Issue 39 • august 26, 2009 Seeking All-Weather Investment Opportunities: Part I
Naturally, this is good news for investors who, last year at this time, were just beginning to feel the effects of the Great Recession. Much has changed for the better in recent months … interest rate expectations are low, inflation is falling, business productivity is improving, and even the much maligned housing market is showing signs of a pickup. This environment has been fundamentally positive for equities. But this is no time to throw caution to the wind ... there are still many clouds on the horizon that could disrupt the calm in financial markets at any time. That’s why, one week ago today, Sebastian Leburn, CFA, and Portfolio Manager of our successful Weiss All Weather Managed Account and I held our first ever online audio conference: Seeking All-Weather Investment Opportunities. We believed it was important to update investors on a wide range of topics, including:
At the end of this exclusive, live Webinar, we engaged our audience in an interactive question and answer session, to address some of their most pressing questions. Now you have the opportunity to access an exclusive online replay of the event by clicking here. Or to read the detailed insight and analysis we provided, here’s the first part of the edited transcript in this issue of Weiss Advice.
Seeking All-Weather Investment Opportunities: Part ISebastian Leburn, CFA, Chief Investment Officer, and Mike Burnick, Director of Research and Client Communications; Weiss Capital Management, Inc. Mike Burnick: Markets around the world have made substantial upward moves in recent months and economists are now forecasting the end of the recession, perhaps before this year is out. After the worst contraction since the Great Depression, recent evidence suggests that we are seeing some improvements in many areas of the economy, including manufacturing, and even in the housing sector. Now the question is: Are these positive developments enough to sustain a market rally over the longer term, and is the financial crisis truly behind us ... or, is this just the calm before the next financial storm? Most importantly, how can you build an all-weather portfolio to help guide your wealth through all market conditions? In this W ebinar, we hope to provide you with specific answers. Joining me today is Sebastian Leburn, CFA, and our Chief Investment Officer at Weiss Capital Management. Sebastian is a Chartered Financial Analyst, with a decade’s worth of experience at Weiss, and, of course, he’s also the portfolio manager for the Weiss All Weather Managed Account. Sebastian, in your view what are the key steps to building an all-weather investment portfolio?
Mike: If investors didn't learn that lesson early this decade, when the Nasdaq lost three quarters of its value, you certainly should have learned it last year when the Dow and the S&P 500 lost about HALF of their values. Sebastian: Just as bull markets suffer major corrections, bear markets are periodically interrupted by sharp rallies, and those rallies can last many months. Only time will tell if the March low proves to be a durable bottom or will be tested, and perhaps broken, at some point. But, the All Weather Managed Account is designed to take advantage of either outcome.
Sebastian: Taking an all-weather investment approach helps avoid the emotional ups and downs so you can stay better focused on your big-picture investment goals. However, this doesn’t mean abandoning the stock market altogether, but it doesn’t mean being fully invested all of the time either. Instead, we focus on more conservative investments that are somewhat shielded from the extreme mood swings of these manic-depressive markets. Of course, all investments are affected to some degree by volatile conditions. The trick is to minimize their effect. And our main goal with the All Weather Managed Account is to grow our client’s wealth at a reasonable rate, without taking unreasonable risks* to get there. Mike: In other words, you should consider a strategy that attempts to take advantage of challenging market swings, rather than a static investment allocation that moves up and down along with the markets. But in reality, many mutual funds and investment programs seem to be managed as if the only kind of diversification needed is to spread your money around in the various stock sectors — and only on the long side. What we’ve found is that this kind of narrow diversification doesn’t work. Sebastian: Virtually all stock sectors were hit hard in 2008, but there were some stocks that — while down — tended to hold up better than the average — some of these were the more conservative, high-dividend companies that we like to focus on. But you also need to diversify beyond stocks — to other asset classes, including bonds, gold and other commodity-based investments, and special situations too. Mike: Assets that are not correlated, or at least less correlated ... Sebastian: If you have a good balance of different kinds of investments, you can usually achieve better diversification than you would in a portfolio that's almost entirely made up of stocks. Mike: Some diversified portfolios that claim to be balanced maintain a fixed allocation to each asset class ... such as