Thu, 13 Oct 2011
The bond market has done very well in the current climate, but we just don't see the prospects going forward to be very attractive, says Accredited Investors' Ross Levin.
Jason Stipp: I do want to shift the conversation and talk to you a little bit about how you're positioning clients right now given the current environment. We have seen that the European situation is still causing a lot of concern for investors, and also the economy just doesn't seem to be picking up the kind of steam that we would like to see.
Given your assessment of the current situation, have you made any changes to, for example, your baseline allocations or your models that you're using, and have you shifted any money from one area to another?
Ross Levin: Throughout the course of the last 12 months, we've actually had several changes and some of them are more pronounced, and some of them we're actually going back into. So, for example, we had a position in emerging markets--a 6% position in emerging markets in June of last year. We sold out of emerging markets in March-April of this year completely, and actually now we're going to tiptoe back in them. So we thought they had appreciated pretty rapidly, and we think that now there is opportunity after this dramatic correction that we've had in emerging markets. So we're not back up to 6%. We're only at 2% allocation in emerging markets now, but we're looking to pick up on that.
I think another area that we are completely out of, commodities was an area that we held until about June of this year, and we totally sold out of commodities. Again, given a global slowdown, we thought commodities would be potentially hard hit.
We still like right now large-cap growth stocks and large-cap S&P kind of stocks. We like companies that are producing cash flow and paying dividends. Some of those companies have not done as well because of their exposure to the euro and some of the international markets, but we think long-term dividend-paying stocks with good growth prospects make a lot of sense.
Our international holdings have been changed pretty significantly. We have taken off our Japan bet that we had a year ago, and we actually changed that in January of last year. We still emphasize some of the more value-oriented investments in the foreign side, and we're less inclined to move toward the growth foreign investments.
The biggest change is in the alternative space, and one of the things that's interesting about the alternative space right now, we are using that as a replacement for bonds. We have been buying bonds that [have] a little bit worse credit, but we think are paying higher yields, and we're also buying a little bit of foreign bonds, but our bond holdings are underweight where we would normally be, and we're replacing those bond holdings with alternatives, things like an AQR Diversified Arbitrage, something that hopefully can create a little bit of incremental return in a very tough market. We're still very nervous about the bond market, and obviously, the bond market has done very, very well in this climate. We just don't see the prospects going forward for it to be very attractive.
Stipp: I'm glad you brought that up, because we do know that interest rates right now--and you mentioned the 10-year Treasury earlier--they just can't go a whole lot lower from where they are now. At some point, the interest rates will have to go up, but right now you're just not getting paid in a lot of those fixed-income instruments.
On the flipside, though, some folks are saying that we might also need to moderate our expectations for stock returns, that we're just in a lower-returning world now than we had been before.
I wanted to ask you a two-part question. First, if you agree that we might need to have more moderate return expectations? And secondly, if that is the case, how my portfolio positionings need to be different going forward than maybe would have been suggested 10 or 15 years ago.
Levin: Well, it's a really good question, Jason. I think a lot of people have been talking about things like risk premium and what will returns going forward be? We calculate prospective returns every month, and we try to use seven-year targets, and what's ironic for us is that given our appreciation models right now, our forecasts are at the highest points since the end of 2009, and that's because of the recent sell-off we've had, coupled with the fact that forward earnings on the S&P stocks look very attractive. Dividend yields look very attractive. And year-over-year sales have been very, very strong.
So we actually think prospectively returns will be OK. We are not expecting huge returns. We are thinking prospective returns will be somewhere in the neighborhood of 5%, maybe above inflation. We think bond returns are going to be a huge drag on the portfolio. So when we look at our prospective returns in an asset allocated position with stocks and bonds, the bonds actually bring down our prospects much more than the stocks do. Now, what's important to know is that once we garner some of these returns, then the prospective returns become diminished. And I think what happens with a lot of investors is that once the stocks start returning great returns, that's when they get more excited about stocks, and the opposite should really take place.
Stipp: Ross, thanks so much for your insights on the current market environment and also your insights on the market that could be to come. Thanks for calling in today and for joining me.
Levin: I appreciate it, Jason. Thank you very much. Take care.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.