Posts Tagged ‘Connie Mack’
Sunday, March 4th, 2012
MIT’s Andrew Lo, “Financial Thought Leader,” and the dean of Adaptive Market Hypothesis, discusses managing your portfolio’s risk in volatile times with Connie Mack.
Here is the full transcript of the interview, courtesy of Wealthtrack.com:
Consuelo Mack WealthTrack – February 24, 2012
CONSUELO MACK: This week on WealthTrack, keep your seatbelts fastened and prepare for turbulence! Financial Thought Leader, alternative investment manager and MIT Professor Andrew Lo says ongoing market volatility requires skillful maneuvers. He’ll tell us which ones to follow next on Consuelo Mack WealthTrack.
Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Investors are dealing with some really difficult choices. The Federal Reserve has kept short term interest rates near zero for three years and has told us it is committed to another three, until late 2014. That means savers are getting zilch- actually less than zilch when you subtract the affects of two percent inflation. So called negative yields don’t pay the mortgage, put food on the table or compound over time because there is nothing to reinvest. The result is that savers and retirees are being forced into riskier investments, that, to paraphrase Mark Twain, don’t guarantee either a return “on” or a return “of” your money.
As you know, many recent WealthTrack guests have been advocating investors return to the stock market and specifically to high quality, dividend paying stocks for capital appreciation and income. Companies are taking note. According to Standard and Poor’s, dividend increases reached $50.2 billion last year. That’s an 89% rise over the $26.5 billion in dividend increases announced in 2010. S&P predicts companies will set a new record for dividend payments this year. Among the reasons: dividend payout rates remain near historically low levels of around 30% of earnings- historically they average 52%, and companies still have robust cash reserves and cash flows. In addition, that much dreaded market volatility of the past four years seems to be abating. The CBOE Market Volatility Index, or VIX, a measure tracking price movements of the S&P 500, has fallen dramatically in recent months. But for how long?
This week’s WealthTrack guest is skeptical of the markets recent docility and believes investors need to be wary, vigilant and more proactive. He is Andrew Lo, a noted Financial Thought Leader, economist, Professor of Finance at the MIT Sloan School of Management, director of MIT’s Laboratory for Financial Engineering and a money manager. He is putting his research to work at AlphaSimplex Group, the investment firm he founded and now chairs, where he and his team run several alternative investment mutual funds under the Natixis ASG name. In his words, they are “designed to help investors achieve greater diversification than traditional stock and bond funds, while actively controlling risk and liquidity.”
I began the interview by asking Professor Lo why he believes market volatility has not disappeared.
ANDREW LO: Well, one of the things about volatility is that it’s triggered by real events. And I think probably the biggest issue hanging over markets today is political instability. It turns out that government has become the biggest source of systemic risk. And until we work out the implications of Dodd-Frank and what’s going on in Europe, I think we’re going to continue having that hanging over the heads of investors.
CONSUELO MACK: So give me a time frame for that, because I don’t have really any particular optimism that we’re going to solve the solutions of Dodd-Frank and government regulation in Europe anytime soon, so this is a multi-year process that you think we’re going to go through?
ANDREW LO: This is definitely a multi-year process. It’s probably going to take between two to five years before we see any real differences. For example, here in the U.S., we’re not going to see much movement on the political scene until after the 2012 elections. And even after that, it’s going to take some time for the new President, whether it’s the incumbent or the challenger, to be able to put in place his or her implementations of various different policies. At that point we’ll see a little bit more clarity, but even then it’s going to take years before the actual implementation of Dodd-Frank becomes clear enough for us to understand.
Even the Volcker Rule is something that is not going to be clear for another two or three years. And in Europe, my guess is that that’s going to be a very slow-burning fuse. Things might come to a head this year, but more than likely they’ll figure out a way to push it off for another year or so. And then we’ll see what happens with Greece, Spain, Portugal and other countries.
CONSUELO MACK: So therefore, get used to market volatility. It’s a way of life for now.
ANDREW LO: I think for now it’s the volatility of volatility that we have to be aware of.
CONSUELO MACK: So talk to me about, what is the volatility of volatility.
ANDREW LO: Well, the idea behind the volatility of volatility is that we’re really on a volatility rollercoaster ride. During periods of time when markets look calm, volatility will be low. The VIX will be at a reasonable range of, say, 15 to 20%. But within a matter of days, after any kind of political change, we may see that volatility going up to 25, 50, 60%. And at 60% volatility, investors are really going to have to be very careful about what’s going on with their portfolios.
CONSUELO MACK: So are there new rules of investing that we need to apply in this new market that we’re seeing?
ANDREW LO: Well, I think there are definitely some new rules. And I would probably focus on three of them. The first new rule is that markets are not stable. That they can change at a drop of a hat. So we have to be more active about managing our risks. So the case in point is volatility. In the past, if you had a 60/40 portfolio- 60% stocks, 40% bonds, you had an idea that you were going to be getting something on the order of overall, ten or 11% volatility for your overall portfolio.
CONSUELO MACK: And let me stop you there. So ten or 20% volatility’s within any given year. that the market would move or your portfolio would move up and down ten or 20%, that was kind of a range that you could depend upon.
ANDREW LO: Exactly. And what we’re seeing now is that even with a 60/40 stock/bond allocation, there are periods of time when your portfolio can have 30/40 percent volatility, which are swings that no investor has signed up for. So the first new rule is that we have to start getting more active about managing our risks and being aware of those risks.
The second new rule is that we all suffer from a disease that I call diversification deficit disorder. That means that we think we’re well diversified with some stock and bond funds, but in fact, we have to be much more proactive about getting diversification across stocks, bonds, currencies, commodities; across different asset classes, across different countries, and over time. So it’s actually harder work now to achieve the same level of diversification that we had before.
And that third new rule is that we have to be aware that while stocks may provide good returns in the long run, that in the long run, we may be dead and we have to make sure the short run doesn’t kill us first. That is that we have to manage our way around these market dislocations. And so it means that we have to pay more attention to our portfolio, we have to spend more time thinking about it. Basically we have to become more educated about our own finances.
CONSUELO MACK: One of the really interesting things, Andy, that you’ve written about and talked about, is the fact that there’s something called the efficient market hypothesis, which is that the markets are efficient. That we’ve been dealing with and have assumed it was going to be the case for the future. And then you’re now talking about something called the adaptive markets hypothesis. What’s the difference between the efficient market hypothesis and the adaptive markets hypothesis?
ANDREW LO: Sure. Well, let me first start by saying that the efficient markets hypothesis has been a very important part of modern finance theory. And it says that prices generally fully reflect al available information. It’s hard to beat the market. And I would say that that hypothesis is still very important, but it’s incomplete. It’s not wrong, but there’s a piece that’s missing. And the piece that’s missing is that, while most of the time, markets do work quite well, and they do reflect most information, and it is hard to beat the market, that every once in a while, markets can be punctuated by periods of dislocation and irrationality. And the important thing to note is that people react to these kinds of market conditions, they adapt.
