Hennessy Funds Outperform With Active Management

More than 70% of actively managed U.S. stock funds lagged their benchmarks over the five years ended June 30, according to the S&P Dow Jones Indices Versus Active (SPIVA) U.S. scorecard.

Hennessy Funds were an exception. Over those five years, nearly 70% of Hennessy’s funds beat their benchmark on an annualized basis.

The SPIVA U.S. scorecard measures performance of actively managed funds against their relevant S&P index in the stock market.

“The past five years (through June 30) have been marked by the rare combination of a remarkable rebound in domestic equity markets and a low-volatility equity environment,” Aye Soe, senior director, Index Research & Design, S&P Dow Jones Indices, wrote in the SPIVA report. Soe added, “This combination has proven difficult for domestic equity managers… across all capitalization and style categories.”

Among U.S. equity funds, 60% of large-cap, 58% of midcap and 73% of small-cap managers underperformed their benchmarks, according to SPIVA.

Managers of international equity fared worse. About 70% of global equity funds, 75% of foreign equity funds, 81% of foreign small-cap funds and 65% of emerging market funds lagged their benchmarks.

Yet of Hennessy Advisors’ 16 funds, which run $5.7 billion, six outperformed their indices for the 12 months ended June 30.

On a five-year annualized basis, 11 funds beat their benchmarks net of fees. Six of the 11 turned over their portfolios just once a year.

“It’s not timing the market, it’s your time in the market,” said Neil Hennessy, the firm’s president, chairman and chief investment officer. “We buy the stocks with a highly disciplined formula, and we hold for a year with no emotions. Then we do it again.”

The two best performers are Hennessy Japan Fund and Hennessy Japan Small Cap Fund.

Over the 12 months that ended June 30, the small-cap fund gained 28.68% vs. the Russell/Nomura Small Cap Index’s 17.21%, says Morningstar. Over the past five years, the fund’s annualized return of 15.13% beat the index’s 9.87% .

The Japan Fund’s 17.54% gain over the past year beat the Russell/Nomura Total Market Index’s 10.86% gain. The fund’s 14.40% five-year average annual return topped the index’s 7.48%.

Among U.S. equity funds, Hennessy Cornerstone Mid Cap 30 gained the most over the 12-month period. Its 31.95% outperformed the Russell MidCap Index’s 26.85%. On a five-year annualized basis, the fund returned 22.32%, beating the index’s 22.07%.

Hennessy Cornerstone Large Growth rose 29.35% over the 12 months ended June 30, exceeding the Russell 1000 Index’s 25.35%. Its five-year average annual return of 19.48% beat the index’s 19.25%.
Hennessy’s best funds over the five years held bonds and stocks. Hennessy Total Return Fund, at 75% equity and 25% bonds, beat the 75/25 Blended DJIA/Treasury Index 15.19% vs. 13.41% on an annualized basis.

Hennessy Core Bond’s 5.42% return outpaced the Barclays U.S. Government/Credit Intermediate Index’s 4.09%.

As for volatility, over the past five years each outperformer beat its bogey four years; the Mid Cap 30 outperformed just three years.

For the full story go to Investor’s Business Daily.

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Hennessy: “I Hope We Go Over Fiscal Cliff”

Neil Hennessy doesn’t just think the U.S. will go over the fiscal cliff; he wants it to happen.

“I hope we go over,” said the Hennessy Funds’ all-around top dog about the fiscal cliff, the name given to the end-of-the year budget changes. On Jan. 1, spending reductions across the entire federal budget will kick in automatically the same day the Bush tax cuts expire. “I guarantee that within six months, Washington will get the tax situation right and the country should be on surer footing. But, within the next 30 days it’s unlikely they would get it right.”

Hennessy presented his 5th annual market outlook, as well as portfolio changes and the renaming of his flagship mutual fund at a New York press conference last Tuesday. Investors are incredibly nervous, said the chairman and chief investment officer of the Novato, Calif., fund house, because there is a crisis of clarity. He pointed to the August consumer confidence level, which hit its lowest point since March 2009, the month the market hit bottom during the fiscal crisis. While the presidential election cleared up the uncertainty over healthcare reform, the fiscal cliff will give us clarity on taxes and regulation, said Hennessy.

