Archive for February, 2013


February 8, 2013

The Underperformance Gap: 

  • Most investors do substantially worse than the mutual funds they invest in
  • Investors sell funds that underperform for 2-3 years
  • Investors switch to funds with several years of outperformance
  • Sell low/ buy high strategy is sure fire recipe for subpar results

If you can’t tolerate sticking with a manager who isn’t doing well, even if they have a great long term record- then go with a passive index fund. If you are willing to stick with a manager you believe in- stay actively invested.  

Watch this Episode

Bill Miller: A Great Investor’s Strategies for His Personal Portfolio

February 8, 2013

Bill Miller, the only mutual fund manager on record to beat the market 15 years in a row reveals the two primary strategies he uses in his personal portfolio. Continue Reading »

Bill Miller: A 9-Year Old “Great Investor” in the Making!

February 8, 2013

Legendary investor, Bill Miller, whose Legg Mason Capital Management Opportunity Trust was the number one mutual fund in 2012, tells Consuelo how he got started in finance. She finds out Miller discovered the market’s appeal at a very young age.

Bill Miller Transcript 2/8/2013 #933

February 8, 2013


#933- 2/8/13


CONSUELO MACK:  This week on WEALTHTRACK, legendary investor Bill Miller is back in the winner’s circle. In a WEALTHTRACK exclusive, Miller shares what drove his Legg Mason Opportunity fund across the finish line in first place last year and how he is accelerating to the lead now. Great Investor Bill Miller is next on Consuelo Mack WEALTHTRACK.


Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. We have an exclusive television interview with legendary investor Bill Miller this week, whose Legg Mason Opportunity Trust fund was the number one mutual fund last year, up a stunning 41%! As has been his history, Bill was looking for opportunities throughout the financial crisis, which hurt him and his investors big time some years and rewarded them handsomely in others.


It seems the rest of Wall Street is just now catching up to his early bullishness. A recent reading of the widely followed survey of investment advisors by Investors Intelligence shows the bulls growing in numbers, above 50% and the bears declining hovering around 20%. This shift in sentiment is starting to show up in mutual fund flows.  Since the beginning of the year, investors have been favoring stock mutual funds over bond funds, practically for the first time since the financial crisis. But are they too late? Since the market bottom in early 2009, the S&P 500 has soared more than 120% while investors have pulled hundreds of billions of dollars from stock mutual funds. According to Miller, there is plenty of upside left.


Bill Miller is the chairman and co-founder of the investment advisory firm, Legg Mason Capital Management. He is portfolio manager of the Legg Mason Capital Management Opportunity Trust mutual fund, which he launched in 1999. Opportunity Trust was the number one mutual fund last year, having fallen to near the bottom of the heap in 2011, after a more respectable 17% advance in 2010 and a spectacular 84% gain in 2009. For 20 years, Bill was the sole manager of the Legg Mason Capital Management Value Trust where he became the only fund manager on record to outperform the market for 15 years in a row, from 1991 to 2005, before taking a beating in the financial crisis.


A deep value investor known for buying unloved and battered down stocks that he believes are selling far below their intrinsic value, Miller is in his element with Opportunity Trust, where he is a major shareholder. I began the interview by asking him what went right last year.


BILL MILLER:  A lot of what went right is what went wrong in 2011 when we had a bad year, and in 2011 people thought that we were going to have 2008 again, except it would be located in Europe. And so Italian bonds, Spanish bonds, everything went crazy, and people sold off American stocks in sympathy with that, and so our fund did poorly even though our stocks did well. When it turned out that we didn’t have 2008 redux, the fund did spectacularly well in 2012, and I think part of what happened was so many people try and surf the market and react to short-term stuff, so people changed their asset allocation and changed what they were buying based on the fears of 2011. We just stayed the course. So when those fears didn’t come to pass, we had a great 2012.


CONSUELO MACK:  So the things that people were fearful of- and this is kind of a trademark of your deep value investing- is they were fearful of anything related to housing, right? You invested in airline stocks which I will talk to you about in a minute. Don’t ask me. I just can’t imagine anyone investing in airlines stocks.

BILL MILLER:  Just me and David Tepper it turns out right now.

CONSUELO MACK:  Exactly right, and some financials, so explain to me, number one, how you view the housing stocks now. Let’s just start with them.

BILL MILLER:  Well, the housing stocks since the fall of 2011 are up 150, 200%, and what was bizarre about, I’ll call it October/November of 2011, was a company like Pulte Homes, a major home builder, was trading at half of where it was trading in 2008 at the bottom of the financial crisis. So it was at three years later after home prices had dropped 35%, after Pulte’s book value had gone from 25 to 5, after they had written off billions of dollars of land and after non-distressed home prices started up, it was half the value it was in 2008. That just made no sense. So Pulte was upping 150% from November of ’11 to November of 2012. So what happened was that people were so terrified of a repeat of 2008 and a further downdraft in housing that they put these housing stocks at crazy valuations even though the evidence would suggest otherwise.


CONSUELO MACK:  So let me stop you there, because you’re right. Other people were terrified and they just, they didn’t want to get anywhere near the housing stocks. So what is it… I mean, how are you not terrified? I mean, how are you not saying to yourself, the market is smarter than I am possibly, and maybe they know something that I don’t know, or maybe these things are just not going to come back for several more years? I mean, I don’t want to be so early that I’m going to lose my shirt and my shareholder’s shirt on this.

BILL MILLER:  Well, I lost a fair amount of their shirt in 2011 by being early, but we weren’t years early; we were months early in that.

CONSUELO MACK:  Right, but how do you overcome that fear that most of us have?

