McGregor on Pitfalls with 'Reversion to Mean'

Benz: So if you are feeling fairly pessimistic about fixed income, does that mean that you are finding relatively better values in equities? And you are a value investor, so I am curious to hear do you think that you are spotting good opportunities in stocks right now?

McGregor: One of my firm, Harris Associates, greatest investors from the past, unfortunately deceased, was famous for saying that the hardest time to invest is always right now. And that's the way it feels, yet, he would turn around and say, but okay, now what do we buy?

We are always finding individual equity names that excite us, that make us glad to be equity-oriented investors in our portfolios. It can be companies that were spun off a couple of years like a Broadridge or it can be a commodity-oriented company in an area that isn't popular right now like Martin Marietta Materials.

It can be when we see a company like Texas Instruments go down after it announces the National Semiconductor acquisition. It could be something like Toyota Motor--which we don't have in the Equity Income Fund portfolio, we have in the Oakmark Global portfolio--that we think is a very interesting stock right now with, obviously, what's going on both in the automotive market and in Japan, generally. So the market always gives us opportunities that we think are interesting, and it's our job to find the ones that really will be productive for our portfolios.

Benz: So it's kind of case-by-case not really macro thing?

McGregor: Yes. Right.

Benz: I did want to discuss the technology position within Equity & Income, specifically. You had mentioned in a recent letter to shareholders that that had been kind of a pocket of weakness for the portfolio. What's your take on that sector now or on the securities and the portfolio now?

McGregor: Right. We have, I think, four technology names in the portfolio, actually two of them have done all right--Mentor Graphics and Texas Instruments. Cisco and the Microsoft position, which we have sold, did not stand out as particularly successful investments for the portfolio.

Oftentimes we as value investors are trying to grab hold of the idea of reversion to the mean in a particular space. It seems to me that oftentimes when we make errors, it is that the mean itself is going down quite rapidly, or there is change in the industry, whether it's, say, the pharmaceutical industry seven, eight, nine, 10 years ago as it began to have the problems of more regulation and lack of fertility from their R&D programs. Even though many of the companies have functioned fairly well in that environment, the stocks have been very quiet over the last decade.

Or you look at a company like Intel, which 10 years ago if you had known that they would be able to have the balance sheet they have today and have earned the earnings that they have and dominate their space with a very large market share the way they have, and yet the stock was down over the past 10 years, it would have been very difficult to forecast that.

So, we have to be careful with reversion-to-mean ideas when the mean itself is shifting quite a bit and that is what I wonder about when I think about our technology investments.