Analysis of Vulcan Value Partners Fund
August 13, 2014
Entering an Exclusive Dimension
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:
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:
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:
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.
January 7, 2014
Beating the Market, an Elusive Goal
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).
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:
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:
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.
December 9, 2013
Value in Technology
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:
*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:
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):
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:
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.
October 26, 2013
Put Cash to Use
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:
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.
July 31, 2013
Easy to Be a Value Investor
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:
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.
July 25, 2013
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:
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.