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 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.
We are a firm that has board oversight and governance that is best-in-breed and an environment where people are concerned where their money is housed and more importantly what the manager is doing with that money in terms of staying true to the style.
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.
With the regulatory schemes we are going to see come out of this, a manager better have scale in compliance and the governance associated with all those elements in order to protect people’s money. Some of the alternative investment strategies, which are one-man shops run out of a house or a small office, are going to have a very hard time competing in this world because people aren’t going to trust them.
Many advisors that I have talked to, are looking hard at what their assumptions are about the markets and the best way to invest on behalf of clients. Do you think that questioning things like asset allocation and Modern Portfolio Theory is the right thing to do? At the point in time where there were so many uncertainties in the systems, where people were just concerned about the solvency of the financial infrastructure in this country as well as around the globe, I think the Central Bank actions to prop up the capital of many of the large financial institutions as well as the nationalization has taken that apocalyptic outcome off the table. Now people see that the world isn’t going to come to an end, it is going to look different, as I think I said, it’s not going to have the growth in the economy globally due to the regulations, the lack of leverage in the system, consumers aren’t going to be allowed to borrow the way they did. Ultimately I think it is a good generational change that people, especially in the U.S., are beginning to save and not consume all the time, because I don’t think that’s a healthy way for society to operate.
So I do think that, as we look back, history always does repeat itself, we’ve had a bear market, we’ve had a deep recession, 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 worst case scenario has been removed, and that moving forward I think that the capital markets wont visit those lows that you just documented.
In terms of asset allocation I get asked this question a lot, and 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 and be more heavily exposed to stocks because they were always going to go up more than fixed income instruments would. People went way out over their skis, whether it was in their 401(k) plans or personal savings, and lo and behold bear markets do happen, recessions do happen, dislocations happen, and equities are much more risky than Treasuries or high-quality fixed income instruments.
The lesson to be learned here is history does always repeat itself, that there are tail events that occur in capital markets that you can’t anticipate, and you have to look at asset allocation, you have to look at rebalancing your portfolios, you have to be diversified, you have to own not only cash-like instruments and non-correlated instruments to the equity market, you’ve got to own fixed income.
I was on CNBC and Sue Herera asked me about asset allocation, that it doesn’t mean anything anymore, everybody got killed. I said, well, if somebody owns Treasury bonds they are up 25%. 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, looking at historical volatilities and returns to provide the optimum point on that efficient frontier for a client to be in.
To flip this whole thing on its head, I think people need to not throw out MPT and asset allocation but they need to go back and read the books and actually do what they said you were supposed to do. I think its back in vogue, and this is a great, particularly for those who are younger as an example of what to watch out for. I don’t think the equity-oriented culture of having so much exposure to one asset class can thrive in the future, and hopefully the next generation will learn that.
The Depression affected people who lived through it for decades afterwards, Is tempering the expectations of investors something that all professionals have to remind investors of, but also maybe that might be a good thing that come out of this? Yeah, the most durable wealth I’ve ever seen built by any individual is over a long, long period of time. If it comes too quickly you’re likely to make errors and give it all back. People do need to ratchet down their expectations of equity market returns. The studies which were the longest dated series of data we have show equity markets return 7% to 9% on average, and so, yes, you should own some equities, This is probably a good time to actually buy equities although people are afraid, but you also need to own some fixed income, you need to own high-grade credit, which right now if you buy some BB and BBB bonds in a basket you can get 8% to 9%, which is historically what the equity market has returned.
So even though there is a dislocation and people have been burned by what’s happened, there’s also wonderful opportunities to invest in markets right now that are giving you outside yields or returns to the risks you are taking. I would also argue that rates on taxes are going to go higher in the next few years and we can obviously point to the factors driving that. Municipal bonds actually yield more than Treasuries, which is an anomaly but also a great opportunity. So in all of this turmoil and dislocation and pain and anguish, there are great opportunities that exist in the marketplace today for those who are willing to open their eyes and be patient.
We’re probably in quite a recovery as we speak, and I don’t know what the market is going do from week to week or year to year, but I think you have to get back to a single-digit expectation of return from stocks. I think people who build their models and their asset allocations on those expectations are going think differently than they have in the past.
If that’s the case, should there or will there be more emphasis on the tax efficiency of investments or on the expense ratios of a given fund? I just think it is a factor, and its really the taxes that create the inefficiencies in the marketplace, for instance with munis where if you wanted to buy high-quality fixed income instruments, don’t buy Treasuries, buy munis, because you can buy AAA munis that yield more than Treasuries. I’m really not getting at the tax aspect of it, because everybody always thinks about managing that expectations, I’m really talking about the anomalies driven off increased taxes and some of the markets that appear to be cheap as a fallout of all of this. In negative terms, most equity mutual funds won’t have capital gains for many, many, many, many years. So it actually makes them much more competitive against an ETF because they have embedded losses in them. So the good news coming out of the backside of this if you’re investing now in an equity fund, it’s unlikely that any gains are gonna get paid out on them.