Dear friends,

June’s column generated rather more feedback than usual, so I thought I’d start by highlighting three sets of comments I received.

RiverNorth Core Opportunity: one correction and one clarification

In June 2009, I profiled RiverNorth Core Opportunity (RNCOX).  RNCOX strikes me as worthy of notice because it offers an experienced management team with a distinctive, sensible strategy.  At base, the fund combines tactical asset allocation with the opportunity to arbitrage the frequently-irrational discounts at which closed-end funds (CEFs) sell.  CEFs, the original version of actively-managed ETFs, are actively-managed funds which sell on exchanges throughout the day.  At the end of each day, you can determine the fund’s net asset value by looking up the actual value of securities in the portfolio.  As it turns out, market inefficiencies (read: “alternating waves of investor greed and panic”) mean that you can frequently buy shares of CEFs for far less than the funds’ NAVs.  When RNCOX’s managers want to invest in a sector, they look to see whether there are CEFs selling at discounts which are substantially greater than what’s typical for those funds.  If so, they gain sector exposure at a discount and look to profit when (1) the sector rises and, separately, (2) when the fund’s discount regresses to normal.

Here’s the correction: RNCOX does not short CEFs selling at an irrational premium to their NAVs, though the managers have other investment products which do have that option.

And the clarification: I correctly noted that the fund’s current expense ratio is 2.45%.  After continuing conversations with the manager, Patrick Galley, I decided to highlight the fact that the e.r. is much more variable than is the case with most funds.  A lot of the expense is the cost of the underlying funds, which can be either low-cost ETFs or relatively high-cost CEFs.  Mr. Galley’s point is that he invests in high-cost funds only when they’re irrationally priced and he believes he can lock in a substantial arbitrage gain.  That strikes me as a perfectly sensible use of investors’ money: charge more only when there’s a high probability that you can make them more. 

We have updated the RNCOX profile to reflect both of these amendments.

So much for Judge Sotomayor’s fund portfolio

In June, I suggested that President Obama had singularly bad taste in mutual funds and offered two hopes: (1) that he has better taste in Supreme Justices and (2) that perhaps his nominee, Sonia Sotomayor (age 55), might harbor a nice global equity fund somewhere in her portfolio. 

While the jury (and the Senate) is out on my first hope, the second has been squashed.  A sharp-eyed FundAlarm reader, “Paul,” writes:

Funny you should mention that as just a few days later, Sotomayer did indeed disclose her personal assets.

$1.16 million as follows:

·        $997,500 in a Greenwich Village condo

·        $20,000  stake in another condo

·        $109,000 in cars and personal property

·        And the clincher: $31,985 in the bank.

Perhaps a bit heavy in the real estate, and it does leave out her defined benefit plan, referred to here: “Sonia Sotomayor has a large defined benefit pension with a current market value of roughly $2.5 million. Sonia Sotomayor has roughly $1 million in equity in her Greeenwich Village condo.”

Some random Googling reproduces these numbers in various locations.

The funny part is that she makes $179,500 annually and is being criticized for not amassing a bigger pile.  Tom Smith, who writes “The Right Coast” blog, chimes in that "any day she wants to she could walk out of her current job and into a partnership at a law firm in Manhattan or DC and get paid (guessing again) maybe $2 million a year, with the potential for a lot more. In short, when you take Sotomayor's human capital and circumstances into account, there is nothing wrong with her balance sheet. Sure, she could have another $500,000 tucked away, and that would be nice. But why should she? She has no dependents, except maybe her mother, but her brother is a doctor who, let us assume, is doing well. She has a guaranteed job for life with very generous retirement and health benefits, and any day she decides she wants to be a millionaire, all she has to do is pick up the phone” (“Mankiw criticizes SCOTUS nominee’s personal finances,” 5/26/2009). 

Good point, Paul!  And thanks for helping me encounter, for the first time, Mankiw’s criticism of the judge’s failure to “save and intertemporally optimize their consumption plans.” 

