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Bernstein: What's 'Good and Cheap' Today?

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. I'm here at the Bogleheads Conference. Bill Bernstein is a strategic asset allocator, but he periodically becomes intrigued by asset classes when they get, what he calls, "good and cheap." He is joining me to discuss some of today's unloved asset classes.

Bill, thank you so much for being here.

Bill Bernstein: My pleasure, Christine.

Benz: Bill, you are widely known as a strategic asset allocator. But I'd like to get your thoughts on a few asset classes that are deeply unloved today and whether you think they are interesting at today's valuations. The first category that I'd like to talk about is precious-metals equities. When you and I were here a year ago, you were enthusing about them being relatively cheap. They've arguably gotten a little cheaper since then. Let's talk about how you are viewing precious-metals equities today.

Bernstein: They've gotten a lot cheaper even since then. So, if I was interested back then, I'm very interested in them right now. I have always believed that a small percentage of precious-metals equity should be part of any diversified portfolio. Not an essential piece, but certainly if you want to entertain that sort of complexity in your portfolio, they are quite reasonable in the range of 1% to 5% of your portfolio.

Benz: What role do they play in, say, a strategic asset allocation?

Bernstein: You can look at it from two perspectives. One is the simple mean-variance perspective, which is that when you add in 1% to 5% of precious-metals equity to a normal portfolio--in normal times at least--you get a bit of a bump in return and you get a bit of a reduction in risk. What are you protecting against? You are obviously in a more heuristic sense protecting against inflation.

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Benz: So, when you look at precious-metals equities from a bottom-up standpoint, what appears attractive about them?

Bernstein: It's very difficult to value precious-metals equities because some of them sell a lot of forward contracts and their earnings are very, very unstable. Really, the only thing you can follow that has any real meaning, I suppose, is their dividend yield. And you can now find precious-metals stocks fairly easily selling at a 1% and 2% trailing dividend. Although that doesn't sound like much, for precious-metals equities, it's quite high. That brings up another subject about precious-metals equity that you have to understand, which is that over the long term, its return is very low--probably no more than 1% or 2%, real. And that's probably all from the dividend. The reason why it's so expensive and has such a low return and has such a low dividend yield is simply because it is such a good diversifying asset class. People recognize that, and they overbid the price, if you will.

Benz: You prefer precious-metals equities versus owning gold bullion. Let's talk about why you have that preference.

Bernstein: It's because you need a whole lot less of it. It's basically a leveraged bet on gold, and I'd rather own 3%, say, of precious-metals equity rather than have to own, say, 15% or 20% of a commodities-futures fund or of something like [SPDR Gold Shares (GLD)]. I'd rather take the difference and invest it in a very low-cost vehicle like an index fund or a Treasury, which has an expense ratio of zero.

Benz: Moving on to another category of unloved investments, let's talk about emerging-markets equities. I know that you have said in the past that you really like emerging-markets equities when they periodically get good and cheap. Are they good and cheap today?

Bernstein: They are cheap; they are not good and cheap. They are certainly not as cheap as they were during the wake of the Asian contagion. What I'm fond of saying about emerging markets is that the really nice thing about them is they really do get good and cheap from time to time. It's not hard to find emerging-markets stocks now that are selling at single digits, and that's when they start to become attractive. It's important for small investors to realize that you can't buy low unless you are willing to deal with bad news. Stocks don't get cheap and prices don't get low without bad news, and you have to be able to ignore the bad news.

Benz: Another category of investments that has been beaten down and would certainly be considered unloved is energy equities. Let's talk about how you see them today.

Bernstein: They are getting interesting and, for all I know, we've seen the bottom--I have no way of predicting that. In general, the oil stocks aren't an asset class I have to own; but when they get to be compellingly cheap, I become interested. When you start seeing the major selling at single-digit trailing multiples, they become of interest. We're not there yet.

Benz: So, when people hear smart people like you talking about the relative valuations of asset classes, how should they use that information--given that, I think, for a lot of people, that strategic long-term mindset makes the most sense? How should they incorporate valuations into their portfolio-management process?

Bernstein: The first thing you have to ask is whether you are cut out to do it. Because in order to be cut out to do it, you have to have the right psychological makeup; you have to be able to be greedy when everyone else is fearful--and fearful when everyone else is greedy. You have to be able to up your allocation to an asset class when it's been very badly beaten down. Let's say you have a 2% allocation to precious-metals equity. To maintain that 2%, not only would you have had to continually be buying over the past two or three years--which is what you would have been doing--you would have been ploughing even more money into it to increase your allocation, if you think that the proper allocation, now that it is cheaper, is 3% or 4%. That's what strategic asset allocation means. Then, you have to also ask yourself the question, "Do I really want to go through the trouble?" Because the data are pretty good that it's hard to beat just having a regular old 60-40 stock/bond portfolio with a fixed allocation between foreign and domestic asset classes within your stock allocation. It's really, really hard to beat that, and you have to ask yourself if you want to fiddle with that.

Benz: Bill, it's always terrific to hear your insights. Thank you so much for being here.

Bernstein: My pleasure.