Bob Rodriquez's Gloomy View

Veteran investor Bob Rodriguez is fiercely protective of preserving shareholder capital. So when Rodriguez, the rare manager who runs both a stock fund and a bond fund, concluded three years ago that a housing boom fueled by funny-money mortgages would end with a massive bust, he began positioning his funds even more conservatively than they already had been.

A few years back, Rodriguez's stock fund, FPA Capital, had about 35% of its assets in cash. More recently, the fund's cash position has been running between 40% and 45% of assets, which totaled $1.8 billion at last word.

Rodriguez's cautiousness has been particularly welcome this year. Year-to-date through April 14, FPA Capital (symbol FPPTX), which is closed to new investors, gained 1%. That beats Standard & Poor's 500-stock index by ten percentage points and the S&P MidCap 400 index by more than seven points.

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The fund's long-term record is even more impressive. Over the past 20 years through March 31, FPA Capital returned an annualized 15.5%, the sixth best record of any fund.

The performance advantage of Rodriguez's bond fund is less dramatic. FPA New Income (FPNIX), which Rodriguez runs with Thomas Atteberry, was up 1.8% year-to-date through April 14, 0.6 percentage point behind the Lehman Brothers U.S. Aggregate Index.

Over the past five years, the fund returned an annualized 4.8%, a smidgen ahead of the bond index. New Income hasn't experienced a calendar-year loss since Rodriguez began running it (and Capital) in 1984. The fund levies a 3.5% sales charge.

We checked in with Rodriguez recently to ask what was behind his pessimism and to learn about his current investment strategy. What follows is an edited version of the interview:

KIPLINGER'S: What's your take on the credit crisis?

RODRIGUEZ: This is the beginning of a new and different era. In the past six years, we had more credit created outside of the banking system than within it. We had the spawning of what I call alphabet-soup securities, such as CDOs, CMOs, CMBs, etc.

Now, a new financial system is in the process of emerging. The whole area of structured finance is dead. I call this the "Post-Bear Stearns phase" versus "the Pre-Bear Sterns phase," before the Federal Reserve stepped in to create new lending facilities for primary broker-dealers and facilitated the merger between Bear and JPMorgan Chase.

Were the Fed's actions appropriate?

I find what it did highly disturbing.

Why?

The Fed's actions were not vetted by Congress, and they put taxpayers' money at risk. I also predict we will see more pressure for a real estate bailout in the residential sector. Politicians will use the excuse that "we bailed out Wall Street, so why not Main Street?"

How do you assess the impact of the credit crunch on the economy?

Because of the credit contraction, any economic recovery will be subdued. I believe we are already in recession, and when the recovery comes, it will be substandard to the one that followed the 2001 recession. In the next five years, economic growth and productivity will be more subdued. The consumer is highly leveraged and this will hinder corporate profitability.

What does all this mean for investors?

I expect stocks and bonds to generate returns in the range of 2% to 5% a year.

How does this color your investment strategy?

I smell risk where others don't. It is better to save money than to go out there and lose it, which is why I have built up cash in FPA Capital in the past two and half to three years.

I spend a lot of time worried about what I have to lose for my shareholders, rather than what I can make. I don't worry about the returns I am likely to miss. At another point in time, I will become as aggressive and as anyone else.

Have you added any new stocks to FPA Capital this year?

We've added a total of two new holdings in the last 18 months, and we've had a halt on all new buying since last December 14.

That said, we are very bullish on energy and have been so for nearly a decade. Energy is a depleting resource. We are not running out, but we are using up the low-cost, easy-to-get-to energy.

How have you been playing energy?

Most of our energy exposure is with drilling companies such as Ensco International (ESV) and Rowan Companies (RDC), since we can get more energy only by punching holes in the ground.

What about Rosetta Resources (ROSE)? FPA is the majority shareholder.

I'm bullish on Rosetta, which is the oil and natural gas operator that was spun out of Calpine (CPN) when it needed capital. Natural gas has a high depletion rate in this country and Rosetta has expanded its reserves.

What are you avoiding?

We have reduced our exposure to consumer-related stocks, including retailing, by half in the past 18 months. Years ago, the fund held financial stocks. I believe they will continue to decline over the next year and do not plan to buy any in the interim.

Let's talk about the fixed-income side because you also run a bond fund. Are you still avoiding high-yield bonds?

I wouldn't touch them with a 5,000-foot pole.

What about Treasuries?

If you extend out along the yield curve by purchasing long-term bonds, you are asking to have your head handed to you. There is no value in any area of the Treasury market today. We have culled anything we could think of in New Income's portfolio that had an element of risk, including the elimination of unsecured bonds from Fannie Mae and Freddie Mac.

Where are the safe havens in fixed income?

We have been selective in our bond acquisitions. New Income is now at its highest quality level in history. We own some agency bonds, including some from the Tennessee Valley Authority. We've also got some agency mortgage securities with ten year maturities.

Given your concerns about the domestic economy, are you looking abroad for investment ideas?

My ego may be big, but it's not that big! I don't invest overseas because I don't understand foreign companies and markets well enough.

Clearly, most investors are having a tough enough time right here in the U.S. Did the majority of investors and money managers sidestep the collapse in 2000? No! Did they sidestep this credit crisis? No!

With all of the education and timely access to data that we Americans have, most of us still managed to blow it over the last eight years. If you cannot get a full grasp of what is going on in your own country, would you be that much smarter at interpreting events elsewhere?

You like to quote Warren Buffett, saying that when people are greedy, you should be fearful and when they're fearful, you should be greedy. When will you get greedy?

People may be somewhat fearful, but I have not yet seen a headlong desire to move into cash. In light of what has gone on with the credit crunch and mortgage-backed securities, I want to see stock prices considerably lower and bond yields considerably higher.