Best Way to Build Wealth - Resilient Investments, Including Gold

Best Way to Build Wealth - Resilient Investments, Including Gold

Show Video

[Music] Consuelo Mack: On WEALTHTRACK,  noted Global Value investor,   Matthew MacLennan on navigating the new  era of higher interest rates and inflation. Matthew McLennan: We probably have one of  the high levels of valuation risk I can   remember in my career. Across many assets,  it’s hard to dispute that we have one of the   higher levels of geopolitical  risks of the last generation.

We also have the risk of the debt overhang  and it’s not just in the United States.   It’s globally. And then we have the risk of  policy credibility being brought into question.   This is a risky constellation. Consuelo Mack: First Eagle Global Fund's Matthew  McLennan is on Consuelo Mack WEALTHTRACK.

Announcer: Funding provided  by ClearBridge Investments,   Morgan Le Fay Dreams Foundation, First Eagle  Investment Management, Royce Investment Partners,   Matthews Asia, and Strategas Asset Management. [Music] Consuelo Mack:   Hello, and welcome to this edition of WEALTHTRACK.  I'm Consuelo Mack. We appear to be in a new   investment era. One of higher inflation and higher  interest rates. As these charts from First Eagle   Investments illustrate, meaningful inflation  has been largely absent in recent decades.

Since the early 1980s, we have been living  through what's been called the great moderation.   A long, multi-decade stretch of low inflation.   That changed dramatically in the past year  as the economic dislocations of COVID-19   kicked in. Consumer prices soared to  40-year highs driven by COVID lockdowns,  

labor shortages, supply chain disruptions and  record amounts of monetary and fiscal stimulus. In response, the Federal Reserve has pivoted  from its unusual role as inflation promoter   to its traditional role of inflation fighter,   which means higher interest rates ahead.  The major macro shifts like these are always   turbulent. How to navigate them without damaging  your portfolio or psyche is our focus today.

Our guest is uniquely suited to tackle  this challenge. He is Matthew McLennan,   a noted global manager, Co-Head of the  Global Value Team at First Eagle Investments,   where he oversees more than 90 billion dollars  in assets, including several mutual funds. His   flagship, First Eagle Global Fund, is rated  four-star by Morningstar with a silver analyst   rating for its unique approach, which has  helped give the strategy a long-term edge. Since McLennan took over the fund from legendary  value investor Jean-Marie Eveillard in 2008,   the fund has far outperformed  its world allocation category   with considerably less volatility than the  stock market. First Eagle is a sponsor of   WEALTHTRACK. McLennan’s track record  and reputation speak for themselves.

I asked him if he believes we are in a new  era of higher inflation and interest rates. Matthew McLennan: Well, we may be in a new  era Consuelo, but the paradox is that we have   higher inflation, mid-single-digit  inflation, but lower interest rates.   And that's the paradox of the moment. And  I think the way to interpret, I think what   the bond market is saying right now is that the  Fed does have to pivot to higher interest rates,   but it's only going to be  able to raise rates so far. Arguably because of the debt  overhang in the economy.  

And that's really what the bond market is trying  to price right now. And that's an open question,   because the longer inflation stays at  these levels, the higher the risk that   expectations adjust up. And the bond market is  not pricing inflation expectations moving up. We're at a very delicate cuspy moment,   one in which the credibility of policy is  really facing a generational challenge.

Consuelo Mack: Talk about the debt overhang and  how much that figures in to the Fed's thinking,   which has the dual mandate of full  employment and also price stability. Matthew McLennan: I don't think they look at the  debt overhang explicitly. I think the Fed itself   is very focused on financial conditions. And what  we've seen over the last several economic cycles,   is that the peak level of debt to GDP,  and that is if we combine household debt   plus corporate debt plus government debt and look   at the total relative to GDP has  been getting higher and higher. And again, this cycle, we’re higher  than we were before COVID struck.  

