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Decade Horribilis

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Even veteran investment professionals, those who have been in the business for decades, are not shy to say that the 2001–2011 period was probably the worst time they have ever been through.

At the outset of a new decade, both the financial markets and the global economy still look tenuous. The European sovereign crisis is not resolved, the U.S. economy is fragile and inflation is on everyone’s cards as a top concern in the years to come.

Yet seasoned investment managers believe that it’s still possible to come out on top, and maybe even perform better in the decade to come, if they approach the market with dedication, discipline and devotion to the practice of investment management.

Here, investment veterans Chuck Akre, managing member and CEO of Akre Capital Management; Hank Herrmann, chairman and CEO of Waddell & Reed; Iain Clark, CIO of Henderson Global Investors; and Gene Needles, president and CEO of American Beacon and president of American Beacon Funds discuss what strategies have worked for them, what they believe will continue to work moving forward and what qualities they consider key for investment management in the future.

Chuck Akre, Akre Capital ManagementChuck Akre, (left), managing member and CEO of Akre Capital Management, credits the success of his 15-year-old FBR Focus, which he left to start his own fund (and that he ran in the same manner he now manages the Akre Focus Fund), and his 23-year track record in managing separate accounts for individual investors to the strict discipline he has always exercised in the investment process. That process, he firmly states, has never changed and will never change.

“We refer to the process internally, and we are known by it externally, as the ‘three legged stool,’” Akre says.

It’s an approach that requires identifying high-return businesses run by managers with equal parts of skill and integrity—businesses that have also generated enough excess cash to be fully reinvested and that can be bought at a good price.

“As long as it’s a great business that’s well-priced, with good people and opportunities to reinvest excess cash, we are keen to own it for a long time,” Akre says.

The past decade, in particular the three years following the 2008 market meltdown, has thrown up a number of lucrative opportunities for Akre that are not only the kinds of businesses he’s always invested in, but that “would, in the future, help us connect the dots in a better way to preserve our capital in adversity.”

The Akre Funds, for example, have an important exposure to off-price retailers—companies that, Akre says, not only post top records in robust economic times, but also work well in an environment “where the consumer needs to work hard to make sure he stretches every dollar.”

Akre also focuses on identifying businesses that have good pricing power and the ability to raise prices over time for their services regardless of the economic environment.

“We continue to own positions in American Tower, and we have recently added holdings in MasterCard,” he says. “These are both businesses that have built-in price escalators, and that’s what we want, particularly in a period of inflation.”

Inflation is definitely rearing its ugly head, and there is nothing investment managers can do except find a way around it. Right now, there’s no map for recovery in either the United States or Western Europe, which means that the markets will be rife with volatility, and investors will be grasping at any snippet of news, positive or negative, that comes their way.

While volatility will be treacherous for those who view the markets as just a short-term way of making a quick buck, it will also throw up great opportunities for long-term investors who, Akre says, have the right temperament to stay the course and not get discouraged.

“Investment managers have their work cut out for them, but there are a lot of businesses out there with terrific potential,” he says.

For Akre, getting hold of this potential means sticking with the three-legged stool approach and choosing to invest in businesses that can grow in the future, even if there is a change in the overall macro picture, the most likely being a rise in interest rates.

“Since they are at zero in the short term, one would think the next move would be up,” he says.

Businesses like TD Ameritrade, for instance, are currently undervalued, but their business model is such that rising interest rates would have a positive effect on their revenue streams.

Akre’s firm manages the Akre Focus Fund (AKREX), a $400 million public mutual fund, a couple of hedge funds and several separately managed accounts for individual investors.

Hank Herrmann, Waddell & ReedHank Herrmann, (left), chairman and CEO of Waddell & Reed, which manages approximately $90 billion in assets and launched some of the first mutual funds in the industry in 1940, has been in the investment business since 1963.

[The print edition of the January 2012 issue of Investment Advisor mistakenly listed Waddell & Reed's assets as $5 billion.]

He has been through many stressful and disappointing times, but the past decade, Herrmann says, was probably as bad as it gets. Yet he believes also that “we are finally approaching a time in which we are going to be forced to change our behavior, and that will set us on a more fiscally responsible course,” though he adds that “there will be a lot of pain for the economy and for the market.”

Herrmann believes that one of the greatest lessons investors and investment managers alike can take home from the past 10 years is that price-to-earnings ratios do matter. As a traditional, long-only, “buy ‘em and hold ‘em” investor, this has always been a top priority for Waddell & Reed, Herrmann says, but so many others forgot its importance, and this is what went against them.

“When the market was selling at 30 times, people argued that price-to-earnings was not important, but that proved to be totally wrong,” he says. “A lot of companies have continued to grow, but their valuations have come down.”

At this time, when investment confidence is low, convincing people that valuations are attractive and that many companies have good future prospects is not an easy task. But Waddell & Reed has always stuck to a conservative investment approach, Herrmann says, one that has favored fundamentals over fads. Recognizing that the firm manages other people’s money means that it is willing to forgo some gains in an effort to protect investors from losses, he says, and this approach is key for the long term. It’s an approach that’s based on discipline, respect and a deep sense of what’s happening in the world at large—values that seem to have been either lost or misplaced during the past decade.

