Episode #281: Adrian Helfert, Westwood Group, “We’re Fundamental Investors And Multiasset Investors That Can Look Across The Capital Spectrum”
Guest: Adrian Helfert is the Senior Vice President and Director of Multi-Asset Portfolios where he leads Westwood’s multi-asset strategies group, which includes the flagship Income Opportunity fund.
Date Recorded: 12/9/2020 | Run-Time: 48:41
Summary: In today’s episode, we’re taking a look at all asset classes. Adrian explains what he seeing in the world, from fixed income to equities and TIPS. We talk about how to earn income in a low interest rate environment through MLP’s and REIT’s, and why TIPS are an attractive insurance policy against high inflation. Then Adrian guest explains his view of the energy sector, gold miners, and the impact of low rates on growth stocks.
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Links from the Episode:
- 0:40 – Intro
- 1:27 – Welcome to our guest, Adrian Helfert
- 8:06 – Westwood’s investment philosophy
- 10:09 – What Adrian sees as the current state of the markets
- 13:37 – How Adrian approaches fixed income investing over the next 5 years
- 18:07 – Thoughts on TIPS
- 20:12 – Dynamics of equities in 2020
- 24:07 – Case study for how he analyzes a stock
- 26:10 – Outlook for REITs and the real estate market overall
- 29:08 – Investing in gold miners
- 32:19 – Sentiment in Texas
- 34:06 – What excites him going into 2021
- 36:48 – The Meb Faber Show – Episode #172: Cam Harvey, Duke University, “This is a Time of Considerable Risk of a Drawdown”
- 38:04 – How Westwood approaches fees
- 40:17 – Most memorable investments
- 43:56 – State of corporate bonds
- 46:48 – Post pandemic bucket list
- 47:31 – Connect with Adrian: westwoodgroup.com
Transcript of Episode 281:
Welcome Message: Welcome to the “Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com
Meb: What’s up, friends? Great show for you today. Our guest is the director of multi-asset portfolios for Westwood Group, where he leads all sorts of strategies like income opportunity, flexible income, global convertibles, and fixed income strategies. In today’s episode, we’re taking a look at all the asset classes. Our guest explains what he’s seeing in the world today, from fixed income to equities and TIPS. We talk about how to earn income in a low-interest-rate environment through MLPs and REITs and why TIPS are an attractive insurance policy against high inflation. Then our guest explains his views on the energy sector, coal miners, and the impact of low rates on growth stocks. As we start to wind down, we talk about Westwood’s unique approach to fees. Please enjoy this episode with Westwood Group’s Adrian Helfert. Adrian, welcome to the show.
Adrian: Thank you for having me.
Meb: Let’s get the awkwardness out of the way first. You’re a UVA undergrad so wahoowa, but also a Dukie. Where does your allegiance lie now? Virginia, the Cavaliers are the champions still, despite losing to San Fran State or something in the first couple of games of the year. Who do you cheer for when you go to a game?
Adrian: They’re all in the ACC and I have to cheer for my undergraduate allegiance, for certain. I am very much a supporter of their basketball program. And still remember the day that Kyle Guy hit that three-pointer to close off into the semi-finals to get into the finals. I’m fanatical about that. The Duke basketball program is awesome. It’s great to go see, especially in Cameron, but UVA takes it.
Meb: I’m a Wahoo through and through, and my favorite storytelling podcast, listeners, was any other ACC school, you had to like camp out for a week to get ACC tournament tickets. But at UVA, if you’re a student, you could just like walk up and get them and then we’d immediately drive down to Charlotte or Greensboro or wherever it was, sell them to the Duke fans for like $1,000 or something, which to a college kid may as well be a million dollars. Watch the UVA playing game because we were always terrible back then and then go home. It was my introduction to arbitrage across terrible and good teams. But we got a good team now. So, no complaints. So, like everyone else in the world, you now live in Texas or moving to Texas. You got Elon soon to be a neighbor. But let’s see, you got UVA, Duke, stint navy, marine, London, and then Texas. Give the quick two-minute overview of your background. How did you get to Texas and where you are now?
Adrian: I joined the military as a military medic prior to going to college, that’s how I paid for college, did it out of service duty even though it’s hard to look back and think why. I went back to the University of Virginia in 1994. So I was that 21-year-old in college that everybody likes to know, for obvious reasons. Spend my four years there studying physics, thinking I was going to be a physicist, all the way up until my final semester when JP Morgan came on campus to interview my roommate, at that point, for an investment banking job and said, “Why don’t you come out to dinner with us?” Me, of course, being a poor student, I said that’s a free dinner. And at the end, they said, “You seem like a reasonably bright character. Why don’t you come to New York City,” where I’d never even set foot in before.
So I went in as a physics student having…you know, I’d worked on linear accelerators, I was going the full route. And therein lies the brain drain, as they say, “Well, you know what, you can make more money here than you can make in 10 years as a physicist.” So, I thought I’d do it for a year and then go back but here I am still doing it. So I came out with my physics degree, went to New York City, worked for JP Morgan Asset Management after 9/11 really. I decided to go back to business school at that point. And so went back to do business school. While there, I worked in asset management in fixed income because I’m a mathematically-oriented guy generally, and did my two years.