From 2008 through 2011, investors have pulled $404 billion out of U.S. equity mutual funds, while putting $775 billion into fixed-income funds. The trend continued into 2012 with equity funds seeing outflows of $116 billion vs. bond fund inflows of $278 billion.

However, Hennessy says equities are the only logical place to be in light of corporate profits near their all-time high. Investors have few other places to go, he said dismissing the real estate sector, the European Union and emerging markets. Meanwhile, bonds are not much of an option with the yield on the 10-year U.S. Treasury bond falling to 1.68% from 2.13% a year ago. Meanwhile, the yield on the “Dogs of the Dow,” the 10 highest yielding stocks in the Dow Jones Industrial Average is 4.13%, or 146% higher than the 10-year bond. The current yield on the full Dow Industrials is 2.67%.

In October, Hennessy Funds acquired all ten FBR Funds and merged them into existing funds. This brings the total assets under management at Hennessy Funds to $3.1 billion and total shareholders to about 180,000. The Hennessy Focus 30 Fund after merging with the FBR Mid Cap Fund was renamed the Hennessy Cornerstone Mid Cap 30.

Based on a rebound in the housing market and consumers spending more on their homes, the fund’s year-end portfolio rebalancing pushed consumer discretionary up to 40% of the assets from 30% a year ago. Industrials jumped from 13% to 30%, while Utilities fell from 30% of assets to 0%. The fund also had no assets in information technology or consumer staples. The fund’s top consumer picks are Pier 1 (PIR), Whirlpool (WHR) and Mohawk Industries (MHK). Industrials. In the housing sector he likes Standard Pacific (SPF), KB Homes (KBH), and Meritage Homes(MTH), as well as building products companies: USG (USG), Masco (MAS) and A.O. Smith (AOS).

“Sleep Well” funds: Where to invest for a good night’s rest

Actively-managed mutual funds took a big hit in the stock market’s 2008 crash. The average equity fund plunged 39.5 percent compared with the 37 percent drop in the S&P 500 Index.

Many investors concluded, “if my active fund is going to fall more than a cheaper index fund, what am I actually paying for?”

Not much, it appears. But what if you could find a mutual fund that managed risk by significantly reducing losses in a down market, that could also capture profits when the market rallied? Now, that would be an expense worth paying.

After last week’s wild market roller coaster, a familiar refrain heard among investors was “where do I put my money now?” Wherever it goes, you can’t afford to stay awake all night worrying about your portfolio. That’s why we went searching for what we like to call “Sleep Well” funds. These are funds that can weather market volatility, give you peace of mind and let you get a good night’s rest.

The three funds mentioned are the Sierra Core Retirement Fund, Permanent Portfolio, and the Berwyn Income Fund.

For the full story go to Reuters Money.

Schwab Puts Nail into Mutual Funds’ Coffin

Charles Schwab knocked down one of the last barriers mutual funds held over ETFs, commission free trading, with the launch of its new family of ETFs on Monday.

That’s right. Free!

Previously free was the sole province of the no-load fund, mutual funds that refuse to charge investors a commission to buy or sell their shares. ETFs, because they trade on the stock exchange, require investors to buy and sell shares through a registered stockbroker. And if there’s one thing you can say about stockbrokers, they don’t trade for free. That means every time an investor wants to buy and sell ETF shares, she needs to pay a commission. While discount brokers have reduced the commission to below $20 a trade, this remains a significant fee for small investors following a dollar-cost averaging schedule.

Until now that is.

Open up an account with Schwab and you can trade any of the new Schwab ETFs for free. The catch? Only the new Schwab ETFs trade for free and only when you buy online. Want to buy online an ETF from another company in your Schwab account? That commission starts at at 12.95. Still, it’s a big deal and it will make a big difference for small investors who either day trade or use a dollar-cost averaging strategy.

Dollar-cost averaging is the strategy of investing a steady amount of money into the stock market on a regular basis, such as weekly, monthly or quarterly. The strategy holds two purposes. One, it forces you to save money and invest it on a regular basis. Second, it’s a form or risk management that averages your cost basis. If you had $50,000, and you wanted to put it into the stock market, you could put it all in a variety of investment vehicles in one day. The big risk is that the market falls soon afterward, providing you with an opportunity to have bought even more at a cheaper price. By investing say $1,000 a week, you can average out the year’s volatility and make it work for you.