Alligators in the sewers, choking Dobermans and cash on the sidelines

Other readers took me to task for endorsing America’s newest urban legend: “cash on the sidelines.” I discussed the possibility in my closing comments:

We enter summer with less certainty than at any time in the recent past. The "sell in May and go away" mantra is being challenged by many seasoned investors who, like Steve Leuthold, have declared "now is the time to make money." His logic is clear: huge piles of cash are sitting in zero interest money markets and low yield bonds (Treasuries may actually have negative returns by the end of 2009), and the managers of those funds are inching closer to an "institutional underinvested panic."

One correspondent regretted the fact that I was “suckered into the myth that there is EVER any ‘mountain of cash’ ready to flood into the market.”  There are, at base, three arguments against the “sidelined cash” claim.  The first is that sidelined cash doesn’t exist; it’s an illusion created by the fact that there’s a huge amount of money in short-term Treasuries.  John Hussman, a former econ professor and manager of the Hussman funds, holds that this money  isn’t fungible: it’s not available to flood anybody since moving that money into the stock market requires selling your Treasuries to somebody.  That “somebody” either already owns stocks (and will have to sell them to raise cash to buy your Treasuries) or might have been in the market for stocks and was lured away by the offer of your Treasuries.  You can review the argument in Hussman’s 2006 essay, “There's No Such Thing as Idle Cash on the Sidelines.”

The second argument is that there is cash on the sidelines but that it’s irrelevant: in the past, huge cash piles – measured by money market assets – have not presaged market rises nor have low cash reserves signaled market tops.  That case is provided in a 2008 SeekingAlpha essay entitled “What About 'All That Cash on the Sidelines'?”

The third argument is that there is such a thing as cash on the sidelines, it did enter the market and it did drive prices higher.  But it’s all gone now.  Charles Biderman of TrimTabs.com makes this argument on a mid-June CNBC interview (available on YouTube), in which he concludes that retail investors are showing up just in time to be eaten alive (again).  He is, not surprisingly, “fully bearish” at the moment and argues for shorting the market, holding cash and/or holding high-grade, long-term bonds.

So, is that it?  Game over?  Not necessarily.  It might be worth looking at the analyses of Dr. Hussman and Mr. Biderman’s forecasts, done by the CXO Advisory Group and presented on the “Guru Grades” page.  They note that neither Dr. Hussman nor Mr. Biderman has gotten even half of their forecasts rights (49% and 44%, respectively) and that Mr. Biderman’s liquidity analyses explain all of 4% of the market’s movement.  And the Investment Company Institute reports (6/17 and 6/24) that flows to both money-market and long-term funds were rising at the end of June. 

Geez, all of this over one measly sentence!  I’ve got to be more careful.

I’m not dead yet!

I’m such a sucker for little funds that have been steadily responsible for decades.  The Valley Forge (VAFGX) fund, toodling along with its tiny asset base and five-star credentials, is cool.  The fact that its manager – Bernard Klawans – has been the same since the first Nixon administration and that he’s gone out of his way to help shareholders and competitors alike just delights me.  I’m likewise intrigued by Stratton Multi-Cap (STRGX), which Jim Stratton has piloted for 37 years, or the Philadelphia Fund (PHILX), whose manager has been on-board for just 22 years but whose origins lay in the Second World War. And I’ve already profiled ING Corporate Leaders Trust B (LEXCX, née Lexington Corporate Leaders), whose portfolio hasn’t changed since 1935.

On whole, there appear to be a dozen stock funds whose managers have been around for a quarter century or more.  Without exception, they’re solid and, almost without exception, they’re tiny.  Investors occasionally have to give up some of the fund world’s frills and fads – oh, say, websites and 800-numbers – in dealing with some of the funds, but you do get a certain calm stability with most.  With the occasional exception of CGM Mutual, the funds have below-average turnover (about half in the single digits), moderate risk, decent bear market performance and below-average expenses.

That said, the prospectuses might want to include a disclosure of “superannuation risk.” In the case of Armstrong Associates, the 73-year-old fund manager is one of the youngsters at the board meetings.  Mr. Lawson’s independent directors were all born between 1927 and 1933, which gives them both the perspective of age and the prospect of erupting in insults aimed at “that socialist scoundrel, Roosevelt.” 

