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Earnings Growth Based On Debt And Buybacks? Totally Unsustainable

My grandfather was never rich. He did have some money in the 1920s, but he lost most of it at the tail end of the decade. Some of it disappeared in the stock market crash in October of 1929. The rest of his deposits fell victim to the collapse of New York’s Bank of the United States in December of 1931. I wish I could say that my grandfather recovered from the wrath of the stock market disaster and subsequent bank failures. For the most part, however, living above the poverty line was about the best that he could do financially, as he buckled down to raise two children in Queens. There was one financial feature of my grandfather’s life that provided him with greater self-worth. Specifically, he refused to take on significant debt because he remained skeptical of credit. And with good reason. The siren’s song of “you-can-pay-me-Tuesday-for-a-hamburger-today” only created an illusion of wealth in the Roaring Twenties; in fact, unchecked access to favorable borrowing terms as well as speculative excess in the use of debt contributed mightily to the country’s eventual descent into the Great Depression. G-Pops wanted no part of the next debt-fueled crisis. Here’s something few people know about the past: Consumer debt more than doubled during the ten year-period of the Roaring 1920s (1/1/1920-12/31/1929). And while you may often hear the debt apologist explain how the only thing that matters about debt is the ability to service it, the reckless dismissal ignores the reality of virtually all financial catastrophes. During the Asian Currency Crisis and the bailout of Long-Term Capital Management (1997-1998), fast-growing emerging economies (e.g., South Korea, Malaysia, Thailand, etc.) experienced extraordinary capital inflows. Most of the inflows? Speculative borrowed dollars. When those economies showed signs of strain, “hot money” quickly shifted to outflows, depreciating local currencies and leaving over-leveraged hedge funds on the wrong side of currency trades. The Fed-orchestrated bailout of Long-Term Capital coupled with rate cutting activity prevented the 19% S&P 500 declines and 35% NASDAQ depreciation from charting a full-fledged stock bear. Did we see similar debt-fueled excess leading into the 2000-2002 S&P 500 bear (50%-plus)? Absolutely. How long could margin debt extremes prosper in the so-called New-Economy? How many dot-com day-traders would find themselves destitute toward the end of the tech bubble? Bring it forward to 2007-2009 when housing prices began to plummet in earnest. How many “no-doc” loans and “negative am” mortgages came with a promise of real estate riches? Instead, subprime credit abuse brought down the households that lied to get their loans, destroyed the financial institutions that had these “toxic assets” on their books, and overwhelmed the government’s ability to manage the inevitable reversal of fortune in stocks and the overall economy. Just like 1929-1932. Just like 1997-1998. Just like 2000-2002. Maybe investors have already forgotten the sovereign debt crisis from the summer of 2011. They were called the “PIGS” – Portugal, Italy, Greece and Spain had borrowed insane amounts to prop up their respective economies. The easy access to debt combined with the remarkably favorable terms – a benefit of being a member of the euro zone – started to come undone. Investors rightly doubted the ability of the PIGS to repay their respective government obligations. Yields soared. Global stocks plunged. And central banks around the world had to come to rescue to head off the disastrous declines in global stock assets. Throughout history, when financing is cheap and when debt is ubiquitous, someone or something will over-indulge. Today? Households may be stretched in their use of cheap credit, and they have not truly deleveraged form the Great Recession. Yet the average Joe and Josephine have not acted as recklessly as governments around the globe. In the last few weeks alone, the European Central Bank (ECB) announced an increase in its bond-buying activity as well as the type of bonds it is going to acquire, Japan has sold nearly $20 billion in negatively-yielding bonds and the U.S. has downgraded its rate hike path from four in 2016 to two in 2016. Add it up? The world is going to keep right on going with its debt binge. Are we really that bad here in the U.S.? Over the last seven years, the national debt has jumped from $10.6 trillion to $19 trillion. In 7 years! If interest rates ever meaningfully moved higher, there would be no chance of servicing our country obligations. We would likely be facing the kind of doubt that occurred with the PIGS in 2011, as we looked for bailouts, write-downs, dollar