By Robert Powell
It’s one thing to be a pessimist. But it’s a whole ‘nother thing to make money in this market despite that outlook. Yet that’s exactly what three managers are doing these days, at least with some of their funds.
Jeremy Grantham, the chief investment strategist at GMO; Rob Arnott, the founder and chairman of Research Associates and manager of PIMCO’s All Asset All Authority; and the team at Sequoia are not the life of the party these days.
In fact, after reading their respective commentaries, you’re more likely to call your physician for a prescription for an antidepressant than to call your stockbroker with an order to buy something in this market.
Consider, for instance, just some of the pearls of despair in Grantham’s latest missive.
The euro zone, for instance, is a “terrifying situation” for which the only appropriate response is “surely to be more cautious that usual.” And, “the U.S., and to some extent the world, will not easily recover from the current level of debt overhang, the loss of perceived asset values, and the gross financial incompetence on a scale hitherto undreamed of.”
And then there’s this one: “…the U.S. in particular has rapidly acquired relative deficiencies over the last 20 years that will hamper the effective functioning and growth of its economy.” And this: “I despair that this country and its government have failed to take at all seriously the most important and the most dangerous issues: depleting resources, development of a comprehensive energy policy, and, yes, global warming.”
It goes on.
Despite that outlook, at least one of the funds in GMO’s family is doing quite well, thank you very much. The GMO Quality IV GQEFX +0.42% is up more than 10% year-to-date, while the Standard & Poor’s 500 SPX +0.32% stock index is down close to 1%.
How could that be possible, given Grantham’s outlook?
According to one analyst, it’s a matter of investing in the right stocks, mainly high-quality mega-cap companies with a history of paying and increasing dividends, at the right time. “Investors are flocking to these sort of companies because of the market volatility,” said Todd Rosenbluth, a mutual fund analyst at S&P Capital IQ Mutual Fund Reports.
And Grantham said this of GMO Quality’s performance: “We would normally count on winning in this strategy in a big down year, but in a nearly flat year this difference is a testimonial to how risk-averse investors have been at the U.S. stock level.”
What’s even better to note is that Grantham still considers U.S. high quality stocks to be relatively cheap.
Others, meanwhile, have a slightly different take on why Grantham, Arnott and the team at Sequoia are doing so well. It’s the best-offense-is-a-good-defense theory of investing. “By being defensive, you can stand out in this market,” said Kevin McDevitt, a CFA charterholder and a Morningstar analyst.
In Grantham’s case, that means investing, as Rosenbluth said, in mega-cap companies. For instance, the average market capitalization of a holding in the GMO Quality fund is $115 billion, which twice the average for large-cap blend funds, said McDevitt.
As for Bob Goldfarb and David Poppe, the managers of the Sequoia Fund SEQUX +0.58% , it might be hard to say just how bearish they might be. They’re bottom-up, not top-down managers according to McDevitt. But judging by the percent Sequoia has invested cash, the two managers are legitimate bears as well. Goldfarb and Poppe, who won Morningstar’s domestic-stock fund manager of the year in 2010, have 27% of the fund’s assets invested in cash and 73% invested in stocks.
Despite that composition, the fund is up nearly 11% year to date, a testament to the fund manager’s stock-picking ability.
McDevitt noted that Goldfarb and Poppe, in the style of Warren Buffett, have a knack for investing in companies that have a quality business and competitive advantage.
The top 10 holdings in the GMO Quality fund include Microsoft Corp. MSFT -0.04%, Johnson & Johnson JNJ +1.30% , Cisco Systems Inc. CSCO +0.17%, Philip Morris International Inc. PM +0.98%, The Coca-Cola Company KO +0.06% , Oracle Corp. ORCL +0.38%, Pfizer Inc. PFE +1.34%, Apple Inc. AAPL +0.20%, Wal-Mart Stores Inc. WMT +0.52% and Google Inc. GOOG +0.05% (GOOG).
Read more about Grantham in this related story, GMO’s Grantham: Risk doesn’t pay.
Also of note, Rosenbluth said, there are three other funds that have a similar investment style to the GMO Quality and that carry S&P’s highest rating, five stars. Those being the Dreyfus Appreciation Fund DGAGX +0.43%, Meridian Growth Fund MERDX -7.19% and the Yacktman Fund YACKX +0.47%.
The top 10 holdings include Valeant Pharmaceuticals International Inc. VRX -0.54% , Berkshire Hathaway Inc. A BRK.A -0.67% , TJX Companies TJX +0.19% , Fastenal Co. FAST +0.59% , IDEXX Laboratories Inc. IDXX -0.23% , Precision Castparts Corp. PCP -0.04% , Advance Auto Parts Inc. AAP +0.20% , Rolls-Royce Holdings PLC RYCEY +1.08% UK:RR +0.78% , Mohawk Industries Inc. MHK -0.35% , and O’Reilly Automotive Inc. ORLY +0.47% .
McDevitt said the Sequoia fund isn’t for investors looking to take advantage of bullish returns from what might seem to be bearish managers. Rather, it’s a fund for those who share Goldfarb and Poppe’s philosophy of investing for the long-term.
The fund own just 35 stocks and has a turnover ratio one-half its category, 23% to 50%. “This is not a fund to buy with the next two, six or 12 months in mind,” said McDevitt. By the way, McDevitt also said the fund’s allocation to cash is less a statement about the manager’s outlook for the market and more a statement about the absence of good values in the market.
Unlike Grantham, Goldfarb and Poppe, Arnott isn’t posting double-digit returns as manager of the PIMCO All Asset All Authority PAUDX 0.00% and the PIMCO All Asset PASDX 0.00% , both of which are funds of funds. But he is a bear and both those funds are in positive territory and outperforming the peer group. The former fund is up 1.4% year to date, while the latter is up nearly 1%. On average, funds in the category are down more than 2%.
Arnott didn’t deliver positive returns by investing only in high quality stocks or by investing heavily in a few dozen stocks. Instead, he’s got a broad mandate. He’s got the ability to invest all over the world in all kinds of stocks and bonds and in the case of the All Authority fund, the ability to go short as well as long.
In Arnott’s case, McDevitt said, his defensive posture has helped and his tactical moves have helped as well. For instance, the fund had just 6.8% of its assets invested in stocks in June. By September, Arnott increased the percent invested in stocks to 13%, taking advantage of the rise in the market at the time. “This could be a core fund for bearish investors who are risk averse,” said McDevitt.