How might the European debt crisis impact investment advisory firm clients and how can they be protected from the fall out? Those are questions that Joseph J. Patracuollo, vice president and director of portfolio research at RIA firm Budros, Ruhlin & Roe, has been working hard to answer.
Patracuollo acknowledged that U.S. money market funds hold a lot of European debt. "Really what it comes down to is how do we do more due diligence ... and who are these issues backed by?" Petracuollo remarked at the final general session of the Fiduciary Gatekeeper Research Manager Summit, sponsored by Financial Advisor and Private Wealth magazines. Petracuollo was part of a panel, moderated by Evan Simonoff, the magazines' editorial director, that also included W. Bradford McMillan, vice president and chief investment officer of Commonwealth Financial Network, and Mark Green, CFA, of Oxford Financial Group. More than 250 advisors and money managers attended the conference this week in Boston.
"We've been on the phone with our portfolio managers on a regular basis trying to back test what is our actual exposure, should there be a default, should there be a trickle-down effect, and trying to get a better understanding on how this is going to trickle down into all of our business. In terms of being a gatekeeper, this is really what we are being paid for. In a perverse way, this is an exciting time because we're able to dig in to the minutia of everything we own and really trying to earn our keep in terms for providing capital preservation and wealth appreciation for our clients," said Patracuollo.
He, McMillan and Green agreed the European debt crisis as well as slow U.S. growth have increased the odds of a recession in this country over the next 12 months to at least 50 percent. McMillan was the most pessimistic when asked about the chances of a U.S. recession. "100 percent. We're in a situation where reductions in aggregate demand are already baked into the cake. ... You look at the reduction in aggregate demand that is scheduled on the federal side and what we expect on the consumer side. I don't expect it to be a deep recession, but it's going to be a recession," he said. But the majority of the population won't feel things have changed much because they already don't think the U.S. economy is doing well, he added.
"We're in a period where economic growth for the next two or three years is going to be subpar," Green said. "It's going to feel like a recession for some time to come. Still, it never felt like there was a recovery .. but what we have seen is that businesses have done everything they can to increase their operating leverage. ... So that's the good news. Even if we end up with a decline in gross domestic product, we may not see any impact on the labor market. We may not see unemployment rise dramatically from here because it's already so high. I'm not sure that corporate America can really afford to lay off that many more people."
How is the economic picture affecting where their firms invest? Green said that near term, some of the best opportunities in fixed income are in high-yield because spreads have widened compared with Treasuries.
McMillan agreed high-yield presents opportunities in the short term. Longer term, he's looking at dividend-paying multinationals. "I think they present the best value in the equity markets," he commented. "I think we have five more years of this, and that being the case I prefer tactical strategies. Financial strategies that don't rely on sustaining multiple expansion to make sense ... I think the days of buy and hold aren't over forever, but that's not going to be the best strategy for the next five to ten years."
Patracuollo said his firm also has been keen on multinationals because of their abilities to capitalize on the demographic shifts in the U.S. and Asian economies. Budros Ruhlin is also positive on emerging sovereigns, especially local emerging sovereigns, where countries are experiencing high growth relative to the United States. "In terms of asset classes that we're excited about, it's really the alternatives. They're a great way, we believe ... to make money for our clients, with derivatives, hedging, long/short. There are a lot of alternatives."
McMillan said over the past 24 to 36 months, Commonwealth also has incorporated more alternatives and strategy diversification. "What you have to do, you can't just look at asset-class diversification. You have to look at strategy diversification within the asset class," he said. He added some utilities, nontraded REITs and master limited partnerships (MLPs) are providing some interesting opportunities.
Green said he agreed with many of Patracuollo and McMillan's ideas. "Within the equity market, we're in large caps for many of the same reasons that have been articulated here before. Small-cap valuations got quite a ways ahead of themselves. ... We have an overweight position in alternative investments, and we think of them in a number of different ways, hedge funds, private equity and other alternative strategies. One of the strategies we've continued to add to is managed futures. We've also added to long/short equity funds."
--Dorothy Hinchcliff