One option is the Loomis Sayles Global Equity and Income Fund. The managers of this $540 million portfolio search for high total return and current income, with flexible strategies to invest in stocks and bonds around the world.

Dan Fuss – winner of the Lipper Award for Excellence in Fund Management – has managed the domestic bonds portion of the portfolio since inception in 1996. David Rolley, who manages the international bonds, joined in 2000, and Warren Koontz, Jr. joined in 2004 as co-manager to manage domestic and international equities.

The fund, known until last year as the Global Markets Fund, outperformed its stock and bond benchmarks (MSCI World and Citigroup World Government Bond Indexes) during the last 10 years. It was a triple winner of the 2012 Lipper U.S. Fund Award in the Global Flexible Portfolio classification for consistent returns (Fuss also co-manages the Loomis Sayles Strategic Income Fund, another 2012 Lipper Award winner).

Co-manager Koontz spoke to Reuters about the outlook for investors in 2012.

Q: How do you execute your asset allocation and securities selection processes with so many managers at the wheel?

A: We’re securities-selection driven. I find stocks across the globe and give the more interesting ones a higher weight, making sure they would give our portfolio appropriate risk characteristics. We may make our parts more concentrated, but, when they’re put together, our portfolio is very diversified and is much less risky than our stock benchmark.

Our asset allocation depends on how we view our respective markets. Given Dan and Dave’s expectation that interest rates will be rising in the next two years and our agreement that equities are more attractive longer term, our equity allocation has been at the maximum around 70 percent for most of the last three years. It’s about 68 percent now.

Q: How low has it been in recent years?

A: Around the market low of March 2009, it was down to 54 percent.

Q: Being bottom-up investors, what do you look for in stocks? Is current income important?

A: In stocks it’s a secondary consideration. Obviously, during the turmoil, a little more from dividends was a comfort. At 68 percent of the fund, stocks’ contribution to income is now pretty significant.

Q: Have your equities ever underperformed your bonds?

A: During the financial crisis, equities did much worse. In 2008, they went down more than 48 percent, while our bonds were down 15 percent. From mid-2009 into early 2010 we made an allocation shift, raising equities 10 percentage points to 64 percent. The benefit was dramatic in 2010, when they returned 28 percent, nearly double the return of our bonds and more than double our MSCI benchmark.

Q: Where have you found stocks that have done so well for you? In broad areas? Individual companies?

A: Always a combination of the two. From the ideas that attract us, we take an area that needs more exposure in our portfolio. Consumer discretionary and technology names did very well when the market rose in 2010.

Certainly Apple was one. Our position went as high as 6.5 percent at one point in 2011, and I sold it down to 4.5 percent as a risk-control measure. Usually I don’t like to have things more than 5 percent. This year it’s back to 5 percent because of its performance.

Q: Can the top sector be the same in both stocks and bonds?

A: It’s theoretically possible. Say I like Bristol-Myers. Dan may be looking at its bonds and realize that the spread on Bristol-Myers is very attractive. Dave may be able to play Bristol-Myers through some of their foreign bonds. We have the ability to play the best securities across a company’s capital structure.

Q: At the end of last year, about two-thirds of the fixed income portfolio was not rated by rating agencies. Your co-managers must have some kind of a rating system of their own on the back of an old envelope.

A: More than the back of an old envelope. A group of 30-plus credit analysts are analyzing these things. With the growth of the firm, the number has grown.

Q: Has there been any change in 2012 in what you favor?

A: Well, our market has certainly been more favorable, starting in the fourth quarter. In the third quarter, when emerging markets got punished, we were fortunate to be underweighted. In the new year, they have played a bigger role.

(Editing By Lauren Young)

One option is the Loomis Sayles Global Equity and Income
Fund. The managers of this $540 million portfolio search for
high total return and current income, with flexible strategies
to invest in stocks and bonds around the world.

Dan Fuss – winner of the Lipper Award for Excellence in Fund
Management – has managed the domestic bonds portion of the
portfolio since inception in 1996. David Rolley, who manages the
international bonds, joined in 2000, and Warren Koontz, Jr.
joined in 2004 as co-manager to manage domestic and
international equities.

The fund, known until last year as the Global Markets Fund,
outperformed its stock and bond benchmarks (MSCI World and
Citigroup World Government Bond Indexes) during the last 10
years. It was a triple winner of the 2012 Lipper U.S. Fund Award
in the Global Flexible Portfolio classification for consistent
returns (Fuss also co-manages the Loomis Sayles Strategic Income
Fund, another 2012 Lipper Award winner).

Co-manager Koontz spoke to Reuters about the outlook for
investors in 2012.

Q: How do you execute your asset allocation and securities
selection processes with so many managers at the wheel?

A: We’re securities-selection driven. I find stocks across
the globe and give the more interesting ones a higher weight,
making sure they would give our portfolio appropriate risk
characteristics. We may make our parts more concentrated, but,
when they’re put together, our portfolio is very diversified and
is much less risky than our stock benchmark.

Our asset allocation depends on how we view our respective
markets. Given Dan and Dave’s expectation that interest rates
will be rising in the next two years and our agreement that
equities are more attractive longer term, our equity allocation
has been at the maximum around 70 percent for most of the last
three years. It’s about 68 percent now.