BILL MILLER:  Well, the question is, what kind of mistake are you likely to make? So if you take something like financials where we made mistakes in 2008, those mistakes prove to be in the case of… you know, you make a mistake on a Bear Stearns or on an AIG, it can be a fatal mistake. These financials are highly levered, and they’re subject to confidence, whereas the housing companies, by and large, it was sort of the opposite of that, which is if you make a mistake, it was a time mistake. They weren’t going to go out of business. Their balance sheets were okay, and mathematically you know that there’s a couple percent scrappage every year. You know that there’s in-migration. You know that there’s household formations of 1.1 million. You know what the existing inventory is.


So the big debate about housing was the so-called shadow inventory, the foreclosures and things like that, and so as we looked at that, it’s like, okay, if we’re going to make a mistake, it’s because the shadow inventory is bigger than we thought, but ultimately this has to work. Mathematically it must work, and Warren Buffett had said the same thing many times about this. He’s got a big exposure to housing, so were just copying him in that sense. We had came to the same conclusion; it had to work.


CONSUELO MACK:  Right, so let’s juxtapose that to the financials. The government is much more involved. I mean, you know all the arguments against buying a Citigroup or a Bank of America. There will only be a few standing, and it’s going to be a totally different business model. It’s not going to be as profitable. What’s your answer to that, to those arguments?

BILL MILLER:  Well, there are several different threads running through that. One of them is just a mathematically challenged thread which is that the capital positions of all the major banks, the top six to eight banks, is radically better than it’s ever been in history. So there is no risk to those… almost all of them now meet the Basel III requirements which don’t kick in until 2018 or 2019, and in part, our thesis on Bank of America last year was it didn’t matter how much money Bank of America reported that they might have lost. It mattered what their capital position was, and once their capital position got sound enough, the stock would recover because people were worried about capital. And so I think all of the top six or eight banks have no capital issues whatsoever. Maybe the more salient issue is, okay, but under Dodd-Frank and this increased rate, what can they actually earn, and for how long can they earn this?

And so a couple things have happened. One of them is that the regulatory burdens are much greater, but who can best bear regulatory burden, small community banks or gigantic banks?  Answer: gigantic banks. So we’re going to see a lot of pressure on the smaller banks I think to merge. The next issue on the big banks is that, like in any industry, when the industry gets more oligopolistic, pricing gets better. So a lot of what’s happening right now, you’re seeing criticisms of people like Wells, JP, BankAmerica that, with the Fed buying all these mortgage-backed securities, and even though interest rates on mortgages are the lowest they’ve ever been, the spreads are still wide. Like why aren’t the spreads, you know, narrower? The answer: there’s less competition in the industry. So why should JP or Citibank or Wells give up profit when they need profit? That’s what they need. So the oligopolistic character of the business is now tending towards greater profitability.


The key thing for us with the banks is that the Fed right now is limiting the banks to a dividend payout ratio of about 30%, and at the end of the day, once they all meet the Basel III requirements, there’s no reason for the Fed to be that involved, and I think then you’ll begin to see, I think, payout ratios move towards a 40 to 50% level. Wells Fargo just raised their dividend 14 or 15% yesterday or the day before.

So what we’re looking at right now is also this goes maybe with a topic we’ll talk about a little bit later, but I think we’re in the beginning of a giant bond bear market which means the yield curve is going to get very steep for the next couple of years as interest rates rise. Well, steep yield curve is fantastic for banks, and I think they’re going to be in a sweet spot where their cost of funds are going to be low, but their ability to actually replace some loans that are burning off and assets that are burning off at better rates of return are going to be good.


CONSUELO MACK:  Airlines. Explain to me airlines, because I can remember in the many years I’ve been covering Wall Street is that airlines literally you blinked, and they had gone up like 30% and then they were down. They were such leading indicators, and they moved very quickly, and it was a lousy business for years. So what’s the deal with airlines, and which airlines in particular?

BILL MILLER:  So the airline industry may be the worst industry in the history of modern capitalism to invest in. People have tried to invest in it and have always failed. Even Warren Buffet.

CONSUELO MACK:  Even Warren Buffett. Exactly.

BILL MILLER:  Even Warren Buffett with a preferred stock didn’t do well with airlines, and that’s because the airline industry historically had everything wrong with it. It was highly regulated. It was highly capital intensive. It was unionized. It was selling a commodity product. It had baffling regulations which the companies had the hoops they had to jump through. If an airline went bankrupt, they’d go out of business, and they just came back again. You know, fuel costs were 30% of the cost, and they were unpredictable, and even worse, it was one of those industries where… in many industries, if your business gets better and more people buy your product, that’s good. Right? But in airlines, the more people that buy the product, that are on the planes, the worse the experience is for the customer. So there was perversity from A to Z in airlines.


Now, what’s different right now about airlines? The major thing is massive consolidations. So up until about three or four years ago, the largest market share of any U.S. airline was around 12 and a half percent. Well, 12 and a half percent in a commodity business with all those problems I just mentioned is a recipe for, you know, disaster, for multiple bankruptcies which we’ve seen. Well, now that we’ve had massive consolidation, and so with Delta and Northwest, with United and Continental, with now perhaps…

CONSUELO MACK:  American and USAir.

BILL MILLER:  … American and USAir, but the big two, Delta and UAL now control over 50% of the industry, and you add in Southwest. You’re in the 60s. You put AMR and US Airways together, you’re in the 70s.  Well, now you’re talking about three or four companies controlling the majority of the business, and that’s why you’ve seen pricing power. That’s why you’ve seen free cash… the industry’s been free cash flow positive for the past five years, and only free cash flow positive in one of the previous 25 years, yet… and we were kind of early on this, because we bought during the crisis some bonds of UAL. They were selling secured bonds. They could only get a couple hundred million dollars of it issue off at around 17%. Now they can borrow at four to five percent unsecured. So the credit markets have figured out…

CONSUELO MACK:  They figured out.


