Morningstar Conference

It's the costs you don't see that will kill you.

M*_Analysts — Fri, 29 May 2009 21:35:00 GMT

Dan Culloton | Associate Director of Fund Analysis

That was the message of University of California Davis professor Roger Edelen during his presentation on trading costs at Morningstar's 2009 Investment Conference.
The impact of mutual fund expense ratios on performance is well documented. Generally, the higher the expenses, the greater chance of subpar, long-term performance.
A study by Edelen, and a similar study conducted by Morningstar, show that trading costs - which funds are not required to disclose - may have an even more powerful impact on fund returns. "This is vastly more important than the expense ratio," Edelen said Friday.

Edelen looked at commissions, bid/ask spreads, and the impact of trading on stock prices. He also factored in individual stocks' average trading volume and quarterly portfolio changes of thousands of funds. He found that, on average, trading costs amounted to about 1.4% for mutual funds. That's over and above the expense ratio. Furthermore, smaller cap funds generally had higher trading costs than larger cap funds, and growth funds had higher average trading costs than value funds.

Morningstar's own study broadly agreed with Edelen's work, though the numbers were slightly different, said Associate Director of Fund Analysis Arijit Dutta. Morningstar, which is working on a trading cost measure for funds, found that managers would have to add an average of 1.6% additional return to make up for their trading costs - a very high hurdle for many funds.

"The hope is that in the shining world of the future, everyone is aware of the visible costs...and the invisible costs," Edelen said.

Foreign-Stock Managers Debate Emerging Markets and Insurers

M*_Analysts — Fri, 29 May 2009 21:29:00 GMT

Greg Carlson | Fund Analyst

Are companies in emerging markets too dependent on the economic fortunes of the countries in which they’re domiciled? That was one point of contention among the three stellar fund managers on the "Stock Selection Amid a Global Recession" panel at the Morningstar Investment Conference. Sarah Ketterer, co-manager of Causeway International Value CIVVX, argued that investing in emerging-markets stocks requires top-down calls on those particular countries and that she doesn’t want to have to worry about potential social unrest or market closures while executing her bottom-up stock selection approach. "They’re labeled emerging markets for a reason," she said.

In contrast, Carl Kawaja, who runs portions of American Funds EuroPacific Growth AEPGX and American Funds New World NEWFX, among other funds, said he's found a number of firms where the fundamentals diverge significantly from those of the countries in which they're based. He cited Companhia Vale Do Rio Doce, a Brazil-based iron ore producer that he said should see its profits rise and fall along with the price of that commodity rather than the fortunes of the Brazilian economy.

Insurers were another hot topic. Ketterer argues that companies such as Manulife in Canada and Axa in France have been unduly punished due to leverage in their business models, and that their portfolios of higher-rated corporate bonds are now selling at a significant discount. Amit Wadhwaney, manager of Third Avenue International Value TAVIX, favors reinsurers, in part because their bond portfolios tend to have shorter durations (a measure of interest-rate sensitivity) and are thus less volatile. For his part, Kawaja is more wary of insurers; he said they were slow to protect themselves as the financial crisis deepened.

Three Takes on Value

M*_Analysts — Fri, 29 May 2009 17:00:00 GMT

Harry Milling | Fund Analyst

This panel may have had only three portfolio managers, but it represented the wide spectrum of risk-taking in the large-value category.

First up, you have Third Avenue Value's TAVFX Marty Whitman, who is famous for diving into distressed companies that can be on the brink of bankruptcy but end up being winners in several years' time.

Then there is Oakmark's Bill Nygren, whose picks may not be on the brink of bankruptcy, but they can be out favor enough to give investors some pause, especially given his penchant to make them oversized positions in his funds.

Lastly, there is AIM Diversified Dividend's LCEAX Meggan Walsh, whose focus on downside protection means she avoided financials in 2008 and gravitated toward safer fare like Automated Data Processing.