And so the adaptive markets hypothesis starts with market efficiency as the baseline and asks the question, do investors maintain that baseline all the time? And from looking at the empirical evidence, or the financial crisis, the evidence is pretty clear that, no, they don’t. That when market conditions change abruptly, people react. And they react in fairly predictable ways. When there’s a fire, people will run out of the room. And when there are losses, people will unwind their portfolios and seek safer ground. So the adaptive markets hypothesis focuses on that dynamic. It tries to understand under what conditions are markets efficient, and what other conditions might make people panic and move into other asset classes, thereby changing the traditional risk-reward relationships.
CONSUELO MACK: So right now, are we in a situation where the markets are not acting as we had assumed they would, and they actually have for, let’s say, the last four years; and in fact, so that the adaptations that individual investors are making, that number one, we’re making possibly wrong decisions. And then are there right decisions? What kind of adaptive behavior should we be adopting?
ANDREW LO: Well, I think there’s definitely some change afoot. And the best way to look at it is by taking the great expanse of market history, say from the 1930s to the most recent period, and just looking at our experience with, say, U.S. equities. From the 1940s to the early 2000s, that six-decade period is a period that I call the Great Modulation. And the reason I call it the Great Modulation is because during that period of time, we had a relatively stable financial regulatory system. In fact, today’s regulatory structure for mutual funds was actually built in the wake of the Great Depression, the 1930s and the 1940s. And those regulations haven’t changed a whole lot since then. Over that six-decade period, we had a relative period of calm and very, very healthy growth. So that no matter what ten or 20-year period you pick in that six-decade-long period, you would have done probably equally as well in terms of investing money in equities. I think that that’s changed. Over the last five or ten years, we have had some very significant shifts.
CONSUELO MACK: So that’s where the stocks for the long run thesis, you know, looking back, it worked.
ANDREW LO: Absolutely.
CONSUELO MACK: So your traditional approach of buying large cap or U.S. stocks, and reinvesting your dividends on a yearly basis, that in fact that was a pretty good strategy to adopt. Now what kind of a market are we in, and what’s changed and what should our investment strategy be?
ANDREW LO: Well, so there are a couple of things that have changed, and I think those changes inform how we want to think about changing our investment approach. One thing that’s changed is population. In 1900, the estimate of the world population was about one-and-a-half billion people. The most recent estimates for our current population of the world is about seven billion people. That is a big difference. And if you think about those seven billion people, most of them are going to need to have some type of financing and saving activities throughout their lives. And so that makes markets much more complex, and much more interdependent.
The second thing that’s changed is financial technology. We now have the ability to invest in a variety of assets, but at the same time we also have the ability at the click of a mouse to wipe out half of our retirement savings. That’s a very dangerous set of technologies to give to ordinary investors who may not really understand all of these kinds of risks.
CONSUELO MACK: Even professional investors make big mistakes.
ANDREW LO: It’s complicated, no doubt. And so I think one clear implication is that we actually need to spend more time thinking about our finances, in the same way that we have to spend more time thinking about our health. In the 1950s we didn’t know about cholesterol, we didn’t know about carbs, we didn’t know about a lot of things that we know now. And so now, to be an intelligent consumer, you really have to spend time learning these new concepts.
CONSUELO MACK: So, Andy, from an individual investor’s point of view, how can we more actively manage our portfolio, realistically- what should we be doing?
ANDREW LO: Yes. Well, first of all it’s hard. It requires work. And what investors should not be doing is becoming day traders. That’s not going to be successful. One thing they can do, though, is to spend more time learning about the investments that they do make. In other words, asking questions like, “what kind of risk profile does this particular investment have over the last ten years, five years, three years,” as opposed to asking “what kind of risk profile it has right now.” Because what looks relatively calm and conservative today may have looked very differently in 2008 or 2009, and may look different yet again next year. So start asking questions about how stable the risk is for each of these funds, that’s the first thing.
The second thing to ask about is liquidity. We haven’t really talked much about liquidity for mutual funds, because by definition, they seem to be liquid. You should be able to get in and out of them every day. But as we saw from the last four years, there are certainly mutual funds that are much less liquid than others and could create all sorts of difficulties for redemptions, if and when they all occur at the same time.
Third, there are a variety of financial instruments available to investors today, including ETFs, and other kinds of fancy securities. Before getting too fancy, investors need to spend time trying to really understand the various different kinds of circumstances under which those products will help or hurt their portfolios. So in other words, each investor now has to become a bit of a financial manager. They are managing their portfolios, and ultimately they’re going to be responsible for those decisions.
CONSUELO MACK: Which is a terrible thought. A very scary thought.
ANDREW LO: It’s scary.
CONSUELO MACK: You have a concept, an approach that I think is really fascinating. We’ve done a lot of work on WealthTrack on asset allocation, and if you go to any financial advisor, they’re going to talk to you about asset allocation, and your risk tolerance, et cetera. But you’re saying that we shouldn’t just manage our asset allocation anymore, that we really need to manage our risk allocation. Can you tell me what it means to manage your risk allocation, and what the difference is?
ANDREW LO: Sure. Well, the first point to start with is that investors generally respond to changes in risk. Most investors are happy to take risk. They’re perfectly willing to take risk. They even, I think, understand what risk means. What they aren’t willing to do is to be uncertain about their risks. If you’re going to take a particular kind of risk- ten percent swings in your portfolio over the course of the year- you want to know that that’s by and large what you’re going to see: ten percent swings in your portfolio over the course of a year. If you see 30% swings, that’s not good news. And so the idea behind risk allocation is to reduce the surprises in risk. If you think you’ve signed up for ten percent swings, then you need to be given ten percent swings. And there’s a way to manage your portfolio to make sure that that’s more likely than less. And the way to do that is to start with a particular risk budget.
Say that ten percent figure that we talked about. And say that if ten percent swings are what I’m comfortable with, let’s divide that up into three percent of that for equities, another three percent for fixed income, another two percent for commodities, and so on. And it’s a little bit more complicated because the risks don’t necessarily add up to 100% because of correlations among these various different investments. But with some help from literature online, or from financial advisors, it’s actually pretty easy to work that out so that you put your money in categories where you know you’re going to get a certain amount of risk. And this way, after the fact, the surprises will be far fewer and far less extreme.
CONSUELO MACK: So if I look at all the asset classes that are available to me as an investor to invest in, are there certain risk profiles that I should be adding to a portfolio that might not be in the traditional portfolio? Are there certain assets that are actually going to steady and provide ballast to my portfolio that I really don’t know about?
ANDREW LO: Well, I think there are other assets and certainly other approaches to investing in different asset classes. Stocks and bonds are the most traditional asset classes that most people have in their portfolios, and we’ve seen over the last few years that the volatility of volatility of those asset classes is quite high. It’s very hard to predict where that volatility’s going to go. But if we now increase the universe of assets to additional alternatives- commodities, currencies, interest rates, and investing long as well as short- if you mix all of those into these new multi-alternative asset classes, I think that there’s a better way to make that kind of diversification and to be able to manage the type of risks across these different asset classes.
