Who needs global diversification when you are sitting in the middle of the world's most freshly scrubbed economy?
That is the basic premise behind the Smead Value Investor Fund (SMVLX), which includes a portfolio of just 27 stocks that draw most of their earnings from inside the United States.
“For a year and a half now we've been calling the U.S. a paradise for investors,” said portfolio manager William Smead, who manages $330 million in this geo-centric strategy at Smead Capital Management Inc.
“The U.S. system has been scrubbed clean because we have spent the past few years getting businesses and households in order and creating an affordable housing market,” he said. “This is the best of all circumstances because we've got slow growth and favorable interest rates, so in our strategy and we're overweight banks because nobody benefits from a housing recovery more than banks.”
The fund, which hit its five-year anniversary in January, has a five-star rating from Morningstar Inc.
It has gained 12.4% since the start of the year, following a 27.8% increase in 2012.
By comparison, the S&P 500 has gained 9.4% since the start of the year, after gaining 16% in 2012.
Despite an occasionally blunt analogy to make his point (“Would you rather hug somebody before they had a shower or after?”), Mr. Smead's strategy is actually grounded in solid macroeconomic theory and bottom-up stock-picking research.
“We believe that in late 1999 and early 2000, when the U.S. stock market got ridiculously overvalued, that started the process of asset allocation nirvana,” he said, referencing the general trend to increased portfolio diversification. “And then the asset allocation nightmare began in July 2011.”
Mr. Smead pointed out that investments in commodities have never done better than the 10-year period through July 2011, and that includes performance relative to equities.
“The driver of the great commodity bull market was uninterrupted growth in China, where they became the largest user of any commodity you can talk about,” he said. “That drove commodity prices, which drove the health of emerging economies as exporters of commodities, and that drove the universal acceptance of international investing.”
But the China boom is waning, and the fallout will hurt the emerging economies, Mr. Smead said.
“We don't own energy, industrials or basic materials because they all participated in the China boom,” he said. “And pretty much across the board we have tried to limit exposure to emerging markets as much as possible.”
The limits are strict and mostly firm.
Mr. Smead does own McDonald's Corp. (MCD), which gets just 2% of its profits from China. But he won't buy Yum Brands Inc. (YUM), which owns such American brands as KFC, Pizza Hut and Taco Bell, because the company gets 35% of its profits from China.
“The U.S. was never more embarrassed or more out of favor in my lifetime than it was in 2009 [at the stock market's bottom], but you have to buy what's contentious to make money,” Mr. Smead said. “Financial advisers spent the last 10 years convincing everyone they need to spread their money all over the world to succeed, and investors are doing it just in time to be wrong.”
Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.