While all learned hard lessons during the 2008 credit crisis, it's not surprising that there were differences among them about stocks they find attractive as well as whether they would be buyers of debt of distressed firms.
Mixed Minds about Getting Distressed

Walsh
She's not convinced it's a better opportunity than common stocks. She mentioned that six months ago, about 15 strategists tried to convince her to buy senior debts of some banks, but she didn't bite. It turns out that that debt hasn't done as well as some of her equity investments. She freely admits that there is opportunity there, but says there is just as much opportunity in stocks for now.

Nygren
For the most part, Nygren agreed by stating you can buy the stock of companies with pristine balance sheets--like Walgreens or Apple--on the cheap. When their profits grow and their stocks rise, you don't have to share your winnings with junior creditors as you would if you bought senior debt.

Whitman
After being badly beaten up by the stock market in 2008, Whitman is more secure investing in debt. He's happy to give loans to companies he thinks can pay it back at a rich yield. For example, when he made a $100 million capital infusion into REIT Forest City Enterprises, he got a double-digit yield.

Lessons from 2008
Nygren
Commenting on 2008, Nygren was blunt, stating they "blew it" when it came to holding on to his oversized bet on Washington Mutual (which was eventually seized by regulators in 2008 and sold to JP Morgan). One major lesson was to be more careful about holding oversized positions in his portfolio--a big lesson given that such bets have been one of his trademarks. It seems the comment was directed at financial stocks as Nygren said that these days, when it comes to a heavily leveraged company, it's almost "impossible" to get enough confidence to hold a massive position. Thus, don't be surprised to continue to see top- heavy portfolios at Oakmark OAKMX or its more concentrated sibling Oakmark Select OAKLX.

Walsh
While Walsh's fund managed to escape the worst of 2008, she still said the year showed her that an investor shouldn't be seduced into buying "the best" of a highly troubled sector. "Buying the nicest house on the block is not good enough," she said. Moreover, she has become more convinced than ever that top holdings should not be overly dependent on the credit markets for survival.

Whitman
The famously blunt manager said he's never seen short sellers be more powerful than they are today.

Here his lesson was short: Buy companies that are in a strong enough position not to fall prey to short sellers. Coming from an investor in distressed companies, this may sound odd, but Whitman continuously emphasized his requirement on a company's underlying financial strength before investing, something borne out in his portfolio.

Undeterred
Nygren
One of the most common misconceptions is that value managers ignore growth companies, Nygren said, quickly noting that Apple is among his more recent purchases. In the 2009 first quarter, he scooped up Apple shares when the stock was being hit with concerns about the health of its CEO, Steve Jobs. Nygren says Apple draws its success from several factors that are not dependent on Jobs. Besides noting Apple's $30 a share in excess cash on its balance sheet, Nygren cited the interdependence between the iPod technology and its corresponding software, iTunes. This fends off competition and maintains pricing power for the music and video player.

Meanwhile, he says the resulting earnings power from iPhones has yet to be reflected in Apple's bottom line due to GAAP accounting. Consequently, its stock price has yet to fully reflect the firm's prospects.

Walsh
Walsh said Johnson & Johnson is presenting a rare opportunity to buy a huge cash-flow generator and 10% earnings grower at only a nine or 10 P/E. She mentioned that all its major businesses are performing well, and specifically, that the investor is getting J&J's consumer products business cheaply considering it would get a much higher valuation if it were split off. She said J&J has no plans to spin off the business, however.

Whitman
He owns Toyota Industries because it's a significant holder of Toyota Motor, but buying Toyota Industries, investors can get Toyota Motor at a 45% discount. He said Toyota Motor will only get stronger because he expects the carmaker to take market share from its much weaker rivals, Chrysler and GM. He noted that Toyota Motor's market cap exceeds Toyota Industries, so it's as if you are getting a stake in the automaker for "free."

