Contrarian Investors At Advisors Capital Management Are Focusing On High-Yield And Very Short Paper Or Floating Rate Securities In Fixed Income Markets For 2012
January 24, 2012 - The Wall Street Transcript has just published Investing in Master Limited Partnerships and Other Investing Strategies Report offering a timely review of the General Investing sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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Charles Lieberman is a Founding Member and serves as Chief Investment Officer for Advisors Capital Management, LLC, a money management and investment advisory firm, servicing financial advisers and private clients throughout the country. Dr. Lieberman has overall responsibility for managing its separate account portfolios. A graduate of the Massachusetts Institute of Technology with a bachelor's degree in economics, he earned a Ph.D. in economics from the University of Pennsylvania before beginning his professional career as an Academic at the University of Maryland, and subsequently, at Northwestern University. In 1997, he left Chase to found, along with Co-Founder Henry Kaufman, the global macro hedge fund Strategic Investors Management LLC and to serve as its Managing Partner and Principal Strategist.
TWST: Is there an example that comes to mind of a stock that fits that profile for the firm recently?
Dr. Lieberman: One great example, and it's one where we were early, which is not an uncommon thing for us, is a company called Trex (TREX). Trex is a company that makes composite wood-decking material, which is obviously housing related. And a couple of years ago, when the market was imploding, especially for anything related to housing, the stock got pretty much annihilated on the basis that no one was ever going to build a house again in the United States for many, many years. Yet you had this company, which was operating at a very low level of capacity utilization, but was cash flow positive and likely to earn some serious money in any kind of housing recovery. The stock at that time was severely depressed. We started buying it in the single digits, like $6 or $7 a share. In late 2007, early 2008, it was trading below $8 a share, and we bought the common for our aggressive clients, our growth portfolios, and we bought the convertible bonds for our income with growth portfolios.
The convertible was a really extraordinary opportunity because it had a conversion price of $21.78, and the stock was trading at less than $8. We paid almost nothing for the conversion feature. And of course, because of the housing market situation and the company was losing money at that time, it was a really busted convert trading at around $65 on the bond price. So it had a current yield of almost 10%, a yield to maturity above 14%, and we felt that the company would survive and come back. So we bought different pieces depending upon the needs of the clients, common stock for growth clients and convertible bonds for income-oriented clients. The convert is a small issue, but we managed to buy a sizable chunk of the outstanding bonds. The stock came back like gangbusters in 2009 and 2010. At its high earlier last year, in 2011, the stock traded up almost to $34 and the bond traded above $150. We are one of the largest owners of this bond.
We suspect that a convertible arb hedge fund was a seller and put a lot of it on the market at one time and we bought it all. We bought the entire position, and we pretty much owned it since then. To our great disappointment, the bond matures July 1, 2012. So we don't expect to be able to keep this bond much longer for our income-oriented clients, but it's marked over $112 right now, and the stock is trading over $23, but we think with considerable upside remaining as the evidence of a recovery in housing continues to mount.
TWST: In addition to housing, what global economic trends or themes do you believe are going to be most important in 2012, and how may those trends or themes impact the firm's investment approach?
Dr. Lieberman: The principal trend that we see is, first and foremost, is an economic recovery in the U.S. In 2011, it looked to us like the economy was beginning to build some momentum to the upside when a couple of external, wide-ranging shocks occurred that hurt growth, including the meltdown of Greece, which sent a tremor through capital markets globally, the earthquake and tsunami in Japan, which disrupted part supplies, especially in the auto sector, and depressed industrial production and car sales in the U.S., and the rise in energy costs and food prices, which took a bite out of discretionary income. It was that confluence of circumstances that slowed down U.S. economic growth and permitted some people to think that the economy was going to relapse into recession.
We didn't share that view, and we thought the adverse effects of these events would prove to be temporary. So our expectation going forward is that we think the economy will gradually improve over the course of 2012, and the recent data gives us a lot of comfort in that thesis. It directs us toward more economically sensitive parts of the market and away from parts of the market that are more stable and less likely to benefit from this recovery. So the areas that we find most attractive to buy include consumer discretionary, industrials, materials and financials. The parts of the market that are less attractive include health care, telecom, utilities and consumer staples. The same underlying logic flows over into our approach to the fixed income market, where we are trying as much as possible to avoid anything that is investment grade, where yields are unsustainably low, and we are focused on high-yield or very short paper or floating rate securities, where we sacrifice yield, but take very little duration risk, and of course, convertibles.
TWST: Would you give us a couple of additional examples of current holdings at Advisors Capital Management that are representative of the types of stocks you are looking for?
Dr. Lieberman: In the case of housing, another company that we like a lot for our more aggressive clients is USG (USG). It's the old U.S. Gypsum, and they make wallboard, which is directly related to housing activity, of course. It is also used in home renovation, but new construction is clearly a very important driver here. With housing activity down so sharply, business has been poor, and the company has been losing money for three or four years now.
But the need for new construction is dramatic. In the United States, we form about 1.5 million new households on average per year given the demographic composition of the population. Construction activity is about 680,000 at an annual rate according to the most recent housing starts report. So the nation needs to more than double - more precisely, about 2.25 times the current level of construction - to keep up with the underlying trend in household formation. Household formation itself is cyclically sensitive. So the recession induced a lot of college grads, for example, to move back in with mom and dad because they couldn't get a job, and therefore, didn't form a household. But that's a temporary event. It's household formation that's deferred. It's not household formation that's foregone. So as the job market picks up and those young people do get jobs, both to their relief and to the relief of their parents, they'll be moving out as soon as possible.
So there is a lot of pent-up demand for housing that I don't think is recognized in the marketplace. USG is right in the way of that wave. As housing demand picks up, so will demand for their product. Moreover, they actually have a superior product because they've introduced some ultra-light wallboard panels that meet the building codes, and yet are lighter, so builders prefer that kind of wallboard. So they have both a very competitive position with product, but they are also in a sector that should see a pretty dramatic increase in demand over the next couple of years. And I don't mind the fact that somebody by the name of Warren Buffett happens to own about a third of the company.
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