There’s a longer story that takes way more than two minutes. Prior to business school, I’d taken some time off to travel and I met my now bride who was living in England. So after business school, I moved over to Scotland, worked in Scotland for the Royal Bank of Scotland for a guy named Fred Goodwin, who used to be a surfer, a good one, but had his title removed. He’s now the pariah of the banking industry there. And then came back to the United States in 2006 to work in asset management and managed funds. I’ve been managing funds here in the United States since that time, moved back and forth across the pond a couple of times. And then just to, kind of, summarize that up, the last point was I was at Amundi Asset Management in London where we’ve got a global fixed income unit there. I was the head of global fixed income for the United States and got offered a job I couldn’t refuse with Westwood Asset Management. And so I moved back here in January of 2019, myself and my family, love the heat.
Meb: There’s a lot to unpack there. First of which is, I was an engineer at Virginia, and they just demolished the Stacks I saw, or renovating it, which had a lot of fondness. But you were a couple of years before me and I remember very distinctly going to college and not studying business, but this would have been the late ’90s, everyone being obsessed with stocks because this was the internet bubble. I mean, I had engineering professors checking stocks during class, talking about stocks. And I remember it so clearly. IPOs were the big thing then, and now it’s SPACs. Do you remember that at all? Was that, sort of, mid-’90s too early for the boom to really catch up the full euphoria of the moment or was it a part of it even when you were there?
Adrian: Oh, really well. I came out and I graduated in 1998. And I feel like similar to, you know, the so-called hemline indicator of markets, there’s also that indicator of recruiting attire. And in 1998, we were nascent bubble there going in and I could have come into an interview in shorts and a t-shirt and been perfectly fine for…everybody wanted to be the cool company of you don’t have to wear a suit and tie here. When I got to JP Morgan in 1998, all meals were subsidized, breakfast, lunch, and dinner. You could wear business casual every single day. Within a year, you could, kind of sense things were changing because they cut the subsidy by half.
And suddenly, you know, you start putting less on your plate because you actually have to pay for it, which is probably a good thing. And it’s business attire except for Fridays, and then by the crash, of course, no meal subsidized and you’re wearing a suit every day because you want to keep your job. I remember it well, certainly during that period of I came out in ’98 when it was recruiting into tech was the cool spot that you could go in and wear a t-shirt and shorts and just be smart.
Meb: Now everyone can wear t-shirts and shorts or pajamas or whatever the work from home attire is. I walked into my closet the other day and I was laughing because I have this entire rack of dress shirts and suits that I don’t think I’ve worn in 11 months at this point. Because there’s no weddings or any reason to dress up either. Hopefully, 2021, we’ll see. So you’re now located in Dallas, are you guys in the Crescent hedge fund investment center?
Adrian: Yeah, we are just across from the Crescent Hotel in what’s called the Crescent Building. Look out over Dallas, which is a nice little area. So we’ve got a financing coming. You mentioned earlier that Texas is where everybody seems to be going. We had that news this week of Goldman potentially going down to Florida but the subtext was if not Florida, maybe Texas. A lot of companies looking to dates and locales where there’s a decent financing, a decent educated populace, and no tax rate.
Meb: Last time I was there, I’m a big Broncos fan, Broncos played Cowboys. This is the Peyton Manning, Tony Romo game where they both scored like 60 points, but was at Crescent, I remember very fondly as well. So I’m sure walked past you in the hallway or the coffee shop in the morning. Tell us about Westwood. What’s y’all’s philosophy? You manage a few different funds and strategies there, which we can dig into, sort of, your ideas, but tell us about the general framework for how you guys think about the world?
Adrian: Well, we’ve long been a quality-oriented philosophy on the equity side. So if you know Westwood is a firm with value-oriented funds in quality as being one of the defining characteristics of that, looking for growth at a reasonable price when we are looking at growth as well. So we’re looking for good realization of cash flows. I work on the multi-asset side, I run our multi-asset unit. And multi-asset, of course, means I’m blending in across the capital structure, across the quality spectrum. And when I say across the quality spectrum, that means lower quality things that are priced well and higher quality things that are also priced well into an overall fund that provides some defensive characteristic, as well as the capital appreciation upside.
Overall is we’re fundamental. We’re looking for those that are under-appreciated as far as what their revenue streams might look like, what the impact of a catalyst might be, how well covered their income stream is, their dividend yield is. When I look at everything I hold, I classify everything I hold into those three categories of capital appreciation. Are they under-appreciated? Is there something that is missing to…? Howard Marx actually, who I really like, is an investor talking about one of the major things that is a component of investing is finding what the error is in analysis and everybody’s analysis. It provides a nice segue as far as, yes, it’s an efficient market.
What I’m looking to doing especially in Microsoft, which is super-efficient, what’s everyone missing? So that’s capital appreciation. What’s everyone missing? It’s an under-appreciated revenue stream. And then I look for event risk, obviously, where it’s under-appreciated, whatever M&A environment, how attractive this asset is or what synergy realization. All this stuff you’re hearing really is we’re fundamental investors and we’re multi-asset investors that can look across the capital spectrum to say, “We can use this underlying fundamental data to generate a signal for tactical asset allocation in the markets as well.”
Meb: Talk to me, in general, we’re winding down 2020, super weird year. What does the world look like to you today? Is it an area of opportunity? Is it an area of danger? Is there quite a bit of dispersion where there’s both? I was just reading and tweeting about Vanguard’s outlook, which is pretty subdued. I said the average pension fund expects 8% and Vanguard does not have a single asset that they expect to return over 8%. And the average investor expects 10% and in some cases 15%, which we saw on a recent survey. What’s the world look like to you? You’re an optimist? You’re a pessimist, something in between?
