This could be the right time for ‘go-anywhere’ mutual funds
Over the last six years, roaring bears and raging bulls both have had their turns to be right about financial markets.
But investing success in the next market phase could be far more about pinpointing individual opportunities than riding a wave.
This is when it should pay for a money manager to have maximum flexibility: the option to go almost anywhere with investors’ dollars in search of decent returns. That could include stocks, bonds, real estate or commodities, for example. Flexibility also can mean the option to just sit and wait for better prospects.
Wealthy investors have long had access to hedge funds and other money managers who offer the nimble, go-anywhere approach. In the last 20 years, the mutual fund industry has done the same for small investors via funds often categorized as “tactical allocation” or “alternative” portfolios.
But Wall Street is notorious for creating fee-generating investment products just to sell them, with little or no regard for whether they’re good for the investors who buy them.
Some go-anywhere mutual funds, however, have attracted billions of dollars from investors over the years by offering clear visions of how they can add value — or, just as important, how they can minimize losses if markets go awry.
There are a few reasons these funds are worth a look now. First, U.S. stock prices are at or near record highs after the stunning gains of the last five years. By classic yardsticks, such as price-to-earnings ratios, stocks are at least fairly valued if not overvalued, at a time when corporate earnings growth has slowed sharply.
Yet many stock-only mutual funds are designed to stay fully invested, no matter the market backdrop. If you’re looking for some measure of protection from any steep market pullback, plain-vanilla stock funds may not provide that.
Second, the global economy’s rescue by central banks over the last five years has entered a new chapter. The U.S. Federal Reserve has begun to cut back on the torrent of money it has been supplying to the financial system to keep interest rates down. In Europe and Japan, meanwhile, central banks say they’re poised to provide even more help to their still-struggling economies.
The banks’ diverging policies add to confusion over the next major move in interest rates, and thus in the value of investors’ bond holdings. A steep jump in market rates would send prices of older bonds tumbling.
Third, while share prices in the developed world have surged in the last few years, emerging markets overall have slumped in the face of weaker economic growth, rising inflation and political upheaval. For value-hunting investors, that means potential opportunities.
Of course, just because a fund can invest in almost anything doesn’t guarantee that the managers will make smart choices.
But even for investors who don’t see a need for these funds, their guiding principles can be helpful at a time like this: Focus on value, and consider whether your portfolio has the balance you want between growth of capital and preservation of capital.
Here are profiles of four popular go-anywhere funds and how they’re investing:
First Eagle Global: While many money managers have been loading up on stocks over the last year as share prices have soared, the $49-billion First Eagle Global fund has been edging away from the market.
“Prices of stocks have moved well ahead of earnings,” said Kimball Brooker Jr., co-manager of the fund in New York. “We’ve had a lot of stock prices converging with what we think the companies are worth,” he said. And when that happens, they start hitting the sell button.
The result: The fund’s cash holdings grew from 14% of total assets two years ago to about 22% at the start of this year, nearing the highest level in the portfolio’s 35-year history.
That leaves about 70% of the fund’s assets in stocks worldwide — and nothing in bonds. Though the fund can buy fixed-income securities, its managers find bonds far less attractive than stocks now, with yields so low.
In the corporate “junk” bond market in particular, Brooker said, “the parallels to the old credit bubble are there.” Investors are willing to accept bonds that are a great deal for the issuer but not for buyers. The average yield on an index of junk bonds tracked by KDP Investment Advisors is 5.21%, nearing the all-time low of 4.86% reached last May.
Of the 70% of the fund in stocks, about half is in U.S. issues; the rest are foreign, mostly in developed markets. The U.S. names include some of the big tech firms that show up on classic value investors’ radar these days, such as Oracle Corp., Cisco Systems Inc. and Intel Corp.
Though those businesses may no longer thrill high-growth seekers, in recent years, they’ve met one of First Eagle’s basic investment guidelines: “We like to have a decent margin of safety [between] what the business is worth and what we’re paying for it,” Brooker said.
The fund also has found relative bargains in Canadian oil and gas producers, including Canadian Natural Resources and Cenovus Energy Inc. And it is spending more time researching stocks in depressed emerging markets, Brooker said.
With 22% of the fund in cash, if stocks keep rising that dry powder will be a drag on returns in the short term. Still, being picky has helped First Eagle Global generate an average annual gain of 10% for the last 10 years, versus 7.4% for the Standard & Poor’s 500 index.
Another help to returns was a stake in gold bullion and gold-mining stocks during gold’s 10-year bull run that ended in 2011. As gold and the miners have slid since then, the fund has been buying again. Its stake in bullion and miners now accounts for about 8% of assets.
Gold isn’t a doomsday bet but some insurance against potential devaluation of paper (or “fiat”) currencies, Brooker said.
“We hold gold as a hedge,” he said. “If you look at the history of fiat money, it’s not a pretty one.”
FPA Crescent: With much of his personal money in the fund, FPA Crescent co-manager Steven Romick has good reason to place heavy emphasis on avoiding crippling losses. And he sees the current risk of loss in global markets as high enough to justify keeping 40% of the $17-billion-asset fund in cash.
