Dear friends,
Tornadoes are the scourge of the Midwest. Here in Iowa, for example, we were struck with 108 tornadoes last year. They’re all bad – even the common F1 tornadoes rip apart mobile homes and other light structures and toss cars off the road – but some are almost unimaginable. The blessedly-rare F5s, like the one that swept away Parkersburg, Iowa, last May – can be a mile wide with 250 mph winds that can pull apart one house and use the shrapnel to blow through the next. One cinematic rendering described them like "the hand of God" sweeping aside every human artifact they encounter.
Even for outsiders – folks who’ve never been nearer to one than The Weather Channel – the destruction is easy to see and to quantify. Eight dead, 67 injured, $100 million lost, 220 homes destroyed, the entire southern third of Parkersburg wiped away. The thing that’s almost impossible to communicate is the sense of utter dislocation that these storms can bring. Even folks intimately familiar with an area stand in the aftermath and don’t know where they are. All the familiar landmarks – the homes, the trees, the schools -- are gone. At times, the roads themselves are pulled out of the ground and tossed aside. Lacking any point of reference, you’re left to pick amidst the debris and wonder, "where am I? Is this the downtown or was this the neighborhood over by the park? Where did the Casey’s store go?" It feels, as Marx wrote, that "all that is solid melts into air" and you have trouble imagining ever feeling normal again.
It’s a sorrowful feeling and I’ve had friends changed, not for the better, by the experience. Folks who were once giving, become grasping. Folks who saw silver linings, become obsessed by grey clouds. Folks who were decisive, check and check again, and still don’t act. I don’t know if the change is forever but it’s at least "for long."
I am, at the moment, possessed by that same feeling of bewildered dislocation. I'm used to losing money. Heck, I owned WorldCom stock: I’m used to losing lots of money. But I’m not used to everything losing lots of money. As I reviewed 2008, I experienced a sense of disorientation and virtual paralysis. Despite my best planning and a cadre of first-rate managers, the answer to the question: "what worked in 2008" is "nothing."
My portfolio lives in two chunks: retirement (which used to be 15 years away but now, who knows?) and not. My retirement portfolio is overseen by three entities: TIAA-CREF, T. Rowe Price and Fidelity. In each retirement portfolio, I have three allocation targets:
Inevitably things vary a bit from those weightings (TIAA-CREF is closer to 75% domestic / 25% international, for example), but I get pretty close. Over the past decade, that allocation and good managers have allowed me to pretty consistently outperform the Total Stock Market by 1 – 2% per year.
In 2008, my retirement portfolios trailed pretty much every plausible benchmark.
|
TIAA-CREF |
(33.4) |
|
T. Rowe Price |
(38.0) |
|
Fidelity |
(39.1) |
|
Vanguard Total Stock Market |
(37.0) |
|
Benchmark Composite: 40% Total Stock Market + 40% Total International Stock + 20% Fidelity Strategic Income |
(34.6) |
How did that happen? TIAA-CREF wasn’t terribly surprising: Stock performed in-line with the markets while Real Estate posted the first loss (14.1%) in its 13-year history. That loss occurred entirely in the fourth quarter. It’s a testament to the fund’s impressive long-term record that it has still returned 7.3% annually for the past decade. The TIPs fund lost only 1.7% -- the best performance of any investment I had!
Most of my T. Rowe Price funds did relatively well (five of eight were above-average) but my largest holding – Global Stock – got crushed. The fund lost 54% and trailed 97% of its peer group after three solid-to-spectacular years. I chose Global because the manager had a great track record and I was hoping to delegate some of the asset allocation and rebalancing decisions. Bad timing as Mr. Gensler’s large emerging markets stake (30% of the portfolio at its peak) blew-up. Speaking of which, Emerging Markets Stock lost more in absolute terms (about 60%) and was almost as bad in relative terms, trailing 92% of its peers.