Adrian: Something in between, but probably skewed more towards the optimist side. I’m that Ray Dalio of we’re going to see ratio straight up to 50 times, which is what we saw recently. It’s more along the lines of yes, we have had inordinate policy stimulus, both monetary policy and now on the fiscal side. So much so that a lot of people are saying, “Well, how do we pay it back?” Because this Ricardian principle of we’re going to reduce our spending in order to meet our future tax liability, I don’t think that’s the case, I think we are in a place where we are going to spend ourselves into prosperity and worry about the bills later. That’s the indication that we’ve been given. That’s what a lot of the market now is predicated on is we’re going to see anchored interest rates. If it’s steepening interest rate curve happens to negatively impact the markets. It’s doing so but only on of style perspective of bringing Tesla’s and other things of the world now.
Then the Fed will come out and do what it’s done previously. The old playbook was to push down the interest rate curve and facilitate the wealth effect. I think there’s positivity to be had. I think there could be a big disparity between asset classes. And gosh, we’ve seen some incredible returns from fixed income. As interest rates, of course, dropped, they provided the insurance policy that risk-free interest rates or fixed income can do. I mean, you buy government bonds really for two reasons. You buy it for the income component. Well, the 10-year interest rate right now is 93 basis points. I can tell you why that might be attractive relative to real rates or certainly our European or Japanese counterparts, but it’s still low. So there’s not much income, and you buy it for the insurance policy. The insurance policy is when things go crack in the night on the equity markets, then your bond prices go up and your interest rates go down because prospective growth goes down. And they are proxy for nominal prospective growth.
With them so low, you have to be thinking for any kind of symmetry, meaning how much further can they go down if things go crack in the night? Then you have to be thinking as a possibility almost at negative interest rates at some point. I do think that is a possibility more than most, even though we’ve been telegraphed that it’s too much even by Chairman Powell, who said it’s too much financial plumbing problems to have that right now. I think it’s a tool in the toolbox, which provides…just thinking about it provides the symmetry of the insurance policy of holding fixed income and investors’ portfolio. But still, we’re not going to see the returns of the past in fixed income. It’s going to be low returns there with better returns on your equity performance.
And I think this coming year or next year, we’ll be talking much, much more about alternative implementations of that insurance policy. So whether it is gold or whatever is driving Bitcoin, whether that’s irrational exuberance or because it’s potentially an alternative kind of currency, we’ll be talking a lot about that. How do you blend out assets in order to…for an investor that’s looking at that whole allocation, how do you build a portfolio that provides that pension return of 8%? Is it inclusive now of fixed income or not?
Meb: The fixed income is a debate that I’m consistently hearing more and more of from advisors, in particular. Many advisors historically had a really large chunk, traditional 60/40; it’s darn near half the portfolio in something that resembles treasuries and their ilk. It’s funny you mentioned the possibility of negative because I was joking on Twitter a month or two ago when I was reading “Barron’s,” and they did a traditional poll that said, “Here, what do you think are most likelihood of bond yield?” I forget it’s the next year or next three years. It was a traditional distribution rates going up but negative wasn’t even a choice. So, I kind of smiled and laughed because we both know that it’s at least possible, whether it’s probable or not. But maybe dig a little deeper on how you guys think about fixed income in the next five years. Is it you still include treasuries for various reasons? Do you shift more towards quality corporates or go out in the curve to emerging market sovereigns? What does it look like? What does it mean to you guys or is the whole sector is just a waste of time?
Adrian: The old paradigm does shift. I’ll step back and say your comment does remind me, in the global financial crisis or just pre, when you go to the FHA website in about 2006, 2007, they had a spot there for homeowners to go calculate the affordability of home mortgages. And you had a place where you could calculate the expected appreciation of your home. And if you put in below zero, not on price appreciation but on price depreciation, the engine broke. The unexpected is one thing that causes biggest financial turmoil. You have to think that similar thing now of, “Gosh, we’ve dropped from nearly 2% at the beginning of the year down to 90 basis points because we saw that over the course of 3 weeks, something like a 30% drop on the equity market.” Well, we’re back above that in the S&P 500. You could talk about sectors and various things. But if we see another crack, a big drop, you have to believe in asymmetry in interest rates to say that that is not going to happen again. Because if we go down 100 basis points, we’re going to be below zero.
You asked a very good question around where does this push you if you’re not excited about earning 90 basis points on a 10-year U.S. Treasury or extrapolate that to whatever? One reason why it is what it is, one reason why they push that out, why they push down the front end is, of course, the portfolio balance channel. And that portfolio balance channel does exactly what you’d suggest, which is, gosh, I’m just not excited about earning nothing on my cash, I’m going to extend out to intermediate treasuries. Gosh, I’m not excited about intermediate treasuries, I’m going to go into investment-grade corporate bonds, extrapolate that out to pushing into I’m not excited about putting in Microsoft corporate bonds, I’ll go into emerging market sovereigns. Or not there, maybe I go into dividend-yielding equities because that’s really attractive looking right, on coverage, relative to the rate I get on my corporate bonds as well.
