Top Managers on Pharma, Financials, and the Market

As you've probably seen from some of the pieces we've recently written, the key topics at this year's Morningstar Investment Conference included issues such as the future prospects of large-cap growth funds and the systematic underinvestment in foreign stocks by U.S. investors. However, there was plenty else going on, too. Read on to see what some of the best money mangers around had to say about pharmaceuticals, financials, and the outlook for the market.

Are Pharmaceutical Stocks on the Mend?
Let's face it, managers who bought big-cap pharma two years ago, when the group first started weakening, have been sorely disappointed. Too many anticipated that this was a replay of the early 1990s, when those stocks were temporarily bid down due to political rather than fundamental reasons. This time, however, it's become clear that big-cap pharma stocks have more problems, including drying pipelines and bloated sales structures. So, what are investors to do?

Continue ignoring them, if you're listening to  Diamond Hill Large Cap's (DHLAX) Chuck Bath, an investor who made a killing on many of these stocks earlier in his career. Bath says these firms' fundamental prospects are weak and that they continue to look like value traps. But others think differently:  T. Rowe Price Equity Income's (PRFDX) Brian Rogers says that after two years of weak performance the firms look to be getting their houses in order--he points to the likes of  Bristol-Myers Squibb (BMY), which he says could cut its sales force and reinvigorate its pipeline in the near future. And he thinks that its dividend is relatively safe. In fact, the same held true for others at the conference, including  Dreyfus Appreciation's (DGAGX) Charles Sheedy, who is hanging on to stocks such as  Pfizer (PFE). And several panelists, including  Templeton Foreign's (TEMFX) Jeff Everett and  Thornburg International Value's (TGVAX) Bill Fries, argued that foreign pharmaceuticals such as  Novartis (NVS) and  GlaxoSmithKline (GSK) don't have the same baggage as U.S. pharmaceuticals and sport attractive valuations. Because I'm a contrarian myself, I found these arguments compelling, especially because pharmaceuticals represent one of the few out-of-favor areas in today's market.

Is It Time to Worry about Financials?
The consensus at this year's conference seemed to be that financials should at least be treated with some caution. Many managers are worried about the prospects of rising rates, the growth of bad loans, and the danger of derivatives. In fact, Rogers said that when investing in firms such as  J.P. Morgan Chase & Co.  (JPM) you have to take a bit of a leap of faith, because it's near impossible to tell what's going on in their derivatives area.

In any case, one lone voice (and one that we happen to agree with),  Selected American's (SLASX) Ken Feinberg, made a good case for not lumping all financials into one group. While Feinberg no doubt has to do this often--Selected American has approximately half its assets in financials--his argument that there is immense diversity in the group is a good one. As Feinberg points out, it's unlikely that insurer  Progressive (PGR),  Golden West Financial , and  Citigroup (C) are all going to be impacted by the same events. Moreover, as he pointed out, there are some financials that actually benefit from a rising rate environment.

While on the topic of financials, it's worth pointing out that Feinberg and  Fidelity Export and Multinational's  Tim Cohen all thought that the market had overreacted to  American International Group's (AIG) regulatory scuffle. Meanwhile, while  Berkshire Hathaway (BRK.B) has had less controversy around it than AIG,  Legg Mason Growth Trust's (LMGTX) Robert Hagstrom thought the stock didn't trade at enough of a discount given his slowing perception of growth, while others such as  Janus Mercury's (JAMRX) David Corkins and Feinberg still liked it.

Up, Down, or Sideways?
As for Mr. Market,  Clipper Fund's (CFIMX) Jim Gipson continued to make the case for taking a cautious approach--his fund has more than a quarter of its assets in cash. Still, while others were cautious, few went as far as Gipson, with most believing that with low interest rates and inflation, stocks should at least be able to beat bonds. There was a feeling, however, that returns weren't likely to reach the double digits.

Speaking of inflation, one can't get away from Bill Gross' assessment that it's going to remain low. In fact, as you've probably read by now, Gross has taken a stand that's quite different from his peers. PIMCO now expects fewer rate hikes--and at a more measured pace--than many of its rivals. If the firm is right, the bond market isn't likely to be as unfriendly as most folks are anticipating, at least in the next year or so. That doesn't mean returns will be great, but at least they may not sink into negative territory.

Whatever the case, I can't help but feel like it's a tough environment for bond and equity investors on the whole. As such, now is a good time to sweep out the high-expense funds from your portfolio. Also, if you're investing in active funds, limit yourself to a selection of funds where the process makes sense to you and where you've got an experienced hand running the show.

Citi/Legg Mason Do the Waltz
You've probably read by now that  Citi is swapping its asset management arm for Legg's brokerage arm. While much has been made of this news in the press, here are a couple of issues that many haven't thought through:

1. While the consensus is that this deal all but wipes away the conflicts between selling and managing funds, I don't think it's that clear-cut. Citi now owns a hefty stake in Legg Mason, so they have every incentive to make sure this deal works.

2. Investors may finally get access to Legg managers through A shares rather than those rotten level-load shares. That's a good thing.

3. Bill Miller could suddenly be managing a lot more money. In fact, it might seem like wishful thinking, but given the strength of Citi's brokerage operation, I wouldn't be shocked to see him running $100 billion or more sooner than later. That's not a good thing.

4. Much has been made about the regulatory reasons for getting this deal done. They are certainly important, but the bottom line is that investment banks have generally done a lousy job with their asset management arms. While Smith Barney has a few talented managers, the firm had a mediocre asset management arm in general. And that's true for many of the other diversified financial companies.

Quiz answer: D. Always a complicated fund,  Columbia Asset Allocation  had 22 comanagers listed in a recent 497 filing. Enough said.