Pimco's Kashkari Gloomy About Equity Returns

Pimco has always been a bond house, but lately they've made a concerted effort to develop mutual fund products for equity investors.  The equity mutual fund field is like the favela in Sao Paulo: dangerous and overcrowded.  Neel Kashkari, a Goldman and U.S. Treasury alumnus, is leading that charge into equity.  In a recent interview with Morningstar, Neel  didn't take a sunny view of equity returns.

Instead, he says that the U.S. is in a long period of adjustment which will mean much lower economic growth and lower asset returns than historical norms.  Like our posts on the so called consumer deleveraging, he says that it has barely begun and has a long way to go.  Large corporations, and to some extent the mid-market firms, have completed their deleveraging and are flush with cash.  However, they will find precious little sales growth here at home if the consumer sector continues on life support.  It's an interesting interview.

Of course, what's the conclusion following from Kashkari's world view?  Get connected with emerging markets. Brazil is apparently fully valued.  China has already produced negative surprises and may have more skeletons emerging from the closet.  Apparently, selected Russian companies may be value plays.

How can a U.S. investor, particularly an individual investor, take these kinds of risks in a low return world without significant risk premia?  Macroeconomic data for all these countries is barely acceptable, the financial press is weak or non-existent, corporate governance is of poor quality and not monitored by strong watchdog groups, and the auditing function is hostage to low quality national partners and shielded from accountability by the structures of the major accounting firms.  Does this sound like an answer to low U.S. returns? 

Look at what happened to Southeastern Asset Management, which runs the Longleaf Funds, very successful long-term value oriented investors.  Mason Hawkins and Stanley Cates have put together the ingredients I look for in a good equity mutual fund manager: good people, an ethical culture, a sound research process and approach to valuation, and manager incentives that are aligned with shareholder interests. Their employees are the largest shareholders across their family of equity mutual funds and have been since time immemorial.  This is the way it should be, but it's rare.

Southeastern has been rattled by being a long-term 5% plus shareholder in Japan's Olympus Corporation, which may have been hiding trading losses for a decade or more.  This is a Tokyo Stock Exchange listed large capitalization company with good businesses and a long track record.  I understand the statistical issues of this being "an n of one" on the TSE or in a diversified portfolio.  My point is look what is still happening even in foreign markets which we consider "developed."

Think now about the same investor's position in a Brazilian oil company, software company, or REIT?  The outside investor is at a tremendous information disadvantage.  Even depending on analysts stationed in the country is no assurance of risk mitigation.  It depends on culture, people and processes in those local operations, which are difficult to manage from afar.  If emerging market investing is an answer, it will have to be on a company-by-company basis.  I don't think it makes sense for investors to buy into, for example, the "Brazilian Miracle," or the "Indian Miracle," or any other gold rush country. 

Reading Kashkari's piece made me lament for the eras of 8% equity returns, which are still embedded in the long-term projections of many public and private pension funds.  The maiden of high returns has vanished, as Neel suggests.   I had to turn to Bill Withers and his baleful tune, "Ain't No Sunshine When She's Gone."  I can go back to my investment statements with some comfort.  Thanks, Bill.