one-third in stocks, a third in bonds, etc. But the All Weather Managed Account is different ... Sebastian: Exactly. I think it’s a mistake to be in a static investment allocation like that, even more so in these highly volatile times. Instead, the Weiss All Weather Managed Account is designed for maximum FLEXIBILITY in asset allocation, which we shift in response to ever-changing market conditions. That way, our clients don’t have to worry about making constant portfolio changes. Instead, you can leave the active management up to us. Mike: This time last year, we were in the midst of a major market decline that was just about to take a serious turn for the worse, as it turned out. But over the past few months, markets appear to have turned on a dime. How are you navigating these wide swings using the All Weather Managed Account? Sebastian: The recent March bottom may have put a floor under equity prices — at least for a while, but even if we have seen the lows, there is still a possibility we’ll at least attempt to re-test those levels at some point in the future. What I’m saying is that it’s highly probable we will see more up and down volatility ahead. Perhaps not as intense as last September and October, but don’t forget: This downturn is unlike any we have seen since before WWII, so it’s likely that we’ll see turbulent market conditions persist for some time. This may be accompanied by more aftershocks as a result of this crisis.
Mike: Several bear markets in the past — both here in the U.S. and in foreign markets like Japan — have actually been much longer lasting, and also been even steeper declines than we’ve seen so far. Sebastian: That’s true Mike. And, even though our government has taken extraordinary steps to stabilize the economy — and it’s working to some degree now — we don’t know the unintended consequences these actions may have over time. And that could be with us for many years to come. Mike: With so many unknowns still, how are you finding interesting buying opportunities in today’s markets? Sebastian: Right now, we are moving very cautiously, given the 50%-plus run-up in the past five months — the largest gains in such a short period of time since the early 1930s. But every crisis ultimately leads to new opportunities that nimble investors can potentially take advantage of in their portfolios. In fact, the more wide swings — both up and down — we see in markets, the greater the likelihood that we’ll see mispricing develop in certain assets. And, mispricing provides opportunities. During the recent rally phase for example, we increased holdings — both domestically and internationally — in a number of our strategies. In fact, internationally, we see opportunities that are even more promising than in the U.S. Mike: In which international markets, specifically? Sebastian: Very few markets appear as compelling as Japan does today, purely from a valuation perspective. Like many economies in East Asia, Japan is a direct beneficiary of the boom in China. But, unlike most Chinese stocks, Japanese stocks still have tremendous relative value and can be bought quite cheaply. Mike: Japan’s economy has been stuck in a rut for about 20 years now and still faces many challenges…
Sebastian: That’s true. And I don't doubt they face long-term negatives. But, from a cyclical perspective, over the mid term, Japanese stocks look quite attractive for a number of reasons. First, its equity market has become very cheap during this historic b ear market, simply because practically everyone had written Japan off — it has been almost completely ignored by the investment community. Second, Japanese stocks have a recent history of bouncing back strongly from deeply oversold levels, which is where we are now. Mike: Yes, rallies of 50% ... 60% ... even 100% or more over a short period of time are not uncommon. So, from a contrarian perspective, this makes Japan interesting.1 Sebastian: In the All Weather Managed Account, we recently invested in Japan, using a diversified ETF, but we view this more as a cyclical trade, not as a long-term, “buy-and-hold” type investment. Mike: You also mentioned U.S. stocks — where in particular are you finding good buying opportunities today in U.S. markets? Sebastian: Selectively, we are finding good long-term buying opportunities across various sectors. Let me stress long-term here. With our Japan investment, we’re making a tactical buy, but with some of our individual stock holdings, we’re seeking out longer-term value, again, being very careful of the price we pay. Mike: Give us a specific example. Sebastian: Health care is one group that appears exceptionally attractive over the next several years ... not necessarily the next several months. Many great healthcare stocks have been pushed down, first because of the bear market in general, and more recently due to fears over the health care reform debate going on in Washington. Mike: You believe these worries may be overblown and already priced in? Sebastian: Yes, in fact health care is the only one of the 10 sectors in the S&P 500 Index that actually posted ANY profit growth last quarter. The health care firms we’re looking at have strong, stable cash flows. They also have exceptionally low valuations and pay very attractive dividends.