And what that's meant is that  over the last several cycles,   interest rates have peaked at successively  lower levels because the economy has reacted   negatively or financial markets have reacted  negatively to lower levels of interest rate hikes. The Fed hasn't even really tightened policy yet.  We're still in QE. The Fed has just signaled   a more hawkish posture. And that's  been enough to create a correction   in the stock market. And the Fed is going to be  attuned to changes in financial conditions, and  

I think the bond market is relying on  that taking care of business, if you will,   as opposed to a higher level of interest rates.  We're just going to have to wait and see.  Consuelo Mack: We've talked in the past  about the fact that the Fed has seemed   really for the last 10 years or longer  constrained by how the markets react. Matthew McLennan: In fact, Consuelo, it  has been even worse than being constrained   on the upside. If you think of the last few cycle,   each time we've had an economic crisis, the Fed  has had to resort to larger and larger measures   of stimulus. First, it was zero interest  rates, then zero interest rates, plus QE. This last time, zero interest  rates, plus super-sized QE.   The Fed has really been asymmetric in its policy  response function. And I think that that can't  

by definition, persist forever. And at some  point, the credibility of policymakers will   come into question, and I think that's  the risk that we face at this juncture. Consuelo Mack: You’re always  concerned about risks at First Eagle.   What are the other risks that you're watching? Matthew McLennan: We'd like to look at   when we start up is price, because price is  subjective. And in some ways, the contours   of 2021 were somewhat reminiscent of 1999. We had  the stock market get to valuation levels that were   at generational peaks. Consistent with the  high levels that we saw in the late 1990s.

The second thing that we saw last  year was not only low-interest rates,   but generationally low credit spreads.  We saw a very low cost of capital.   And alongside that, the Fed didn't just  succeed in reopening capital markets.   There was a whole host of speculative activity.  We saw concept stocks get to record valuations. In fact, the growth universe of stocks peaked  only towards the end of last year versus the   value universe of stocks. We saw IPOs for SPACs  and new stocks that didn't yet have earnings to   speak of or even revenues in some cases. And we  saw the high yield markets wide open for issuance.

And the second risk I would say that we  saw last year is that assets were priced   for very low risk and that is its own risk.  I think beyond that, I think everyone's aware   of the host of geopolitical risks  that we see out there in the world. Consuelo Mack: We've got  Russia, China, Iran, North Korea   most likely cooperating with each other, against  the U.S., against the West, against democracies.   It does seem like a very challenging  environment. As a world allocation fund   manager, how do you incorporate those  challenges in the investment process? Matthew McLennan: I think these threats are one of  the reasons we like to own part of our portfolio   in a potential hedge like gold because I believe  that the market is underpricing these risks. And  

I think the final thing I'll just mention is that  we've spoken a lot about monetary policy today,   but the fiscal policy settings  that we've seen have been   every bit as extreme as the  monetary policy settings. We saw double-digit fiscal deficits.  I think more importantly than that,   we saw a second round of  fiscal stimulus even after   business confidence had recovered. So it's  going to be a really big challenge to restore   fiscal credibility in the United States. That's  going to be a headwind for many years to come. Consuelo Mack: The fiscal credibility.  Who's judging their credibility?   Where is that going to  affect the financial markets? Matthew McLennan: I think we ultimately see  credibility expressed in currency markets. 

Consuelo Mack: Right. What kind of risk are  you seeing in the dollar now, for instance? Matthew McLennan: The challenge for the dollar  is that it's been strong for the last decade. Consuelo Mack: Right. Matthew McLennan: And the risk for the currency  is that it's expensive. We expanded our monetary   base more than other developed markets. We  have a trade deficit and the question is   if interest rates don't go up very much, are  we going to attract the capital when there's   an issue of confidence in policy that occurs  at some point over the next couple of years? Consuelo Mack: Right. That's something you've  been concerned about for a while, Matt,  

and it really hasn't happened  yet. How real is this risk and   is it something that you're doing  something about as a money manager? Matthew McLennan: I think it's difficult to  continue as we are because as we discussed   earlier on, the policy settings in each successive  recession have become more and more extreme. Consuelo Mack: Right. Matthew McLennan: By definition, I  don't think we're on a sustainable   long-term path. Our preferred way  of addressing these risks is to have   a potential hedge in the portfolio and we  express that through the ownership of gold. Consuelo Mack: As you're describing  these extremes that you're seeing,   has gold become, from your point of view,  even more valuable to you in the portfolio? Matthew McLennan: If I step back and I  just think about the backdrop objectively,   we probably have one of the higher  levels of valuation risk I can   remember in my career across many  assets. It's hard to dispute that  

we have what one of the higher levels of  geopolitical risks of the last generation. We also have, as we discussed earlier  on, the risk of the debt overhang. And   it's not just in the United States, it's  globally. And then we have the risk of  

