Tag Archives: mutual funds

Evaluating Actively Managed Stock Funds With iM’s Terminal Value Rating System

This rating system identifies funds which may provide better returns than a benchmark index-fund by measuring fund performance from the perspective of savers who make regular monthly contributions to funds. It compares the terminal value from periodic $1.00 monthly contributions to a fund with the terminal value from the same contributions to a benchmark index-fund over the same time period. Specifically, the system calculates 1-year and 5-year rolling terminal values from $1.00 monthly contributions to the fund and the benchmark index-fund. Predictive information comes from the relationship between the fund and the benchmark rolling terminal values, allowing an estimate of future fund performance relative to the benchmark index-fund. The Terminal Value Rating System Since most investors aim to save an adequate amount for retirement, it is appropriate to calculate the terminal value from monthly contributions to a particular fund and compare this to the terminal value if the same contributions had been made to a benchmark index-fund instead. (In this analysis SPY, the ETF tracking the S&P 500, is used as the benchmark index-fund, hereinafter referred to as benchmark.) This method provides a better picture of fund performance for savers as it measures the end value from periodic investments to a fund, rather than performance over standard fixed time periods. (Fund prices adjusted for dividends are mainly from Yahoo Finance. Also, the system only applies to funds with no front load fees.) An evaluation of the relationship between the 1-year and 5-year rolling terminal values for investments in a fund, and the corresponding rolling terminal values for investments in the benchmark, can provide a good estimate of future fund performance relative to the benchmark. The relationship is termed “Rolling Performance” and is defined in the Appendix. The ratings derived from this analysis range from a grossly underperforming ‘E’ to a good outperforming ‘A’. In the charts, the ratings are based on the most recent past 1-year and 5-year Rolling Performances, shown as “iM RATING: 1yr(5yr)”. Desirable funds should have a 1-year rating of ‘C’ or better, and a 5-year rating of ‘B’ or better. (See the Appendix for Rating Criteria) Over and above the simple 5-bin rating, charts are produced to visualize, and substantiate, the fund’s rating. How to interpret the charts The upper two graphs in the charts show the actual terminal values obtained from investing $1.00 every month in the fund and the benchmark. These are the sums of all contributions including all gains and losses to the end of November 2015, and indicate the total savings over time. A desirable fund would continuously have had higher terminal values than those for the benchmark. The lower two graphs in the charts are the 1-year and 5-year Rolling Performances. The 5-year Rolling Performance should preferably be continuously positive, which would indicate that an investor would always have done better investing in the fund than in the benchmark over a five year period. For future fund performance to be better than the benchmark would require the 1-year and 5-year Rolling Performance graphs near the end to be positive and to have upward (positive) slopes as well. Positive 1-year and 5-year Rolling Performances show that a fund performed better than the benchmark over the last year and the last five years, respectively. Upward slopes of the Rolling Performance graphs would indicate that fund performance had constantly gained over the benchmark while the slopes were positive and should also signal further excess gains for the fund over the benchmark in the near-term future. Example of a fund likely to outperform SPY An example of a fund that should continue to provide better performance than the benchmark is T. Rowe Price Growth Stock (MUTF: PRGFX ) with an iM-Rating of B(A). Had one invested $1.00 each month starting on the last day of February 1993, one would have contributed a total of $274 including the last contribution at the end of November 2015. The terminal value, that is the sum of all contributions including all gains and losses to November 2015, would have been $893. Had one made the same contributions to SPY, then the terminal value would have been $746. A saver would have had 19.7% more money at the end from investing in PRGFX than from investing in SPY. The upper pair of graphs in the chart which are plotted to a semi-log scale shows the performances over time. (click to enlarge) (click to enlarge) The terminal value rating system is especially useful to determine the likely future performance trend for a fund. The 1-year and 5-year Rolling Performances