From the April 2009 issue of Investment Advisor • Subscribe!

April 1, 2009

Clark at Large: Timing Is Everything

A solution for advisors not quite ready to cash out of equities

I don't usually write about mutual funds. My now ex-wife was/is a partner at Thornburg Funds, and it didn't seem fair to expect people to believe I'd be objective. But now that we're divorced, the handcuffs are off (I'll try not to be swayed the other way, either). This is a good thing, because in this economic environment, it's hard not to talk about investment portfolios in general and mutual funds in particular.

Most of the advisors I know are doing a lot of soul searching about their investment strategies these days, and it's not hard to guess why. When all your "well-diversified, uncorrelated" asset classes drop at one time, and client portfolios lose half their value, it has to leave you scratching your head, wondering if a buy-and-hold, value/growth, large cap/small cap/international, and bond fund allocation is really the prudent approach.

I believe much of the blame lies with Paul Volcker, the Federal Reserve chairman in the early 1980s, who engineered the low interest rate, low inflation, low tax environment that spawned the Reagan/Bush/Clinton/Bush II 27-year bull market. Sure, we saw some major hiccups in '87, '91, and '01, but each time the old Bull just came roaring back stronger than ever, creating the impression that equities really only go up, and the job of an investment manager or financial advisor is simply to identify which classes of equities are currently going up the fastest.

The lesson of the Mortgage Meltdown of 2008 may well be to remind us that there are other possible economic environments that require different investment strategies. When I started covering financial services in the early '80s you couldn't give away a stock or bond mutual fund and a "well allocated" portfolio contained real estate, oil & gas, and gold. Today, with President Obama, Nancy Pelosi, and Harry Reid in charge, together seemingly intent on exploding the Federal budget deficit and raising taxes, it's at least likely that we're headed for an economic environment more like the Carter years than the golden age of the last quarter century.

As far as I can tell, all this has advisors more willing than ever to look beyond the boundaries of Modern Portfolio Theory, exploring areas that only a year ago would have been unthinkable, including asset classes and strategies not taken seriously since the Dow last stood under 1,000: Commodities, real estate, short selling, and even strategic and/or tactical asset allocation. However, if you're not yet ready to embrace the strategy-formerly-known-as-market timing or feel you have to hang in there with equities so your clients won't be on the sidelines for the eventual recovery, we'll be seeing a growing number of solutions offering to help keep the costs of investment management more in line with your new revenue levels. Case in point: I had a conversation with an accountant and doctor the other day that made me think: "These guys are at exactly the right place at the right time."

The Accountant & the Doctor

Okay, to be fair, the accountant was Bill Quinn, who started his career at Arthur Young & Co. in 1969 and is now chairman and chief investment officer of American Beacon Advisors, which he founded. Among his many credits, Bill is the chair of CIEBA, a group of the country's largest pension funds, and is on the NYSE Pension Managers Advisory Committee.

The "doctor" is Kneeland Youngblood, who, in addition to having an MD from the University of Texas, is the former CEO of American Beacon Advisors, and now co-founder and managing partner of Pharos Capital Group, the private equity firm that bought the $65 billion AUM American Beacon from American Airlines.

These guys are big-time institutional managers, with careers built on overseeing one of the largest pension funds in America. Now, they're making a big push to move into the independent advisor market, with eight equity funds, three index funds, five bond funds, and two money market funds.

Their bond and money market funds are managed in house, with over 20 years of fixed income expertise. But what makes American Beacon different--and particularly attractive to independent advisors these days--is that their equity funds are "funds of funds," each managed by a diversified group of two to five top institutional management companies that very few independent advisors or their clients could approach on their own: Brandywine, Goldman Sachs, The Boston Company, Dreman Value Management, and Hotchkis and Wiley, to name drop a few.

But unlike most funds of funds that have a tendency to overshadow whatever their attraction might be with layers of high fees, these subadvisors and American Beacon itself are players in the highly competitive institutional world. Consequently, the fees they offer to their institutional clients and to advisors' clients are extremely reasonable for mutual funds of any kind: most funds charge from 57 bps (balanced) to 80 bps (small-cap value). On the high end with 140 bps is emerging markets, and on the low side, their S&P 500 Index is at 18 bps.

No Wirehouses Need Apply

I was also impressed that, according to Bill Quinn, American Beacon has no plans to seek wirehouse money: "We're interested in attracting institutional and independent advisory assets managed with an eye toward long-term investing and management of risk" he told me.

For advisors interested in maintaining a broad equity exposure in their client portfolios at what appear to be near-rock-bottom prices, American Beacon offers institutional level oversight of top management firms at a price that's certainly no higher (and often lower) than most traditional mutual funds. "We select top management firms with a range of approaches within each asset class," says Quinn. "Then we closely monitor both their performance and their strict adherence to that asset class and their investment style."

For its part, American Beacon Advisors has substantial motivation to offer its institutional funds to independent advisors. Kneeland Youngblood and his partners in the Pharos Capital Group paid some $480 million for 90% of AB last April. Although they paid a conservative 11 times AB's $43.6 million in pretax earnings, it's hard to conceive of worse timing. When I tactlessly asked him how he is feeling about the acquisition now, he said: "Sure, the timing could have been better, but we got what we think is a great investment company at a very reasonable price. We're long-term investors, and we think the long-term prospects of American Beacon are still very, very good."

As far as I can see, the surest way for Youngblood and Pharos to boost the value of their recent purchase would be to increase its revenues, which at the time of the buyout averaged a very institutional 15.5 bps ($101 million on $65 billion in AUM in 2007). And the surest way to do that is to expand their market beyond large pension funds that can negotiate hard on fees and into the somewhat smaller scales of the independent advisory world, whose clients would pay quite a bit more than that and still get a great deal compared to their alternatives. The proverbial "win/win."

With manager selection and monitoring provided for free (or at least for no additional cost) by American Beacon, advisory firms need only direct portfolio holdings into the appropriate asset classes. That should translate into less professional staff, more client and marketing time for firm principals, or most likely, both. That strikes me as a good solution at exactly the right time: Help reducing firm overhead, while providing clients with low-cost, institutional quality management and diversification to put them in the very best position to recoup their losses as the economy and world markets recover.

Of course, American Beacon Funds, or any similar solution, won't help advisors wrestle with the big questions about whether buy and hold is still the soundest investment strategy or just which asset classes clients should buy and hold in this new investment environment. "We leave the portfolio allocations up to the advisors," says Quinn. "Our job is to give them the best tools to work with; the highest-quality portfolios in each asset class." For advisors who still believe--at least in part--in traditional diversification, it's hard to imagine a more sound solution for today's challenges.


Bob Clark, former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at rclark7000@aol.com.
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