policy credibility being brought into  question. This is a risky constellation   even though we're in the midst of what  feels like a robust economic recovery. And it's for those very reasons that we  want some potential protection against   a tail state of the world. And it's fair  to say that gold hasn't really been moving  

much higher to price those risks. In fact,  gold has de-rated since the middle of 2020. Consuelo Mack: Right. Matthew McLennan: And if we look  at the price of gold, for example,   relative to U.S. money supply and two,  when we look at it relative to equities,   the price of gold has retraced to levels  that were consistent with when the Fed   was at the peak of its prior tightening  cycle, such as Q3 in 2018, or Q2 in 2007. Gold has in a sense discounted a certain amount  of tightening in financial conditions. And I think  

the question for gold is going to be: What happens  next? What happens once the Fed tries to tighten?   And or if any of these risks that we  discussed start to surface themselves? Consuelo Mack: What does happen? How do you  think gold will respond under those conditions? Matthew McLennan: In my opinion, the Fed is  behind the curve. We have seven percent inflation.   We're still doing QE. One or two things can happen  in my mind that would constitute tail risk states.   One is that we end up repeating  the experience of the 1970s that   Chairman Powell becomes the second generation  of Chairman Arthur Burns from the early 1970s.

And that we get a period of  stagflation. Now, during the 1970s,   gold performed particularly well. It had its ups  and downs, but it did perform particularly well   over that decade. The other  scenario that could play out is that   the Fed remains committed in a Volcker-like  way to restoring its credibility. In which case we might need substantially  tighter monetary conditions than what the   bond market is currently discounting. I think in  that scenario, real assets would suffer initially   and gold could even conceivably go down. But  the question is would it fall by as much as,  

say, equities if the Fed really  jammed on the handbrake at that stage. And we think that the value of gold in those tail  states of the world could perform reasonably well   relative to equities. And because we're primarily  an owner of equities, that's valuable to us from   a portfolio construction standpoint. And I  would just make the final point. There is   always the smooth landing scenario. We'll wait  and see. I think that's what the bond markets   and asset markets are pricing  right now, and I wish them luck.

Consuelo Mack: Matt, Morningstar describes  First Eagle's approach as unique, giving   it a long-term edge. Aside from your holdings  in gold, which is a trademark of First Eagle,   what else are you doing that's different  from the world allocation funds? Matthew McLennan: At our core, Consuelo,   was the notion that we would like to  create resilient wealth over the long term.   And when we talk about gold and we've given  a lot of focus to it today. We need to put it  

in the context that it's a minority of our  portfolio. It exists as a potential hedge. And the path to resilient wealth creation for us  is primarily through the ownership of businesses   that embody some kind of scarcity value. And  where we plant seeds, we invest and we hold   for the long-term. Our average turnover  is quite low. We’re nearly a decade   horizon investor when we buy into businesses. We really aim to grind it out over time. We  want to grow wealth relative to nominal GDP,   but we want to do so in a way where  we have an eye to what can go wrong   so that when we have the  inevitable crises along the way,   our clients have the staying power to endure  that and benefit from long-term compounding.

Consuelo Mack: You just mentioned  scarce and durable assets.   Can you name a couple of companies that  represent those scarce and durable assets   that are in your portfolio now  that you've held for a long time? Matthew McLennan: Yes. If you look at our largest  equity holding, it's a company called Oracle.   They're the world leader in relational  databases. And their business is transforming   to cloud delivery. They're annuitizing  their business. The rate of growth in   their business is also accelerating as  they're going through that transition.

And it speaks to the fact that not only do they  have this sticky, stable market share position,   but it's priced in a way that the arithmetic  works. The company today has a free cash flow   yield, arguably north of six percent. And you  get the benefit of mid-single-digit growth,   a six percent free cash flow yield,  and a steady business over time. If I look around the world, we look for a range  of different kinds of businesses. For example,   the largest business that we own in our overseas  portfolio is a company called Richemont.   We used to own Tiffany's. It got acquired by LVMH.  

If you want to own a leading jewelry  Maison, you have to look internationally. And Richemont is the holding company  that owns Cartier and Van Cleef.   They also own IWC Watches and Piaget.   All of these brands are more than a century old.  That's an example of business duration. And the   company trades at a discount to the valuation  that LVMH paid when it acquired Tiffany's. Consuelo Mack: Prudent management, another  quality that you look for. And I know that you  

frequently invest in companies that are run by   founders or founding families. Can  you give us some examples of those? Matthew McLennan: Interestingly enough,  the last two companies we just discussed   have found a billionaire at the helm, basically. Consuelo Mack: Right. Yes, they do.