Q: How low has it been in recent years?

A: Around the market low of March 2009, it was down to 54
percent.

Q: Being bottom-up investors, what do you look for in
stocks? Is current income important?

A: In stocks it’s a secondary consideration. Obviously,
during the turmoil, a little more from dividends was a comfort.
At 68 percent of the fund, stocks’ contribution to income is now
pretty significant.

Q: Have your equities ever underperformed your bonds?

A: During the financial crisis, equities did much worse. In
2008, they went down more than 48 percent, while our bonds were
down 15 percent. From mid-2009 into early 2010 we made an
allocation shift, raising equities 10 percentage points to 64
percent. The benefit was dramatic in 2010, when they returned 28
percent, nearly double the return of our bonds and more than
double our MSCI benchmark.

Q: Where have you found stocks that have done so well for
you? In broad areas? Individual companies?

A: Always a combination of the two. From the ideas that
attract us, we take an area that needs more exposure in our
portfolio. Consumer discretionary and technology names did very
well when the market rose in 2010.

Certainly Apple was one. Our position went as high as 6.5
percent at one point in 2011, and I sold it down to 4.5 percent
as a risk-control measure. Usually I don’t like to have things
more than 5 percent. This year it’s back to 5 percent because of
its performance.

Q: Can the top sector be the same in both stocks and bonds?

A: It’s theoretically possible. Say I like
Bristol-Myers. Dan may be looking at its bonds and
realize that the spread on Bristol-Myers is very
attractive. Dave may be able to play Bristol-Myers
through some of their foreign bonds. We have the ability to
play the best securities across a company’s capital structure.

Q: At the end of last year, about two-thirds of the fixed
income portfolio was not rated by rating agencies. Your
co-managers must have some kind of a rating system of their own
on the back of an old envelope.

A: More than the back of an old envelope. A group of 30-plus
credit analysts are analyzing these things. With the growth of
the firm, the number has grown.

Q: Has there been any change in 2012 in what you favor?

A: Well, our market has certainly been more favorable,
starting in the fourth quarter. In the third quarter, when
emerging markets got punished, we were fortunate to be
underweighted. In the new year, they have played a bigger role.

The 2012 Lipper U.S. Fund Awards recognize equity, bond and mixed-asset funds that outperformed their peers in volatile markets with lower risk and more consistent performance.

This year’s list of winners includes funds from well-known players like Fidelity, T. Rowe Price, MFS, Dodge & Cox, Putnam, John Hancock, Oppenheimer and Pimco. But it also highlights funds from firms that might not be so familiar, including Huber Capital, Villere & Co, Virtus, Matthew 25 and Scout Funds.

In fact, plenty of funds with an asset base under $500 million are among the top performers, demonstrating the flexibility and agility that’s inherent to tinier portfolios, says Tom Roseen, head of research services at Lipper, a Thomson Reuters company. Fund managers of small funds can seize market opportunities and trade in and out of securities with ease.

“Of course, we’ll see the big behemoths on the list – the Darwinian theory is the funds that couldn’t hang on the vine are going to disappear,” Roseen says. “Some smaller boutique funds offer a niche focus and actually do well. They don’t move the market with every buy and decision sell they make. But they are nimble and quick.”

Overall, as many as 5,131 funds met the requirements to be considered for this year’s awards. To trim that list to 287 winners, Lipper uses a methodology it developed and applies to funds offered around the globe.

Lipper’s highest ratings don’t necessarily go to the funds that rack up the biggest returns, however. What counts is consistency. “The goal is to identify the funds that provide investors with the smoothest ride compared to their peers over time,” explains Matthew Lemieux, Lipper research analyst.

Through good and bad markets, equity, bond and mixed-asset funds are rated for the consistently superior short- and long-term risk-adjusted performance. Those in the top 20 percent of each investment objective category are designated as top funds.

This year, Lipper recognizes 107 funds for consistently superior risk-adjusted returns in the three years ending November 30, 2011. (In cases of funds with more than one share class, Lipper awards the one with the best performance on a risk-adjusted basis.)

An additional 101 funds are recognized for such performance for the five years through November and 79 funds won awards for outstanding performance for the 10-year period.

(Not considered for awards: money market funds, Standard & Poor’s 500 Index funds, ultra-short obligation funds, exchange-traded funds and mutual funds in about 20 equity, bond and mixed-asset categories that did not have the minimum of 10 funds with at least one share class.)

Funds under consideration for Lipper U.S. Fund Awards, now in its tenth year, are judged on the following criteria:

* Lipper assesses cumulative and annualized total return data, based on information received from fund companies, gathered monthly, for award-eligible funds in appropriate classifications for rolling 3-, 5-, and 10-year periods.

* For the same periods, Lipper ranks each eligible fund’s total returns within its peer group and then rates it on a scale of 1 (low) to 5 (high).

* At the same time, it updates — for the three rolling periods — the data that enables it to rate the eligible funds according to four other measures: consistent return, capital preservation, tax efficiency and expenses. (Only consistent returns are considered in awards.)

* The top 20 percent of funds for each classification are screened for total returns in the three periods and designated as top funds.

* To determine the funds who win the top rating of 5 for consistent return, Lipper uses a proprietary model to compute risk-adjusted performance that differs from long-familiar ones such as standard deviation, which reflects the volatility of asset prices or returns.

* Lipper’s computers analyze each fund’s actual returns for periods of various lengths — to capture all measurable losses and gains. Those returns also are compared to peer averages. Funds are ranked in descending order and assigned to quintiles (or 20 percent batches). Those in the highest quintile receive the top rating of 5.

* The 5-rated fund with the highest effective return in each classification and each period gets a trophy.

WHAT ABOUT TOTAL RETURN?

Does focusing on a fund’s risk-adjusted return, an abstract concept, require you to be content with a low unadjusted total return?

Not necessarily.

For example, all the winning funds for the last 10 years in 13 major U.S. equity fund categories, including small-, mid-, large- and multi-cap growth, were also rated 5 for total return.

To learn whether your funds won, check out our interactive list of winners. To drill down further, you can examine portfolio data on a fund’s risk, holdings and cash levels to unearth gems – both big and small.

(Editing By Lauren Young and Beth Pinsker Gladstone; Desking by Andrew Hay)

The 2012 Lipper U.S. Fund Awards recognize equity, bond and
mixed-asset funds that outperformed their peers in volatile
markets with lower risk and more consistent performance.

This year’s list of winners includes funds from well-known
players like Fidelity, T. Rowe Price, MFS, Dodge & Cox,
Putnam, John Hancock, Oppenheimer and Pimco. But it also
highlights funds from firms that might not be so familiar,
including Huber Capital, Villere & Co, Virtus, Matthew 25 and
Scout Funds.

In fact, plenty of funds with an asset base under $500
million are among the top performers, demonstrating the
flexibility and agility that’s inherent to tinier portfolios,
says Tom Roseen, head of research services at Lipper, a Thomson
Reuters company. Fund managers of small funds can seize market
opportunities and trade in and out of securities with ease.

“Of course, we’ll see the big behemoths on the list – the
Darwinian theory is the funds that couldn’t hang on the vine are
going to disappear,” Roseen says. “Some smaller boutique funds
offer a niche focus and actually do well. They don’t move the
market with every buy and decision sell they make. But they are
nimble and quick.”

Overall, as many as 5,131 funds met the requirements to be
considered for this year’s awards. To trim that list to 287
winners, Lipper uses a methodology it developed and applies to
funds offered around the globe.

Lipper’s highest ratings don’t necessarily go to the funds
that rack up the biggest returns, however. What counts is
consistency. “The goal is to identify the funds that provide
investors with the smoothest ride compared to their peers over
time,” explains Matthew Lemieux, Lipper research analyst.

Through good and bad markets, equity, bond and mixed-asset
funds are rated for the consistently superior short- and
long-term risk-adjusted performance. Those in the top 20 percent
of each investment objective category are designated as top
funds.

This year, Lipper recognizes 107 funds for consistently
superior risk-adjusted returns in the three years ending
November 30, 2011. (In cases of funds with more than one share
class, Lipper awards the one with the best performance on a
risk-adjusted basis.)

An additional 101 funds are recognized for such performance
for the five years through November and 79 funds won awards for
outstanding performance for the 10-year period.

(Not considered for awards: money market funds, Standard &
Poor’s 500 Index funds, ultra-short obligation funds,
exchange-traded funds and mutual funds in about 20 equity, bond
and mixed-asset categories that did not have the minimum of 10
funds with at least one share class.)

Funds under consideration for Lipper U.S. Fund Awards, now
in its tenth year, are judged on the following criteria:

* Lipper assesses cumulative and annualized total return
data, based on information received from fund companies,
gathered monthly, for award-eligible funds in appropriate
classifications for rolling 3-, 5-, and 10-year periods.

* For the same periods, Lipper ranks each eligible fund’s
total returns within its peer group and then rates it on a scale
of 1 (low) to 5 (high).

* At the same time, it updates – for the three rolling
periods – the data that enables it to rate the eligible funds
according to four other measures: consistent return, capital
preservation, tax efficiency and expenses. (Only consistent
returns are considered in awards.)

* The top 20 percent of funds for each classification are
screened for total returns in the three periods and designated
as top funds.

* To determine the funds who win the top rating of 5 for
consistent return, Lipper uses a proprietary model to compute
risk-adjusted performance that differs from long-familiar ones
such as standard deviation, which reflects the volatility of
asset prices or returns.

* Lipper’s computers analyze each fund’s actual returns for
periods of various lengths – to capture all measurable losses
and gains. Those returns also are compared to peer averages.
Funds are ranked in descending order and assigned to quintiles
(or 20 percent batches). Those in the highest quintile receive
the top rating of 5.

* The 5-rated fund with the highest effective return in each
classification and each period gets a trophy.

WHAT ABOUT TOTAL RETURN?

Does focusing on a fund’s risk-adjusted return, an abstract
concept, require you to be content with a low unadjusted total
return?

Not necessarily.

For example, all the winning funds for the last 10 years in
13 major U.S. equity fund categories, including small-, mid-,
large- and multi-cap growth, were also rated 5 for total return.

To learn whether your funds won, check out our interactive
list of winners. To drill down further, you can examine
portfolio data on a fund’s risk, holdings and cash levels to
unearth gems – both big and small.

But then Jon B. Lovelace, chairman of Capital Research and
Management Company, came up with an idea to create a mutual
fund that would try to give investors at least some of the best
of all possible worlds: Capital Income Builder .
Lovelace died on Wednesday at age 84, about eight months before
the $71 billion fund celebrates its 25th anniversary.

It is a fitting tribute that Capital Income Builder
accomplished Lovelace’s objectives — despite wars, recessions,
financial crises, bear markets, “corrections,” and “bubbles” –
by outperforming targeted benchmarks and keeping shareholders
ahead of inflation.

How did Lovelace pull off the feat? It started back in 1986
after a chat about individual and institutional investing with
actress Stefanie Powers (see),
president and co-founder of the William Holden Wildlife
Foundation. Her comments about her search for an ideal strategy
for the foundation and herself ignited an idea: A fund that
“would deliver above-average and growing income with reduced
risk in declining market periods and reasonable participation
in rising markets.”

Within a year, Lovelace launched Capital Income Builder
with two primary investment objectives — current income that
exceeds the average yield of the Standard & Poor’s 500 Index
along with a growing long-range income stream. The fund’s
secondary objective: significant capital growth.

Lovelace also assigned it an informal, apparently
unprecedented objective: increased income dividends every
calendar quarter.

“It remains an informal goal of ours,” says James B.
Lovelace, known as Jim, who is Lovelace’s older son and
vice-chairman and principal executive officer of Capital Income
Builder.

To meet the fund’s objectives, 90 percent of assets are
allocated to income-producing securities. At least 50 percent
are invested in common stocks, picked for current yield and
potential for increased dividends along with capital
appreciation.

When interest rates and dividend yields on quality stocks
and bonds are as low as now, Capital Income Builder’s
above-average results warrant a look, especially if growing
income and appreciation potential are important to you.

–Higher yields. The portfolio is generally invested from
50 to more than 70 percent in equities. With the Federal
Reserve’s easy monetary policy limiting the yield boost that
bonds can provide, lifetime annual yields have ranged from 5.6
percent to as low as 3 percent.

These yields (which reflect sales charges, if any) have
unfailingly topped the S&P 500′s — by as much as 200 basis
points (2 percent) in some years. The fund yielded 3.44 percent
on October 30, more than 100 basis points above the Barclays
Capital’s investment-grade bond index.

Jim Lovelace sees no need now to incur the risks of U.S.
junk bonds or non-dollar denominated bonds to find more yield.
“In the environment today, we are generally finding enough
attractive equity investments — in the 4 to 6 percent yield
vicinity that bonds would normally occupy — to allow us the
income flexibility to also seek more rapid growth at more
modest yields,” he said in an interview shortly before his
father’s death.

At the end of September, telecom’s 8.8 percent of net
assets was the largest share of any industry; AT&T and
Verizon had its biggest slices. Tobacco, led by Philip
Morris International — the fund’s largest individual
position on October 31 at 3.4 percent — and Altria , was
second.

The other largest sectors: Oil, gas & consumable fuels
(Royal Dutch Shell and Conoco Phillips),
pharmaceuticals (Novartis and Abbott Laboratories ), and electric utilities (Scottish and Southern
Energy).

–Growing annual income. Dividend income, adjusted for
reinvested capital gains, increased in all but three of 22
years (2003, 2004 and 2009) through 2010. Its 4.05 percent
annualized growth rate for this period was ahead of both the
consumer price index’s 2.8 percent rise and the 3.9 percent
increase in dividends paid by S&P 500 companies.

“(We were) trying to maintain a yield in an environment of
historically low dividend yields and declining interest rates,”
Lovelace explained, recalling the challenges for Capital Income
Builder from 2001, a recession year, when corporate dividend
payments declined as S&P 500 earnings per share were halved and
the Fed slashed its federal funds rate target from 6.5 to 1.75
percent.

– Increased quarterly dividends. Through September,
dividends on original shares — to investors who took them in
cash — rose in 79 of 96 quarters (after adjustments for
reinvested capital gains distributions) while total dividends
per share of S&P 500 companies were up in 54.

Owing largely to falling interest rates and, in the recent
past, also to widespread corporate dividend cuts and omissions,
the fund’s dividends were flat in nine quarters and down in
only eight.

–Above-average returns. Reflecting reinvested
distributions as well as capital growth, Capital Income
Builder’s Class A shares posted an average annual total return
of 9.6 percent before (and 9.3 percent after) the maximum 5.75
percent sales charge, well above the S&P 500′s 8.3 percent,
from inception through October.

Their lowest yearly performance was a loss of 30.1 percent
in 2008, when the S&P was down 44.7 percent, and the highest
gain was 25.1 percent in 1991, when the index soared to 37.6
percent. And that’s just as Jon Lovelace had imagined that day
at Stanford: “reduced risk in declining market periods and
reasonable participation in rising markets.”

