Registered Investment Advisor located in Middleburg, VA. Mr. Akre, the founder of the firm, has been managing portfolios since 1986, and has worked in the industry for over 40 years. At 12/30/09, the firm had over $500 million in assets under management split between Akre Capital Management, which handles the firm’s separately managed accounts ($1 million minimum), a couple hedge funds, and Akre Focus Fund.  Mr. Akre founded ACM in 1989, while his business partners went on to form FBR.  As a business development move, it operated it as part of Friedman, Billings, Ramsey & Co. from 1993 – 1999 then, in 2000, ACM again became independent.

Manager

Charles Akre, who is also CEO of Akre Capital Management. Mr. Akre has been in the securities business since 1968 and was the sole manager of FBR Focus (FBRVX) from its inception in 1996 to mid-2009.  He holds a BA in English Literature from American University, which I mention as part of my ongoing plug for a liberal arts education.

Managements Stake in the Fund

Mr. Akre and his family have “a seven figure investment in Akre Focus, larger than my investment in the FBR fund had been.”

Opening date

August 31, 2009 though the FBR Focus fund, which Mr. Akre managed in the same style, launched on December 31, 1996.

Minimum investment

$2,000 for regular accounts, $1000 for IRAs and accounts set up with automatic investing plans.

Expense ratio

1.46% on assets of about $150 million.  There’s also a 1.00% redemption fee on shares held less than 30 days.

Comments

In 1997, Mr. Akre became of founding manager of FBR Small Cap Growth – Value fund, which became FBR Small Cap Value, the FBR Small Cap, and finally FBR Focus (FBRVX). Across the years and despite many names, he applied the same investment strategy that now drives Akre Focus.

Here’s his description of the process:

The process we employ for evaluating and identifying potential investments (compounding machines) consists of three key steps:

1. We look for companies with a history of above average return on owner’s capital and, in our assessment, the ability to continue delivering above average returns going forward. Investors who want returns that are better than average need to invest in businesses that are better than average. This is the pond we seek to fish in.
2. We insist on investing only with firms whose management has demonstrated an acute focus on acting in the best interest of all shareholders. Managers must demonstrate expertise in managing the business through various economic conditions, and we evaluate what they do, say and write for demonstrations of integrity and acting in the interest of shareholders.
3. We strive to find businesses that, through the nature of the business or skill of the manager, present clear opportunities for reinvestment in the business that will deliver above average returns on those investments.

Whether looking at competitors, suppliers, industry specialists or management, we assess the future prospects for business growth and seek out firms that have clear paths to continued success.

Mr. Akre’s discipline leads to four distinguishing characteristics of his fund’s portfolio:

1. It tends to be concentrated in (though not technically limited to) small- to mid-cap stocks.  His explanation of that bias is straightforward: “that’s where the growth is.”
2. It tends to make concentrated bets.  He’s had as much as a third of the portfolio in just two industries (gaming and entertainment) and his sector weightings are dramatically different from those of his peers or the S&P500.
3. It tends to stick with its investments.  Having chosen carefully, Mr. Akre tends to wait patiently for an investment to pay off.  In the past ten years, FBRVX never had a turnover ratio above 26% and often enough it was in the single digits.
4. It tends to have huge cash reserves when the market is making Mr. Akre queasy.  From 2001 – 04, FBRVX’s portfolio averaged 33.5% cash – and crushed the competition. It was in the top 2% of its peer group in three of those four years and well above average in the fourth year.

Those same patterns seem to be playing out in Akre Focus.  At year’s end, he was 65% in cash.  Prompted by a reader’s question, I asked whether he had a goal for deploying the cash; that is, did he plan to be “fully invested” at some point?  His answer was,no.  He declared himself to be “very cautious about the market” because of the precarious state of the American consumer (overextended, uncertain, underemployed).  He allowed that he’d been moving “gingerly” into the market and had been making purchases weekly.  He’s trying to find investments that exploit sustained economic weakness.  While he has not released his complete year-end portfolio, three of his top ten holdings at year-end were added during the fourth quarter:

• WMS Industries, a slot machine manufacturer. He’s been traditionally impressed by the economics of the gaming industry but with the number of casino visits and spending per visit both down dramatically, his attention has switched from domestic casino operators to game equipment manufacturers who serve a worldwide clientele.  By contrast, long-time FBRVX holding Penn National Gaming – which operates racetracks and casinos – is a “dramatically smaller” slice of AKREX’s portfolio.
• optionsXpress, an online broker that allows retail investors to leverage or hedge their market exposure.
• White River Capital, which securitizes and services retail car loans and which benefits from growth in the low-end, used car market

Potential investors need to be aware of two issues.