printing and/or methods to push borrowing costs even lower than they are today. That’s not the end of it either. The biggest abusers of leverage and credit since the end of the Great Recession? Corporations. There are several indications that companies are already seeing less bang for the borrowed buck. For instance, low financial leverage companies in the iShares MSCI Quality Factor ETF (NYSEARCA: QUAL ) have noticeably outperformed high financial leverage companies in the PowerShares Buyback Achievers Portfolio ETF (NYSEARCA: PKW ) since the May 21, 2015 bull market peak. It gets more ominous. The enormous influence of stock buybacks by corporations – where companies borrow on the ultra-cheap and acquire shares of their own stock to boost profitability perceptions as well as decrease share availability – may be fading. For one thing, buyback activity has not stopped profits-per-share declines across S&P 500 companies for 4 consecutive quarters (Q2 2015, Q3 2015, Q4 2015, Q1 2016 est). Equally worthy of note, when the bottom line net income of S&P 500 corporations began to decline in earnest in 2007, buybacks began to decline in earnest in 2008. Bottom-line net income has been deteriorating since 2014, but favorable corporate credit borrowing terms has kept buybacks at a stable level into 2016. Nevertheless, once corporations begin recognizing that the buyback game no longer produces enhanced returns (per the chart above) – that stock prices falter in spite of the buyback manipulation efforts, they could begin to reduce their buyback activity. When that happened in 2008, the lack of support went hand in hand with a 50%-plus decimation of the S&P 500. The ratio of buybacks to net income in the above chart can become problematic when companies spend a whole lot more of their bottom-line net income on share acquisition. Maybe it’s a positive thing as long as stock prices are going higher. Yet FactSet already reports that 130 of the 500 S&P corporations had a buyback-to-net-income ratio higher than 100%. Spending more than you earn on acquiring shares of stock? That means very few dollars are going toward productive use, including human resources, research/development, roll-out of new products and services, equipment, plants and so forth. Maybe it wouldn’t be so bad if one could forever count on the notion that interest expense would be negligible. Unfortunately, when total debt continues to rise, even rates that stay the same become problematic. Consider the evidence via “interest coverage.” In essence, the higher the interest coverage ratio, the more capable a corporation is at paying down the interest on its debt. Yet if the debt is rising and the interest rates are roughly the same, interest expense increases and the interest coverage ratio decreases. Here’s a chart that shows challenges in the investment grade, top-credit rated universe. You decide. There are still other signs that show a potential “tapping out” for corporations. Corporate leverage around the globe via the debt-to-earnings ratio has hit a 12-year high. Aggressive financing in the expansion of debt alongside additional interest expense is rarely a net positive. On the contrary. Aggressive leveraging typically means a high level of risk. Granted, if corporations were taking on more debt to increase their value via new projects, expansion, new products, growth and so forth, it might represent high risk-high reward. In reality, however, everyone recognizes that the game has been about loading up on debt at ultra-low terms to acquire stock shares – a short-sighted practice of enhancing earnings-per-share numbers for shareholders. Click to enlarge In sum, low rates alone won’t make it easier for corporations to pay off their substantial obligations. Paying down debt is more challenging in low growth environments – 1.0% GDP in Q4 2015 and 1.4% GDP estimate for Q1 2016. Why might that be so? Corporations did not choose to put borrowed money into capital investments that might ultimately help service interest expense. Stock buybacks? Additional stock shares cannot provide the cash flow necessary for debt servicing the way that capital investments can. To the extent one has equity exposure, he/she would be wise to limit highly indebted, highly leveraged companies. The steadily rising price ratio between QUAL and the S&P 500 SPDR Trust ETF (NYSEARCA: SPY ) tells me that investors are wising up. In particular, they’re more concerned by poor credit risks across the stock spectrum. And while QUAL certainly won’t provide bear market protection on its own, it will likely lose less in downturns; it will likely hold its own during rallies. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

How Benjamin Graham Will Possibly Invest In A World Without Net-Nets

