TFS’s Eric Newman: ‘We only want to offer our best stuff’

After more than five years of solid performance, including a run in 2009 that saw assets more than double to nearly $1 billion, the TFS Market Neutral Fund (TFSMX) is introducing a “hard close” and will stop taking any investments on Jan. 22.

After more than five years of solid performance, including a run in 2009 that saw assets more than double to nearly $1 billion, the TFS Market Neutral Fund (TFSMX) is introducing a “hard close” and will stop taking any investments on Jan. 22.
The decision, filed with the Securities and Exchange Commission on Jan. 7, follows a “soft close,” limiting access to existing investors, which has been in place since June 30.
“We only want to offer our best stuff, and in this case, the demand for our product has exceeded our ability to find new ideas,” co-portfolio manager Eric Newman said.
The fund, which has a five-star rating from Morningstar Inc., is the flagship product of TFS Capital LLC and is co-managed by Rich Gates.
From its September 2004 inception through the end of 2009, the fund generated an annualized return of 9.8%, which compares with a 2% annualized return by the S&P 500 over the same period.
According to Mr. Newman, the recent appeal among investors kicked into high gear after the fund lost just 7.3% in 2008, while the S&P 500 fell 38%.
Last year, when the index gained more than 20%, the fund was up 16.6%.
“Everybody says they can protect on the downside, but it takes a bear market like 2008 to prove you really can protect,” Mr. Newman said. “People started noticing.”
The strategy is purely quantitative, highly diversified and includes an annual turnover ratio of around 500%.
TFS doesn’t share a lot of the details behind the proprietary-trading strategy beyond saying it calculates and analyzes everything from basic financial data to third-party-research data and bond ratings.
“We’re always looking for new ways to analyze stocks, because we’re always looking for new sources of alpha,” Mr. Newman said.
The pursuit of that alpha is the main reason the fund is forced to stop taking in money from investors.
“Most of the alpha we’re finding is in the small-cap space, and we’re dealing with limited capacity,” Mr. Newman said.
On any given day, the fund will have upward of 2,500 positions, which includes a steady 33% net long bias.
At the end of 2009, the fund had 1,706 long positions and 1,096 short positions.
Reopening the fund will require an expansion of research to help the strategy migrate into more larger-cap names.
Mr. Newman said the idea of simply launching a fund to handle the growing demand is not an option, because it would end up being a second-tier fund.
Meanwhile, investors truly hungry for a taste of the TFS quantitative model might consider the $23 million TFS Small Cap Fund (TFSSX), which was launched in March 2006.
The long-only strategy uses the same quantitative research but doesn’t offer the market-neutral exposure, meaning that it won’t likely provide the same level of downside protection.
As far as the upside goes, the fund gained 65.4% in 2009, which compares with a 27.2% gain by its benchmark Russell 2000 Index.