First, despite Morningstar’s “below average” to “low” risk grades, the fund is not likely to be mild-mannered. FBRVX has trailed its peer group – often substantially – in four of the past ten years.  If benchmarked against Vanguard’s Midcap Index fund (VIMSX), the same thing would be true of Mr. Akre’s private account composite.  Over longer periods, though, his returns have been very solid. Over the past decade returns for FBRVX (11% annually, as of 12/31/09)  more than doubled its average peer’s return while his separate accounts (8%) earned about a third more than VIMSX (6%) and trounced the S&P500 (-1.0%).

Second, Mr. Akre, at age 67, is probably . . . uhhh, in the second half of his investing career.  Marty Whitman, Third Avenue Value’s peerless 83-year-old star manager, spits in my general direction for mentioning it.  Ralph Wanger, who managed Acorn (ACRNX) to age 70 and won Morningstar’s first “fund manager lifetime achievement award” in the year of his retirement from the fund, might do the same – but less vehemently.  Mr. Akre was certainly full of piss and vinegar during our chat and the new challenge of building AKREX as an independent fund is sure to be invigorating.

Bottom Line:

Partnership is important to Mr. Akre.  He looks for it in his business relationships, in his personal life, and in his investments.  Folks who accept the challenge of being Mr. Akre’s partner – that is, investors who are going to stay with him – are apt to find themselves well-rewarded.

Fund website

Akre Focus Fund

FundAlarm © 2010

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May 1, 2009

FundAlarm Annex – Fund Report

Fund name:

Aegis Value (AVALX)

Objective

The fund seeks long-term capital appreciation by investing (mostly) in domestic companies whose market caps are ridiculously small. On whole, these are stocks smaller than those held in either of Bridgeway’s two “ultra-small” portfolios.

Adviser:

Aegis Financial Corporation of Arlington, VA. AFC, which has operated as a registered investment advisor since 1994, manages private account portfolios, and has served as the Fund’s investment advisor since the fund’s inception. They also advise Aegis High Yield.

Manager

Scott L. Barbee, CFA, is portfolio manager of the fund and a Managing Director of AFC. He was a founding director and officer of the fund and has been its manager since inception. He’s also a portfolio manager for approximately 110 equity account portfolios of other AFC clients managed in an investment strategy similar to the Fund with a total value of approximately $80 million. Mr. Barbee received an MBA degree from the Wharton School at the University of Pennsylvania.

Management’s Stake in the Fund:

As of August 31, 2008, Mr. Barbee owned more than $1 million of fund shares. He will also be the sole owner of the adviser upon retirement of the firm’s co-founder this year.

Opening date

May 15, 1998

Minimum investment

$10,000 for regular accounts and $5,000 for retirement accounts, though at this point they might be willing to negotiate.

Expense ratio

1.43% on assets of $66 million

Comments:

Let’s get the ugly facts of the matter out of the way first. Aegis Value is consistently a one- to two-star small value fund in Morningstar’s rating system. It has low returns and high risk. The fund’s assets are one-tenth of what they were five years ago.

‘Nuff said, right?

Maybe. Maybe not. I’ll make four arguments for why Aegis deserves a second, third, or perhaps fourth look.

First, if we’d been having this discussion one year ago (end of April 2008 rather than end of April 2009), the picture would have been dramatically different. For the decade from its founding through last May, Aegis turned a $10,000 initial investment into $36,000. Its supposed “small value” peer group would have lagged almost $10,000 behind, while the S&P500 would have been barely visible in the dust. Over that period, Aegis would have pretty much matched the performance of Bridgeway’s fine ultra-small index fund (BRSIX) with rather less volatility.

Second, ultra-small companies are different: benchmarking them against either small- or micro-cap companies leads to spurious conclusions. By way of simple example, Aegis completely ignored the bear market for value stocks in the late 1990s and the bear market for everybody else at the beginning of this century. While it’s reasonable to have a benchmark against which to measure a fund’s performance, a small cap index might not be much more useful than a total market index for this particular fund.

Third, ultra-small companies are explosive: Between March 9 and April 29, 2009, AVALX returned 66.57%. That sort of return is entirely predictable for tiny, deep-value companies following a recession. After merely “normal” recessions, Morningstar found that small caps posted three-year returns that nearly doubled the market’s return. But the case for tiny stocks after deep declines is startling. Mr. Barbee explained in his January 22 shareholder letter:

. . . in the 5 years following 1931, the Fama/French Small Value Benchmark returned a cumulative 538 percent without a down year, or over 44 percent per year. Even including the damaging “double-dip” recession of 1937, the benchmark returned over 21 percent annually for the 7 years through 1938. After market declines in 1973 and 1974, over the next 7 years (1975 through 1981), the Fama/French Small Value Benchmark returned a cumulative 653 percent without a down year, or greater than 33 percent per year.

