This post is going to begin with a lengthy preamble; please bear with me. So far, I have restrained from commenting on any specific investment vehicles. Obviously, managing money is what I do for a living and finding the needles in the haystack is part of what hopefully gives me an edge. Equally important, there are legal issues: the following commentary is not an offer to sell nor recommendation to buy any specific security. Every investor needs to consider their personal situation, risk tolerance, time horizon, etc.
The second part of the preamble has to do with understanding various types of mutual funds. The most common type of fund adheres by prospectus to a particular “style box”. For example, a large cap domestic growth fund invests in those types of securities only. This is good if you know that is what you want. But there is a downside. Even if the manager of that fund knows it’s a poor time to do so, the manager must invest in those securities by prospectus.
Only a relative few mutual funds are not constrained in their investment choices. The managers of these funds are allowed to invest in any number of asset classes, any number of security types, and move between these investments as they see fit. In essence, they act more like overall portfolio managers than mutual fund managers.
One such fund is the Ivy Asset Strategy fund, which has earned the highest (5-star) rating from Morningstar. As a licensed investment professional I have the opportunity to participate in monthly update calls from the managers of funds like this and hear how they are managing the fund. While these managers are keenly focused on the economy, unlike economists they must translate theory and outlook into concrete investment ideas and strategies.
With that out of the way, here are my notes from today’s call. Bear in mind that I may have misinterpreted what the managers said or meant and their opinions are subject to change at any time.
As of today, the fund is:
- 37% equities. This includes a majority of short positions on the S&P 500, so that the net long position is only 17%. The shorts have been added to the portfolio over just the past few days. Long positions are high quality companies with high free cash flows or solid dividends. These positions are 92% in the US, the rest in Asia and China.
- 17% gold. This is a hedge against the threat of inflation longer-term (once economic recovery begins). It is also a hedge against the mid and longer-term threat of currency devaluation. They believe that the current rally in the US dollar is merely a temporary flight to safety as other currencies react to their own economic problems and devaluations.
- 7% fixed income. This number has been going down recently as they have been selling their US treasury positions and taking profits. Remaining holdings are 98% “very high quality” (which they defined as at least BBB) domestic corporate bonds with an average yield of 8.5% and maturity under 4 years. They think it is a good time to add to positions here.
- 39% cash and near cash. Near cash is mostly very high quality commercial paper.
As reflected in the composition of the fund, their outlook is negative in the short term. Short term, any recovery is wholly dependent on government fiscal stimulus and actions taken so far on this front have had little noticeable impact. Further large scale efforts are required but it looks like the government is going to take too long. They estimate March before anything of sufficient size makes it out of Congress, and there will be lag time before any impact is realized from this. The other significant source of downside pressure comes from the continued deleveraging in the US consumer and financial sectors. Finally, earnings expectations in the US remain elevated and the housing market has yet to find a bottom. Thus, economic recovery will most likely not occur until 2010.
In prior calls they were hoping for a recovery in the S&P 500 in the first half of 2009, they now think it is the second half or more likely 2010. They foresee a relatively tight trading range in the S&P of approximately 750 to 900 for some time. There will be bear market rallies, but they will not be able to significantly break out of the trading range. The analogy was made between now and the S&P in the 1970s. (Note: If you bought the S&P 500 in January 1973 you would have been underwater until July 1980; 7.5 years later.)
The macro discussion was interesting as well. Global equities markets have been highly correlated due to the global dependence on the US consumer as a primary driver of demand. The US consumer must be replaced by some other demand source in order for a new secular bull market to begin. The leading candidate for this new source of demand remains the emerging market consumer.
The markets may have gotten ahead of themselves in the past few years in investing in this theme, but it remains key. They are looking for entry points, particularly in China and Asia, over the next 12-18 months.