Dear friends,
I am, as I write, waiting quietly. I’m waiting for the end of an unusually brisk winter. As the songbirds slowly migrate back and the neighborhood skunks awake from hibernation, I know the end is near. I’m waiting to travel back to Ireland, three interminable weeks from now. And I’m waiting for my students to return.
Augustana is midway through spring break, and the kids have scattered. One set of my students spent January on internship in Australia, their high summer season. Another set has headed off to provide medical aid to homeless children in Nicaragua, while a third are packing for our spring term program in Ireland. In a week or two they will, in their thousands, return to campus. Then I’ll take to the lectern to guide another group through Propaganda in the 20th Century or Communication and Emerging Technologies, and my drowsy respite will be at an end.
But, for now, I celebrate the opportunity to sit back, relax and think a bit.
Fund Face-off: Matthews Asia Dividend vs. Matthews Asian Growth & Income
Several weeks ago, some of the folks at FundAlarm’s discussion board mentioned that they had been moving assets from
Matthews Asian Growth & Income (MACSX) to Matthews Asia Dividend (MAPIX, formerly Matthews Asia Pacific Equity Income). Since MACSX has long been one of the most profitable ways to invest in Asia, I was intrigued and went off to update my understanding of the funds. Here’s the short version of what they are:Matthews Asian Growth & Income is managed by Andrew Foster. The fund invests in "dividend-paying equity securities and convertible securities." The fund has about two-thirds of its money in stocks and is famously effective at downside protection. During the 2008 meltdown, for example, MACSX lost 32% while its average competitor lost 52%. It always trails in strong upmarkets but still makes good money. During 2009’s rally, for example, it returned 41% which still landed it in the bottom of the Asian fund heap. Over the past 10 and 15 year periods, it has outperformed more than 98% of its peers.
Matthews Asia Dividend is managed by Jesper Madsen, with Mr. Foster playing a back-up role. The fund invests in "income-paying publicly traded common, preferred and other equity-related instruments." In general, the fund puts its money into common stocks though it sometimes nibbles at other assets. During 2008, it performed spectacularly by losing only 26% then earning 47.6% in 2009. Both performances put it solidly in the Asia fund elite, and its three year record has it besting 99% of its peers.
The fact that MAPIX beat MACSX in 2009 was perfectly predictable. The fact it also won in 2008 was astounding. MAPIX outperformed in all four quarters during 2008 and three of four quarters in 2009. Since nobody is better at downside protection than MACSX, I thought I’d ask the managers if they could help me understand.
The answer is: yes, and no. Yes: Andrew and Jesper were incredibly gracious in setting aside almost an hour when we could talk together. No: I was lost in the discussion more often than I’d like to admit. Having two brilliant, high energy guys talking together – with rising excitement – about a subject that they’re passionate about, modestly outstripped my capacity to follow.
Mr. Foster explained the difference this way: MACSX had "a terrible ‘08" – he didn’t reposition the portfolio as aggressively as perhaps he should have and several of his individual picks underperformed his expectations. (By way of context, remember that this was still one of the two best-performing Asia funds during that terrible year.) It didn’t help that debt markets were virtually frozen for much of the year. That was followed by a "great ‘09" in which the fund had the second greatest returns in its history. He was effusive about Mr. Madsen’s work in positioning the fund against the storm. Madsen became "increasingly conservative" throughout 2008, entirely eliminated his China positions by mid-year, shifted to firms with rock-solid balance sheets and put 25% into Japan – which benefited from the same "flight to quality" that the US did that year. As the market thawed, he moved the fund toward a more aggressive dividend-growth focus; that is, less mature, fast growing firms whose stocks had been priced for bankruptcy. The fund now yields 4.4%, well more than twice the yield on the S&P 500 and 160 basis points more than MACSX boasts.
Over the long term, they agreed that Asia Dividend was likely to be the more nimble fund, with a greater latitude for making substantial tactical and strategic portfolio shifts. At the same time, Asian Growth & Income was likely to emerge as the more defensive, lower volatility fund.
But why invest in Asia at all? An interesting discussion began to develop at the end of our hour together. Mr. Madsen wanted to consider how investors should think about Asian funds. The traditional answer is "it's part of my international allocation." The point that the Matthews folks got me moving toward is, that might be an obsolete construct that ends up misdirecting folks. Instead of region, should we instead focus on strategy? In that case, your answer might be "it's part of my large cap core allocation."
