Tag: master limited partnerships


January 27, 2014

CONSUELO MACK: This week on WealthTrack: Where can you find income in a low yield world without taking on too much risk? Morningstar favorite Mark Freeman of Westwood Income Opportunity Fund shows us where he is finding that illusive income catch, on the next Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack.  Don’t fight the Fed is a long-held investment maxim because over the years it has frequently worked.  But in recent months it has seemed like a particularly difficult rule to follow because no one has been quite sure what the Federal Reserve is going to do next. We do have a pretty good indication of how Federal Reserve Chairman-nominee Janet Yellen feels however. In testimony before the Senate Banking Committee, the current Fed Vice Chairman cheered the markets by saying that although progress has been made since the financial crisis and recession  “unemployment… is still too high, reflecting a labor market and economy performing far short of their potential.”

Wall Street’s conclusion:  The Fed’s unprecedented quantitative easing program of buying $85 billion worth of mortgage and treasury bonds a month is not going to slow, or in Fed lingo,  “taper” anytime soon which will keep a lid on long term interest rates. As for short term interest rates which the Fed has kept near zero since December of 2008, no one is even talking about when those will be  raised — think a couple of years or more according to the Washington analysts at Cornerstone Macro.  There is a heated debate going on about the wisdom of the central bank’s policies however.  Larry Fink, the CEO of Blackrock, the world’s largest money manager recently said the Fed’s policy is contributing to “bubble-like markets” in both the stock and bond markets as investors search for higher income and returns.

If you ask any investors, especially retirees what their top investment concerns are, the answers will include income and market volatility, caused in part by these novel Federal Reserve policies. Finding income without taking undue risk has been a constant theme of ours on WealthTrack and this week’s guest has a successful track record of doing both.

Mark Freeman is Chief Investment Officer at Westwood Holdings Group. He succeeded now-retired Great Investor Susan Byrne at that job in 2012. Among his many responsibilities, he is Senior Portfolio Manager of the Westwood Income Opportunity Fund, which he launched in 2005. The conservative allocation fund is a Morningstar favorite because of its “attractive total return with moderate risk”

I began the interview by asking Freeman how his search for income opportunities has changed during these years of low interest rates and low bond yields.

MARK FREEMAN: That’s a great question and when I think back about it over the last several years, the way it’s changed is ultimately it’s not really from a process standpoint or ultimately in terms of what we’re looking for, but what has really changed is, where do you find it?  And I look back, and if you look at, say, the top level across our asset allocation, that’s what’s changed, and that asset allocation reflects where we’re finding those opportunities that offer income but also growth, but again, it’s not static. It doesn’t stay in just one part of the market, and the fixed income market is a perfect example.


CONSUELO MACK: So let’s talk about how your asset allocation has changed, because right now more than 50% of the portfolio in the fund is in stocks, you know, common stocks or, what, preferred convertibles or preferred stocks, and so traditionally that’s a heavier weighting than you would normally have.  Correct?


MARK FREEMAN: It is on a historical basis. Matter of fact, at the beginning fixed income was roughly 45%.


CONSUELO MACK: You mean in the beginning in 2005 when you started the fund?

MARK FREEMAN:  For the mutual fund, for the strategy… Exactly right, because again, that was a time and a place where we could actually find attractive opportunities in fixed income, and so now if you fast forward to today, and we all know what’s happened in terms of interest rates and them being at extremely low levels today, you know, our fixed income exposure has come down rather significantly. We’re probably now in the mid-teens in terms of fixed income exposure, but at the same time our equity exposure has really done the opposite. It’s gone from roughly mid-teens to, as you mentioned now, in the roughly high 40 percent of the portfolio.


CONSUELO MACK: You are a new face to our WealthTrack viewers. I’m delighted to have you here. Your predecessor, Susan Byrne at Westwood Holdings, who is now retired, was not a new face, but I’d love to know what your investment objectives are with the Income Opportunity Fund and also talk to us a little bit about process as well.


MARK FREEMAN: Sure.  Let me kind of, as you said, let’s take a step back and kind of give you a little bit of history of the strategy.  So when we started it, we started it because our clients were coming to us because of what had taken place in the bond market, and rates had fallen rather dramatically, and they were saying, “look, there’s got to be something better out there, a better alternative to the return profile that we’re seeing in fixed income,” and so we said, okay, that’s great, but what they were also saying was that we want a better return profile, but in many ways we still want the volatility profile or the low volatility profile that fixed income investors had typically experienced. And so ultimately what they were saying is like we would like to earn an attractive total rate of return but with an acceptable, i.e., low level of overall volatility in the portfolio.


CONSUELO MACK: Right, and low level of volatility compared to the stock market.


MARK FREEMAN: Absolutely. Certainly even less than a pure equity type of product, because at the time that was really the traditional mindset, and really that was really from a product offering. That’s all there was. You could either have fixed income or you could go into “equity income products” which were basically just dividend-paying stocks, but they still had the same volatility profile as roughly the equity market, and so that really wasn’t a suitable solution for what those investors were asking for. So we literally just took a blank sheet of paper and said, “Okay, how do we solve this problem?” And ultimately tried to come up with a solution, and the income opportunity strategy was the end result, and so ultimately we said, “Look, how do we do this?” We’ll use income-producing securities, and we’ll use those from up to eight different asset classes. So that gives us the diversification, but I think what’s also important to understand is, what is the role of income? Why is income so important, and I think everyone understands it from the return standpoint. Okay, here’s the yield and everyone has cash in hand, and you can get that, but it’s also very important on a total return basis.  It gives you a nice foundation. If you can add two, three, four percent yield and then add a capital appreciation component, you then generate on a total return basis what I think is a pretty attractive overall total return profile.