are shown by the green and purple graphs, respectively, at the bottom of the chart. One can see that since May-2000 for most of the time PRGFX provided better returns over five years for savers than SPY. As of 11/30/2015, the value of the 5-year Rolling Performance is +7.6%, and the 1-year Rolling Performance is +2.8%. This indicates that over the last five years and one year a $1.00 per month investor would have had, respectively, 7.6% and 2.8% more savings from PRGFX than from SPY. Both Rolling Performance values are positive and the slope of the 5-year Rolling Performance graph since Aug. 2014 is also positive, which is a good indication that performance of this fund relative to SPY should be higher also for the near-term future. Example of a fund likely to underperform SPY An example of a fund that will likely continue to underperform the index-fund is the CREF Stock Account (QCSTRX) with an iM-Rating of D(E). This is one of the oldest and largest actively managed stock funds in the U.S. with about $117-billion in assets, representing about 13.5% of total assets under management at TIAA-CREF. Had one invested $1.00 each month starting on the last day of February 1993, one would have contributed a total of $274 including the last payment at the end of November 2015. The terminal value, that is the sum of all contributions including all gains and losses to November 2015, would have been $651. Had one made the same contributions to SPY then the terminal value would have been $746. A saver would have had 14.6% more money at the end from investing in SPY than investing in the CREF Stock Account. The upper pair of graphs in the chart which are plotted to a semi-log scale depicts the performances over time. (click to enlarge) (click to enlarge) The fund versus benchmark 1-year and 5-year Rolling Performances are shown by the green and purple graphs, respectively, at the bottom of the chart. One can see that QCSTRX provided worse 5-year returns for savers than SPY from 1998 to 2002 and then again from 2011 to 2015. The latest value of the 5-year Rolling Performance for QCSTRX is -8.2%, meaning that over the last five years a $1.00 per month investor would have had 8.2% less savings from the CREF Stock Account than from SPY. Similarly, the 1-year Rolling Performance for QCSTRX is -2.2%, meaning that over the last year a $1.00 per month investor would have had 2.2% less savings from the CREF Stock Account than from SPY. Both Rolling Performance values are negative, and at the end the trajectories of both Rolling Performance graphs also point lower. This indicates that this fund is likely to provide lower returns for investors than SPY in the foreseeable future as well. Conclusion Of the many actively managed stock funds we investigated only a few funds have produced better returns than the benchmark SPY, and are likely to continue to outperform SPY. These funds are characterized with 1-year and 5-year ratings better than ‘C’, and would have had positive 5-year Rolling Performance over longer periods. The charts and iM-Ratings for three such large-cap stock funds, JGASX, FDGRX and GTLLX are provided in the Appendix. Appendix Special terms and abbreviations Terminal Value (TV): The sum of all contributions including all gains or losses from a specified starting date to the present or to a specified past date. PRGFX(+1/mo), QCSTRX(+1/mo), SPY(+1/mo): Terminal values from all past consecutive monthly $1.00 contributions made in PRGFX, QCSTRX, and SPY. 1-year Rolling Performance: The percentage difference between the terminal values from the past 12 consecutive rolling monthly $1.00 investments made in a fund and the benchmark, calculated as (TV12 (fund) – TV12 (bench) ) / TV12 (bench). 5-year Rolling Performance: The percentage difference between the terminal values from the past 60 consecutive rolling monthly $1.00 investments made in a fund and the benchmark, calculated as (TV60 (fund) – TV60 (bench) ) / TV60 (bench). iM-Rating Criteria The Rating criteria are based on the most recent past 1-year and 5-year Rolling Performances with the thresholds as listed below. Performance Rating Thresholds Rating Thresholds A above 6% B 2% to 6% C -1% to 2% D -5% to -1% E below -5% Other Funds likely to outperform SPY JPMorgan Growth Advantage Sel (MUTF: JGASX ) with iM-Rating C(A). The funds VHIAX, JGACX, JGVRX, JGVVX are of the same class family and all enjoy the same rating. (click to enlarge) (click to enlarge) Fidelity Growth Company (MUTF: FDGRX ) and FDEBX of the same class, both have an iM-Rating of C(A) (click to enlarge) (click to enlarge) Glenmede Large Cap Growth (MUTF: GTLLX ) with IM-Rating C(A) (click to enlarge) (click to enlarge) No Recession Is Signaled By iM’s Business Cycle Index: Update December 31, 2015