That portfolio balance channel is still in effect, that’s not broken. So, where will it push people? It will push people into emerging markets. I think there’s a very good prospect for emerging markets right now. That’s the effect of stimulus. That’s the effect of the portfolio balance channel. That yield-seeking behavior that we’ve seen over the last 11, 12 years, guess what? It’s back in force, I do see the prospect of investors getting pushed back out. What that doesn’t do for you, it does not provide you with that insurance policy that we talked about. So investors need to think about, “Well, if they take themselves out of fixed income because they’re just not excited about earning that 90 basis points on a 10-year U.S. Treasury and they put it in emerging market sovereigns, and we see a crisis, of course, they’re going to be negative.
Whereas maybe you think about alternative ways to do that, you think about whether gold miners or anti-correlated assets or even equities with good dividend yield that have good coverage are a better place to be relative to your overall portfolio mix that is inclusive of equities. I’m starting to think that route of pushing my equity exposure and mixing it with my fixed income exposure in a way that provides me with more income but hopefully, there’s a similar amount of insurance policy.
Meb: I was just thinking as you were talking, particularly talking about emerging market bonds and depending on where you characterize them, one of the Mount Rushmore trades of the past decade has got to be buying Greek bonds when they were in, like, 2009. I mean, I think they were trading at like 30 percentage points or something yield, and now they’re essentially close to darn near zero, and then Portugal and on and on, which is astonishing change of affairs of yield and some of these sovereigns. How do TIPS play a role? Do they? Is that something you guys are interested in, or that a balance to the Treasury allocation or something that’s not that interesting?
Adrian: TIPS do still play a role in our service in the Treasury inflation-protected securities. You know, I watch these every day because the indication of those is the expected inflation rate, five-year expected inflation price by chips right now is about 1.85%. I do not see high inflation coming in the near term. I do see the prospect of you need this insurance policy on. And gosh, that protection right now against high inflation, with as much liquidity as we have pumped into the environment, that protection is reasonably cheap. I hold some Treasury inflation-protected securities in my portfolio. Another one where I think there are assets that are attractive, I think a lot of people are going to be pushed into dividend-yielding equity. Because what you know about equities is, it’s effectively a real rate product. Your dividend yield on an equity on yielding equity, they’re real dividend. That goes up with equity prices. And equity prices can act in a real manner.
So I think there’ll be a rotation away from TIPS a little bit in that realm, as we’ve got anchored interest rates and uncertainty on the nominal side. But it’s still a good indication. And if we see prices rise significantly in core CPI, that’s what you get compensated for directly in the rate of those. It’s still a reasonably attractive rate, but it’s low. I mean, our target is 2% from the Fed, was up until they enacted average inflation targeting. They’re letting the economy run hot and targeting jobs more. And what they’re effectively telling us is not that they’re going to let it run hot so much as they’re not worried about inflation right now because they just don’t see it as a prospect.
Even with all this money flowing about…is sucking it up and we’re not seeing the velocity of money. We’re not seeing the rotation of money and consumption in a way that would generate inflation. Until we do, let’s focus on jobs and unemployment as supporting the economy. They play a role, their protection is cheap. I think what could happen in the coming year or so is that investors may get pushed into dividend-yielding equities because that dividend yield, people forget, is a real yield.
Meb: Let’s talk about stocks, in general. Is the U.S. Stock Market broadly interesting to you? If not, are there pockets that are particularly out of whack or interesting? I’m thinking as a local Texas guy, nothing has seen more absolute punishment than energy sector, which was down around like 2% of the S&P versus a peak of, I think, close to 30%. What’s the U.S. stock world look like you? And feel free to put this in context of 2020, as well as the course of the year and how your views may have changed. Anything looking good, terrible, in-between?
Adrian: One of the big dynamics has been this has impacted energy and financials. I mean, with energy, obviously, there was the impact of in February, Saudi Arabia and Russia had their spat, which basically just released the information that we could get on the supply side. We didn’t know that demand was going to be impacted by COVID at that point, we just knew that supply was going to become unhinged. We didn’t know what that was going to look like. That was a big knock on energy at a time when we saw it potentially coming back. We’re still kind of there. We have OPEC plus that needs to think a little bit further. And it does introduce a risk premia in energy prices, generally, that get reflected across. There will be opportunity there. The other thing that has impacted them has been the value versus growth style trade. What’s happened there, in large part, has been that as interest rates dropped so precipitously, given COVID and nominal interest rates effectively following economic growth rates as well as being pushed down logistically by the Central Bank in the frontend, is that just think about your general discounted cash flow model.
You think about those companies that are earning cash flows or profits, not today, but in 5 years and 10 years. Think Workday and Splunk, and these very growthy companies that have wonderful prospects, yet they’re not realizing cash flows today, they’re realizing them in the future. If I’m a discounted cash flow modeler, these are the, you know, so-called growth companies. I’m a discounted cash flow modeler, then I take that lower rate and I discount those cash flows and with a lower discount rate, which that makes them more attractive. The lower discount rate means that with a higher discount rate, it’s like I buy a hamburger today is worth more than a hamburger tomorrow. But when interest rates are near zero, hamburger today or hamburger tomorrow is worth about the same. Thus growth companies became really attractive, and not because they were going to grow at a faster rate, because those far in cash flows were becoming more attractive with a low discount rate.