The Next Move for Berkowitz, Marsico, and Weitz

M*_Analysts — Thu, 28 May 2009 18:58:00 GMT

Hilary Fazzone | Mutual Fund Analyst

Kicking off Day Two of the 2009 Morningstar Investment Conference was a panel consisting of three great stock-pickers: Bruce Berkowitz, Tom Marsico, and Wally Weitz. The three came together to discuss the current investment landscape, mistakes made, and how they've been spending their time recently.

Berkowitz
Bruce Berkowitz has run Fairholme FAIRX, a concentrated value fund with a patient eye for good businesses run by great managers, for nearly 10 years—eight of which have produced top-quartile results. Berkowitz relishes the low valuations that have resulted from 2008's downturn, and he said with a wink that he hopes this great environment won't go away too quickly.

He dug into financial-services companies as their stock prices plummeted, scooping up such firms as American Express AXP at less than $10 per share. It took an iron stomach and a long-term purview to do so, and Berkowitz laments not doing more now that stock prices have started to climb higher.

He also admits to having over-assessed management teams in the past, and said that his view that a good manager can tackle a bad business has changed. Now, he prefers businesses that "even your idiot nephew could run and make money."

Berkowitz has found such companies in the health-care sector, which currently claims nearly 50% of his fund's assets. He has a double-digit stake in Pfizer PFE, which he likes for its high free cash-flow yield, durable business model, and capable management, among other things.

He's also spending his time looking at the senior bonds of the companies he owns, some of which are returning 18%-20%. In his mind, "in the same way that stocks are the most junior of bonds, bonds are the most senior of stocks." He sees tremendous value in this lower-risk level of the credit structure.

Marsico
Tom Marsico runs his namesake firm's Growth MGRIX and Focus MFOCX funds and co-manages its Global MGLBX fund. He points to the need for greater transparency of hedge fund portfolios coming out of this downturn, and believes that regulation along those lines is warranted. Some of the problems that perpetuated 2008's sell-off were short and forced selling, and greater visibility of these large asset managers' portfolios could alleviate those problems in the future.

Marsico also pointed out that there is now about $4 trillion sitting in money market funds right now earning nothing. As the economy stabilizes and people swing from fear to greed, he anticipates a big re-engagement with the stock market.

Marsico admits that his expectations for health care in the wake of the 2008's presidential election were off. He avoided the sector with the thinking that its stocks were punished in 1992 after Clinton's Democratic administration was elected, and he expected the same to be true this time around. That hasn't been the case, and in fact health care was one of the best performing sectors at the end of 2008. As investors are now trading their defensive positions for more cyclical fare, Marsico sees an opportunity to revisit the sector.

More broadly speaking, his firm has been spending more time focusing on the global nature of the markets, and he expects that asset allocation will generally shift more toward international assets. Though Marsico has been conservative in his expectations, he says that he is now hopeful.

Weitz
Wally Weitz has been at the helm of Weitz Value WVALX since its 1986 inception. A contrarian value investor, Weitz focuses on stocks trading well below his assessment of their private market value and has no qualms about loading up on sectors where he finds bargains, or cash when bargains are scant.

Reflecting on 2008, Weitz distinguishes the period from the lows of the early 1970s. In the early '70s, he woke up every day expecting the market to be down, in late 2008 he woke up every day wondering which pillar of the financial world had disappeared. Yes, this made for incredibly attractive stock prices, and Weitz says, "it would have been fun if it hadn't been so terrifying."

Going forward, he expects that the duration of this bottoming process will determine the extent to which things change or don't change. Consumers, in particular, have a long memory of being rewarded, or rather, not punished, for their overborrowing and overspending. The extent to which that behavior and mind-set will change, Weitz thinks, depends largely on how long and hard consumers are punished in the near future.

Considering his own mistakes last year, Weitz doesn't feel badly about the good companies he didn't buy, but rather about those he failed to sell. He says he became comfortable being contrarian and owning certain cyclical companies, and admits he should have revisited them.

