Bright Futures Up-and-coming fund makes market inefficiencies work for you.
By Bill Whitt
Opinions expressed by BIZ Experiences contributors are their own.
If you took a finance class in business school or college, yourprofessor probably drilled into your head the "efficientmarkets" theory, which says that it's nearly impossiblefor an investor to beat the market in the long run. Well, businessprofessors, take note: There is one mutual fund that's almostcertain to prove those theorists wrong--Smith Breeden EquityPlus.
How does the fund do it? Its strategy is complicated, but in anutshell, it takes advantage of market inefficiencies. The fundbuys futures contracts that mimic the performance of the Standard& Poor (S&P) 500, an index of the 500 largest U.S.companies' stocks. The advantage of buying futures contractsrather than the individual stocks in the index is that futuresdon't require the buyer to pay the full amount owed until threemonths after the purchase date. This means a buyer has three monthsto invest that money elsewhere.
When sellers price futures contracts, they assume buyers willput their money in three-month Treasury bills. This is where theinefficiency arises. Smith Breeden doesn't invest its money inthree-month Treasuries but rather in longer-term mortgage-backedbonds. Such bonds almost always pay a higher interest rate thanthree-month Treasuries. The difference in interest rates is whatthe fund earns in addition to the index's return. For example,if the index goes up 15 percent one year and the difference betweenthree-month rates and longer-term mortgage rates is 3 percent, thenthe fund will gain 18 percent. When 1 percent in expenses issubtracted, the fund's 17 percent gain still beats theindex's 15 percent return.
This strategy involves only a little extra risk beyond thenormal risk you would take in buying the stocks in the index.Because the fund uses Treasury futures to protect its mortgagesfrom changes in interest rates, the main risk is that rates onTreasury bonds and rates on mortgages will move in oppositedirections. Although this can occur over short time periods, itvirtually never happens over longer periods.
Of the 475 funds in Morningstar's database with 15-yearrecords, only 32 have managed to beat the S&P over that period.Smith Breeden Equity Plus' strategy seems to indicate that 11years from now, it will belong to a similarly select group offunds.
But how does the fund stack up now? It's been around forabout four years, and its performance so far has met earlyexpectations: Its return since start-up beats the S&P's by1.66 percent per year.
Smith Breeden has two other assets that most rival funds lack:Its expenses are fairly low, and because its strategy is highlyquantitative, management changes won't seriously affectperformance.
The fund has only one drawback. Because it has to roll over itsfutures contracts, it realizes capital gains fairly quickly. Thus,it's not very tax efficient. For that reason, investors shouldonly own shares of it in a tax-deferred account, such as anIndividual Retirement Account or a Keogh plan. The fund would alsomake an excellent choice for your business's 401(k) plan.
Contact Source
Bill Whitt is an international funds analyst at Morningstar.The above opinions are those of the author and not of BIZ Experiences.This investment vehicle may not be right for you. Carefullyinvestigate before investing.