CONSUELO MACK: Speaking of low risk, and lower risk than the stock market, so when I look at your portfolio today, for instance, with more than 50% in stocks, how do you avoid the risk that you’ve got in stocks?


MARK FREEMAN:  Well, I think there’s a couple of different ways. One reflects Westwood’s philosophy in terms of the type of companies that we invest in, and those are companies that are what we perceive to be as very high quality. They have strong balance sheets. They’re generating high levels of free cash flow. So when you look at those metrics, typically those are companies that tend to have a lower volatility profile, certainly less so than those companies that, say, have no earnings or let alone pay dividends or maybe they have distressed balance sheets. And so really our investment philosophy is really the starting point that takes us in that direction in terms of limiting volatility.


The other thing, are the types of names themselves. I mean, we’re in some of the traditional areas if you look at, say, consumer staples. That would be one area.  They also tend to have a lower overall beta, if you will, than the market. We have used names in the utility space even though that’s a little bit less attractive than it has been, but I think ultimately what it gets back to are just very high-quality companies that are generating high levels of free cash flow, and again, that dividend yield itself provides an important valuation support in many cases, and so look.  The other thing I would just mention is that when we talk about volatility, by definition there’s two parts of volatility. There’s upside volatility and downside. My phone has never rung even once with anyone complaining about upside volatility. They only care about the downside part, and so that’s what we focus on and things like quality, dividend yields, providing the yield support, valuation support, those all come into play when you care which is on the down side.


CONSUELO MACK: So the upside volatility portion of your portfolio, which is actually quite high now in your stocks, and I’m looking at your top holdings, so Novartis, Pepsi, General Mills, GE and  J & J, they’ve all had big run-ups in recent months.


MARK FREEMAN: They have.


CONSUELO MACK: Nearly 30%or above, so how do you assess their valuations now, and your portfolio traditionally has a pretty low turnover. You hold stocks on average five years, so how do you address the valuations now in the stock portion of your portfolio?


MARK FREEMAN: Well, ultimately you go back to your process, and a fundamental part of our process is that every security that we own has a price target, and so we are constantly looking at and evaluating that individual security on ultimately what is the upside, which is the reward, versus what is the downside, which is the risk, and so ultimately we want to continue to make sure that in the portfolio we have a group of holdings that we feel have an attractive reward to risk profile, and the other thing is that, as you mentioned, look, many of these securities have had very strong run as has the broader market from there, so we’re very conscious in terms of, well, where are we in terms of valuation, and so when a security hits its price target, it’s sold, and then we go out and we’ll look for another opportunity. It doesn’t necessarily have to be an equity. It can be anywhere in terms of the various eight asset classes that we use.


CONSUELO MACK: So speaking of, you know, you’ve got price targets on your stocks, and when I’m looking at the asset allocation of your portfolio, again, you’ve got about 20% in cash. And recently the CEO of Blackrock, the largest asset manager in the world, Larry Fink, mentioned that he felt that the market was in bubble mode, that certain aspects of the market were in bubble mode. Do you feel that way as well? Do you think that there is some really frothy parts of the market that are of concern to you?


MARK FREEMAN:  The short answer is yes, but let me explain that.  You know, I certainly respect Larry’s comments, because obviously he sees the market very well, but I think what I would note is that in his comments he was not purely focusing on, say, equities. He was focusing on what I think was also a very, very critical component, and that was actually the fixed income or the credit market, and I think that that often tends to get lost in terms of, okay, well, look. We always talk about valuations in equities, but if you ask the average person, “well, what’s the valuation in fixed income?” Most people wouldn’t know, and i think what he was trying to highlight is that there are some parts of the fixed income market that are appearing stretched or, as he referred to it, have some bubble-like characteristics, and of course, I think there’s some parts of the equity market where you could certainly debate whether some of the valuations are justified from there, but I think in a broader sense what his message was, was giving where we are from a rate environment, given where we are in terms of quantitative easing, it’s time for investors to be on guard and to be on the lookout for those areas where there are potential excesses and, more importantly, not be there.


CONSUELO MACK: One of the things that you told me in a pre-interview is one of the things that you’re doing at Westwood is that you look at where not to be …


MARK FREEMAN: … exactly right.


CONSUELO MACK: … is as important as where to be. So again, looking at your portfolio in the Income Opportunity Fund with, what, 11 percent in the bond market, clearly you’ve decided that the bond market is not a place you want to be.


MARK FREEMAN: Exactly right.




