Russ Kinnel: Hi, I'm Russ Kinnel, director of manager research for Morningstar. I'm joined today by Ed Meigs and Giorgio Caputo of First Eagle Global Income Builder (FEBAX). It's a fund that was launched about three years ago and will shortly have its first star rating.
Giorgio and Ed, thanks for joining us.
Giorgio Caputo: Thank you, Russ.
Ed Meigs: Thank you, Russ.
Kinnel: Why don't we start with the basic questions: What's the goal of the fund? What's the philosophy of the fund?
Caputo: The goal of this fund is to deliver a meaningful and sustainable level of income, and what we mean by that is an income that is helpful to our clients today, that is significant, but also one where we ensure the ability to generate that income in the future. So, if you're distributing something like 1% to an investor, that isn't particularly helpful. They have to have a very significant asset base in order to generate income, but on the other hand, you don't want to overdistribute income because that might impair your ability to grow your principal ahead of inflation and make sure that you can generate an income in the future. So, when we think about balancing those two objectives, we believe an income level in the range of 3.5% to 4% balances the need for income today and income in the future.
Kinnel: Ed, of course, philosophically, the fund is built on the First Eagle premise that we know from First Eagle's other funds. These are conservative, wide-ranging global funds.
Meigs: Absolutely. And taking a very flexible approach to providing the meaningful and sustainable level of income. So, it is a fully flexible mandate. We really are focusing on downside protection, avoiding the permanent impairment of capital.
Kinnel: I think maybe that makes you stand out a little from some of the other allocation funds with income in their name in that they may be stretching for yield both on the income side and the equity side.
Caputo: It's a dangerous environment for income-oriented investors today. Obviously, the level of interest rates is very low, and we've seen a lot of income-related assets trade at very high valuation levels. REITs, for instance, in the United States and utilities--just to name a couple of asset classes. And it's an environment where investors are at risk of potentially reaching for yield. You mentioned the First Eagle valuation framework. Basically, what we're trying to do is invest with a margin of safety whenever we put capital into a risk asset, and that is irrespective of whether it pays an income or not; we have very definitive criteria for when we believe something has enough of a margin of safety to warrant an investment.
So, in launching this fund, what we wanted to do was bring this discipline to the income space and essentially be an income fund that will say no to yield sometimes when we believe that a margin of safety does not exist.
Kinnel: So, there are four managers on the fund. How do you all divvy up responsibilities?
Meigs: Well, Sean Slein and I manage the fund with Giorgio Caputo and Rob Hordon. Sean and I focus on the fixed-income portion of the portfolio, while Rob and Giorgio focus on the equity portion. Now, we are not managing separate sleeves. It's not that we manage the fixed-income portion and they manage the equity. We all vet the investments that are going in, but they're going to do the primary work on the equity side, while Sean and I will do the primary work on the fixed-income side.
Kinnel: And I gather you're not, then, making a big top-down call in terms of thinking that bonds are going to get hit so you're going all the way into equities? You're not making top-down calls, but you are adjusting that asset mix. How does that work?
Caputo: It's done, really, one security at a time. It is a flexible fund, so if we see opportunities on the equity side to put money to work that meet our margin-of-safety requirements, the portfolio will evolve to be more equity-heavy. And on balance, if we are selling equities and finding opportunities perhaps in credit or in sovereign debt, you'll see a shift that way.
Kinnel: And the fund does have a bit of gold exposure, which is not uncommon for a First Eagle fund. How does that factor in?
Caputo: We view gold as a potential hedge. It is an asset that has had diversifying properties for portfolios going back many years. In the '70s, for instance, you saw relatively poor performance from stocks--and bonds as well. Gold was an asset that helped investors preserve their purchasing power and capital through that decade. So, we try to build resilient portfolios at First Eagle, and gold is an important component of doing that for us.
Kinnel: You mentioned a couple places you don't like to go for income right now--U.S. REITs and U.S. utilities. What are some places that are attractive today?
Meigs: We are currently finding that the high-yield market remains attractive. We focus on the BB and B sectors--so in the higher-quality part of the market. We are concerned about taking duration risk. We're more concerned about interest rates than credit. So, right now, we are more focused on the B sector versus the BBs, but we continue to see what we think are the best risk-adjusted returns in the fixed-income market within high yield.
Kinnel: And not so much sovereign debt, I assume.
Meigs: We have a small allocation to sovereign debt at this point; but in the current extraordinary interest-rate environment, we are not seeing very much value there.
Kinnel: What about on the equity side?
Caputo: On the equity side, of late, we've been sellers on balance of our U.S. equities, as a number of those have reached their intrinsic-value targets. Where we are finding some value is in equities internationally. We found some opportunities in some consumer-products champions in in Europe. And also on the real estate side, I mentioned REITs in the United States are trading at relatively high valuations, but we do own real estate assets in Asia. For instance, we own a company called Frasers Commercial Office Trust (FRSCF), which is a Singapore REIT that owns buildings in downtown Singapore, that in this yield-starved environment generates a dividend north of 6%. So, it's definitely an advantage to be global in this restrictive rate environment.
Kinnel: Are there any U.S. companies on the debt or equity side you care to mention?
Meigs: Certainly. I'll touch on just one on the fixed-income side. ACCO Brands (ACCO), which is a company providing office supplies. Maybe you know them for the staplers on many people's desks in this paperless environment in which we live. ACCO purchased the office-products division of MeadWestvaco and took on additional debt to make that acquisition. While it is a shrinking business overall, it is shrinking at a slow rate and is really focused on paying down debt. They generate free cash. So, you've got a management that's focused on deleveraging and a company that has the ability to generate the free cash to do just that.
Kinnel: Finally, I just wanted to touch on currency--since that's such a big focus of the markets and investors today. How does the fund manage currency?
Caputo: So, in terms of our currency framework, when dealing with fixed-income instruments, since those are contractual payments that are determined at a future point in time, we do hedge those back to the U.S. dollar. Now, in the case of equities, where a business might benefit perhaps from a low currency, we do have a framework that helps us figure out whether or not it makes sense to hedge a currency exposure. And, really, what we're trying to do is we're trying to avoid losing in an overvalued currency what we might make in a cheap stock.
So, we've obviously had a very pronounced move in currency markets with the dollar appreciating very significantly against the euro and the yen. And ironically, it's after this move that we get a lot of questions from financial advisors about hedged international investment products. We would generally caution people from doing so, given the move. And for us, we've generally unwound much of our hedge on the equity portfolio versus the euro and the yen.
Kinnel: Giorgio and Ed, thanks so much for joining us.
Meigs: Thank you.
Caputo: Thank you, Russ.
Kinnel: Thanks for joining us. I'm Russ Kinnel.