What’s happening now is that we’re seeing the interest rate curve steepen. We are seeing interest rates go up and 10-year yields that are going up and expectations that are going up. As that happens, of course, the value of those cash flows comes down. It’s not that we are losing economic growth, but the value of those cash flows are coming down. And so days like today, that’s exactly what’s happening is U.S. interest rates are up a little bit and growth companies are coming down much more than value-oriented companies. So you think Home Depot, companies that are selling things now and generating profits now and much more discounted now as opposed to what their growth rate looks like in the future.
So you ask about one of the big stories of 2020, that’s one of the big stories of 2020, and it’s precipitant. That was 2019 and ’18 as well; these growth companies were doing really well relative to value. And I think in 2021, that’s something that the market will be very watchful for. This is a much more extended conversation than around what would drive interest rates up in economic growth. And if we get a fiscal package that’s a strong fiscal package that pushes expected growth rates up and subsequently the proxy of nominal interest rates up, then that rubber band that has been really stretched of value underperforming growth could snapback. We could see value performed really well because the discounting of those cash flows achieved far in the future on the growth companies, cash flow’s worth less, not that economic growth goes down.
Meb: Who might be some examples of stocks or securities or investments that might be good case studies, just so people could put a face…ticker to a name, ticker to an idea, or sectors, any way to illustrate exactly who might be a good candidate for, kind of, what you’re talking about?
Adrian: It’s always tough to play a ticker out because my compliance department then listens and gets on me. But just generally, think, let’s look at the tech sector. Maybe you look at the typical work-from-home tech sector. You know these names I just mentioned, some of them, things like Workday and Splunk, or Zoom, you and I are on Zoom now. And I’m going to date myself and say, quite honestly, I’d never heard of Zoom before COVID. I also never used Uber Eats. So things that are all of a sudden becoming more attractive, well, that’s more growth but they also…they’re looking at deploying a lot of capital into becoming the lifeblood of the new economy and new efficiencies. So they’re achieving cash flows much further in the future. Those are growthy companies, things like those that are looking for new economic growth and new paths for which we haven’t adopted yet but everyone, kind of, sees the light.
And you see these companies that are IPOing, that are IPOing with negative earnings but, of course, they’re coming out with crazy valuations. Got the pick of the litter there. Whereas when you think your lifeblood value companies, these value companies are the old mill, this is the stuff that we’re purchasing now. They are the traditional ones are what we call a cash cow. They are milking their customers now for earning profits and hopefully doing so with a good service that is right now appreciated. That’s why, you know, I mentioned companies like Home Depot fit that bill of if you have, just as an example, not a recommendation, those kinds of companies that are making sales now, generating profits now, doing well now, and servicing an economy that exists right now, not so much predicated on future growth. That’s the realization of near term cash flows. That’s been a big dynamic that I think it’s under-appreciated to a lot of daily investors.
Meb: You guys do a handful of other sectors that I think would be interesting to people in general, and we’d love to hear just any general 10,000-foot thoughts on some of them. One example that, again was also demolished, but very…not homogenous sector. There’s all sorts of different types, is real estate, and certainly for REITs being a pretty big sector of the U.S. economy investable. Is that something that looks attractive to you guys, do particular areas look attractive? Is it close your eyes, hold your nose, stay away, stinky? What does the REIT space look like?
Adrian: I think the REIT space is going to be very attractive. And it’s going to be very attractive because it’s actually separated out into different types of real estate investment trust. You have the REITs that are focused on malls, and that’s really social aggregation. That is brick and mortar when I could go online and do it. Did that pull forward our transition to going online and saving time and doing it? Or are we going to go back into malls? For those kind of REITs, there’s a big question, which creates inefficiency, which creates investment opportunity. I want to tell you that I think that there’s investment opportunity there. They’re providing a very good yield. We’ve been dealing with coverage on several of these.
And the big question in the room is, are malls dead? I mean, there’s a whole website that just lists dead malls around the world. Is that kind of socially aggregated shopping dead? I really don’t think so. I think that myself and my friends or my wife, my kids enjoy the aspect of going out and picking over things. And it’s not about trying it on, I’m comfortable that I can order something on Amazon and if it doesn’t fit and it back quickly. It’s about walking around, discussing things, pointing at things, going to the Starbucks next door, maybe hitting the doughnut shop if they’re lucky, my kids. There’s an aspect to it that is much larger than just having to buy the item and having to try it on. That makes that retail sector of REITs still attractive and downtrodden. I think there’s an attractive opportunity there.
Other stuff that’s out there are like storage REITs, and industrial REITs, and medical REITs where your doctor sets up their shingle so they can see you as a patient. By and large, you still need to go see your doctor in their office. I mean they have online, but they still want to be able to take your temperature manually, and you need to see your doctor. Storage has obvious implications. And we saw that after the global financial crisis of an economic downturn that was more elongated, storage became really attractive. Those areas, they weren’t a flash in the pan, they’ve done well. They provide decent yield. They’ve been reasonably defensive.
I think we’ll see a rotation away from some of the defensive into the reopening, and the reopening is more of that retail kind of trade. You’ll need to pick…investors will need to pick over very well the style of retail trade, the style of REITs. There will be those that are impacted by maybe some of the regulation from the new administration, as well, given that you’ve got healthcare REITs, and it’s quite a differentiated sector where you’ve got a differentiated impact with the healthcare REIT, or a storage REIT, or a retail REIT.
Meb: So you got a couple of other categories in there, MLPs, royalty trusts, I see even a gold miner or two. What do those look like? What’s the thesis there?
