Tag Archives: mutual-fund

TCW/Gargoyle Hedged Value, September 2015

By David Objective and strategy TCW/Gargoyle Hedged Value seeks long-term capital appreciation while exposing investors to less risk than broad stock market indices. The strategy is to hold a diversified portfolio mid- to large-cap value stocks, mostly domestic, and to hedge part of the stock market risk by selling a blend of index call options. In theory, the mix will allow investors to enjoy most of the market’s upside while being buffered for a fair chunk of its downside. Adviser TCW. TCW, based in Los Angeles, was founded in 1971 as Trust Company of the West. About $140 billion of that are in fixed income assets. The Carlyle Group owns about 60% of the adviser while TCW’s employees own the remainder. They advise 22 TCW funds, as well as nine Metropolitan West funds with a new series of TCW Alternative funds in registration. As of June 30, 2015, the firm had about $180 billion in AUM; of that, $18 billion resides in TCW funds and $76 billion in the mostly fixed-income MetWest funds. Manager Joshua B. Parker and Alan Salzbank. Messrs. Parker and Salzbank are the Managing Partners of Gargoyle Investment Advisor, LLC. They were the architects of the combined strategy and managed the hedge fund which became RiverPark/Gargoyle, and now TCW/Gargoyle, and also oversee about a half billion in separate accounts. Mr. Parker, a securities lawyer by training is also an internationally competitive bridge player (Gates, Buffett, Parker…) and there’s some reason to believe that the habits of mind that make for successful bridge play also makes for successful options trading. They both have over three decades of experience and all of the investment folks who support them at Gargoyle have at least 20 years of experience in the industry. Strategy capacity and closure The managers estimate that they could manage about $2 billion in the stock portion of the portfolio and a vastly greater sum in the large, liquid options market. TCW appears not to have any clear standards controlling fund closures. Active share “Active share” measures the degree to which a fund’s portfolio differs from the holdings of its benchmark portfolio. High active share indicates management which is providing a portfolio that is substantially different from, and independent of, the index. An active share of zero indicates perfect overlap with the index, 100 indicates perfect independence. Gargoyle has calculated the active share of the equity portion of the portfolio but is legally constrained from making that information public. Given the portfolio’s distinctive construction, it’s apt to be reasonably high. Management’s stake in the fund As of January 2014, the managers had $5 million invested in the strategy (including $500,000 in this fund). Gargoyle Partners and employees have over $10 million invested in the strategy. Opening date The strategy was originally embodied in a hedge fund which launched December 31, 1999. The hedge fund converted to a mutual fund on April 30, 2012. TCW adopted the RiverPark fund on June 26, 2015. Minimum investment $5000, reduced to $1000 for retirement accounts. There’s also an institutional share class (MUTF: TFHIX ) with a $1 million minimum and 1.25% expense ratio. Expense ratio 1.50%, after waivers, on assets of $74.5 million, as of July 2015. Comments Shakespeare was right. Juliet, the world’s most famously confused 13-year-old, decries the harm that a name can do: ‘Tis but thy name that is my enemy; Thou art thyself, though not a Montague. What’s Montague? it is nor hand, nor foot, Nor arm, nor face, nor any other part Belonging to a man. O, be some other name! What’s in a name? that which we call a rose By any other name would smell as sweet; So Romeo would, were he not Romeo call’d, Retain that dear perfection which he owes Without that title. Her point is clear: people react to the name, no matter how little sense that makes. In many ways, they make the same mistake with this fund. The word “hedged” as the first significant term of the name leads many people to think “low volatility,” “mild-mannered,” “market neutral” or something comparable. Those who understand the fund’s strategy recognize that it isn’t any of those things. The Gargoyle fund has two components. The fund combines an unleveraged long portfolio and a 50% short portfolio, for a steady market exposure of 50%. The portfolio rebalances between those strategies monthly, but monitors and trades its options portfolio “in real time” throughout the month. The long portfolio is 80-120 stocks, and stock selection is algorithmic. They screen the 1000 largest US stocks on four valuation criteria (price to book, earnings, cash flow and sales) and then assign a “J score” to each stock based on how its current valuation compares with (1) its historic valuation and (2) its industry peers’ valuation. They then buy the hundred most undervalued stocks, but maintain sector weightings that are close to the S&P 500’s. The options portfolio is index call options. At base, they’re selling insurance policies to nervous investors. Those policies pay an average premium of 2% per month and rise in value as the market falls. That 2% is a long-term average, during the market panic in the fall of 2008, their options were generating 8% per month in premiums. Why index calls? Two reasons: (1) they are systematically mispriced, and so they generate more profit (or suffer less of a loss) than they theoretically should. Apparently, anxious investors are not as price sensitive as they should be. In particular, these options are overpriced by about 35 basis points per month 88% of