Medtronic2, for example, is one stock we own in the All Weather Managed Account, and in some other strategies. This company is a leading medical device maker and, for nearly a decade, it has expanded its sales 13% per year, while profits have grown nearly 12% a year, on average. Its dividends have more than tripled since 2000 and it just raised its dividend again in July.3 Mike: That’s interesting, since many S&P 500 firms are slashing their dividend payouts, but here’s a company still raising its dividend. How well do you expect Medtronic to perform in this economy?
Mike: So, you’re saying Medtronic can perhaps outperform the overall market by 40% or more over the next few years, according to your analysis? Sebastian: Yes, but as you know Mike, when it comes to performance, there are never any guarantees. Still, this is the essence of what we look for in ANY stock purchased for our managed accounts at Weiss Capital Management, Inc. We focus on firms with competitive advantages where we expect a return on investment well above the market over a three to five year period. And, if we are fortunate enough to own a stock that hits our target sooner, we may sell and move on to new opportunities. The same is true if our selection doesn’t appear to be on target to meet our expectations. Mike: This gets back to our proactive approach to managing your investments, rather than just buying and holding for the sake of holding. This is the same kind of common-sense, value-conscious strategy that has served us well for many years with the Weiss Balanced Program, for example. But after the big rally we’ve seen since March, isn’t it more difficult to find stocks that measure up to these high standards? Sebastian: You certainly must be more selective today than you needed to be a few months ago, but yes, I’m still finding attractive investments ... not just in healthcare, but also in sectors such as energy and consumer staples too. Any company that can survive a severe economic meltdown, as we’ve seen, while maintaining consistency in sales, profits, and dividends, should be well positioned to thrive as the economy rebounds. Mike: So, for the All Weather Managed Account, you’re investing in selected high-quality dividend-paying domestic stocks that should perform well even in a slow-growth economy and a low-return investment climate … Sebastian: That’s right. Take the recent rally, for example. For the most part, it has been a “low quality” rally, because the stocks that have run up the most are generally not sound companies. For instance, companies with a CCC-credit rating ... up +26.4% since early July, but many of these firms have problems because they are rated below investment-grade. Meanwhile, AAA-rated stocks have only risen 9.5% over the same period. This raises a red-flag in my mind about the durability of this rally.4 We’re also finding good opportunities in high quality corporate bond funds ... again, these mostly hold investment-grade bonds. As you know, Mike, the All Weather Managed Account is truly a diversified program with an investment mix that includes both U.S. and international markets — investing in stocks, fixed income, and even in commodity-based and other specialty investments ... Seeking All-Weather Investment Opportunities: Part IIMike: Today’s extremely low interest rate environment is very challenging for fixed income investors. Give us some details about your fixed income holdings in the All Weather Managed Account ... specifically what type of bonds look attractive here? Sebastian: In the All Weather Managed Account, our largest allocation at present, is a few carefully selected fixed-income mutual funds. We believe high quality corporate bonds look very attractive. In fact, corporate bonds have been the best performing asset class this year — up about 12% in total return. And in our view, high quality bonds may continue outperforming. We see even more potential gains ahead.5 Mike: Of course, investment-grade bonds are also considered less risky than stocks, while offering much higher returns than money market accounts, or even Treasury bonds.
But you must remember: Not all corporate bonds are created equal. So, we seek to reduce risk* by investing in diversified bond mutual funds, alongside some of the best bond managers in the business, those with solid long-term track records. Mike: Folks these days are also very worried about interest rates moving higher, perhaps accompanied by higher inflation. How can investors take steps now to protect themselves? Seb: As Warren Buffett has said, “It is certain we’ll have more inflation over time.” And we agree! But, perhaps NOT overnight, in our view. Washington and other governments around the world are printing a lot of money to solve this crisis. But right now, consumer prices are actually lower than they were a year ago. That's not exactly runaway inflation. Inflation is not an immediate concern, but likely will be at some point not too far off. Mike: So, it’s not a question of “IF” but “WHEN” inflation becomes a problem again?
