Greg Carlson: Hi, my name is Greg Carlson. I am a fund analyst with Morningstar. I am joined today by Kevin Holt, the lead manager of Invesco Van Kampen Comstock Fund. Kevin, thanks for joining me today.
Kevin Holt: Thanks, Greg.
Carlson: I wanted to start off by talking about the transition that your team has made. You've run this fund for a long time, but it has changed names. It used to be just Van Kampen Comstock, and it was under the wings of Morgan Stanley. Over the past couple of years you've transitioned over to Invesco, as Invesco acquired Van Kampen. Can you talk about how that transition has gone and what it's meant?
Holt: Sure. It's really been a positive experience for the team. You never know going into these situations what's going to happen, but going from Morgan Stanley, which was broker dealer to Invesco, which is a 100% asset management shop, has really been I think a positive experience for the team.
The good thing from a logistical standpoint, we moved six blocks. So the value strategy, our team in particular, we're all based in Houston, so it's been a very easy transition for the teams and the families of the people.
And moving over to Invesco, to an organization that is a 100% asset management, the resources have been terrific, the systems are very good, given it's an asset management firm--so they know exactly what we need. It's really been a good two years, and we look forward to many more with Invesco.
Carlson: Now turning to the portfolio, let's talk about an area that you focus on--financials--and what you've been doing there. Obviously you've been adding to banks, which were seen as a very risky investment, I would say. Well, they still are, to a large degree. Maybe you can talk about what you've been doing there?
Holt: I think a lot of us in the market and most people have some scars from 2008 and what happened in the financial sector, which is still making people very reluctant to invest in lot of those stocks, which has created some tremendous opportunities for value managers.
So over the last 12 months, as we kind of understand the business models and what the rules of engagement are going to be going forward with some of the legislation that's passed, we've been adding to a lot of the big banks--Citigroup, JPMorgan, Wells Fargo--in particular in the portfolio where we think these companies, if you look out over a multiyear horizon, are going to generate tremendous amounts of excess capital far in addition to what the government is requiring them to hold, even though those standards have been raised quite a bit.
So, we're pretty positive on that. We own Goldman Sachs and Morgan Stanley, too. We're keeping our eye on the international situation, and really the risk within these businesses at this point is the counterparty risk with European financial institutions, but we think there's enough cushion within the capital bases, which there was not three years ago, that they can absorb some losses, which I think is unlikely, but if that does happen. But you're going to see tremendous dividend increases and buybacks for the next probably five-plus years within this area, and I think it's very underappreciated by the market, given the valuations.
Carlson: Maybe you could talk a little bit more about the valuations, because some of these stocks have obviously had excellent runs just in the first four months of this year--some were up 30%- 40%?
Holt: I've had that question a lot, and I've pointed out to people, if you look at the last 12 months, the stocks are still down 20% to 30% depending on the name. Some are around flat. We think the small regional banks are pretty full on valuation, but again some of these larger banks--Citibank selling at 60% of tangible book value. You look at what that implies, and it implies about a 2%-3% return on equity as we move forward. We think Citibank's franchise, particularly as Citi Holdings winds down, which is some of their bad assets, their ROE is likely to be 10% to 12%, you move out three, four, five years, which at a minimum will get them up to a tangible book valuation.
So we're looking at the companies on a price-to-tangible book and whatever the relevant ROE is. JP Morgan is operating a little bit better. They don't have some of the issues. So they sell at a premium to tangible book, but not much, but their ROE is going to be high teens, too. So commensurate with that, they should probably sell at a price-to-tangible book value of 1.5-1.6, which is quite a bit higher than where they are at today.
Carlson: Quick question, how tangible are those book values today, as opposed to a couple of years ago?
Holt: Yeah, that's really the tough thing, and I tell investors, in most industries we have a cash flow statement and we can really get to the quality of the earnings. Within the financials, the accounting is much more opaque. But the good news is, I think the government has really come to over the books for the last three years.
So I think we can trust the book value much, much more than we have been historically, because of what we went through in 2008, and the government reviews of these investments and these books, and I think the companies who were very highly levered in the past--we had leverage ratios 30-40 to 1 for some of these financial institutions--leverage ratios have come down partly because of the regulation and partly because of companies being more responsible just with internal risk controls to 10 to 12 times.
So I think there is a lot less risk within the investment portfolios of these companies. So you need to be cognizant of it. We need to keep an eye on Europe and what's going on, but we feel just given where we are at in the cycle that we can trust these investments and these book values much more than we have in the past, and most importantly we have a lot of excess reserves, which we didn't have in 2008.
Carlson: Can you talk a little bit about technology? I know that's not an area you cover, Devin Armstrong does, but maybe you could talk a little bit more about what you've been doing in that sector?
Holt: Technology is always interesting for value investors, because you get a lot of growth companies, and technology changes so quickly, it's a little bit different than a consumer staples company or a consumer discretionary retailer.
But what we've been doing, we have owned HP. It's kind of been a tough road for us over the last 12 months, but we have been adding to that position, and we feel with the addition of Meg Whitman, HP is more likely to give excess cash generated back to shareholders as we move forward, and really focus on running their core businesses as opposed to making large acquisitions within the software service area.
So we are kind of early. Typically we would buy a stock, we are kind of early in, we average down. This one has been a little bit tough from the outset, but we think it presents really good value over a period of time.
Additionally, a stock that has worked out well for us, but we have been selling it, eBay; it's been a tremendous stock. A couple of years ago, people didn't know if it was a viable entity. Now with PayPal and what they have been able to do within their marketplace business, the stock has worked out well, but we are kind of in the seventh inning of that story, so we have been reducing that position.
In addition we have Microsoft represented in the top 10. We think their new operating platform--Devin is very positive on that, and we think hopefully it's going to raise a sleeping giant that has been asleep for a number of years. It's a very inexpensive stock and hopefully this is the thing that will push them over the edge and get some price appreciation and gain some market share.
Carlson: One other sector I wanted to touch on before we wrap up--energy. You have owned some of them more volatile stocks within that sector lately?
Holt: It's interesting. If you look back at the beginning part of the decade--2000, 2001, 2002, 2003--we were overweighed energy. Very inexpensive valuations. As you know, we went to a big underweight position as we got to '05, '06, '07, '08. The price-to-book valuations now are back to 1999 levels, so you have seen us over the last particularly 12 months, increase our energy exposure. It's kind of funny, but as much as the world changes, it doesn't change.
So we are back to where we were 12 years ago. There are opportunities presenting themselves, not only natural gas stocks that we have purchased, but additionally some of the oil service names. There have been some capacity issues within pressure pumping there. But we think as that works itself through the system over the next couple of quarters, these stocks are presenting really good value opportunities, and it's funny, you go from a very low position three or four years ago to now we are kind of at a market weight, probably going to an overweight position, because valuations have become very compelling.
Carlson: All right. Well, thank you very much for your time.
Holt: Thank you, Greg.