CONSUELO MACK: So let’s talk about what you’re doing at the Natixis ASG Funds that you’re replacing the traditional asset allocation approach with what you call a new narrative. And that is, it’s how many dollars that you invest in different asset classes, instead of that, it’s how much risk you allocate to different asset classes. So just give us an example of what you’re doing, for instance, with your flagship from the Natixis ASG Global Alternatives Fund, which you’ve established an eight percent volatility. That’s your goal. So how do you achieve that?
ANDREW LO: Well, it’s actually pretty easy. What we do is to use futures contracts, which are very liquid, and we invest in futures across a variety of asset classes; stocks, bonds, currencies and commodities. And we are trying to capture the broad exposures of the entire hedge fund industry. But what we do that’s different from what hedge funds do is that we manage our volatility on a daily basis; where we balance our futures exposures to these various different asset classes so that we’re achieving a relatively steady level of volatility of around eight percent. And so when the underlying instruments that we invest in become much more volatile, as they did during the fourth quarter of 2008 after Lehman went under, we will reduce our exposures to those contracts, and thereby achieve a relatively steady rate of volatility. When that volatility of the underlying instruments comes down to a normal level, we’ll put back that market exposure.
So it’s a lot like cruise control in your car. Your car knows when it’s going uphill, it’ll put on the gas; your car knows when it’s going downhill it’ll put on the brakes. All the while achieving a relatively steady speed of 60 miles an hour. And if eight percent volatility’s what you’re trying to achieve, by using this kind of cruise control mechanism and by doing it on a daily basis, you can actually manage your risks more effectively than if you just rebalanced once a month or once a quarter.
CONSUELO MACK: Basically you’re managing volatility on a daily basis. Individual investors really can’t do that. If I went to a traditional asset allocator, they would tell me, well, you know, what you need to do, Consuelo, is put more TIPS in your portfolio or more treasuries in your portfolio, or more managed futures in your portfolio. Is there any way to manage the volatility that we’re talking about, without actually managing it on a daily basis?
ANDREW LO: Well, I think it’s a matter of degree. So obviously managing it on a daily basis is one extreme. Not looking at your portfolio for a year is another year. Trying to be more sensitive to correlations is one way of managing it. So for example, you mentioned managed futures and TIPS. Those are two asset classes that are not part of the traditional investment portfolio which could actually help in terms of dampening some of those fluctuations and reducing the volatility of volatility. So by being more aware of different investment alternatives, by asking questions about how stable the risks are, by looking at the potential correlations of those risks, it is possible to put together a more robust portfolio than just simply picking stocks and bonds.
CONSUELO MACK: Are there any specific segments or products that are out there that we should have ourselves and our financial advisors look at?
ANDREW LO: The ones that I think might be most useful for an investor are these multi-alternative categories, managed futures, because they provide opportunities that are not easily accessible from the traditional stock/bond perspective. And many of these products are properly risk-controlled, so that they won’t provide the kind of unpleasant surprises that you might find in some traditional mutual fund products and ETFs. So I think that having a broad exposure to a variety of asset classes across different countries, across different securities, is really the best way to go and to spend more time thinking about these opportunities; to work with a financial advisor to get the best advice possible. But in the end, to answer the question, how much risk am I willing to take? What kind of portfolio swings can I withstand? And then to maintain as much of an investment in those types of securities with that level of risk that you can.
CONSUELO MACK: How important is it to pay attention to macro trends, number one? And to react to them, number two, in our portfolios? Do we need to time macro trends, not time the market, but possibly what’s going on in the macro level?
ANDREW LO: Well, I think it’s incredibly important to pay attention to macro trends. How we react to them is also critical, and there I think that most investors need help. I don’t think it’s possible for individual investors to understand, necessarily, how to interpret a European default. We need help from financial advisors, from various institutions, to understand how our reactions may or may not be beneficial to our portfolios. But I do think that it’s important for us to try to react in a sensible way as opposed to simply assuming things will work out in the end. Depending on what one’s horizon is, maybe that is true, but if your horizon is less than 50 years, I’m not sure that things will work out for you, with any degree of confidence. We need to think a little bit about how to change our behavior in the proper way to react to these market conditions.
CONSUELO MACK: And final question is for a long-term diversified portfolio, what is the One Investment or one strategy we should all adapt?
ANDREW LO: Well, I think that right now, the one idea that we should all adopt is to think very carefully about risk, is to manage risk actively. And that means thinking about diversification, thinking about broader asset classes like multi-alternatives or managed futures. Thinking about how our portfolio may change over time and over market conditions, and to do that soon. Not after the disaster hits, when we’re all going to be panicking. But rather do it now, while we’re relatively calm, and when we have some idea of what kind of consequences we can or cannot tolerate.
CONSUELO MACK: We will leave it there, Andrew Lo. Always wonderful to have you on WealthTrack.
ANDREW LO: Thank you, it was a pleasure.
CONSUELO MACK: Thought-provoking, you are an original thinker from AlphaSimplex Group and from MIT, thanks so much for being here.
ANDREW LO: A pleasure, thank you for having me.
CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week’s Action Point picks up on a major theme of Andrew Lo’s investment approach, which is to manage portfolio risk. So this week’s Action Point is: consider the risk allocation in your portfolio.
Investors have traditionally thought in terms of asset allocation, assuming relatively predictable returns and behavior in stocks and bonds over time. As Lo points out, for a number of reasons, the markets have changed. They have become much more complex, uncertain and volatile, so managing risk has become much more important. Building a portfolio around risk expectations for different asset classes can help you manage and control the risk according to your personal preferences.
Next weekend, as many public television stations start their spring fund raising drives, we will revisit our conversation with Sheryl Garrett and Mark Cortazzo, two top rated financial advisors who are catering to small investors. If you want to see WealthTrack interviews ahead of the pack, subscribers can do so 48 hours in advance. Go to our website, wealthtrack.com to sign up. And that concludes this edition of WealthTrack. Thank you for watching and make the week ahead a profitable and a productive one.
Tags: Alternative Investment, Blip Tv, Capital Appreciation, Cash Reserves, Cboe Market Volatility Index, Connie Mack, Consuelo Mack, Consuelo Mack Wealthtrack, Dividend Increases, Dividend Paying Stocks, Dividend Payments, Dividend Payout, Food On The Table, Full Transcript, Investment Manager, Maneuvers, Market Hypothesis, Market Volatility, Market Volatility Index, Professor Andrew, Seatbelts, Standard And Poor, Term Interest, Thought Leader, Video Transcript, Volatile Markets, Volatile Times, Wealthtrack, X Shockwave Flash, Zilch
Posted in Markets | Comments Off
Thursday, March 1st, 2012
MIT’s Andrew Lo, “Financial Thought Leader,” and the dean of Adaptive Market Hypothesis, discusses managing your portfolio’s risk in volatile times with Connie Mack.