the time. For sellers such as Gargoyle, that means something like a 35 bps free lunch. Moreover, (2) selling calls on their individual stocks – that is, betting that the stocks in their long portfolio will fall – would reduce returns. They believe that their long portfolio is a collection of stocks superior to any index and so they don’t want to hedge away any of their stock-specific upside. By managing their options overlay, the team can react to changes in the extent to which their investors are exposed to the stock markets movements. At base, as they sell more index options, they reduce the degree to which the fund is exposed to the market. Their plan is to keep net market exposure somewhere in the range of 35-65%, with a 50% average and a healthy amount of income. On whole, the strategy works. The entire strategy has outperformed the S&P. Since inception, its returns have roughly doubled those of the S&P 500. It’s done so with modestly less volatility. Throughout, it has sort of clubbed its actively-managed long-short peers. More significantly, it has substantially outperformed the gargantuan Gateway Fund (MUTF: GATEX ). At $7.8 billion, Gateway is – for many institutions and advisors – the automatic go-to fund for an options-hedged portfolio. It’s not clear to me that it should be. Here’s the long-term performance of Gateway (green) versus Gargoyle (blue): Two things stand out: an initial investment in Gargoyle fifteen years ago would have returned more than twice as much as the same investment at the same time in Gateway (or the S&P 500). That outperformance is neither a fluke nor a one-time occurrence: Gargoyle leads Gateway over the past one, three, five, seven and ten-year periods as well. The second thing that stands out is Gargoyle’s weak performance in the 2008 crash. The fund’s maximum drawdown was 48%, between 10/07 and 03/09. The managers attribute that loss to the nature of the fund’s long portfolio: it buys stocks in badly dented companies when the price of the stock is even lower than the company’s dents would warrant. Unfortunately in the meltdown, those were the stocks people least wanted to own so they got killed. The fund’s discipline kept them from wavering: they stayed 100% invested and rebalanced monthly to buy more of the stocks that were cratering. The payback came in 2009 when they posted a 42% return against the S&P’s 26% and again in 2010 when they made 18% to the index’s 15%. The managers believe that ’08 was exceptional, and note that the strategy actually made money from 2000-02 when the market suffered from the bursting of the dot-com bubble. Morty Schaja, president of River Park Funds, notes that “We are going to have meltdowns in the future, but it is unlikely that they will play out the same way as it did 2008 . . . a market decline that is substantial but lasts a long time, would play better for Gargoyle that sells 1-2% option premium and therefore has that as a cushion every month as compared to a sudden drop in one quarter where they are more exposed. Similarly, a market decline that experiences movement from growth stocks to value stocks would benefit a Gargoyle, as compared to a 2008.” I concur. Just as the French obsession with avoiding a repeat of WW1 led to the disastrous decision to build the Maginot Line in the 1930s, so an investor’s obsession with avoiding “another ’08” will lead him badly astray. What about the ETF option? Josh and Alan anticipate clubbing the emerging bevy of buy-write ETFs. The guys identify two structural advantages they have over an ETF: (1) they buy stocks superior to those in broad indexes and (2) they manage their options portfolio moment by moment, while the ETF just sits and takes hits for 29 out of 30 days each month. There’s evidence that they’re right. The ETFs are largely based on the CBOE S&P Buy-Write Index (BXM). Between 2000 and 2012, the S&P 500 returned 24% and the BXM returned 52%; the options portion of the Gargoyle portfolio returned 110% while the long portfolio crushed the S&P. Nonetheless, investors need to know that returns are lumpy; it’s quite capable of beating the S&P 500 for three or four years in a row, and then trailing it for the next three or four. The fund’s returns are not highly correlated with the returns of the S&P 500; the fund may lose money when the index makes money, and vice versa. That’s true in the short term – it beat the S&P 500 during August’s turbulence but substantially trailed during the quieter July – as well as the long-term. All of that is driven by the fact that this is a fairly aggressive value portfolio. In years when value investing is out of favor and momentum rules the day, the fund will lag. Bottom line On average and over time, a value-oriented portfolio works. It outperforms growth-oriented portfolios and generally does so with lower volatility. On average and over time, an options overlay works and an actively-managed one works better. It generates substantial income and effectively buffers market volatility with modest loss of upside potential. There will always be periods, such as the rapidly rising market of the past several years, where their performance is merely solid rather than spectacular. That said, Messrs. Parker and Salzbank have been doing this and doing this well for decades. What’s the role of the fund in a portfolio? For the guys, it’s virtually 100% of their US equity exposure. In talking with investors, they discuss it as a substitute for a large-cap value investment; so if your asset allocation plan is 20% LCV, then you could profitably invest up to 20% of your portfolio in Gargoyle. Indeed, the record suggests “very profitably.”