The near-term global economic outlook is too complex to call, said Romick, who has managed the Los Angeles-based fund for the last 20 years at First Pacific Advisors, earning a top five-star rating from investment research firm Morningstar Inc.
One possible economic scenario, he said, is that the Fed and other central banks have reached the end of the line in terms of helping to support growth. “It could be that the economy slows and the central banks have done what they can do,” he said.
Instead of wasting time on economic forecasting, “At the end of the day we let price be our guide,” Romick said. In the stock market, he said, that often means “looking for the best businesses in the world — and for someone to dislike them for one reason or another.”
Microsoft Corp., which has been FPA Crescent’s top holding, is a prime example. The stock went nowhere for the last decade, but lately has hit 14-year highs in part on excitement over its new chief executive, Satya Nadella. “They had to do a few things right and they’re now doing it,” Romick said.
Another big holding is insurer American International Group, rescued by the government in the 2008 financial meltdown. “The property and casualty insurance business was horrible in the U.S. and good outside the U.S. Now the U.S. business has gotten significantly better,” Romick said. The stock has surged to about $50 from $32 in mid-2012.
Romick still finds enough to like about stocks to keep 53% of the fund’s assets in equities. By contrast, he is avoiding bonds almost entirely because of paltry yields, he said. Instead, he has tried to boost the fund’s returns by investing small amounts in assets that are relative rarities even for go-anywhere funds: construction loans for new commercial real estate, for example, and farmland.
But as FPA Crescent’s 40% cash stake shows, Romick is mostly just content to wait for cheaper prices in all assets. Patience has worked for him in the past: The fund’s goal — to deliver stock-market-like returns with less risk than the market — is “a hurdle it has far exceeded over the past decade,” Morningstar says.
Pimco All Asset All Authority: There’s not much chance of mistaking this fund’s flexibility, given its name. And Newport Beach money manager Research Affiliates, which manages the fund for Pimco, has made full use of that flexibility.
Rob Arnott, the head of Research Affiliates, calls the shots for Pimco All Asset All Authority. Instead of investing in individual stocks, bonds, commodities or other assets, he invests in other Pimco funds that own those sectors, to create a portfolio with a specific aim: generate an annualized return that is at least 6.5 percentage points above the U.S. inflation gauge, the consumer price index, over time.
But over the last few years the $27-billion-asset fund has fallen far short of its target. The problem: Arnott has invested in assets that he believed would offset rising inflation. Yet the inflation rate has mostly remained under 2%. And many of Arnott’s asset choices have backfired, including using Pimco funds that “short” U.S. stocks (betting on lower prices) and others that invest heavily in emerging-market bonds.
Pimco All Asset All Authority slid 6% in 2013, while investors in U.S. stock funds typically reaped returns of 20% or better. It didn’t help that the Pimco fund uses leverage — borrowed money — to enhance its bets.
Arnott isn’t budging, however. He continues to pitch the fund as a way for investors with mainstream stock-and-bond portfolios to diversify via what he calls “third pillar” assets: investments such as commodities and inflation-indexed bonds, which may offer a way to offset future turmoil in mainstream markets.
“The third pillar got cheaper last year,” Arnott said. “That’s the good news for contrarian investors.”
And unlike money managers who see no value in bonds at current yields, Arnott believes that returns on junk bonds and emerging-market issues, in particular, are attractive in a slow-growth global economy. They’re also helping him keep the annualized yield on the fund above 5%.
He noted that the Fed, by pumping trillions into the financial system, is trying to boost inflation to avoid the opposite fate — a Japan-style deflation.
He sees “strong odds” that annual U.S. inflation tops 5% sometime in this decade, a level stocks and high-quality bonds aren’t anticipating, he said. “The Fed is inflationary. My bet is the Fed wins,” Arnott said.
BlackRock Multi-Asset Income Fund: Managers of this 6-year-old fund use complex strategies to try to meet a simple goal: deliver decent returns to income-focused investors without putting their principal at undue risk.
Team leader Michael Fredericks, who took over the New York fund in 2011 for BlackRock, has remade it from a more traditional stock-and-bond portfolio to one that ranges further afield, including into high-dividend preferred stocks and master limited partnerships. The $7-billion-asset fund can own individual securities as well as shares of BlackRock sector funds.
Fredericks said the fund is designed for “retirees or those close to it, who are mostly concerned about the risk they’re taking” but who also need income.
The fund’s current yield of about 4.6% is bolstered in part by strategies such as the use of “put” and “call” options on stocks in the portfolio to generate additional income. By selling call options, for example, the fund collects a premium from the call buyer, who gets the right to buy the stock at a preset price by a specific time in the future.
Over the last five years, the fund has produced an average annual return of 13.6%. While that ranked about average for its category, it was achieved with below-average risk, Morningstar said.
The fund recently had 35% of assets in stocks, 52% in fixed-income investments, and the remaining 13% in cash. Worried about the potential for rising interest rates, Fredericks said he is focusing largely on high-quality corporate bonds as a relative haven in the fixed-income sector.
“Our view is that shorter-term rates are going to rise,” he said. “We see longer-term rates moving higher too, but more gradually.”
Even so, he said, given the risks facing stock and bond markets that both have rallied powerfully since 2009, “We’ve been looking at taking our cash up even more” as a way to keep money free for better opportunities.