Thursday, September 23rd, 2010
WealthTrack’s Connie Mack interviewed MIT’s Andy Lo. Here for your review are the video and transcript. Lo discusses his ‘Adaptive Market Hypothesis‘ which in a nutshell, challenges Modern Portfolio Theory’s ‘Efficient Market Hypothesis.’ Lo contends that markets are not efficient, but rather adaptive.
Click play to watch.
CONSUELO MACK: This week on WealthTrack: fasten your seat belts. Our Financial Thought Leader, alternative investment manager and MIT professor Andrew Lo, says the market’s volatility and uncertainty is here to stay. Strategies for riding the financial roller coaster are next on Consuelo Mack WealthTrack.
Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Do you feel that the financial markets are more unpredictable and arbitrary than ever? Well it is not your imagination! Unless you lived during the Roaring Twenties and the Depression-era thirties, you have never seen anything like it, until now.
Take a look at this chart provided to us by this week’s Financial Thought Leader guest. It shows the historical volatility of a broad-based stock market index from 1926 to the present. Notice the wide and wild swings at the beginning, the twenties and thirties, followed by the relative calm for the decades in between- the historical average of market volatility is 14.5%- and then the astonishing pick up in market volatility during the last couple of years. This week’s guest says “fasten your seatbelts,” the roller coaster ride will continue.
One of the true treats of WealthTrack is our ability to talk to some of the most creative and original thinkers in the investment world. And today’s guest is right up there with the best of them. This week’s Financial Thought Leader is Andrew Lo, PhD economist, professor of finance at the MIT Sloan School of Management, director of MIT’s Laboratory for Financial Engineering, and author of numerous articles and several books, including A Non-Random Walk Down Wall Street . Professor Lo also puts his ideas to work as an investor. He is the founder and chief scientific officer of AlphaSimplex Group, an investment firm whose slogan is “adaptive strategies for evolving markets.” In recent years, the firm has introduced several mutual funds under the name of its parent company Natixis, which are designed to help investors protect themselves in these ever evolving markets by limiting their portfolio risk and volatility. We will provide a link on our website, wealthtrack.com.
I asked Professor Lo to talk about some of the biggest changes he sees in the markets, starting with what he calls internet time.
ANDREW LO: We are living in Internet time now, and I mean that not just as an analogy but literally in the sense that, because of the Internet, information is transmitted at lightning speed, whereas before it would take weeks or months for certain kinds of news to get out. Nowadays it’s reflected almost instantaneously and this has dramatic implications in how financial markets operate and how we react to those kinds of surprises. Over the last two or three years, I think we’ve been on this volatility roller coaster ride where traditional investments that offered relatively traditional kinds of risks are now really unpredictable in the kind of volatility that they provide to investors.
CONSUELO MACK: Such as which kind of investment? Stocks and bonds?
ANDREW LO: Well, yeah, for example, let’s take stocks. You know, the S&P 500 traditionally has had a volatility of around 15% per year. Well, during the fourth quarter of 2008, the volatility reached as high as 85%. At 85% annual volatility, there’s a good chance that an investor can lose all their investment over the course of a few days. I don’t think anybody could withstand that kind of a risk. Fortunately it doesn’t last very long, but for the periods where volatility spikes, it’s tremendously disruptive for investors. And that’s really a relatively new phenomenon.
CONSUELO MACK: So when you say it’s a new phenomenon- now there’s a sentiment on Wall Street, in fact, that the kind of volatility that you just alluded to in 2008, 2009, that that’s over and essentially that we’re back to a normalcy that we’ve had for the last 40 or so years. You’re not sure that’s the case though, right?
ANDREW LO: No, I’m not. I think that it is over until it’s not, and so a good example of this is what happened in the beginning of this year. It looked like we were heading to calmer waters. It looked like the market was recovering. Certainly, last year was a good year for the stock market, and things were going pretty well until April and May, and what happened then was Greece. Now, certainly people knew that Greece had a debt problem even as early as, you know, three or four years ago, but it didn’t become a public problem until April and May. And during that period of time, the market volatility spiked yet again, and so next year it may not be Greece. It may be Spain. It may be Portugal. It may be emerging market debt. It may be gold. It may be something that will cause the public to fly to quality and safety.
CONSUELO MACK: i.e., Treasuries.
ANDREW LO: That’s right.
CONSUELO MACK: Which they’ve been doing.
ANDREW LO: And in fact, Treasuries have been remarkably volatile themselves in terms of the money flowing in and out. In fact, as we know, Treasuries have had negative yield for periods of time over the last couple of years. I mean, negative yield is a remarkable phenomenon. It basically says that I’m willing to lose money over the course of the next three months in order to put my money in U.S. Treasury securities, and that’s a sign that there is genuine fear in the marketplace. When you have this kind of fear, markets are very unpredictable and moreover, the volatility of volatility becomes an important factor.
CONSUELO MACK: Listening to you, I’m getting terrified.
ANDREW LO: I’m sorry.
CONSUELO MACK: Essentially, but here you are. You’re a PhD economist, and you are a behavioral economist as well as a risk management expert. So if uncertainty like that you’ve just described is going to be part of our life for the foreseeable future- correct? Then how do we deal with the risks of uncertainty as individual investors? What can we do to protect ourselves, aside from withdraw from the markets?
Tags: China, Commodities, Connie Mack, Consuelo Mack, Efficient Market Hypothesis, Financial Engineering, Financial Roller Coaster, Historical Volatility, Investment World, Management Director, Market Volatility, Mit Sloan School, Mit Sloan School Of Management, Modern Portfolio Theory, Natural Gas, Professor Andrew, Relative Calm, Roller Coaster Ride, Seat Belts, Sloan School Of Management, Stock Market Index, Thought Leader, Wealthtrack
Posted in China, Gold, Markets | Comments Off
Sunday, February 28th, 2010
Connie Mack recently interviewed David Darst, chief investment strategist for Morgan Stanley Smith Barney, and Robert Kessler, head of Kessler Investment Advisors, which runs portfolios for institutional investors and governments around the world. This is a MUST view/read interview. The complete transcript follows.
CM: David Darst is known as a master of the art of asset allocation. He is the chief investment strategist for Morgan Stanley Smith Barney. David is also a teacher and prolific author, and his latest book is The Little Book that Saves Your Assets . And it’s great to have you both here. Thanks so much for joining us on WealthTrack.
Robert Kessler, U.S. Treasuries, you make your living in investing and managing portfolios of U.S. Treasuries, and as long as I’ve known you, they have been denigrated by most of the competition except in this most recent period when everyone rushed to Treasuries, but now the naysayers are back again. So why are they wrong again about Treasuries?