“The length of the holding period for the average stock has plummeted so that people are no longer investing for the long term; they are just gambling,” Herrmann says. “The more speculative in nature investing becomes, the higher the cost of capital for companies and the harder it becomes for them to grow. Here we are, worried about creating jobs, and we have behavior patterns that are just not in line with the fundamental picture.”

Iain Clark, Henderson Global InvestorsBeing a relatively late entrant to the U.S. market has actually served Henderson Global Investors well through the past decade.

The firm launched its International Opportunities Fund (HFOAX) in late August 2001, just a few days before 9/11, says Iain Clark, (left), CIO at Henderson. In the immediate aftermath of that fateful and tragic event, the firm somehow succeeded in wrestling with the next 15 months of falling markets.

“But when we launched, we knew we had to put our best foot forward and focus on the things that would make us work here in the [United States],” Clark—who has been working in investment management since the early 1970s—says. “The approach we took has done very well for us over the past 10 years, and it’s the approach we are going to stick with.”

Henderson entered the U.S. market with the goal of creating an all-weather fund that would give American investors access to what Clark calls its “conviction ideas.” This meant selecting five managers with different approaches for various market segments—Europe, Asia ex-Japan, Japan and technology, all areas in which Henderson already had a proven track record—who would work in a multi-managed strategy targeting growth and value at the same time and in different ways.

“In Europe, one manager is a growth manager, the other focuses more on value,” Clark says. “In Japan, we slightly favor value and in Asia, we slightly favor growth, so we have a balance within the portfolio because each manager is looking at slightly different characteristics.”

The mixed approach enabled Henderson to capitalize on its strengths and to minimize the effects of various market downdrafts.

“Even though it’s getting a bit trickier to go with this approach because correlations are all pretty high now, conviction ideas have worked well for us over the past decade and we’re going to stick with this approach,” Clark says. “We don’t want to be put in either a growth box or a value box, and this means that in times of maximum performance, we won’t be at the top of either one, but it also means that we should do well in all circumstances.”

Maintaining a focus on growth and value also implicitly includes what Clark believes to be the greatest investment lesson of all: Investing for the long term.

“We’ve really got to go back to fundamentals, to get people to not think that they can make a lot or lose a lot in a short time, but rather that they are in for the long haul,” he says. “We need to get back to what investing is all about, and it’s about people saving for their pensions, not about throwing gambling chips on the poker table.”

Selecting stocks that are reflective of that longer term view, that take into account both value and growth for the future, underscore the return to fundamental investing that Clark believes is important from here on.

To that end, Henderson is focusing more on opportunities in emerging markets as well as companies like Unilever and Colgate, which derive substantial revenues from emerging market shares. They are companies that will continue to earn over time and that people who really want to invest for investing’s sake can hold for the long haul.

Gene Needles, American BeaconThe investment vehicles that will succeed in the future and deliver to investors the returns they’re looking for will be those that can protect capital when there is risk of erosion and will also be capable of growing it when there’s an opportunity for capital appreciation.

American Beacon’s recently launched American Beacon Flexible Bond Fund (AFXIX) is designed to do just that, says Gene Needles, (left), president and CEO of American Beacon and president of the American Beacon Funds. It’s a product that embodies the kind of flexible investing that’s probably going to become increasingly the norm over the next 10 years, Needles says, because it can invest anywhere in the fixed income universe, across sectors, geographies and currencies, and it has the ability to go long or short in its holdings.

“Why is that interesting? Well, the headlines are all about government credit, currency and curve,” Needles says. “They represent the three greatest challenges investors are going to have to face over the next three to five years, but they also represent the three greatest opportunities they can avail of.”

Having a flexible fund, one that “allows you to be in the right place at the right time” while avoiding to the best extent possible the pitfalls of concentrated risk, embodies what Needles calls “the investment experience,” something he believes will become a big theme over the next decade.

“When I entered the investment business, it was all about setting objectives for clients, but somewhere along the way, we lost sight of that, and the past 10 years have been more about putting people into style-box type funds, rather than thinking about what they want to accomplish and where they want to go,” Needles says. “I think that after all we have been through over the past decade, we will now start to revert back to the idea of realizing objectives such as growth and income and capital appreciation, and investing will be about solutions that deliver absolute returns.”

Flexible investment styles will make those goals possible, and Needles also believes that a multi-managed approach will allow funds to accomplish even more.

“The likelihood of a single manager betting wrong is pretty high so we think a multi-managed strategy will be the best way to manage against risks and optimize results,” he says.

Flexible investing is also the best way to counter market volatility, something that Needles is convinced will continue to exert great pressure on assets and, more importantly, play with investors’ minds.

“It’s a lot for a single manager to have to contend with the kind of volatility we’ve seen and to stick to their guns when you’ve got a market that’s down 6.5% one day, then up 4.5% the next, only to be down again 6% and up again in the days after that,” he says.


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