Fidelity hosted the saddest bunch of all. Only two of my nine Fido funds – Low-Priced Stock and Diversified International – outperformed their peers while three others were stunningly bad (Growth Discovery, Small Cap Stock and International Real Estate). My attempts to find portfolio hedges – in International Real Estate, Strategic Real Return and New Market Income, which invests in emerging market bonds – failed utterly.
My non-retirement portfolio is considerably more conservative: about 25% US stocks, 25% foreign stocks, 25% bonds and 25% cash. It posted substantial but not paralyzing losses of about 20%. I was (relatively) pleased with Artisan International Value (managed by Morningstar’s International Managers of the Year) and Leuthold Global (which lost about 28% from its midyear inception). The big blow-ups came in Utopia Core (which crashed, closed and liquidated) and Baron Partners (which merely crashed – down 47% despite a mandate which allows the manager to short stocks).
What am I doing in response to all of this?
I took a fairly serious look at where I stand. I did that by running my portfolio, age, salary and such in T. Rowe Price’s Retirement Income Calculator. The outputs there suggest that my current level of savings was no longer adequate to provide the prospect of a comfortable retirement. Before the crash, the same software predicted that I have a really high probability of reaching that goal. It suggested that I either delay retirement for a year or two (from 67 to 69) or increase my investments. A far-simpler program at Morningstar suggests that I’ll probably be okay, as long as I promise to die rather promptly. And so . . .
I’ve increased by retirement savings by a percent to about 12% of my salary. Augustana College, my employer, contributes an amount equal to 10% of my salary. Given TIAA-CREF’s relatively limited array of choices, I’ll continue to invest in Stock, Real Estate and TIPs.
I’ve decided to simplify my Fidelity portfolio hedges and plan to transfer the balance from International Real Estate, Strategic Real Return and New Market Income to Strategic Income. Strategic Income has many of the same investments and delegates the asset allocation to someone who obsesses on the topic.
I’m adding Strategic Income, Price’s newest fund, to my portfolio. I’ll fund the addition by transferring money from Spectrum Income and add monthly. The net effect will be an increased exposure to high yield and international bonds in the portfolio, both of which have attractive long-term potential.
Finally, I’m searching for a replacement for the defunct Utopia Core fund. Candidates include Hussman Strategic Total Return (HSTRX) and Nakoma Absolute Return (NARFX). Both offer the prospect of meeting my goal (positive real returns – not huge piles o’ loot but returns in excess of the CPI) and have attractively low investment minimums ($1000). And both, for better or worse, are run by college professors and have been profiled at FundAlarm. Nakoma’s expense ratio is high but they’ve got a good track record. I’d be happy, however, to consider other possibilities if folks would like to offer them.
I recently heard some very Midwestern advice from a fairly Midwestern voice: "Starting today, we must pick ourselves up, dust ourselves off, and begin again the work of remaking America." I suppose that’s about as healthy a plan as I could propose for a portfolio, so I guess that’s what I’ll try.
Oh, had I mentioned that the folks of Parkersburg are coming back? The Aplington-Parkersburg High School football field – known locally as "The Sacred Acre" and a symbol of local pride – was leveled in May (along with the coach’s own home) and rebuilt by August. The money came from local residents, but also from fund-raisers staged across the region by Parkersburg’s football rivals and by former Parkersburg players. Parkersburg and West Marshall were on the field for the scheduled season opener, playing in a chilly rain with the score kept on a scoreboard battered and twisted by the storm, but resurrected from the mud and still working. It is, perhaps, the best any of us can hope for.
A look at Roy's portfolio, and a few words of encouragement, sort of
Roy writes:(as of December 31, 2008, in alphabetical order within each percentage category) |
| More than 10% by dollar value | ||
|
Back to David, who asks: "Could anything look worse than my portfolio?"
I’m happy to report that the answer is a resounding yes. In our ongoing series of inquiries into the performance of various market wizards, we turn our attention to the folks who trumpet their "tactical allocation" skills. Tactical allocation funds typically start by surrendering to the obvious: the majority of stock pickers cannot beat a simple index and the vast majority cannot beat the index by any appreciable margin. Despite the self-serving twaddle peddled by a new generation of gurus ("buy and hold is dead," "the long-term is now," "it’s a stock-picker’s market"), over two-thirds of Vanguard’s low-cost index funds beat the majority of their actively-managed peers in 2008. Again. Over a three-year horizon, nearly 90% of index funds best their peers. Over five years, the fraction climbs to 95%.
