So, what’s so terrific about stability?
I asked that question of Eric Newman, a portfolio manager for TFS Capital LLC in Pennsylvania, who spoke recently in Ridgewood, N.J. His answer:
^ So that, faced with huge losses all over the place, you don’t panic and sell just when you shouldn’t—when the securities you own are down only temporarily.
^ So that you aren’t forced to sell something that’s down temporarily, just to raise money you need. (Because, God forbid, you lost your job—for example.) You don’t have to sell stuff at a fire-sale prices.
While Newman is an ardent believer in the virtue of diversification, he worries that too many investors blithely believe that they own a well-diversified portfolio when they have anything but. They own common U.S. stocks, foreign stocks, and real estate investment trusts—and think their assets aren’t correlated when they’re actually kissing cousins. (Correlated: They go up and down almost in lockstep.)
Take foreign stocks. Vanguard Global Equity (VHGEX) has become over 90% correlated with the Standard & Poor’s 500—whereas back in 1996 it was less than 50% correlated.
Same goes for REITS. Vanguard REIT Index (VGSIX) was around 10% correlated with the S&P back in 1999. Now it’s more than 80% correlated.
“So investors who have 40% of their portfolio in the S&P and 20% in international really have 50% or 60% in the same asset class: stocks.” And this year, just as the S&P 500 is down, almost all foreign stock funds are down, too. “When the tide goes out, all ships sink.”
Still, bonds remain decently uncorrelated. Commodities are only somewhat uncorrelated. But even certain hedge funds are strongly correlated.
The growing kinship between different kinds of stocks may help explain the flowering of alternate investments like hedge funds, Newman went on. (The fact that the Congress changed the rules in 1998 also gave market-neutral funds a boost.) “It’s one of the fastest-growing categories,” he said of market-neutral or long-short funds. (Long-short funds may vary what percentage they are long or short. Said Newman: “Some are 99.8% long.” Market-neutral funds keep the same percentages. TFX Market-Neutral maintains a ratio of about $0.70 short for every $1 invested long.)
The TFX Market Neutral fund is no-load, and has earned 5 stars from Morningstar. Minimum: $5,000. (The author owns some shares.) While the expense ratio is high, total expenses are not out of the ordinary for an alternative mutual fund, Newman noted, and far below that of true hedge funds. One of the fund’s biggest expenses: paying for really accurate historical market data.
The fund is up around 13% a year over the past three years, far outstripping the S&P 500.
Is the fund equally weighted? I asked. No, but no stock composes more than 2% of the portfolio.
Someone else asked: How much should he put into this fund? Newman said he couldn’t give advice, but investors typically have 5%-10% of their portfolios in TFX Market Neutral.
Someone else asked: Why buy a fund that sells short even in bull markets? My own answer: Even in bull markets, certain stocks retreat. Especially stocks that I happen to own.
The fund’s turnover is high: Typically, the fund holds a stock for only two or three months. But the fund doesn’t use leverage. And the fund (besides being no-load) doesn’t get “soft” dollars—paying a brokerage firm a bundle for trades, then getting a free Bloomberg machine, say, or free research.
When is Newman happiest—when the market is down, sideways, or up? His answer: “It certainly feels like the fund is adding the most value when the market is down and the fund is up. But I’m generally happy as long as the fund is performing well, regardless of the market.”
How to choose a long-short fund? Look at the number of holdings—to make sure it’s diversified enough. Make sure the investment style remains consistent. And that the managers remain in place. And be sure that any outstanding performance is not due to just a few big bets.
I myself have lost a little money in TFX, but I tell myself that if I had invested elsewhere, I would have lost more. And, one of these days, I expect happy days to be here again.