BILL MILLER:  …but the equity market is still trading these things at, you know, three times or four times enterprise value at EBITDA,  or EBITDA in that case. So we think that there’s a lot of upside left. They’ve done very well. USAir has more than doubled this year early on. Delta’s now doing well. UAL is the laggard, so I think UAL is the best value in the industry right now, but then there are other new entrants like Spirit Airlines which we don’t own. It’s fairly thin, but it’s like Ryanair. It’s a very low-cost producer. That company can probably go 20% a year for the next five to seven years, and it trades at 10 times earnings. So it’s a very interesting industry now, much more interesting than it used to be.


CONSUELO MACK:  So how long will you give, you know, an industry like the airlines. Obviously, they’ve done very well for you now, but for kind of the market to catch up with you. Is your willingness to stick with a company as long as it has been in the past?

BILL MILLER:  We’ve been tending to be over, again, the decades saying we’re willing to be a year early on fundamentals if the stock is cheap enough. I think now we’re probably a little closer to that, saying we’re willing to be a quarter or two early on fundamentals, but not a year or two years on fundamentals. And again, in this kind of market, which is kind of a just-in-time market, this is a market where we have negative real interest rates and guaranteed negative returns on TIPS, so people are terrified, and in a terrified market you don’t need to be early, because you can make plenty of money just when things visibly turn.


CONSUELO MACK:  Right, so speaking of TIPS, Treasury Inflation-Protected Securities, you just said that you think that we are at the beginning of a major prolonged bear market. Now the Street, as you know, is littered with people who have made that kind of prediction for like the last five years. What’s different now? Why are you so convinced that this is the beginning of the bond bear market?

BILL MILLER:  So the question is, how long are you willing to lose money? And when the S&P500 right now yields more than the 10-year Treasury, we haven’t seen that since the 1950s except during this crisis, and we saw it in the 1940s and 1950s because of the Great Depression, but it was obviously a great time to buy stocks when they yielded more than bonds, and I’d say the same thing right now and, more importantly, theoretically the 10-year Treasury, whatever the benchmark Treasury is- we use the 10-year- ought to have a yield roughly equal to the nominal GDP growth, and nominal GDP should be four to five percent normalized. Five would be more normal, but in a new normal world, a PIMCO world, maybe it’s four, but it’s not 180, and that’s…


CONSUELO MACK:  Right, and nominal being including inflation.

BILL MILLER:  Yeah, inflation plus real, inflation plus real. So that would mean that the 10-year ought to be four to five percent. During the great bull market of the 1990s, the 10-year was six percent, and we had a great bull market, so if interest rates rise, that’s not going to be an inhibitor to the market doing well. In fact, I think it will be an accelerant to the market doing well because so much money’s parked in bonds. We have a bubble in bonds at least equal to the bubble in housing in 2005 and the bubble in Internet stocks.


CONSUELO MACK:  Stock market. You are on record of being bullish on stock market. You think 2013 is going to be another really good year. How good and why?

BILL MILLER:  I think the stock market with balance sheets the best they’ve ever been in corporate America’s history, with housing coming back and with the Fed going to be accommodative toward 6.5% unemployment and 2.5% inflation, stocks are pretty much the only game in town. What’s the risk? The big risk in terms of political dysfunction that appears, most of those risks appear to have dissipated at least short term. Europe is a risk. China’s a risk. Iran, Israel’s a risk. There’s always risk but given that there’s always risk, I think stocks are basically where you have to be.


CONSUELO MACK:  So which stocks do we have to be in, Bill Miller, or do you have to be in? I’ve got to ask you about Apple, you know, disappointing earnings report recently. So what’s your take on Apple?

BILL MILLER:  Apple is the Dr. Jekyll and Mr. Hyde of the stock market. It’s the Dr. Jekyll in the sense that they are one of the greatest product innovators creating products that people love and a brand that people love, and they’re Mr. Hyde in their completely idiotic and dysfunctional capital allocation which is the worst probably in the history of corporate America among good companies. So they have $135 billion of cash. They have much more cash than Amazon has market cap. Tim Cook said when they had $90 billion of cash, he said it was way too much. They had not possible reason to use it, announced a modest dividend and a modest share buyback that would not even draw down the cash at all, not one dollar. A year later, $135 billion of cash. Cash is equity. Equity has a cost. The cost of equity, if you’re optimistic like me, it’s six percent. If you’re historical like others, it’s eight percent. So take six or seven or eight percent and multiply it times $130 billion, and that’s how much they’re destroying value every year with dumb capital allocation. They could double the dividend tomorrow and still have a big share buyback and never touch the cash. So Apple’s a case where when the company had a massive growth rate… and it’s still got a good growth rate… the stock went up because people didn’t care about the bad capital allocation, but now it’s in the Microsoft camp. Now it’s in the Cisco camp.


CONSUELO MACK:  So it’s there. It’s that kind of mature. It’s that …

BILL MILLER:  Now the market is saying, as the market has taken Microsoft’s multiple down every year, why do you have $85 billion of cash? You generate two billion a month. Why? Why aren’t you raising the dividend 25% a year instead of 15? Why aren’t you buying back stock? And so I think that’s the dilemma with Apple. I think Apple at $450 a share has huge optionality. It’s nine and a half times earnings. It’s going to grow probably 15 or 16% this year consensus, 12 to 14 next. Coke grows six to eight percent and trades at 17 times earnings, so if Apple had a capital allocation like IBM or like McDonald’s… McDonald’s pays out 100%of free cash flow to shareholders and trades at 15, 16 times. Apple would be up 50% on just sensible capital allocation.