ROBERT KESSLER: It’s not a question of being wrong or right. A Treasury is really a benchmark to almost every other asset class. So as a benchmark, you can’t be wrong or right about a benchmark. It’s just simply matter of spread between what other asset classes are selling at. So in the Treasury market, we’re lucky enough to be able to have a choice of overnight Treasuries, which is cash, or longer-term Treasuries. And longer term Treasuries are really based on whether you believe inflation is going to be an issue or whether disinflation will be an issue.
So right now we’re in what we call a credit crisis. We’re in a credit recession. And during credit periods of time, you don’t want to own risk assets, and if you don’t want to own risk assets, you want to go to something that has very little risk, which is a Treasury. Now the question becomes: do you own Treasuries as bills overnight or do you really believe that rates are going to come down because there’s very little inflation in the world? So since we believe rates will come down because there is very little inflation, then Treasuries become very attractive.
CONSUELO MACK: All right. So let me stop you there and we’re going to follow up on that in a couple of minutes. David Darst, as a global strategist first and as an asset allocator second, how do you view this?
DAVID DARST: It’s a great point because really, inflation is a monetary phenomenon. We have a big war going on between this monetary phenomenon called inflation potential down the road.
CONSUELO MACK: Right.
DAVID DARST: And deflation is a credit phenomenon. And right now credit is contracting. The latest month figure for December showed it contracted, consumer credit, Consuelo, by $2.5 billion. That’s 11 months in a row the government has been keeping these numbers since 1943. It’s never contracted for 11 months in a row. So right now we have this epic, titanic struggle between the deflation phenomenon, credit contracting and the inflation phenomenon, which is the government attempting to pump up the money supply, add liquidity to the system, which people, makes them worry about inflation down the road. So we feel that maybe Treasury bonds, Treasury securities, you can have them in the portfolio right now, you need to have a little offense as well as a little defense. Treasury securities are a defensive investment in our opinion. Last two years ago they were up 20%. They were up 20% in 2008 when the stock market went down 37%. Last year, ten-year Treasuries lost 9.9% on a total return basis.
I’m very receptive. For a person basically to say stay away from Treasuries means they think interest rates are going to rise. That means the consumer is going to come back. That means that credit is going to stop contracting and we’re going to worry about inflation. But over the next 12 months, I’m not so sure those things are going to be an issue, Consuelo.
CONSUELO MACK: So short term at any rate, next 12 months, Treasuries are probably a good place to be defensive.
DAVID DARST: I think you can have some in the portfolio. We are underweight. We are underweight. Normal is 16%. We’re 7%. That’s our largest single underweight. We are very underweight because we’re worried about the health of sovereign credit finance about the condition of the U.S., the U.K., the European community and so forth, the condition of these finances. So much money has been issued.
CONSUELO MACK: Okay. How do you answer that argument because, in fact, as you know, that most people who are looking at U.S. Treasuries are saying, we’ve got a record deficit; we have to finance that record deficit. If we are basically having to sell a lot of Treasury bonds, that is going to mean that the value of the dollar of our securities is going to go down. And then, in fact, that means that it’s going to be inflationary for the U.S. So how do you respond to that argument? Why aren’t you worried about the size of the deficit and what we have to finance being inflationary?
ROBERT KESSLER: Let me answer two questions. The first question is this concept of the deficit. There is this constant talk of deficits lead to inflation. We don’t really have any indication that that’s true. In the Depression in the United States, we had huge deficits, of course, and we had no inflation. We had deflation. Japan has gone through 20 years now of deficits that are far, far higher than ours, and they have deflation. So we don’t know anything about the inflation side of it. What’s really important is that if people can’t raise prices and there’s an awful lot of excess capacity in the world and wages are going down and unemployment keeps staying kind of sticky at these very, very high levels, it’s very difficult to have inflation.
And so there is no inflation. That’s not our issue. The real issue is– television was interesting today because not only are we dealing with Greece, Greece is very interesting because we’re bailing out Greece and bailing out perhaps Portugal next, but we’re probably going to bail out New Jersey after that. Because New Jersey just announced today that they’re running into a huge deficit, too.
CONSUELO MACK: As are a lot of states.
ROBERT KESSLER: As are a lot of states. So we have states having problems, lowering wages, firing people; very, very difficult to raise prices and consequently, very difficult to have inflation.
CONSUELO MACK: All right. So you think we’re deflationary. You think the credit contraction you think which is extraordinary is actually, we’re in the beginning stages of it. You’re not thinking a year down the road, you’re thinking for inflation, you’re thinking, what three, four, five…
ROBERT KESSLER: It sounds like I’m being very pessimistic.
CONSUELO MACK: You’re a bond person.
ROBERT KESSLER: No, no but I don’t want to be pessimistic. We just got back from the Middle East. I have to tell you, not only is everything for rent in the Middle East, not only are buildings completely unoccupied, but banks, since we deal with banks, banks right now are doing one trade. They’re doing what we call a carry trade, meaning they’re buying their sovereign debt, either U.S. sovereign debt or their sovereign debt short term and they’re carrying it at very low cost.
CONSUELO MACK: Because they can borrow it at very low cost.
ROBERT KESSLER: Because they can borrow at very low cost, as is JP Morgan in the United States and as is Morgan Stanley and everyone else. So the fact of the matter is when people say we’re in a bear market in Treasuries, it’s ridiculous. Last year, even though David is correct, the ten-year Treasury was down 9%. The fact of the matter is we made more money last year in two-year Treasuries than any year I can think of because everyone was carrying a two-year Treasury at zero and getting a point. Now, in bank talk…
CONSUELO MACK: So they were borrowing at lower than 2% and then they were buying the two years… So they made?
ROBERT KESSLER: They do it at a very high leverage level because they don’t need to do very much with a capital question. So the fact of the matter is you have this bull market going on and yet everyone is saying, anything but Treasuries. Tell that to JP Morgan.
CONSUELO MACK: Right. So David, not to completely focus on Treasuries, but as far as asset allocation, you said that your biggest underweight is U.S. Treasuries right now.
DAVID DARST: It’s sovereign credit, Consuelo.
CONSUELO MACK: Across the board.
DAVID DARST: It would include U.K., it would include Canada, it would include Europe.
CONSUELO MACK: And the reason for that is what?
DAVID DARST: Well, the sovereign… we believe there’s so much issuance of sovereign debt; we do believe that the balance sheet of the Fed has ballooned from $900 billion to $2.2 trillion. We do see the deficits as being quite large on out into the future. And we do believe that these trillion dollar and trillion and a half dollar deficits are going to have to be bought and to entice people, which will cause higher interest rates. So that’s why Morgan Stanley’s economists have a big out-of-consensus call, which Robert is very familiar with. And by the way, the word Robert means bright fame. His name means bright fame. Now Robert is familiar with this- Morgan Stanley is expecting 5.5%. And every conversation I get into, I have to argue we think that inflation fears will be higher towards the end of 2011. We see all this slack. But there’s concern. Supply, which you mentioned, that is the excess issuance by the Treasury, and also the Fed, and I know there’s a lot of disagreement over this, we expect them to begin their exit strategy later this year, second half of this year.