Asset allocators ‘fess up to the problem but try to shift the grounds of the argument: "You’re right," they say, "we can’t pick superior stocks with any consistency. But what we can pick is asset classes. I may not be able to figure out whether Citigroup is about to tank, but I’ve got the dollar:euro exchange futures down pat!" These funds claim no overarching philosophy or strategy. Their mantra is "shift with the market." The Pacific Financial Group, for example, explains their Tactical fund’s approach this way:
"Tactical" investing involves modifying the allocation of a fund’s investments according to the valuation of the markets in which the fund invests. For example, the adviser may reduce the Tactical Fund’s investments in stocks when the adviser believes that other securities, such as bonds, are poised to outperform stocks. Unlike stock picking, in which an investor predicts which individual stocks will perform well, tactical investing involves judgments of the future return of complete markets or sectors.
As a result, most of these funds invest in (i.e, take on the expense ratios of) other mutual funds and ETFs. For reasons not immediately clear, fund companies decided that 2008 was to be the Year of the Allocators: 8 of the 10 funds with "tactical" in their names launched in 2007 or (more commonly) 2008.
How are the Wizards of Allocation doing? In general, not well. Two funds come close to being "bright spots." Pacific Financial Tactical (PFGTX) is the star of the show, losing just 6% since inception in July 07 while the Total Stock Market was dropping about 44%. The pricey (2.5%) fund-of-funds holds both long and short positions on the U.S. stock market, bonds and shorts on the U.S. dollar. Northern Global Tactical Asset Allocation (BBALX) is the grand-daddy of such funds. Launched in 1993, this institutional fund (can you say "$5,000,000 to start"?) has returned about 5% annually since inception. Its 21% loss in 2008 easily topped both the Total Stock Market and its peer group of hybrid funds. Its portfolio is mostly meat-and-potatoes: nearly 40% in domestic bonds, over 50% stocks with just about 5% devoted to global real estate and commodities. Like many tactical funds, it’s a fairly high-turnover fund-of-funds.
That’s about where the good news ends. The rest of the crew has managed returns somewhere between "sort of comparable to the market" and "pitiful, just pitiful." In the former category you find names like Arrow DWA Tactical and FundX Tactical Upgrader, and ING Tactical Asset Allocation.
Arrow DWA Tactical A (DWTFX) invests in ETFs. Since its launch last May, the fund has lost a percent or two less than the market. It combines a 5.75% front load with 2.06% expenses.
FundX Tactical Upgrader (TACTX) charges 2.11% and has modestly trailed the market since launch at the end of February 2008. The advisor relies on its proprietary Tactical Model ("composite of a series of models") to figure out where to invest and when to "market conditions warrant a defensive posture," at which point it invests in short funds. Apparently defensiveness wasn’t warranted in 2008 since only one of the 36 funds in its most recent portfolio (Diamond Hill Long-Short) had the option of shorting the market. Diamond Hill, along with a gold fund, constituted less than 5% of the fund’s portfolio.
ING Tactical Asset Allocation (ITAIX), another institutional fund, also modestly trailed the market since launch in March of 2008.
The latter category ("pitiful") is headlined by Wells Fargo WealthBuilder Tactical Equity (WBGAX): Over the past twelve months, through January 28, 2009, WealthBuilder has been a stunning WealthWrecker. The fund has declined by about 45% while the boring old Total Stock Market index lost a third less (about 35%). WealthBuilder’s losses are compounded by its 2.4% expense ratio, which creates a considerable headwind for its managers. Quaker Global Tactical Allocation (QTRAX) is down 48% since inception compared to a Total Stock Market loss of 40%. The expense ratio is 2.0%.
The Stars Actually Were, by contrast, Stars in 2008.