MARK FREEMAN: … not in a meaningful way, and the reason why is that ultimately I think it would probably be helpful to understand in terms of, well, look, how do we get to those various allocation levels? And so how we get there is through our bottom-up fundamental process, and at Westwood, I’m fortunate to work with an extremely talented, hardworking group of analysts, and the reason why I mention that is because it is the idea flow that is coming from our bottom-up fundamental process, and those analysts looking across their areas of coverage that generates, that tells us where to be, but it also tells us in terms of the lack of ideas coming from those areas, it tells us where we don’t want to be. And so that has worked well for us. We do not walk into the meeting and say, “Okay, we want 48%in equities. Let’s go find them.” To me, that’s not the best way or suboptimal way to do it.  How we do it is we look at where are the best opportunities coming from the areas that we cover and also talking to the analysts and saying… They will say, “look, I’m just not finding a lot of opportunities here.”  Well, why?  It’s typically because of things like valuation from there. So that’s what ultimately drives that, but to your point, I would much rather want to know where I don’t want to be versus… It’s great to know where you want to be, but it’s really important to know, well, here’s where I don’t want to be, because again in terms of volatility and downside protection.

CONSUELO MACK: So Mark, how treacherous is the bond market for individual investors?


MARK FREEMAN:  Ultimately what I would say is that this is, when I look across the fixed income and the credit market landscape, this is not a time to be trying to stretch for that incremental yield, because the incremental risk that comes with that is typically significantly higher than the compensation you’re receiving for that slightly more additional yield.


CONSUELO MACK: Right, so don’t want to be in low-quality debt. Don’t want to be in high-yield debt necessarily.


MARK FREEMAN: I think one needs to be cautious in those areas when you look at absolute yield levels there and also the underlying assumptions and specifically in terms of what are investors assuming in terms of loss ratios going forward. The assumptions are fairly aggressive I would say.


CONSUELO MACK: So one of your themes that you also told me about previously was that you don’t want to own Fed-dependent securities.


MARK FREEMAN: Exactly right.


CONSUELO MACK: So along those themes, what are other Fed-dependent securities that you’re avoiding?


MARK FREEMAN: You know, ultimately when I say Fed-dependent, I mean in terms of dependent on the Fed and their policy of quantitative easing. Okay? I don’t know when the Fed is going to eventually end quantitative easing. Quite frankly, I’m not sure if the members of the Federal Reserve know when they’re going to do so, but i do think that this is a prudent time for investors to start thinking about, well, what types of securities do i want to own that are not dependent upon the quantitative easing programs that we’ve had for the last several years? What quantitative easing is very effective at is influencing valuations, and you see that directly through the level of interest rates and ultimately valuations for all asset classes. The single most important variable are interest rates, and quantitative easing significantly influences or artificially depresses the level of interest rates which then has an impact on valuation. So what i would say is that if you’re looking at securities, then let’s not look at and focus on securities that are dependent on valuation support, i.e., multiple expansion. Let’s look at those securities that can stand on their own from an earnings standpoint, because if quantitative easing goes away, and even if interest rates stay low, you’re going to want to be in those securities that ultimately can still benefit, and the way they benefit is that they’ll be able to produce respectable earnings growth.


CONSUELO MACK: So let’s talk about some of the themes that you are investing in, and one of them is energy, you know, energy production in the U.S. and energy self-sufficiency. So give us some examples of how you’re investing in that theme.


MARK FREEMAN: I think that even though it is very widely discussed and perhaps understood, I think it’s still relatively underappreciated, especially on the domestic level, and that’s ultimately what we’re talking about, and so not just in energy but what it means to the broader economy, to continue to move towards self-sufficiency, and so we view this not as a process that’s going to play out over one quarter, two quarters or three. We view this as a process that is going to continue to play out over the next several years, and so we’re looking for companies that are going to directly benefit and participate in that. I mention master limited partnerships. That is one type of company that is really in the middle, literally and figuratively, of that process, because the ones that we focus on are referred to as midstream master limited partnerships. You have upstream which are the companies that bring the oil and gas out of the ground. You have downstream which are the refineries. Well, the mid-streams, those are the ones who own the pipelines and the storage, and they help get the commodity, oil and natural gas, to the refiners.  They are the toll collectors of the energy world, and so what they provide to us is a nice yield but then also the abilities as those volumes grow, that distribution growth will also continue.


CONSUELO MACK: And what’s a vehicle, a master-limited partnership that you’ve been invested in in the fund?


MARK FREEMAN: Well, there are several. Kinder Morgan is one of the largest players.


CONSUELO MACK: Really well known.


MARK FREEMAN: Very well known. Enterprise product is another very well known, so we’re sticking to what we feel are the highest quality names in that segment of the market, but you don’t have to stay just there. You can actually do it through equity exposure in names that are participating.  One name, Occidental Petroleum is a name. There’s really kind of a very interesting structure. It’s really going through a transformation, if you will, and we think that what you’re left with at the end is going to be very attractive to investors.


CONSUELO MACK: So here’s a company that’s shrinking and that you mentioned to me. I mean, they’re selling off their international operations. They want to focus on Texas and California production…


MARK FREEMAN: Exactly right.


CONSUELO MACK: …which strikes me as, gee, that sounds high risk. We’ve been there before, and it can really hurt you, but you’re saying it’s a good opportunity.


MARK FREEMAN: I think so. I think when you look at Occidental specifically in terms of what they want to do and where they want to be, as the CEO mentioned, he said, “we want to become smaller and less volatile,” and what they’re doing are focusing on their highest quality assets, and so when they sell, their plan is to sell a portion of the Middle Eastern assets there. That’s going to generate a very sizable component of cash which they’ll be able to return to shareholder. They’re also paying down debt, so the balance sheet is in order. They’re also looking at other assets to sell off, specifically their mid-continent assets, but ultimately it’s what are you left with and then what you’re left with are the California and Texas assets which are very high quality, and ultimately from the energy what you want to see is, well, what does production growth look like, and those are assets that are generating we think very attractive levels of organic production.


