Beware of double-dip recession, investment managers warn

The U.S. economy could well be headed for another downturn — and financial advisers should direct clients to move their money out of the domestic equities market and into long-range opportunities overseas and alternative-asset classes, two well-known investment managers said last week.

Speaking at the InvestmentNews Retirement Income Summit in Chicago on Tuesday, Robert Arnott, chairman of Research Affiliates, and Dennis Stattman, managing director and senior portfolio manager of BlackRock Inc.’s Global Allocation Fund, sounded a clear warning about America’s economic prospects.

“There’s better than a 50% chance that we will see a second dip in the economy,” cautioned Mr. Arnott, co-author of the book “The Fundamental Index — a Better Way to Invest” (Wiley, 2008).

“If I had to give you just one message today that message would be: “Open your mind to a very broad set of investments, especially geographically,’” Mr. Stattman said. “Because that’s where the wealth is; that’s where the growth is; that’s where money is going to be made to an increasing degree, over the next five, 10, 15 and 20 years.”

But advisers, wary of the risk and volatility in Greece and other European markets, said global investing would be a hard sell to their clients, even though U.S. markets were rocked by a sharp sell-off last week.

“My clients are middle America,” Vivienne Strickler, a financial planner, said. “How do I incorporate what I’m hearing into my clients’ portfolios?” she asked. “I’ve got happy clients despite the mess; how do I bring new ideas to my happy clients?”

Most of Ms. Strickler’s 300 clients, who collectively provide her with $50 million to manage, are currently in U.S. stocks and bonds, plus some real estate investment trusts, she said.

Both Mr. Arnott and Mr. Stattman were stark in their criticism of the world’s largest economy, pointing to America’s crippling debt, dwindling labor force and marked imbalance between consumption and production.

“Our basic problem as a nation is that we’re essentially consuming beyond our means,” Mr. Stattman said.

“We’re not producing enough with respect to what we spend,” he said. “Until we get production moving up in line with consumption, we are building a bigger and bigger problem.”

U.S. investors are living in an “artificial” world of zero interest rates, Mr. Stattman said. “It’s pulling down the short end and long end of the yield curve, and keeping interest rates lower than they would otherwise be,” he said.

Not everyone buys their assessment of the U.S. economy.

“The problem I have with the doom and gloom is that it assumes the entire U.S. economy is going in the toilet,” Malcolm Polley, president and chief investment officer of Stewart Capital Advisors LLC, said after the conference but before the market plunge Thursday. His firm manages $1 billion.

“What [Mr. Arnott and Mr. Stattman] are pushing is their investment expertise. Does it fit for the average investor? No,” Mr. Polley said.

The average investor should stick with stocks, bonds and cash, because they may not have the necessary tolerance for more volatility and risk, he said.

Michael McCabe of WNA Wealth Advisors, who manages $160 million, pointed out after the panel discussion that it’s bad business to be too adventurous with a client’s portfolio, because he or she has the benchmark of decent comparative returns in the United States.

The S&P 500, for example, returned 4.9% in the first quarter and 65% since its low in March 2009.

Indeed, Mr. Stattman’s own fund, the BlackRock Global Asset Allocation Fund, underperformed the S&P 500 in the first quarter by about 3 percentage points, in part because of its underweight position in U.S. equities.

He boosted the fund’s allocation to U.S. equities in the period by 30 basis points, to 31% of the portfolio.

“Notwithstanding the structural changes facing the U.S. economy, the S&P 500 Index has been among the best-performing equity markets in the world,” the fund’s quarterly report acknowledged.

The fund Mr. Arnott manages, a fund of funds at Pacific Investment Management Co. LLC, returned 2.69% during the quarter. He focuses on global stocks and bonds, real estate and commodities.

Advisers said that it is also critical to keep in mind that alternative assets often mean more volatility. The No. 1 holding in the Global Asset Allocation Fund, for example, is a gold ETF, the SPDR Gold Trust.

Randy Mascagni, a planner who manages $125 million in his own firm, Mascagni & Co., has been getting inquires about gold from his clients, but he tries to point out the risks of investing in commodities to them.

“Gold has had a very nice run, but most people don’t understand it can be a very volatile asset,” he said.

And even branching out into international equities has its problems, given the strong connection among all world markets. The phenomenon was in evidence last week, when concern about the Greek financial crisis dragged down stocks in U.S. markets, as well as global markets.

“The last time I looked at the correlation between the S&P 500 and emerging markets, it was over 90%,” Jack Ablin, the chief investment officer of Harris Bank, who oversees $55 billion in assets, said. “If you’re trying to buy emerging equities to diversify risk, it’s not going to work.”

E-mail Hilary Johnson at [email protected].

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