Last Updated Oct 8, 2009 1:29 PM EDT
FPA portfolio manager Tom Atteberry
Warren Buffett. Bill Gross. Jack Bogle. Tom Atteberry. Okay, "Atteberry" may not be the boldface name in investing circles that the other three are, but perhaps he should be. While his better-known colleagues expressed little more than general uneasiness as the financial markets were hitting new highs in 2007, Atteberry actually identified the time bomb that was mortgage-backed securities before it blew up. A veteran investor and longtime partner at FPA Capital, Atteberry had a conversation with a Bear Stearns analyst that made him realize that much of Wall Street was delusional. The analyst, Atteberry says, stated matter-of-factly that house prices always go up. Not long after that, Atteberry met with an analyst from credit-rating agency Fitch, who explained how some less-than-stellar mortgage-backed bonds still warranted top ratings. "What happens to your model if home prices drop?" Atteberry asked. "The model blows up," he was told. It sure did.
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FPA investors, however, did pretty well, all things considered. Atteberry’s New Income fund, with its capital-preservation-minded approach, did exactly what its name says it does. The fund ended 2008 with a 4.3 percent gain, beating most of its peers and providing a positive return in a year when keeping losses to the single-digits was considered a victory. Unfortunately on Wall Street, being correct in the long run can be very expensive in the short run, and FPA lost many clients in the two years running up to the crash. The $11 billion firm, known for its outsized characters with opinions to match (particularly CEO and loudmouth-in-chief Bob Rodriguez, who is heading off on a long-planned sabbatical in 2010), alienated some clients with its bearish stance.
CBS MoneyWatch caught up with Atteberry to talk about why the Lehman Bros. crash wasn’t a surprise to him, why the firm is holding fast to its six-year “buyer’s strike” for Treasury bonds, and where he sees opportunities for investors in the post-crash world.
So what did you see a year ago that others missed?
We’d been concerned about the credit markets since 2005. Late in ’05, we held some Chase mortgage securities. About three or four months in we noticed that delinquency rates were creeping up to 3, 4, 5 percent. It didn’t make sense for the quality securities we had purchased, so we sold the bonds — into a great market. By mid 2006 we had begun a massive investigation as to what was going on.
First we found poor underwriting practices and lots of bad data. By 2007 we started seeing fraud. We knew it was going to end badly.
But in the meantime, you lost a lot of money — clients were pulling money out of your firm to chase the returns other firms were offering.
Yes, a lot of clients left in 2005 and 2006, even some in 2007. We had one client pull a $100 million account. We probably won’t get that account back, either, because they know we’d have to ask the question: “How’d that work out for you?”
So do you feel vindicated?
I feel like we did the job we told our clients we were going to do — protect their capital and not be so dazzled by the upside that we forget to look at the downside.
Let’s talk about Treasury bonds. You went on a “buyer’s strike” back in 2003 and haven’t owned any since — even as everyone else was rushing into them, in search of a safe haven.
Treasury yields just weren’t that appealing and we didn’t see a catalyst for them to get better. We looked at research done by the Leuthold Group that found that, historically, the median yield for the 10-year Treasury was 6.21 percent. And it was there in 2000, not that long ago. We’re at 3.3 percent today. We’ve had a moderate position in TIPS [Treasury Inflation-Protected Securities] in that time, and think they’re still a decent idea.
So you’re waiting for yields to return to their historical median?
Why wouldn’t we expect to see them return to their median yields once we work this bubble off?
“Bubble” isn’t a term usually associated with bonds, let alone Treasury bonds.
In 2003, interest rates were too low. In 2008 we were printing lots of money. If we’re printing lots of money, trying to stimulate the economy by throwing lots of money at it, you’re looking at an inflationary environment. Inflation isn’t just paying another dollar or two at the dry cleaner; it’s also what drove home prices up. So in an inflationary environment, the yield on the Treasury these days is nil.
Are there other areas of the bond market investors can find bigger returns? High-yield bonds have been on quite a tear.
High-yield bonds have returned about 40 percent since the beginning of the year. In order to justify that, we need the economy to look like it did in 2004 and 2005. It doesn’t. There’s too much leverage in the system. Individual households, the federal government — there’s too much borrowing, too much debt.
Sure, too much borrowing arguably got us into this mess, but some economists say we need to spend our way out. Doesn’t that mean more debt?
Consumers make up 71 percent of GDP — 10 years ago that was 66 percent. Ten years before that it was 65 percent. Consumer spending, fueled by borrowing, has grown too fast. Total credit as a percentage of GDP at the end of March was 375 percent.
