Analysis of Parnassus Core Equity Fund
active management, analysis, mutual fund, value investing

A recent story in The New York Times focused on Parnassus Investments and its Core Equity Fund (PRBLX; Investor Class shares). This $15.7 billion large-cap no-load fund has a reasonable 0.87% net expense ratio and 23% turnover. According to the article

Value-oriented investors who screen out companies that don’t meet strict social standards, [the fund managers], over the last year, generated a respectable 14 percent return in their core equity fund where they have large stakes in Apple and Google. But the positions are not nearly enough to keep pace with the 18 percent return of the Standard & Poor’s 500-stock index, within which six of the 10 top components are now technology stocks.

Over the longer term, however, the Parnassus results are better. For 10 years, the core equity fund handily beats its benchmark — 9 percent compared with 7 percent, a record that outpaces 98 percent of the competition.

This post is a follow-up to our previous coverage of this fund.

Let’s start with rolling returns. The fund’s primary prospectus benchmark is the S&P 500® Index. One of the long-lived implementations of this index is the SPDR® S&P 500® ETF (SPY). From January 2000 through June 2017, the fund returned more than the ETF in approximately 62% of all rolling 36-month periods, 56% of 24-month periods and 54% of 12-month periods. However, the dispersion of outcomes was quite wide, as shown in the following chart and statistics:

Rolling Returns of Parnassus Core Equity Fund (PRBLX) and SPDR S&P 500 ETF (SPY) since 2000

While a rolling returns analysis provides useful information about relative performance over typical holding periods, it does not take the fund’s exposures or risk into account. To more accurately adjust for the latter, let’s employ the simplest variant of Alpholio™ patented methodology. In this approach, a custom reference ETF portfolio is built for each analyzed fund to most closely track the fund’s returns. The portfolio has a fixed ETF membership (with a configurable limit) and weights, thus facilitating an easy implementation.

The following chart with associated statistics shows the cumulative RealAlpha™ for Parnassus Core Equity over the ten years through June 2017 (to learn more about this and other performance measures, please visit our FAQ):

Cumulative RealAlpha™ for Parnassus Core Equity Fund (PRBLX) over 10 Years

Compared to the reference portfolio of up to six ETFs, the fund added a fair amount of value over this analysis period and did so with a RealBeta™ well below one.

The following chart with statistics depicts the constant composition of the reference ETF portfolio over the same evaluation period:

Reference Weights for Parnassus Core Equity Fund (PRBLX) over 10 Years

The fund had equivalent positions in the iShares MSCI KLD 400 Social ETF (DSI), Vanguard Consumer Staples ETF (VDC), PowerShares BuyBack Achievers™ Portfolio (PKW), iShares Morningstar Large-Cap Growth ETF (JKE), First Trust Water ETF (FIW), and iShares U.S. Energy ETF (IYE).

Now let’s take a look at the fund’s performance over the last five years. Here is the resulting cumulative RealAlpha™ chart with related statistics:

Cumulative RealAlpha™ for Parnassus Core Equity Fund (PRBLX) over 5 Years

Since mid-2015, the fund lost all of the cumulative RealAlpha™ it previously generated in this analysis period. Also, despite lower volatility (measured by the standard deviation) the RealBeta™ of the fund was higher than that over the broader evaluation period.

The following chart with statistics illustrates the static composition of the reference ETF portfolio over five years:

Reference Weights for Parnassus Core Equity Fund (PRBLX) Over 5 Years

The fund had equivalent positions in the PowerShares S&P 500® Quality Portfolio (SPHQ), iShares MSCI USA ESG Select ETF (SUSA; formerly KLD), SPDR® S&P® Dividend ETF (SDY), iShares U.S. Industrials ETF (IYJ), Technology Select Sector SPDR® Fund (XLK), and Consumer Staples Select Sector SPDR® Fund (XLP).

The final chart with conventional statistics shows the total return of the fund and two of the reference ETFs:

Total Return of Parnassus Core Equity Fund (PRBLX), iShares MSCI KLD 400 Social ETF (DSI) and iShares MSCI USA ESG Select ETF (KLD) over 5 Years

Over the five-year period, the performance of the two ETFs, and especially DSI, converged with that of the fund.

