Go-anywhere funds have nowhere to go

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. Problem is, he says, the best companies are overvalued, and the rest are cannibalizing each other’s business.

“In a low-growth economy with huge headwinds, it’s tempting for mediocre companies to compete on price to increase sales,” he says. “Price wars erode profit margins.” Since last March he has cut the fund’s stock position from 70 percent to 61 percent and increased cash to 18 percent.

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 of the $28.5 billion Pimco All Asset All Authority Fund says it is “reasonably likely” the U.S. will enter into a recession in 2013 and “a near certainty that we at least have a major slowdown.” Arnott and his peers favor assets ranging from short-term emerging-markets bonds to preferred stock to gold bullion.

Arnott’s Defensive Play

Arnott, whose fund can invest in stocks, bonds or commodities and can short (bet against) securities, is avoiding the U.S. in favor of emerging markets. Those markets, he says, aren’t overleveraged and have better growth prospects. Almost 40 percent of his fund is invested in Pimco’s emerging-markets funds; almost 80 percent 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 Arnott. “Emerging-markets currency bonds with maturities of one to three years enjoy a premium yield of 2 to 3 percent over comparable U.S. bonds,” he says. “And by owning them you move your money away from the U.S. dollar, which is vulnerable to devaluation.” That explains his fund’s 12 percent weighting in the Pimco Emerging Markets Currency Fund.

Arnott is also betting that high-yield bonds will continue to rally, and has 16 percent of his fund in them. Yet he’s cognizant of their potential for volatility should the U.S. 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, he’s hedging his exposure with the Pimco StocksPlus TR Short Strategy Fund, which bets against large U.S stocks. That short position reduces the fund’s overall volatility.

Going for Gold

Some bearish go-anywhere managers are using a different line of defense — gold. Bullion and mining stocks accounted for 5.5 percent of de Vaulx’s portfolio at IVA. To critics who say gold isn’t an investment because it produces no cash flow, he replies: “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.”

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, he sells. Gold seems a particularly worthwhile hedge against U.S. bonds and the U.S. dollar now, he says, because Treasury bond and CD yields are less than the inflation rate. That’s a strong indication that they’re overvalued, de Vaulx says, since in inflation-adjusted terms bond and CD investors are losing money.

Matthew Eagan, who co-manages the $14.7 billion Loomis Sayles Strategic Income Fund, is also a Treasury bear. Though he isn’t expecting a rate increase this year, he thinks it’s 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,” says Eagan.

Though primarily a fixed-income investor, Eagan is taking full advantage of his fund’s flexibility to buy convertible bonds, preferred stocks and dividend-paying common stocks. He likes convertible bonds, which have the ability to appreciate like stocks when the bond market stagnates, from companies like Ford Motor. And he has almost 18 percent in preferred and common stocks like Intel, which has a dividend yield of 4.1 percent — higher than its own 10-year corporate bond’s 2.7 percent yield.

Such distortions in the yield relationship between stocks and bonds have become commonplace. “The dividend yield on the average stock in the S&P 500 now outyields AA-rated high-quality corporate bonds,” says Eagan. “That’s the first time we’ve seen that since the early 1970s.”

Dividend Increases

In fact, 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,” says 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 percent of earnings. McMahon thinks one of his top holdings, JPMorgan Chase, could easily pay $3 a share in dividends as government restrictions are lifted — a big increase from the $1.15 it paid in the past year.

While most go-anywhere managers agree that stocks should beat conventional Treasury and corporate bonds in 2013, even that enthusiasm is tempered. Michael Avery of the $25 billion Ivy Asset Strategy Fund has been bullish on stocks since the bailouts began in 2008, realizing the government would do all it could to stimulate the markets. His 80 percent equity stake is on the high end of his 20 percent to 90 percent historical range. The reason: He thinks 2013 will be the year individual investors who have been pouring money into low-yielding bonds realize they can’t meet their investment goals and finally shift to stocks.

Once the herd tramples in, however, Avery expects the equity rally to end. “I suspect a year from now I’ll have less equities, more cash and be more defensively postured,” he says. “Generally if you move in the opposite direction where the masses want to go, you not only survive but you tend to do well.”
–Bloomberg News–
(Lewis Braham is a freelance writer based in Pittsburgh.)