CONSUELO MACK: So I have to ask you about one other holding, and that’s General Electric. So tell me how that figures into your portfolio.


MARK FREEMAN: We feel like this is a time now for GE in terms of how they’re positioned, and specifically it’s on the industrial side. So GE has two components. Okay, there’s GE Capital which is the financial part of it, and then there’s ge the industrial side of it, and ultimately from our perspective, if you own GE, you’re owning it for the industrial side, and that’s what’s most highly …


CONSUELO MACK: So just write off GE Capital?  No, no, we can’t.


MARK FREEMAN: No, no, no. You’re right. You don’t want to just write it off. That would be a negative outcome, because there’s still value there, but I think ultimately it is about shrinking that part of the company which then in turn allows them to focus on what we feel is the more value-added part of the company which is the industrial side, but to your point, you may say, “well, what does this have to with energy?” If you actually look in the various segments on the industrial side, it’s the energy component that is the fastest growing and will be a very significant contributor both in terms of revenues and earnings going forward.


CONSUELO MACK: Last question that we always ask our guests, you know, what’s the One Investment we should all have in a long-term diversified portfolio? What would you have us own?


MARK FREEMAN: I think there’s kind of a checklist, if you will, in terms of what do you want to own there. You want to own a company whose end markets are growing, so that helps your top line. You also want to own companies that have room for margin improvement which then flows through to the bottom line, and then back to the quality aspect. You want to own companies that have solid balance sheets, which gives them financial flexibility. They’re not dependent on the Fed and maintaining lower interest rates. They’re generating high levels of free cash flow, and ultimately what we also want to see are companies that then are willing to commit and say we’re willing to take those high levels of free cash flow and return it to shareholders either in terms of a dividend or a buyback.  So if you take top line, bottom line and then buyback through that, that’s a pretty powerful combination, long-term combination for earnings growth.


So to answer your question, a company I think that tracks and checks those boxes is Covidien, so back in the health care space. It’s a medical technology and product company, and if you look across it and say, well, okay, top line, what do they have going for them there, one is which is that currently right now it’s only about 13%of revenues coming from emerging markets, but those markets are growing at about 15% a year. So over the long run, that’s an area that eventually will be able to be a material contributor to their overall growth. The other part of it is that if you look at it, they provide surgical products, and if you look at overall surgical procedures, they’re growing about one or two percent a year. However, what they really focus on, are what are called minimally invasive procedures.


CONSUELO MACK: Huge growth. Right?


MARK FREEMAN: Exactly, exactly right, and so that’s really their niche play, and so that’s going to come through, and then on a broader basis I would say this. If you look at health care usage in the U.S., right now we have roughly 160 million individuals participating in the system. We know what the affordable care act estimates are. We’ll probably add another 20 million, so that’s a long way of saying we think usage is going to go up, so we think that’ll help in the top line. They have room for bottom line improvement, and then last what I would mention is that management recently committed they were going to return 50% free cash flow back to shareholders in terms of either dividends or buybacks.  Right now, the dividend payout ratio is about 30%. It gives you about a two percent yield. They’ve signaled that they’ll go to 35%. The rest they can use for buybacks from there, so if you put all of those together, what we get is roughly about a 10% organic earnings growth, and then what they’ve also done very successfully is gone out and made small acquisitions of products that they can then utilize through their distribution system which then also adds to earnings growth. So that, kind of in a summary way, I think that gives you the characteristics of a company that would make for a long-term holding.


CONSUELO MACK: All right, and the kind of company that you own at Westwood Income Opportunity Fund. So Mark Freeman, thanks so much for joining us on WealthTrack, delighted to have you for the first time.


MARK FREEMAN: Thank you. It was my pleasure.


CONSUELO MACK:  At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term.  This week’s Action Point is:  Start taking some money off the market table.  We have seen a big multi-year run up in both stock and, until very recently, bond prices.  Several of the Great Investors we have talked to recently, both on camera and off- Yacktman Funds’ Don Yacktman and fpa Crescent’s Steven Romick come to mind- are sitting on cash because they see very few undervalued investment opportunities. And what they do own is very high quality. They would rather be safe than sorry and have cash to deploy when the market corrects, which it inevitably will do.

Next week during pledge drives on public television stations, we are going to revisit our classic active versus passive investing debate with Vanguard’s Daniel Wallick and Gerstein Fisher’s Gregg Fisher. And just in case WealthTrack is pre-empted on your local television station, we will have an additional Extra feature, a web-only interview with last week’s guests. Morningstar veterans Christine Benz and Russel Kinnel will discuss the best and worst mutual fund products and share more of their specific fund recommendations. You will find them on our Extra page. In the meantime, have a very happy Thanksgiving and a joyous Chanukah.  We hear that the next time the two holidays will coincide will be in the year 79,811 so we better enjoy this one! And, of course, make the week ahead a profitable and a productive one.



June 28, 2013

American women control $8 trillion in assets, yet the traditional wealth management approach doesn’t necessarily work for women’s needs. In the first of our two part series on Women, Investing and Retirement, Consuelo speaks with Morgan Stanley’s award-winning financial advisor, Ami Forte, and GenSpring’s Senior Strategist, Jewelle Bickford on how women can start taking ownership of their financial power.