Seb: Yes, that’s our view. We will certainly have to pay the consequences of this massive government spending down the road, but we don’t believe it will necessarily be tomorrow, or next week, or even next year. Still, we’re prepared for the return of inflation at Weiss Capital Management and in the All Weather Managed Account strategy. Mike: How? Seb: We own mutual funds that invest in Treasury Inflation Adjusted Securities, or TIPS bonds, which can provide protection. We don’t view “runaway inflation” as a major near-term risk, but one way the All Weather Managed Account could benefit — if and when inflation becomes a bigger concern — is from our ability to effectively sell short long-term Treasury bonds using inverse funds designed to profit from a sharp Treasury bond market decline as interest rates rise. Of course, this is also a key part of our Weiss Bear Strategy, which is a component of the All Weather Managed Account. Mike: Sebastian, we have received a number of questions from investors concerned about the falling value of the U.S. dollar. Let’s hear your view.
For example, international equity and fixed income mutual funds or ETFs are a couple of ways. When we invest internationally** — either in stocks or bonds — we typically select investments that DO NOT hedge currency exposure. Mike: In other words, the securities within an international fund or ETF are priced in a currency OTHER than the U.S. dollar, which provides an automatic hedge. Seb: Right. Another way is to own domestic companies with substantial overseas sales. These stocks can actually benefit from a weaker dollar, because the sales earned overseas by these multinational firms are worth MORE when converted back into cheaper U.S. dollars. Mike: We have another question about commodity holdings. Commodities are historically a good diversifier for a fixed income and stock portfolio. And, of course, commodities tend to offer an inflation adjusted “real return” that can also provide you with a hedge against a declining dollar ...
Emerging markets have seen a rapid rise in their living standards in recent years ... in spite of the global recession, and so growth has continued at a strong pace in countries like China and India. We believe demand for energy, metals and agricultural commodities will keep increasing over time. Mike: And you already have the All Weather Managed Account positioned for this bullish secular uptrend in commodities, don’t you? Seb: We do. Because of the risks involved in futures contracts, we prefer to invest in commodities through mutual funds or ETFs, which provide more diversification. In fact, one of our “best ideas” that we’re holding right now is a mutual fund that tracks a commodity real-return index. We believe this is a great long-term special situation investment for our All Weather Managed Account and other Weiss strategies. Mike: Helping protect investors from another sharp stock market decline is a big part of what we do at Weiss and in the All Weather Managed Account strategy too. We haven’t had to be as sensitive to this concern during the last few months, but another important question is: How are you preparing NOW should markets roll over again this year, or next?
This is why the All Weather Managed Account continues to hold some hedge positions — using inverse mutual funds to protect our long investments AND aim for short-term capital gains should markets suffer another big sell off. Mike: But investors buying inverse funds or ETFs, on their own, could be exposing themselves to potentially much greater losses than they may even realize because many of these funds are not designed to be held over the long term. Seb: The number of ETFs on the market has expanded rapidly, and many leveraged and some inverse ETFs are only designed to achieve their objectives on a daily basis. That means the effect of compounding can negatively impact their performance over longer periods of time. As professional money managers, we’ve been using inverse funds for over a decade and are very experienced and diligent about which inverse funds we choose. But you absolutely should NOT buy these inverse funds and then forget about them.