The Stars in the Shadows feature profiles funds that have two characteristics: records of consistent excellence and very little evidence of investor interest. The price of long-term excellence tends to be short-term disaster. Managers make money by thinking and acting differently than the majority of their colleagues. That notion has now been enshrined as "active share" in the academic literature. Larger active shares correlate with stronger long-term returns. The problem is that such managers tend to get ahead of the market: they buy what others shun, which means they lag the market until the herd begins moving down the trail they’ve blazed.
So, how’d they do? There are 37 "stars" and you’d expect three or four of them to be in the top 10% of their peer groups and another three or four to be in the bottom 10%. As it turns out, 11 stars ended up at the top of the ratings: three times as many as you’d expect. The top performers, relative to their peer groups, were:
FMI Provident, Hussman Strategic Total Return, Matthews Asian Growth & Income and Pinnacle Value – all in the top 1% of the peer groups. FMI Large Cap, Sextant Growth, Dreman Contrarian Small Cap Value, ING Corporate Leaders, Pennsylvania Avenue Event-Driven, Presidio and Sextant Core complete the list of funds at the top of their peer groups.
At the other end, seven funds ended up at the very bottom of their peer groups, about twice as many as you’d expect. The Dogs of ’08 were Metzler/Payden Emerging Europe, Dreman Contrarian Large Cap, E*TRADE Delphi Value, TCW Focused, Matthews Asian Technology, Alger (formerly Spectra) Technology and Auer Growth. The Auer result must have been particularly devastating to the manager since the fund, which lost 53.25% in its first year as a fund after years of success as a private account, holds all of his father’s retirement savings.
What distinguished the winners from the losers? I looked at a number of the usual suspects: manager tenure, expense ratio, portfolio concentration, portfolio churn – and found no obvious answer. The lower funds had a bit more turnover but otherwise had comparably-experienced managers, similar portfolios and so on. The most interesting pattern was in Morningstar’s risk ratings. The brief explanation of their system is this:
An assessment of the variations in a fund's monthly returns in comparison to similar funds, with an emphasis on downward variation. The greater the variation, the larger the risk score. . . Morningstar Risk is measured for up to three time periods (three-, five-, and 10-years). These separate measures are then weighted and averaged to produce an overall measure for the fund.
The clearest pattern in the fund performance for 2008 is that funds with lower risk scores consistently outperformed funds with higher scores. Of the 10 funds with the best relative performance, nine had "low" or "below average" risk. Of the 10 funds with the worst relative performance, eight had "above average" or "high" risk.
Wags have suggested that "beauty may be only skin deep, but ugly goes to the bone." In mutual fund terms, past performance may not predict future returns but – especially in a turbulent market – past risk does.
Time for our Annual Archive Clean-up
You’ll notice a series of changes in the new fund and "stars" archives this month. We’ve recognized a bunch of name changes and have dropped a couple funds. Name changes:
We bid a less-than-fond farewell to Spectra Technology – now the load-bearing Alger Technology – and Utopia Core, which is being liquidated.
At the same time I’m working overtime to clutter the Archive with updates
In penance for my arguably-disrespectful treatment of Fidelity’s Dynamic Strategies fund last month (I did sort of describe its portfolio as a "sprawling mess"), I thought I’d offer updates this month of three Fido offerings that we’d covered earlier:
Since Fidelity Emerging EMEA has so many overlaps with T. Rowe Price’s Africa and Middle East fund, I thought it sensible to add the Price fund. Then one other, for reasons I can no longer recall.
Briefly noted
If you want to see me look utterly baffled, ask me why Manning & Napier Tax-Managed (EXTAX) has only $15 million in assets. Frankly, I have no idea of why. EXTAX beat the market again in 2008, a feat it’s accomplished in eight of the past 10 years. While many folks bemoan "the lost decade" in which both the Total Stock Market and S&P 500 have lost money (VTSMX is down 0.7% annually, VFINX down 1.5% annually), EXTAX has actually made money. Its 10-year return is a bit above 4% and it generates a minimal tax drag. There are precisely seven large-core funds with a better long-term record than EXTAX, the next-smallest of which is 20 times EXTAX’s size. Durndest thing.