Matthew McLennan: And I think it's  particularly important at this point in time.   I described a macro environment to you that could  be very uncertain in the next five to 10 years. And what matters to us is knowing that this  management at the helm of these companies that   have a track record of not just wealth creation,  but adaptive behavior. So investing alongside a   founder, I think, is a good way to make sure  that your capital, the free cash flow that's   being generated by those businesses, is going  to be thoughtfully stewarded over time. And that   capital structures will be robust. In fact, if you look at Richemont,   it essentially has close to no net debt.  It's very conservatively capitalized.

Consuelo Mack: Your value investors  looking for that margin of safety   and considering how expensive the  U.S. market is, where are you finding   those margins of safety? Where are you  finding good value in the world today? Matthew McLennan: Last year, prudence  was not particularly rewarded. Consuelo Mack: No. Matthew McLennan: And as you suggested, the US  was at the epicenter of that. It's a dominant   part of the benchmark and the MSCI World. It  was also the hub of growth stock investing.  

I think if you're looking to diversify  and look for some opportunities elsewhere,   that may be less in favor, I would focus  on some of the Asian markets, for example. And in fact, Japan has been quite weak in  resonance with what was a bear market in China   last year. And not only is the currency weak and  potentially attractive, as we discussed earlier on   but a range of different companies  are valued very conservatively. If I look at our largest stable type  businesses in Japan. Companies like Seacom,   which has over 50 percent market  share in commercial alarm systems,   or Mitsubishi Estate, which owns a third  of the square footage in the Marunouchi,   the prime CBD real estate in Japan. These  companies trade at very modest valuations.

And there are businesses in other parts of the  world that own special assets or market positions,   and they may also be in currencies that  are quite depressed relative to history.  Consuelo Mack: Should we be looking overseas?  Is that where you think the values are? Matthew McLennan: Look, we've  found value in the United States. Consuelo Mack: Right.

Matthew McLennan: We own a range of U.S. listed  companies that we think are attractive to own   for the next decade. But I think it would be  remiss of an investor to ignore the opportunity   set overseas. The fact that the United  States equity market’s nearly 70 percent of   the MSCI World tells you that the average  investor is actually not that diversified.

So I think now is probably a prudent time to  consider some element of diversification because   many of the currencies internationally  are quite depressed relative to the   dollar. It's not a call on where  they go in the next 12 months,   but if you're going to be an owner for the  next decade, that's a good starting point. Secondly, the valuations of markets outside  the United States are quite a bit cheaper   than the US equity market. And if you're  selective, you have the ability to find   companies that either control special assets  or are run by talented management teams. Consuelo Mack: I just want to go back to  gold because when you're talking about   your gold holdings, you don't just own the  bullion, but you also own the gold miners.  

Are there gold mining companies that   one would consider to be sustainable and  responsible and environmentally friendly? Matthew McLennan: When one  thinks of the mining business,   one doesn't naturally think of something  that's sustainable in inverted commas. Consuelo Mack: Right. Matthew McLennan: But when you step back  and you really think about this industry,   this is an industry that's actually been  around for literally thousands of years. There are very few industries that have shown the  persistence of this industry. I think the second   thing that's critical is that if you look at the  large leading gold miners, whether they're royalty   companies or their miners, they have to operate  in all kinds of jurisdictions around the world. Consuelo Mack: Right.

Matthew McLennan: Social license is incredibly  important. And I think the most talented   management teams in the gold mining universe  devote a huge amount of their energies towards   finding the right balance between the local  communities they operate in and the economics   of the mines that they're running. You can't  be a good miner without a social license. Finally, from an environmental and safety  standpoint. A good mine is a safe mine. And  

your social license is invariably tied up with  the environmental footprint of how you mine. So   I would say that many of these  companies are far more thoughtful   than you would think on these variables. Consuelo Mack: And which company has done  particularly well among the gold miners? Matthew McLennan: One of our largest holdings  in the space is a company called Barrick,   run by Mark Bristow, who's got an incredible track  record of creating value in the gold industry. And   he inherited a range of social license  issues. But I think if you look at their   actions over the last couple of years, they've  made meaningful progress on all of those issues. And I think it's a good example of someone trying  to do right. They've also set a very clear roadmap  

to carbon mitigation over time. They take  this seriously and they believe it makes   very good economic sense. It will position them  on the right side of the cost curve long term. Consuelo Mack: ExxonMobil is also  one of your largest holdings.  