CONSUELO MACK:  From your lips to Tim Cook’s ears. I don’t know whether it’s going to happen or not. What’s the most radical position in your portfolio?

BILL MILLER:  The autos are probably a very good example. We added Ford to the portfolio in the fourth quarter. The auto companies have radically restructured. They can be profitable at nine million cars, never before. Their wage rates are competitive globally. Ford just doubled their dividend. We’re at about 14 and a half to 15 million units right now. Equilibrium is 16, 16 and a half, and that’s equilibrium. The fleet’s the oldest it’s ever been. We’re looking at years of rising earnings in the auto companies.


CONSUELO MACK:  Car sales.

BILL MILLER:  And their balance sheets are great, and they trade at two and a half times or three times enterprise value to EBITDA. They ought to trade 50% higher easily. So that’s a case where I think… the biggest thing we have in our portfolio is… and maybe to answer your question a different way is people look at our portfolio and say, “That’s a scary portfolio because everything in it is very cheap but very risky,” and our comment is or my comment is, “Historically it might have been risky, but the fundamentals are so powerful here.” So again, Pulte homes, risky at $3.50. It’s $21 today. I would argue it’s more risky today than it was at $3.50, but I still don’t think it’s very risky at year one of problems an eight or nine-year housing cycle. So I think that’s the thing we have going for us in the Opportunity Trust. I think there’s a lot of tailwinds in a portfolio that’s had… you know, we’ve beaten the market eight out of twelve years, but two of those four years were really bad, ’08 and ’11, but we had a great year last year.  We’re up over 10% in the first three weeks of this year, and I think that the outlook is good.


CONSUELO MACK:  Is there any way that you would try to mitigate those down years?

BILL MILLER:  Well, yes. That’s a great question, because there’s two things. One of them is those two big down years were both the result of the same phenomenon expressed differently. One of them was in the crisis of 2008; what we had was the fundamental economic relations that held the economy together blew apart. Commercial paper market got crushed; a former triple A company like AIG went effectively bankrupt. So when the economic relations that exist in the society blow apart, you either get that right and realize it, like John Paulson did at least in…

CONSUELO MACK:  Very, very few did.

BILL MILLER:  … and you make a huge amount of money, or you don’t realize it like me and you lose a lot of money. 2011 was different which is where people thought it might happen again, but it didn’t, in which case we got hit hard, but it turned out that we were right and the rest of the people were wrong. That was just a quotational error. So I think from the standpoint of mitigating risk, part of what we’re trying to do is to say, are we seeing risk that could be systemic? If there are, that are rising. So take an example. If rates start to rise in Italy and Spain again, we will probably put on various hedges just to protect against that tail. One of the things that we actually did that worked out great last year was in 2011 at the end of the year, we bought a lot of really high yielding mortgage REITs and BDCs- business development companies. So the yields were anywhere from 12 to 15%. So our overall portfolio yield was well above the market, in fact, 50% higher than the stock market. That helped us last year during corrections, because those things didn’t go down very much.


CONSUELO MACK:  Didn’t go down as much, right.

BILL MILLER:  So our yield right now is maybe market or a little bit below, and I think our protection this year, if we need it, will be through various hedges when the market kind of spikes up as it’s done recently.


CONSUELO MACK:  Final question, One Investment for a long-term diversified portfolio, what should we all have some of in our portfolio?

BILL MILLER:  Most people are way overweight bonds based on history. They’re way underweight stocks because they’re fearful. It’s hard to go against your psychology if you’re fearful to take more risk. So I think the answer to that would be, okay, take the lowest possible risk in equities which is to buy the largest, most successful, most stable companies with high dividends. Call it the S&P top 50 or top 100, and they’re extraordinarily cheap based on history. They’re cheap based on comparison with bonds, and their dividend yields are higher than bond yields, and they’re also less volatile in the market as a whole, and so I think that’s probably the single best risk-reward for the average investor.


CONSUELO MACK:  Bill Miller, so great to have you back. I’m so glad Bill Miller is back in more ways than one.

BILL MILLER:  Oh, thank you. Thanks for having me on. It’s great.

CONSUELO MACK:  Especially on WEALTHTRACK. Thanks, Bill.

BILL MILLER:  Pleasure.


CONSUELO MACK:  We had an extended interview with Bill Miller beyond what we had time for today. To see the complete conversation, go to our website, You will find it in our WEALTHTRACK Extra section early next week.


At the conclusion of every WEALTHTRACK, we give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: ask yourself if you should be invested with an active manager or a passive index fund. There have been numerous studies showing that investors do substantially worse than the mutual funds they invest in- we call it the underperformance gap- because they sell when a manager has had two or three years of underperformance, which even the best ones do- Bill Miller is a case in point, and switch to managers who have had several years of outperformance. Studies show that this “sell low/ buy high” strategy is a sure fire recipe for subpar results. If you can’t tolerate sticking with a manager who isn’t doing well, even if they have a great long term record, then go with a passive index fund. If you are willing to stick with a manager you believe in- stay actively invested.


Next week we are going to talk to a mutual fund manager whose fund has paid an uninterrupted monthly dividend since 1948! Ed Perks has run the venerable Franklin Income Fund for a decade. He will be joined by global value investor Chuck De Lardemelle of IVA Worldwide fund. And that concludes this edition of WEALTHTRACK. Thank you so much for watching. Have a happy Valentine’s Day and make the week ahead a profitable and a productive one.

