Of Mutual Interest

Conservative fund manager sees cause for caution, not alarm

By Trevor Delaney
Associated Press / May 24, 2009
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Mutual fund managers are human too. Their nerves can be frayed by a volatile market just like the rest of us.

"There's a difference between feeling emotional and acting emotionally," said Steve Romick, manager of FPA Crescent fund, "so my investment actions are clinical."

It's a calm reserve that you would expect to hear from the manager of a billion-dollar fund. Romick's Crescent fund is hard to categorize because he's allowed to buy stocks, bonds, and covertibles.

Managing the fund since its inception in 1993, Romick has posted a return of more than 9 percent though May 20, and a 5-year annualized return of 4.84 percent.

A fund manager with unusual flexibility, Romick recently sat down for an interview with the Associated Press. Here are excerpts.

Looking at all that's going on in Washington, D.C., and the recent rise in the market, where's your head at in terms of how you're processing this information?

There's a lot to process, because there are cross-currents. The government is making rules that they are changing and applying inconsistently, and it's scary. I feel like I'm at the blackjack table and cards have been played and I've made my bets. And the dealer hasn't finished playing his cards yet, and he looks at me and says, "Hey, the game is now 23."

Tell me more about what you mean when you say the rules are being applied "inconsistently."

I mean, Bear Stearns is saved, Lehman isn't. Rules are changing regarding student loans, there's health reform coming, there's a lot of different pieces to this puzzle. Some are rules that are changing, some rules are inconsistently applied; it's both. And then you've got the idea that the sanctity of contract law was subverted for the benefit of Chrysler unions. It makes me cautious at best.

Expand on that idea of being cautious. We've been seeing more about people slowly increasing their willingness to get back in the market. Are you feeling any more comfortable as of late?

Everybody's been using this term "green shoots." It's a term that's way too overused. What do people expect when consumer spending has fallen off a cliff in the fourth quarter and it's up 2 percent in the first quarter, well some of that is deferred spending. It's going to be a long bumpy road.

There are opportunities out there. As we survey the landscape, those opportunities aren't just in equities. They're in other asset classes like distressed corporate bonds. And that's where we've actually spent more of our time in allocating more of our capital in the last four or five months.

Your fund is included in Morningstar's moderate allocation category. What does that signify?

I can't speak to the moderate allocation category. But the Crescent fund is a unique fund. It's a fund that can go anywhere and do almost anything, though it doesn't do everything. The goal is to generate equity rates of return with less risk than the market. So the way we've accomplished that over time has been to buy corporate bonds as part of the mix. We do it across the capital structure: We'll buy common stocks, preferred stocks, convertible bonds, subordinated debt, senior notes, and bank debt.

By blending this portfolio together it ends up creating a portfolio that's less risky than the market.

For investors who are thinking about their own asset allocation, what's your portfolio looked like over the last year or so?

We saw a lot of this coming. We wrote about the "case for cash" in 2004, and started building cash at that time. We didn't own financial stocks because we were concerned about a lot of these issues that have manifested themselves. So going into all of this we were relatively well positioned - with cash in the portfolio, last September, of almost 40 percent. Now that cash has come down to the low- to mid-20s as we've put a lot of capital to work in debt.

So today we have about 37 percent long equities. We do have the ability to short stocks and we are 7 percent short, so net equity exposure in our fund is only 30 percent. And we also have a little over 30 percent in debt. And the debt in our portfolio had a yield-to-maturity, at the end of March, of 22 percent and change. It's clearly not a low risk portfolio. We look at this debt as if it's equity, we just think it offers greater relative value when compared to equity.

Within the stock market, are there sectors that you like?

We like energy for three reasons. We like the supply demand characteristics of energy. I haven't seen any dinosaur roaming the streets of New York, which probably means there's not more supply coming - on the fossil fuel side anyway. And there's this inexorable increase in demand over time, albeit with certain dips along the way due to the weak economies we have today globally. So we think demand will increase over time and we do believe supply will continue to decrease, so we like those characteristics.

But the way the government is using the dollar creates the potential for inflation. There's no guarantee, but that risk is there and oil will certainly be a beneficiary of that.

We also think there's going to be future devaluation of the US dollar against certain global currencies. Since oil is a commodity that is priced in dollars, as the US dollar weakens, the commodity is more expensive in dollar terms which is attractive for the investment that we have.

For investors who look at their fund portfolio makeup with, say, a large-cap fund, a small-cap fund, how does size factor into your investment decisions?

I look for good businesses that are inexpensively valued. I don't think about big versus small or medium. If you look at an office building, whether it's a 50-story building versus a 20-story building, it's the same analysis. It's really a function of what's the best risk/reward out there in the marketplace.

For the individual investor, they need to accept and expect volatility. If you don't you're going to buy high and sell low.

Looking ahead is there a key sign people should keep an eye on in terms of a turnaround?

I think employment is a very good indicator. The employment measure is different today than it has been used in the past.

We're looking at unemployment which is now at around 9 percent. But there's something that works in to the equation today that wasn't as important in other periods, in the recent few decades when unemployment was higher - which is underemployment. So you have people who want to work a 40-hour week who are only getting 28 hours. And that's not showing up in the unemployment number. But it will show up in retail sales. People aren't going to be able to afford as much.

Trevor Delaney is personal finance editor for the Associated Press