Robert L. Rodriguez was the former portfolio manager of the small/mid-cap absolute-value strategy (including FPA Capital Fund, Inc.) and the absolute-fixed-income strategy (including FPA New Income, Inc.) and a former managing partner at FPA, a Los Angeles-based asset manager. He retired at the end of 2016, following more than 33 years of service.
He won many awards during his tenure. He was the only fund manager in the United States to win the Morningstar Manager of the Year award for both an equity and a fixed income fund and is tied with one other portfolio manager as having won the most awards. In 1994 Bob won for both FPA Capital and FPA New Income, and in 2001 and 2008 for FPA New Income.
The opinions expressed reflect Mr. Rodriguez’ personal views only and not those of FPA.
I spoke with Bob on June 22.
In a recent quarterly market commentary Jeremy Grantham posited that reversion to the mean may not be working as it has in the past. What are your thoughts on mean reversion?
There will be a reversion to the mean. We are in a very difficult and challenging time for active managers, and in particular, value style managers. Many of these managers are fighting for their economic lives.
Given that I am no longer involved professionally in managing money, I believe the standards in the industry are being compromised; monetary policy has so totally distorted the capital markets that you are now into an eight-year period that is unprecedented in the likes of human history.
The closest thing we have had would have been between 1942 and 1951 when the Fed and Treasury had an accord to keep interest rates low. Things were basically being manipulated for the sake of the World War II effort. With the renewal of inflation after the war, there was a war between the Treasury and the Fed and an accord came together. But that is the only time we’ve had a period of nine years of manipulated, price-controlled interest rates.
This was something I told my colleagues upon my return from sabbatical in 2011: what could unfold was controlled, manipulated and distorted pricing that disrupts the normal functioning of the capital markets. The cycles that Jeremy would be referring to about the reversion to the mean can be distorted for a period of time.
But I do not believe the economic laws of gravity have been permanently changed.
At a Grant’s Conference last year Steven Bregman asserted that indexation in general and ETFs in particular were factors in the under-performance of active managers and are potentially a bubble. Are you familiar with his work and what are your thoughts on ETFs? What is driving the flow of mutual fund assets to passive strategies and what can or should fund companies do in the face of this trend?
I go back to a speech I gave in 2009, Reflections and Outrage, and buried within that speech is a section that said that if active managers did not get their act together then the likelihood would be that passive strategies would continue to take market share. When you have a market that is distorted by zero interest rate policy, David Tepper said it very well many years ago, he said, “Well, you’ve got to ride it.”
It’s a rocket ship that’s going up. If you are fully invested in the right areas, you have a shot at out-performing. But if you are an active manager with discipline and looking at the valuation dynamics in the capital markets and have been doing so for several years, then you will be carrying elevated levels of liquidity if you were allowed to do so. As such, you will underperform.
Active managers have not demonstrated a value-add to an appreciable extent over the last 20 years. When I look at what happened prior to 2000, if an active growth manager could not see the most extraordinary distortion and elevated, speculative market in history, when will they? In the lead up to the 2007-2009 crisis, value managers did not cover themselves in glory. If you looked at what their ownerships were, they were very much in large banks and various types of depository institutions that were going to get crushed in the credit downturn. If they couldn’t acknowledge or identify the greatest credit excess in history, when will they?
I’m picking on both growth and value style managers for missing two of the great bubbles. This led to capital destruction. Now we have a clueless Fed that has never known what a bubble is and has accentuated them by carrying out a policy of insanity of QE. Markets are going straight up predicated on that.
The public looks at that and says, “Why should I pay higher fees to managers who can’t outperform or can’t even identify a major speculative blow offs. I might as well be fully invested. I might as well be in an ETF index fund.”
Thus, since 2007, indexing or passive activities have risen from approximately 7% to 9% of total assets to almost 40%. As you shift assets from active managers to passive managers, they buy an index. The index is capital weighed, which means more and more money is going into fewer and fewer stocks.
We’ve seen this before. If you didn’t own the nifty 50 stocks in the 1970s, you underperformed, so money went into them. If you were a growth stock manager in 1998-1999 and you were not buying “net” stocks, you underperformed and were fired. More and more money went into fewer and fewer stocks. Today you have the FANGS and you are driving more and more money into a narrower and narrower area. In each case it has not ended well.
When the markets finally do break, as they always have historically, ETFs and index funds will be destabilizing influences, because fear will enter the marketplace. A higher percentage of assets will be in indexed funds and ETFs. Investors will hit the “sell” button. All you have to ask is two words, “To whom?” Index funds and ETFs don’t have any cash. The active managers have been diminished in size, and most of them aren’t carrying cash for fear or business risk.
We are witnessing the development of a “perfect storm.”
Full article at Advisor Perspectives