Thu, 15 Nov 2012
A very difficult investing environment has forced many managers to try atypical strategies, says Morningstar's Kevin McDevitt.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm talking today with Kevin McDevitt. He is a senior analyst at Morningstar. We're going to look at his favorite world-allocation funds and where those managers are placing their bets today.
Kevin, thanks for joining me.
Kevin McDevitt: Thanks for having me, Jeremy.
Glaser: So, let's talk little bit about what you look at in world-allocation funds? What are the hallmarks of a great fund that investors should be considering?
McDevitt: Sure. Well, there is tremendous amount of variety when it comes to world-allocation funds. So, as an investor, I think, here more than most categories you really want to have a handle on the manager's strategy, and just how far afield they will go in terms of asset classes, and also how frequently they will tinker with those weightings. So, you have everything from very steady consistent funds, funds that don't change their asset allocations all that much, such as funds like Capital Income Builder from American Funds, BlackRock Global Allocation, those tend to be fairly steady funds. And you have funds that tend to be bit more tactical in terms of how they do things and I'll throw into that camp Ivy Asset Strategy and perhaps even Rob Arnott's PIMCO funds, All Asset and All Authority, to some extent.
So, you really want to be aware of, again, what the manager's strategy is to get an idea what asset classes they will invest in, but again then also how frequently they are tinkering with those weightings. It's really in many respects it's a matter of matching your own profile, your own profile as an investor with the strategy that make sense for you. Perhaps you are looking for a fund that is more tactical, such as Ivy Asset or with Rob Arnott's fund, or perhaps you're looking for a more steady asset allocation around which you can build a portfolio. So, really comes down to investor preference.
Glaser: So, when you look at those managers of those funds that you like today, where are they finding value? Have you seen any big tactical shifts in these portfolios over the last few months?
McDevitt: Yeah, it's very interesting because you're seeing a lot of different responses to a very--what I think is and I think most would agree--is an extremely difficult environment right now from an investment standpoint. You're seeing some things that are arguably atypical. For example, in a lot of the American funds allocation funds, such as Capital Income Builder, but some of others as well like American Balanced, you've really seen them make a strong move to equity. And really they've gone away from fixed income in a very big way. Both of those funds are at all-time highs in terms their equity weighting.
Part of that is actually ironically enough a search for income. If you are an income-oriented investor, arguably you could find better yields and perhaps in some cases even more safety. In a sense you can have some strong blue-chip European companies that don't drive a lot of their sales from continental Europe which have pretty strong yields. So, if you're an income-oriented investor, as some of those American funds are, you actually are looking at blue-chip European stocks in some cases. Not to say those are a substitute for fixed income in terms of a risk/reward trade-off, but arguably again if you are more income-oriented, that's where some investors are going.
If you look someone like Rob Arnott, he doesn't really share that perspective. To the extent he is getting equity exposure and equity exposure has gone up quite a bit in his funds, it's coming more through emerging markets. There have been some additions to Europe and Japan, both markets which are arguably pretty cheap, but I think he finds more promise in emerging markets. And given the fact that emerging-markets valuations have come down over the last 12 to 18 months, he is finding more opportunities there.
Glaser: So, you mentioned Europe a few times as an area that could look cheap. Certainly, we heard from value managers for quite some time that they are getting these great franchises at a great value. Do you still hear that as much or do you think that some managers are starting to turn away from Europe? Or are they getting not little bit fatigued by either some of the crisis there?
McDevitt: When it comes to the American funds, the managers there are being very cautious when it comes to Europe and are actually looking to reduce their exposure to Europe as much as possible. If you have a fund of a global mandate, you can only, I guess, move so far afield from Europe. You're seeing far more managers get their exposure through companies aren't tied to the eurozone, so you're seeing greater weighting perhaps in the U.K., Switzerland, and some of the Scandinavian countries. So, you're seeing a push I think to some extent away from eurozone, at least when it comes to American Funds.
To the extent that managers are still investing in Europe, they are seeing good valuations, but they really are trying to source the revenues from outside of Continental Europe. We're seeing firms focusing more on businesses that are driving a lot of their sales from emerging markets and even from the U.S. which is comparatively more attractive I think in their minds than we are seeing in Continental Europe and eurozone, in particular.
Glaser: You mentioned that Rob Arnott is looking at emerging markets. Are you hearing from any other managers who are moving into that space, who really see a compelling valuation there?
McDevitt: Not as much. As I would have expected you are not seeing as much of a move there. You mentioned other value managers. First Eagle would be another example where they have been finding more values, let's say, in Japan, for example. They have close to a quarter of their portfolio in Japan, a little over 20%. So, in their case, for example, they'd rather go to Japan than go to emerging markets. In the case of Dennis Stattman with BlackRock Global Allocation, again not as much. I don't see them making as much of a move to emerging markets as Rob Arnott has. I should qualify that, too, in terms Arnott, it's not just emerging-markets equity; it's really even more so emerging-markets debt. He has been moving a lot of his assets into emerging-markets debt funds both of those denominated in dollar-based securities and those in local currencies. So, that's been really his push. That's where he's been moving and at the expense to some extent of more domestically based fixed-income vehicles.
Glaser: So, we looked a little bit across different geographies. How about different sectors? Globally are there areas that the managers are finding, say that health care or tech looks undervalued, or is it seem to be more evenly distributed?
McDevitt: Well, I think, again this is a very challenging market I think for a lot of managers, especially more value-oriented managers because I feel like they got a bit of free ride two or three years ago when coming out of the credit crisis you had a lot of small- and mid-cap stocks rallying in 2009 and 2010. And that was to some extent at the expense of very high-quality blue-chip companies, large-cap companies in many cases. And their valuations got left behind. So, lot of value managers were able to step in and kind of snap up some great brands, great companies at good prices and that has kind of run its course. So, you're seeing a lot of value-oriented mangers kind of taking profits in lot of those companies. And I think to some extent they're at a bit of a loss as to what to do next.
I think from a valuation standpoint, I think they feel like cyclical companies are starting to look attractive. They're trying to see better valuations there. You are seeing some value managers picking up energy companies, for example. The Tweedy Browne guys are picking up oil stocks for really the first time in at least a decade. But I think it's with tepid enthusiasm. I think they are holding a lot of cash; you see a lot of value managers holding a lot of cash. I mentioned First Eagle before; they have about 19% in cash right now. You look across the board, you look at funds like Sequoia, you look at the Tweedy Browne funds, and Weitz Funds. They are all holding a lot of cash. So, I don't think there is any one area that's really driving or really receiving a lot of enthusiasm from investors.
Glaser: Well, Kevin, I really appreciate the update today.
McDevitt: Thank you, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser.