Morningstar Magazine - June/July 2017 - 12

Dispatches

How to Win at Active
Management
New research paints
a dire picture,
but FPA Crescent
is a winner.

Perhaps one could devise a market-timing
model that would have been savvy enough to hold
more cash before the market plummeted than
before it recovered. Perhaps, although real-world
examples of such successes are few and
far between. However, that model would have
been hard-pressed to incorporate Romick's
fixed-income strategy. Romick shuffles Crescent's
bond position, sometimes favoring relatively risky
bonds, at other times preferring cash.
Big Changes Over Time

IVORY TOWERS

John Rekenthaler

FPA Crescent FPACX manager Steve Romick
was in Morningstar's offices in April.
When asked about competition from index funds,
he looked puzzled. They are not on his radar,
he responded.

Usually when an active fund manager says
that, it's time to reach for your wallet; you're being
hustled. In this instance, however, that claim
is true. There's no index fund-or another active
fund, for that matter-that behaves like Crescent.
There is no close substitute for Crescent.
Crescent's divergence begins with its asset
allocation. The fund currently has about
60% of its assets in stocks, 44% in bonds and cash,
and 4% short stocks. Netting the long and short
stocks leads to an effective allocation
of 56% equities, 44% bonds. That's not unique;
an allocation index fund could mimic
that position.
However, it would be tougher to mimic Crescent's
asset allocation over time. Notably, Romick
built up cash during the financial crisis, with the
fund's cash stake peaking at a whopping
45% entering fourth-quarter 2008. Unlike almost
every other manager who had the foresight-
or good fortune-to dodge the worst that year,
Romick quickly put some of that protection back to
work. Over the next six months, he reinvested 7
percentage points' worth of his cash into securities
that rebounded sharply from their lows.

Morningstar June/July 2017

Thus, the fund's bond stake was negligible
through 2008, soared above 30% in early 2009
as Romick snapped up high-yielding, lowerquality bonds that had been pummeled by the
financial crisis (at the time, he believed
that many companies' bonds were an even better
deal than their stocks), dropped again to
almost nothing, jumped again over 30%, and
is now again modest. No index fund will do that.
Nor will such funds place 20% of their equity
investments into energy, then gradually reduce
that percentage over several years so that now
energy stocks make up almost nothing at all. As for
Crescent's stock selection, it is not particularly
quirky, in part because the fund's large size
prevents it from establishing big positions in small
companies, but it is far from indexlike either.

year of 2008 and then the recovery of 2009
continues to boost its 10-year numbers. But its
2013-14 returns were also relatively strong,
as was last year's 10.3% gain.
True, there's no guarantee that the next time this
fund zigs the financial markets won't zag.
But there is more evidence in support of Romick
than I have so far offered. His tenure dates
to the fund's origin in 1993, and since that time,
Crescent has only placed in the bottom
quarter of its category twice-the New Era
bull-market years of 1998 and 1999. It promptly
made up all that lost ground and more by
finishing number one in its category in 2000, then
number one again in 2001. It would land in
the top half of its category for the next 10 years,
until that streak was snapped in 2012.
So, the fund has pedigree.
One drawback: FPA saddles the fund with a
flat 1% management fee that does not decline with
scale. Crescent's overall expense ratio is 1.07%,
steep indeed in today's marketplace for a $17
billion fund. Crescent may be immune from direct
poaching by index funds, but it is not invulnerable
to the industry's increasing price pressures.
Easier Said Than Done

In summary, Crescent owns several types of assets
rather than one; it varies that asset mix over
time, sometimes dramatically; the sector
weightings of its stocks often differ sharply from
those of any index, and they, too, vary over
time; and, finally, its stock selection is idiosyncratic.
All those items not only ensure that the fund
will wander far from any index, but they
also forestall competition from active funds that
use algorithms-unless such funds can somehow
replicate what lies inside Romick's head.
Getting It Right

None of this would matter if Crescent had
performed poorly. Standing alone is no
virtue unless that independence leads to success.
In Crescent's case, it has. The fund's rare
feat of finishing in the top quarter of its investment
category (defined by Morningstar as the
allocation-50% to 70% equity group, the closest
of various possible misfits) during both the down

Although Romick might be the rare active manager
who is irreplaceable, most are not, as we all know.
More evidence of this appeared in April. The Wall
Street Journal reported that "indexes beat stockpickers even over 15 years." That is, after paying
their expenses, most actively run stock funds
posted lower returns from January 2002 through
December 2016 than did their no-cost benchmarks.
You knew that already. Technically, you did
not know that the indexes had triumphed for 15
years, because previous active management
versus index comparisons have been conducted
over 10-year periods. But you would have
strongly suspected such a thing.
However, here are three additional items that
may surprise you. (If none do, congratulations! Feel
free to inform me of your coup. But not my
editors, thanks much; they don't need to learn that
I am replaceable.)

Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2017