Alpholio™ App for Android – Mutual Fund Service
October 24, 2014
Fairholme Fund Reopens
In one of the previous posts, we introduced the Alpholio™ app for Android. This post is the seventh and final one in a series covering the app’s services in more detail.
The Mutual Fund service analyzes mutual fund performance using Alpholio™’s patented methodology. For a detailed explanation of the methodology, please visit our FAQ. To see how the methodology is applied in practice, please review our blog posts that analyze various mutual funds.
To analyze a mutual fund, Alpholio™ finds a reference portfolio of exchange-traded funds (ETFs) that most closely tracks the fund’s performance over time. In general, there are three ways such a reference portfolio can be constructed with respect to its ETF membership and weights (percentages of each ETF’s value relative to the overall portfolio value):
- Fixed membership and fixed weights (we call it a “regular fit”)
- Fixed membership and variable weights (“fine fit”)
- Variable membership and variable weights (“detailed fit”)
(The fourth alternative, variable membership and fixed weights, makes little sense.) More variability results in a more accurate fit, but it also causes more changes in the reference portfolio. A detailed fit, which selects ETFs from a large pool of candidates multiple times, is also much more computationally intensive than the other two.
To access the service, start the app, open the navigation drawer and tap the Mutual Fund item:
This will open a new screen, on which you can configure the analysis:
By default, the app analyzes FAIRX (The Fairholme Fund). To change the fund’s ticker, tap the corresponding field and use the pop-up keyboard to edit it. (If you need to find the ticker based on other information, use the Security Lookup service of the app.)
To modify either the From or To date, tap its corresponding button. This will pop up a standard date selection dialog. The From date must chronologically precede the To date.
To select a different fit type, tap the corresponding radio button. (The Detailed fit is disabled in the beta release of the app.)
After you specify all parameters, tap the Analyze Mutual Fund button. If any of your inputs are invalid, you will see a brief pop-up warning. If all settings are acceptable, they will be saved on the device for subsequent use. Please note that to use the service, your device must be connected to the Internet.
After the app obtains and processes the data, you should see the following screen:
This is a chart of the total returns of the analyzed fund and its reference ETF portfolios. To learn about the difference between the regular reference (Ref in the chart) and lag reference (Lag Ref) portfolios, please consult the FAQ.
To select a different analysis screen, tap the spinner on the action bar and then tap a corresponding item in the dropdown menu:
Here is the cumulative RealAlpha™ chart for FAIRX:
Below the chart, there is a Statistics section that you can collapse and expand by tapping on its header. The section contains annualized standard deviation for the fund and reference portfolio, as well as annualized discounted RealAlpha™ and RealBeta™ measures for the the regular and lag reference portfolios.
Here is the reference weights chart for FAIRX:
The Statistics section below the chart contains statics for each ETF in the reference portfolio. As you can see, the fund had a largest equivalent position in VFH (Vanguard Financials ETF). This was a reflection of large holdings in Fannie Mae and Freddie Mac, which recently caused the fund to lose 9.6% in a single day as a result of an unfavorable court ruling.
The Smooth Buy-Sell and EMA Buy-Sell charts provide hypothetical buy-sell signals derived from the cumulative RealAlpha™. The difference between the two stems from the smoothing method: The former uses forecasting (which has less latency but can cause more frequent buy-sell transitions), while the latter employs an exponential moving average (EMA) approach that has opposite characteristics. Here is a sample chart based on the first method:
Press or tap the Back button and change the fit type to Regular to see how this affects the membership and weights in the reference ETF portfolio for the fund. Give the app a try today:
August 28, 2013
A number of articles from The Wall Street Journal, Barron’s, and InvestmentNews covered a recent reopening of the Fairholme Fund, closed to new investors since the end of February 2013. Should potential investors care?