Asia Dividend, for example, has a dividend growth focus. So do -- or should --folks think about choosing between Vanguard Dividend Appreciation and Matthews Asia Dividend -- which would be the strategy focus -- or between T Rowe Price New Asia and Matthews Asia Dividend -- which would be the geographic focus? Morningstar has already crept in the former direction by classifying Matthews Asian Technology (MATFX) as a "tech" fund rather than an "Asia" fund. Shifting focus from region to strategy would have major portfolio construction implications. We might, for example, end up comfortable with Asia Dividend and Artisan Small Cap Value as our two "core" holdings.
Traditionalists argue that Asia can’t be a core holding in the same way that a domestic fund can because, well, you know, it’s just not done. (The same logic would imply that the only logical course for a wise Bulgarian investors would be to keep 80% in stocks traded in Sofia, while allowing a modest American allocation.) In reality, the Asian stock market is bigger than the American market. The combined capitalizations of the NYSE and NASDAQ is some billions smaller than the combined capitalizations in Asia. Asian economies are faster growing and their governments are remarkably more fiscally sound than ours is. By the Central Intelligence Agency’s calculations, Japan and Singapore are the only Asian nations more profligate than we. While the US public debt-to-GDP ratio is 66%, China and Hong Kong sit at 18% and South Korea at 28%. If you add in our private debt (for example, money borrowed by US corporations from foreign lenders), our total external debt-to-GDP ratio is 95.9%. In Asia, only Australia and Hong Kong exceed that debt burden.
One could certainly, and rightly, argue that the US has an infinitely more mature system for legal protection of property rights and an incredibly stable democratic form of government (though that government has managed, over the course of the past 45 years, to entirely duck the challenge of paying all its bills). With the steady evolution of respect for property rights, increasing integration of global markets and economies, it’s less clear that "Asia for the sake of Asia" makes any particular sense while "Asia as the place to most effectively harvest the rewards of a dividend growth discipline" might.
While I’m not packing up and moving out a la Jim Rogers, I am wondering whether the trendiest received wisdom – a stock portfolio roughly equally divided between foreign and domestic companies – is all that compelling. If (hypothetically) the research says that a 50% allocation to high dividend yield stocks and a 50% allocation to microcap value stocks defines "the efficient frontier," what do I gain from putting virtually all of the former into the US market? Alternately, what would I lose if I’d put virtually all of it into an Asian fund?
Fascinating. I’m glad that my students have given me the quiet time to muddle on about this.
Trading the goose that lays the golden eggs for the San Diego Chicken
In February, I discussed FBR’s decision to drive off star manager Chuck Akre, who promptly formed a competing fund company and began siphoning the assets of FBR Focus
’s (FBRVX) into his new Akre Focus (AKREX) fund. A superficial reading would suggest that FBR screwed up. But the San Diego Chicken begs to differ. He thinks that FBR knew what they were doing and got what they wanted.Here’s what the Chicken knows: in 1993, the San Diego Padres ownership had a sudden, brilliant insight. They would make more money fielding a wretched team than fielding a good one. They could trade their best players for cash and cheap minor leaguers, which would save them a ton in payroll. Those starters could be replaced with dirt-cheap minor leaguers who could also be raffled off if they began to show promise. Television and revenue sharing would contribute the bulk of the team’s income and, even though ticket sales would drop, the lost revenue would be far offset by the decreased payroll. Despite being just seven games out of first place, The Great San Diego Fire Sale of 1993 commenced. In short order, the team dispatched:
In 1994, the team lost over 100 games yet still met the owner’s financial expectations.