Transcript: David Rolley & Rupal Bhansali 12-21-12 #926

February 4, 2013


12/21/12- #926


CONSUELO MACK: This week on WEALTHTRACK, the hunt for big investment gains in out of the way places. Two global money managers- Ariel Investments’ stock star, Rupal Bhansali and a Loomis Sayles bond leader, David Rolley- travel off the beaten path to find hidden winners next on Consuelo Mack WEALTHTRACK.


Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. How do you feel about your portfolio this year? If you are similar to the vast majority of investors, you are probably leery of stocks, resigned to bonds, and grateful for anything yielding more than the 2.5% or less offered on ten-year treasury notes.


In fact the trend away from stocks and into bonds has grown more pronounced since the 2008 financial crisis. As this chart from innovative research firm Strategas shows, net inflows into bond mutual funds have accelerated in recent years, whereas stock mutual funds have seen quickening outflows.  It is a stunning divergence.


Do these gigantic shifts still make sense? Well, stocks have had a remarkably good year- the S&P 500 is up double digits as is the NASDAQ and major European and emerging market indices. Meanwhile, there is huge divergence in bond performance. Ten year treasuries have lagged significantly, but high yield bonds have delivered equity like returns as have emerging market issues.


So where in the world should you look for opportunities in 2013? Two global investors are joining us this week, both with excellent track records, one in stocks and one in bonds, and both are new to WEALTHTRACK. Rupal Bhansali is a star global stock manager who is now the Chief Investment Officer of International Equities at Ariel Investments and portfolio manager of Ariel International Equity and Ariel Global Equity funds. Bhansali spent a decade at Mackay Shields where she ran a top decile, five star rated international equity fund. David Rolley is co-head of the global fixed income group at Loomis Sayles and co-portfolio manager of the Loomis Sayles Global Bond Fund, Loomis Sayles International Bond, and Global Equity and Income funds. Over the years, Dave and his team have been recognized as best in their categories by Morningstar and Lipper. I began the interview by asking them what surprised them the most in the markets in 2012.


RUPAL BHANSALI:  The markets always surprise, but I think the surprise for everybody in 2012 was that developed markets, equity markets in Europe and the U.S. outperformed by a mile emerging markets. You know, the inflows into mutual funds have all been into EM, and to think that DM would shoot the lights out compared to EM I think was the biggest surprise.


CONSUELO MACK:  That is a big surprise when you look back. Dave, from your perspective as a global bond fund manager.

DAVID ROLLEY: I think one of the reasons why that might have happened is my surprise which was how little volatility we had. I mean, after August and September of 2011, a lot of people went into 2012 prepared for essentially more bad news from Europe and, in fact, Europe really was not the big problem for investors. It was a low volatility year, and a low volatility year is not what people were looking for.


CONSUELO MACK:  So that risk on, risk off trade that we all kept reading about and talking about and everything else, you know, refresh my memory. That didn’t really happen this year?

DAVID ROLLEY: It was really muted. I’d say we certainly had risk on. In January and February, all markets rallied, particularly, you know, importantly risk markets with the liquidity from the European central bank that began about this time a year ago, and they did more of it in February. The only thing we had that really looked much like a sell-off was a bit of a pullback in May, and it was not nearly as bad as the previous year.


CONSUELO MACK:  Except right after the election, but then since then it’s been fine. So what about 2013? We’ve just got a little bit of time left in this year, so what are you planning for, Rupal, in 2013?

RUPAL BHANSALI:  I think that the markets in general have gone up a lot, and so next year and many years going forward, I think it’s going to be about choosing and selecting alpha rather than relying on beta to get your performance. So stock picking…


CONSUELO MACK:  And explain for our viewers the difference between alpha and beta.

RUPAL BHANSALI:  Oh, sure. Beta is something where the asset class itself, you know, just by being long the asset class, you can get your returns, because it’s just undervalued across the spectrum.


CONSUELO MACK:  So the markets go up.

RUPAL BHANSALI:  That’s right. The whole market goes up, and you just go up with the tide. I think that given the valuations of the market, I think stock picking, so cherry picking your exposures, being in particular parts of the market rather than the entire market is what’s going to serve you well in 2013, and that’s how we are positioning. We are looking specifically for those portions of the market where you can get the best combination of growth and value, because both are very important to improve the risk/reward of an investment proposition which is kind of our mantra. We don’t look just for return management. We look for good risk management.


CONSUELO MACK:  And what about in the bond market? And I’m thinking the bond market which, of course, everyone has been saying for years that bonds are really expensive and especially sell Treasuries. They’re the most risky investment you can possibly buy. So what are you expecting for 2013?

DAVID ROLLEY: Well, I’m hoping that we have a sideways market in 2013, but I’d have to agree with your comment, and this is embarrassing. If I just say, well, gee, interest rates are really low now, I’m thinking, wow, that’s an expert remark, isn’t it? I mean, you get nothing if you hold cash, and you don’t get very much if you hold two-year or five-year Treasuries. You get 1.6%, something like that, if you hold 10-year Treasuries, but it’s not just the United States.  The U.S. Treasury market is expensive, meaning yields are really low, but so is sterling, so is the northern half of the Euro Zone. So is Japan, and that’s 85% of my benchmark. So what I’m hoping to do in 2013 first is protect capital and then, after that, do exactly what Rupal said and replace market risk with specific risk. So in this yield desert, what we’re going to be looking for is little oases of positive return, and there are going to be lots of different little things, so no one big theme, lots of small themes.


CONSUELO MACK:  So talk to me about some of your big themes, the big investment themes that you have.