CONSUELO MACK: And exit strategy could mean raising the federal funds rate?
DAVID DARST: Higher short-term interest rates, and that means we think higher long-term interest rates. We take a little bit of respectful issue with Robert Kessler’s brilliance over here. But we believe the essence of our underweight versus sovereign debt is because of enormous supply and people’s concern. Inflation is the biggest… The biggest inflations of all times have all come from fighting deflation. In the 1946 to 1949 period in Germany, in communist China, in the 1920s and 1923 period of Weimar Germany, the biggest inflations have all come from fighting deflation.
CONSUELO MACK: So what’s interesting is the common ground is here. Right now we are fighting deflation, which is actually positive at least for the next 12 months, possibly for…
DAVID DARST: Steroids, financial steroids. Mark McGuire has admitted to it and the Fed is taking financial steroids.
ROBERT KESSLER: Let me be a little contrary for a second.
CONSUELO MACK: For a second?
ROBERT KESSLER: All right, for 30 seconds. The fact of the matter is we talk about this exit strategy all the time about the Fed. I’m into the entrance strategy. I am trying to figure out how we’re going to help out 8.5 million people who don’t have jobs. It’s probably closer to 17 million because that’s really a more correct figure.
CONSUELO MACK: The ones who have been discouraged and not looking for jobs anymore.
ROBERT KESSLER: Why we’re talking about exit strategies is very, very disconcerting to me.
CONSUELO MACK: Because the Fed is actually. Bernanke is talking about it, right.
ROBERT KESSLER: What we’re talking about again is Wall Street and the banking industry. When you get to, excuse me, the middle of the United States, at least where I live.
DAVID DARST: Right, you live in Denver.
ROBERT KESSLER: In Denver. People don’t have a clue to what JP Morgan is doing or Morgan Stanley is doing. What they’re looking for is their job, and when someone says, excuse me, I think it will be a good idea to raise interest rates, they can’t even borrow money; not only can’t they borrow money, no one will lend them any money. So they’re really…
CONSUELO MACK: Like the credit contraction you were talking about.
ROBERT KESSLER: So the issue is why are we talking about exiting the strategy?
DAVID DARST: The reason we’re talking about exit strategy is psychological. It’s the use of Shakespearean language and words to try to divert people from worrying about the debasement of the currency, internally and externally. And that’s why he’s saying it. And I agree with you. I don’t see rates jacking way up very quickly. This is going to be gradual, but we went from $900 billion Fed balance sheet to $2.2 trillion. And it is very, very important.
Sarkozy, during the last four weeks– opening speech at the World Economic Forum said that in 2011 France is going to be head of the G7 and the G20 and he says his number-one agenda item is to create a new world monetary system, a new system without the United States dollar as the primary reserve currency. The reason they talk about exit strategy, Robert, is to keep people from going to this new currency.
CONSUELO MACK: So how concerned are you about the fact that the dollar could be replaced as the reserve currency?
ROBERT KESSLER: First of all, for a second I’m going to represent Main Street as opposed to Wall Street, and Main Street doesn’t have a clue to what we’re talking about.
CONSUELO MACK: Right.
ROBERT KESSLER: Believe me. This all gets very, very complicated to talk about.
CONSUELO MACK: And our viewers are investors.
ROBERT KESSLER: They’re investors, so my answer to all of this is the United States will continue to be the reserve currency. There’s nothing wrong with the dollar. Everyone will put money into the dollar, as we’re doing today. Today is a very, very good example. We had a 30-year auction today. What was exciting about it, even though it didn’t go over very big as an auction, didn’t go well, but what was exciting about it is 23% of the auction was bought by Americans. What we call direct investors.
CONSUELO MACK: We’ve seen a trend here where the direct investors, Americans are buying more and more of their Treasury securities.
ROBERT KESSLER: And so when you look at the American dollar, as you can look at the Japanese yen- the reason the yen has stayed strong for so long is because the Japanese support their own country.
DAVID DARST: Internal savings, financing.
ROBERT KESSLER: And in the United States, we are beginning to do the same thing. And so even though we have a deficit, if we’re willing to pay for it, then frankly there’s nothing so terrible about the deficit.
DAVID DARST: Your legion of viewers in the aggregate have 25% stocks, 25% their home and 7% bonds. That’s why, as you’ve pointed out on the show, Consuelo, over the nine months from March through December, they, we all put $315 billion net into bond funds and ETFs, $35 billion into non-U.S. stocks and minus $24 billion into U.S. stocks. So there has been this trend. 1982, the average baby boomer, the median age was 25 years old. Today it’s the reverse of the digits- 52 years old. People have been killed by the dot com meltdown, the housing price meltdown and the financial stock meltdown and that want to set aside some money. So your point is an excellent point, Robert. They want to put this money and maybe some of the buyers will be U.S. households.
ROBERT KESSLER: Let me add one more statistic.
CONSUELO MACK: Very quickly because we have to get to the One Investment.
ROBERT KESSLER: The statistic being, that if Americans begin to invest in Treasuries the way they have in the past, then there would be no deficit. There would be simply no deficit.
DAVID DARST: We’re sitting on $8 trillion of cash right now. And they need only $1.5 trillion, but we need higher rates, Robert, to entice us to take it out of the cookie jar and the mattress and put it in Treasuries.
CONSUELO MACK: So one quick question for you, David Darst, and this is put your asset allocation hat on again. What are you overweighting, in a minute or less?
DAVID DARST: We’re overweighting corporate credit to summarize quickly. That would be high yield bonds, and high grade bonds.
CONSUELO MACK: Because of the yield.
DAVID DARST: The yield is more attractive. We are overweight in real estate investment trust, which have a nice yield to them.
CONSUELO MACK: Right.
DAVID DARST: We’re overweight in emerging market stocks and Canadian stocks, Australian stocks, and in small cap stocks. They have basically taken a little gas in the first part of this year. We think that’s a pause, a healthy, needed correction that we will believe as the economies grow around the world- we just jacked up our China forecast to above 10% for this year- and we think probably world growth will surprise to the up side. Maybe that’s why yields will surprise to the up side, too. Interest rates.
CONSUELO MACK: Very interesting. And so let’s go to the One Investment for our investor viewers out there, and Robert Kessler, guess what you’re recommending.
ROBERT KESSLER: A quick comment.
CONSUELO MACK: Yes.
ROBERT KESSLER: A quick comment. I am so weary of people who wear white suits and recommend emerging markets. Now, David’s not.
DAVID DARST: White suits?
ROBERT KESSLER: White suits.
DAVID DARST: Tom Wolf.
ROBERT KESSLER: Right.
CONSUELO MACK: I don’t understand that.