The Chicken wants to point out a certain parallel logic in the FBR case. FBR was in financial trouble, with most of their funds operating in the red. FBR Focus, sub-advised by Mr. Akre, helped bring in most of the firm’s assets and generated most of its earnings, but at a high price: Mr. Akre’s firm was being paid something like $6 million a year
Look at FBR's position. FBR charges a 90 basis point (bp) advisory fee (that's Morningstar's report of their management fee). Akre got 55bp, they got 35bp. On a billion dollar fund (Mr. Akre's estimate of its size when he departed), they get $3.5 million and Akre gets $5.5 million. So they offered a new deal that would split the revenue (45bp/45bp), netting them a million a year. It’s possible that they offered the deal expecting Mr. Akre to reject it. Which he did. Mr. Akre leaves in a huff, and suddenly FBR is getting all $9 million. Okay, their costs go up because they bought three fund managers -- the average for such guys is $400,000, including benefits. (Source: Paul Farrell, "Become a Fund Manager," 4/8/06) So, they pay $1.2 million for these guys and are pocketing $7.8 million. Even if a third of assets follow Mr. Akre out the door, they still pocket $4.8 million (90 bp times $667 million minus $1.2 million in new salaries), which is millions more than under the old contract, and hundreds of thousands more than they were angling for in negotiations. FBRVX has always been a very low turn-over fund, so the new guys can coast for quite a while. If the new guys are no worse than mediocre, they can probably limit their defections to no more than a third of the fund.
And that’s how they play in the majors.
TCW, on the other hand, seems not to have mastered the art of the break-up. Star manager Jeffrey Gundlach left, taking 45 staff members and over $6 billion in fund assets with him. That’s particularly painful since fees from his fund, TCW Total Return Bond (TGLMX), accounted for more than half of TCW’s revenue last year. As assets poured in from stock-scarred investors, the fund’s fees more than tripled at the same time that revenue from TCW’s stock funds tanked (source: Bloomberg, 2/11/10). In total, institutional and individual investors pulled a total of about $25 billion from TCW since Gundlach’s termination (source: Los Angeles Times, 2/24/10). In order to hold the remainder, TCW had to chop its management fees on two hedge funds Gundlach launched to 1% from 2% and reduced their take of the funds’ profits from 20% down to 5% (source: Bloomberg, 2/4/10).
Gundlach hasn’t yet bought ad space on Morningstar’s profile of the TCW fund, but he also hasn’t had time to launch his competing mutual funds yet.
US News
weighs in: the best mutual funds for 2010US News
has decided to deploy the expertise that keeps them perpetually at the edge of bankruptcy to the mutual fund world. The magazine now publishes a Best Mutual Funds issue and website. The best funds are those with the highest US News score. And how does US News generate their score? They sensibly enough decided to do no original research on their own. Instead, they find a fund’s rating at each of five advisory services – Morningstar, Lipper, Zacks, Standard & Poors, and TheStreet.com – and convert that rating to a ten point scale, then average the five.What’s the highest rated of all mutual funds? The Parnassus Workplace Fund (PARWX) with a score of 9.8. At the other end of the scale, the lowest rated fund is Hennessy Cornerstone Growth II Fund HENLX) with a measly 1.7. US News quickly leveraged this insight into a list of "The Best Funds for 2010." Sadly, the list and the rating system are just about pointless. Three problems fling themselves to mind:
The ratings apply only if a particular fund is rated by all five sources: if four or fewer firms rate a fund, it receives an N/A designation. Of the 269 pages of fund results, the last 86 are devoted to N/A funds.
The ratings assume that all of the sources use equally valid methods: Morningstar’s ratings are weighted equally with TheStreet.com’s, despite the fact that TheStreet barely hints at how they assign ratings (an "A" means "an excellent track record of maximizing performance while minimizing risk," with no hint of what criteria were used for making that judgment), and has never attempted to validate its ratings. Zacks makes no assessment at all of the fund. It merely ranks the quality of stocks in the portfolio. The more stocks with a high Zacks rating, the better the fund -- an approach that completely ignores asset allocation (think of a fund sitting 40% in cash), expenses, volatility, tax efficiency . . .
The conversion assumes that other folks’ ratings were assigned at equal intervals: in converting Morningstar’s rating, for example, a four-star fund gets six points. A five star fund is two points better than a four while a three-star fund is two points worse. Which would be fine if Morningstar gave five stars to the top 20%, four stars to the next 20%, three stars to the next and so on. But they don’t. Only 10% of funds receive five stars, 22.5% receive four, 35% receive three. As a result, five stars is a lot rarer than three. The problem is worse in converting the Lipper scores, which focus on five distinct attributes (such as returns and tax efficiency). Lipper explicates rejects the legitimacy of combining the five different scores into one global rating, as US News does.
Briefly noted
A bunch of fund launches have been delayed: FBR has delayed both its proposed Balanced and Core Bond funds, Motley Fool delayed the Independence Fund, and Harbor Special Opportunities enters its sixth month of limbo.
One of Roy’s favorite-to-dump-on former fund managers, Alberto Vilar, was been sentenced to nine years in prison for money laundering, and donating tens of millions of dollars (of other peoples’ money) to his favorite charities. Vilar, whose Amerindo Technology fund was not implicated in the crime, apologized in court for any "inconvenience our 14,000 clients might have suffered."
In a weird, sex-change operation sort of way, Grail Advisors, which specializes in actively-managed ETFs, announced plans to buy two mutual funds and convert them to ETFs. They won’t release the names of the targeted funds until late spring (source: Wall Street Journal, 2/8/10).
In closing
Thanks to all of the folks on
FundAlarm’s discussion board who weighed-in on the question of how to think about Asian funds, in general, and the Matthews funds in particular. Their comments reflected the usual mix of good sense, passionate conviction and curiosity. I’m grateful for them all. If you want to share your opinions about something we’ve written, please do spend some time visiting with folks on the discussion board or write to Roy and me directly. We love hearing from you.As always, we depend on your willingness to support FundAlarm’s operations and we’re grateful for the folks who choose to use
FundAlarm’s link to Amazon.com, which generates most of the site’s income. Several folks have chosen to make a direct contribution to the site, which is both easy and tremendously reaffirming.As ever,
David
| NEW Discussed this month: | ||
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| Amana Developing World (AMDWX) : For many Americans, the Muslim law of "sharia" conjures up some shadowy medieval code of conduct involving beheadings and the oppression of women (search Google Images for "sharia" if you think I’m misinterpreting the popular mind). In fact, sharia is an ethical code whose financial principles come down to something like, "don’t make money by exploiting others." In the hands of an experienced investor, that can be a recipe for steady, substantial gains. | ||
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Emerging Global Shares Dow Jones Emerging Markets Consumer Titans Index Fund seeks investment results that generally correspond (before fees and expenses) to the price and yield performance of the Dow Jones Emerging Markets Consumer Titans 30 Index. Expenses of 0.85%. Thesis Flexible Fund (TFLEX) seeks long-term growth of capital while reducing exposure to general equity market risk. The fund will take long and short positions in domestic and foreign common equity securities (including emerging market securities), American Depositary Receipts ("ADRs"), Global Depositary Receipts ("GDRs"), domestic and foreign fixed income securities (including securities of foreign sovereigns and supranational organizations and emerging market securities), precious metals, and commodities and commodity-related contracts. Stephen Roseman, CFA and Mark Hanratty, CFA are the portfolio managers. From 2003 to 2005, Roseman was a portfolio manager at Kern Capital Management, where he managed the consumer, retail, and business services portfolio. His previous professional experience includes OppenheimerFunds (where he worked as a senior equity analyst with the Discovery Fund), PaineWebber Group and Sperry Van Ness. The projected expense ratio is 3%, including an exceedingly rich 2.25% for Messrs Roseman and Hanratty. Minimum is $2500, reduced to $1000 for AIP. Expenses not yet released. Turner Global Opportunities will generally invest in common stocks and other equity securities of U.S. and foreign companies that Turner believes have strong earnings growth potential. Investments will generally be in securities of companies with market capitalizations of greater than $2 billion. The Fund is managed by Christopher McHugh, Donald Smith, Mark Turner and Robert Turner. Minimum is $2500, reduced to $1000 for AIP. Expenses not yet released. William Blair Mid Cap Value Fund will seek long-term capital appreciation by investing in the equity securities of mid cap companies. The midcap universe is defined by the Russell Midcap Value Index. The fund will be able to buy both stocks and convertibles. It will be managed by Mark Leslie, David Mitchell, and Chad M. Kilmer. Expenses not yet released. $5000 minimum, reduced to $3000 for IRAs. |
| NEW Discussed this month: | ||
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| Intrepid Capital (ICMBX): Just because everyone else chooses white bread and mayo doesn’t mean that you need to. Sometimes ciabatta and stone ground mustard aren’t just a change of pace. Sometimes they’re the basis of a much better meal. The same holds true for the rare "balanced" fund that chooses to step out of line. | ||