At Morningstar Conference, PIMCO Powerhouse Rob Arnott Is Sober yet Optimistic

Arnott tells investors of a 'generational opportunity' to capitalize on inflation

Just in on the red eye, PIMCO powerhouse Rob Arnott spoke to a standing-room-only crowd of about 800 at the Morningstar Investor Conference in Chicago on Thursday, June 24, about real return investing, lessons from the past, and thoughts about the future.

"Is there a better way to allocate assets and construct portfolios?" Arnott asked. "There are always interesting investments--the challenge is identifying opportunities wherever they might be."

One of those periods of opportunity may be over the next 12 to 18 months when, he predicted, there will be a "generational opportunity to put inflation protection pieces in place when people aren't worried about inflation."

The founder of Research Affiliates and manager of PIMCO All Asset and All Asset Authority funds, Arnott is perhaps best known for his view that fundamentally-weighted indexes--those that use fundamental investment metrics such as dividends, sales, revenues, and price-to-book value--do better than cap-weighted indexes, because in cap-weighted indexes you buy more of the "most expensive companies."

First he wanted to dispel some myths: Arnott contended that in what he calls the "Noughties," the "lost decade was only lost for [investors who were] equity-centric and anchored on cap weighting."

"Are stocks priced to deliver a large risk premium? No," Arnott asserted. While a decade ago they were "extraordinarily expensive," now they are "moderately expensive."

Do "stocks beat bonds by 5% over the very long run?" No, Arnott said again. "Real stocks beat bonds by 2.5%, not 5%." But it matters when you buy; if you "buy when they are cheap, you don't have to wait for the long run; buy when they are expensive--the long run could be very long."

Arnott said that cap weighting on the bond side is a "mistake" too. Fundamental weighting matters for bonds as well. Further, he said, for the last 41 years, bonds have had the same rate of return as stocks, but in the last decade, "bonds materially outperformed" stocks, flipping the stocks outperform notion on its head.

He cautioned investors about the "3-D Hurricane: deficit, debt and demographics." He asked the audience to raise their hands if they were born in 1963 and before, then 1964 and after. Then he addressed the post-Boomer 1964 and beyond crowd: "Medicare is a promise we made to ourselves and we expect you to honor it!" There was a lot of laughter but it subsided when he pointed out that public debt in the United States is 143% of GDP if you count state and local taxes and government sponsored entities (GSEs) like Fannie Mae and Freddie Mac.

"Greece is in trouble at 120% of public debt to GDP," he noted.

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Comments? Please send them to kmcbride@wealthmanagerweb.com. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.

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