In a continuation of a prior Alpholio™ post, here is an updated cumulative RealAlpha™ chart for the fund:
The trend of a relatively flat cumulative RealAlpha™ since early 2012 has persisted through the end of July 2013. Here are the updated reference weights for the fund:
Although the equivalent position in the Vanguard Financials ETF (VFH) decreased from the peak of almost 97% in April to about 57% in July, it still dominates the fund’s portfolio. At 22%, the PowerShares Dynamic Market Portfolio ETF (PWC) has the highest second weight, followed by the Vanguard Energy ETF (VDE; 14%).
According to the most recent filing, as of May 31, 2013 the fund held almost 90% of its assets in just ten positions:
This highly concentrated portfolio led to a much higher volatility of the fund compared to that of the reference portfolio. As the above analysis demonstrates, existing investors were hardly compensated for the elevated risk carried by the fund. To most prospective ones, the fund’s reopening should be a non-event.
July 25, 2013
Analysis of Fairholme Fund
A recent article in Barron’s contains an interview with industry experts about the pros and cons of a growing trend of actively-managed exchange-traded funds (ETFs). In that context, the discussion covered one of the most prominent mutual funds, The Fairholme Fund. One of the experts, Ben Johnson, global director of passive-funds research at Morningstar, stated that:
Q: Are there any strategies not suited for the ETF structure?
“Some of the most successful strategies on the equity side may never end up in this format. Look at Bruce Berkowitz, manager of the Fairholme fund (FAIRX). He is Morningstar’s equity manager of the decade. And yet he is pretty much running from something as liquid as a traditional mutual fund, to say nothing of ETFs.”
The counterpoint to that statement was posted by AdvisorShares:
“Lastly, the prominent mutual fund (Fairholme Fund) cited by Morningstar’s Ben Johnson is a poor example of the type of strategy that wouldn’t be a good fit for the liquidity of an ETF. In fact, the mentioned fund is the perfect example of the inefficiency of the mutual fund structure. In the Fairholme example, a lot of hot money comes in which is more wear and tear on the portfolio manager to put the cash to work. There is a cost to do that: spreads and settlement costs that impact both the new investors and your long-time shareholders. Then something happens: the fund falls out of favor, all the hot money is flying out, the PM is now selling what he can to meet redemption requests with those costs again impacting the departing shareholders, but also being born by the long-term shareholders. In reality, it is the long-term shareholders that will suffer the most by the tax inefficiency of the capital gain generating transactions.”
Luckily, from the Alpholio™’s perspective, it does not matter whether Fairholme is constructed as a mutual fund or an ETF. What really counts is how much value active management by Mr. Berkowitz adds or subtracts on a truly risk-adjusted basis (RealAlpha™). In the past eight years, the results have been mixed.
July 18, 2013
The Fairholme Fund (ticker symbol FAIRX) is a mutual fund with approx. $7.8 billion in assets managed by Bruce Berkowitz and associates. Morningstar awarded Mr. Berkowitz designations of the Fund Manager of the Decade and Fund Manager of the Year 2009 for Domestic Equity. Currently, Morningstar rates the fund Two Stars / Silver in the Large Value category, and says that “It’s more top-heavy than ever, but this fund is in some ways more stable.” The fund has recently been closed to new investors. Using Alpholio™ methodology, let’s see how Fairholme performed in the past eight years.
First, the total return chart, which assumes reinvestment of all distributions into the fund and each member of the reference portfolio, respectively:
From early 2005 through the trough of the recent market downturn in early 2009, the total return of Fairholme could generally be matched by the reference portfolio of ETFs. Subsequently, the performance of the fund and the reference portfolio significantly diverged, with the maximum difference at the beginning of 2011.
This is further illustrated by the cumulative RealAlpha™ chart:
An investor who bought the fund at the beginning of 2005 realized no cumulative RealAlpha™ in the four-year period to the beginning of 2009. While the cumulative RealAlpha™ peaked at about 17% in mid-2007, it was subsequently lost.
From early 2009 to early 2011, Fairholme generated a significant amount of RealAlpha™ by effectively riding the market rebound. But after that, not only did the fund lose that entire accumulated alpha, but it also subtracted an additional 15% of it. Only in 2012 did the fund restore its cumulative RealAlpha™ to a positive level (see a recent article from Bloomberg Businessweek).
