Stephen Smithruns the $1.8 billion global bond fund at Wilmington, Del.-based Brandywine Asset Management. While the fund is global in scope, Smith says it can invest in corporate credits, mortgage- and asset-backed bonds and government bonds with no rating or country specific allocation issues. An 11-year veteran of Brandywine, Smith has been in the portfolio management business since 1967.
How would you describe your investment philosophy?
Our approach is best characterized as "common sense/top-down." We will not invest in a country unless we are certain that the macroeconomic factors are solid, if not promising. This would explain our avoidance of Japan, which is arguably in a depression. We also do not get too involved with measuring ourselves against an index--we understand indices and respect what they try to do, but our opinions often go contrary to how their allocations shake out, thankfully.
Can you elaborate on your differences with the index?
Our index is the Salomon Smith Barney global bond index. It has a 27% weighting to Japan. We have none. Japan is in what is now a second decade of severe recession and we can see little that will force bond spreads tighter, other than pure luck. On the other hand, Norway, New Zealand and Sweden now constitute 3% of the Solly index; they are 40% of our portfolio. Indexers, at least ones that play the multi-national bond game, tend to get killed.
You have 40% of your portfolio in small, highly regulated economies?
They are small, and regulation does differ widely, but they are friendly places for investors looking for total return. Take Norway. It's a nation of 4.5 million people with a $23 billion slush fund in cash, sort of like Alaska's surplus fund. Its private sector is in decent shape and inflation is not a worry. They have a base of huge oil reserves and with oil, their primary export, stabilizing recently, we felt its govvies were a good deal at 160 off of [German] 10-year bunds. They are now at about 100 off--their historical average--and we like them until the 80 range.
Any other examples?
New Zealand, and for that matter, Australia, look great to us. If you believe in a global recovery, then I cannot see owning a cheaper call option on it than Australia and New Zealand. They are natural resource rich, and both their currencies are very cheap to the dollar. Look at Australia: coal just ended a long bear market, and nearly 17% of its economy is leveraged to coal in some fashion. The purchasing power differential is incredible. You can stay in an Australian Four Seasons hotel for around $89 in some places, which should be tempting to Americans who want to go a little off the beaten path, and the statistics say tourism is increasing. So we see both of their economies expanding from these developments and have put sizable positions on in their government bonds, wholly out of proportion to their representation in the index.
You seem to be avoiding international corporate credits. Why?
The reason behind it is simply that we cannot get paid abroad for risk, especially in the Eurozone. When you factor in currency and accounting concerns, we would need to see about 100 basis points worth of widening in the investment-grade sectors there to compensate us on the risk premium front. So we play it safe with governments.
Are you doing anything "off-the-run" given your investment freedom?
We have a good size position in inverse floater mortgage-backed bonds, more than 5% of our total portfolio. These bonds yield 18% on average. Even if U.S. rates doubled--and I do believe that we have clearly hit the bottom of this rate cycle--they will return 14% and give us three times the cash flow of long Treasuries. We have also put 12% of the portfolio in "opportunistic" type U.S. corporate bonds, mostly what they call "crossover credits." We've bought positions in names like CalPine and Royal Caribbean, usually at 600-700 basis points off the curve, situations where our credit research says that given a turnaround in the U.S. economy, you can be looking at expanded cash flows and [ratings] upgrades. It will not happen overnight, but these names are "money good" and we are paid up to 12% annually to wait.
What areas or sectors are you avoiding?
Over the last year, we took our Canadian position down from 25% of the portfolio to 5%. We thought the currency would rebound, driven by improving economic fundamentals. It remains an attractive place to do business given its strength versus the dollar; unfortunately, that's about its primary attribute right now. The U.K. had been 18% of our portfolio, now we have virtually nothing. On a purchasing power parity basis, it's fairly dead money compared to select situations in the Eurozone.