In sum, while the Parnassus Core Equity Fund has a decent long-term record, its recent performance has been similar to that of index-based environmental, social and governance (ESG) products with lower expense ratios. With approximately 40 positions, the fund’s portfolio is fairly concentrated – top ten holdings currently constitute almost 39% of the total. In three of the last four calendar years, the fund had significant distributions, which made it less suitable for taxable accounts.

To learn more about the Parnassus Core Equity and other mutual funds, please register on our website.

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Analysis of Vulcan Value Partners Fund
analysis, mutual fund, value investing

A recent article in Barron’s profiles the Vulcan Value Partners Fund (VVPLX). This $1.1 billion no-load fund, started at the end of 2009, has a total expense ratio of 1.18%. With just 32 holdings as of the end of June 2014, the fund is non-diversified. According to the article

…Vulcan Value Partners fund (ticker: VVPLX) is up an average of 22% a year over the last three years, putting it in the top 1% of large growth funds.

The primary prospectus benchmark for the fund is the Russell 1000® Value index. The secondary benchmark is the S&P 500® index. A practical implementation of the primary benchmark is the iShares Russell 1000 Value ETF (IWD). Since its inception, the fund outperformed this ETF in about 69% of all rolling 12-month periods.

However, neither index is a good reference for the Vulcan Value Partners fund, which has a growth tilt. In Alpholio™’s simplest analysis, both membership and weights of ETFs in the reference portfolio are fixed throughout the entire analysis period. In that reference portfolio, two out of the top three ETFs are technology-oriented: iShares Global Tech ETF (IXN; weight of 17.3%) and Vanguard Information Technology ETF (VGT; 12.6%).

In a more refined Alpholio™ analysis, the ETF membership in the reference portfolio is fixed, but weights can change over time. Using this approach, the following chart shows the cumulative RealAlpha™ for the Vulcan Value Partners fund since its inception:

Cumulative RealAlpha™ for VVPLX

From early 2010 through mid-2011, the cumulative RealAlpha™ for the fund trended lower. Subsequently, the cumulative RealAlpha™ rebounded and increased by about 20% through the end of 2013. The lag RealAlpha™ curve was below the regular one, which indicates that not all new investment ideas worked out as well as intended (for a detailed explanation of the regular and lag RealAlpha™, please consult the FAQ). Overall, the fund generated about 2.2% of the regular and 1% of the lag annualized discounted RealAlpha™. At about 14.1%, the fund’s standard deviation was about 0.5% higher than that of the reference ETF portfolio.

The following chart illustrates changes in the reference ETF portfolio composition over the same analysis period:

Reference Weights for VVPLX

The fund’s top equivalent ETF positions were in the iShares S&P 100 ETF (OEF; average weight of 19.7%), Vanguard Information Technology ETF (VGT; 17.4%), Vanguard Consumer Staples ETF (VDC; 15%), iShares Russell 1000 Value ETF (IWD; 13.4%), Vanguard Consumer Discretionary ETF (VCR; 13.2%), and iShares MSCI United Kingdom ETF (EWU; 7.7%). The Other component of the chart collectively represents six other ETFs with smaller average weights.

The final chart demonstrates a hypothetical buy-sell signal for the fund derived from the smoothed cumulative RealAlpha™ curve shown previously:

Buy-Sell Signal for VVPLX

An investor following this signal would have avoided a period of the fund’s underperformance from the fourth quarter of 2010 through the third quarter of 2011, and capture the benefits of subsequent outperformance.

In the past three years, the Vulcan Value Partners fund exhibited good risk-adjusted performance. However, in its first year as well as so far in 2014, the fund failed to outperform its reference ETF portfolio. Although the fund’s historical standard deviation was similar to that of the ETF implementing its primary benchmark (IWD), the fund’s concentrated portfolio (top ten holdings constitute over 44% of total assets) may result in a higher volatility in the future.

To learn more about the Vulcan Value Partners and other mutual funds, please register on our website.

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Entering an Exclusive Dimension
analysis, factor investing, mutual fund, value investing

A cover story in Barron’s provides lots of interesting details about the history and operations of Dimensional Fund Advisors (DFA). Founded in 1981, DFA has recently reached $332 billion in assets under management (AUM).

DFA's Three Decades of Growth

About 78% of these AUM are in stocks, and about 85% in low-cost mutual funds with an average expense ratio of 0.39%. The funds have a small-cap and value tilt, based on the Fama-French three-factor model. Lately, the firm started to augment its funds with a profitability factor.