September 2015, Funds In Registration

By David American Beacon Bridgeway Large Cap Growth Fund American Beacon Bridgeway Large Cap Growth Fund will seek long-term total return on capital, primarily through capital appreciation. Bridgeway is selling their LCG fund to American Beacon, pending shareholder approval. The fund will still be managed by John Montgomery and the Bridgeway team. The initial expense ratio will be 1.20%, rather above the current Bridgeway charge. The minimum initial investment is $2500. Aristotle Small Cap Equity Fund Aristotle Small Cap Equity Fund will seek long-term capital appreciation by investing in high quality, small-cap businesses that are undervalued. The fund will be managed by David Adams and Jack McPherson. The initial expense ratio will be 1.15%. The minimum initial investment is $2,500. Aristotle Value Equity Fund Aristotle Value Equity Fund will seek long-term capital appreciation by investing mostly in undervalued mid- and large-cap stocks. The fund will be managed by Howard Gleicher, Aristotle’s CIO. The initial expense ratio will be 0.68%. The minimum initial investment is $2,500. Aston/River Road Focused Absolute Value Fund Aston/River Road Focused Absolute Value Fund will seek long-term capital appreciation. The plan is to deploy that “proprietary Absolute Value® approach,” in hopes of providing “attractive, sustainable, low volatility returns over the long term.” The fund will be managed by Andrew Beck, River Road’s CEO, and Thomas Forsha, their co-CIO. The initial expense ratio will be 1.26%. The minimum initial investment is $2,500, reduced to $500 for various sorts of tax-advantaged accounts. Brown Advisory Equity Long/Short Fund Brown Advisory Equity Long/Short Fund will seek to provide long-term capital appreciation by combining both “long” and “short” equity strategies. The plan is pretty straight forward: go long on securities with “few or no undesirable traits” and short the ugly ones. They have the option of using a wide variety of instruments (direct purchase, ETFs, futures and so on) to achieve that exposure. The fund will be managed by Paul Chew, Brown Advisory’s CIO and former manager of the Growth Equity fund. The initial expense ratio will be 2.24% for investor shares and 2.49% for advisor shares. The minimum initial investment is $5,000 for investor shares and $2000 for advisor shares, which are designed to be purchased through places like Scottrade. Dana Small Cap Equity Fund Dana Small Cap Equity Fund will seek long-term growth. The plan is to create a risk-managed portfolio by using a sector-neutral, relative-value, equal-weight discipline. The large cap version of the strategy has been around for five years and has been perfectly respectable if not particularly distinguished for good or ill. The fund will be managed by a team from Dana Investment Advisers. The initial expense ratio will be 1.20%. The minimum initial investment is $1,000. Driehaus Turnaround Opportunities Fund Driehaus Turnaround Opportunities Fund will seek to maximize capital appreciation, while minimizing the risk of permanent capital impairment, over full-economic cycles. The plan is to invest in the equity and debt securities of “distressed, stressed and leveraged companies,” on the popular premise that they’re widely misunderstood and their securities are often incorrectly priced. The fund will be managed by Elizabeth Cassidy and Thomas McCauley of Driehaus. The initial expense ratio has not been released. The minimum initial investment is $10,000 for retail accounts, reduced to $2000 for retirement accounts. Ensemble Fund Ensemble Fund will seek long-term capital appreciation. The plan is to identify 15-25 high-quality companies with undervalued stock, then buy some. The fund will be managed by Sean Stannard-Stockton, Ensemble’s