So Americans will simply have to spend less?
Lower income people simply cannot spend more in this environment. Middle income households have the highest debt-to-income ratio, saw the biggest drop in net worth and disposable income, and have real estate making up more than 50 percent of their total assets with the highest mortgages relative to household income. They aren’t going to spend us out of this. The only people who can keep the music going are the wealthy, and they’re about to be taxed more.
That’s a fairly grim outlook. What does that mean for the bond market?
We’ve had a 25- to 28-year bull market in bonds. In the past 25 years, the S&P 500 had an annualized total return of 10.1 percent, while the annualized return of a 10-year Treasury bond was 9.7 percent.That slight outperformance of stocks versus the 10-year does not appear to be significant given the added risk.
That’s changed.During the second quarter of 2009, the S&P 500 returned 17.45 percent while the 10-year Treasury lost 5.97 percent.
The high-quality bond market is going to be an extremely difficult place to make money in the next five years. There will be some opportunity in places like the credit markets and structured mortgage products, but you’ll have to be very selective and do tons of homework.
There’s no aspect of the bond market you think will exceed expectations?
Retail investors will probably find some opportunity in non-dollar-denominated bonds. You take on currency risk when you buy foreign bonds, but they will offer more opportunity. Much of that opportunity for return, though, comes from the value of the dollar declining. That means investors should buy funds that don’t hedge to the dollar. But investors need to remember that foreign bonds incur credit risk and currency risk. So while there will be some opportunity there, from a risk perspective, you have to look at them as being more similar to equities. It’s not a safety play.
Anything else in bonds?
A moderate position in TIPS probably isn’t a bad idea, but on the whole, the bond market will likely return less than 3 percent. Investors will need to find more returns in the stock market, which we expect to return 4 to 7 percent.
Any particular areas of the stock market you find especially promising?
Well, the U.S. is going to grow much slower, so it makes sense to invest in companies with a global focus, either multinational firms or foreign companies. We also like oil. Its value has declined ― from $150 a barrel to $70 ― but the oil didn’t disappear. We think that still makes a tremendous amount of sense: The world is consuming more oil. Oil services companies, drillers, exploration and production companies, even natural gas firms should do well in the long term. Newfield Exploration Company (NFX), for example, has both an onshore business in the United States, deep-water Gulf of Mexico, and offshore Asian fields. The price of oil will rise again, unlike the value of subprime securities that fell from $20 to $1.
Technology is another promising area. America has a great ability to find the new whiz-bang technological device. I look to the companies that supply the parts for all that development. Western Digital (WDC) is a good example; it’s a disk drive company. They supply everyone, so I don’t have to figure out if Dell or HP is going to sell more laptops this year.
Those few areas don’t exactly add up to a well-diversified portfolio.
It’s our belief that, especially now, investors need to find a manager who runs a fund that doesn’t look like an index. They need a manager with a rifle, who shoots a lot better than the guys buying 300 stocks. Going forward, it’s the concentrated portfolios that will outperform.
Concentrated portfolios can be tough for individual investors, because you’re making bigger bets on fewer investments.
That’s why you need to find a fund manager you trust to make those decisions for you. I’m not a big proponent of index funds, especially when you’re talking about the broad indexes returning 4 to 7 percent over the next few years.
What else should investors be thinking about?
Investors need to set their expectations lower in terms of the returns they’re assuming. They’ll have to save more — if you need your portfolio to grow at 10 percent a year to get to your retirement goal, you may need to contribute 5 percent of that. And that could mean working longer, especially as people live longer. It could be that no one retires at 65.
Increased savings, reduced spending, less debt, working longer: It sounds like you’re not just talking about resetting portfolio growth expectations — you’re talking about a cultural shift in our financial behavior.
It very well could be a cultural shift. Think of all the people that took early retirement. What happened to them? Are they going to have to re-enter the workforce? The assets they took out are certainly worth less now. Plus you have older workers not retiring. If we also see slower economic growth, how are companies going to keep earnings up? They’re going to hire less, and make the employees they have more efficient. Unemployment will remain around 9 or 10 percent for a while.
Any other good news?
This economy is going to grow much slower than you think. We’ve gone through the liquidity problem of the big banks and avoided the worst-case scenario; now we’re dealing with the smaller banks. There are still hundreds of banks on the Fed’s watch list. We are not [V-shaped] recovery people. The rebound we’ve seen in high-yield [bonds] and equities is unsustainable. Triple-C [aka junk] bonds ran up 74 percent this year. That’s an overshot. There will be a meaningful correction in both high-yield bonds and equities.
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