Net-Nets Disappearing In The U.S. In Chapter 7 of the value investing classic “The Intelligent Investor,” Benjamin Graham referred to net-nets as “The type of bargain issue that can be most readily identified is a common stock that sells for less than the company’s net working capital alone, after deducting all prior obligations. This would mean that the buyer would pay nothing at all for the fixed assets – buildings, machinery, etc., or any good-will items that might exist.” When Benjamin Graham did a compilation of net-nets in 1957, he found approximately 150 net-nets. But Benjamin Graham also added that “during the general market advance after 1957 the number of such opportunities became extremely limited, and many of those available were showing small operating profits or even losses.” Based on market data as of March 11, 2016, there were 95 net-nets (trading under 1x net current asset value) listed in the U.S., excluding over-the-counter stocks. If I include a market capitalization criteria of the stock being greater than $20 million, the list of net-nets is almost halved to about 54 names. Assuming the market capitalization criteria is further tightened to $50 million, only 27 net-nets remain on the list. Among the 27 net-nets, only nine of them were profitable in the trailing twelve months. There are two key factors that have been commonly attributed to the disappearance of net-nets in the U.S. Firstly, investors armed with sophisticated screening tools have found it easier to screen for net-nets, compared with the limitations of using a pencil and a calculator in the past. As a result, it can be said that the net-net investment opportunity has been arbitraged away. Secondly, as America made the shift from an industrial economy to a knowledge-based one over the past decades, the value of most U.S.-listed companies no longer resides with their tangible assets. Deep value investors have always sought out cheap stocks, but struggled to find a common denominator for undervaluation. Net current asset value, as a proxy for liquidation value, is probably the closest that one can come to identifying a worst-case scenario valuation metric that is easily calculated and applicable across most situations. However, if one digs deeper into the concept of deep value and the underlying rationale of net-net investing, it is possible to widen the deep value investment universe considerably beyond net-nets. Deep value, whose definition may vary widely, is premised on downside protection in the form of asset values, in my opinion. As I will highlight in the sections below, there are still plenty of deep value investment opportunities in the U.S. and in the Asian markets as well. I will apply the $50 million minimum market capitalization for the screens and specific stocks I am discussing below. Net Cash Stocks / Negative Enterprise Value Stocks Net cash stocks refer to companies with net cash (cash and short-term investments net of all interest bearing liabilities) accounting for a significant percentage of their market capitalization. In the extreme case, some of these stocks might have net cash exceeding their market capitalization, and they are also referred to as negative enterprise value stocks. I see net cash stocks as a special case of the classic sum-of-the-parts valuation, where an investor is backing out the easy-to-quantify elements (usually cash and listed investments) of a stock to ultimately get to the stub value of the remaining parts of the company, typically what is difficult to understand and value. For negative enterprise value stocks, the stub value is zero or negative, implying investors are getting certain assets or businesses for free by virtue of the purchase price. I found 126 U.S. stocks trading at 2 times net cash or less (in other words, net cash accounts for over 50% of market capitalization), and 18 negative enterprise value stocks. One example of a net cash stock is RealNetworks (NASDAQ: RNWK ) whose net cash accounts for approximately 61% of market capitalization, implying that the stub (operating businesses excluding Rhapsody) trades at a trailing enterprise value-to-revenues of 0.48 times. RNWK is a digital media services company operating under three business segments: RealPlayer Group, Mobile Entertainment, and Games, which accounted for 23%, 52% and 25% of its 2015 revenue, respectively. RNWK’s operating businesses are not doing well. With the declining popularity (that is an understatement) of RealPlayer and the deteriorating performance of its Mobile Entertainment, and Games businesses, RealNetworks is looking increasingly like a melting ice cube with its top line decreasing in every year from $605 million in 2008 to $125 million in 2015. It was also loss-making in four of the past five years. But there are some recent