Marketers to mutual fund: “Well, duh!”

Effective June 30, 2009, the Trust’s Board of Trustees approved a change to the name of the Dorfman Value Fund (DORFX) to Thunderstorm Value Fund. The reason for the name change is that the parent firm of Thunderstorm Mutual Funds LLC (the “Adviser”), Thunderstorm Capital LLC, has decided the best way to promote a more coherent marketing message is to rebrand all of its products to begin with the word “Thunderstorm.”

Earth to Dorfman: did you really think that naming your fund after a character in Animal House (Kent Dorfman, an overweight, clumsy legacy pledge), especially one whose nickname was “Flounder,” was sharp to begin with? Name recognition is all well and good . . . . as long as your name doesn’t cause sniggering. I can pretty much guarantee that when I launch my mutual fund, it isn’t going to be Snowball Special Strategy (DAVYX).   The manager, John Dorfman, was a Wall Street Journal and Bloomberg News columnist.  He’s put up okay, but not startling, numbers investing in “good companies plagued by bad news.”  The fund, past and present, sports a 2% expense ratio and $25,000 investment minimum, below average returns.

What exactly qualifies as “tweaking”?

I can find three common definitions: “to fine-tune,” “to make fun of,” and (in urban slang) “to be under the influence of methamphetamine.”  The question arises from the MutualFundWire.com’s announcement that “WisdomTree Tweaks Four ETFs” (6/25/2009).  Among the tweaks, WisdomTree Japan Equity Income fund became the World ex-US Growth Fund.  So, let’s say you’re an investor who bought the ETF in pursuit of conservative exposure to Japan or dividend income.  Would you consider a shift from Japan to “everyone but the U.S.,” from value to growth, and from dividends to not, more like a “fine-tuning” or more like the fund’s board “making fun of” you?  WisdomTree’s Low P/E Fund has been tweaked so that it will no longer screen funds for . . . well, low P/E.  Europe Equity Income will no long fret about pursuing equity income from European stocks but instead will invest in U.S., developed and developing markets as the Global Equity Income Fund.

The last comparable “tweak” I can recall came with the creation of the PFW Water Fund (PFWAX).  Prior to a June 1, 2007 tweaking, it was known as the Bender Growth Fund. Then, for about 60 days, it was SBG Growth Fund. Before being tweaked, it was a diversified domestic growth fund, run by Robert Bender and possessing a decent long-term track record.  It invested, e.g., in Monster WorldWide, eBay, Apple, and Starbucks.  After June 2007, the only thing that remained was the track record, which shows up in the fund’s Morningstar profile and prospectus though not in its marketing material. The Board of the new fund also considers investing in water-related securities to be “non-fundamental,” which means that – with 60 days notice – they could transform this into the Santa Barbara Japan Small Cap or SB “Throw a TARP Over Them” Financials fund.

Don’t Blame the Lawyers, They’re Obligated to Say This Stuff

The various State and Model Codes of Professional Responsibility make it clear: lawyers must “vigorously represent” the interests of their clients.  Heck, in some jurisdictions, their obligation is to “zealously represent” them.  Former Janus manager Ed Keely sued Janus for millions in compensation that he claimed he was unfairly denied.  Janus provided evidence to the contrary which was, unfortunately, faked.  Here’s Denver District Judge John McMullen on the matter:

What I have found is manipulation of critical evidence that would have resulted in false testimony had it not been uncovered. I would find that there’s very strong circumstantial evidence that this was not an innocent mistake.

Janus’s lawyers were pretty make stuck with saying some version of the following: it was all just an "honest mistake," "the court’s ruling . . . based on misapprehension of the facts" and they were "confident the decision will be reversed" by the time of the trial in May (“Public relations rule #2: Don’t get caught tampering with evidence in a court trial,” March 2009).

Oops.  Far from a reversal, a Colorado jury awarded nearly $5 million to Mr. Keely. Yes, Esteemed Esquire, we know: Just another "honest mistake."