If the share price falls, because you didn’t put it all in at once, you get an opportunity to buy at a lower price, and get more shares. If the share price rises, you do get less than you would have earlier, but you’re making a profit, your shares are rising.

Realizing investors want to put their feet back into the market, but have lost a taste for niche portfolios; Schwab has created eight conservative, broad-based ETFs to grab the widest audience.

· Schwab U.S. Broad Market ETF (SCHB) – this tracks the Dow Jones U.S. Broad Stock Market Index, a market-cap weighted benchmark that contains the 2,500 largest stocks in the U.S. market. This provides a comparable index for people who want to track the Russell 3000. The expense ratio is 0.08%, which comes in one basis point lower than the Vanguard’s Total Stock Market ETF (VTI) and less than half the 0.21% charged by the iShares Russell 3000 Index (IWV).

· Schwab U.S. Large-Cap ETF (SCHX), which follows the DJ U.S. Large-Cap Total Market Index, a cap-weighted index of the 750 largest U.S. companies. This is Schwab’s alternative to the S&P 500 Index. It also charges 0.08%, compared with 0.09% on the SPDR.

· Schwab U.S. Small-Cap ETF (SCHA). This follows the DJ U.S. SmallCap Total Stock Market Index, the 1750 members of the DJ U.S. Broad Market Index not included in the large-cap index above. This would be analogous to the Russell 2000 small-cap index.

· Schwab International Equity ETF (SCHF). The tracks an index by FTSE, the people who made the benchmark for the British stock market. The FTSE Developed ex-US Index holds about 85% large-cap stocks and 15% small-cap from more than 20 developed markets outside the U.S. It charges an expense ratio of 0.15%.

By the end of the year, Schwab expects to launch four more ETFs to track large-cap growth, large-cap value, international small-cap and emerging markets.

The no-load ETF appears to be part of Schwab’s broader strategy to become the lowest-cost provider in the ETF space. In addition to no commissions, the Schwab ETFs either beat or match the expense ratios of its nearest competitors, making them the lowest priced ETFs on the market.

This follows Schwab’s move in May to lower the expense ratios on all its no-load equity index funds with a minimum investment of $100. At the time Schwab lowered the expense ratio on its Schwab S&P 500 Index Fund to nine basis points, the same charge as the SPDR and half the cost of the Vanguard 500 Index fund, the benchmark for low cost index funds.

Schwab Ready to Enter ETF Market

Mutual fund giant Charles Schwab Investment Management expects to launch its first ETFs during the first week of Novemeber.

A subsidiary of The Charles Schwab Corp., the investment management unit is one of the nation’s largest asset management companies. It held more than $210 billion in assets under management as of September 30. The firm, which says it’s the third-largest provider of retail index funds, manages a total of 82 mutual funds, with 36 actively-managed.

James Sees Market Testing March Lows

Short ETFs may see a resurgence if Barry James’ prediction comes true.

The Direxion Daily Financial Bear 3X Shares (FAZ), the ProShares UltraShort QQQ (QID) and the ProShares UltraShort Russell 2000 (TWM) were among the top 12 stocks to see the most net cash inflows today according

In a presentation yesterday by mutual funds recently named Lipper Leaders, Barry James, the portfolio manager of the James Balanced Golden Rainbow Fund, says we’re entering a depression.

Lipper, which competes with Morningstar as an evaluator of mutual funds and ETFs, rates funds according to five criteria: total return, consistent return, capital preservation, expenses and tax efficiency. The ratings go from 1 to 5, with 5 being the highest. I’ve attened quite a few of these Lipper Leader presentations over the years and Barry James keeps popping up. Compared to other mutual funds in the same category of balanced funds, those that hold stocks and bonds, the James Balanced Golden Rainbow Fund has scored a 5 in total return, consistent return and capital preservation for all the measured periods: the three-years ended March 31, the five-year period, the ten-year period and lifetime of the fund.

