Go-anywhere funds have nowhere to go, managers say

Jan 20, 2013 @ 12:01 am

By Lewis Braham

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Charles de Vaulx's job should be easy.

The manager of the $8.9 billion IVA Worldwide Fund has the flexibility to invest in stocks and bonds anywhere in the world.

The problem is, the best companies are overvalued, and the rest are cannibalizing one another's business, Mr. de Vaulx said.

“In a low-growth economy with huge head winds, it's tempting for mediocre companies to compete on price to increase sales,” he said.

Since last March, he has cut the fund's stock position to 61%, from 70%, and increased cash to 18%.

Go-anywhere managers are worth paying attention to because they have no biases toward any country, sector or asset class. Right now, many of the best ones are decidedly bearish.

Rob Arnott, manager of the $28.5 billion Pimco All Asset All Authority Fund, said that it is “reasonably likely” the United States will enter into a recession this year and “a near certainty that we at least have a major slowdown.”

He and his peers favor assets ranging from short-term emerging-markets bonds to preferred stock to gold bullion.

DEFENSIVE PLAY

Mr. Arnott, whose fund can invest in stocks, bonds or commodities and can short securities, is avoiding the United States in favor of emerging markets.

Those markets aren't overleveraged and have better growth prospects, he said.

Almost 40% of Mr. Arnott's fund is invested in Pacific Investment Management Co. LLC's emerging-markets funds. Almost 80% of that is in emerging-markets bonds and currency, and the remainder in emerging-markets stocks.

The shortest-maturity emerging-markets bonds, which have the least downside volatility, hold the most appeal for Mr. Arnott.

“Emerging-markets currency bonds with maturities of one to three years enjoy a premium yield of 2% to 3% over comparable U.S. bonds,” he said. “And by owning them, you move your money away from the U.S. dollar, which is vulnerable to devaluation.”

That explains Mr. Arnott's fund's 12% weighting in the Pimco Emerging Markets Currency Fund.

He is also betting that high-yield bonds will continue to rally. Mr. Arnott has 16% of his fund in them.

Yet he is cognizant of their potential for volatility should the United States slip into recession, and views them more as equity substitutes than as conventional bonds.

To counteract the downside risk in junk bonds and emerging-markets stocks, Mr. Arnott is hedging his exposure with the Pimco Stocks Plus TR Short Strategy Fund, which bets against large U.S. stocks.

Some bearish go-anywhere managers are using a different line of defense: gold. Bullion and mining stocks account for 5.5% of Mr. de Vaulx's portfolio at IVA.

To critics who say that gold isn't an investment because it produces no cash flow, he responds: “All we ask of gold is that it be a currency that maintains its store of value. And the neat thing about it is that it's inversely correlated to stocks and bonds.”

Mr. de Vaulx values gold relative to financial assets. When stocks or bonds look expensive, as he thinks they do now, he buys bullion.

When stocks or bonds look cheap, as stocks did in the summer of 2011, Mr. De Vaulx sells.

Gold seems a particularly worthwhile hedge against U.S. bonds and the U.S. dollar now, he said, because yields on Treasury bonds and certificates of deposit are less than the inflation rate.

That is a strong indication that they are overvalued. In inflation-adjusted terms, bond and CD investors are losing money, Mr. de Vaulx said.

Matthew Eagan, who co-manages the $14.7 billion Loomis Sayles Strategic Income Fund, is also a Treasury bear.

Although he isn't expecting a rate increase this year, he thinks that it is best to prepare for the inevitable reversal.

“There's no yield in most bonds, and embedded within them is a high degree of interest rate risk,” Mr. Eagan said.

Although primarily a fixed-income investor, he is taking full advantage of his fund's flexibility to buy convertible bonds, preferred stocks and dividend-paying common stocks.

Mr. Eagan likes convertible bonds, which have the ability to appreciate like stocks when the bond market stagnates, from companies such as Ford Motor Co. (F).

And he has almost 18% in preferred and common stocks such as Intel Corp. (INTC), which has a dividend yield of 4.1% — higher than its own 10-year corporate bond's 2.7% yield.

DIVIDEND INCREASES

Some stocks may be due for significant dividend increases this year, especially in the banking sector.

“Traditionally, banks have been good dividend payers, but their dividends are being restrained in the U.S. for political reasons,” said Brian McMahon, co-manager of the $11.5 billion Thornburg Investment Income Builder Fund, which seeks income from stocks and bonds throughout the world.

The restraint, a result of the government's bailout of the banks, limits bank dividend payouts to 30% of earnings.

Although most go-anywhere managers agree that stocks should beat conventional Treasury and corporate bonds this year, even that enthusiasm is tempered.

Michael Avery, co-manager of the $25 billion Ivy Asset Strategy Fund, has been bullish on stocks since the bailouts began in 2008, but once more investors pile into the market, he expects the rally to end.

Lewis Braham is a freelance writer for Bloomberg News.

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