Adrian: Gold miners are catalysts. We’re a fundamental investor at heart. So I can tell you why our individual selection’s undergoing a joint venture, which they’re going to realize synergies and various other things. But the gold miner selection is looking at the underlying yellow metal and saying that that underlying asset that drives the bottom line is attractive. Historically, I haven’t really been a gold investor. It’s hard to value, hard to look at supply and demand metrics on something that has little industrial usage. It’s a historical association with inflation, a historical association with systematic risk.
One of my old professors, Cam Harvey at Duke, just published on gold and the potential for that historical association on inflation to maybe not be as strong in the future as it’s been in the past. I tend to think that investors are looking for an alternative asset for protection. And gold still provides that, that store of value, which historically has been a primary driver for the gold miners. And obviously, getting in there is the importance of finding those that you think have the important catalysts and the underlying cash flows and the resilience of balance sheet to manage what is the volatility of the underlying asset.
You asked about some others, which are master limited partnerships. Generally, these MLPs are like a real estate investment trust, it’s a regulated income stream. So you got a certain amount of regulated payout of your profits, which means for these, the ones that are still out there and haven’t converted themselves into a C Corp…because there was quite a push because of some of the accounting dynamics to move into C Corp structure. For these master limited partnerships in the energy sector, what’s the driver there? It’s energy and assigning the right mechanics and to know whether this is an energy pipeline-oriented company or one that is much more a holder of what’s in the ground. We’ve been focused more on the pipelines. And that’s, kind of, a defensive play of looking for those that have pipelines that also facilitate that gas as well.
Because you asked about energy earlier, the secular trend for traditional energy, it’s not great, it’s hard to ignore that when the value of Tesla is, you know, it’s down 7% today, but $600 billion market cap, that’s giving you a pretty big signal right there of traditional energy prospects in the future. Looking for things that are still resilient in this, provide good income stream are very important. It’s going to be interesting for investors because I talk a lot about this potential push that we’ll see the portfolio balance channel and a yield-seeking behavior. Do investors that are pushed into yield, are they going to be pushed into MLPs and REITs, or really MLPs, where it’s a secular downtrend, is what it looks like, but they provide such attractive yield, or does it make emerging markets a little bit more attractive?
I tend to think emerging markets are a really attractive asset class generally, especially in equity. It’s something that I do look at, but MLPs are something we invest in, and I’ve been pushing it more towards the pipeline element where these are facilitating as opposed to priced primarily on the underlying, what comes out of the ground. And I like those that have the ability more on the natural gas side, as well.
Meb: What’s the general mood in Texas from a state that, on one hand, you have a very energy dominated population? On the other hand, it seems like all the demographics, everyone wants to move to Texas this year. Is the mood subdued? Is it okay? What’s the general vibe?
Adrian: I’m going to guess that if you ask the guy from Austin, a gal from Dallas, and a guy from Houston, you’d probably get three different answers. You know, as you know, Austin is where Elon Musk is making his home and we’re seeing, you know, a lot of the tech. Houston is, of course, really energy corridor dominated. The mood is probably a little bit more downbeat there. Dallas has got reasonable tech in its industrial center, but it’s still a lot of energy well that is here. But broadly, I’d say the mood is positive, we see an inflow of economic activity and populace coming in. And I mean, just like the overall country, GDP, if you think about what drives economic growth, one of the key factors of economic growth drivers is population growth.
In Texas, we’re seeing that, we’re seeing an inflow of population that are increasingly coming here because of, I think, low tax rates and no state tax. Maybe that’s a preface to, and I mentioned earlier, that I don’t really necessarily think that in the near term, we’re going to see this so-called Ricardian principle. Ricardian principle is the idea that people restrain spending now because they expect higher tax rates in the future. So they need to meet that liability in the future. Maybe this is the preface to that Ricardian principle that corporations, companies like Tesla, like Goldman Sachs, are now with a movement to a low tax rate area, Florida and Texas, in the expectation of higher tax rates elsewhere.
Meb: As 2020 winds down, and you look out to the future investment world, what are you excited about? As we look out to the horizon next few years, you talked about emerging markets, which I echo your optimism on that as an asset class, what other things that you’re thinking about? Are there any risks that you think are underappreciated or any opportunities you think people aren’t realizing, anything else generally on your brain?
Adrian: Always lots on the brain. And I’d say, you know, the exciting areas, especially primarily investing in domestic markets, are…because a lot of underappreciated areas in financials. We didn’t talk about financials, but after every single recession, what do you see happening with the interest rate curve? Interest rate curve, I should go back to Cam Harvey because he fashions himself as a discussion point around the interest rate curve when it drops to zero historically, that means the recession is coming. And funnily enough, you could almost say that the 2-10 interest rate curve going below zero predicted the coming of COVID. Because we just went below zero and here we had a short recession.
After every recession, what do we see? We see that economic growth in the future potential rise, which pushes up that nominal interest rate. So you see the interest rate curve rise. For banks, that means higher net interest margins. They can make more by…what do they do? They borrow short and they lend long. In doing so, lending going at a higher rate and borrowing at a lower rate, that helps their overall income. That’s a positive for banks. And you might actually look and say, a lot of times I think cycles are…it’s not just a vanilla economic cycle that goes up and down. It is a financial cycle and industrial cycle, financial cycle and industrial cycle. We just saw a financial cycle. And we saw Dodd-Frank that came out of that. And I think suddenly, well, pieces of Dodd-Frank came out smelling like a rose because they cleaned up a lot of balance sheets where that was helpful.