RUPAL BHANSALI:  I think a lesson and a principle that all investors would be well advised to pay attention to is the following: All good things come to an end. The corollary of that is all bad things come to an end and, in investing, a lot of people tend to own the good things that have happened to them, which is fixed income, for example, and they tend to over own it. They over own the portions of the market that have performed very well, like the fixed income proxies, utilities, real estate, the REITs, energy stocks, and so on. We think that that good trade has come to an end, and we think some of the bad things that are coming to an end provide an excellent investment opportunity.

Patent cliffs in the pharmaceutical sector. You know, we all talk about patent cliffs and generics threat. Well, that sort of played out over the last decade, but the pharma stocks are extremely cheap now and, frankly, some of the pharmaceutical companies that invest in R&D which takes 10 to 12 years to fructify, well, the payday is now around the horizon. Take GlaxoSmithKline. They have a lot of drugs in the pipeline that are in phase III, and you can look forward to both a single-digit to double-digit earnings growth, cash flow growth, and a low valuation of 10 times with a five, six percent dividend yield. So contrary to what you have in the fixed income markets where you have extremely low yield, there are portions of the equity markets where you have very high yield. So I would say that that’s where the opportunity is. That’s the big theme. All good things coming to an end, all bad things coming to an end, so it’s time to reposition the portfolio.


CONSUELO MACK:  Would you agree that basically that all good things come to an end and, therefore, the good place to be has been in the bond market overall for like the last 30 years? And that, in fact, the best things in the bond market, the best performance in the bond market, are behind us now? And that there is going to be some sort of a reversion to the mean which people have been talking about now for five years?

DAVID ROLLEY: That’s a really deep question.

CONSUELO MACK:  I’m not sure about that, but …

DAVID ROLLEY: It may be the deepest question in fixed income, and let me explain why it’s really fairly profound.  I believe in reversion of the mean and so do most investors, but what you have no consensus on is whose mean are we going to revert to? And what I’m really talking about is the difference between traditional American valuation metrics and traditional American levels of interest rates and Japan. If you think about Japan, you had very low interest rates not for a year or two years, but for…

CONSUELO MACK:  Twenty years.

DAVID ROLLEY: …20 years, 20 years, and the question is, are we all becoming Japanese? The United States, I think, will not become Japanese, and I think the reason is that there are no votes in that. I think that the policymakers, particularly the Federal Reserve, is targeting nominal GDP growth. When they talk about what they do, they talk about a dual mandate- unemployment rate on one side, inflation on the other side. You put them together, you’re talking about how the economy overall is doing. If you were going to use one number to do that, you’d look at how the whole economy is growing not in real terms- that’s how it’s usually discussed by us and by others- but in nominal terms. That used to be five to six percent per year. We’re growing at about four percent a year and struggling.


CONSUELO MACK:  In nominal terms.

DAVID ROLLEY: In nominal terms.

CONSUELO MACK:  That’s the GDP growth, what, of two percent and inflation of two percent?

DAVID ROLLEY: Yeah, GDP growth of two percent on a good quarter and inflation of about two, and you add those together. You get that four percent number, and we’re throwing everything but the kitchen sink in monetary policy to hold that number up. Well, the problem is, the way the Fed throws liquidity to try to push up nominal GDP… the other name for nominal GDP is our tax base. You see why they want it up. You want a tax base up if you’re worried about tradeoffs between cutting back government transfer payments and government expenditures on the one side and raising taxes on the other side. The higher the tax base goes up, the easier that tradeoff becomes, but the way you do it with quantitative ease is also called yield suppression. So the government policy from central banks, and not just ours but the United Kingdom and others, is to push yields down to try and get nominal GDP up. Well, nominal GDP is my value metric. You know, for 30 years if I ask, “What’s fair value for a bond yield?” I’ll look at nominal GDP trend growth. So if they want it higher, that means that at some point out there, there is a pretty ugly bond bear market. So ultimately I’m saying we mean revert to something that looks more American in terms of GDP history and less Japanese…


CONSUELO MACK:  Globally more American.


DAVID ROLLEY: Globally, because if we don’t I think the fiscal conversations are just going to be very, very unpleasant.


CONSUELO MACK:  So you think bonds are really expensive, too. Correct?

RUPAL BHANSALI:  Absolutely. Yes, I think that investors have pushed the envelope on this good thing and, again, it’s a rearview mirror. Because they perform so well, there’s a lot of money chasing this asset class, and I think what investors are forgetting is they are so afraid of the volatility risk in equities because equities bounce around in double digits too often in ’08. In 2001, 2002, sort of really put the fear of volatility risk. I think people are forgetting that by owning fixed income, you may have less volatility risk, but you have swapped for another form of risk which is valuation risk which is the biggest risk of all. You know, real estate didn’t have too much volatility until it fell 30, 40%. It’s a one-way move down.

CONSUELO MACK:  Right, until it did.

RUPAL BHANSALI:  Exactly, and I think that’s sort of what is lulling people into thinking that fixed income is safe because it doesn’t fall as much, and it doesn’t have that much volatility, and I think that’s the biggest misnomer in the markets. I’m not such a believer of mean reversion as much as I am of, you know, we have to think for ourselves. So independent thinking is what categorizes Ariel and some of these investment propositions that I’m giving to you, and I think in that construct of independent thinking, looking at portions of the equity market, not the ones that are crowded trades which everybody wants to flock to, that tends to take the valuations to very unattractive levels.


