Of Mutual Interest

Taking on more risk may still be a bit dicey

By Mark Jewell
Associated Press / March 14, 2010

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Steven Romick admits to a potentially unhealthy habit: internalizing anxiety from Uncle Sam’s surging budget deficits.

“You’re talking to someone who just doesn’t sleep well at night,’’ the manager of the $2.8 billion FPA Crescent Fund says.

Romick fears that the nation’s mounting debt will eventually become a major drag on the economy and corporate earnings. In the short term he suspects the economy may prove to be in much worse shape than we thought, once the government’s stimulus measures wear off.

But if troubled sleep has left Romick drowsy, you wouldn’t guess it from the impressive numbers FPA Crescent racked up last decade. The fund’s average annual return was 10.7 percent, versus a 1 percent loss for the Standard & Poor’s 500 index in what was mostly a lost decade for stocks.

Romick’s record impressed Morningstar so much that it named the 46-year-old one of five finalists for its domestic stock fund manager of the decade award. (Fairholme Fund’s Bruce Berkowitz won the title.)

FPA Crescent has the flexibility to buy stocks and bonds, and it’s not unusual for Romick to move heavily into cash when he senses markets may be overheated. In fact, during its nearly 17-year history, the fund has held an average of 25 percent of its assets in cash, and around 50 percent in stocks. That helped soften the blow from market downturns.

These days, Romick is playing plenty of defense, due to his worries about deficits, the economy, and inflation. The fund’s portfolio was nearly 37 percent in cash as of Jan. 31 — nearly as big as the 42 percent in stocks listed in the latest holdings report.

Here are excerpts from an interview with Romick on investment risks and opportunities:

Q. In your letter to fund shareholders in January, you wrote that investors who became so afraid of risk after 2008 seem to have dropped their fears in the bull market that started last March — you wrote about an “illicit love affair with risk assets.’’ What did you mean?

A. Risk has come back into the marketplace, and people are no longer scared. Their love affair with the stock market seems to have been renewed, their faith has been restored. And I think that faith is not entirely well-founded.

The risk in the system is tremendous. It doesn’t mean things are going to go to hell in a handbasket any time soon. But we’re still running a fairly leveraged system. The consumer is still overleveraged, banks still overleveraged. We haven’t broken the logjam of risky assets at the banks. Commercial real estate is one large asset class that has not really been dealt with yet.

Q. So do you think the market is headed down?

A. If the world is all fine, I think the stock market will do fine. That’s because it’s not expensive by historic measures — particularly given the low interest rates today. However, we think there still is a lot of risk to corporate earnings, because we don’t know how well the economy is really doing.

Q. How might the economy fare once government stimulus measures wear off?

A. It’s as if your child has flu, and you’ve given them Motrin to bring their fever down. Once that wears off, then you will know whether they are feeling better, if there is still a fever. But while their fever is muted or has disappeared temporarily because of the medication, that doesn’t mean they’re well.

We don’t have any idea really what kind of shape the economy is in, because there’s so much medication in the system. I feel like we’re just guessing, it’s all a game of guesswork right now. I tend to invest capital when there is not a lot of guesswork.

Q. How does the federal government’s heavy borrowing affect your outlook?

A. Debt is going to inhibit our growth. We think overall economic output is going to be lower than people expect in the future.

We’re selling a little bit of our country to foreigners every year as we sell more and more Treasury debt. So we believe Treasury rates are going to go higher, with or without inflation, which is rare.

Mark Jewell writes about personal finance for the Associated Press.