News and commentary

RightSide Commentary -Internationals

By Vivian Lewis
Updated: Wednesday, August 20 2008 01:08:PM

 

Frida Ghitis writes:

   "Turmoil in the markets will no doubt cause many investors to retreat into familiar territory, shying away from non-US investments, and sticking with well-known companies. If you listen to one of the smartest investors working today, however, that would be the wrong approach. The world is changing, and the time has come to put most of our money beyond American shores, says a man with a spectacular track record, now overseeing hundreds of billions of dollars in investments.

   "According to Mohammed El-Erian, who until recently led the legendarily successful Harvard endowment and currently co-chairs bond giant PIMCO, we are not going through a run of the mill financial adjustment. This is a tectonic change and we need to position our money accordingly.
 
   "El-Erian recommends investing no more than a third of your money in U.S. equities. The rest should be divided equally between non-U.S. developed and developing countries. He has more specific guidance on what type of investments to choose, and ponders what will happen to banks.
 
   "El-Erian made his case in several interviews and in his book, When Markets Collide: Investment Strategies for the Age of Global Economic Change. Collision refers to a clash between yesterday's and today's markets. What we are experiencing now, he writes, is 'a gradual hand-off to a set of countries that previously had little if any systemic influence'.
 

   "El-Erian, the Oxford and Cambridge-educated son of an Egyptian diplomat, spent 15 years at the International Monetary Fund before seven years managing PIMCO's Emerging Markets Bond Fund. In 2006 he went to Harvard. Rumor is his family hated the weather in Boston. Or he received an offer he couldn't refuse from his former bosses and this year rejoined Bill Gross in sunny Newport Beach, CA as Pimco's Co-CEO and co-Chief Investment Officer.

     "El-Erian sees an ongoing chain reaction of economic and political events. American consumers battered by rising oil and food prices, falling home equity, growing unemployment, and tightening credit will no longer act as shoppers of last resort to rescue the global economy. Fortunately the global economy can survive despite U.S. loss of relative economic power.

      "Developing countries now have other markets, including their own. The growing middle class in Brazil, India, and China will demand products Americans stop buying. America's recession  will hurt the developing world, but much less than it would have done in the past. The current slowdown will affect everyone, but the U.S. more than others.

 
    "One unsettling corollary of rising living standards in developing countries is the return of inflation. For years impoverished workers in old 'Third World' provided cheap labor that brought down inflation in rich countries. That is now coming to an end, El-Erian says. So inflation is here to stay. Investors should prepare by investing in commodities, real estate, and inflation-protected bonds. Such investments should be made gradually, because commodities are volatile, as we have recently witnessed.
 
    "He divides banks in three groups: small weak banks will fail and be taken over by the FDIC, hurting stock- and bond-holders to protect insured depositors; medium-strength banks will be bought by stronger ones and equity holders may suffer while bond-holders do better; the strongest best-managed banks able to buy other banks and assets at discounted prices will do best. This is where money will be made.
 
    "El-Erian offers useful advice for individual investors from his experience running the $35 bn Harvard endowment. When he took it over in 2006, many doubted he could match the prowess of his predecessor, who racked up an average annual return of 16%. El-Erian surpassed it, bringing a 23% return last year (but one year is not a trend: VL).
 
    "The lesson from running an endowment, he says, is the focus on the long-term, much easier for an endowment that has to last forever. Still, the need to find lasting global trends without falling for short-term distractions is excellent advice. The bottom line: think long term and invest beyond the U.S."

         Vivian adds: Apologies to Mr. El-Erian and Frida for misspelling his name last week; I did spell David Rockefeller's right.

          However, I totally disagree with Mr. El-Erian's lessons for retail investors based on the Harvard Endowment experience. Unfortunately, we do not have huge wads of alumni money coming at us from in dollars from, among others, Mr. Rockefeller. Nor do we have 21st century plans to go global by opening campuses in Dubai, Barcelona, Singapore, wherever. So first of all, I think his 67% non-U.S. target for placing money is totally unrealistic for our kind of investors. And I am speaking as a long-term advocate of going global.

    Retail investors have to cover their needs at home, not splurge out in international risk. Unlike a huge fund or endowment, we cannot cover exchange rate risks cheaply. And as the present currency market shows, even the dollar has moments of strength. I would suggest that a maximum of 40% of U.S. investor portfolios be international, and that the emerging market part be a maximum of half the global total.

    Another El-Erian motif at Harvard was non-conventional investing, how he produced those impressive numbers. He used hedge funds, commodities, and real estate. Again, the message is misleading for most individual investors. As Frida points out, commodities can also go wrong. Hedge funds lost 2 1/2% on average in July, and that means some of them lost a lot more than 2 1/2%.

   Most importantly, few of us began investing in 1640 when John Harvard donated so much money that the new college took his name. Even wealthy families rarely last as long as endowments because people are less predicatable than overseers. Even Harvard has had a much more checkered management history than its hived-off investment arm, which is why Larry Summers was replaced by Drew Gilpin Faust.

    One Harvard Endowment theme everyone should put into their portfolios is closed-end funds selling at a deep discount. CEFs have made much money for my alma mater, and also for me and my readers. The current market malaise, ironically enough, has tended to reduce the discount because the share price have gone down faster than the actual decline in net asset value. This is true of both stock funds and bond funds in our model portfolios.

    With discounted closed-end funds, you are putting $1 to work for you for as little as 85 or 90 cents. Even if the discount remains forever you still get the growth and yield from the underlying portfolio, not what you actually paid for it.

    Overhanging the closed-end bond fund world now is uncertainty about the leverage strategy many of them follow, using Auction Market Preferred Shares. In fact there is no auction market for AMPS currently so many leveraged funds face a potential lien against their payouts to shareholders. This illiquid funding source has had to be replaced by other funding mechanisms like debt.

    *Our Aberdeen funds led the way in redeeming AMPS but now other funds are doing so too. (Please note that the CEF price and NAV data in our tables are not updating properly. The price of CEFs is determined by market trading so they can move to above the value of the portfolio or, more commonly, to below it. To track discounts and premiums, please use data at www.cefa.org or Barron's magazine and many newspapers. Our technical difficulties will soon become a thing of the past, but note also that stock prices are not showing correctly and that our performance is much better than appears.)