James makes the top of the class by properly evaluating the risk in the market. So, he’s worth listening to. He thinks the economy is heading into a depression. He comes to this conclusion because businesses have cut inventories, but he doesn’t see any increases in production. Restaurants at resorts are seeing declining business. He thinks the economy remains weak, which will lead to a weakened stock market. James expects the market to test the March low.

He said the recent rally has been a short covering rally. More than growth or value driving the market, he said the rally has been based on “silly cheap stocks. In terms of quality, poor, or low-quality stocks have been running rather than growth or value stocks.
to the Wall Street Journal.

Dow Kicks Out GM; S&P Still Holds It

Former GM CEO Rick Wagoner upon realizing what just hit the fan.

4 pm.

Late night I sent my story about General Motors and the indexes out to a few people, including some people at Dow Jones. This morning General Motors is pulled from the Dow Jones Industrial Average. Coincidence? I’ll let you decide.

Today, Dow Jones pulls GM and Citigroup out of the DJIA. The two companies will leave June 8 to give index fund investors time to adapt to the deletion and addition of two new components, Cisco Systems and Travelers. Since GM is getting knocked off the New York Stock Exchange tomorrow, GM will be going to an over-the-counter market, representatives for Dow Jones Indexes said they will use “the best available price source” for the next week. Can you imagine, the Dow being priced off the Pink Sheets. That’s the true Wild West of Wall Street. Oh, the humanity!

Since the DJIA is created by the editors of the Wall Street Journal, there’s no requirement for them to remove GM before today.

One thing to remember is that an index isn’t a portfolio. A fund or ETF is a portfolio. It lives in the real world and costs money to maintain. An index is just a construct that measures the market.

A Dow component since 1925, GM has been a significant part of measuring the stock market through the 1920s bubble, the crash of 1929, the Depression and every up and down of the American economy since. It’s only fitting that the index itself should suffer and be brought down by this once mighty component. If the index is the market and GM has been a huge part of the market and the American economy for so long, it’s appropriate that the Dow should hold it until today to give a proper measurement of the U.S. stock market and economy. But, that’s not good for funds that follow the Dow, such as the Dow Diamonds (DIA). They will probably suffer the loss even though they would have liked to get rid of the stock months ago.

However, the S&P 500 is rules based and a company needs to have $3 billion of market capitalization to remain in this “Large-cap index.” GM hasn’t had $3 billion since December. At the close on Monday, it was still in the index.

Here’s a great video from The New York Times: The Decline of G.M..

Meanwhile back at the other automobile bankruptcy in America, it appears Tommy Lasorda has been brought in as Chrysler’s vice chairman to make the Chrysler bankruptcy work. I wonder if they will bring in Joe Torre to fix GM.

Funds Hold GM to the Bitter End

What does a company need to do to get kicked off of an index around here?

As of Friday, General Motors was still in the S&P 500 and the Dow Jones Industrial Average. If the indexes hold the stock until the company declares bankruptcy are the index funds and ETFs that track indexes with GM as a component obligated to hold it to the bitter end? Are they are allowed to sell it ahead of time or do they have to suck up the loss, even though everyone saw this coming from a mile away?

According to AOL Money & Finance, all of GM’s shares are now owned by large block holders. Institutions hold 36%, mutual funds, which includes ETFs, hold 62% and the rest with others like the executives. State Street Global Advisors hold the most GM shares of any institution, 26.9 million, or 4.37% of all the GM shares outstanding. Surprisingly, only 5.26 million of those shares reside in the SPDR Trust (SPY). Still that’s a big loss for one fund no matter how you slice it. Vanguard Group has the second most shares, 23.99 million, or 3.93% of the shares outstanding. However, four of its funds are in the top 10 holders, the Vanguard 500 Index (VFINX) has the most shares of any fund, 5.8 million. This is followed by Vanguard Mid-Cap Index Fund (VO), Vanguard Total Stock Market Index Fund (VTI) and Vanguard Institutional Index Fund. Barclays Global Investors, owner still of the iShares ETF family, comes in third with 17.8 million shares.

The shocking part is that according to Standard & Poor’s, a component of the S&P 500 needs to have a market cap of at least $3 billion. With 610 million shares outstanding, GM would have to trade at $5 to make that. But GM last saw $5 on its shares on Dec. 8, 2008, more than five months ago. It’s not like S&P doesn’t remove stocks from the index. It’s deleted nine companies already this year.