The article states that

More than 75% of its funds have beaten their category benchmarks over the past 15 years, and 80% over five years, according to Morningstar — remarkable for what some investors wrongly dismiss as index investing.

To substantiate this, the article compares two similar funds from DFA and Vanguard:

For example, take the Vanguard Small Cap Value index fund (VISVX), which is based on the S&P 600 Small Cap Value index and is the counterpart to Dimensional’s DFA US Small Cap Value (DFSVX). The DFA fund has a much smaller tilt — its average market value is $1.1 billion, versus Vanguard’s $2.7 billion — and on all measures is much more value-oriented. So the Dimensional fund better captures the market-beating advantage of small and value stocks. In fact, a lot better: The DFA fund returned 42% in 2013, beating 88% of its peers in Morningstar’s small-cap value category, versus the Vanguard fund’s 36% return, which beat just 53%. Over 15 years, which includes periods that were less favorable to small and/or value stocks, DFA’s fund returned an average of 12% a year, beating 80% of peers. The Vanguard fund returned 10% on average, beating just 37% of peers. The Dimensional fund costs twice as much as Vanguard’s — 0.52% versus 0.24% — but the significant outperformance more than makes up for that difference.

That only tells a part of the story. According to Morningstar data, DFSVX had a lower Sharpe Ratio than VISVX in the 3-year (0.96 vs. 1.01) and 10-year (0.47 vs. 0.48) periods through 2013. This is also reflected in the generally higher volatility and upside and downside capture ratios for the DFA fund. As a result, the DFA fund produced lower returns than the Vanguard fund did in the down years of 2007, 2008 and 2011.

The article says that a deliberately paced trading as well as market making in the 14,000 stocks DFA owns both add to its outperformance. However, DFA faces an ongoing criticism: since its funds are sold exclusively through 1,900 rigorously screened and trained financial advisors, they are not easily accessible to individual investors, especially those with a small amount of investable assets, not willing to pay advisory fees or already having an unaffiliated advisor. This is what creates an “exclusive dimension” of DFA, which Alpholio™ can help investors enter. Following up on one of the previous posts, let’s analyze DFSVX in more detail.

The following chart shows the relative performance of the fund vs. its reference portfolio of ETFs:

Cumulative RealAlpha™ for DFSVX

An investor who committed to the fund in early 2005 would have gained only a modest amount of cumulative RealAlpha™ by late 2013. This was mostly caused by the fund’s underperformance in the three years mentioned above. In addition, at about 22.7% the annualized volatility of the fund was 2% higher than that of its reference portfolio in the overall analysis period.

The next chart illustrates ETF weights in the reference portfolio in the same period:

Reference Weights for DFSVX

The fund could effectively be emulated by a collection of just four related ETFs: iShares Russell 2000 Value (IWN; average weight of 34.9%), iShares S&P Small-Cap 600 Value (IJS; 30.1%), iShares Morningstar Small-Cap (JKJ; 18.5%), and iShares Morningstar Small-Cap Value (JKL; 13.7%). (The remaining two ETFs accounted for only 2.8% of the reference portfolio on average.)

The weighted expense ratio of these four ETFs is currently only 0.33% compared to the fund’s 0.52%. In addition, while an investor trading these ETFs might incur some commission, spread and premium/discount costs, he/she would not have to pay a recurring advisory fee of about 1% (or be forced to switch advisors) to gain benefits similar to those offered by DFA funds. Over time, dedicated factor ETFs will likely make such fund substitution even easier. Thus, entering an exclusive dimension of factor investing is no longer as hard as it has been.

To get a unique perspective on the DFA and other funds, please register on our website.

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Beating the Market, an Elusive Goal
analysis, mutual fund, value investing

Contrary to the main thesis of an article in The New York Times and despite emphatic proclamations, beating the market remains an elusive goal. A mutual fund manager, Robert A. Olstein, featured in the article, finds the arguments for index funds personally insulting:

“It’s like saying mediocrity is O.K. — that it’s more than O.K., it’s the best that anyone should hope for,” Mr. Olstein says. “It’s saying a guy like me can’t beat the market — that he shouldn’t even bother trying. That’s wrong! It really ticks me off. I can beat the market. I have beaten the market.”

