(Chicago) “Corporate bonds have the stock guys salivating,” according to Morningstar’s Russel Kinnel, while attending the 2009 Morningstar Investment Conference (held May 27-29 in Chicago). And fund managers have been “finding great buys in the bond world. A couple months ago yields peaked in the hefty double-digit range and many are still offering sizable yields,” says the director of mutual fund research for the independent research firm.
As for corporate bonds, they seem “like a more natural fishing pond for stock managers,” Kinnel notes. “They’re just expanding the reach of their research and moving along the capital structure to find the most attractive spot to invest.”
Marty Whitman, manager of Third Avenue Value (TAVFX), told attendees that he has been buying the bank debt of companies that look poised to pay off in the long run, while Steve Romick of FPA Crescent (FPACX) has done a lot of bond buying.
Bruce Berkowitz of the Fairholme Fund (FAIRX) says that bonds are very inexpensive and some senior bonds have double-digit yields. And while those at Morningstar’s recent meeting may have found reasons to warm to bonds, they got a downright chilly viewpoint on the industry’s performance in ’08 and the government’s behavior.
‘Reflections and Outrage’
Bob Rodriguez, who manages FPA Capital (FPPTX) and FPA New Income (FPNIX), and plans to take a sabbatical next year, shared his displeasure over the industry’s failure to note and respond to the housing and credit bubble. Fund managers are too afraid to lag their benchmarks and hence won’t retreat to cash or make strong bets against the major market indexes, he noted in his speech, appropriately entitled “Reflections and Outrage.”
“Did the industry try and prepare for this tsunami of a credit debacle? I don’t think so,” asks the head of First Pacific Advisors. “Whether in stocks or in bonds, it seems as though the same old strategies were followed — be fully invested for fear of underperforming and don’t diverge from your benchmark too far and risk index tracking error.
“The industry drove into this credit debacle at full speed. If active managers maintain this course, I fear the long-term outlook for their funds, as well as their employment, will be at high risk,” Rodriguez adds. “If they do not reflect upon what they have done wrong in this cycle and attempt to correct their errors, why should their investors expect a different outcome the next time?
“Investors have long memories, especially when they lose money,” the fund manager notes.
“We owe our shareholders more than platitudes if we expect to regain their confidence,” he says, sharing that he’s put some of the cash he was holding last year into energy stocks. He sees energy prices as rising long term.
Rodriguez also shared his concerns over credit, housing, mortgage and emerging markets in the recent past and has altered his portfolios accordingly. He expressed his severe lack of trust in most segments of government because of the course of financial events since 2000.
The fund veteran sees the federal debt increasing rapidly, predicting it could hit about $15 trillion or more by 2011. This means the United States will have to borrow more money from abroad and print more money, so he’s not buying long-term Treasuries.
He is cautious about the current rally, seeing investor optimism as misplaced.
“What new procedures and policies have they implemented at their firms to address this new environment and protect them from making similar mistakes in the future? I believe these are questions that must be answered in order to regain and retain investor trust,” Rodriquez emphasizes.
Some of his other key points:
o Having the courage to be different comes at a steep price but can result in deep satisfaction and personal reward.
o Superior long-term performance is a function of a manager’s willingness to accept periods of short-term underperformance, and this requires the fortitude and willingness to allow one’s business to shrink while deploying an unpopular strategy.
o In a low-return world, a well-diversified mutual fund of U.S. stocks will likely have a harder time outperforming stock averages and index funds, as a result of its higher expense ratio.
o A more focused strategy will be necessary to excel.
For Chris Davis, who manages Selected American Shares (SLASX), this means investing in globally dominant, self-financing companies like Johnson & Johnson that aren’t in need of capital injections. “These are the sorts of things you can buy and put away,” Davis said. Other examples are Berkshire Hathaway and Loews.
Like other speakers, he is bullish on energy, commodity and agriculture-related companies because of the growth in emerging markets. And overall, Davis says, it’s important to stay with a disciplined investment approach, rather than staying out of the market or putting everything into bonds.
‘The New Normal’
Keynote speaker Bill Gross of Pimco gave attendees his assessment of the recent past and what to expect going forward. Gross believes there will be a new investing landscape that includes a permanently weaker economy and lower returns.
“Of one thing you can be sure however: Over the next several decades, the ability to make a fortune by using other people’s money will be a lot harder. Deleveraging, re-regulation, increased taxation, and compensation limits will allow only the most skillful — or the shadiest — into the Balzac or Forbes 400,” he explains.
Part of this outlook is tied to the large global imbalances in the system, namely the indebtedness of the U.S. consumer and the Western financial system vs. the growing foreign exchange reserves of China and other nations. Thus, fund managers, analysts and investors need to assess many long-held notions as they adjust to this “new normal,” an expression coined by his colleague Mohammed El-Erian.
And given the subdued economic climate he expects, Gross says more bonds and stable blue chip stocks could be the way to go in portfolios. Also, he suggests raising investments outside the U.S to cope with a weakening dollar tied to U.S. debt and the likelihood the dollar will lose at least some of its status as a reserve currency.
“Staying rich in this future world will require strategies that reflect this altered vision of global economic growth and delevered financial markets. Bond investors should therefore confine maturities to the front end of yield curves where continuing low yields and downside price protection is more probable. Holders of dollars should diversify their own baskets before central banks and sovereign wealth funds ultimately do the same,” Gross explains.
“All investors should expect considerably lower rates of return than what they grew accustomed to only a few years ago,” he notes. “Staying rich in the “new normal” may not require investors to resemble Balzac as much as Will Rogers, who opined in the early ’30s that he wasn’t as much concerned about the return on his money as the return of his money.”
Likewise Vanguard founder and former chairman Jack Bogle urged attendees to lower their expectations, warning of single-digit returns for stocks (8 percent at most) and less from bonds. He thinks some municipal bonds could pay off handsomely, but they should be bought via bond funds of high quality and good diversification.
As for what to expect in terms of future growth, “I’ve never seen a time in my whole career when it’s been harder to answer that question,” the Vanguard veteran shares.
Speaker Jeremy Grantham, a co-founder and now chairman of the global investment firm GMO, shares a roadmap (and philosophy) that may help: “Life is simple. If you invest too much too soon, you will regret it,” he explains. “On the other hand, if you invest too little after talking about handsome potential returns and the market rallies, you deserve to be shot.”
“We have tried to model these competing costs and regrets,” Grantham says. “You should do the same. If you can’t, a simple clear battle plan — even if it comes directly from your stomach — will be far better in a meltdown than none at all.”