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Women, Investing & Retirement, Part 1 Transcript 6/28/2013 #1001

June 28, 2013

CONSUELO MACK:  This week on WealthTrack, the right path to a secure retirement. Why women’s financial needs and priorities call for a different route than men’s. Two knowledgeable financial advisors, GenSpring’s Jewelle Bickford and Morgan Stanley’s Ami Forte, show us the way next on Consuelo Mack WealthTrack.


Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. This week we are starting a series on women and investing. Why is this such a critical topic? Because increasingly women are where the wealth is and, unfortunately, most women aren’t taking ownership of their financial power. Remember the last season of Downton Abbey when Lord Grantham lost Lady Grantham’s inheritance, which had kept the estate and family going? We don’t want this to happen to you!

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David Darst Transcript 9/14/12 #912

September 14, 2012

WEALTHTRACK Transcript #912- 9/14/12

CONSUELO MACK: This week on WEALTHTRACK, what will it take to rebuild damaged investor confidence? Financial Thought Leader David Darst, Morgan Stanley’s Chief Investment Strategist, shows us the steps to take to build a stronger and more secure financial house.  David Darst is next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK. I’m Consuelo Mack. Is the cult of equity dying, as bond king Bill Gross recently opined in his monthly investment outlook? Gross runs the world’s largest and one of its most successful bond funds, the PIMCO Total Return Fund and is one of the country’s most influential investors and prognosticators. As Gross’ chart, “Stocks For The Really Long Run” shows, stocks, with their 6.6% annualized inflation adjusted returns, have vastly outperformed bonds and cash over the last one hundred years; a fact chronicled by Wharton professor Jeremy Siegel in his investment classic, Stocks For The Long Run. Gross maintains this track record is unsustainable for a number of reasons, not the least of which is PIMCO’s expectation that the economy will grow at a much slower pace for the foreseeable future.  Under PIMCO’s now famous “new normal” forecast, real GDP should crawl along at 1-2% a year versus the historical average of 3.5% in the post-war era.

Many investors seem to agree that the cult of equity is dying. Investors have been pulling money out of stock mutual funds for years. As independent research firm Bianco Research reports and its chart of cash flows into U.S. stock mutual funds shows, “investors correctly started selling domestic equity mutual funds on an annual basis in mid-2007… in fact, in the months ending May 2012, net new cash flow out of these funds set a record at $193.93 billion.” You sure wouldn’t think so looking at how the markets have performed this year though. Stock markets across the world have rallied, led by the U.S. Professional investors are much more bullish than individuals are about the ability of the Federal Reserve and the European Central Bank among others to boost growth and stimulate demand.

Put this week’s WEALTHTRACK guest in the optimist’s camp, with some caveats and measured advice for investors. He is Financial Thought Leader, David Darst, Chief Investment Strategist at Morgan Stanley, where he criss-crosses the globe advising clients. He is also an acknowledged expert in asset allocation and a prolific author. Among his most recent books is a best seller, The Little Book That Saves Your Assets, which I highly recommend. I began the interview by asking David, given recent events, why should investors trust the financial markets.

DAVID DARST:  Well, I think the basic reason is that we trust America, the United States of America. America is certainly a country that’s had its ups and downs. We’ve been through the Depression, we’ve been through world wars, we’ve been through great conflicts that were not of world war scale, but they’ve been significant for our heroes and heroines. But I have great faith in the people, the deep-keeled strength of this nation to keep this nation in balance. This nation is the destiny, this nation is the hope of this world.

And why should Americans trust in the financial system? We will get it right. No family is perfect. Marriages have problems. Your kids have problems. Everybody has problems. It’s not the problems- it’s how do we deal with problems? I was recently having lunch with someone and she said it’s not what baggage you have, it is how you deal with the baggage you have, and I think this is baggage- these scandals, the trading, the high frequency trading, the flash crashes. These are things, this American ideal, this American history, and it’s 100% correct, we move to basically… we love problems. We go with the problems and we solve them. Do we do it overnight? No.

And I also have faith in the basic people who do the work in this country, and who do the work in this financial system, that they will do the right thing. Do you have bad eggs? Read the Old Testament. There’s thousands of stories in there of people … one guy kills his brother because the smoke goes up to heaven and his doesn’t. But does that mean we have to stop the Bible in Genesis right there, Cain and Abel? No. And we’re going to have people who make mistakes. We’re going to have pilots who… we’re going to have planes that crash, we’re going to have systems that crash, but I think this whole American ideal is that we will work to fix this.

CONSUELO MACK: So what has been fixed that you think that we can feel better about the fact that we are addressing our issues?

DAVID DARST:  Consuelo, number one is public awareness. A show like yours educates people. It is not a high frequency trading show. It is the antidote. You and I have talked about this. It is a show of thoughtfulness, of reflection, of appropriateness, of judiciousness. And I believe what has been fixed is there’s much greater public awareness of these things, and they are now on the agenda. They are not hidden. They are not something that we’re blissfully ignorant of. What has been fixed? People, the SEC, the NASDAQ, people are aware of some of the big egregious errors; the word egregious comes from egrex- in Latin, out of the flock. These things that have been outliers, have been recognized as such, and we are going like the good shepherd to bring that thing back like Rin Tin Tin and Lassie, and bring them back into the fold.

