Pouncing in the Downturn

Mike Breen: Greetings. This is Mike Breen coming to you from the 2009 Morningstar Investment Conference, where we've collected some of the best investors in the mutual fund industry. And we are fortunate to have one of them with us right now, Charles De Vaulx of the IVA Funds. How are you Charles?

Charles De Vaulx: Good morning.

Breen: And we are very familiar at Morningstar with you, and a deep-value, all-cap, all-asset-class style of investing. So it should be kind of your sweet spot right now in terms of everything being down, a pretty fortuitous time for someone like you to start a fund. What have you been finding attractive and what are you staying away from?

De Vaulx: OK. As you know from the past...we are not called as deep value, I think I would say we care deeply about value. But we are not deep value in the sense of Ben Graham's Net Nets and dirt cheap and cigar butts. In fact, if anything, sometimes we would rather own better businesses and pay up a little bit for them.

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Breen: OK.

De Vaulx: But what's so interesting today is that there are many asset classes that may be equally, if not more attractive than equities. In equities, last year, foreign stocks fell a lot more than U.S. stocks did, and so now they have become cheaper than U.S. stocks, which is why in our worldwide fund we have a record low allocation to U.S. stocks--around 8%, in addition to 16% U.S. high-yield bonds. Our biggest weighting, in fact, is in higher-yielding bonds--31% of our worldwide fund. I don't want you to believe that we own junk. A lot of the high yields we own are triple-A CMBSs, triple-A or triple-B paper in America and Europe.

Breen: Many corporates as well?

De Vaulx: Some corporates...some here in Europe. Many unrated convertible bonds, which we think are very strong credits.

Breen: Are you seeing any differences between the U.S. and Europe on the spreads, or is it kind of wholesale, and asset class is discounted?

De Vaulx: Its wholesale discounted. At the margin, you have slightly higher spreads in Europe, but that's about it. And on average, even though the high-yield market has run up, on average, the yield to mature in the bonds that we own today is 9.8%, and so 10%, we view, as an equity type return. And we have kept our bonds neither too short nor too long, between four and eight years. And we think that those are very competitive returns. We are intrigued by the fact that over the past year, Berkshire Hathaway seemed to have done most of the pouncing owning or buying bonds as well as some preferreds yielding 10% from G.E. and Goldman Sachs. So we like the idea of that almost one third of the portfolio, mechanically, assuming we have done our credit analysis right, will deliver returns of 10% for the next few years.

Breen: One the equity side is I think is very telling looking at your most recent portfolio we had, so maybe these positions aren't there, but the bottom-up approach you use really comes out, and its very wide-ranging. You have a name like Nestle and then you also have a Bangkok Bank or a Thai beverage company, so an emerging-market that's having political turmoil and a small-cap company there versus global behemoths. So can you kind of elaborate on where you are finding stock opportunities, although they are limited?

De Vaulx: Right. Last fall we did buy a few stocks in the emerging markets. We wish over the last few months that we had done more of that--our mistake. We had owned no banks for many, many years before the IVA and First Eagle, and so it was interesting last October to buy our first bank in a long time--Bangkok Bank. Even though, as you said, there are some political issues in Thailand, that bank today is squeaky clean, very well capitalized, tangible equity to assets 10%, well funded, loan to deposit ratio of 90%, a plain-vanilla kind of banking, what I call the 3-6-3: you borrow at 3, the bank, and you lend at 6...hit the golf course by 3:00 in the afternoon.

The only blemish is that...

Breen: The old school style of a bank.

De Vaulx: The only blemish is that 10% to 12% of the loan portfolio is outside Thailand, and whenever we see banks start lending outside their territory, typically bad things happen.

Breen: Things get out of their circle of competence. Anything else you are seeing that's attractive in general?

De Vaulx: Last summer we had no interest in oil, when oil peaked at $146...

Breen: ...makes sense.

De Vaulx: ...which struck us as being twice the replacement cost of oil. Also the world was aware back then that the myth of de-coupling had been shattered, therefore there would be a slowdown in China. But late last year, and early this year, when the price of oil fell to below $30, we got intrigued, and we have in the worldwide fund a 4%-5% allocation to energy. That's a combination of natural gas related stocks or oil, both E&P companies, oil service companies, as well as some bonds of energy within there.

Breen: Well fantastic. We thank you for your time and wish you the best of luck.

De Vaulx: Thank you. Bye-bye, Mike.

Breen: Take care.