positive developments in the past year. RNWK sold its social casino games business, including Slingo, for $18 million, which was first announced in July 2015. This implies management is open to the possibility of monetization and divestment, when the right opportunity arises. In November 2015, RNWK announced a partnership with Verizon Communications Inc. (NYSE: VZ ) to allow it to offer its customers the ability to share, transfer and create digital memories with RealNetworks’ newest video app, RealTimes. RNWK also has a hidden asset in the form of its 43% stake in Rhapsody carried on the books at zero value, which boasts close to 3.5 million paying subscribers. Music subscription service peers like Deezer and Spotify were valued at between $270 and $425 on a per-subscriber basis, based on actual and planned fund raising activities. If I apply the lower end of the valuation range to Rhapsody ($270 per subscriber), the value of RNWK’s interest in Rhapsody should be worth $406 million, more than 2.5 times RNWK’s current market capitalization. Robert Glaser, the founder of RNWK, returned as interim CEO in 2012 and assumed the role as permanent CEO in 2014. His 35% interest in RNWK suggests that his interests are firmly aligned with that of minority shareholders. He is likely to act in the best interests of himself and minority shareholders to eventually halt monetizing the value of RNWK’s assets, if he does not manage to turn around RNWK’s operating businesses. The key risk factors for RNWK include the continued cash burn at its operating businesses being unsuccessful and the decline in the value of Rhapsody due to competition. Net cash stocks with the following characteristics should be heavily discounted: the company is a melting ice cube and burning through cash rapidly (RNWK is an exception considering its stake in Rhapsody and the alignment of interests between the CEO/founder and minority shareholders); the nature of the company’s business requires it to hold cash for either working capital or expansion opportunities; there is a timing issue e.g. a huge special cash dividend has been factored into the price, but not the company’s financials yet, or the company may have an element of seasonality which causes it to accumulate cash at a certain point of the year and draw down the cash to meet liabilities later; the company has significant off-balance debt; the bulk of the stock’s cash is held at partially owned subsidiaries where the possibility of repatriating the cash to the parent company is low; the stock may have certain operating subsidiaries which are mandated by laws and regulations to maintain a certain cash balance. Low P/B Stocks One has to go back to Eugene Fama and Kenneth French’s 1992 research paper titled “The Cross-Section of Expected Stock Returns” to find the first (as far as I know and have read) academic study showcasing the outperformance of low P/B stock relative to their high P/B counterparts. Moving from theory to practice, Donald Smith is one of a handful of fund managers who devotes himself exclusively to the low P/B deep value approach. On his firm’s website, it is emphasized in the Investment Philosophy and Process section that “Donald Smith & Co., Inc. is a deep-value manager employing a strict bottom-up approach. We generally invest in stocks of out-of-favor companies that are valued in the bottom decile of price-to-tangible book value ratios. Studies have shown, and our superior record has confirmed, that this universe of stocks substantially outperforms the broader market over extended cycles.” Fishing in the bottom decile of price-to-tangible book value ratios as opposed to net-nets has its advantages, considering that there will always be stocks (10% of the universe) trading in the bottom decile of price-to-tangible book value ratios even as an increasing number of stocks are valued above net current asset value. One such deep value low P/B stock is Orion Marine Group (NYSE: ORN ). Orion Marine trades at 0.54 times P/B & around tangible book, and it is trading towards the lower end of its historical valuation range. Click to enlarge Started in 1994 and listed in 2007, Orion Marine is a leading marine specialty contractor serving the heavy civil marine infrastructure market in the Gulf Coast, Atlantic Seaboard & Caribbean Basin, the West Coast, as well as Alaska and Canada. Its heavy civil marine construction segment services include marine transportation facility construction, marine pipeline construction, marine environmental structures, dredging of waterways, channels and ports, environmental dredging, design, and specialty services. In 2015, the Company started its new commercial concrete business segment with the acquisition of TAS Commercial Concrete. Founded in 1980 and headquartered in