This weekend’s profile in Barron’s features the Hennessy Cornerstone Mid Cap 30 Fund (HFMDX; Investor Class shares). This $930 million no-load fund has a 1.32% gross expense ratio and 5% turnover. According to the article
Over 10 years, mid-caps delivered 6.7% annually, versus 6.4% for large companies, and 4.7% for small. The Cornerstone Mid Cap fund returned 6.8%, beating 86% of its peers.
Alpholio™ agrees that mid-cap equities are a compelling asset class.
The primary prospectus benchmark for the fund is the Russell Mid Cap Index. One of the accessible implementations of this index is the iShares Russell Mid-Cap ETF (IWR). Alpholio™’s calculations show that since late 2004 the fund returned more than the ETF in approximately 61% of all rolling 36-month periods with a median cumulative (non-annualized) outperformance of 1.3%. Similarly, the fund outperformed the ETF in 59% of all rolling 24-month periods and 62% of 12-month periods.
The secondary prospectus benchmark for the fund is the S&P 500® Index. One of the low-cost implementations of this index is the iShares Core S&P 500 ETF (IVV). Over the same evaluation interval, the fund returned more than the ETF is about 78% of all rolling 36-month periods (with a median cumulative outperformance of 5%), 72% of 24-month periods and 60% of 12-month periods.
While comparisons of rolling returns provide a valuable insight, they do not take the fund’s risk into account. To do so, let’s employ Alpholio™’s patented methodology. One variant of this approach constructs a custom and dynamic reference portfolio of ETFs for each analyzed fund. This portfolio has a fixed ETF membership but variable weights, which enables it to more accurately track the fund’s composition over time. Here is a resulting chart of the cumulative RealAlpha™ for Hennessy Cornerstone Mid Cap 30:
Over the last 11 years, the fund produced around 3.1% of annualized discounted RealAlpha™ (to learn more about this and other performance measures, please visit out FAQ). However, the fund achieved this commendable result at the expense of elevated volatility: standard deviation of 18.3% compared to 16.9% of the reference ETF portfolio. This was underscored by considerable declines of the cumulative RealAlpha™ in September 2008 and from the second half of 2015 through January 2016. The fund’s RealBeta™, measured against a broad-market equity ETF, was 1.04.
The following chart illustrates changes of ETF weights in the reference portfolio over the same analysis period:
The fund had top equivalent positions in the iShares S&P Mid-Cap 400 Growth ETF (IJK; average weight of 37.3%), iShares Morningstar Small-Cap ETF (JKJ; 17.7%), PowerShares Dynamic Market Portfolio (PWC; 11.3%), iShares Transportation Average ETF (IYT; 10%), iShares Morningstar Mid-Cap Growth ETF (JKH; 8.3%), and Vanguard Energy ETF (VDE; 8%). The Other component in the chart collectively represents additional two ETFs with smaller average weights.
The Hennessy Cornerstone Mid Cap 30 Fund added a substantial amount of value on a truly risk-adjusted basis. However, the cost of this performance was a significant volatility that stemmed from a concentrated nature of the fund’s holdings (30 equally-weighted positions, constructed annually). Although turnover was very low, the fund produced relatively big distributions which made it largely unsuitable for taxable accounts.
To learn more about the Hennessy Cornerstone Mid Cap 30 and other mutual funds, please register on our website.
Today’s mutual fund snapshot in Barron’s profiles the Hennessy Focus Fund (HFCSX; investor shares). This $1.7 billion, no-load fund sports a low 14% turnover and has a 1.46% gross expense ratio.
As its name suggests, this is a concentrated fund: As of the end of March 2015, its portfolio consisted of just 22 positions and its top-ten holdings comprised 65% of assets. Interestingly, the fund held over 12% in cash and fixed-income securities at that time.
According to the article:
In the past 15 years the fund has racked up an average annual return of 12.87%, putting it in the top 1% of its category based on performance, according to Morningstar. In the three- and five-year periods the fund has topped 95% and 93% of its peers, respectively. With a small number of holdings of varying market value, the fund does not fit neatly into any fund category or against a benchmark. But for comparison’s sake, the Dow Jones U.S. Total Stock Market Index has returned an annualized 4.7% over 15 years, so Hennessy has handily outperformed. This year the fund is up 6.2%, compared to 1.4% for the Standard & Poor’s 500.
These long-term comparisons are misleading. The fund’s original manager since 1996 stepped down and the current three managers took over in late August 2009. Therefore, a 15-year history of the fund is irrelevant. For further analysis, we will use the period beginning in September 2009, the first full month under current management.
The primary prospectus benchmark for the Hennessy Focus fund is the broad-market Russell 3000® Index. One of the practical implementations of this index is the iShares Russell 3000 ETF (IWV). According to Alpholio™’s calculations, since September 2009 the fund returned more than the ETF in about 90.6% of all rolling 36-month periods. With 24-month periods, the fund outperformed the ETF about 84% of the time, and with 12-month periods about 66% if the time. However, this comparison does not take the fund’s volatility (risk) into account.
In the simplest variant of Alpholio™’s patented methodology that adjusts for risk, both the membership and weights of ETFs in the reference portfolio are fixed over the analysis period. This type of analysis shows that that the fund generated approximately negative 0.9% of annualized discounted cumulative RealAlpha™ and a negative 0.1% of its lag counterpart (to learn more about RealAlpha™, please visit our FAQ). The fund had the top-four equivalent positions in the Consumer Discretionary Select Sector SPDR® Fund (XLY; fixed weight of 34.1%), PowerShares DWA Industrials Momentum Portfolio (PRN; 14.3%), SPDR® S&P® Retail ETF (XRT; 10.1%), and Vanguard Utilities ETF (VPU; 7.4%). At 14.6%, the fund’s standard deviation was approximately 0.7% higher than that of the reference ETF portfolio and its RealBeta™ was 1.03.
In a more elaborate variant of our methodology, the membership in the ETF reference portfolio remains fixed but ETF weights can fluctuate over the analysis period. The following chart depicts the resulting cumulative RealAlpha™ for the fund:
The chart starts in November 2009 because at least three full months of the fund’s history under the current management are required for the analysis. Over that period, the fund produced a negative 0.8% of regular and negative 0.6% of lag annualized discounted RealAlpha™. The fund’s standard deviation of 14.6% was about 1.1% higher than that of its reference ETF portfolio. The fund’s RealBeta™ was around 1.02.
The next chart illustrates changes of ETF weights in the reference portfolio for the fund over the same analysis period:
The fund had top equivalent positions in the Vanguard Consumer Discretionary ETF (VCR; average weight of 44.3%), iShares Core S&P Small-Cap ETF (IJR; 16.2%), iShares Select Dividend ETF (DVY; 13.8%), iShares Transportation Average ETF (IYT; 7.2%), iShares 20+ Year Treasury Bond ETF (TLT; 5.0%), and iShares North American Tech-Multimedia Networking ETF (IGN; 3.8%). The Other category in the chart collectively represents additional three ETFs with smaller average weights.
Under the current management since 2009, the Hennessy Focus Fund did not deliver the same outstanding performance it produced over the past 15 years. Despite a highly-concentrated portfolio, the fund could easily be replaced with a relatively small reference portfolio of ETFs with better return-to-risk characteristics. Even with its low turnover, over the last four years, the fund had substantial distributions: In 2011, 11.7% of net asset value (NAV), in 2012, 8.8% of NAV, and in 2014, 8% of NAV. While these distributions mostly consisted of long-term capital gains, this indicates that the fund may be less suitable for taxable accounts.
To learn more about the Hennessy Focus and other mutual funds, please register on our website.