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Danger & Opportunity: Taking the Really Long View

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When Rob Manning goes to work every day, he’s got big shoes to fill, since he oversees the first mutual fund, Massachusetts Investors Trust, which this year marks its 85th anniversary. We spoke with Manning, the CEO and CIO of MFS Investment Management, by telephone on June 1 to learn what MIT and its parent company can teach us.

Please talk about the history of Massachusetts Investors Trust and the MIT approach when it comes to the role of the mutual fund in investing.

Obviously we are biased and believe mutual funds are a great vehicle. Here at MFS we have an 85-year history of running actively managed, open-ended mutual fund pools. One of the threats that has come up in the past five to 10 years has been indexing through ETFs, as well as alternative investment strategies. We have been competing against indexing for generations long before ETFs proliferated. The only advantage that an ETF gives you over an index fund is that you can trade it intraday. If you want to get exposure to a market it shouldn’t matter whether you do it intraday or at the end of the day or at the end of the month. The important thing is that you are going to get the market return minus whatever the embedded costs are in that instrument. We believe, and we can show you statistics on our performance, that an actively managed portfolio, even with the expenses associated with it over the course of a cycle, if you do it well, you generate a lot of excess return for the risk you are taking for a client.

On the other end of the spectrum we have this proliferation of instruments, and that has not worked out well–everything from the Bernie Madoff scandal to fund of funds managers, to some hedge funds closing their doors and shutting redemptions down because they weren’t able to handle liquidation. That really plays into the strength of MFS, which is that we are a very large global company, around for 85 years, owned by Sun Life of Canada, no debt on our balance sheets, we operate under the most strict regulatory schemes in everything that we do.

Firms like an MFS we think are going to come back into vogue in the next cycle because of the safety, the liquidity, but more importantly the investment framework that has allowed us to outperform passive products and the competition in the actively managed space. An active manager who can prove they add value over time will still be able to thrive and do well in the world we are going to be living in, which is probably going to be a slower economic environment with less leverage both at consumer and corporate levels.

Many advisors that I have talked to are questioning even asset allocation and Modern Portfolio Theory.

History always does repeat itself, we’ve had a bear market, we’ve had a deep recession, but we will come out of it, growth will resume, capital markets will recover. It’s not going to be a straight line, there will continue to be some volatility, but I think that the worst-case scenario has been removed, and that moving forward I think that the capital markets won’t visit those lows that you just documented.

In terms of asset allocation, I think people need to go back to disciplined asset allocation; that’s what was missing. People’s expectation on equity market returns were completely out of the realm of reality, and in fact many people in their 60s, 70s, and 80s, because of longevity, believe that they should throw asset allocation and Modern Portfolio Theory out the window. People went way out over their skis.

You have to go back to the efficient frontier, Modern Portfolio Theory, your age, you expectation on income, and the volatility and risk you’re willing to assume for the returns that are available in the marketplace. I think that firms like MFS can help clients such as reps and financial advisors not only by doing a good job in the styles that we’re hired to manage, but also through some of our asset allocation and target date products, where we manage that aspect of the allocation process with sophisticated models.

Has the crisis led you to change the way you build portfolios at MFS?

The way that we manage money here is unique. MFS has a global research platform with analysts all over the world who operate in sector teams… We look at everything from the balance sheet and how the credit people look at the story, to what global companies that operate around the world are experiencing, because we have people on the ground in different geographies around the world. We’re looking at relative value and analysis and understanding all the inputs that are required to make good investment decisions.

People are going to do analysis differently, particularly in actively managed funds as we do, and having a global perspective is going to be key. You need that global footprint, but more important you have to integrate all of these different disciplines into one team that can look across the spectrum of everything that is going on and make good investment decisions.

It sounds like you need some serious scale to do that globally.

I think you need the scale, but more importantly what you need is a culture of cooperation, and that’s not something that money can buy. It’s done through time, through compensation structures, and it’s done through attitude of the senior leadership team on the investment side, and the type of people that you bring in and their belief in that system.

And that starts at the top?

I started here as an analyst, and we believe that any asset management firm, particularly a global asset manager, should be run by an investment person, because ultimately that’s what drives the firm. You need to have someone who understands the investment process and sends a consistent message on what the expectations are to the people you are not only bringing into the firm but those who are here today.

Do you expect there to be further consolidation either in the funds industry or in the asset management industry?

I do think you will see particularly subscale players–less than $100 billion in assets–talk with one another about how to marry to get larger scale and size. I also think on the upper end you will see some very large asset management firms break themselves apart because it is very difficult to generate alpha when you are managing hundreds of billions of dollars in assets; you cannot move quickly and you become so large relative to the market caps you’re investing in that it’s tough to develop relative performance.

(The interview above appears as it did in the print version of Investment Advisor, a longer transcript is available here.)