Fourth, the case for investing in ultra-small companies is especially attractive right now. They are deeply discounted. Despite the huge run-up after March 9, “the companies held by the … Fund now trade at a weighted average price-to-book of 29.4%, among the very lowest in the Fund’s nearly 11-year history.” The universe of stocks which the manager finds most attractive – tiny companies selling for less than their book value – has soared to 683 firms or about five times the number available two years ago. After the huge losses of 2008 and early 2009, the fund now packs a tax-loss carryforward which will make any future gains essentially tax-free.

Bottom Line

Mr. Barbee, his family and his employees continue to buy shares of Aegis Value. He’s remained committed to “buying deeply-discounted small-cap value stocks,” many of which have substantial cash hoards. Investors wondering “how will I ever make up for last year’s losses?” might find the answer in following his lead.

Fund website

Aegis Value fund

FundAlarm © 2009

Fund name

Pinnacle Value (PVFIX)

Objective

Pinnacle Value seeks long-term capital appreciation by investing in small- and micro-cap stocks that it believes trade at a discount to underlying earnings power or asset values.  It might also invest in companies undergoing unpleasant corporate events (companies beginning a turnaround, spin-offs, reorganizations, broken IPOs) as well as illiquid investments.  It also buys convertible bonds and preferred stocks which provide current income plus upside potential embedded in their convertibility.  The fund can also use shorts and options for hedging.  The manager writes that “while our structure is a mutual fund, our attitude is partnership and we built in maximum flexibility to manage the portfolios in good markets and bad.”

Adviser

Bertolet Capital of New York.  Bertolet advises one $10 million account as well as this fund.

Manager

John Deysher, Bertolet’s founder and president.  From 1990 to 2002 Mr. Deysher was a research analyst and portfolio manager for Royce & Associates.  Before that he managed equity and income portfolios at Kidder Peabody for individuals and small institutions.  The fund added an equities analyst, Mike Walters, in January 2011.

Manager’s Investment in the fund

In excess of $1,000,000, making him the fund’s largest shareholder.  He also owns the fund’s advisor.

Opening date

April Fool’s Day, 2003.

Minimum investment

$2500 for regular accounts and $1500 for IRAs.  The fund is currently available in 25 states, though – as with other small funds – the manager is willing to register in additional states as demand warrants.  A key variable is the economic viability of registered; Mr. Deysher notes that the registration fees in some states exceed $1000 while others are only $100.  The fund is available through TD Ameritrade, Fidelity, Schwab, Vanguard and other platforms.

Expense ratio

1.47% on assets of $47 million.  Some sources report a slightly higher ratio, but that’s based on the fund’s ownership of a number of closed-end and exchange-traded funds.  There is a 1% redemption fee for shares held less than a year.

Comments

Could you imagine a “Berkshire Hathaway for ultra-micro-caps”?  Five factors bring the comparison to mind.  With Deysher, you’re got:

1. a Buffett devotee.  This is one of very few funds that provides a link to Berkshire Hathaway on its homepage and which describes Mr. Buffett’s reports as a source of ideas for companies small enough to fit the portfolio.

   Like Mr. Buffett, Mr. Deysher practices high commitment investing and expects it of the companies he invests in.  His portfolio holds only 47 stocks and his largest holding consumes 4% of the fund.  The fund’s prospectus allows for as much as 10% in a single name.  One of the key criteria for selecting stocks for the portfolio is high insider ownership, because, he argues, that personal investment makes them “pay more attention to capital allocation and not do dumb things just to satisfy Wall Street.”

   Also like Buffett, he invests in businesses that he can understand and companies which practice very conservative accounting and have strong balance sheets. That excludes many financial and tech names from consideration.

2. a willingness to go against the crowd.  Deysher invests in companies so small that, in some instances, no other fund has even noticed them.  He owns companies with trade on exchanges, but also bulletin board and pink sheet stocks.  As a result, his median market cap (MMC) is incredibly low.  How low?

   The average market cap is under $250 million, 10^thlowest of the 2300 domestic stock funds that Morningstar tracks, and he’s willing to consider companies with a market cap as low as $10 million.

   Deysher acquires these shares through both open-market and private placements.  He seems intensely aware of the need to do fantastic original research on these firms and to proceed carefully so as not to upset the often-thin market for their shares.

   One interesting measure of his independence is Morningstar’s calculation of his “best fit” index.  Morningstar runs regressions to try to figure out what a fund “acts like.”  Vanguard’s Small Value Index acts like, well, an index – it tracks the Russell 2000 Value almost perfectly.  Pinnacle acts like, well, nothing else.  Its “best fit” index is the Russell Mid-Cap Value index which tracks firms 22 times larger than those in Pinnacle.  When last I checked, the closest surrogate was the MSCI EAFE non-dollar index.  That is, from the perspective of statistical regression, the fund acted more like a foreign stock fund than a small cap US one.  (Not to worry – even there the correlation was extremely small.)

