Offense vs. Defense: Which side should investors play?

This week on WealthTrack, our investment targets are income and capital preservation. Portfolio manager, Ed Perks, hits the bull's eye every month with his Franklin Income Fund, while Chuck de Lardemelle aims for portfolio protection at IVA Worldwide. Income and protection are next on Consuelo Mack WealthTrack. You at the Franklin Income Fund have made a major shift in allocation from bonds to stocks. Tell us about that, what's going on and why you're doing that? -Yeah, that certainly is something that's played out a little bit more recently in 2012 in particular. You know, going back the last three to five years, we did have a higher emphasis on fixed income markets, on fixed income securities in the portfolio than we normally have had. And some of that was out of the opportunity that existed at that time, meaning we had higher overall interest rates, and we also had very wide corporate credit spreads, and that's something that, you know, we felt very compelled about that opportunity on an income basis, on a total return potential basis as well as volatility and overall level of risk we were taking in those securities. -And it certainly worked for the Franklin Income Fund. -No-- It has. It has benefited from the tailwind that has been lower long-term interest rates. The actions of the Federal Reserve, of the global monetary authority certainly have encouraged investors to look for other riskier assets and, as you alluded to, that was certainly a response to the financial crisis was safety and fixed income investing. We've seen that in the flows across a wide range of markets. You know, but at this point, you know, we're compelled to start looking for other asset classes, and it's not that we can't still find some opportunities in fixed income,-- -Uh-huh. -but on balance we're finding more opportunities. So our weighting just in the last 12 months has flipped,-- -Right. -where fixed income a year ago had a predominant role in the portfolio. We've now reversed that, so from roughly 55% fixed income down closer to 40%, and equities have gone the other way. So we don't like to hold a lot of cash in Franklin Income Fund. It is a significant drag on income. It's not what we think our investors are asking us to do. So-- -Right. And you have an income mandate, right? -Correct, correct. So, that's what's probably the most interesting, you know, aspect of it today. Normally, I would say when you shift from fixed income to equity, you have a real detriment or a pullback in your overall level of income, and today, given where fixed income yields are-- -Right. -and where dividend yields are and, more importantly, where dividend yields are going, I think that creates a really compelling opportunity. Many of the companies that we're investing in today, and these are very high-quality, well-known, global players-- -Such as? -such as Merck, a substantially higher dividend yield on the common stock than is available on their long-term debt securities. -On their bonds, right. -And that's a dynamic that one company after another you can cite and see, and that's something that we don't normally see. So, you know, to us, that opportunity for yield now is biased more toward certain segments of the equity market. We still think the valuations, although there's been a lot of talk about the global search for yield. You know, we don't think it's really progressed very far at all, and it's still very compelling. -So, Chuck, you might have a slightly different view. I mean, when I talked to you in a pre-interview, you basically said that you're positioning your portfolio more defensively as far as your equity positioning, and you feel that a lot of the-- that the dividend plays that Ed is talking about are actually expensive. So, tell me what you're doing at IVA Worldwide. -Well, we certainly have the same view that, in terms of asset classes, equities today are a better-- -Than bonds. -asset class than bonds. -All right. -It's a better house in a bad neighborhood. -Uh-huh. -We want to be somewhat conservative, because we do not believe that equities in the U.S. are extremely-- are that cheap, I would think, or all that fairly valued. If you look at market capitalization to GDP, which is the price-to-sales ratio,-- -Uh-huh. -today in the U.S. market you are 110%. Over the long term, you were 90%, so it shows a little bit of over valuation. It's driven in good part by extraordinary profitability by U.S. corporations. So-- -Right, record profits. -That's right. So, I think the stock picking can help a lot. We are about 60% in equities of that you have in the Worldwide Fund. Of that, you have about 30% in the U.S., about 15 in Europe, and about 10 in Japan. And in Japan, you see the same dynamics where the dividend yields there can be as high as 3%, 4% with a 10-year yield that's at 0.75, so you have the discrepancy that's very much there, and the payout ratios tend to be fairly low in Japan. It's been a value market for a long time. It is a cheap market around tangible book and the question is whether or not they can snap out of deflation. -So are you repositioning your portfolio as dramatically as Ed is, and again, if 60% equities is considered to be a defensive position, other things that you're doing-- I mean, you've always had a gold position-- -Correct. -for about 5% now,-- -Yes. -but your bond position is low, right? Relatively low? -Low. We have about-- Well, we have about 10% in high-yield, but it's really the remnants of what we bought in '08, '09-- -Right. -where credit provided more than equity-like returns at the time with we thought a lot less risk, and it turned out to be the case. Our high-yields are very short in duration, so it's really a portfolio that's expiring, and as it expires, we either put the money to work in equities if we can find the right names or we let the cash build up. -Right. -So, today we're about 25% in cash if you include the Singaporean government bonds which is a way for us to park the cash outside the U.S. dollar, because we do not trust Bernanke and his policies.