Value Added


Investing in the New Normal

Steven Goldberg

Pimco’s Mohamed El-Erian aims at making profits and reducing risks in an uncertain time with his Global Multi-Asset fund.



The term new normal has entered our lexicon as shorthand for expectations that the global economy and markets will improve at a glacial place for the foreseeable future. The U.S. and much of the rest of the developed world remain mired in debt, meaning that countries and their populations will be paying off their obligations instead of spending on more-productive purposes. This will lead to slow economic growth and volatile markets. As Federal Reserve chairman Ben Bernanke put it, we are in an “unusually uncertain environment.”

What should you do if, like me, you largely agree with that assessment? Can you still make money? I put that question to bond-manager Pimco’s CEO, Mohamed El-Erian, who coined the phrase new normal. El-Erian says you can profit in any investment environment but that it’s much trickier than usual nowadays. “We think that the global economy and markets are on a bumpy journey to a new destination, the vehicle is being driven primarily by policymakers, and they have already used the spare tire.”

The gloom thickens as El-Erian goes on: “Unemployment is not only high, but it will remain high for a number of years. Policy outcomes have consistently fallen short of expectations. This is not a classic recession. You have to deal with the debt overhang and the housing inventory.” Despite all the uncertainties, El-Erian argues, “most people are still overexposed to risky assets.”

To navigate the new normal, the U.S. needs to provide further economic stimulus aimed at creating jobs and restructuring the economy for the 21st century, he says. The U.S. should “increase its productivity and enhance its ability to grow and create jobs.” But it also needs comprehensive budget reform to ensure that the federal deficit declines to a sustainable level in the coming years.

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To invest in the new normal, El-Erian and two co-managers launched Pimco Global Multi-Asset D (symbol PGMDX) in October 2008. The fund is designed as a new-normal substitute for a traditional balanced fund, which contains 60% stocks and 40% bonds. From the fund’s inception through October 15, it returned an annualized 15.0%, compared with 15.4% for Standard & Poor’s 500-stock index. More important, El-Erian says, the fund has produced those returns with much less volatility than the S&P 500.

As you might expect, Global Multi-Asset is an unusual mix. About 48% of its assets are in stocks, including 11% in emerging markets. The fund hasn’t usually held that much in stocks, but the managers added to their stock holdings during August’s selloff. Nearly one-fourth of assets are in high-quality, developed-market bonds with relatively short maturities, and another 13% are in emerging-markets bonds. Global Multi-Asset has 10% in commodities, including 4% in gold. The fund invests in other Pimco funds, as well as in individual stocks and bonds.

Global Multi-Asset also invests in a number of defensive securities, including options, designed to limit the fund’s losses in any year to less than 15%. These include a variety of investments that would rise sharply if the markets fall sharply. El-Erian likens these derivatives to automobile insurance: They are unlikely to be necessary, but if there’s a market smashup, they should pay off handsomely.

Wait to buy gold

El-Erian thinks that inflation, which is practically nonexistent, will continue to decline for maybe the next six months. He worries that after that, inflation could resurge. That’s the reason for the fund’s gold investment. “We want to buy these inflation assets when they’re cheap,” El-Erian says, meaning the fund’s stake in gold will likely rise if the metal’s price falls.

The fund is too new to recommend. But Pimco’s reputation and El-Erian’s background are big pluses. If the fund errs, it will be on the side of being too defensive, not too aggressive. After all, Pimco is almost exclusively a bond shop, and bond managers can be a dour bunch. One negative: Expenses of 1. 92% on the Class D shares, which you can buy without a sales fee through many discount brokers.

Want to do it yourself? I wouldn’t advise individual investors to buy index options aimed at insulating their portfolios from market declines. But the rest of El-Erian’s approach is one any investor can implement.

Start by putting a big slug of your investments into funds that invest in stocks and bonds of emerging markets. El-Erian sees these economies and markets as the big winners in the coming years. Don’t ignore developed markets, of course. Lots of multinational companies in the U.S. and elsewhere are achieving much of their growth by selling in developing nations.

Add a high-quality bond fund or two, but don’t stretch for yield by investing in a high-yielding “junk” bond fund or a long-term bond fund. And wait for the price of gold to fall as deflation fears mount. Don't buy gold at today's high prices.

As for the longer term, El-Erian is not so glum. “We have been in this plane with one massive engine called the U.S. consumer. That engine is dead. At the destination is a plane with multiple smaller engines. The transition is going to be difficult. You need to be positioned both for the journey and the destination.”

The destination is a world in which emerging markets are much more important than they are now, and where most of the developed world is less important. But it’s one with sustainable growth.

The journey will take many years. It’s unrealistic to expect a smooth handoff in demand from U.S. consumers to emerging-markets consumers. The global economy still faces potholes.

By normal standards, El-Erian’s approach is chintzy when it comes to stocks. I think it’s a little too chintzy. But El-Erian believes limiting stock investments is crucial to protecting your nest egg during this period of wrenching economic change.

Steven T. Goldberg (bio) is an investment adviser.



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