3. a patient, cash-rich investor.  Like Mr. Buffett, Mr. Deysher sort of likes financial panic.  He’s only willing to buy stocks that have been deeply discounted, and panics often provide such opportunities.  “Volatility,” he says, “is our friend.”  Since his friend has visited so often, I asked whether he had gone on a buying spree. The answer was, yes, on a limited basis.  Even after the instability of the past months, most small caps still carry an unattractive premium to the price he’s willing to pay. There are “not a lot of bargains out there.”  He does allow, however, that we’re getting within 5 – 10% of some interesting buying opportunities for his fund.

   And he does have the resources to go shopping.  Just over 42% of the portfolio is in cash (as of mid-October, 2011). While that is well down from the 53% it held at the end of the first quarter of 2011, it still provides a substantial war chest in the case of instability in the months ahead.  Part of those opportunities come when stocks “go dark,” that is they deregister with the SEC and delist from NASDAQ.  At that point, there’s often a sharp price drop which can provide a valuable entry point for watchful investors.

4. a strong track record. All of this wouldn’t matter if he weren’t successful.  But he is.  The fund has returned 3.9% annually over the past five years (as of 9/30/2011), while its average peer lost 1.4%. As of that same date, it earned top 1% returns for the past month, three months, six months and year-to-date, with top 2% returns for the past year and for the trailing five years.  That’s accomplished by staying competitive in rising markets and strongly outperforming in falling ones.  During the market meltdown from October 2007 to March 2009, Pinnacle lost 25% while his peers lost over 50%.  While his peers roared ahead in the junk-driven rally in 2009 and early 2010, they still trail Pinnacle badly from the start of the meltdown to now (i.e., October 2011).  That reflects the general pattern: by any measure of volatility, Pinnacle has about one-third of the downside risk experienced by its peers.
    
5. a substantial stake in the fund’s outcome.  As is often the case, Mr. Deysher is his own largest shareholder.  Beyond that, though, he receives no salary, bonus or deferred compensation.  All of his income comes from Bertolet’s profits.  And he has committed to investing all of those profits into shares of the fund.

   He has, in addition, committed to closing the fund as soon as money becomes a problem.  His argument, often repeated, is pretty clear: “We expect to close the fund at some point.  We don’t know if we will close it at $100 million or $500 million, but we won’t dilute the quality of investment ideas just to grow assets.”

Over the past few years, Mr. Deysher experimented with adding some additional elements to the portfolio. Those included a modest bond exposure and short positions on a growth index, both achieved with ETFs.  He also added some international exposure when he bought closed-end funds that were selling at a “crazy” discount to their own NAVs.

Quick note on CEF pricing: CEFs have both a net asset value (the amount a single share of the fund is worth, based on the minute-to-minute value of all the stocks in the portfolio) and a market value (the amount that a single share of the fund is worth, based on what it’s selling for at that moment.   In a panicked market, there can be huge disconnects between those two prices.  Those disconnects sometimes allow investors to buy $100 in stock for $60. Folks who purchase such deeply discounted shares can pocket substantial profits even if the market continues to fall.

Mr. Deysher reports that the bond ETF purchase was about a break even proposition, but that the short ETFs have been sold to generate tax losses.  He pledges to avoid both “inverse and long-macro bets” in the future, but notes that the CEFs have been very profitable.  While those positions have been pared back, he’s open to repeating that investment should the opportunity again present itself.

Bottom line

The manager trained with and managed money for twelve years with the nation’s premium small cap investor, Chuck Royce.  He seems to have internalized many of the precepts that have made both Mr. Royce and Mr. Buffett successful.

Pinnacle Value offers several compelling advantages over better known rivals: the ability to take meaningful positions in the smallest of the small, a willingness to concentrate and the ability to hedge.

Many smart people hold two beliefs in tension about small cap investing: (1) it’s a powerful tool in the long term and (2) it may have come too far too fast.  If you share those concerns, Pinnacle may offer you a logical entry point – Mr. Deysher shares your concerns, he has his eye on good companies that will become attractive investments should their price fall, and he’s got the cash to move when it’s time.  In the interim, the cash pile offers modest returns through the interest it earns and considerable downside cushion.

Company website

Pinnacle Value

© 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.

Objective

The fund will pursue 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.”

Adviser

Mairs & Power, Inc.  Mairs and Power, chartered in 1931, manages approximately $4.2 billion in assets. The firm provides investment services to individuals, employee benefit plans, endowments, foundations and close to 50,000 accounts in its three mutual funds (Growth, Balanced and Small Cap).