Houston, Texas, TAS Commercial Concrete is the second-largest Texas-based concrete contractor and provides turnkey services covering all phases of commercial concrete construction. While Orion Marine is no wide moat stock, it does benefit from moderate entry barriers. Dredging and marine construction are immune to foreign competition, thanks to the Jones Act. Orion Marine also benefits from its longstanding working relationships with the government which grants the necessary security clearances. This gives the Company an edge over new entrants in the bidding for public projects. The decent future growth prospects for Orion Marine in the mid-to-long term should increase its capacity utilization and enhance profit margins. Firstly, funding for public projects remains healthy. For example, the U.S. Army Corp of Engineers funds the country’s waterways and is focused on expanding the usability of the Gulf Intracoastal Waterways. Its annual budgets for Operations and Maintenance and Construction are $2.9 billion and $1.7 billion, respectively. Another example is The RESTORE Act (the Resources and Ecosystems Sustainability, Tourist Opportunities, and Revived Economies of the Gulf Coast States Act), signed into law in July 2012, is focused on coastal rehabilitation along the Gulf Coast and is expected to be a long-term driver (estimated $10-$15 billion over the next 15 years) of coastal restoration work. Secondly, the expansion of the Panama Canal (Gulf and East Coast Ports deepening channels and expanding facilities to handle larger ships), expected to be completed in 2016, requires ports along the Gulf Coast and Atlantic Seaboard to expand port infrastructure and perform additional dredging services, to cater to increases in cargo volume and future demands from larger ships transiting the Panama Canal. Thirdly, the Company currently serves several popular cruise line destinations, making it a beneficiary of port expansion and development to meet increasing demands as a result of the growing number and size of cruise ships. Orion Marine is less vulnerable to oil price declines as its energy & energy-related opportunities are largely concentrated with the midstream or downstream energy segments. The key risk factor for Orion Marine is that it runs a capital-intensive business with high fixed costs (operating leverage implies that the bottom line will decrease to a significantly larger extent compared with the top line), so revenue and capacity utilization are key to profitability. Furthermore, the Company has a history of M&A, which can be potentially value-destroying. Click to enlarge Interestingly, Orion Marine is a holding of Charles Brandes of Brandes Investment. Charles Brandes met Benjamin Graham when he was managing the front desk of a small brokerage firm in La Jolla, California, which inspired him to start his investment firm operated along Graham principles. On the investment firm’s website, Brandes Investment Partners writes that it “believes the value-investing philosophy of Benjamin Graham – centered on buying companies selling at discounts to estimates of their true worth – remains crucial to delivering long-term returns. This singular focus has allowed Brandes to help clients worldwide with their investment needs since the firm’s founding in 1974.” Brandes Investment has been aggressively adding to its position in Orion Marine in the past three quarters, purchasing 58,150 shares, 26,245 shares and 40,464 shares in Q2 2015, Q3 2015 and Q4 2015, respectively, effectively tripling its stake over this period. It is noteworthy that Brandes Investment claims to be “among the first investment firms to bring a global perspective to value investing” in its corporate brochure , and this links well to the next section on replicating the net-net investment strategy outside of the U.S. Asian Net-Nets Going back to net-nets that I first touched upon at the beginning of the article, the opportunity set for net-nets still exists, if one is willing to look beyond the U.S. market, particularly Asia. There are approximately 256 Asian-listed (including Japan, Hong Kong, Australia and South East Asia, but excluding Korea and Taiwan) net-nets with market capitalizations above $50 million, of which 206 were making money in the last twelve months. Japan (including the Tokyo and Nagoya Stock Exchanges) accounts for more than half of the 206 names with 111 net-nets, while Hong Kong is a close second with 74 profitable net-nets. I have written extensively about Asian net-nets in articles published here , here and here . Graham’s Final 1976 Interview In Benjamin Graham’s last published interview in 1976 with the Financial Analysts Journal, he still expressed his strong conviction in net-nets, when asked “how an individual investor should create and maintain