Weitz is spending his time as deep in his companies' fundamentals as he can get, and trying to understand how the changing regulatory landscape will impact their long-term prospects. He expects a mixed bag of economic news over the coming year, and looks forward to the volatility, and thus the opportunities, that will result.

Want Some Fresh Insights About Asset Allocation?

M*_Analysts — Fri, 29 May 2009 02:17:00 GMT

Greg Brown | Fund Analyst

Tom Idzorek of Ibbotson Associates, Vineer Bhansali of PIMCO, and Mark Balasa of Balasa, Dinverno, Foltz, and Hoffman talked about some of the hot topics regarding asset allocation. Below are the highlights and insights from their conversation.

Tactical Asset Allocation vs. Buy and Hold Allocation
Tom Idzorek was quick to point out that tactical asset allocation is a form of active management. And if you get it wrong, your losses can be severe (he also admits to the inverse, which is why most are tempted by it). He feels that the average person would be best served by utilizing a buy and hold strategy. When asked what Ibbotson uses for their clients, Tom said it's mostly a buy and hold approach, with tactical strategies at the margins (for example, underweighting REITs prior to 2008's meltdown and now increasing exposure to TIPS).

Mark Balasa also uses mostly buy and hold strategies, with some tactical allocations at the margins. He confesses that he uses tactical asset allocation mostly for the psychological needs of his clients. That is, his clients want to see moves (action) of some sort during a tumultuous market. In the end, Mark feels that even small tactical moves can help keep clients from making big mistakes.

Vineer Bhansali is attempting to transcend the whole Tactical vs. Buy and Hold debate by using a novel "risk factor" based method of asset allocation. He feels that a better approach is to start with risk. That is, begin the process by stating how much risk you want to take and then determine exactly how much risk you are taking.

According to Vineer, understanding the true exposure to equities and bonds is critical. He gave the example that a standard 60/40 split between stocks and bonds, using his methodology, has an “equity factor exposure” of more than 80%. The exposure is higher, Vineer says, because diversified bond funds usually have corporate bonds and other securities that are highly correlated to the equity markets. Vineer says his approach creates truly separate silos for each risk factor, which gives him a more accurate representation of the risk he is taking between equities, bonds, and other asset classes.

Other risk factors that Vineer believes are important to consider are bond risk (duration, yield curve positioning, credit exposure), monetary policy risk (what the government is doing), currency risk, and liquidity risk.

Vineer also manages risk by "cutting off the tails," a reference to the "unlikely event" at the tail ends of a standard distribution curve. Vineer feels a portfolio should be insured, at a small premium, against large, but unlikely, events such as the current epic bear market. He mentioned a small premium in the neighborhood of 50 basis points should be adequate to cover a portfolio against severe downturns. One of the methods he briefly mentioned to accomplish this is option-like instruments, such as S&P 500 puts.

Inflation Risk
Tom handles inflation risk differently depending on the life stage of the person. He said that accumulators (younger investors) have more human capital. That is, they have more earning years ahead of them and, according to Tom, they have a "built-in inflation hedge."

On the other hand, those near or in retirement have more inflation risk (less human capital) and should be more on guard. His preferred investments to hedge against inflation risk are TIPS (Treasury inflation-protected securities), real estate investments, and commodities.

Mark mentioned that there's no magic bullet to guard against inflation. He agrees with Tom on the use of TIPS, real estate, and commodities to guard against inflation.

Vineer, reiterating his stance on using insurance against big losses, feels that he can reduce inflation risk by using a type of insurance against inflation. He mentioned that at this point in time it is incredibly cheap to buy inflation insurance. ("We are now buying this out of the money insurance.")

Risk Tolerance
Toward the end of the discussion, Mark mentioned that people don't know their risk tolerance until the worst happens. In this current epic bear market, Mark has learned that many people underestimated their ability to withstand severe losses. He talked about trying to quantify risk, but ultimately gave up because in his words, "people are just too fluid." He now feels that trying to gauge a client's tolerance for risk is "20% science and 80% art."