CONSUELO MACK: So let’s talk about what’s changed as far as when you’re talking to clients and advising them on their investments, because many people feel that the markets have fundamentally changed. You mentioned the flash crash, for instance. The fact is that we have had, in the last five or six years, or ten years, we’ve had two back-to-back market declines of 50% or more.

DAVID DARST:  Well said.

CONSUELO MACK: So there’s tremendous volatility in the markets right now. It feels like the very nature of the markets have changed, that computers are in charge and the humans are not. So, what has changed and how do we adapt to it to get the kinds of returns that we want from the market?

DAVID DARST:  What has changed is in 1876 somebody dropped acid on himself in Boston, Massachusetts and said, “Watson, come here, I need you.” And Alexander Graham Bell, Watson came running in, and we had the telephone and we were able to have information travel through the distance and now it’s sped up to almost instantaneous speed of light. What has changed is the speed at which things are being thrown at us, and we have to become a little bit more nimble, we have to pay a little bit more attention. You and I have discussed you had to drive, you have to drive occasionally with both hands on the steering wheel, wear a seat belt and pay attention to the road. This is not autopilot.

CONSUELO MACK: And you said it’s not a cruise control market, but it hasn’t been in quite a while. So if it’s not cruise control, I mean, you know, do I have to be a Grand Prix driver in order to navigate the market, in which case–

DAVID DARST:  Stay within your lanes, stay down the middle of the highway, and if it says “Don’t Pass” don’t pass. And what I mean by that is, what’s changed is the speed. What has not changed in 10,000 years since they began drawing images at Lascaux, Spain and Altamira, okay, over there in those caves– what’s not changed is the things that frighten us are still the things that frighten us and the things that get us excited and greedy are still the same things. Human nature has not changed. The world has changed.  I tell all of our financial advisors, our clients, the world as we know it is not the world today that we did know it. It is the end of the world as we know it, Consuelo, is not the end of the world. We have three big changes: demographics, technology and globalization. And the technology piece is what you’re putting your finger on, and that has changed, no question about it.

That having been said, the things… Buffett says when people are greedy then you have to basically stand back. When people are fearful, then you’ve got to force yourself. And I think one of the great things of this show is that you give this long-term perspective, and when things get sold down, our philosophy, number one, asset protection is paramount. The key second word of our philosophy is the word protection; secondly is correlations are critical. You want to have asset classes that zig when others zag so that you’re calm and you are like a surgeon operating on your own relative. You have ice water in your veins, and that’s given to you by assets that do well when others aren’t doing well.

CONSUELO MACK: And the non-correlated assets continue to be non-correlated.

DAVID DARST:  Those are cash. Those are managed futures. Those are precious metals. Those are inflation index securities which you have been a pioneer on in your show.

CONSUELO MACK: Let’s go back to some of the fundamental changes, and you mentioned demographics. A lot of people don’t pay as much attention to the aging baby boomers, which made such a huge difference in the market rallies of the ’80s and ’90s and so …

DAVID DARST:  It was like a religion. They told us to buy stocks and hold them.

CONSUELO MACK: Right.  There’s a major reason why stocks went up, because the baby boomers were a huge consumer, huge stimulative factor.  They are now aging, so their patterns are going to change. How much of a drag or a headwind is that going to be on market returns for the next 20 years?

DAVID DARST:  Consuelo, I think many of the baby boomers are going to want their portfolios to be more stable and they’re going to want them to generate more income. Those are a couple of givens . Professor Siegel and, you know …

CONSUELO MACK: Jeremy Siegel, right, Wharton.

DAVID DARST:  Jeremy Siegel at Wharton. Professor Siegel, in his first book, I remember the last chapter said the U.S. companies are going to be so good and so global that many of these rich emerging markets, people in Indonesia, people in Taiwan, people in China, are going to want to buy stocks of these American global gorillas. I thought, how crazy.  Now, 15 years later after is first edition, he was brilliant with that statement. I don’t even know if he realized totally that these young people are going to look for companies they trust, going back to your first point, they’re going to look for companies whose accounting they know, they’re going to look for companies that have been around 160, 170, 180 years. You take companies that are in the consumer products area that have global footprints, these people touch these products every day and they’re going to want to own shares of these. And so I think we have another wave of buyers…

CONSUELO MACK: A global wave of buyers buying these multinational…

DAVID DARST:  Global wave of buyers of U.S. companies and European and Canadian and U.K. companies that have good accountings, that have good accounting systems, good managements, that have a global mindset and a global… these companies…

CONSUELO MACK: Are you seeing that happening now? Where is the demand coming from?  I thought it was coming from…

DAVID DARST:  I just got back from Brazil, as you know. You go to Brazil and you see people coming to investor presentations, you see questions that indicate that the middle class is growing all over the world. The 1700s were about the deposition of monarchies. The 1800s were about getting rid of slavery. The 1900s were about the eradication of fascism, totalitarianism and Communism. This century now that we’re entering is going to be about, number one, the emancipation and the no more oppression of women, globally. And they are savers, and they are household maintainers, along with their spouses, along with their partners, and they are going to buy stocks and they’re going to buy things they trust and they’re going to buy the products of the companies they trust, and they’re going to buy stocks of those companies.