Not that anyone really cares, but Northern Trust has decided to liquidate all 17 of its NETS-branded ETFs. They were mostly single country funds that allowed interested parties to place concentrated bets on Ireland, Portugal or Italy. It turned out that no one was interested, the funds had total assets of just $30 million and maintaining them made no sense.
If you’re anxious for the opportunity to be guaranteed virtually no return on your investment, you’d better act quick before you lose the chance. While virtually all formerly-closed equity mutual funds have reopened, one set of funds is closing at an accelerating pace: Treasury (or tax-free) money market funds. Allegiant, Evergreen and Schwab closed their funds to new investors in December, JPMorgan closed theirs a bit earlier while Vanguard closed two of theirs in late January. The problem is simple: the yield on 3-month Treasurys is one (1!) basis point and the funds’ average yield is about 20 basis points while the cost of running the funds is somewhere around 75 basis points. In short, every new dollar entering the fund pushes the fund’s advisor closer to bankruptcy.
Why would you want a fund that pay 0.01% interest? At that rate, a $1000 invest would grow to $1010 – in a century. Nonetheless, large investors – folks whose investments are far larger than the amounts guaranteed by the FDIC – view Treasury funds as the single-safest parking place for large amounts of money in uncertain times. As investors frantically scramble to buy Treasurys, their prices go up, their yields go down and investors are left with zero. Or less, since some commentators have fretted about the prospect of "negative yields". That’s right – that would be a fund which guaranteed to lose money for you, but only a little.
And, finally: So that we are able to pay the bills
If you’re interested in supporting FundAlarm but just don’t buy that much stuff from Amazon, don’t forget the other easy options. Folks with a PayPal account (the money transfer system used by eBay, among others) can just click here to make a contribution – ehhh . . . how about a buck-fifty a month? – with just a couple mouse clicks. Folks suspicious of electronical stuff are always welcome to send a check directly to FundAlarm, 18653 Ventura Boulevard, PMB #638, Tarzana, CA 91356.
As ever,
David
| NEW Discussed this month: | ||
|---|---|---|
| Pacific Financial Tactical (PFGTX): This fund has the ability to go anywhere and buy anything in pursuit of its goals of low volatility, consistent performance, and positive total returns regardless of market conditions. It has succeeded brilliantly over its first 18 months of existence and is using its flexible mandate to great effect. The question is whether I’m setting myself up for another heartbreak. | ||
Congress Large Cap Growth Fund will seek long-term capital appreciation by investing in stock of large cap companies that "demonstrate consistent earnings growth and potential relative to other companies in their industry, and the market overall." They can invest in international stocks through ADRs. The fund will be managed by a three-person team led by Daniel A Lagan, the president of the advisory firm. The firm’s private account composite has, over the past ten years, comfortably outperformed both the S&P500 and the Russell 1000 Growth indexes. Minimum investment is $10,000 which is lowered to $5000 for AIP accounts and $2000 for retirement accounts. 1.25% expense ratio.
| Incline Capital Long/Short Fund seeks long-term capital appreciation across a wide variety of market conditions, with a secondary objective of capital preservation during adverse market conditions. The Fund will apply "proprietary, trend-following methodologies to invest in exchange-traded funds," including those which invest in U.S. and foreign equity securities; U.S. fixed income securities; commodities; and the U.S. dollar. The fund may be positioned anywhere from 130% net long to 50% net short. The fund "Adviser also actively employs the use of cash and cash equivalents as a strategic asset class in an attempt to ... sidestep market declines." Michiel H. Hurley is the Portfolio Manager and managed Fusion Global Long/Short Fund (FGLSX) from its inception in September 2007 to November 2008. During Mr. Hurley’s tenure, that fund lost 2% while the market dropped 40%. The minimum initial investment is $2,500 for regular accounts and $1,000 for retirement accounts. Expense ratio of 2.45%.