Manager

Andrew Adams.  Mr. Adams joined Mairs & Power in 2006.  From August 2004 to March 2007, he helped manage Nuveen Small Cap Select (EMGRX).  Before that he was the co-manager of the large cap growth portfolio at Knelman Asset Management Group in Minneapolis.   He also manages about $67 million in 64 separate accounts (as of 08/11).

Management’s Stake in the Fund

Mr. Adams and the other Mairs & Power staff have invested about $2 million in the fund.  At last report, that’s 83% of the fund’s assets.  Mr. Adams describes the process as “passing the hat” after “the lowest key sales talk you could imagine.”

Opening date

August 11, 2011.

Minimum investment

$2500, reduced to $1000 for various tax-sheltered accounts.  The fund should be available through Fidelity, Schwab, Scottrade, TD Ameritrade and a few others.

Expense ratio

1.25% after substantial waivers (the actual projected first-year cost is 12.4%) on an asset base of $2.4 million.

Comments

If you’re looking for excitement, look elsewhere.  If you want the next small cap star, go away.   It’s not here.

If you’d like a tax efficient way to buy high-quality small caps, you can stay.  But only if you promise not to make a bunch of noise; it startles the fish.

The Mairs & Power funds are extremely solid citizens.   Much has been made of the fact that this is M&P’s first new fund in 50 years.  Less has been said about the fact that this fund has been under consideration for more than five years.  This is not a firm that rushes into anything.

Small Cap is a logical extension of Mairs & Power Growth (MPGFX).  While Mr. Adams was a successful small cap fund manager, his prime responsibility up until now has been managing separate accounts using a style comparable to the Growth funds.  That style has three components.

• They like buying good quality, but they’re not willing to overpay.
• They like buying what they know best.  About two-thirds of the Growth and Small Cap portfolios are companies based in the upper Midwest, often in Minnesota.  They are unapologetic about their affinity for Midwestern firms: “we believe there are an unusually large number of attractive companies in this region that we have been following for many years. While the Funds have a national charter, their success is largely due to our focused, regional approach.”
• And once they’ve bought, they keep it.  Turnover in Mairs & Power Growth is 2% per year and in Balanced, where most of their bonds are held all the way to maturity, it’s 6%.

Mr. Adams intends to do the same here.  He’s looking for consistent performers, and won’t sacrifice quality to get growth.  About two-thirds of his portfolio are firms domiciled in the upper Midwest.  While he can invest overseas, in a September 2011 conversation, he said that he has no plan to do so.  The prospectus provision reflects the fact that there are some mining and energy companies operating in northern Minnesota whose headquarters are in Canada.  If they become attractive, he wants authority to buy them.  Likewise, he has the authority to buy convertible securities but admits that he “doesn’t see investing there.” And he anticipates portfolio turnover somewhere in the 10-20% range.  That’s comparable to the turnover in a small cap index fund, and far below the 50% annual turnover which is typical in other actively-managed small cap core funds.

Mairs & Powers’ sedate exterior hides remarkably strong performance.  Mairs & Power Growth (MPGFX) moves between a four-star and five-star rating, with average to below-average risk and above-average to high returns.  Lipper consistently rates it above-average for returns and excellent for capital preservation.  Mairs & Power Balanced (MAPOX) offers an even more attractive combination of modest volatility and strong returns.

Bottom Line:

There’s simply no reason to be excited about this fund.  Which is exactly what Mairs & Power wants.  Small Cap will, almost certainly, grow into a solidly above-average performer that lags a bit in frothy markets, leads in soft ones and avoids making silly mistakes.  It’s the way Mairs & Power has been winning for 80 years and it’s unlikely to change now.

Fund website

Mairs & Power Small Cap 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.

Objective

The Fund pursues long-term capital appreciation by investing primarily in common stocks of small and mid capitalization companies. Small and mid capitalization companies are those with market capitalizations of $4 billion or less at the time of purchase.  The Fund typically invests in 40 to 50 companies. The manager reserves the right to go to cash as a temporary move.

Adviser

Walthausen & Co., LLC, which is an employee-owned investment adviser located in Clifton Park, NY.  Mr. Walthausen founded the firm in 2007.  In September 2007, he was joined by the entire investment team that had worked previously with him at Paradigm Capital Management, including an assistant portfolio manager, two analysts and head trader. Subsequently this group was joined by Mark Hodge, as Chief Compliance Officer, bringing the total number of partners to six.  It specializes in small- and mid-cap value investing through separate and institutional accounts, and its two mutual funds.   They have about $540 million in assets under management.

