Fund Times: Bill Gross' Grim Economic Outlook

In his May 2006 investment outlook commentary, PIMCO managing director Bill Gross likens auto giant  General Motors (GM) to a canary in the coal mine of the U.S. economy. That is, the problems and struggles GM faces today, according to Gross, are ones the nation may be facing more broadly in the years to come.

Gross argues that General Motors and the U.S. economy share flaws that will lead them to similar fates. "They appear to be conjoined primarily by the uncompetitiveness of their existing labor cost structures and the onerous burden of their future healthcare and pension liabilities." At GM it is estimated that "$1,500 of every�car sold in dealer showrooms goes to pay for current and future health benefits of existing and retired workers, a sum totaling nearly $60 billion. The total future healthcare liability for all U.S. citizens can be measured in the tens of trillions."

While General Motors and the nation seem to face analogous problems, Gross argues that the remedies they are currently undertaking to solve these problems, and those solutions they may embrace in the future, could also be similar. For instance, Gross believes that the survival tactics that General Motors is attempting "in the form of contract renegotiations (the heavy lifting of which is now being expressed via its parts supplier Delphi in bankruptcy court) will likely be replicated at some point via U.S. economic policies emanating from the U.S. Treasury and Federal Reserve." According to Gross, these future policies could include the eventual abandonment of the "strong dollar" policy, protracted periods of historically low real interest rates, legislative changes, and tax increases. These policies, Gross states, could produce "higher inflation�higher taxes, [and] currency devaluation" particularly against the currencies of Asian nations. He adds that it may be possible for the U.S. to grow its way out of its current difficulties, through "productivity gains, by emphasizing innovation, and upscaling education," however, as he points out, these are well known tools that may be difficult to gain an advantage on now.

Though these are longer-term trends, and things will not change overnight, what does this mean for investors? Gross urges investors to move away from U.S. assets and "toward more competitive economies less burdened by health and pension liabilities, those personified by higher savings rates and investment as a percentage of GDP. Need I say more than to sell U.S. assets and buy Asian ones denominated in their local currencies; or if necessary to hire a global asset manager with sufficient flexibility and proper foresight to thrive in an increasingly difficult investment environment."

Many Morgan Managers Dine on Goose Eggs
We were disappointed to see, in a recent regulatory filing, that many managers at J.P. Morgan refuse to eat their own cooking. In fact, fund managers at the firm often have no personal investments whatsoever in the funds they run. To us, this signals a lack of confidence in the funds' investment process and in the future prospects these managers see for the funds.

For example, as of June 30, 2005,  JPMorgan Large Cap Growth (OLGAX) manager Giri Devulapally, held no shares of the fund. This is true of many others, such as JPMorgan Large Cap Value (OLVAX) manager Bradford Frishberg. And the list goes on. While some of these managers are new to these offerings, we'd like to see them hold at least a modest personal stake in the funds they run.

There are a few managers who show considerable confidence in their investment process, such as fixed-income manager Douglas Swanson and mid-cap strategy manager Jonathan Simon, both of whom invest significant amounts of money in some of their funds.

Michigan Won't Let Its Tobacco Bond Revenue Go Up in Smoke
The Detroit Free Press reported yesterday that Michigan state Attorney General Mike Cox sued 23 tobacco companies for withholding a partial payment they are required to make under the terms of the 1998 Master Settlement Agreement between the 46 participant states and many of the largest tobacco companies. With this action, Cox joins several other state attorneys general in their attempt to defend the MSA. The tobacco companies claim that the terms of the settlement allow them to lower the level of payment to state coffers in the event of market share losses to competitor firms. It appears that this legal wrangling could go on for some time.

Why does this matter to fund investors? It's a big deal for shareholders in municipal-bond funds, because many states securitized the income streams generated by the agreement. These "tobacco bonds" have become an important part of the portfolios of a large number of municipal mutual funds, and in recent years they have been a strongly performing segment of these portfolios. So much so, in fact, that the bonds have drawn the attention of many nontraditional players in the municipal markets, such as hedge funds. We'll be keeping a close eye on these legal challenges as they proceed through the court system, and these events illustrate why we have continually warned investors about the possibility of litigation risk with funds that hold large position in these bonds.

TIAA-CREF Senior Manager Retires
John Somers, head of the fixed income and real estate divisions at TIAA-CREF, will retire at the beginning of June 2006, after working with the firm for close to 25 years. Somers began his investment career at Prudential Insurance in 1972, and he joined TIAA-CREF in 1981. Edward Grzybowski, chief investment officer, will serve as interim head of fixed income and real estate, and we expect the management transition to proceed smoothly.

Diamond Hill Promotes Fixed-Income Manager
Diamond Hill Investment Group has elevated William Zox to the position of comanager on Diamond Hill Strategic Income (DSIAX). Zox, an attorney prior to joining Diamond Hill in January 2001, has worked closely with the fund's manager, Kent Rinker, and assumed his new position on April 30, 2006. Since Zox has been Rinker's right-hand man on the fund for several years, we see the move partly as a formality. However, we also think Diamond Hill may also be preparing its succession planning for the fund.

Oakmark Funds Announce New Board Member
Oakmark Funds has elected Northwestern University's Steven Rogers, who holds the title of Gordon and Llura Gund Family Distinguished Professor of Entrepreneurship, to the fund group's board of trustees. Rogers' addition brings the Oakmark board to 10 members, eight of whom are independent, and he'll bring his own talents in the field of entrepreneurial finance to the group.

In Memoriam: Louis Rukeyser
Louis Rukeyser, 73, famed television host of "Wall $treet Week With Louis Rukeyser" died on May 2, 2006, at his home in Greenwich, Conn. His enormously popular public television show, which ran from 1970 until 2002, achieving a larger audience than any other program in financial journalism. Additionally, he was a best-selling author, columnist, and noted lecturer. A 1954 graduate of Princeton University, he worked as a foreign correspondent for the Baltimore Sun, and later as a correspondent for ABC News. He will likely be remembered for his light-hearted approach to investing.