—

The author is a Reuters contributor. The opinions expressed
are his own.

That could have been the right strategy if you were not
appropriately invested, but horrible if you were trying to time
the market. Why? You can’t be sure when stock prices reach
their lows or highs for any market cycle – or how much it would
matter to have remained out when prices hit either.

Consider, for example, an analysis by T Rowe Price ,
based on the S&P 500, a popular benchmark for measuring the
performance of the stock market: If you could have been fully
invested in the index from December 31, 1995 to December 31,
2010, your annual return would have averaged 6.76 percent based
only on the 500 stocks’ prices – that is, excluding their
reinvested dividends (which are included in total returns).

If you had missed being in stocks on the market’s 10 best
days of those 15 years, your average annual return would have
only been 1.93 percent. If you had missed the 20 best days,
your average annual return would have been minus 1.19
percent.

On the other hand, consider the findings of a Vanguard
research paper, which looked at S&P returns (averaging 5
percent annually and also excluding reinvested dividends)
during a much longer period, 1928-2008. Missing either the 20
worst or the 20 best trading days in the 81-year period would
have increased or decreased an investor’s overall return by
approximately 50 percent, the report says.

For a real-life example of the risks and rewards inherent in
being in or out of the market in a single year, consider the
experience of Dr. Rajendra Prasad, a Long Beach,
California-based doctor, who started the Prasad Growth Fund in 1998 and guided the fund in 2008, a recession
year, to number one of 432 funds in the small-cap growth fund
category at Lipper, a Thomson Reuters company.

He credits his market timing, as well as stock selection,
strategies for achieving the total return of minus 7.4 percent
that year, which was good enough to beat the S&P 500′s minus
37.0 percent and Russell 2000 (Small-Cap) Growth Index’s minus
38.5 percent by a country mile.

All of this, unfortunately, was a remote memory when the
fund’s latest fiscal year ended last March 31, with a total
return of minus 37.5 percent, dropping to the bottom of its
Lipper peer group, while Russell’s index was up 31.0 percent
and the S&P 500, 15.7 percent.

“I had been subscribing to a number of newsletters written
by some prominent financial gurus,” Dr. Prasad reported to
shareholders. “Many of them were forecasting a crash of the
market…following the crash of 2008… Because of this, I was
positioned for an imminent crash… It did not happen in
2010.”

In an email exchange, he recalls “repeatedly” taking losses
not only in stocks but also in both put options and, perhaps
more importantly, certain types of exchange-traded funds
(ETFs), in which he had invested “based on the negativity the
newsletters were indicating.”

If you were to temporarily unbalance a balanced long-term
portfolio by leaving well-researched equity funds for these
ETFs, which offer prospects for making money in a bear market,
you could be accepting a much larger potential risk than by
just finding refuge from stocks in a money market mutual
fund.

Whether you’re an individual temporarily unbalancing a
balanced long-term portfolio by dumping equity funds or an
actively trading portfolio manager reducing a fund’s exposure
to the stock market, moving to these ETFs, which offer
prospects for making money in a bear market, is, naturally,
more risky than the alternative of a money market mutual
fund.

Unlike traditional ETFs, which resemble mutual funds, the
newer “inverse ETFs” and “leveraged inverse ETFs” meet their
investment objectives by going up when stock indexes which they
track go down, as Dr. Prasad had expected in 2000 – or go down
when, as happened to him in 2000, the market goes up.

An inverse ETF targeting the S&P 500 should go up 1 percent
on a day when the index goes down 1 percent, and vice versa.

A leveraged inverse ETF is managed to achieve a multiple -
say, double or triple – of the opposite of an index’s
performance. Thus, a fund which would go up 2 percent on a day
when the 500 falls 1 percent would fall 2 percent when the 500
rises 1 percent.

It is critically important to remember that these ETFs are
managed to meet their investment objectives within one day and,
therefore, must be closely watched. “The lesson? Leverage
kills,” says Dan Wiener, who edits The Independent Adviser for
Vanguard Investors (see). “For
the individual investor it strikes me that the growing interest
in and availability of leveraged ETFs is where they can go
wrong.” So in making bets on or against bonds, stocks and
commodities, take heed: “If you get on the wrong side of the
bet, you can get in trouble.”

You could suffer truly huge losses if you hold these ETFs
longer than one day. That, after all, is what they are managed
for.

—

The author is a Reuters contributor. The opinions expressed
are his own.

When it gets that five rating consistently for 21 months — a record that Lipper’s research services head, Tom Roseen, calls “rare and worth a look” — you may be ready to plunk down some money.

But do your research first. The fund that currently holds this esteem is the Oceanstone Fund, a $15.5 million no-load, multi-cap value fund, which received its first five when it turned three (and became eligible) in November 2009 and its most recent five in July.

Its significance: Risk-adjusted performance reflects the volatility level its manager incurred to achieve it, and consistently superior risk-adjusted performance implies returns that are up more in up markets, and down less in down markets, than those of peer funds.

(Note the power of adjustments for risk, which can produce high ratings for consistency even when annual total returns fluctuated between negative 10 percent in 2008 and positive 264 percent in 2009.)