Manager

John B. Walthausen. Mr. Walthausen is the president of the Advisor and has managed the fund since its inception. Mr. Walthausen joined Paradigm Capital Management on its founding in 1994 and was the lead manager of the Paradigm Value Fund (PVFAX) from January 2003 until July 2007.  He oversaw approximately $1.3 billion in assets.  He’s currently responsible for about half that amount.  He’s got about 30 years of experience and is, as I noted above, supported by the team from his former employer.  He’s a graduate of Kenyon College (a very fine liberal arts college in Ohio), the City College of New York (where he earned an architecture degree) and New York University (M.B.A. in finance).

Inception

December 27 2010.

Management’s Stake in the Fund

Mr. Walthausen has between $100,000 and $500,000 in this fund, over $1 million invested in his flagship fund and also owns the fund’s adviser.

Minimum investment

$2,500 for all accounts.  There’s also an “investor” share class with a $10,000 minimum and 1.46% expense ratio.

Expense ratio

1.70% on an asset base of about $1.2 million (as of 01/31/2011).

Comments

The case for Walthausen Select Value is Paradigm Value (PVFAX), Paradigm Select (PFSLX) and Walthausen Small Cap Value (WSCVX).   Mr. Walthausen is a seasoned small- and mid-cap investor, with 35 years of experience in the field.   From 1994 to 2007 he was a senior portfolio manager at Paradigm Capital.  He managed Paradigm Value from its inception until his departure, Paradigm Select Value from inception until his departure and Walthausen Small Cap Value from its inception until now.

Mr. Walthausen’s three funds have two things in common:  each holds a mix of small and mid-cap stocks and each has substantially outperformed its peers.

Walthausen Select parallels Paradigm Select.  Each has a substantial exposure to mid-cap stocks but remains overweight in small caps.  In his two years at Paradigm Select, Morningstar classified the portfolio as “small blend.”  Paradigm currently holds about one third of its assets in mid-caps while Walthausen Select is a bit higher, at 45% (as of 04/30/2011).  In each case, the stocks were almost-entirely domestic.  Walthausen Small Cap Value has about 85% small cap and 15% mid-cap, while Paradigm Value splits about 80/20.  In short, Mr. Walthausen is a small cap investor with substantial experience in mid-cap investing as well.

Each of Mr. Walthausen’s funds has substantially outperformed its peers under his watch.

Paradigm Select turned $10,000 invested at inception into $16,000 at his departure.  His average mid-blend peer would have returned $13,800.

Paradigm Value turned $10,000 invested at inception to $32,000 at his departure.  His average small-blend peer would have returned $21,400.  From inception until his departure, PVFAX earned 28.8% annually while its benchmark index (Russell 2000 Value) returned 18.9%.

Walthausen Small Cap Value turned $10,000 invested at inception to $14,000 (as of 08/2/2011).  His average small-value peer would have returned $10,400. Since inception, WSCVX has out-performed every Morningstar “analyst pick” in his peer group.  That includes Royce Special (RYSEX), Paradigm Value (PVFAX), Vanguard Tax-Managed Small Cap (VTMSX), Bogle Small Cap Growth (BOGLX), Third Avenue Small-Cap Value (TASCX) and Bridgeway Small-Cap Value (BRSVX).  WSCVX earned more than 40% in each of its first two full years.

Investors in Walthausen Select are betting that Mr. Walthausen’s success is not due to chance and that he’ll be able to parlay a more-flexible, more-focused portfolio in a top tier performer.   A number of other small cap managers (at Artisan, Fidelity, Royce and elsewhere) have handled the transition to “SMID-cap” investing without noticeable difficulty.  Mr. Walthausen reports that there’s a 40% overlap between the holdings of his two funds. There are only a few managers handling both focused and diversified portfolios (Nygren at Oakmark and Oakmark Select, most famously) so it’s hard to generalize about the effects of that change.

There are, of course, reasons for caution.  First, Mr. Walthausen’s other funds have been a bit volatile.  Investors here need to be looking for alpha (that is, high risk-adjusted returns), not downside protection.  Because it will remain fully-invested, there’s no prospect of sidestepping a serious market correction.  Second, this fund is more concentrated than any of his other charges.  It currently holds 42 stocks, against 80 in Small Cap Value and 65 in his last year at Paradigm Select.  Of necessity, a mistake with any one stock will have a greater effect on the fund’s returns.  At the same time, Mr. Walthausen believes that 75% of the stocks will represent “good, unexciting companies” and that it will hold fewer “special situation” or “deeply troubled” firms than does the small cap fund. And these stocks are more liquid than are small or micro-caps. All that should help moderate the risk.  Third, Mr. Walthausen, born in 1945, is likely in the later stages of his investing career.  Finally, the fund’s expenses are high which will be a major hassle in a market that’s not surging.