To verify this statement, let’s take a closer look at the performance record of his Olstein All Cap Value (formerly known as Olstein Financial Alert). First, some information about cost. Class C shares of the fund (OFALX), established in September 1995, carry a hefty 2.31% expense ratio, including a sizable 12-b1 fee of 1%. In addition, there is a 1% contingent deferred sales charge (CDSC) imposed if an investor redeems Class C shares within the first year of purchase.

The Adviser Class shares (OFAFX), which became available four years later, have an expense ratio one percentage point lower than Class C shares. However, as their name implies, these shares are available to individual investors only through investment advisers who typically charge 1% in advisory fees. Therefore, from an individual investor’s perspective, the cost of both classes of shares is comparably high, which makes it difficult for the fund to outperform on an after-fee basis.

Second, there is an issue of a proper benchmark for the fund. As its name suggests, the fund pursues undervalued stocks in a broad spectrum of market capitalization. Yet its primary prospectus benchmark is the large-cap S&P 500® index (the secondary benchmark is the Russell 3000® index that includes smaller-capitalization stocks). Historically, Morningstar classified the fund into the mid-blend category; only in 2010 did the category change to large blend. As of the end of October 2013, about 40.2% of the fund’s holdings were still in the mid- and small-cap equities.

Third, the article states that

From its inception through November this year, including fees, his flagship fund returned 10.7 percent, annualized. That’s more than 2.4 percentage points better than the Standard & Poor’s 500-stock index, and substantially better than comparable small-cap indexes.

The problem is that this outperformance mostly stems from a relatively short period in the fund’s 18-year history. Here are the cumulative returns of the fund and the S&P 500® index in various periods:

From Through Fund Benchmark
1995 1999 166.9% 171.4%
2000 2003 45.6% -19.7%
2004 2006 30.6% 34.7%
2007 2010 -13.6% -3.3%
2011 2013* 46.5% 53.0%

*through December 6

The above data show that the fund’s lifetime outperformance of its primary benchmark can be mostly attributed to a relatively short four-year interval from the beginning of 2000 through the end of 2003. In other periods, the fund’s returns were sub-par.

What about risk-adjusted performance of the fund, determined with the simplest (single-factor) approach? Here are the fund’s Sharpe Ratios vs. those of its primary and secondary benchmarks implemented by the SPDR® S&P 500® ETF (SPY) and SPDR Russell 3000® ETF (THRK), respectively:

3 Years 1.12 1.36 1.31
5 Years 1.09 1.10 1.13
10 Years 0.30 0.46 0.48
15 Years 0.41 0.24 N/A

The Sharpe Ratio figures corroborate our cumulative return findings: a more recent performance of the fund was also unimpressive on a traditional risk-adjusted basis.

The following Alpholio™ chart illustrates a relative performance of the fund vs. its reference portfolio of exchange-traded funds (ETFs):

Cumulative RealAlpha™ for OFALX

In this analysis period spanning almost nine recent years, the cumulative RealAlpha™ of the fund exhibited a mostly downward slope. This indicates that the individual stock picking skills of the management team left a lot to be desired. In addition, the annualized volatility of the reference portfolio was slightly lower than that of the fund.

Here is the dynamic composition of the fund’s reference portfolio in the same analysis period:

Reference Weights for OFALX

The fund’s top three equivalent positions were in the Guggenheim S&P 500® Equal Weight ETF (RSP; average weight of 24.8%), Vanguard Consumer Discretionary ETF (VCR; 19.3%), and SPDR Russell 3000® ETF (THRK; 8.6%).

In conclusion, the fund did indeed beat the market, but only in terms of returns and mostly in one, relatively short and long-ago period of its 18-year lifespan. The fund’s performance after adjustment for risk, using either a traditional approach or the modern Alpholio™ methodology, has been quite unimpressive. Thus, beating the market, at least for this fund’s manager, remains more a fleeting gain than a solidly reachable goal.

To learn more about the Olstein All Cap Value fund, please register on our website.

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Value in Technology
mutual fund, value investing

According to an InvestmentNews article, Oakmark Funds, managed by the value investment firm Harris Associates, are increasingly holding technology stocks traditionally preferred by growth strategies:

The Oakmark Select [OAKLX] Fund has a 24% weighting to technology, and the flagship $11 billion Oakmark Fund (OAKMX) has a 19% weighting.