Morningstar has assigned a “corporate culture” grade of D to Janus. Fortunately for Janus, being reprimanded by a judge for (probably intentionally) manipulating evidence isn't considered by Morningstar in arriving at that grade. Otherwise, a "D" actually might be generous. 

July’s Fund Update: Industry Leaders Fund (ILFIX)

Industry Leaders remains on my short-list, with Manning & Napier Tax-Managed (EXTAX), of the funds that long-term investors really should be taking more seriously.  While the fund’s performance remains the same – which is to say, consistently strong – some fairly important business development changes are afoot.  And they do have some of the fund industry’s cutest tchotchkes.

Briefly Noted:

Half right on Top Flight: In the June cover essay, I noted that the former Rock Canyon Top Flight Long -Short Fund (TOPFX) was becoming the Quaker Long-Short Tactical Allocation fund. I speculated that “the new fund will combine its current high expenses with a sales load.” Right about the sales load: 5.75% for the “A” shares. Wrong about the expense ratio: it will decline from its current 4.2% to between 2.83 – 3.65%, depending on share class.

Dreman decides to reduce its exposure to the retail market. Effective June 1, Dreman Contrarian MidCap Value, Dreman Contrarian Large Cap Value Fund and the Dreman Quantitative Large Cap Value Fund became institutional funds with $100,000 minimums. In a slightly churlish renaming, Dreman Quantitative Large Cap Value became Dreman Market Over-Reaction Fund. Dreman still offers several no-load, retail funds: Contrarian International Value (which has performed splendidly since its October launch), Quantitative Small Cap Value (still is pretty weak), Contrarian Small Cap Value (a consistent peer-beater), and Quantitative Mid Cap Value (on which the jury’s still out).

SPARX Japan Fund (SPXJX) and SPARX Japan Smaller Companies Fund (SPJSX) will become “Hennessy” funds in September, at the same time that SPARX Asia Pacific Opportunities Fund and SPARX Asia Pacific Equity Income Fund become “former” funds. The two Japan funds are pretty solid offerings.  SPJSX, in particular, offers rare access to smaller Japanese companies, which often seem more compelling than their large cap counterparts.

Adding to the fund liquidation tally, the Board of Trustees voted to liquidate the Aston/Fortis Global Real Estate Fund on or about July 30, 2009. At about the same time, Aston’s board fired MB Investment Partners, who advised Aston/MB Enhanced Equity Income Fund (AMBEX) and hired M.D. Sass Investors Services in their stead. The fund was promptly rechristened Aston/M.D. Sass Enhanced Equity Fund. There is no change in the Fund’s current investment objective or principal investment strategies, which is to generate income by investing in dividend-paying stocks and writing covered call options on a substantial portion of the underlying portfolio.

PIMCO’s Board decided to liquidate the PIMCO Fundamental Advantage Tax Efficient Strategy Fund on or about June 29, 2009.

The Nicholas Liberty (NLBTX) fund has been liquidated by its shareholders.  It was a tiny, mediocre mid-cap growth fund.

The Atlantic Whitehall Growth, Atlantic Whitehall Mid-Cap Growth, and Atlantic Whitehall Equity Income Funds are being eaten by a series of AIM funds: AIM Large Cap Growth, Mid Cap Core Equity and Disciplined Equity Fund, respectively.

Value Line Centurion Fund (available only as an insurance product) is the latest Value Line fund to discover that it’s hard to make money using the Value Line system.  Effective mid-June, the manager gained the freedom to invest in all funds ranked 1, 2 or 3 in the Value Line system.  Before that, he had to actually buy from stocks that Value Line liked, the 100 stocks ranked 1 and the top 100 stocks ranked 2.  The First Trust Value Line 100 ETF (FVL) has pretty consistently trailed its mid-cap peers and the S&P500, while the Value Line Fund (VLIFX) is solidly in the bottom 5% of its peer group over the past five years. Brad Brooks has put together a splendid record at Value Line Income & Growth (VALIX), a stock-bond hybrid, but it’s not clear how much of that is due to the Value Line stock system as opposed to asset allocation and bond selection decisions.