Bottom line

There’s considerable reason to give Walthausen Select careful consideration despite its slow start.   From inception through late August 2011, the fund has slightly underperformed a 60/40 blend of Morningstar’s small-core and midcap-core peer groups.   Mr. Walthausen’s track record is solid and he’s confident that this fund “will be better in a muddled market” than most.  While it’s more concentrated than his other portfolios, it’s concentrated in larger, more stable names.  Folks willing to deal with a bit of volatility in order to access Mr. Walthausen’s considerable skill at adding alpha should carefully track the evolution of this little fund.

Company link

Walthausen Funds homepage, which is a pretty durn Spartan spot but there’s a fair amount of information if you click on the tiny text links across the top.

© 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.

Objective

The fund seeks long-term growth by investing in global corporations involved in infrastructure and utility projects.  The fund holds about 100 stocks, 70% of its investments (as of 3/31/11) are outside of the U.S and 20% are in emerging markets.  The manager expects about 33% of the portfolio to be invested in emerging markets. The portfolio is dominated by utilities (45% of assets) and industrials (40%).  Price highlights the fund’s “substantial volatility” and recommends it as a complement to a more-diversified international fund.

Adviser

T. Rowe Price.  Price was founded in 1937 and now oversees about a half trillion dollars in assets.  They advise nearly 110 U.S. funds in addition to European funds, separate accounts, money markets and so on.  Their corporate culture is famously stable (managers average 13 years with the same fund), collective and risk conscious.  That’s generally good, though there’s been some evidence of groupthink in past portfolio decisions.  On whole, Morningstar rates the primarily-domestic funds higher as a group than it rates the primarily-international ones.

Managers

Susanta Mazumdar.  Mr. Mazumdar joined Price in 2006.  He was, before that, recognized as one of India’s best energy analysts.  He earned a Bachelor of Technology in Petroleum Engineering and an M.B.A., both from the Indian Institute of Technology.

Management’s Stake in the Fund

None.  Since he’s not resident in the U.S., it would be hard for him to invest in the fund.  Ed Giltanen, a TRP representative, reports (7/20/11) that “we are currently exploring issues related to his ability to invest” in his fund.  Only one of the fund’s directors (Theo Rodgers, president of A&R Development Corporation) has invested in the fund.  There are two ways of looking at that pattern: (1) with 129 portfolios to oversee, it’s entirely understandable that the vast majority of funds would have no director investment or (2) one doesn’t actually oversee 129 funds, one nods in amazement at them.

Opening date

January 27, 2010.

Minimum investment

$2,500 for all accounts.

Expense ratio

1.10%, after waivers, on assets of $50 million (as of 5/31/2011).  There’s also a 2% redemption fee on shares held fewer than 90 days.

Comments

Infrastructure investing has long been the domain of governments and private partnerships.  It’s proven almost irresistibly alluring, as well as repeatedly disappointing.  In the past five years, the vogue for global infrastructure investing has reached the mutual fund domain with the launch of a dozen funds and several ETFs.  In 2010, T. Rowe Price launched their entrant.  Understanding the case for investing there requires us to consider four questions.

What do folks mean by “infrastructure investing”? “Infrastructure” is all the stuff essential to a country’s operation, including energy, water, and transportation. Standard and Poor’s, which calculates the returns on the UBS World Infrastructure and Utilities Index, tracks ten sub-sectors including airports, seaports, railroads, communications (cell phone towers), toll roads, water purification, power generation, power distribution (including pipelines) and various “integrated” and “regulated” categories.

Why consider infrastructure investing? Those interested in the field claim that the world has two types of countries.  The emerging economies constitute one type.  They are in the process of spending hundreds of billions to create national infrastructures as a way of accommodating a growing middle class, urbanization and the need to become economically competitive (factories without reliable electric supplies and functioning transportation systems are doomed).  Developed economies are the other class.  They face the imminent need to spend trillions to replace neglected, deteriorating infrastructure that’s often a century old (a 2009 engineering report gave the US a grade of  “D” in 15 different infrastructure categories).  CIBC World Markets estimates there will be about $35 trillion in global infrastructure investing over the next 20 years.

Infrastructure firms have a series of unique characteristics that makes them attractive to investors.

• They are generally monopolies: a city tends to have one water company, one seaport, one electric grid and so on.
• They are in industries with high barriers to entry: the skills necessary to construct a 1500 mile pipeline are specialized, and not easily acquired by new entrants into the field.
• They tend to enjoy sustained and rising cash flows: the revenues earned by a pipeline, for example, don’t depend on the price of the commodity flowing through the pipeline.  They’re set by contract, often established by government and generally indexed to inflation.  That’s complemented by inelasticity of demand.  Simply put, the rising price of water does not tend to much diminish our need to consume it.