Vineer felt that risk tolerance is irrelevant if you can insure against large losses. He said for some events the severity is simply too big of a shock for most people to absorb. As an analogy, Vineer pointed out the fact that most people are comfortable buying homeowner's insurance to guard against the rare, but potentially devastating loss of your home.

Full Notes from Grantham Presentation

M*_Analysts — Fri, 29 May 2009 03:49:00 GMT

Ryan Leggio | Fund Analyst

Wrote an article in March ("Reinvesting When Terrified" available on GMO Web site). Wrote to himself as much as anyone else. Felt strange 1974 feeling where people suffered from falling stock prices and when people who had cash were hugely reinforced.

Only antidote to tumultuous time: come up with "a battle plan."

Do not want to optimize. Just need a rough plan. Optimization is a "delusion."

Most of the time GMO would not have less than 50% equity exposure. There were so few places to hide this time. Convinced clients to go down to 45% this time. Neutral weighting is 65%.

First truly global bubble (2007). Every risky asset was overpriced.

Did not rebalance when prices fell. Rebalancing is academic.

Thinks most people fail to invest when they should, and they are left behind. This is due to panic, among other factors.

Had sharpest rally in equities in March since 1938.

April was a monster. Was one of the worst months of his career. Stocks under $5 were up staggering amounts but blue chips only 10%-15%. Was a "junk rally." Everyone was trying to catch up.

You have to balance regret: investing in March and market going lower or not investing in March and the markets go higher.

Fair value is 880 on the S&P 500 and maybe a little lower. 930 on the S&P is within noise levels of the fair value.

How they do seven-year market forecasts: assume everything will be normal by that time (P/E and profit margins will be normal).

GMO expected S&P 500 would do -1.1% real annualized for 10 years in September 1998. The S&P 500 ended up doing 0.1% . (My comment: Almost right on!)

Thinks U.S. high-quality stocks will return 11.5% from their levels on April 30, 2009 for the next seven years; thinks S&P 500 will do 5.9%.

In February, U.S. high quality would have expected to return 12.7% real per year for seven years.

Thinks bad news of the next six months will be commercial real estate.

If there is a mild economic recession the S&P 500 could expect to reach 820 by Shiller's S&P 500 P/E ratio (10 years average P/E metric laid out in his book “Irrational Exuberance”), if it matches market lows during other mild recessions. With a strong recession, the S&P could get to 600.

Thinks unemployment moves the needle in elections and unemployment goes lower in the six months before the election. The completely “independent Fed” (Grantham does not think the Fed is independent) moves rates lower to help the economy and get presidents re-elected.

The markets do the best in year three of the presidential term (see Grantham's article on GMO's website).

Housing market bubble was a three sigma, hundred year event.

There is a significant amount of moral hazard now since the government will bail out any financial institution in trouble.

Did not cut back on high-quality stocks even though he thinks junky ("flaky") stocks will go up for sometime.

The Fed is the "dominant force in the world."

Need U.S./U.K. to save and for Germany, Japan and China to spend money. Chinese will not spend, though, until there is a safety social net.

Thinks emerging markets will grow GDP around 4.5% while developed world will grow at only 2.5%

Questions from Audience
Q: How does China enter into your thoughts?
A: Japan, South Korea did not benefit investors because they would put other interests ahead of shareholders.
Does not think Chinese investors will do "brilliantly."
China and India together are changing the world because commodity prices will rise, while real commodity prices have fallen over the last decade.

Q: Gold?
A: Hates gold and never invested in it. He broke his vow though and bought gold because he thought people would panic but "lost money in it."