ROBERT KESSLER: Consequently, what I’m saying is I think you want to be in everything that is risk-averse. And therefore I would suggest that a Treasury, whether it’s overnight money or it’s ten or a 30-year Treasury, I think the ten year will probably outperform everything this year, and that’s a way-out kind of a call, but I do think that rates are going to substantially come down, and they do usually the second or third year after a recession, and since we’re only a year into this, we have a long ways to go, and I think you’ll see the ten-year Treasury probably back at 2% range or lower. And that’s a big move.
CONSUELO MACK: Wow. And David Darst, you’re thinking defensive action, too.
DAVID DARST: I am, Consuelo. Procter & Gamble (PG), which I’ve recommended on the show before- they have 23 products with over $1 billion in annual sales, and they have 20 products in addition with over $500 million in annual sales. They just changed leaders. Robert McDonald takes over from A.G. Lafley. McDonald has been with them for 29 years. He sold Folgers Coffee. He’s selling off the pharma area to focus on personal care, on household products and human well-being, okay. We see three billion people every day out of six billion in the world that are touched by a Procter & Gamble product.
CONSUELO MACK: Wow.
DAVID DARST: He wants it to go up to four billion. Only 30% of their revenues are outside the U.S. and Europe. Stock sales are 14 times last year’s earnings. It yields 2.9%. They’ve not been buying stocks in a year and a half. They’ve just begun to buy stocks, and the last thing is it was only up 1% last year with its lag to market. It went down less than the market. It went down 14 in ‘08 when it went 37 down, up 1% last year. We think this is a company that’s been a defensive stock about to go on the offense.
CONSUELO MACK: So we have a diversified portfolio right here between the two of you. Robert Kessler from Kessler Investment Advisors, thank you so much for coming in from Denver and from New York, it’s great to have you regardless, David Darst from Morgan Stanley Smith Barney, thanks so much for joining us.
At the conclusion of every WealthTrack, we tried to leave you with one action to take to build and protect your wealth over the long-term, as well. This week we’re revisiting a retirement income theme that we and many of our guests have emphasized over the years. This week’s Action Point is: lock in some retirement income for life.
How do you do that? The Obama administration recently came out in support of annuities as a tool to deliver a form of “guaranteed lifetime income.” Specifically, President Obama has called for a change in federal rules to allow adding annuities to 401(k) retirement plans.
Until that becomes a reality, one way to assure a stable flow of income that you can count on for life is to buy the simplest, plain vanilla version, an immediate fixed annuity, also known as a single premium immediate annuity. You turn over a one-time payment to an insurance company, and it in turn will provide you with a predictable and guaranteed monthly income as long as you live. To make sure it’s there, that it is as long as you live, only work with life insurance companies that have the highest credit ratings, and don’t put all your eggs in one basket.
The financial advisors we have talked to recommend investing only a portion, no more than one-third of your retirement assets, in annuity products, and also recommend consider staggering the amount you put in over a number of years, so you can adjust your income stream as you need it. To get an idea of what kind of monthly income a given amount will return, go to immediateannuities.com for a quote.
Now what troubles many people about these immediate fixed annuities is that you might die before you have recovered your investment, your heirs don’t get any benefit, and inflation can eat away at the value of the income stream. So the insurance industry, in its infinite wisdom, has responded with variations on immediate annuities that address these concerns. The tradeoff is the adjustments reduce the monthly income. Annuities are not right for everyone, but as a vehicle to create your own guaranteed pension plan for life, an immediate fixed annuity is definitely worth considering.
That concludes this edition of WealthTrack. Join us for one of our Great Investors series next week. I’ll sit down with Steven Romick, portfolio manager of the FPA Crescent Fund, a finalist for Morningstar’s Domestic Equity Fund Manager of the Decade award. In the meantime, to watch this program again, please go to our website, wealthtrack.com. Starting Monday, you can see it as streaming video or a podcast. Thank you for visiting with us. And make the week ahead a profitable and a productive one.
Source: Consuelo Mack, WealthTrack, February 19, 2010
Tags: Asset Allocation, asset class, Asset Classes, Bonds, Canadian Market, Chief Investment Strategist, Connie Mack, Credit Crisis, David Darst, Disinflation, Emerging Markets, ETF, ETFs, Institutional Investors, Interview Transcript, Kessler Investment Advisors, Morgan Stanley, Naysayers, Prolific Author, Recession, Robert Kessler, Smith Barney, Stanley Smith, Treasuries, Treasury Market
Posted in Bonds, Canadian Market, ETFs, Markets, US Stocks | Comments Off
Monday, November 9th, 2009
Last week, James Grant appeared on Connie Mack’s WealthTrack for an in-depth interview. Grant is bullish about the recovery, saying the recovery is going to be surprisingly strong. Grant is must-see, must read material. If you missed the video, you may watch it here.
CM: … He is James Grant, editor of the biweekly newsletter Grant’s Interest Rate Observer, a self-described independent, value-oriented and contrary-minded journal of the financial markets. A financial thought leader, Jim is one of Wall Street’s most astute, erudite and articulate observers. He is also the author of six books including a wonderful biography of the nation’s second president titled John Adams: Party of One and his most recent Mr. Market Miscalculates: The Bubble Years and Beyond. In an interview conducted before this week’s third quarter GDP report showing the economy expanding at a well above consensus pace of 3.5%, I asked Jim why he, a notorious glass half empty kind of guy has recently gone from economic bear to bull.
How zippy is the recovery?
JAMES GRANT: Pretty darn zippy. The finest expression was that of a long deceased economist named Pigou, a Brit actually, sounds French, who said that the error of optimism dies in the crisis; it is followed by the era of pessimism, which is born not an the infant but a giant. Which is a wonderful expression of the human tendency to overdo it. So all of the new era cats find out that they didn’t get the memo. They were all wrong. There was in fact a debt problem. It burst in their faces. What they do now? They are disconsolate, they inconsolable.
Nothing like this has been seen in the history of the world, the patient will not live sadly. So it’s like that. And especially they overdo it on the downside and I think that goes for our esteemed government, especially the Fed, which not only didn’t see it coming but also didn’t comprehend it once it splattered all over its face like a cream pie.
CM: How robust do you think the recovery will be?
JAMES GRANT: I think it’s going to surprise to the upside and so old am I, Consuelo, I’m not going to give a number, nor am I going to give a date, but I think that it’s going to be surprisingly strong. The consensus is for next year to generate growth in our gross domestic product of about 2.5% after adjustment for price fluctuations. I expect it will be much better than that. Certainly for a couple of quarters which I think will jar people- they’ll say, wait, that was an unauthorized, who said they could do that? And you can see some of this in the making. The earnings call recently from Caterpillar featured the information that the dealers had run down their stocks to half of the usual and if they were only to restock to the little bit of the normal, there would be a big sales boom and CAT was kind of venturing that not implausible outcome next year would be growth of more than 10%. And I could see that throughout the economy, and people are expecting much, much less.
