Please Note: Market opinions contained herein are intended as general observations and are not intended as specific investment advice.
MATHIAS: These are unusual times. What do you think investors should be concerned about as we look ahead?
BEATTY: This is a time to worry about risk and to be very careful about using borrowed money. The banking system is under a lot of pressure on its own balance sheets and is pulling back. Many of the issues have to be looked at in a global context. Americans in general, not necessarily people in Washington, are still getting used to doing that and it doesn’t feel very comfortable and they don’t like some of it …. But it is the reality. The Federal Reserve and the Treasury can pull levers that influence banks and influence corporations in the United States. Whether that influence is anywhere near as strong in places like Beijing and Dubai, where the United States has to borrow a billion dollars a day, is questionable. Some of the biggest decisions affecting our economy and financial system are now being made outside of the United States.
FISHER: Some part of the overall economy is sort of A Tale of Two Cities. Cosumers are overextended in many ways, particularly in the housing market, which is now going through a correction. Much of the rest of the economy is doing better than the headlines would have you believe. So far this year, the corporate profits of nonfinancial corporations are up something like nine percent. The upshot is that we’re in a stress test period, and our best guess is we’re not going to have a bad recession in the classic sense. They may not call it a recession, but we’re in an extended period – a year and a half, maybe – where two sides of the economy are going through different experiences, and it’s a very difficult environment to operate in and to invest in. Having said that, pay attention to quality, be careful about leverage, spread it around different asset classes and be a little bit on the conservative side. There will be some great opportunities developing out of this.
EISEN: We believe we’re in a period where we could see the markets virtually go nowhere over a 15 to 18 year period but with a lot of ups and downs in it. And, in fact, from the beginning of 2000 with the market down 46 percent and then up 70 percent, we’re still down since 2000. We saw this in the 60s, the mid-60s to the early 80s, where the average decline in the market was 25 percent and the average rally was 33 percent. The difference is that there are alternative investments available to a lot of people that have only been available to institutions and to the ultra-wealthy in the past: private equity.
FISHER: We’ve definitely seen one of the most interesting first quarters, I think, as it relates to the markets. Anxiety levels have remained pretty high among a lot of investors because of the volatility that we’ve experienced. The definition of recession has been debated and discussed recently, but I think it’s probably safe to say that we’re there. But I think there are many catalysts for eventual recovery to start to take root in the markets, and housing has worked off a lot of its excess. Monetary policy, as we have seen, has been a little more accommodating. Corporate health appears to be robust. And, as a result, many of the valuations within the market do appear to be compelling.
DANIELS: If you look at what’s going on in a global perspective, things are positive. Overall, global growth is expected to be about 2.6 percent, and it’s supposed to be about 2.5 percent in 2009. If you break out the established economies from the emerging economies, growth is expected to be about 6.5 percent this year and 6.2 percent in 2009. If you look at the United States, we have not seen out commercial clients having difficulty. People are growing, particularly companies that are doing business outside of the United States. Their businesses are achieving a natural balance because they are in more than one economy.
MATHIAS: Let’s deal with some issues facing a hypothetical individual investor of $5 to $10 million net worth, middle age …. What are reasonable return expectations in the environment that you forsee?
FISHER: Our clients are trying to preserve a wealth to support their lifestyle – and our minimums are $10 million, with the average client tending to be north of $25 million. With that in mind, we’ll construct a portfolio that accomplishes that by using all the major asset classes.
MATHIAS: What’s a reasonable return expectation over the time horizon that you’ve identified?
FISHER: We all got spoiled by fairly strong double-digit returns back in the late 90s, and I think we’re going to see a lot of volatility coming out for the next several years as the markets shake out. You can’t say with any kind of definitiveness what to expect.
EISEN: Most of our clients are between $50 and $70 million net range on the individual side, who are really not spending down principal for the most part …. The goal is to establish a target that will allow them to have a reasonable chance of meeting a spending policy of their own in retirement and still offer the ability to pass money on to the next generation. We do believe that returns are not going to be what they were before. We think that they’re going to be somewhat muted, possibly because of what I said earlier in terms of growing very quickly in value. [In terms of range], probably high single digits, seven to eight.
MATHIAS: When you look at a portfolio of your average client, what is the time horizon that you’re thinking of and what is a reasonable expected rate of return?
BEATTY: On rate of return, we claim no special expertise, and so I am going to wimp out and fall back on David Swenson, head of Yale Endowment, who has put a lot of thought into this. He says that we’re all accustomed to thinking in nominal terms. So when we say seven percent or eight percent, we’re talking about before inflation. When he thinks about returns, he is thinking about real returns. So when you read the Yale Annual Report or his books, he talks about why Yale tries to minimize their investment, say, in bonds; it is because when you look at the current coupons relative to any kind of historical guess about inflation, your real return today and for the last number of years has been very low, like zero. You throw in a little taxes, so we’re talking about real returns going from something like zero on good quality bonds, which doesn’t say somebody shouldn’t own some, but you’re not going to make a return there.