Additional Statements Made after the Speech
--thinks we can solve current debt crisis without "massive inflation"
--short long U.S. bonds right now
--GMO is the largest shorter in the world of long-term U.K. TIPS
--550/650 on the S&P is roughly when GMO would be all in
--can't make a true GMO retail fund (the only retail fund currently is the Evergreen fund) because retail investors can't stomach the volatility (or the fund being "wrong a little")
--sometimes you have to wait 20 years to get your money back (jab at Jeremy Seigel); evidence: Japan stock market from 1978–2008
--biggest failing of the institutional investors is for their tendency to "stand their ground" when they should be avoiding large asset bubbles

Bogle: What to Expect for Equity Returns

M*_Analysts — Fri, 29 May 2009 02:32:00 GMT

Dan Culloton | Associate Director of Fund Analysis

Nearly a decade ago at the Morningstar Investment Conference, in the midst of investor euphoria about a roaring bull market and optimism about future returns, Vanguard founder and former chairman Jack Bogle told attendees to curb their expectations.

Then he warned investors to expect single-digit returns for stocks at best, based the sources of returns: their dividend yields, prospective earnings growth, and potential multiple expansion, which Bogle predicted would be nil or worse given the S&P 500's then-lofty valuations. Nine years later, investors who got low-single-digit results from stocks consider themselves lucky.

So, after the second-worst calendar year for the stock market in recorded history and the worst in Bogle's memory, what does he think about prospective equity returns? At an appearance at Morningstar's 2009 Investment Conference Thursday, Bogle said investors shouldn't expect much more than an 8% return from stocks and considerably less from bonds. Bogle based his admittedly back-of-the-envelope projection on a 3.5% dividend yield for the S&P 500 (a conservative estimate based on a rash of recent dividend cuts), the assumption that corporate earnings grow about as fast as the economy and get an extra boost from inflation to add another 5% to 6%, and the expectation that the market's price/earnings multiple actually comes down a bit.

Bogle, however, tempered his comments by saying, "I've never seen a time in my whole career when it's been harder to answer that question" about what to expect going forward.

On a more optimistic note, Bogle said he thought municipal bonds looked attractive. In some cases they currently offer tax-equivalent yields that approach his projected return for equities. He recommends municipal bonds as long as investors buy them in high-quality, extremely diversified (1,000 securities or more), low-cost bond funds. In other words, funds that look a lot like Vanguard's lineup of municipal bond funds.

The Long and Short of It: Bath and Romick Talk Health Care, Government Intervention, and Shorting

M*_Analysts — Fri, 29 May 2009 02:00:00 GMT

Katie Rushkewicz | Fund Analyst

Chuck Bath and Steve Romick's funds don't look a lot alike on paper. Bath's Diamond Hill Long-Short DIAMX fund invests only in U.S. equities, going either long or short (currently the fund has 54% net long exposure). Romick takes a more free-wheeling approach at FPA Crescent FPACX, investing all over the world, throughout the capital structure, and taking some short positions. Despite these differences, both valuation-focused funds tend to keep volatility in check. Though both managers say that's more a byproduct of their processes than an intentional move.

So what are they buying, and perhaps more interestingly, what are they shorting? The managers were hesitant to name specific short positions, but they did offer some intriguing insight into how broad topics like government intervention and consumer overspending factor in to their decision-making process.

One common theme was concern about the consumer. Both managers agreed that consumers have been over-levered, and since the shape of an economic recovery is still unknown, stocks exposed to consumer spending make fertile ground for shorting. Bath shorted MGM on fears that the consumer-oriented Vegas market will suffer and because of a questionable balance sheet. Romick recently closed out a short position in Gamestop, which is consumer-dependent and could also come under intense pressure as more video games go online. Romick is short European banks, though the fund does have quite a bit of debt exposure to financials. He also occasionally shorts in pairs, meaning he'll buy a company he likes and then short some of its competitors, as he's done in health care.

Speaking of health care, the two managers had clear differences in opinion on this sector. Bath, who had a bigger health-care stake in the 1980s and 1990s and cut down exposure earlier this decade when valuations got too high, has become more interested in the sector as valuations have come down recently. He's optimistic that acquisitions--like Pfizer's purchase of Wyeth--will lead to cost-cutting and more growth opportunities. He's also confident that U.S. health-care companies have a prominent place on the world stage.

