I spent the day in Chicago where I’d been invited to debate the merits of my book, The Hedge Fund Mirage, with a pleasant fellow named Ed Butowsky who runs a fund of hedge funds. I’ll leave it to the audience to decide who won – it is the season of debates after all. I’ll simply say that I continue to much prefer taking my side of the debate than the other!
What I did find interesting though was the clear focus of so many financial advisers on alternatives in various forms of packaging. The tyranny of low interest rates is causing investors to look high and low for something that can generate a return greater than bonds while not blowing up in a collapsing equity market. There are “liquid alternatives”, which are mutual funds that do some hedging, business development companies that offer some very attractive yields, REITs and managed futures.
There probably are some interesting investments among some of these offerings. However, it’s still asset allocation that is the most important decision, and bond avoidance must surely be a cornerstone with negative real yields as far out as one can forecast. A barbell consisting of one part equities with four parts cash can provide the same return as the ten year treasury note as described in previous blogs (assuming 4% annual growth in S&P500 dividends) and bonds are unlikely to be much of a diversifier since rising bond yields (whenever that happens) will no doubt cause a sell off in equities.
I’ve noticed Intrade has seen a drop in Obama’s odds of winning, now down to 58% although he’s still the favorite. It does seem to me though that the likeliest outcome is a return of the status quo in two weeks at which point we’ll be looking to the same legislators who brought us to the brink of fiscal disaster with the debt ceiling crisis last year to resolve the fiscal cliff with only 12 days when Congress is in session. I don’t see how we can expect an agreement much before the very end of the year, timing which we ensure each side has extracted what it can in negotiations but will not be kind to any business that relies on capital spending or solid forecasts of consumer demand.
Most recently we sold a little of our natural gas E&P exposure since we continue to like the sector but valuations had made it somewhat less attractive. The New York Times ran a piece over the weekend warning investors that profits in natural gas are hard to find. However, it could also have been called “Don’t Invest with Aubrey McLendon, Chesapeake’s CEO” based on the examples the writer used. Less leveraged companies with lower production costs are still to be found, but overall we have about one third less direct exposure to this sector than was the case six months ago.
The biggest position in our Deep Value Equity Strategy remains the Gold Miners ETF (GDX) which we think is supported by efforts at central bank reflation on the downside and should rise with other commodities if equities resume their rally. We’re also awaiting news from Corrections Corp (CXW) on their possible conversion to a REIT. We expect the company to provide an update in the next few weeks.