On the upside, several funds have actually reduced their expense ratios. Effective July 1, 2009, Third Avenue lowered the expense cap for Third Avenue International Value (TAVIX) to 1.40%, for a two year period. (The previous expense cap was 1.75%, and the current gross expense ratio, as of April 30, 2009, is 1.51%).

At a special meeting held on June 5, 2009, The Azzad Funds Board of Directors decided that the Azzad Ethical Mid Cap Fund’s (ADJEX) overall expense ratio will be reduced from 1.9% to 0.99% with the fund’s new fiscal year starting July 1, 2009.  Presumably that’s a marketing move: the fund hired a new manager last year and has only $3 million in assets, despite a modestly above-average record.

Speaking of marketing moves, the Board of Trustees has approved a reverse split for Direxion Daily Mid Cap Bear 3X Shares. After the close of the markets on June 24, 2009, the Mid Cap Bear Fund made a two for one reverse split of the Fund’s shares.

Class A shares of the Forward International Fixed Income Fund were liquidated on June 9, 2009. On June 12, 2009, the Kensington Select Income Fund was reorganized as the Forward Select Income Fund.

In closing . . .

Each year, Roy and I disclose our portfolios, discuss their composition and the changes we’re making.  Our discussion, in February, of 2008 was understandably bleak but I tried to draw some strength from the resilience of the good people of Parkersburg, Iowa.  The town had been leveled in May by an F-5 tornado, once likened to “the hand of God.”  Hundreds of homes – nearly a third of the town – were flattened and eight people perished.  More hopeful, I noted:

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.

I am deeply saddened to report that Ed Thomas, the Parkersburg coach who touched so many lives in 34 years as coach and who spearheaded the town’s rebuilding, had his life ended on June 24^th.  Thomas was in the school gym, working with dozens of young players, when a deranged former student approached and shot him.  He died after reaching the hospital.

If his death reminds us of the fragility of life, his life, more powerfully, reminds us to live beyond ourselves.  Americans are famously fickle: It's an attribute recognized as early as the 1835 publication of Tocqueville’s Democracy in America:

In America I saw the freest and most enlightened men placed in the happiest circumstances that the world affords; it seemed to me as if a cloud habitually hung upon their brow, and I thought them serious and almost sad, even in their pleasures.

The chief reason for this [is that the Americans] are forever brooding over riches they do not possess. It is strange to see with what feverish ardor the Americans pursue their own welfare, and to watch the vague dread that constantly torments them lest they should not have chosen the shortest path which may lead to it.

A native of the United States clings to this world's goods as if he were certain never to die; and he is so hasty in grasping at all within his reach that one would suppose he was constantly afraid of not living long enough to enjoy them. He clutches everything, he holds nothing fast, but soon loosens his grasp to pursue fresh gratifications.

In the United States a man builds a house in which to spend his old age, and he sells it before the roof is on . . . he embraces a profession and gives it up; he settles in a place, which he soon afterwards leaves to carry his changeable longings elsewhere. If . . . at the end of a year of unremitting labor he finds he has a few days' vacation he will travel fifteen hundred miles in a few days to shake off his happiness.

If you read Tocqueville and think “I hope that’s not me,” perhaps you’re actually saying “I hope I’m Ed Thomas.”  He was one of the nation’s best high school coaches, ever.  He took tiny Aplington-Parkersburg High to sixteen playoffs and six state title games.  He amassed nearly 300 wins and was the NFL High School Coach of the Year in 2005.  He produced four NFL players.  He had a lot of opportunities to move on, to move up, to move into the spotlight.  But he didn’t.  He was offered positions in prestige high schools and colleges, but stayed where he could make the greatest difference.  He stayed in Parkersburg.  He stayed with a $7000 coaching salary. Started a flag football program for the littlest kids.  Was an elder at his church.  Rebuilt the field.  Rebuilt the town.  Made the difference we all aspire to.

As ever,

David