The reason is that prices of traditional value equities have increased to the point where the technology sector is more attractive. To illustrate that, here are some statistics from a recent edition of S&P’s The Outlook:

S&P 500 GICS Sector Performance

At 12.9, the price to estimated 2014 earnings ratio of the information technology sector is lower than that of classic value sectors, such as consumer staples (15.9) or utilities (14.7). In addition, the 13.1% year-to-date return of the sector trails that of the overall S&P 500® (19.1%). Finally, the price-to-earnings-growth (PEG) ratio of 1.0 for the sector matches that of consumer discretionary for the lowest value of all sectors. In a low-interest-rate environment maintained by the Fed, investors in search of dividend income have pushed the PEG of the consumer staples sector to 1.7 and telecom services to 1.6.

While the emphasis on technology stocks may improve the funds’ performance, as shown in a previous Alpholio™ post, past selection of securities in OAKMX did not lead to spectacular results when measured on a truly risk-adjusted basis. Therefore, investors should view the latest attempts with caution.

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Put Cash to Use
mutual fund, value investing

An article on Bloomberg describes major market timing efforts by “value” managers who currently cannot find underpriced stocks and therefore have large cash positions in their mutual funds:

Mutual Fund Ticker % of Cash
Weitz Value WVALX 30
Weitz Partners Value WPVLX 30
Yacktman Focused YAFFX 19
Westwood Income Opportunity WHGIX 16
IVA Worldwide Fund IVWCX 28
GoodHaven GOODX 33
Forester Value FVRLX 25
Cook & Bynum COBYX 40

This problem was already addressed in a previous post. While the managers are attempting to generate returns superior to those of their funds’ benchmarks and to reduce fund volatility, they are also distorting asset allocation in their investors’ portfolios. It should be up to an investor to decide what specific percentage of cash he/she wants in the portfolio, and not up to a manager of the equity portion of the portfolio.

So, how to solve this problem to the satisfaction of both parties? The manager should keep only a minimal amount of cash at hand, and temporarily invest the rest of it in an index instrument, such as an exchange-traded fund (ETF), that follows the fund’s benchmark. This way, the fund would be almost fully invested in equities, and there would be not forgone gains if the market kept going up. (The managers’ argument for keeping cash is not that a collapse of the equity market is imminent; it is that no sufficiently deep value stocks are available.)

This proposal certainly sounds like a blasphemy — after all, these managers want to show off their skill in picking individual stocks, instead of becoming “index huggers.” However, it does keep the best interest of investors in mind — to at least keep up with the market. Since most market timing efforts backfire, staying close to fully invested is the only prudent thing to do.

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Easy to Be a Value Investor
analysis, mutual fund, value investing

A recent post on Barron’s reports on statements made by Bill Nygren at the Morningstar Investment Conference. Mr. Nygren, manager of Oakmark Fund (ticker OAKMX), claims that it is easier to be a value manager today than it was 20 to 30 years ago because:

  • The analysts his firm hires now are “definitely” smarter than those it was hiring when he started out
  • His firm’s investment horizon for a security is five to seven years, as opposed to, say, only a couple of quarters for other investors.

So, let’s see how this is reflected in the historical performance of the above fund. First, as indicated in the most recent SEC filing, the annual turnover rate of the fund was 27% during the most recent fiscal year (18% and 24% in the two prior years, respectively). For simplicity, let’s assume an average turnover rate of approximately 23% and that a different part of the portfolio is replaced each year. Then it would take a little over four years to replace all holdings. This implies that an average security persists for only about two years in the portfolio. Even if this is not entirely accurate due to simplifying assumptions, that period is a far cry from the much longer investment horizon mentioned above. So much for the buy-and-hold philosophy.

Second, the Alpholio™ analysis of the fund shows that in the past eight years, it practically generated no alpha for its shareholders, when fully adjusted for the ever-changing risk of its positions:

Cumulative RealAlpha™ for OAKMX

In other words, instead of investing in carefully-analyzed individual stocks, the fund would do a comparable job investing in a reference portfolio of exchange-traded products (ETPs). In addition, this reference portfolio would have a smaller volatility of returns. (Alpholio™ calculates such reference portfolios for all US mutual funds on an ongoing basis.)

Therefore, while it may be true that today’s analysts are smarter than those hired in the past, it is definitely not any easier to be a value investor with a self-proclaimed long-term horizon.

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