How do you view the energy and oil  industry in particular and those companies?   Both from an investment point of view and  also from a sustainability point of view? Matthew McLennan: The fossil fuel  industry has been the poster child   for a pariah industry during the past few years. Consuelo Mack: Right. Matthew McLennan: There's no question about that.   Having said that, one has to think at  a second-order level. Ultimately, there  

is a roadmap underway for people to transition  the auto fleet to electric vehicles over time. But one can't lose sight of the fact that  there are certain applications for which   dense and portable energy still is going to  require oil for a very long time. The reality   is that the field decline rate in this industry  that's been a pariah industry and where there's   been substantial underinvestment,  not just because of the ESG taint,   but because of the low prices during the  COVID crisis, has meant that there's been   insufficient investment to sustain field  life relative to the pace of transition. These companies need to exist. As you're  thinking about investing as a portfolio manager,   a real risk that you have to deal  with is the price of the world's   most consumed commodity going up  a lot because of underinvestment. Consuelo Mack: Right.

Matthew McLennan: And there's a role for  energy in a portfolio as a potential hedge.   Meanwhile, what's going on at these companies  is that they're arguably part of the solution.   Exxon is a world leader in carbon capture  technology, for example, and it's doing   a lot of research into  alternative fuels such as algae. They have new directors on the  board who bring environmental   change pedigree to the company. And the  company trades at a very undemanding valuation.   The thing I'd like to get across here  is that when you're thinking about ESG,   if I could give you analogy, think  of the world of credit investing.

You make money in credit investing by finding  a credit that's getting better over time.   In the world of ESG investing, it's our  belief as a value investor that ESG improvers   could be a source of real investment opportunity.  It's not just the history and the historical taint   of a business that makes sense. It's what a  management doing to improve the situation. Consuelo Mack: Matt, we always  asked the one investment for a   long-term diversified portfolio. Is there  something we should all own some of? Matthew McLennan: I think a lot of the  conversation today has centered around   the importance of diversification in a moment like  this. I think diversification is a key principle.   If you want to own a technology company like  Oracle, why not consider some tech leaders   internationally like Fanuc and Robotics or  Taiwan Semi in semiconductor foundry equipment? If you want to own a consumer staple in the United  States like a Procter & Gamble, why not consider a   Unilever internationally that's under an activist  attack right now at a third less of the valuation?   We've given a number of examples  today of the ability to buy   good businesses at reasonable  prices outside the United States.

And I think now's the time to think about that  from a long-term portfolio planning standpoint. Consuelo Mack: Matt MacLennan,  always a treat to talk to you, and   always appreciate your very thoughtful  conversations as well. Thanks, Matt. Matthew McLennan: Thank you so much. [Music] Consuelo Mack:   At the close of every WEALTHTRACK,  we try to give you one suggestion   to help you build and protect  your wealth over the long term.   This week's Action Point is adding some inflation  beneficiaries to your portfolio. As just discussed  

with few exceptions, gold has held its value.  It also serves as a hedge against disaster. Owning the bullion through an ETF makes it more  accessible. The SPDR Gold Shares ETF symbol GLD   is the oldest. Other traditional inflation  plays include a variety of commodities. A broad-based commodity ETF is the iShares  S&P GSCI Commodity Index Trust, symbol GSG.   Real estate is another traditional choice.  Real estate investment trusts, or REITs, offer  

shares in pools of income-producing properties.  The Vanguard Real Estate ETF, symbol VNQ,   provides low-cost exposure  to a broad range of REITs. And finally, Treasury Inflation-Protected  Securities or TIPS are U.S. Treasury bonds   indexed to inflation. You can buy  them directly from the government  

or through an ETF like the iShares  TIPS Bond ETF, symbol TIP. Now,   most of these investments have been out of favor  for years. They are under-owned by most investors. This is a good time to diversify into some  inflation beneficiaries for the years ahead.  

Next week, the bullish case for the market  from influential economist Eddie Yardeni.   In this week's extra feature, Matt MacLennan  looks to the future with a book recommendation. Please follow us on Facebook,  Twitter, and our YouTube channel. We so appreciate your spending  time with us. Have a lovely weekend  

and make the week ahead a healthy,  profitable, and productive one.

2022-02-14 08:40

Show Video

Other news