So financials came through this reasonably well, I’d say financials came through this well. We don’t have the mass loan defaults on the balance sheet, we didn’t have the liquidity on the balance sheet. Even when we saw the prospect of treasuries that were a bid-ask of two basis points during that March 9th week when things were really cracking, the Fed stepped in. So financials came into this in a better place and is one of the three big categories that is still underwater for the year. Financials and energy are still not up on the year for financials, low-interest rates, the low-interest rate curve, that does not help. As I said, value has not been a high performer on the year because growth has been a better performing asset class. So when you look at the S&P 500 headline level, a lot of that’s driven by your big 5 in there, shortly that will be one of the top 10. I think that there’s some excitement to be had there that sector.
Meb: I was just nodding as you’re talking about Cam because I was thinking about the podcast, and he’s such an awesome guy, also so prolific. My God, how does he put out so much research on so many different topics? I remember him talking about the yield curve inversion and thing, he successfully predicted all these recessions. And we don’t know what may be the cause of this next one. I’m sure his detractors will say, well, you could never have predicted a pandemic. But hey, it was right, again, chalk it up to another positive outcome for that indicator.
Adrian: I’ll tell a quick Cam story, he’ll probably be mad at me. I consider him a friend and we still communicate because he was not only my professor for one of the greatest classes I had called Global Asset Allocation at Duke but he also worked and a little bit helped hire me at my last firm, and we worked together on various projects. So he and I know each other well. I sat next to him on a plane on a flight to Chicago or someplace, I just remember him going through academic papers at a rate of about a page every 10 seconds. I mean, it was where I read these things and I have to look at the formula and I probably take my pen and I try and do something. He’s prolific not only in his writing, but in his reading, he absorbs material unlike just about anybody I’ve seen, or at least he reads it, I think he absorbs it. I can’t absorb it that…He’s a lot of fun to work with, a really, really thoughtful investor.
Meb: You guys manage funds, separate accounts, all sorts of good stuff there. You guys have a unique feature. I don’t know if I’ve seen before, at least the way that it’s described, regarding fees. Can we talk about that, y’all’s his approach to fees?
Adrian: Our approach to fees, and this is not on all funds, this is something that we have championed with some others as well that have been in this … What you really want out of your asset manager is you want to incentivize them in the right way to stay active and to look for opportunities and to create alpha. And how do you do that? Well, you financially reward them. And when, myself as an investor, I have a bad year, my investor doesn’t want to pay inordinately over what effectively they could over an ETF or something because they’re like, “Gosh, I could have made that in an ETF.” Well, you know, I’m active, and so I take risks. And over the full market cycle, what I expect is to provide my investors with excess compensation over an index, whether that’s a cash index or it’s some other index.
So we have, let’s say… there’s others. Peter Kraus is one of the notables that has had some success on creating fee paradigms that say, we call it sensible fees. And that sensible fee is a very low base fee but with a performance fee attached. Not all of my funds, but on some of my funds, I have this fee set up that really ensures that I’m excited every day to try and create alpha and I don’t have the adverse, I don’t have the mal-incentive that if it’s just a base fee of…well, you know, I’m not too worried because whatever the assets are, just gather assets, and I make money on those assets, the same fee for all those assets. Let’s be real, at the same level of assets and I have more return, I want to benefit and I want our investors to benefit as well. So it aligns our interests as investors and asset owner.
Meb: Number one thing I think we talked about so much is so much in our world is driven by incentives. Having people on the same side, not just investing but really almost any service business or partnership creates much better outcomes than particularly ones where they’re conflicting, which so much of Wall Street is in general. Adrian, as you look back, you’ve managed money professionally for a long time, and also personally. What’s been some of your most memorable investment, good, bad, in-between, anything come to mind?
Adrian: I’ve had my share of great ones and my share of misses. I think you learn from all of them and then you learn over time. I’ve had my share of memorable investments on both sides of that, looking back at things like Verizon…I’m a multi-asset guy, I look at both equities and bonds and commodities, and I use a derivative or a cash instrument to try and achieve my overall target goal. On the corporate bond side, you know, we’re often looking at companies that come to finance and markets. And when they come to finance and markets, you’re a lender, you’re going out and you’re lending them money, even if I’m one of a million other lenders that I’m just giving them a million dollars and they’re borrowing $5 billion.
And I do remember specifically Verizon coming out when they did that, at the time, it was the largest investment-grade issuance, and I think that was…I’m going to put it 2010, 2011. And they came out with a $15 billion deal for which when stuff like that happens, you just load the boat, as we would say, they’ve provided enough excess compensation. And so when I’m thinking on that side of the house, the capital structure, corporate bonds, it’s I’m trying to value excess compensation as default compensation. What’s the possibility that Verizon is going to default? How much should I be compensated for that? And then if I’m compensated above that, I have excess default compensation. The excess default compensation was so large on a corporate bond that we really put an order, I think it was for 100 million bonds for a very, very small fund and just hoped that it would hit. Then you, kind of, fast forward to how that helps you start thinking, what we saw in that March 9th week really. I remember because I was supposed to…on March 8th was that Sunday, and I was watching the futures markets on a Sunday night, and they were down 6% on the S&P.