I think that the wisest course for investors is to heed the advice from the scripture of value investing, the Graham and Dodd idea that we can not know the future, therefore seek a margin of safety in investments in the present. That is to say, we can’t know really what’s going to happen in 2010, let alone 2017, but we can observe two things. We can observe the opportunities that are in front of us, in the securities as they are now priced, and two, importantly, they didn’t say this but I will, you can observe how the world is positioning itself for an expected outcome.
Tags: Biweekly Newsletter, Connie Mack, Cream Pie, Debt Problem, Depth Interview, Downside, Financial Markets, Gdp Report, History Of The World, Human Tendency, Independent Value, Interest Rate Observer, James Grant, John Adams, New Era, Pessimism, Quarter Gdp, Six Books, Thought Leader, Wealthtrack
Posted in Markets | Comments Off
Thursday, July 23rd, 2009
Connie Mack interviewed First Pacific Advisors’ CEO, Robert Rodriguez, co-portfolio manager of FPA Capital, a mid cap value fund, and FPA New Income, his bond fund, which just celebrated its 25th year in positive territory. Rodriguez is one of only two fund managers to have been honoured by Morningstar as best fund manager three times in his career. The other is Bill Gross.
Here are some excerpts from this in depth interview, which you should make a point of watching.
Rodriguez describes the economy as entering a “repression,” not as bad as the Great Depression, but worse than a bad recession.
CONSUELO MACK: You’ve quoted in one of your speeches and one of your shareholder letters too that legendary economist John Maynard Keynes describing the long-term investor as eccentric, unconventional and rash in the eyes of the average opinion, which fits you to a tee, actually. So where does the eccentric and unconventional side of Bob Rodriguez come from? Where did you get this?
ROBERT RODRIGUEZ: I really don’t like following the norm. If I follow the norm, I would never have been in this business. My last name is not a competitive advantage when I entered the field, and had to knock down a lot of doors, and you had to do things to separate yourself from the crowd, so that all started way back when I was very young. My first time I got anything to do with the investment field was writing a letter to the Federal Reserve chairman when I was ten. It was a school assignment.
CONSUELO MACK: And he wrote you back.
ROBERT RODRIGUEZ: And he wrote me back, and I said gee that’s kind of neat, how many people would do that. What’s the down side? So I started thinking differently about what the norm is, and then how can you turn that to your competitive advantage? So it’s always been that way. I would say when I was in graduate school or just going into graduate school, I discovered Graham and Dodd during the summer before I was coming back to graduate school. And it really struck home, and I had the good fortune of meeting Charlie Munger in our investment course there.
CONSUELO MACK: Warren Buffett’s kind of unknown partner.
ROBERT RODRIGUEZ: As Warren Buffett says, he’s the smart one. And after the class I asked him, I said what can I do to make myself a better investor, beyond just what I’m doing here and researching, et cetera? And he said, read history. Read history. Read history. And if people had read history about the economic crises of before, not only the depression but even before then, they would have said this is an old friend, and so that helped. It’s come from a number of different parts, but I think really not being afraid to fail and be different. That’s what it took in order to differentiate in this business.
I had a friend of mine who was a growth stock manager who got just before the debacle of 2000, we were having lunch together in January of 2000 and he was buying all this dot com, and I said why are you buying this crap? And he says, because you have to, he says yes, if I don’t buy it we won’t be competitive. I said, but don’t you realize, you are at the epicenter of a debacle that’s going to occur? And when you get destroyed, you know, you could either have cash or you can buy these things. If you have cash, you get fired. If you buy the dot-com and it blows up, you get fired. So in both cases you’re fired. What’s the difference? Over here the one with the cash, where you held your investment discipline, you can rebuild your business. Over here, you’ve destroyed your credibility, you can never rebuild.
CONSUELO MACK: Let’s talk about some of your unconventional current calls. You’re describing the current economic state that we’re in as a repression, which it’s not as bad as the Great Depression, but it’s also worse than a recession. Where is this repression taking us? What’s it going to feel like?
ROBERT RODRIGUEZ: Here in the firm, we’re using a new term for the economy. We’re calling it the caterpillar economy. Where it goes up and goes down, goes up and goes down, but it doesn’t move forward very fast, after this waterfall collapse that we had. And this is different from any other kind of economic environment that we’ve been in since the depression. You don’t destroy the consumer’s balance sheet, like what’s gone on. You don’t have the leverage in the system that we have and expect to come out of it the way we’ve come out of other periods. The president, I argue, that I think he’s on the wrong road and when I compare him to let’s say FDR. When he came into power, the debt to GDP was barely 17% when FDR came here, whereas now we’re now at 65% going to 75, going to 90% this year.
Rodriguez says that the rebound in the market and economy is a “head fake.” He suggests the way to go is to stay high quality and use a rifle, as opposed to shotgun, approach to investing, the next 5 to 10 years. He says highly diversified equity funds will be a competitive disadvantage – you may as well buy an index fund rather than pay an active fund manager who isn’t necessarily going to deliver an edge in this market.
CONSUELO MACK: So how do you invest in an environment that is going to be substandard growth, that you don’t know what the rules of the game are because you don’t know what the government is going to do next, what do you do?
ROBERT RODRIGUEZ: It’s going to be very hard. As a result, on the fixed income side, we’re still maintaining our highest levels of quality. We haven’t gone into the lower rungs of the high yield area, even though there’s been big rungs there, because we think this is a head fake of what’s going on in the economy and this rebound, the green shoots that people talk about. So we’re going to stay high quality and let other people destroy themselves.
On the equity side, we think you have to be very focused in terms of the industries you go after. So we have a natural decline rate in, let’s say energy, supplies of energy. So we think longer term- three, five, ten years. Energy prices are going to be considerably elevated from where they are today. So we have a heavy exposure there.
CONSUELO MACK: Heavy, like 55% of the FPA Capital Portfolio, is that right, is in energy?
ROBERT RODRIGUEZ: Well, about 41% of the total portfolio, about 55% of the equity. Okay. So we’re looking for other areas to deploy capital that will both benefit from the international side but also from the commodities side.
So we see, you have to be rifle shooting over the course of the next five years or ten years, and that’s why I gave a speech in Chicago at Morningstar that in my opinion, a highly diversified equity fund in this new order will be at a competitive disadvantage, especially if it carries management fees, et cetera, so you’re going to have to do something different from the rest of the market in order to differentiate again, and that’s what we’re doing.
The whole transcript will be available for a limited time only (two weeks) as WealthTrack charges for archived transcripts. Read it here.
In case you didn’t see the video 2 weeks ago, here it is again:
Tags: Bill Gross, Bond Fund, Ceo Robert, Commodities, Connie Mack, Depth Interview, Economist John Maynard, Federal Reserve Chairman, First Pacific Advisors, Great Depression, Investment Field, John Maynard Keynes, Mid Cap Value, Mid Cap Value Fund, Portfolio Manager, Robert Rodriguez, Rodriguez Co, School Assignment, Shareholder Letters, Term Investor, Writing A Letter
Posted in Markets | Comments Off