Natixis CGM Advisor Targeted Equity Fund: An End Of An Era

Summary Natixis Asset Management, the fund’s distributor, has recently announced the closure of the CGM Advisor Targeted Equity Fund to new investors, and plans to liquidate the fund on 2/17/2016. The fund is managed by CGM’s Kenneth Heebner and has been active since 1968. Fund has significantly underperformed the market over the last 8 to 10 years. One of the oldest mutual funds is about to shut the doors. Natixis has just sent out a letter to financial advisor informing them of the board’s decision to liquidate the CGM Advisor Targeted Equity Fund (MUTF: NEFGX ) (MUTF: NEBGX ) (MUTF: NEGCX ) (MUTF: NEGYX ) on February 17th, 2016. As per the letter… The Board considered a number of factors in making this decision. Natixis Funds are managed solely by firms in which Natixis Global Asset Management has an ownership interest. In early January 2016 Natixis will no longer hold any ownership interest in Capital Growth Management (CGM). The Board determined that, since there is no other manager or fund within the Natixis Funds complex that has a similar investment style, it would not be in the best interest of shareholders to have another portfolio manager assume responsibility for managing the Fund or to merge it into another fund. If you are currently an investor, what are you to do? The Basics Originally launched in 1968, the fund has been managed over the last 39 years by Kenneth Heebner. Fund Basics : Sponsor: Natixis Global Asset Management Managers: Sub-Advised by CGM, Kenneth Heebner AUM: $448.53 Million across share classes Historical Style : Large Blend Investment Objectives: Seeks long-term growth of capital through investment in equity securities of companies whose earnings are expected to grow at a faster rate than that of the overall United States economy. Number of Holdings: 21 Current Yield: 0%, Annual Distributions Inception Date: 11-27-1968 Fees: A Share : 1.15%, I Share: .89% Source: Natixis Global Asset Management The fund’s special sauce is twofold. First, the fund is concentrated and typically holds between 20 and 30 securities. The reasoning for this being, if you hold 100 names or more and many funds do, you might as well own an index fund as you are in a quasi index fund with higher fees. As a concentrated fund, you are able to make specific investment bets. The second part to the special sauce is selecting “aggressive large-cap” holdings with a competitive long-term track record. The Numbers Pre 2007 the fund was a shining example that active management can work. 2007 in particular was a stand out year where the fund returned 34.42%, beating the S&P 500 by over 28%. Yes, the fund was concentrated and had a higher beta, it certainly brought alpha to the portfolio. Unfortunately, since 2008, the fund has been mediocre at best. (click to enlarge) Source: YCharts Even over the last 10 years, the fund has still not gotten its mojo back. (click to enlarge) Source: YCharts Putting this into perspective, we can take a look at the Risk Reward Scatterplot and MPT statistics for the fund compared to the S&P 500. (click to enlarge) Source: Morningstar While the fund has returned positive numbers, it has done so with both a higher beta to the market, and a lower alpha, not keeping up with the market. This trend holds true for both the 3, 5 and 10 year numbers. Our Take & Bottom Line This was a great fund Pre 2008, however during the great financial melt UP inspired by zero interest rate policy, active managers have been left behind as the entire markets went up. All you heard for the last 8 years has been index funds, ETFs, etc. Only this year have you started seeing a return to good active managers in a market that has gone nowhere for the year. The question is…. what does the future hold? Unfortunately, no one knows how CGM will manage in the future. The fund has typically had very active turnover in the portfolio with very little to show for it. It would not be prudent to invest in the funds right now, so this discussion focuses for those that are current investors. Even though Natixis will be liquidating the funds, CGM does have 3 mutual funds that are no load funds, as opposed to the Natixis CGM funds that were sold primarily through financial advisors. For investors who still believe in CGM and Kenneth Heebner, your choice would be to invest in the CGM Focus Fund (MUTF: CGMFX ) which mimics the Natixis fund very well. Unfortunately, the performance has been just as tepid. Perhaps this fund closing is just an opportunity to take a moment and reevaluate your options. In any case, it would be prudent to process your sell order now, rather than wait for the fund liquidation to happen by itself and hope to avoid any other special distributions & 1099s.