Mike: In past bear markets, we have seen sharp rallies that were often mistaken for new bull markets, but markets eventually rolled over again into another downtrend. How will you attempt to take advantage of the next broad market declines in the All Weather Managed Account? Sebastian: When our technical and fundamental signals tell us to expect a decline in either stocks OR bonds, we purchase inverse mutual funds to potentially earn gains as markets fall in value. But, when our signals turn positive, we proactively close out our inverse holdings or reduce them. This is similar to our Weiss Bear Strategy philosophy, which is an important part of our All Weather Managed Account. Our primary goal in creating the All Weather Managed Account is to offer a flexible strategy with the ability to be defensive when necessary, to help protect wealth during prolonged market declines, yet also offer the potential to grow your portfolio consistently when markets move higher. That’s why we refer to it as an all-weather strategy ... it’s appropriate for the full market cycle ... both ups and downs. Mike: How do you decide the ongoing percentage allocation to each portion of the All Weather Managed Account? In other words, since this program is a blend of the Weiss Balanced Program and the Weiss Bear Strategy, then how much money gets allocated to each? Seb: There are many factors that go into our allocation decisions. For the stock market, I use both a valuation model to capture the long-term perspective and a technical model for short to intermediate-term trend changes in the market cycle. When BOTH of these models are favorable for stocks, we reduce the weighting to the Bear side, and allocate more money to the Balanced program. Mike: And when these models are both negative? Seb: This would signal a potential market decline ahead, so we reduce the weighting on the Balanced program, in this case, and boost the Bear component. Remember, the All Weather Managed Account is not designed to be fully invested all the time for maximum capital appreciation, because doing so would also entail much higher risks — on both sides of the market. Instead, it is designed to minimize volatility as much as possible, because wild swings in portfolio value can often lead to losses for investors who are impatient. But even in a confirmed bear market, the Bear component of the All Weather Managed Account will rarely exceed 50% of the portfolio — it’s a way to hedge your other investments — not a way to go all-out short. Mike: When your signals indicate that it’s time to get more defensive, how do you switch emphasis within the portfolio? Seb: More often than not, most large, efficient markets tend to move in long-term cycles — or trends. As these cycles shift from bullish to bearish, most of the long-term trend can be captured with some consistency. My point is this: We don’t try to anticipate or “guess” turning points in the market. Instead, we prefer to wait for some confirmation that a new trend is emerging and then invest accordingly. We proactively manage the All Weather Managed Account to shift our asset allocation incrementally, over time, in an effort to stay a step ahead of ever-changing markets. Mike: In other words, you’re making every effort to achieve a smoother and steadier ride, without big swings in account value ... either up or down. Seb: Yes, many investors I speak to have seen enough up and down market volatility in recent years to last a lifetime ... our primary goal is to provide consistent returns without taking undue risks and to avoid wide swings. But, let me add, this doesn’t mean we’ll make the right move, every time! There is always potential for loss in every investment strategy. Mike: Agreed. Some questions we received indicate a bit of confusion regarding how the All Weather Managed Accounts are structured. For example, I have heard some folks refer to it as the All Weather Fund or the Weiss Bear or Balanced “Funds,” but I think it’s important to point out that our managed account strategies at Weiss are not mutual funds, where your money is pooled with other investors and shares of the fund can be bought or sold each day. Seb: That’s a great point and it’s an important distinction. All of the strategies offered by Weiss are managed with your specific goals and objectives in mind. And each client has a separate account, set up in their name, with our custodian, Fidelity Investments. The investments we make on your behalf – each mutual fund, ETF, or stock we buy, is held in your individual and private account. Mike: Sebastian, thanks for taking the time to share your thoughts and update us on the All-Weather investments you’re making now. Seb: My pleasure Mike. One last point: Since we launched this program in June, we’ve only allocated a modest portion of new money in the All Weather Managed Account due to the extended nature of this market rally. But we are ready to put more money to work just as soon as attractive investment opportunities appear ... perhaps even at lower prices than today. Editor’s Note: This concludes the final portion of our transcript – but it’s only the beginning of exploring the investment opportunities we see ahead. To learn more about the investment moves were making now in the All Weather Managed Account AND for all of the professional investment programs we offer at Weiss Capital Management, please feel free to contact us directly. Importantly, please keep in mind that the investment ideas and forecasts we discussed in this exclusive online Web conference are highly time-sensitive in nature, and subject to change in today’s turbulent markets. For this reason, a replay of Seeking All-Weather Investment Opportunities Webinar can only be kept online for a short time. To view the complete Web conference now, while it’s still available, go here now. To learn more about the Weiss All Weather Managed Account, you can also request a copy of our special report: The Weiss All Weather Investment Guide by going here. As always, for immediate answers to any of your questions, please contact one of our financial advisors by calling: 1-800-814-3045. Until Friday, good investing!