Peter Cohan knows how to evaluate a company. He’s amazing at looking under the hood and breaking apart a company’s financial statements to see the rotting husk of a business. At Daily Finance, he says the failure of GM matters because it shows of success can lead to failure and how now the U.S. can’t even fail right. Companies can’t shut down without government intervention. He adds that the U.S. system of economic growth, venture-backed innovation, has been nearly snuffed out and that is not good news.

Cohan also list the five big reasons why GM didn’t have to fail and squarely lays the blame at the feat of managers who were overly impressed with themselves for no good reason. The five reasons: 1) bad financial policies, 2) Uncompetitive vehicles, 3) ignoring competition, 4) failure to innovate, 5) managing the bubble. Ignoring the competition and failure to innovate are the worst crimes and that should justify Rick Wagoner’s firing pretty easily.

Book Review of ETFs for The Long Run

Research Magazine just came out with a supplement called the Guide to ETF Investing 2009. Some great articles in there.

On page 8 of the guide is a review of my book ETFs for the Long Run. The link goes to a PDF file. The article was written by Ron DeLegge, the editor of ETFGuide.com, a great resource for ETF information. I am reprinting it here because I can’t link directly to the article.

Long-Term Thinking

Mutual funds may have enjoyed a 65-year head start, but the interest in ETF investing by individual investors and financial professionals is blossoming. Naturally, the rise of ETFs has led to a proliferation of subject material related to this still emerging investment vehicle. ETFs for the Long Run tackles this growing investment universe in a fun, readable and easy-to-comprehend manner.

The first few chapters take readers through a brief review of how ETFs came about. Nathan Most, a product developer for the Amex was instrumental in helping to launch the U.S. ETF marketplace. Most asked his development team, “Why can’t we create a warehouse receipt which would be backed by the underlying stock in the index but trade like a share of stock itself?” His question would later be answered with product prototypes that would eventually lead to the first U.S.-listed ETF in 1993, the Standard & Poor’s Depository Receipt (SPY).

Author Lawrence Carrel writes about ETFs as being a “better mousetrap.” He argues that mutual funds are inefficient from a cost standpoint: “Funds charge their shareholders for everything that goes on inside the fund, such as transaction fees, distribution charges, and transfer-agent costs.” On top of these costs, Carrel explains that there are additional charges that erode performance such as capital gain distributions. These often have the ugly habit of surprising mutual fund investors.

Timing Trouble

Remember the mutual fund timing scandal from 2003? Carrel suggests the 2003 scandal actually helped to fuel the popularity of ETFs. As you may recall, mutual funds were accused of breaking their own rules by allowing a select group of privileged investors to late-trade and market-time within their funds. On one hand, fund companies were telling investors to be long-term investors. On the other hand, these same companies were allowing hedge funds to make quick short-term profits at the expense of long-term investors. In contrast, ETFs avoided becoming tainted by the scandal because ETF investors are unaffected by the trading activity of their fellow shareholders.

ETFs for the Long Run explains the importance of building an ETF portfolio that accomplishes a logical financial mission. Carrel cites the classic 60/40 conservative portfolio which has substantially less exposure to stocks and more exposure to bonds. He suggests an equity mix using SPY, VO, IWM and EFA. For the bond position, he uses BSV, BLV, CFT and TIP. He also throws in a REIT fund (VNQ) for non-correlated market exposure.

Future Tense

Toward the end of the book, Carrel considers what the future of the ETF marketplace could become. While active ETFs have yet to make any significant impact in the business, the number of active mutual funds outnumbers that of index mutual funds. Could the same thing eventually happen with ETFs? Another area of future ETF asset growth is inside the lucrative 401(k) retirement market. Millions of 401(k) investors have no low-cost investment options or diversified choices like commodities, international bonds or REITs. Companies like Invest n Retire and WisdomTree are already aggressively pushing ETF/401(k) retirement plans. As complicated as ETF investing may sometimes seem, simplicity is often best. “The basic challenge for
the individual investor is to achieve a broadly diversified portfolio for the least amount of money,” states Carrel. This book should go a long
way to helping not just investors but top-notch financial professionals accomplish this noble objective.