You know, emerging markets is a classic example where everybody over the last decade has gone into it. It’s exactly what happened when people went to technology stocks, you know, TNT, in the late ‘90s, and they couldn’t have enough of it and then, of course, look at the reaction on the other side of the fence. Today I would argue after 10, 11, 12 years, the technology stocks in the U.S. are some of the cheapest out there, and yet nobody wants to own them. So there is opportunity. There is tremendous opportunity, because the good thing with equities is you can truly pick your spots. You don’t even have to have beta. You can have pure alpha, and I have many examples if your viewers care, but…


CONSUELO MACK:  I think we do care, and so one of the things that you had told me is that as far as the “all good things must come to an end”, that Apple is an example of all good things must come to an end and all bad things must come to an end. That Microsoft is… I mean, so that’s a classic example in the technology sector. You would sell Apple stock and buy Microsoft? Is that essentially a trade that you would make?

RUPAL BHANSALI:  When we make any investment decision, we weigh- and I suggest all investors do this- not just the reward or the return they expect from the investment opportunity but the risk they take, so the down side that you can expose yourself to with that investment as well. When I look at Apple, when the stock is in the 500s, you know, give or take, because it’s been up and down now, and it’s got a market cap of close to half a trillion dollars, for me to think that I’m going to get 30, 35% upside in Apple, means the market cap has to go to $800 billion. Never happened in the history of the world, by the way, so now you’re expecting something that is excruciatingly challenging, you know, even against the odds, right? On the other hand, can I think that Apple could go down 25, 30 percent from here? Absolutely, because there are lots of things that it can have a challenge in succeeding in.


Then you take Microsoft, a stock that’s already derated so much to the point of being on six times X cash, nine times with the cash, excluding the cash earnings. This is a company that generates billions and billions and billions of free cash flows here and now, and that’s the multiple you have to pay. It’s like a 15% free cash flow yield. You can easily see the stock going up 35, 40%, and it’s extremely hard to see why it will go down 10%. So here you’ve got the odds risk/reward, you know, three to one, four to one, and this is a mainstream blue chip company you can have in your portfolio and clip a coupon of three and a half percent, well above the 10-year bond rates of most markets out there.


CONSUELO MACK: All right, and, David, speaking of independent thinking, Loomis Sayles is also known for being an independent thinker, and one of the things that you told me is like first do no harm. So where are kind of the niches, the special places that you’re looking at Loomis Sayles, especially considering that there could be tremendous harm if… and I don’t know when… but if the bond market does implode?

DAVID ROLLEY: Well, as we look at the fixed income landscape right now, we’re driven to certain strategies through almost a process of elimination. Now, if we hold very short maturity securities in good companies, we get paid relatively little as approximating nothing, and so cash-type substitutes do not appeal. It’s a liquidity reserve. It’s not an investment return idea, but at the same time, given that I think that the overall level of interest rates has been artificially suppressed by policy and some day will adjust, I don’t want to own 30-year paper because those will be where you have your biggest capital losses. At least I don’t want to own 30-year paper unless I’m getting paid seven or eight percent to do it. You could find some of those.



DAVID ROLLEY: So if I’m not going to be taking a lot of market risk, it comes back to specific risks. There are things we don’t like, and many of them may be the same companies that Rupal does like. Let’s take, say, GlaxoSmithKline. Now, if their dividend is between five and six percent, that’s an interesting equity dividend, but if Glaxo came to the bond market and wanted to borrow a billion dollars, they wouldn’t pay investors anything like five or six percent. It would probably be more like two something. So two percent in the bond, five percent in the stock. If you think in five years’ time Glaxo’s a bigger and more successful company, you prefer the equity. Having said that…


CONSUELO MACK: Right, you go with Rupal.

DAVID ROLLEY: Yeah, but having said that, you can find parts of the bond market that can return that 35%. Let me give you an example. In Europe, you can find good quality companies that have really been beaten down. Some of them are big large-cap utilities. So if we’re talking about…


CONSUELO MACK: So are you talking about stocks that have been beaten down or the bonds?

DAVID ROLLEY: We’re talking about the bonds.


DAVID ROLLEY: The bonds have been beaten, but the stocks have been beaten down, too, in certain cases, but in many cases the bonds have been beaten down. So you can look at big companies, and we’re talking about like the phone companies and the power companies, so places like Italy, Spain, Portugal, France. Veolia was one of the best performing things in my portfolio. Why? A lot of the people were worried about the euro stuff. They drove their long bonds down to 86. The other day they were 118. Well, you know, 86 to 118 on par is a pretty good return, and so it’s still possible to find securities in the fixed income markets that can return 30 to 40%. It doesn’t seem like that would be possible, but if you can buy them at 85 and sell them at 118, that’s a good day.


CONSUELO MACK: So that’s another issue. So are you finding… when I’m hearing that kind of appreciation, is it time to sell these issues? I mean, are there a lot of your portfolio that looks overvalued that you’ve really got to, you know, got to start thinking of putting somewhere else?

DAVID ROLLEY: Where we find bonds that have had tremendous performance and now trading at a substantial premium to par, we’re more likely to be sellers than buyers. We are buying more new issues coming at close to 100 than might be normal for us. Our preference is to buy good quality companies at a discount to par in the secondary market. Yields are so low that there’s not that many discounts around right now, so we are using more new issues, but we’re still finding islands of opportunity.


One of the places we’re finding it, and here I’m going to go maybe in a different direction from what Rupal said about emerging markets, is in emerging market corporates. Many of them are coming to market for the first time of the bond markets. They have never been issuers before, and so to access global capital, they’re prepared to pay a new issuer premium, sort of just we’ll pay you a little extra compared to our rating and compared to our cash flows so that you will look at us and consider us. Many of them are emerging markets banks. They’ve never had to access the bond market before. They could get cheaper funding from other banks in the developed world, but if you think about the stress that American banks have gone through, that European banks are continuing to go through, well the price of a term loan from a French bank is different from what it used to be in 2007, and they now look at the bond market and say, “Well, you know, five-year dollar pay paper. Maybe we should do some of this.” So you’ve seen a lot of emerging market banks. We’re talking about folks that in that country’s market are blue chip.


