Insights & News

October 2012
Investment Outlook

With Little Faith In Fed, Advisers Plan Accordingly

Dow Jones Newswires Interview with J. Michael Martin


By Daisy Maxey, posted Friday, October 5, 2012 by the Editors of Dow Jones Newswires

The Federal Reserve's latest stimulus action may have buoyed the markets a bit, but some financial advisers have little faith that it will heal the economy. These advisers now are repositioning client investments to leverage against what they predict will be a new phase of slowing growth and higher inflation. "I think it [the Fed's move] is going to have minimal impact," said Janet Briaud, president of Briaud Financial Advisors, a College-Station, Texas-based registered investment adviser that oversees about $490 million in assets.

"The big story is the deleveraging story. We think the Fed acted with a massive easing just because they feel something wrong is going on; it says to me that they're very worried about the future." Just after the Fed announced the latest quantitative easing on Sept. 13, Ms. Briaud added Treasurys to clients' portfolios as 30-year Treasury yields moved to 3.09%. The portfolios had about 10% each in intermediate-term and longer-term Treasurys, and she bumped the longer-term portion up to 15%. Ms. Briaud holds Treasurys for appreciation, not income, and says she made 30% last year on 30-year bonds. "We believe the long Treasury bond [yield] will go to somewhere around 2%, which would mean nice appreciation," she said.

But she's not fond of stocks now. She reduced stock holdings to 25% of clients' portfolios in 1999, took them out of stocks completely in 2007 and they've remained there. While she missed the rally, the portfolios have made money elsewhere, including gold and limited partnerships that invest in natural-gas royalties, she said. "We won't go back until we feel that our potential rate of return is at least 10%," said Ms. Briaud of stocks. "The risk is always that you can lose 50% or more." John Gugle, an adviser with Charlotte, N.C.-based registered investment adviser Alpha Financial Advisors LLC, which oversees about $63 million, believes the Fed's latest round of mortgage-bond buying is adversely affecting the nation's long-term economic health. He expects a sharp rise in interest rates over the next five years as the same pressures that have pushed rates up in Spain, Greece and Italy ultimately manifest in the U.S., he said. In an effort to shield client portfolios, Mr. Gugle increased their alternative investments and reduced bond holdings in late September. Previously, clients in his balanced or market-neutral allocation had 50% in equities, 35% in bonds and 15% in alternative investments.

Now, 50% remains in equities, but 25% each is in bonds and alternatives, he said. The fixed-income portfolios are now primarily made up of intermediate-term bonds, but Mr. Gugle has considered shortening the duration and using short-term bonds instead. In addition, he's mixing preferred and global bonds into the portfolios. The alternative investments have been spread across merger/arbitrage, long/short and commodity funds, but he's recently added real estate investment trust funds.

Michael Martin, chief investment officer of Columbia, Md.-based Financial Advantage Wealth Management, which oversees about $305 million, believes the prolonged  impact of the Fed's plan to buy mortgage bonds against a background of large federal deficits will be "pronouncedly negative." Suppressed interest rates create a disincentive to save and invest, which deprives the economy of a pool of private capital eager to fund risktaking innovations, he said. As a result, his core portfolio is structured for slow growth and inflation, with about 30% in equities; 41% in bonds; 13% in hard assets, mostly gold and some timber land; 9% in tactical strategies; and 7% in cash. The equity exposure is about half what it would be if valuations were better or the outlook was brighter, Mr. Martin said.

As for bonds, they'll be adversely affected if the inflation he expects arrives. To minimize exposure to interest-rate risk, Mr. Martin is keeping durations low and sticking to corporate bonds and adjustable-rate bank loans. Within the last three months, he shortened the portfolio's duration to 2.2 years from 3 years--which means that if interest rates rise 1%, the bonds' prices would fall by 2%. His bond portfolio has earned 6.5% so far this year, he said. The investments in precious metals and timber land are a defense against the intentional devaluation of paper currencies in the developed world, Mr. Martin said. As for the tactical exposure, he invests in two funds that are able to short—Pimco All Asset All Authority Fund (PAUIX) and Altegris Futures Evolution Strategy Fund (EVOIX). Mr. Martin said he wouldn't be in those funds if he loved stocks and bonds, both of which he called "expensive."

Daisy Maxey is a Dow Jones columnist who writes about matters of interest to advisers, including hedge funds, annuities, closed-end funds and new trends in mutual funds. Her columns are available to Dow Jones subscribers.


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