CONSUELO MACK:  So what are you telling your clients? How are we getting through this transition and do we have to adjust… during these kind of transitions there’s so much displacement in transitional periods, I mean do we have to adjust our investment expectations? Do we have to adjust our portfolios to new asset allocation, use different sectors? Tell us how we adjust to survive.

DAVID DARST:  First of all is diversification. You’ve preached this, I have preached this. You want to basically have a bunch of assets that are non-correlated, good quality assets. Take baby steps. I see people that come in and they get disgusted and they want to change the entire décor of their house. Listen, change the house one room at a time. Focus on, are your equities of high quality, global companies that have free cash flow generation, that have dividend-friendly policy, shareholder-friendly policies, and managements that are trustworthy and are doing things to expand the global footprint? That’s one.

CONSUELO MACK:  So David, a lot of people say that’s a very crowded trade, they’re expensive now, especially the global gorilla type of stocks that have a total return, they’re paying regular dividends. That’s the … the criticism is that that stuff is really expensive now. What’s your view?

DAVID DARST:  Breathing is a crowded trade. Does that mean I have to hold my breath? Running out of a movie theater when the building is on fire is a crowded trade. Does that mean I have to be contrary? There’s a time to be contrarian. I’m going back to Ecclesiastes. You’ve heard me talk about Ecclesiastes. In there, it says there’s a time for being part of the crowd and there’s a time for standing away from the crowd. And right now, if I saw these valuations, the valuation of the U.S. stock market had come down from 33 to around 12. Has it stopped? Could it go down to six or seven? Of course it could. That’s usually the long-term bottom.  But in 2000, and you remember it very well, 2000 the stock market PE was 33 times earnings. It’s come down in dribs and drabs, because the market’s done nothing over these 12 years, to a PE of 12. Therefore, you want to basically own some of these companies that have good valuations.

CONSUELO MACK:  So let’s talk about some of the positive things that you’re seeing where there are investment opportunities. So one of them is energy.

DAVID DARST:  One of them is energy, Consuelo. I think there’s legitimate concern over fracking. Are we going to be protective of the water? And this is something that this generation demands in a way that our generation was only beginning to, but they really draw the line and say we need confirmation that this drilling is so far below that, that it’s impossible to taint the water…

CONSUELO MACK:  To pollute the water supply.

DAVID DARST:  And we want our water, we want our air to be clean, and I think there are so many countries in the world, including the number two economy in the world after the United States now, China, they would love to have clean air and clean water. And we, I think, set a standard. So one is in the area of energy. Another one is in the area of water. We have water, but we also have, even in this drought condition year that we’ve just finished, we have filtration, we have desalination techniques, and those are two of the areas that folks in your investment mindset need to be look at is water, not just bottled water. Bottled water is a soft drink, what you need is filtration, you need irrigation, and you need desalination.

CONSUELO MACK:  What’s on the radar screen of you, an investor, shorter term- the election, what’s at stake?

DAVID DARST:  What’s at stake, Consuelo is the United States’ view towards capital, the United States’ view towards regulation, the United States’ view towards the spending and debt limits. Those are the four things: regulation, capital… listen, these big companies, 80 to 90% of their profits are abroad. They can’t bring them back here. It’s simple, your seven year old niece could put this on a postcard and send it to 1600 Pennsylvania Avenue and say give them a break on the taxes if they hire people and build things here. Let me tell you, Airbus is pulling Boeing. What is that? They’re going to build airplanes in the south part of the United States because they have hardworking, disciplined, non-unionized workers, who work in a country where things get crazy, we depreciate the currency a little bit externally to make the thing competitive, and they don’t have that in Europe.

CONSUELO MACK:  What are you telling your clients how to deal with the crisis in the Eurozone?

DAVID DARST:  Europe, everybody wants to put it down and says it’s nothing but a big Disneyland over there and it’s people having espresso in the piazza all afternoon. No, Europe is German companies, Europe is Danish companies, Europe is Swedish companies, Europe is Italian leather manufacturers that are not even listed in the telephone book. The Economist magazine said the strongest person in Europe was the Italian manufacturer with less than 15 people because they don’t have to register. Ninety percent of women’s leather glove, to date-Vietnam, Philippines, Bangladesh, okay, Sri Lanka, they’re not made in Asia- 90% of women’s leather gloves in the world are made in Naples, Italy, but Consuelo, there’s not one glove manufacturer listed in the telephone book. It’s all done off the books.

CONSUELO MACK:  So what are the investment opportunities in Europe?

DAVID DARST:  I think you’ve got some of these phenomenal European companies, these healthcare companies, the dividends on these Swiss, giant pharma companies, the dividends on the French giant pharma company, the U.K., the dividends are five, six, seven percent.

CONSUELO MACK:  So these are, again, global gorillas.

DAVID DARST:  These are global gorillas. You have some of these German powerhouse manufacturing companies, the big multi-industry companies. Buffett bought into these reinsurance companies in Switzerland and in Germany, and they are conservative, and they have tremendous bookkeeping and they have tremendous risk control. Nobody said a word about these great reinsurance companies. So Europe has tremendous opportunities. Am I going to sit here on your show and tell people to buy the European banks? Not now, because people still don’t know what’s inside their balance sheets.