CONSUELO MACK:  …are the blue chips.

DAVID ROLLEY: You know, top two, top three banks in their local neighborhoods. So the people there think this is a terrific bank, but the people that don’t live there may not know them so well. You can find actually very interesting yields with that kind of an opportunity or other companies in other industries that are looking to grow out of their local footprint and become true multinationals and just need the funding.

RUPAL BHANSALI:  It’s interesting. Every security-specific portions of the market he referenced that he’s finding value and opportunity in the bond markets, which is the utilities and telecoms in Europe and the banking sector in emerging markets, et cetera, are exactly the portions of the market that I would not own in the equity markets, and we think that those sectors have significant challenges, and actually the equities are quite overvalued despite the correction. So I think that what it boils down to for any investor is to have a combination of what he can do for the portfolios and what I can do for the portfolios, and the fact of the matter, it sounds like we’d be pretty diversified, because we’re not making the same bets.


DAVID ROLLEY: Let’s talk about that equity. What might be bad for Rupal’s returns if she buys a stock in emerging market might be good for me. I’m a bond investor in that I am senior to that equity. The bigger the market cap of that firm, the more cushion of value there is underneath me, and the more that has to be eliminated before I don’t get paid, before I don’t receive my coupon on my principal back. So an overvalued stock market is not necessarily bad news for a bond investor.


CONSUELO MACK:  For a bond investor. So I need to switch gears here, because we’re almost running out of time. I can’t believe that we are. This is so much fun. So Rupal, the One Investment for long-term diversified portfolio, what should we own some of in a diversified long-term portfolio?

RUPAL BHANSALI:  This will prove to be a very contrarian, possibly controversial idea for people, but that’s exactly what we at Ariel do. We try to pick the best investment ideas before the market discovers it, so here I go.

CONSUELO MACK:  So we could be early, right.

RUPAL BHANSALI:  I would say that the biggest mistake people are making in their portfolios today is not owning Japanese multinational companies. You know, everybody wants to own emerging markets. Japan is viewed as a submerging market. I think that’s where you go, because some of these Japanese multinationals- Toyota, Nintendo, Canon, and I can give you a string of names like that.  I don’t mean Japan, the domestic stocks, but I mean the multinationals. I think they have extremely good products. They’re very competitive, and they have the global marketplace as their opportunity. So no matter what happens to Japan, they will sell their wares in overseas markets.


CONSUELO MACK:  And they’re undervalued right now.

RUPAL BHANSALI:  And they’re very undervalued. You get four to five percent dividend yields in a stock like Canon. I mean, this is unheard of in Japanese markets. They’ve corrected 75%  from the peak while the U.S. market of the same period, about the last 25 years, is up 500%. Japan is down 75%. Enough is enough. All good things will come to an end. All bad things will come to an end.


CONSUELO MACK:  Very intriguing idea. Dave, what would your recommendation be?

DAVID ROLLEY: I think that the two fixed income ideas that probably will not break your heart over the next year would be emerging market corporate debt…

CONSUELO MACK:  Which you just talked about.

DAVID ROLLEY: …which I’ve talked about and, to go domestically, bank loan portfolios but that are actively managed. Again, now you’re at the top of the capital structure, and you have a decent yield. We’re talking about a flow income of over four percent, so that’s… in a dangerous fixed income landscape, that’s a relatively safe place to be.

CONSUELO MACK:  Well, thank you both very much. You know, as we kind of close the year and we’re heading into Christmas and the holiday season, I think you both have given us some terrific investment gifts. So I really appreciate your being here on WEALTHTRACK. Rupal Bhansali, it’s great to meet you here finally and have you on WEALTHTRACK and, Dave Rolley, I’ve seen you in many conferences. I’m glad to finally have you on WEALTHTRACK as well. Thanks for joining us.


CONSUELO MACK:  And Happy Holidays.

RUPAL BHANSALI:  Same to you.

DAVID ROLLEY:  Thank you very much.


CONSUELO MACK: As we close out this edition of WEALTHTRACK, we want to share some holiday gift suggestions with you as well. There have been several excellent business/investment books published this year that our Financial Thought Leaders and others have recommended. They might be worth putting under your tree. I know I want them under mine- hint, hint!


One is Walter Isaacson’s biography, Steve Jobs. Everyone I know who has read it has been mesmerized. And as Mae West used to say, goodness had nothing to do with it. Another much mentioned favorite among investment pros is The Signal and the Noise by Nate Silver, a now famous political analyst who tackles the art of prediction and his thoughtful approach to it in a wide range of areas from economics to terrorism to weather, baseball and the markets. Finally, behavioral economics is making more and more sense. Who better than Nobel Laureate Daniel Kahneman and his new book Thinking, Fast and Slow to help us understand how we think, react and make decisions in all phases of life including investing. I am looking forward to reading all three.


And of course check out our WEALTHTRACK bookshelf with books we and our guests have already read and in some cases authored, on our website, Speaking of which, in the next couple of weeks we will be upgrading our website and adding more content and features from our exceptional guests and sources. We look forward to your comments and suggestions as we roll it out. And that concludes this edition of WEALTHTRACK. Thank you so much for watching. Have a Merry Christmas and make the week ahead a joyous, profitable and productive one.

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