Ben Fischer, Managing Director

NFJ

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Take the Long-Term View and Preserve Real Capital

NFJ’s Ben Fischer offered his thoughts on the severe volatility roiling markets worldwide: why it happened, what the future may hold, how NFJ has positioned its portfolios and where the opportunities exist for longterm investors.

What’s your perspective on the current market environment?

We’re obviously in a pretty serious financial crisis. I’ve seen them ever since the 1970s, and this is probably the worst, but there’s a psychological environment now that reminds me of previous emotional bottoms. You’ve got a lot of fear in the marketplace and there’s a tremendous amount of money on the sidelines. We’re seeing redemptions, enormous volatility and pressure on the government to solve the problem. It’s gotten to the point where people on the street are aware of how bad it is.

But on a long-term basis, time and time again, I’ve seen an environment like this to be a better buy than a sell. Which is why as far as Morgan Stanley and Goldman Sachs are concerned, I just am amazed at what happened. I think there’s nothing wrong with those companies, but if there’s enough fear in the marketplace with no remedy, the short-sellers create an atmosphere where people say “gee, something’s wrong with these independent investment banks—they’ve been knocked down 30%, so maybe I should quit loaning money to them.” And that’s what’s been happening—these stocks just fell off a cliff. I hope the SEC cures this shorting problem. Essentially, Morgan Stanley and Goldman Sachs are good companies, but in this environment, fear just breeds fear.

You’ve mentioned you’ve seen situations like this before. What did you mean?

If you look at the Texas real estate deals with the savings and loan crunch in the 1980s, and you adjust the numbers for inflation, generally the same thing has happened. When Regulation T was in effect, loans could be capped on interest that could be paid on deposits, so banks couldn’t loan money, and housing was stopped. But in the 1980s, Regulation T was eliminated and loans went berserk. The commercial banks joined in, because they wanted to prove they could grow just as fast as competitors, so we ended up with a lot of bad real estate loans. But the Fed set up the Resolution Trust Corp., and the bad loans eventually got paid off—and, of course, the taxpayer took a hit.

So while the order of magnitude was different— instead of about $500 billion then, it’s perhaps $2 trillion now—it’s essentially the same thing. People got leverage and went out and made bad loans, and they were basically all insolvent at the end of the ride.

What do you think is on the horizon in the U.S.?

Hopefully the government will take all the bad paper and hold it for 15-20 years—expanding the Fed balance sheet and creating a new wall of money to re-liquify the economy and give people their confidence back. I think we’re looking at 10 years of re-regulation, along the magnitude of what we had after the Great Depression. Eventually we’ll make sure the barn door is securely nailed shut after, unfortunately, some of the horses are long gone—Lehman, Bear Stearns and the rest of them.

And your global outlook?

I used to think 15%-20% international was a prudent weighting, but now I think 40%-50% is a better hedge against the dollar. Real assets, energy, machinery—the companies that provide real services and actually create the materials and the goods and services, those will do okay.

I believe China and India may have slowdowns in growth—maybe to 8% from 10%—but they’re not that dependent, in my view, on what’s going on in our housing market. They’re going to continue to grow, and I think there will be a very positive impact on the BRIC (Brazil, Russia, India, China) countries, Australia and other countries that supply raw materials.

I think there are a lot of parts of our economy— industrials, materials, energy—that should also do pretty well, although current and future portfolio holdings are subject to risk. Look at Caterpillar Inc.: if the world is going to mine coal, uranium, copper, etc., it will likely be with their equipment. Overseas, people will be flying—and Boeing will supply a lot of airplanes over the next 10 years. And a lot of the service companies and oil companies are going to pitch in and supply whatever they can in terms of extra energy.

Basically, I think world economic growth is not seriously in question. We’ll certainly have bad markets and big corrections and slowdowns, but I don’t believe we’re going to see a depression. I think as world economic activity improves, all the economically sensitive parts of the asset allocation wheel are going to work. I think we’re okay, but I’m taking a long-term point of view when I say that. And that’s where we’ve pointed our portfolios.

What’s been happening to financials in your portfolios?

We’ve underweighted financials across the board. Obviously there will be times when they rally, if they get oversold enough, but we have underweighted financials vs. our benchmark. And that’s one of our contributions to this at NFJ: As equity managers, we try to not be so volatile on the downside. But it’s tough. You just have to grit your teeth, lash yourself to the mast and hold on. Experience shows that if you’re patient, you’ll come out of it okay, and if you’re not patient, you’ll ultimately lose all your capital.

Any thoughts for investors?

I think the mistake people may be making now is to run for cover and try to sell everything and go into cash. If you invest in short-term U.S. Treasuries, you get such a low yield that you’re in effect giving up real capital because your yield is lower than inflation.

The challenge for any investor longer term is to preserve real capital in the face of inflation. And to do that, I believe it’s better to hang in there and buy at this point—or at least not sell, because if you sell you won’t get back in. You might be relieved that you salvage what’s left of your capital, but when the market does rebound, you will have lost your position. And to get out of a position in real assets or equities at this point is the wrong thing to do, because you lose a set of assets that’s positioned to do well ultimately against fixed financial assets and especially against the dollar.

Near term, don’t give up the ship. Take the longterm view. Remember to preserve real capital. It won’t be like the 20-year period from 1980 to 2000 where rates went down, inflation went down, hedge funds didn’t exist and people thought the best way to make money was to be in an index fund. I see this as a different environment. You’re going to have to broaden your asset allocation and look for the best opportunities you can find. Some sectors and companies will do better than others, which is why we believe that experienced asset managers who focus on balance sheets and help provide downside protection can really help you over time. That’s what we’ve always done at NFJ.

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