I think we’re in an upper single digit environment where it depends on the degree of risk you’re willing to take. The reason to hold onto bonds, for most investors, is stability of cash flow. It is one of the easy, dependable, and marketable ways you can do that. It provides sort of a cushion, or insurance, so that when you get the inevitable swings, you don’t swing as much. And, if it’s an extreme dislocation, maybe it gives you a secondary reserve where you can go shopping. So most people still have some, but I think for most of our clients, the percentage that you would have normally looked at in fixed income 10 or 15 years ago is much lower today.
MATHIAS: Historically, the old bank department rule was 60 percent stocks, 40 percent bonds.
BEATTY: And as you got older, they tweaked it.
FISHER: These days, traditional asset classes are not what you’re going to find with a majority of sophisticated investors – you see them reduce the fixed income exposure typically by using some alternative methods of investing, such as hedge funds, private equity, and others. Overall, you’re reducing risk and reducing correlation amongst each of the asset classes.
EISEN: Treasury bonds are clearly a safe place to be in a time where there’s turmoil.
MATHIAS: Do you think it likely that taxes will be going up over the next several years? Is that something that investors should think about?
FISHER: They’re not going down.
BEATTY: One hundred percent yes. If we have a Democratic president, along with a Democratic Congress, they’re going to come harder … even if McCain wins, under our constitutional structure, all money bills originate in the House of Representatives. The President gets to sign them at the end of the day, but Congress really has tremendous leverage.
MATHIAS: It’s just impossible for the candidates to do anything about the programs they’re talking about, much less the deficit. It’s almost inevitable you’ll have a rise in taxes …. Related to that, and related to some of the deficit, is inflation. Does it seem likely that inflation will be on the rise?
BEATTY: I had thought inflation was going to be on the rise for the last decade, and more or less, I’ve been wrong. A major thing happened in 1991, which was that the [Berlin] Wall came down and the Cold War [ended]. And the biggest consequence was that 60 percent of the world’s population had been cut off from the free, capitalistic, Democratic market. And so we overnight increased the workforce by a factor of two. The single biggest thing [that] has been rippling through and holding inflation down is this hue new workforce.
MATHIAS: If you were concerned about inflation as an investor, what would you do?
FISHER: Well, we prematurely thought we were addressing the problem. Over three years ago, we created a real return for all of our clients to participate in, just in a nominal way, 7 to 10 percent of their overall portfolio. And it allows us to invest in those aspects of the market that would tend to do well during inflationary times: agricultural products and industrial materials, precious metals and energy, infrastructure, and real estate. And we do that selectively, looking at the investment either from owning it outright, the commodity or the exposure outright, or owning companies that tend to operate in that arena.
MATHIAS: What are the mistakes or problems that investors have today?
EISEN: People can take too much risk and try to ride too much of the participation on the upswing of the market. If you believe, like we do, that you’re in a range-bound market with a lot of volatility, you’re not going to be rewarded for being on the up market, because you’re not going to know where to readjust on the downside. And we believe that most portfolios that are protected on the downside ultimately do better over time.
DANIELS: HBSC’s view is that global inflation is about 3.6 percent, but in the emerging markets, it’s expected to be above 6 percent this year and 5 percent next year, so it definitely is a factor. Our economists say it’s the worst performance since 1998, and it’s different this time, because the foreign exchange market at that time kind of … the exchange rate collapsed. This time that’s not going on.
BEATTY: The dollar has collapsed.
FISHER: Yes, but the weaker dollar provides a lot of advantages. U.S. competitiveness increases, exports are up 64 percent since 2002. Foreign investment in the U.S. has grown by 159 percent since 2002, and it has enhanced returns.
DANIELS: It also creates an opportunity for U.S. companies to look at exporting that didn’t exist in the past.
BEATTY: You’ve got to get more integrated into the global community or you’re not going to make it. I would say the two areas that we think we have the greatest opportunity in, and that everyone should be looking at, number one, is the whole globalization issue, which we think is a critical one. There is risk, but people are losing money in India, China, whatever. I don’t know exactly where the bottom is, but I’m a lot more comfortable thinking about it now than I was last fall, when everybody was pouring money in and everyone was starting a fund. So, basically, we think the rise of Asia is the biggest thing going on in this period in world history. And the second area [is] what has happened with the banks, the lenders. A year and a half ago, they would lend you 80 to 90 percent. Today, they’ll lend you 60 percent if you’re lucky, and you’ve got to guarantee the first 10 percent …
WASHINGTON LIFE: What are foreseeable problems from a CEO’s and/or CFO’s perspective that may come across in the future, and how can they avoid them – especially when expanding abroad?
DANIELS: The weakness of the dollar also creates opportunities for U. S. companies. From an exporter’s perspective, or a CEO looking to expand abroad and take advantage of the current weakness of the dollar, it is important that they look at various countries for business opportunities – especially emerging markets, which are growing as the U.S. economy slows. Diversification in a company’s revenue stream is as important as diversification in one’s personal portfolio.