Not surprisingly, Lipper has also been rating Oceanstone a five for total returns and a four for capital preservation.
High Lipper ratings, of course, would not alone constitute a recommendation — even if you ignore its one’s for low tax efficiency (because of taxable capital gains distributions resulting from portfolio turnover) and high (1.8 percent) annual expenses. Neither would Morningstar’s five stars for risk-adjusted performance.

Such ratings can, however, be a cue to check whether a fund is suitable.

Oceanstone’s prospectus and shareholder report shed light on the fund, but they also leave important questions about performance and stock selection unanswered. (Go to www.oceanstonefund.com or call Mutual Shareholder Services, transfer agent, at 1-800-988-6290.)

Investment objective:
Capital appreciation

Management:
James J. Wang of Carlsbad, California, is portfolio manager, president, and controlling shareholder of Oceanstone Capital Management, the investment adviser firm formed in 2006, six months before the fund. His previous experience was as investment adviser to individuals and small businesses, 2003-2006. (He has not responded to requests for an interview or faxed questions.)

Investment strategy:
Wang’s general strategy, popular with managers who take above-average risks to seek above-average appreciation, has been:

• To invest only in stocks — of small- and mid-cap companies and, to a lesser extent, of less risky large-caps.
• To go up to 100 percent cash as a defensive measure when necessary. Except when fully invested in 2009, he kept about 10 percent to 40 percent in cash.
• To concentrate in few (15 to 30) stocks and engage in “active and frequent trading,” which can increase transaction costs and trigger taxable capital gains distributions.  He turned over the portfolio at rates of over 400 percent in Fiscal Years (FY) 2008 and 2009, ending June 30.

Style preference:
A comparison of Oceanstone’s November 2010 prospectus with earlier versions — to understand whether Wang preferred growth or value stocks — resulted in a discovery: He apparently switched style emphasis from growth to value in 2009.

The 2010 prospectus’ clues: He introduced a preference for “stocks … that (he) believes are undervalued “and omitted key phrases, such as “growth at reasonable price,” “favorable long-term future growth prospect,” and “favorable short-term future growth prospect.” The word, “undervalued,” appeared four times; “growth,” not once.

In Oceanstone’s annual report for FY 2009, Wang had indicated the change earlier: “With so many undervalued stocks in the U.S. stock market during this period, the Fund found some of them. Now the Fund continues to search for the undervalued stocks …”

Lipper, which bases its classification system on three years of shareholder reports’ portfolio data, reclassified the fund in April from “core,” a combination of growth and value, to “value” (and from mid-cap to multi-cap.)

Morningstar has Oceanstone in its small-cap value category, also based on three years of portfolio data, but a recent “snapshot” put it in mid-cap.

Stock selection: The 2010 prospectus tried to describe how Wang picks “undervalued stocks as compared to their intrinsic values,” but erred when it began: “To determine a stock’s intrinsic value (IV), the Fund uses the equation: IV=IV/E x E,” (in which) E is the stock’s earnings per share for its trailing 4 quarters … ”

The equation, previously used in the June 2009 annual, is clearly misstated: multiplying the first E by the second leaves you, unhelpfully, with IV = IV, and wondering what he intended to say.

Performance:
With little or none of the SEC-required annual report discussions of “the factors that materially affected the Fund’s performance … including the relevant market conditions and the investment strategies and techniques used … ,” it’s not easy to understand how the fund outperformed peers. (No market sector or stock is mentioned in Wang’s first four annual report letters.)

Compare the portfolios of March 31, 2009 and June 30, 2009, and you can see how stunning performance by some stocks must have contributed to the 134 percent return of 2009’s second quarter, Oceanstone’s best.

Three of the top five June 30 holdings, whose positions Wang kept throughout the period — Dollar Thrifty, Sonic Automotive and Avis Budget — were up 1,103 percent, 535 percent, and 521 percent. Fuqi International, whose position he enlarged during the three months, was up 341 percent.

Value or growth stocks, correct equation or not, can Oceanstone keep up the pace?

Wang makes no promises. “We don’t know when or where … investment opportunities (in undervalued stocks) will develop,” he wrote in the 2010 annual. “It is difficult to identify them and easy to be wrong.”

That is especially true for independent directors, who have been required to hold a majority of all funds’ board seats since 2002 and who are increasingly assigned additional responsibilities, most recently resulting from the mutual fund insider scandals revealed in 2003 and the 2007-2008 financial crisis.

When Congress drafted the 1940 act to supplement state business laws with federal mutual fund regulations, it faced a challenge. Unlike ordinary companies with internal managements, mutual funds were managed by the external investment adviser firms that sponsored them — and that tended to pick agreeable people to serve on the boards.

There were differences in the Senate and House on how to provide for two categories of directors: those who were “affiliated with” advisers and those who were not. They could easily be on opposite sides of an issue, as when advisers wanted higher fees, which could raise shareholders’ costs.

While the Senate bill required independents to have a majority, the House bill gave “affiliated persons” up to 60 percent of board seats. The House bill, limiting independents to 40 percent out of fear that an independent majority might reject an adviser’s recommendations, became law.