CONSUELO MACK:  So David, one of the other questions that a lot of your clients are asking you is- again, these are the baby boomer clients- in a low yield world, where can we go for income? So what are you telling them?

DAVID DARST:  We say take a little, have a sprinkling of real estate investment trusts. They’ve done well this year, Consuelo. The domestic ones recently were up as much as 13, 14%. People were looking for yield. The international ones, which don’t get mentioned on your program a lot, but there are indices that follow them, and there are funds that track these international real estate investment trusts, those things are up 24%.

CONSUELO MACK: So everything has a price so…

DAVID DARST:  That’s income. Secondly is master limited partnerships. We’ve talked about these on your show. These are energy infrastructure. They’re pipelines, they are oil storage facilities. They are not downstream, which is refining and marketing, where we buy our gasoline. They’re not upstream, which is drilling for oil. They call this midstream, okay, master limited partnerships is… Congress, in 1961, created real estate investment trusts. In 1987, they created master limited partnerships to encourage national investment in this infrastructure, and to build out the midstream aspect of the energy industry. That’s yield oriented. So you say, where do you go for yield? You want to go with the healthcare sector. Those things are yielding four, five, six percent.

CONSUELO MACK: These are big drug companies?

DAVID DARST:  Your telephone companies and your Canadian, the big Canadian giants, Consuelo, you want to own some of those. You want to own your big U.S. carriers, and your biggest Canadian carrier. These yield 4.5, five percent. Those are generous yields that can be maintained, so there’s where you want to be looking for yield these days.

CONSUELO MACK: One Investment for a long-term diversified portfolio- what should we all own some of?

DAVID DARST:  Johnson & Johnson is a company of 126 years.

CONSUELO MACK: It’s had some problems.

DAVID DARST:  It’s had some problems. They’ve had some recalls, some product recalls, they’ve had some manufacturing issues. This is one of the great ethical companies of all time. They’ve just installed a new chairman succeeding Bill Weldon, who did a good job. They’ve installed on April 12th of this year, Alex Gorsky. He’s a U.S. Military Academy grad, he’s a native of Michigan, he’s one of five kids, he was posted in Greece, he was posted in Hawaii. He then went to work as a salesman for J&J, and 28 years later he’s the CEO. What is he doing? In short, they are basically taking their global footprint and now going to expand it. You take companies that are the biggest consumer products companies in the U.S. They are about 34% emerging markets. You take the big beverage companies, okay, your big cola companies, they are about 50% emerging markets; you take the biggest toothpaste companies that we have, they are 50% in emerging markets.

CONSUELO MACK: Johnson & Johnson?

DAVID DARST:  Johnson &  Johnson is only 20% in emerging markets. They have a gross margin, that’s sales less cost of goods sold, of 70%.  Their revenues this past year were $70 billion, their earnings were 20%, after taxes, $14 billion. They have $12 of debt, they have $70 billion of equity.

CONSUELO MACK: And the dividend policy is…

DAVID DARST:   Dividend is 3.5% and a tendency to grow the dividend over time. We think this is a classic example, and I am thrilled that it’s cheap. They can earn $5. It sells for 13 times earnings. It’s towards the low end of its historical multiple. That’s the kind of company that’s emblematic of the themes that we’ve been discussing that we think will give you along, a good return to buy in, it’s just cheap valuation.

CONSUELO MACK: David Darst, Morgan Stanley. Thank you so much for joining us on WEALTHTRACK, as always.

DAVID DARST:   Thank you for having me. Nice to be with you.

CONSUELO MACK: At the end of every WEALTHTRACK, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week I am taking some advice from PIMCO’s star bond manager Bill Gross, whom I quoted in the beginning of the program. This week’s Action Point comes right from Bill. It is: balance your asset mix according to your age. Gross advises “own more stocks if you are young, but more bonds if you are in your 60’s or older” as he is. It also fits nicely into a core part of David Darst’s strategy, which is to be broadly diversified with portfolio protection in mind.

I hope you can join us next week. I am going to sit down with a next generation Great Investor, Matthew McLennan, successor to legendary portfolio manager Jean Marie Eveillard, at the First Eagle Funds. If you would like to watch this program again, please go to our website, wealthtrack.com. It will be available as streaming video or a podcast no later than Sunday night. You can also see additional interviews with WEALTHTRACK guests in our new and improved WEALTHTRACK Extra feature. And that concludes this edition of WEALTHTRACK. Thank you for watching. Have a great weekend and make the week ahead a profitable and a productive one.

David Darst: Should You Trust the U.S. Financial Markets?

September 14, 2012

Is the cult of equity dying, as bond king Bill Gross recently opined in his monthly investment outlook? Gross runs the world’s largest and one of its most successful bond funds, the PIMCO Total Return Fund and is one of the country’s most influential investors and prognosticators. As Gross’ chart, “Stocks For The Really Long Run” shows, stocks, with their 6.6% annualized inflation adjusted returns, have vastly outperformed bonds and cash over the last one hundred years; a fact chronicled by Wharton professor Jeremy Siegel in his investment classic, Stocks For The Long Run. Gross maintains this track record is unsustainable for a number of reasons, not the least of which is PIMCO’s expectation that the economy will grow at a much slower pace for the foreseeable future.  Under PIMCO’s now famous “new normal” forecast, real GDP should crawl along at 1-2% a year versus the historical average of 3.5% in the post-war era.
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