Meb: Never a good sign when watching futures on a Sunday.
Adrian: No, it’s not. It’s a sign of addiction is what it is. But I told my wife to cancel the vacation, you just kind of know when things are about to get oily. We cancelled the vacation. But that March 9th week when things got bad, and you just knew the old playbook was going to come out, and companies were coming to finance in the markets at rates that were extraordinary and extraordinarily above any way I could get to the possibility that they could default. AT&T was one of those that they were pricing in something like a 10% chance of default in the next 5 years. This is AT&T, and it could happen. It’s just not that default probability. And so the excess compensation is so extraordinary that on a bunch of these, we got involved.
And then, subsequently, of course, the Federal Reserve, the Central Bank, did what they needed to do, which was step in and say not only are we going to buy agency mortgage-backed securities, we’re going to buy corporate bonds as well, effectively providing some rap for guarantee. Not really, but providing some support, I should say, to corporate bond valuations. It’s one where you learn from and I spent a lot of time evaluating that. It’s very memorable because of how much compensation was there. And then it makes you salivate when you see the same opportunity happen again, you know, fast forward to the now.
On the equity side, there’s quite a few of…especially, you know, most people would point back to the internet bubble because everybody had their, kind of, favorite that they were getting involved in and pick your internet bubble, kind of, stock that was going to grow at whatever rate forever and it’s valued at…because you’re not valuing time to earnings. You’re valuing it at price per click. Probably that experience, without naming any particular one, does shape as well how I look at some of these now that are coming out. I mean, we’ve had…Uber’s out as we’re talking, and Doordash and others that these are very growth-oriented and how do you evaluate these? It’s just about taking away from those that helped me, kind of, evaluate in the market now.
Meb: What would corporates look like now? I mean, that’s a pretty widespread pretty different time than we see now where corporates are darn near inflation levels. And in some countries, you can issue corporates at essentially zero, which is odd, certainly. What does the corporate landscape look like to you? Is it attractive, not attractive, insane, in-between?
Adrian: Some countries, you can issue corporates at negative rates, which is truly odd.
Meb: It hurts my brain. They didn’t teach us that at UVA.
Adrian: No, they did not. We’ve achieved now, on average, investment-grade corporate bond, the index trades at about 100 basis points, about 1% over a match maturity, risk-free U.S. Treasury. So you get compensated for an extra 1% for going out lending now to X company that’s investment-grade, which is skimpy. It’s not much. And if you think about a histogram of how often that occurs, we’re about the 24th, 25th percentile, 75% of the time, you get compensated more than now, 25% of the time you get compensated less than now is where we are. Where we came into this is we came into this with less consumer leverage, less consumer balance sheet concerns, with less financial products leverage, or I think less hidden leverage, we’ve kind of seen that.
As I talked about, the differentiation between financial and industrial cycles. We have seen industrial leverage pickup though. Industrial leverage is not low. If you’re looking at debt to EBITDA to earnings, still it’s higher, but it’s not as high when you look at that interest coverage, which is now how people look at it because you can be higher leveraged if it’s lower interest rate because you can manage your liability stream better. I think it’s we’re getting down to that level where it’s not that attractive in corporate bonds land, back to what I was talking around, or equity dividend yield on many of these is so great compared that it’s hard not to get more excited about an equity dividend deal that is something like six times the relevant Treasury yield, which is very high on average. So I’m not that excited about corporate bond valuations.
I am pushing down…and it sounds funny to say, but I’m still pushing down a little bit in quality, which means I think high yield has some attractiveness left. And part of that is because the leverage of those companies remained a little bit more restrained. And because you still have investor leverage capabilities, you have high savings rate, people are going to push into risk, and you’re going to see that portfolio balance channel at work, that’ll be a bigger beneficiary. We’ve already seen it where the Fed has come in and provided this rap to the investment-grade side in large manner. So on the investment-grade, corporate debt side, pretty skimpy right now. When I get paid, oftentimes I’m looking to rotate that around to earnings yield on equity, or push down in quality. And maybe that’s by force, maybe that’s the portfolio balance channel at work.
Meb: What are you most looking forward to when everyone’s vaccinated and the world returns back to normal, you got anything high on your to-do list?
Adrian: I’m looking forward to going back over to Europe visiting my wife’s family. I’m looking forward to hugging friends and family. I was thinking the other day, there’s going to be some interesting things that come out of…even the people that sell the shirts that are going to say, “You can hug me now.” I’m just looking forward to social aggregation.
Meb: This is someone who went to school in the South, this has got to be hardest for the Southerners, a very touchy part of the country. Hugs, kisses, everything in-between. I mean, it’s particularly tough, almost like the Italian family as well. Live music for me and seeing a movie in a movie theatre, those are two big ones. I’m ready for both of those. So knock on wood. Adrian, where do people…when they want to see what you guys are up to, follow your writing, keep up with what’s going on your brain, where do they go?
Adrian: So they go to our website, and we maintain our writing, my writings, or these videos and this podcasts, I’m sure, will be posted on our website. We’ve got a content feed as well. So if you follow our LinkedIn, we post everything there. I’d love to hear from people as well that have alternative opinions.
Meb: Well, you’ll definitely get some of those. Adrian, thanks so much for joining us today.
Adrian: Yeah, thank you for having me.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us an email at feedback@themebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.