Making the Case for Index Funds

Investing is long term. Speculation is short term.

Can you watch the market every day? If not, you should invest, rather than speculate. Without a doubt indexing is the way to invest. The crash of 2008 has not only highlighted the risk of owning single stocks, but also exposed the dirty underbelly of actively managed mutual funds.

Going for the index avoids getting stuck with the stocks that might be left behind. If you believe in the concept of diversification, then single stock risk is just too huge of a risk to take. And while you might be able to buy 20 stocks and build out a nice portfolio, one bad stock can wipe out 5% of your portfolio and two bad stocks decimate the fund. (Get it? Decimate? Remove 10%. Ok, moving on. …)

If you want to own financials, 30 are better than two stocks. If the two financials you owned last year were Bear Stearns and Lehman Brothers, you, my friend, have completely lost your portfolio of financials, and maybe your entire portfolio. Buying an index fund tracking the financial sector of the S&P 500, such as the Financial Select Sector SPDR (XLF), gives you 80 stocks, about 11% of the S&P 500. You can get more exposure to one narrow niche of the market and diversification at the same time, hence less risky. Sure, the financials took a hit, but considering most of them are still in business, you still have some of your investment.

So, single stock risk is out if you’re not buying for dividends. But what about actively managed mutual funds? The whole point of the actively managed fund is to give you, the investor, alpha, those extra percentage points of return that comes from the fund manager’s skill and intellect. The financial crisis has shown how hard it is to find true alpha.

It’s pretty much common knowledge these days that only about 20% of active fund managers beat the major market benchmarks. Considering many active funds are essentially index fund copycats, you will never beat the market with their huge management fees. Fund managers counter that even if they don’t beat the market going up, they at least have the ability to post narrower losses on the way down, because they can sell off the worst performing sectors while the index can’t. I think a little bit of research will show they are also posting returns worse that the indexes on the loss side as well.

And even those that don’t post worse losses, is a 35% loss that much of an improvement over a 37% loss?

So, if you eliminate single stock purchases and actively managed funds, deductive reasoning says you must go with the index. Of course, this mostly applies to U.S. equities. In some markets, such as emerging markets, a smart manager might have some market knowledge that hasn’t disseminated widely, but in the U.S. that kind of information gets spread around pretty quickly.

Indexes can be volatile and risky. If the stock market falls, an index tracking the stock market will fall. However, with the index fund you can rest in the knowledge you matched the market and didn’t do worse than most of the market.

If you really want a lesson, John Bogle, the inventor of the index mutual fund, explains why indexing is better than stock picking in “The Little Book of Common Sense Investing.” Essentially, Bogle says you can maximize returns and lower risk by not buying single stocks but mutual funds. Followers of Bogle have written a book called “BogleHeads” which expands on this theme.

Now in a shameless plug for myself, my book ETFs for the Long Run takes Bogle’s argument one step further. I agree with Bogle that indexing is the way to invest. Bogle likes the mutual fund structure, but I think Exchange Traded Funds are the mutual fund for the 21st century. In the book, I explain indexing, the advantages of buying mutual funds instead of single stocks and then why ETFs are better than mutual funds. The key reasons being they are cheaper, more tax efficient, more transparent and more flexible. I also explain how to buy and sell ETFs and how to use them to build a portfolio.

Since you don’t know what sector of the market will rise, you should own a broad market index, such as the Vanguard 500 mutual fund, (VFINX), or buy an ETF such as the SPDR, (SPY), or the iShares S&P 500 Index (IVV). The Diamonds Trust (DIA) tracks the Dow Jones Industrial Average and the PowerShares QQQ (QQQQ) follows the technology heavy Nasdaq 100 index. The Vanguard Total Bond Market (BND) is a broad bond index.

Then you break it down into sector specific indexes that you want to follow.

Finally, you need to watch fees. ETFs typically charge smaller expense ratios than mutual funds. However, if you are dollar cost averaging, which in this market is the only way to go, the ETF’s commission will significantly eat into your returns if you invest less than $1,000 a pop. If you are investing less than $1,000 a pop, then go with a no-load index fund. Buying an index fund with a load is like paying for your own security in a gated community. It’s a waste of money.