It is therefore likely that Fairholme made big directional bets, which sometimes worked well, but often backfired. The overall numerical results demonstrate this very clearly:
In the entire analysis period, the annualized regular RealAlpha™ was just slightly positive. Even in the lag RealAlpha™ case, which tends to reward successful active management bets, the annualized alpha figure was not substantially higher.
Instead of investing in Fairholme in 2005 and staying put through late 2012, the investor would have been almost as well off by buying and maintaining a reference portfolio of ETFs determined by Alpholio™. This is further supported by volatility figures:
At almost 22%, the annualized volatility of returns of the fund in the entire analysis period was high, and could not be matched by that of the reference portfolio of ETFs. This implies that the fund was likely concentrated in a small number of positions. Indeed, the fund typically held less than 25 securities, with a large portion of its assets in just a few of them. For example, at the end of November 2012, more than 86% of the fund’s net assets were held in just eight stocks (see the Top Ten Holdings by Issuer table on p. 5 of the FY2012 shareholder report). Again, sometimes such a concentration was beneficial, but frequently it was not.
So, what types of securities did Fairholme hold? This chart shows the major investment “themes” of the fund over time:
The biggest equity theme by far is the equivalent position in VFH, a Vanguard ETF that represents the financial sector of the U.S. economy. Mr. Berkowitz started building up this position right after the market bottom in March 2009, and it persists to this day. Once it became clear that the U.S. government provided an effective bailout to large financial institutions, the sector rebounded. This is what generated close to 25% of cumulative RealAlpha™ of the fund by the end of 2010. However, as this large position continued, it caused the fund to underperform by losing all of that alpha and more within a year. Only in 2012 did the position rebound again and helped the fund recover some alpha, although with a significant fluctuation. Even with that RealAlpha™ gain, the investor should have carefully considered if he/she wanted to invest in, practically, a financial-sector fund.
The historical cash theme is represented by an equivalent position in SHY (short-term Treasury bond ETF). This position was at times very high as a percentage of the reference portfolio, indicating major market timing attempts in 2005 and 2007 in the fund that was expected to invest predominantly in equities. Arguably, this hurt the fund’s performance in that period. A related equivalent position in LQD (iShares Investment Grade Corporate Bond ETF) also illustrates cash-similar instruments held in this equity fund.
The next three largest equity themes are represented by JKJ (iShares Morningstar Small Core Index ETF), EWC (iShares Canadian market ETF), and VDE (Vanguard Energy ETF). An equivalent position in small-capitalization stocks is quite surprising for a “large-value” fund and signals a potential style drift. A large actual position in Canadian Natural Resources (CNQ) in 2006 explains the second of these themes.
How could an investor capture the relatively short period of time when Fairholme outperformed its reference portfolio? A simple algorithmic buy-sell signal is shown in the following chart:
The analysis starts with an assumption that the investor initially bought the fund in early 2005 and intended to hold this investment indefinitely, i.e. at least through early 2013. The blue curve depicts the cumulative RealAlpha™ in that entire period. Since there is a degree of high-frequency oscillation in that curve, its longer-term trend can be elicited from the exponential moving average (EMA) of RealAlpha™, depicted by the smoother green curve. (Note that the byproduct of smoothing is a slight lag of the EMA vs. its source.) Subsequently, a simple decision criterion is applied to determine whether the investment in the fund should be retained. So long as the fund generates positive monthly increments to cumulative RealAlpha™, the investment in the fund is considered beneficial. Conversely, if the fund’s cumulative RealAlpha™ begins to consistently decrease, the investment is no longer considered attractive.
This simple decision criterion indicates that the fund should have been divested in early 2008, reacquired in the second quarter of 2010, and divested again from the second half of 2011 until present. This led to the capture of most of the positive cumulative RealAlpha™ run during the market rebound, while avoiding the most recent fluctuation due to a dominant position in financials.