VFORX: How A Target Date Fund Should Be Built

Summary The Vanguard Target Retirement 2040 Fund has a simple construction and a low expense ratio. Despite being a very simple portfolio, they have covered exposure to most of the important asset classes to reach the efficient frontier. The fund is mostly in equity but has materially underperformed the S&P 500 over because of a strong allocation to international equity. Lately I have been doing some research on target date retirement funds. Despite the concept of a target date retirement fund being fairly simple, the investment options appear to vary quite dramatically in quality. Some of the funds have dramatically more complex holdings consisting with a high volume of various funds while others use only a few funds and yet achieve excellent diversification. My goal is help investors recognize which funds are the most useful tools for planning for retirement. In this article I’m focusing on the Vanguard Target Retirement 2040 Fund Inv (MUTF: VFORX ). What do funds like VFORX do? They establish a portfolio based on a hypothetical start to retirement period. The portfolios are generally going to be designed under Modern Portfolio Theory so the goal is to maximize the expected return relative to the amount of risk the portfolio takes on. As investors are approaching retirement it is assumed that their risk tolerance will be decreasing and thus the holdings of the fund should become more conservative over time. That won’t be the case for every investor, but it is a reasonable starting place for creating a retirement option when each investor cannot be surveyed about their own unique risk tolerances. Therefore, the holdings of VFORX should be more aggressive now than they would be 3 years from now, but at all points we would expect the fund to be more conservative than a fund designed for investors that are expected to retire 5 years later. What Must Investors Know? The most important things to know about the funds are the expenses and either the individual holdings or the volatility of the portfolio as a whole. Regardless of the planned retirement date, high expense ratios are a problem. Depending on the individual, they may wish to modify their portfolio to be more or less aggressive than the holdings of VFORX. Expense Ratio The expense ratio of Vanguard Target Retirement 2040 Fund is .18%. That is higher than some of the underlying funds, but overall this is a very reasonable expense ratio for a fund that is creating an exceptionally efficient portfolio for investors and rebalancing it over time to reflect a reduced risk tolerance as investors get closer to retirement. In short, this is a very solid value for investors that don’t want to be constantly actively management their portfolio. Composition The fund is running almost 89% stocks to about 11% bonds, but over time the portfolio shifts to sell off stocks and hold more bonds as Vanguard assumes that investors nearing retirement will have a reduced risk tolerance. This portfolio strategy is the embodiment of what financial advisors seek to do for clients. Unfortunately Vanguard does not know the unique circumstances of every client, but for a .18% expense ratio they are doing a great job. Holdings The following chart demonstrates the holdings of the Vanguard Target Retirement 2040 Fund: (click to enlarge) This is a fairly simple portfolio. Only four total funds are included so the fund can gradually be shifted to more conservative allocations by making small decreases in equity weightings and increases in bond weightings. The funds included are the kind of funds you would expect from Vanguard. They are all solid funds with strong internal diversification in the holdings and low expense ratios. The Vanguard Total Stock Market Index Fund is also available as an ETF. The ETF version is the Vanguard Total Stock Market ETF (NYSEARCA: VTI ). To be fair, Vanguard has a great reputation for running funds but not for coming up with creative names. I have a significant position in VTI because it carries an extremely low expense ratio and offers excellent diversification across the U.S. economy. Volatility An investor may choose to use VFORX in an employer sponsored account (if their employer has it on the approved list) while creating their own portfolio in separate accounts. Since I can’t predict what investors will choose to combine with the fund, I analyze it as being an entire portfolio. Since the fund includes domestic and international exposure to both equity and bonds, that seems like a fair way to analyze it. (click to enlarge) When we look at the volatility on VFORX, it is only slightly lower than the volatility on SPY. Despite similar levels of volatility, it has underperformed SPY. Generally investors will expect a target date fund to hold up better in a bear market and to fall behind in a bull market. For a portfolio with a target date as distant as 2040, investors have to expect strong equity positions will result in similar returns to the market. The real weakness demonstrated here was largely a function of the international equity markets underperforming the domestic equity markets. A Suggested Modification Even though this portfolio is designed for investors that are 25 years away from retirement, for the sake of lower annualized volatility I would like to see a slightly larger allocation to very long term treasury bonds. Since Vanguard is regularly rebalancing the fund it should be able to benefit from the strong negative correlation between the domestic equity market and the long term treasuries. To be fair, international markets have also been showing a negative correlation with long term treasury returns, so it really should be able to dramatically reduce the volatility without creating a very large drag on earnings. The benefit of the negative correlation with frequent rebalancing allows investors to be regularly buying low and selling high. Compared to most active investment strategies, a simple rebalancing plan that combines long term treasuries with domestic equities has been a very solid and remarkably simple strategy. Conclusion VFORX is a great mutual fund for investors looking for a simple “set it and forget it” option for their employer sponsored retirement accounts. It is ideally designed for investors planning to retire around 2040, but can also be used by younger employees with lower risk tolerances or older workers with higher risk tolerances.