Important Disclosures: * All investments carry risk, the All Weather Managed Account strategy is no exception. It is possible to lose money by investing in this strategy. Before investing, please review all strategy materials & the firm’s ADV Part II. ** International investing presents certain risks not associated with investing solely in the United States. These include, for instance, risks related to fluctuations in the value of the U.S. dollar relative to the values of other currencies, custody arrangements made for foreign holdings, political risks, differences in accounting procedures, and the lesser degree of public information required to be provided by non-U.S. companies. Forward-looking: This article contains forward-looking statements regarding intent and belief with regard to the program and the market in general. Listeners are cautioned that such statements are not a guarantee of future performance and actual results may differ materially from those statements. Securities: Discussion about the prospects of any specific security is based on the opinion of the Portfolio Manager and should not be construed by the listeners as a specific recommendation to buy or sell the security. Potential earnings estimates are based on information available at the time of this broadcast and actual results may differ materially from those statements. Commodities: The risk of loss can be substantial with commodities. To help reduce risk through diversification, Weiss Capital Management utilizes commodity-based investments such as exchange traded funds (ETFs) or mutual funds. The value of the ETFs or mutual funds relates directly to the value of the underlying commodities. 1 BCA Research Global Investment Strategy, 6/5/09 Disclaimers: 1. Weiss Advice is a publication of Weiss Capital Management, an SEC Registered Investment Adviser. Weiss Research is a separate, but affiliated publishing company. Both entities are owned by Weiss Group, LLC. 2. "Weiss Advice" is published for general information and educational purposes only and should not be construed as a specific recommendation to buy or sell any security. Specific recommendations can only be given to advisory clients of Weiss Capital Management, with the benefit of knowing their financial condition and suitability. Receipt of this publication should not be construed as a solicitation to do business outside the jurisdiction for which the Firm is approved. Currently, Weiss Capital Management offers investment advisory services to individuals maintaining legal residency within the United States. For details, please contact the Firm. View Weiss Capital Management's Privacy Policy. To make sure you don't miss our urgent updates, add Weiss Advice to your address book. Just follow these simple steps. |
In recent weeks, we’ve seen even more evidence of a rebounding economy and stocks have gobbled up the good news by continuing a robust rally ... now at +50% from March lows. 
Our overall market and economic outlook ...
Sebastian Leburn: The first step is to recognize that blindly buying and holding a so-called "diversified" portfolio, regardless of valuation, could be a recipe for disaster in today’s markets. 
Mike: The size of these volatile mood swings ... plunging last year and then surging over the past several months ... just shows how emotionally driven this market is … Whatever you do with your money, don’t get caught up in this emotional roller coaster.
Sebastian: We’re looking for average annual returns better than 10% over the next five years. This compares to our outlook for market returns of maybe 5-7% per year for the S&P 500 Index over that same period. 
Seb: That’s right Mike. Today, you can earn a yield of around 6-7% in high quality bonds. That’s 3% more than long-term Treasuries and substantially better than cash. The bottom line is this: Corporate bonds have expected returns nearly as high as stocks AND with much less expected volatility along the way. 
Seb: At Weiss, we are very sensitive to the U.S. dollar, because so many clients who come to us naturally have the bulk of their assets denominated in dollars. And there are multiple ways you can potentially benefit from a dollar decline. We use a number of techniques in our investment programs. 
Seb: That’s right Mike. Commodity investments historically move up in value with inflation ... OR as the dollar moves down. Commodities are also quite attractive to us on a fundamental supply-demand basis. 
Sebastian: We’re ALWAYS watching for signs of a market reversal. Recently, we’ve seen some signs of growing complacency among investors. For instance, the CBOE Volatility Index is down to its lowest level since last fall, just before the huge market decline. 