James Long-Short Fund seeks to provide long-term capital appreciation. The Fund can invest, long and short, in stocks and ETFs. The long-short balance will shift with the adviser’s market outcome. At the extremes, the fund can be 100% long or short. The fund will be managed by a seven-person team which includes three members of the founding James family. The same team runs James Market Neutral, which has been one of the best performing funds in its category. Minimum initial investment is $2,000 or $500 for IRAs or Coverdells. Expenses will be north of 2.0% but haven’t yet been finalized.
Manning & Napier Real Estate seeks to provide high current income and long-term capital appreciation by investing principally in companies in the real estate industry. The fund is focused on U.S. real estate and might invest in real estate investment trusts (REITs), real estate developers and brokers, and real estate operating companies (REOCs), building suppliers, and mortgage lenders. The management team has about 10 people, including Manning & Napier’s senior people. $2000 minimum investment. Expenses capped at 1.40%.
Motley Fool Independence Fund will seek capital appreciation by investing globally, with a bias toward smaller cap stocks. They describe their approach as "value-based" They maintain the right to buy, or short, pretty much anything: common stocks, convertibles, ETFs, ADRs, REITs, MLPs, warrants and bonds. The managers will be Bill Mann, senior investing analyst for The Motley Fool from 2001 to 2008 and editor of several of their newsletters, and Bill Barker, senior analyst for equity research, specializing in value-stock analysis at Motley Fool. Mr. Barker has also worked for the SEC’s Office of Investor Education and the Treasury Department. Expenses of 1.35% after waivers, plus a 2% redemption fee and a $24/year nuisance charge for accounts with under $10,000. There will be a performance adjustment to the fee after the fund has been in operation for 12 months. The minimum initial investment in the Fund is $3,000 though there’s no automatic investment option. When I tried to learn a bit more by going to foolfunds.com, I received this distinctly ominous warning: "The Web server you are attempting to reach has a list of IP addresses that are not allowed to access the Web site, and the IP address of your browsing computer is on this list."
PowerShares Prime Non-Agency RMBS Opportunity Fund will be an actively-managed ETF whose investment objective is total return. The Fund will invest in "non-agency mortgage-backed securities collateralized by pools of Prime residential mortgage loans." Those are pools of mortgage loans sold to investors by banks and similar firms. "Prime" is the highest of the three grades of mortgage loans. It will be managed by a team of five Invesco managers. Expenses not yet announced.
PowerShares Alt-A Non-Agency RMBS Opportunity Fund will be an actively-managed ETF whose an investment objective of total return. The fund will invest in non-agency mortgage-backed securities collateralized by pools of Alternative-A (Alt-A) residential mortgage loans. Alt-A loans were made to folks whose credit history did not qualify them for prime loans. In the pressure to generate sales volume, this loan category became the homeground of low-documentation loans, then no-documentation loans and what were cynically called "liar loans." At base, a lot of Alt-A borrowers were folks making $30,000 who were told they needed to claim $90,000 in income to qualify for a loan, so they claimed $90,000 in income. Invesco believes that the mortgage market is badly oversold and that many of these securities are way underpriced for the actual amount of risk they pose. It will be managed by a team of five Invesco managers. Expenses not yet announced.
Royce Focus Value Fund’s investment goal is long-term growth of capital. It will invest mostly in micro- to mid-cap stocks and may invest up to 35% internationally, including in emerging markets. Whitney George will manage the fund. He currently, and successfully, manages a bunch of other Royce funds including Micro-cap, Premier, Value and Global Select. $2000 minimum, $1000 for AIPs and IRAs. Expenses of 1.49%.
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| NEW Discussed this month: | ||
|---|---|---|
| Capital Advisors Growth Fund (CIAOX): If you’re like me, you spend a lot of time pondering this question: "so, where do big money investors from Broken Arrow and Sapulpa put their money to get the big returns?" After considerable investigation, I may have found the answer: the Capital Advisors Growth Fund, headquartered in Tulsa, Oklahoma. | ||