While Bath thinks that the risk of government regulation in health-care is already priced into valuations, Romick couldn't disagree more. Romick is leery of government involvement in the health-care space, calling it "scary stuff," and thinks these risks require additional discounting. Suffice it to say, he's not thrilled with the populist undertones that have been radiating throughout the government as it's gotten entangled in the private sector.

That's one of the reasons international investing is all the more attractive to Romick. In fact, Romick recently hired an international analyst and is looking for companies domiciled outside the U.S. or ones that do most of their selling overseas.

Bath, who sticks to U.S.-domiciled companies, agrees that international growth--especially in Asia--is intriguing and is looking at industries where the U.S. is very competitive overseas, such as energy and consumer products. On the flip side, he's trying to avoid U.S.-centric consumer industries that might continue to face headwinds, like retailers and homebuilders.

Other areas of interest? Bath's been intrigued by tech recently, an area he's largely stayed out of for the past few years due to high valuations. He's also used the recent market upturn to short some low-quality names that have rallied off the bottom and to sell some long positions that did well in favor of higher-quality companies like P&G and PepsiCo. Meanwhile, Romick's found bonds especially attractive--debt has jumped up to 30% of the fund's assets--but has waded in slowly because he'd been out of the high-yield space for awhile and needed to get reacquainted with it.

10 Key Points from Grantham’s Speech

M*_Analysts — Fri, 29 May 2009 01:05:00 GMT

By Ryan Leggio | Fund Analyst

I wanted to highlight several interesting points from Grantham's speech today at the Morningstar Investment Conference. See my full notes on his speech in a separate Morningstar Conference Blog post.

1. Key question for investors: "How cheap would the market have to get in order to be fully invested?" The answer to that question should be written down.

2. In March the market was the cheapest it had been in 20 years, but GMO was still underweight stocks. If the market (S&P 500) was under 666 for one more trading day, GMO would have been overweight equities for the first time in 20 years. Instead, GMO was underweight by 3-4 percentage points.

3. The market is about fairly priced today. Grantham recommends investors take a year to 15 months and get to normal equity investment weight and slowly average into the market.

4. Assume the market screams up to around 1000-1100. Normally GMO would do nothing because it waits for extreme outliers--normally GMO doesn't do much when the S&P 500 is 10%-20% overpriced. This time Grantham is thinking about breaking the rules. If the S&P 500 goes over 1000, he would probably raise some more cash.

5. A comment to institutional investors: Everyone is chasing tiny bits of alpha, chasing a good mutual fund manager instead of looking at big return differences between asset classes. Big asset classes drive success. What is counterintuitive is that big asset classes are very inefficiently priced.

6. Grantham outlines return expectations for high-quality U.S. stocks: U.S. high-quality equilibrium real return expectation: 5.7% per annum (Ben Inker informed me there was a typo in the presentation materials, which had it at 5.8%); large-cap domestic is 5.7%; small cap domestic is 6.2%.

7. Volker was the only Fed chairman who would not play the game and who had “backbone and ethics.” Greenspan was another story; he would stimulate the economy again and again with lowered interest rates.

8. Grantham thinks 550-650 will be the low for the S&P for this economic cycle because of the large, rapid, coordinated economic stimulus enacted worldwide.

9. Can’t make a true GMO asset allocation retail fund (the only retail fund currently is Evergreen Asset Allocation EAAFX) because retail investors can't stomach the volatility (or tolerate GMO "being wrong a little" for an extended period of time).

10. Morningstar.com exclusive question:

Q: Why has the fair value of the S&P 500 come down in recent quarters for GMO from over 900 in 2008 to around 880 today?

A: One reason is that GMO has slightly lowered its assumptions for U.S. equities over the last year.