his common stock portfolio.” My first, more limited, technique confines itself to the purchase of common stocks at less than their working-capital value, or net-current-asset value, giving no weight to the plant and other fixed assets, and deducting all liabilities in full from the current assets. We used this approach extensively in managing investment funds, and over a 30-odd year period we must have earned an average of some 20 per cent per year from this source. For a while, however, after the mid-1950’s, this brand of buying opportunity became very scarce because of the pervasive bull market. But it has returned in quantity since the 1973-74 decline. In January 1976 we counted over 300 such issues in the Standard & Poor’s Stock Guide – about 10 per cent of the total. I consider it a foolproof method of systematic investment – once again, not on the basis of individual results but in terms of the expectable group outcome. Graham acknowledged that net-net investing in the U.S. “appears severely limited in its application, but we found it almost unfailingly dependable and satisfactory in 30-odd years of managing moderate-sized investment funds.” He proposed an alternative investment approach involving “buying groups of stocks at less than their current or intrinsic value as indicated by one or more simple criteria.” Graham’s preferred metric was trailing P/E under 7, but he suggested other metrics as well, including dividend yields exceeding 7% and book value more than 120 percent of price (which is equivalent to a P/B ratio of under 0.83). Note: Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks get full access to the watchlists, profiles and idea write-ups of deep-value investment candidates and value traps, which include net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Managed Futures To Smooth Out Market Bumps

This article first appeared in the March issue of WealthManagement magazine and online at WealthMangement.com . Skeptics were easy to find in the bull market, but these funds are now working as advertised. If there was ever a time when a countertrend strategy was needed, it would be now. By countertrend, of course, I mean a tactic that gains while the stock market swoons. There are bear market funds aplenty but those aren’t suitable as permanent portfolio allocations. There are bond funds of various stripes, too, which boast of low correlations to equities, but those are typically low volatility products whose gains are often swamped by equity losses. Enter the 361 Capital Global Counter-Trend Fund (MUTF: AGFQX ) , a managed futures strategy of a different sort. Employing a suite of systematic trading models, AGFQX takes long and short positions in equity index futures contracts – and equity futures only – in U.S., European and Asian markets. At times, the fund also goes to cash. Over the past 12 months, the $18.9 million fund gained more than five percent while the S&P 500 lost nearly nine. Countertrend indeed. It didn’t score its gains by simply shorting equity futures. That would be trend following, just in an opposite direction. No, AGFQX thrives where there’s short-term up-and-down movement in its target equity indices. The fund aims to sell overbought contracts and buy futures at oversold levels to harvest market “noise,” or the frequency of directional changes. The greater the number of price swings, the more opportunities to buy on down days and sell on up ones. The fund’s managers, expecting that the size of trading losses and gains will be roughly equal over time, rely upon a high “hit ratio” (percentage of winning trades) to garner profits. The fund runs into trouble when its target markets trend violently in one direction. That’s what happened late last summer when a market drop sent the fund skidding into a sharp drawdown (see Chart 1). The fund subsequently recovered, ultimately reaching new highs as the broad stock market found fresh lows. More Strategies The equity countertrend fund wasn’t the only managed futures strategy that found purchase this year. In fact, 96 percent of public managed futures funds – exchange-traded and ’40 Act alike – have booked year-to-date gains. Some capitalized on the downtrend in the petroleum complex. Some picked up bullish gold positions. Others bought bond futures. For most, though, the gains haven’t been enough to overcome a year’s worth of setbacks. Of 34 portfolios extant (31 mutual funds and 3 ETFs), 21 are still under water on a 12-month basis. A handful, AGFQX included, stand out because their year-to-date gains built on positive results earned over the preceding 12 months. They’re tallied in Table 1. Like most managed futures strategies, these five mutual funds exhibit little correlation to the equity and bond markets. Notice the low r-squared (r 2 ) coefficients versus the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) and the iShares Core U.S. Aggregate Bond ETF (NYSEARCA: AGG ) . Think of these values representing the degree (in percentage points) that movements in the index ETFs explain the managed futures products’ price variance. Most are quite low, though AGFQX, not surprisingly, shows a modest link to SPY because of the summer selloff. Notable, too, is volatility or, rather, the relative dearth of it. Maximum drawdowns for four of the five funds are fractions of SPY’s. These drawdowns represent the greatest peak-to-trough loss for each portfolio before a new high is attained. Maximum drawdown is used to compute a managed futures or hedge fund’s risk-adjusted return. You can think of the Calmar ratio as the alternative investment world’s Sharpe ratio. The higher it is, the better an investment performed over a specified time period; the lower the ratio, the worse it behaved. Under the Hood We’ve already looked inside the 361 Capital countertrend portfolio, so let’s peek under the hoods of the others: The $555.4 million LoCorr Managed Futures Strategy Fund (MUTF: LFMAX ) manages the futures side of its portfolio through an investment in a wholly-owned Cayman subsidiary. This controlled foreign corporation (“CFC”) is not subject to all of the investor protections of the ’40 Act, a fact that might be worrisome for some investors. At the very least, the arrangement makes the fund opaque. We can see fairly well how the fund’s collateral – the fixed income portfolio used to meet margin requirements – is managed, but insight into the fund’s futures strategy is extremely limited. The fund engages a triad of trend-following commodity trading advisors (“CTAs”) on the futures side. At last look, the fund had a sizable short exposure in the energy sector. LFMAX is the most expensive product in the table with an annual expense ratio at 2.11 percent. The Abbey Capital Futures Strategy Fund (MUTF: ABYIX ) is another multi-manager product which allocates, through its own CFC, to a roster of nine global investment advisors, each pursuing diverse trading strategies. Like the LoCorr fund, ABYIX actively manages its fixed income collateral. And, like the LoCorr fund, Abbey’s $353 million futures fund most recently has been short the energy sector. Shorts in agricultural commodities also added to the fund’s gains. You’ll pay 1.99 percent a year to invest in ABYIX. Trend momentum drives the Goldman Sachs Managed Futures Strategy Fund (MUTF: GMSAX ) which has profited through short positions in the commodities, currency and equity sectors as well as positions designed to capitalize on flattening in the fixed income sector’s yield curve. GMSAX’s fund runners don’t use a CFC and manage the fund in-house, keeping the cost structure relatively low. Annual expenses run 1.51 percent currently for the $153.3 million portfolio. With assets of just $16.9 million, the TFS Hedged Futures Fund (MUTF: TFSHX ) is the table’s smallest – and best performing – portfolio. The fund relies upon a Cayman-based CFC to obtain its futures exposure which is managed internally based on proprietary models. The TFS models don’t look for trends. Instead, they plumb the futures market term structure looking for value plays – buying underpriced contracts and selling those deemed rich which, by combination, reduces exposure to the underlying asset. Ergo the “hedge” in the fund’s title. Hedging comes at a price, namely a 1.80 percent expense ratio. A Diverse Variety of Strategies Managed futures – at least those funds showcased here – represent a diverse variety of strategies. That makes them difficult to classify as a true asset class. It behooves investors, and their advisors, to look closely at a fund’s return pattern to get a sense of its ability to mesh with existing allocations. Sometimes, a fund with a high return takes a backseat to one that is the better yin to an investor’s yang. A lookback over the past 12 months (see Table 2) illustrates the impact each of our five managed futures funds might have had on classically allocated stock and bond portfolio. Here, a 20-percent exposure to managed futures is obtained with a carve-out from the equity allotment, transforming a 60/40 (by percentage, SPY and AGG respectively) portfolio into a 40/40/20 mix. Adding any of the managed futures products to the basic portfolio improves returns. Though a 20 percent allocation isn’t enough to overcome the entirety of the equity market’s damage, it comes darn close. Portfolio volatility, too, is appreciably dampened. Is it likely these funds will continue their (mostly) winning ways? Keep the words of Finnish Formula 1 racer Kimi Raikkonen in mind: “You always want to have a winning car, but there is no guarantee that it will be.”