Both houses agreed on two major points: Funds using affiliated advisers required boards with independent majorities and only majorities of independent directors could approve contracts with advisers and principal underwriters.

It would be 30 years before Congress would correct a major flaw in the act with a word change, replacing “affiliated person” with “interested person,” which reclassified board members who had ties to advisers but were not counted as “affiliated” directors.

It would take another 30 years — until January 2001, when most fund boards had independent majorities through some clause — that SEC Chairman Arthur Levitt and his fellow commissioners approved an SEC rule amendment requiring all funds to have them.

For Levitt and his team — led by two directors of the SEC’s Division of Investment Management, Barry P. Barbash and Paul F. Roye — it was the culmination of years of effort, starting in 1995.

That’s when Levitt called for “greater and more effective involvement by fund boards — especially independent directors” — at the Investment Company Institute’s annual meeting. By his return in 1998, he could announce an SEC Roundtable discussion on fund governance.

Held in February 1999, the roundtable paid off. Participants agreed on three key recommendations in addition to the one to require all fund boards to have independent majorities. The four were incorporated in a rule proposal in October 1999 and survived the rule’s final revision.

The other three:
1.    Existing independent directors should choose who would fill vacancies.
2.    Independent directors should have independent counsel.
3.    So that shareholders could judge independent directors’ independence, they should get more information about them.

Why did all this matter?

“A majority requirement will permit, under state law, the independent directors to control the fund’s ‘corporate machinery,’ i.e., to elect officers of the fund, call meetings, solicit proxies, and take other actions without the consent of the adviser,” the commission said.

In control, and armed with powers to represent shareholders in hand, the world did not wait long to give independent directors new work to add to their historic load.

Three examples illustrate major issues:

Mutual fund scandals
Cases of illegal conduct, brought against fund insiders starting in September 2003, confirmed the need to require all funds to have effective compliance functions. Proposed early in the year, rules were adopted by year’s end, providing “funds, their directors and advisers the tools they need to root out these evils,” as Roye told commissioners. They required funds to adopt and implement compliance policies and procedures and to designate chief compliance officers. Directors — including majorities of independents — had to approve them. CCOs would report directly to boards, which would control their pay.

Run on money market funds
After watching money market funds experience substantial losses on holdings in 2007-8, the Commission proposed a money market fund reform rule in June 2009. The goal: to make such funds more resilient to risks. (One fund “broke the buck” in September 2008 and priced shares at 97 cents, which led to a run primarily on institutional money market funds.)

Approved in January 2010 after revisions to reflect comments, the rule provided several new functions for money market fund directors. Examples: designate at least four credit rating agencies whose ratings will be used to determine the eligibility of securities, determine annually that the firms’ ratings “are sufficiently reliable,” and permit funds to take steps “to facilitate … orderly liquidation” if directors, including majorities of independents, approve.

Dodd-Frank Directive
When in July 2010, Congress passed and President Obama signed the Dodd-Frank Act, the SEC — like other agencies — was directed to replace references to credit ratings in its rules with alternative criteria of creditworthiness.

Although its reform package had barely become effective and although the Commission had “found no evidence that over-reliance on … ratings contributed to the problems that money market funds (had just) faced,” it had to comply with the new law.

It, therefore, responded in March with a rule proposal, which, among other things, would have a money market fund’s board determine that a security’s issuer has “the highest capacity to meet its short-term financial obligations.”

The Commission received comments in April but has yet to issue a final rule.

“What is the public good that this institution is providing that makes it worthwhile to run a big risk: vulnerability to a crisis?”

He was speaking at a Securities and Exchange Commission discussion of another truckload of proposed regulations — intended, like a now-effective 2010 set, to prevent a recurrence of the September 2008 “run” on such funds — after joking about his long service to the country by identifying himself as having been “once in a while with the Federal Reserve.” The SEC is considering further regulations on money market mutual funds but there are no indications that any formal proposals will be made soon.

It seems like we’ve seen this film before.

It was way back in 1981 that Volcker said “money market funds] are becoming … more like banks … but they do not operate under the disabilities that banks and thrift institutions do.”  He said “the question, obviously, is whether (the same constraints) are appropriate for money market funds, too.”

Back then, as Fed chairman, he was asking Congress for the authority to impose reserve requirements on money market fund accounts from which shareholders could “make withdrawals.” He never got it.

Fast forward 30 years, past the 2008 credit crisis, and he’s still saying that money funds should face bank-like requirements on capital reserves and liquidity.  Maybe, this time, he’ll win. One proposal being considered would regulate money funds as special-purpose banks.

But the counter argument has been made, too: Shouldn’t regulators and shareholders have longer experience with the SEC’s newly acquired weapons before having to deal with new ones?

In thinking about all this, remember a few things.

1. Money market funds are managed to provide a stable share price of $1.00, but they cannot guarantee it — and must say so in their literature. That stable share price isn’t guaranteed by the government, either.

2. Prices of the short-term securities in which the funds invest fluctuate, but they fluctuate so little that, the $1.00 price should be maintained when those prices are rounded in accordance with current regulation.