In addition, they are making small tweaks to their model. Example: The long-term average P/E for the market is around 14, according to Grantham. The P/E ratio has been elevated above this level for some time, and GMO was forecasting it would revert to a lower P/E number--16. They are using a 15 P/E now that the market has corrected even though they still believe it should eventually trade at around 14 P/E under normal conditions. This, among other factors, has reduced GMO's fair value estimate of the S&P 500 slightly.

U.S. Stock Managers Look Abroad for Growth

M*_Analysts — Fri, 29 May 2009 00:49:00 GMT

Greg Carlson | Fund Analyst

While they have limited ability to invest in non-U.S. companies, the three successful growth fund managers on the "Deal of the Century" panel at Morningstar's Investment Conference agreed that a number of large economies outside the U.S. are likely to grow faster and could be profit centers for U.S. firms. (That theme was also touched upon by PIMCO's Bill Gross in an earlier keynote speech at the conference.)

Kent Gasaway, comanager of Buffalo Small Cap BUFSX (as well as several other Buffalo funds), said that the best opportunities for large U.S. companies lie in their overseas operations. "Many (U.S.-based) brands haven't gotten a lot of penetration in markets outside the U.S.," he said. "That's where they'll get their growth." And Glenn Fogle of American Century Vista TWCVX is getting more interested in energy firms, despite weak demand within the U.S., because he believes the price of oil will be driven higher again by emerging economies. "The U.S. no longer sets the oil price. It's set by economies that are growing," he said.

The managers also expect a low-growth environment in the U.S. to give fund managers who choose the right stocks plenty of opportunity to distinguish themselves. "There should still be pockets of 10% growers,” said Gasaway. But the three managers are finding such growth in different areas. For example, Eric Fischman of MFS Growth MFEGX, favors biotech firms with advanced drugs and health-care equipment makers that significantly impact patients' lives, reasoning that those businesses are less likely to face increased regulation. Fogle's emphasis within energy is on energy-efficiency plays that could drive productivity gains. Meanwhile, Gasaway is buying education providers that can help retrain people for new jobs.

Managers with Globe-Roaming Strategies Talk Stocks

M*_Analysts — Thu, 28 May 2009 08:18:00 GMT

by Karin Anderson | Fund Analyst

In the first fund manager panel discussion at the 2009 Morningstar Conference, three of our favorite world stock managers came together to discuss the types of opportunities that they’ve been finding across the globe.

Rajeev Bhaman, manager of world stock fund Oppenheimer Global OPPAX, doesn’t zero in on specific regions based on economic indicators, but instead aims to find great businesses with stocks that are trading cheaply based on their long-term prospects. That said, his long-term views certainly play an important role. For several years, he has been bullish on both luxury goods and consumer staples firms in light of the strong demand growth from developing countries. Lately, he has been particularly enthusiastic given that he can buy many of his favorites, including luxury goods firm LMVH Moet Hennessy Louis Vuitton and consumer staples giant Colgate-Palmolive CL, at extremely attractive valuations.

Dodge & Cox International Stock DODFX manager Diana Strandberg stressed the importantance of investing in firms that keep interests aligned with long-term shareholders. She cited Ultrapar UGP, a small chemical firm in Brazil, for doing a good job of returning capital to shareholders. In general, she zeros in on firms that exhibit growing earnings and cash flows, and she and the team of managers behind this fund have recently been focused on technology and health-care firms. Like Bhaman, she also keeps long-term themes in mind, including the effects of growing demand for consumer staples and luxury goods in emerging economies. She plays on this theme through both smaller firms, including Belle International, a leading women's shoe company in China, as well as through industry giants such as Nokia NOK, which has a large global footprint for its cell phones.

David Winters, skipper of the Wintergreen Fund WGRNX, finds that good stewardship is key to any stock pick, and he cited Nestle as a fine example. Among the three panelists, he cited the most clearly defined regional focus--Asia. His rationale stems from the higher projected economic growth compared to North America and Western Europe. He cited Jardine Matheson, a 175-year-old firm with a diverse set of retail operations, as a great way to participate in wealth that’s being created in Asia.