president and CIO. The initial expense ratio will be 2.0%. The minimum initial investment is $5,000, reduced to $1000 for IRAs and accounts established with an automatic investment plan. FFI Diversified US Equity Fund FFI Diversified US Equity Fund will seek long-term capital growth. The plan is to invest in 40-50 U.S. stocks, with a target portfolio market cap of $20 billion. The fund will be managed by a team from FormulaFolio Investments, led by CIO James Wenk. The initial expense ratio will be a stout 2.25%. The prospectus doesn’t offer any immediate evidence that the guys will overcome a high expense ratio in such a competitive slice of the market. The minimum initial investment is $2,000, reduced to $1,000 for retirement accounts and those established with an automatic investing plan. Gripman Absolute Value Balanced Fund Gripman Absolute Value Balanced Fund will seek long-term total return and income. The plan is to pursue a conservative asset allocation on the order of 30% equity/70% intermediate-term fixed income. A sliver might be in junk bonds. The fund will be managed by Timothy W. Bond. The initial expense ratio hasn’t been announced. The minimum initial investment is $2,000. Harbor Diversified International All Cap Fund Harbor Diversified International All Cap Fund will seek long-term growth of capital. The plan is to invest mostly in cyclical companies, which you typically buy when they look absolutely ghastly and sell as soon as they start looking decent. The fund will be managed by a very large team led by William J. Arah from Marathon Asset Management, a London-based adviser. Mr. Arah founded Marathon, which also serves as sub-advisor to Vanguard Global Equity. The initial expense ratio will be 1.22%. The minimum initial investment is $2,500. Iron Equity Premium Income Fund Iron Equity Premium Income Fund will seek to provide superior risk-adjusted total returns relative to the CBOE S&P 500 BuyWrite Index (BXM). The plan is to buy ETFs which track the S&P 500 while writing call options to generate income. The fund will be managed by a team from IRON Financial. The initial expense ratio will be 1.45%. The minimum initial investment is $10,000. Preserver Alternative Opportunities Fund Preserver Alternative Opportunities Fund will seek high total returns with low volatility. The plan is to hire sub-advisers to do pretty typical liquid alts stuff in the portfolio. The subs have not yet been named, though. The initial expense ratio will be 2.43%. The minimum initial investment is $2,000. Quantified Self-Adjusting Trend Following Fund Quantified Self-Adjusting Trend Following Fund (really? It feels like they consulted with Willy Wonka to select their name.) will seek “high appreciation on an annual basis consistent with a high tolerance for risk.” Do you suppose it’s really seeking a high tolerance for risk, or merely requires that prospective investors have a high tolerance? The plan is to determine the market’s trend, then invest in ETFs, leveraged ETFs or inverse ETFs. If there’s no discernible trend, they’ll invest in bonds. The fund will be managed by Jerry Wagner, President of the Flexible Plan Investments, and Dr. Z. George Yang, their director of research. The initial expense ratio will be 1.75%. The minimum initial investment is $10,000. T. Rowe Price Mid-Cap Index Fund T. Rowe Price Mid-Cap Index Fund will seek to match the performance of the Russell Select Midcap Completion Index, with a correlation of at least 0.95. The fund will be managed by Ken D. Uematsu. The initial expense ratio will be 0.32%. T. Rowe Price Small-Cap Index Fund T. Rowe Price Small-Cap Index Fund will seek to match the performance of the Russell 2000®Index with a correlation of at least 0.95. The fund will be managed by Ken D. Uematsu. The initial expense ratio will be 0.34%.