3. When funds’ investment advisers have faced the possibility of “breaking the buck” in the past, they have put up capital or obtained money from affiliates or others to prevent it.

Until 2008, except for only one small institutional fund long ago, no fund broke the buck. But in the wake of the Lehman Brother bankruptcy in 2008, the Reserve Primary Fund (ironically the original money fund) had to price its shares at 97 cents on September 16, 2008. It lacked the resources to bolster the fund when its Lehman holdings plunged.

In the aftermath of that, the SEC passed a 60-page comprehensive money market reform package of regulations early in 2010. Its major components dealt with portfolio quality, maturity, liquidity, disclosures and the orderly liquidation when necessary, as in 2008.

At that time, SEC Commissioner Chairman Mary Schapiro called it a “first step.” There was another reform package was coming down the tracks from outside the SEC’s incubator.

That other package of suggested regulations was released in October 2010 by the President’s Working Group on Financial Markets (PWG), chaired by Treasury Secretary Timothy F. Geithner. The PWG came up with an additional list of possible rules that include the special purpose bank idea and a long-discussed, highly controversial proposal that money fund share prices be permitted to float as their portfolio securities’ prices changed. It also included the idea of a  private industry facility to which funds having liquidity problems could turn; insurance; and in-kind redemptions (securities instead of cash).

Some are, and some are not.

As stock prices have gone through wide swings in recent memory — with the Standard & Poor’s 500 Index plunging 57 percent from its all-time high of October 9, 2007 to the low of March 9, 2009 and then bouncing back nearly 100 percent — it’s understandable that young investors would have varied reactions.

Their views of market risk have depended not only on how much money they can afford to invest but also on the ways they invest: as employees in 401(k) defined contribution (DC) plans, individuals invested in IRAs, people investing outside tax-deferred accounts, “non-working” spouses self-employed and so on.

What’s more, opinions also could have depended increasingly on relatively new DC plan factors whose significant features may not yet be widely understood.

The importance of greater understanding was brought out at the recent annual meeting of the Investment Company Institute, when ICI Chairman Edward C. Bernard gave special attention to investors under 40 as he recalled recent ICI investor surveys’ findings that “across a wide spectrum of ages, investors have a reduced appetite for risk.”

“What’s particularly striking,” the T. Rowe Price Group vice-chairman says, “is that … Americans born in the 1970s — today’s 30-somethings … are less willing to take investment risk than their counterparts born in the 1960s … this group is shy about investing in stocks.” In 2010, the share of households headed by 30-somethings that own stocks was lower than in any other cohort born after the Great Depression, he noted.

A few days after he urged ICI members to help the younger generation understand the power of long-term investing “to overcome short-term setbacks and to outrun inflation over time,” a contrary impression of younger investors was conveyed by The Vanguard Group when, coincidentally, it issued an 11-page paper, Generations: Key drivers of investor behavior.

Vanguard’s survey — its first study of the generational differences in equities investing among participants in the retirement plans it administers — doesn’t only yield significant findings, but it offers reasons why differences may exist.

The thrust of the conclusions of co-authors John Ameriks, head of Vanguard’s investment counseling and research group, and Stephen P. Utkus, head of its center for retirement research: many in the younger generations have indeed accepted the risks always inherent in equities.

“While there is evidence that overall equity ownership among younger generations of U.S. investors has fallen in recent years,” they write, citing ICI data similar to those to which Bernard refers, “we find that, within DC plans, younger investors actually have higher equity allocations than (earlier investors) had at the same age.”

Why? There are two recent changes in plan and investment menu design resulting in major enhancements of employers’ 401(k)-type DC plans authorized under the Pension Protection Act (PPA) of 2006 and the Labor Department’s and Internal Revenue Service’s associated regulations.

They are:

Automatic enrollment of employees
Instead of still postponing enrollment in plans indefinitely, under PPA employees must opt out of participation or be enrolled, thus meeting Labor’s goal of increased enrollment. PPA also relieved employers of concerns about (a) legal liability for market fluctuation and (b) the unhelpful investment of employees’ contributions in low-risk, low-return “default” investments for workers who are many years from retirement.

Target-date funds as default options
For employees who become participants but can’t decide how to invest their contributions, more employers can and do offer target-date funds which satisfy Labor’s definition of “qualified default investment alternative:” a mixed asset-fund that is “appropriate as a single investment capable of meeting a worker’s long-term retirement savings needs.”

How do target-date funds satisfy the Labor Department’s requirements? By having a portfolio whose stocks/bonds/cash/mix takes into account an individual’s age or retirement year.

How does a sponsor do that? Usually, by choosing appropriate portfolio mixes for people retiring in, or around, every fifth year (2025, 2030, 2035, etc.) and bringing investors there from first investment to the year for which the fund is named by automatically reallocating assets (replacing stocks with bonds) regardless of markets, as fully disclosed in advance.

“These changes have led younger investors to behave differently than prior generations, who were more likely to invest conservatively and remain at these cautious allocations due to inertia,” Ameriks and Utkus write, adding a forecast: “Equity risk-taking by participants will be increasingly the result of plan design and menu choices, and less a function of participant reaction to current market conditions.”