These are many of the characteristics that made tobacco companies such irresistible investments over the years.

While the US continues to defer much of its necessary infrastructure investment, demand globally has produced startling results among infrastructure stocks.  The key index, UBS Global Infrastructure and Utilities, was launched in 2006 with backdated results from 1990.  It’s important to be skeptical of any backdated or back-tested model, since it’s easy to construct a model today that would have made scads of money yesterday.  Assuming that the UBS model – constructed by Standard and Poor’s – is even modestly representative, the sector’s 10-year returns are striking:

Now we get to the tricky part.  Do you need a dedicated infrastructure fund in your portfolio? No, it’s probably not essential.  A complex simulation by Ibbotson Associates concluded that you might want to devote a few percent of your portfolio to infrastructure stocks (no more than 6%) but that such stocks will improve your risk/return profile by only a tiny bit.  That’s in part true because, if you have an internationally diversified portfolio, you already own a lot of infrastructure stocks.  TRGFX’s top holding, the French infrastructure firm Vinci, is held by not one but three separate Vanguard index funds: Total International, European Stock and Developed Markets.  It also appears in the portfolios of many major, actively managed international and diversified funds (Artisan International, Fidelity Diversified International, Mutual Discovery, Causeway international Value, CREF Stock). As a result, you likely own it already.

A cautionary note on the Ibbotson study cited above:  Ibbotson says you need marginal added exposure to infrastructure.  The limitation of the Ibbotson study is that it assumed that your portfolio already contained a perfect balance of 10 different asset classes, with infrastructure being the 11^th.  If your portfolio doesn’t match that model, the effects of including infrastructure exposure will likely be different for you.

Finally, if you did want an infrastructure fund, do you want the Price fund? Tough question.  The advantages of the Price fund are substantial, and flow from firmwide commitments: expect below average expenses, a high degree of risk consciousness, moderate turnover, management stability, and strong corporate oversight.  That said, the limitations of the Price fund are also substantial:

Price has not produced consistent excellence in their international funds: almost all of them are best described with words like “solid, consistent, reliable, workman-like.”  While several specialized funds (Africa and Middle East, for example) appear strikingly weak, part of that comes from Morningstar’s need to place very specialized funds into their broad emerging markets category.  The fact that the Africa fund sucks relative to broadly diversified emerging markets funds doesn’t tell us anything about how the Africa fund functions against an African benchmark.  Only one of the Price international funds (Global Stock) has been really bad of late (top 10% of its peer group over the three years ending 7/22/11), and even that fund was a star performer for years.

Mr. Mazumdar has not proven himself as a manager: this is his first stint as a manager, though he has been on the teams supporting several other funds.  To date, his performance has been undistinguished.  Since inception, the fund substantially trails its broad “world stock” peer group.  That might be excused as a simple reflection of weakness in its sector.  Unfortunately, it also trails almost everyone in its sector: for both 2011 (through late July) and for the trailing 12 months, TRGFX has the weakest performance of any of the twelve mutual funds, CEFs and ETFs available to retail investors.  The same is true of the fund’s performance since inception.  It’s a short period and his holdings tend to be smaller companies than his peers, but the evidence of superior decision-making has not yet appeared.

The manager proposes a series of incompletely-explained changes to the fund’s approach, and hence to its portfolio.  While I have not spoken with Mr. Mazumdar, his published work suggests that he wants to move the portfolio to one-third North America, one-third Europe and one-third emerging markets.  That substantially underweights North America (50% of global market cap) while hugely overweighting the emerging markets (11%) and ignoring developed markets such as Japan.  The move might be brilliant, but is certainly unexplained.  Likewise, he professes a plan to shift emphasis from the steadier utility sector toward the more dynamic (i.e., volatile) infrastructure sector without quite explaining why he’s seeking to rebalance the fund.

Bottom Line

The case for a dedicated infrastructure fund, and this fund in particular, is still unproven.  None of the retail funds has performed brilliantly in comparison to the broad set of global funds, and none has a long track record.  That said, it’s clear this is a dynamic sector that’s going to draw trillions in cash.  If you’re predisposed to establish a small position there as a test, TRGFX offers a sensible, low cost, highly professional choice.  To the extent it reflects Price’s general international record, expect performance somewhat on par with an index fund’s.

Fund website

T. Rowe Price Global Infrastructure.  For those with a finance degree and a masochistic streak (or an abnormal delight in statistics, which is about the same thing), Ibbotson’s analysis of the portfolio-level effects of adding infrastructure investments is available as Infrastructure and Strategic Asset Allocation, 2009.

© 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.