VGSH: For The Investor That Wants Reduced Exposure To A Hot Equity Market

Summary The Vanguard Short-Term Government Bond Index ETF is an intelligent holding within a portfolio, especially when the equity market is hot. The ETF has low volatility and low correlation with other important investments. The credit quality is excellent and the expense ratio is reasonable. The big weakness is a very weak yield. The fund is relatively similar to simply holding cash within the account. Within a diversified portfolio almost all of the risk (volatility) attributed to VGSH is eliminated. The Vanguard Short-Term Government Bond Index ETF (NASDAQ: VGSH ) is a very solid choice for investors trying to limit volatility in an equity market that has been trading at fairly high levels over the summer. By many fundamental measures, such as P/E, the equity market is feeling expensive enough that investors may want to consider increasing their bond exposure. Unfortunately, the yields on debt have been very low, contributing to higher valuations in the equity market. For investors wanting to see their portfolio risk reduced, VGSH is a great tool to get there. Duration The following chart breaks down the duration of the funds. Holdings are all less than 3 years and usually more than 1 year. Again, this is a solid choice. It shouldn’t be surprising that such short-term debt is unlikely to have any meaningful volatility since this is high quality government debt and the short duration limits any volatility from shifts in the yield curve. Of course, there is one major weakness, which is the fund having a yield of .56%. That is a pretty severe weakness for the ETF, but it is a cost of acquiring such low volatility. Some investors may point out that they might as well just deposit their cash in the bank. If the investor has that as an option, that is a fine choice. However, if the investor is working with funds in retirement accounts, that may not be an option. If the account is a 401k and the exposure needs to be accomplished through mutual funds, VGSH also trades as a mutual fund under the ticker (MUTF: VSBSX ). A Hypothetical Portfolio I put together a very simple sample portfolio using Invest Spy. Due to some of the ETFs being newer, the sample period is limited to a little over two years. (click to enlarge) This hypothetical portfolio is weighted to 60% equity and 40% bonds. To break that down, the weights from the equity section are 30% total market index (NYSEARCA: VTI ), 10% equity REITs (NYSEARCA: VNQ ), 5% Utilities, 5% Consumer Staples (NYSEARCA: VDC ), 10% International Equity. The bond section is holding 10% in junk bonds (NYSEARCA: JNK ), 5% in extended duration treasuries (NYSEARCA: EDV ), 5% in emerging market government bonds (NASDAQ: VWOB ), 5% short term corporate debt (NASDAQ: VCSH ), 5% in short term government debt , 5% in mortgage backed securities (NASDAQ: VMBS ), and 5% in intermediate-term corporate bonds (NYSEARCA: BIV ). This portfolio won’t be perfect for hitting the efficient frontier, but it should beat the vast majority of real portfolios investors are using on a risk-adjusted basis. If long-term rates were higher, I would have used a higher weighting for long duration bonds due to their exceptional correlation to major equity classes. My disclosure already states it, but I’ll reiterate that I am long VTI and VNQ. Annualized Volatility When measuring risk-adjusted returns for a portfolio, the most efficient method is usually to use the Sharpe ratio. For that ratio, we are taking the total return annualized return and subtracting the risk free rate. Then we divide the resulting number by the annualized volatility. The problem is that this metric is only really known after the fact. Predicting the level of returns in advance is problematic, but correlations and relative volatility are more reliable over time than returns. Within the chart investors can see the annualized volatility of each holding as well as the resulting annualized volatility for the portfolio. While some holdings have higher annualized volatility scores, such as EDV, the ETF makes up for that by having negative correlation to a few of the equity holdings. As a result, the ETF only contributes .6% of the total risk in the portfolio. VGSH has an annualized volatility of .9%, which is extremely low. Once we adjust for correlation, the risk contribution to the portfolio is only .1% of the total. That means VGSH fits extremely well in this kind of hypothetical portfolio. This is fairly similar to using cash as part of the portfolio value except the returns over time here should be positive. I wouldn’t bother using VGSH outside of a retirement account, but it is a fine holding to use within the retirement account if the investor is concerned about the high valuations in the market. Correlation I want to dive a little deeper into the correlation statistics. The table below provides the correlation across each of those ETFs, which should make it very quick to see which ones are work very well together. When a correlation is shown in the tan color, it indicates a negative correlation which is very attractive for reaching the efficient frontier. You’ll notice that quite a few of the bond funds have negative correlations to VTI and the S&P 500 (NYSEARCA: SPY ). Since VTI and SPY have a correlation ranging between 99% and 99.9%, depending on the measurement period, it should not be surprising that those two funds have very similar correlations to other holdings. Here is the correlation table: (click to enlarge) Conclusion The expected returns on VGSH will regularly be weak when yields are already very low. On the other hand, with high valuations throughout the equity market, there is a solid argument for keeping part of the portfolio protected from the fluctuations in equity valuations. Disclosure: I am/we are long VTI,VNQ. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.