Velocity Of Money Accelerates As Unemployment Drops: Veteran Bond Portfolio Manager David Pequet With History Of Positive Returns Analyzes The Fixed Income Market For 2010 Through 2014
October 25, 2010 - The Wall Street Transcript has just published Large-Cap Growth and Other Investing Strategies Report offering a timely review of the Asset Management 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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DAVID W. PEQUET, President and CEO of MPI Investment Management, Inc., earned his Engineering degree from Michigan State University in 1974. He entered Naval Aviation Officer Flight Program following college. Mr. Pequet began his career in the securities industry in 1976. He founded the investment advisory firm, MPI Investment Management Inc, in 1986.
Prior to starting MPI, he specialized in fixed income sales at several Wall Street securities firms including Prudential-Bache and Mosley Securities. For the last 20 years, Mr. Pequet has been active at the executive level in several community and youth programs, including eight years as a Board member of the Oak Brook Plan Commission, six years as coach and Director of the Hinsdale Little League, 23 years as Treasurer of the Roger B. Chaffee Scholarship Fund and he has been a Director and Treasurer of the Hinsdale Library Foundation for the last five years.
TWST: You were pleased with the performance of your portfolio last year. How have the last 12 months been for your type of investing?
Mr. Pequet: Fixed income markets have been strong and our performance has been good this year. We're probably going to see gross performance in the 3% to 4% range this year, which includes income and some appreciation. We'll have good solid performance this year in both our taxable and tax-free accounts. What we like to focus on is, when we discuss performance, and obviously there are no guarantees moving forward of what our performance may be, is how a manager performs in difficult markets. Everyone should do well in good markets. We like to look at 2008 when the average bond fund manager in the US, including mutual funds and separately managed funds, was down about 4%. But the average bond fund manager was down 4% in 2008 and we were up in our taxable accounts approximately 5.5% gross before fees. We had approximately 3.5% positive performance before fees in our tax-free municipal accounts. If you have one bad year as a manager it can take years to catch up.
We have never experienced a down year in our fixed income product history. Our Gibbs compliant track record goes back 19 years for our taxable product. One bad year can take away a lot of performance and a lot of goodwill for several years to come to make that backup.
TWST: What about the volatility in the markets? How do you attempt to survive the volatility, and have you made any shifts in emphasis to deal with events like that?
Mr. Pequet: There has been a tremendous amount of volatility in the fixed marketplace from U. S Treasuries all the way across high-yield junk corporate bonds and everything in between. There has been a lot of volatility, volatility on the downside in 2008; volatility on the upside side in 2009; and more strength again this year. Because our style is so conservative and short-intermediate duration, we experience just by definition of our style, far less volatility than most other asset classes in the fixed income world. Our high quality, short duration style really stabilizes and moderates market volatility. That said, we have made portfolio adjustments. We have not owned straight U.S. Treasuries for well over a year. When Treasuries made their big move up in late 2008 or early 2009, we swapped out of our straight treasury issues and moved into agencies, GSE's, TIPS and mortgage backs. That was one response to volatility.
On the upside, that adjustment has been a positive driver in our portfolios. At some point in time, we're going to see some more volatility come into these markets when interest rates begin to go up. It's not going to happen tomorrow. It's probably not going to happen for the next couple of quarters. But, at some point in time, rates will begin to cycle back up, we're going to see a lot of volatility in the intermediate and longer maturities and in lower quality issues, and obviously we avoid that potential risk because we're short duration, high quality issues.
TWST: What is your macro outlook for the bond markets going forward, especially with interest rates and inflation concerns?
Mr. Pequet: There has been a tremendous amount of liquidity that has been injected into the bond market by the Fed. The Federal Reserve has significantly grown their balance sheet. All this liquidity that has gone into the market, at some point in time, will have to come out. The main driver that's going to determine the timing and the velocity of that money coming out of the market or more money going for that matter, in is primarily unemployment data. All the focus is on unemployment and housing; and really they're interconnected. Unemployment is going to have to start to go down for the economy to pick up. When the economy starts to pick up, it's going to help burn off the housing inventory and the economy will start to recover. We're seeing very early stages of that right now, but it's going to take some time.
A tremendous amount of damage was done to our economy in the last few years. It's going to take time to repair that. It will repair, but I think we're going into a new period where stabilized unemployment levels will be higher than the historic 4-5% range. We might have to live with 6-7% unemployment even after a recovery. A lot of jobs that have left our economy or left our country or both are not going to come back. Historically the auto industry and the housing industry would lead us out of a recession. If you look back to over the last several recessions going back, 60 years, industry, primarily the auto industry and housing industry, were the first industries to shut down, easy to throttle down but also easy to start back up.
The auto industry is a lot different than what it was say two decades ago; it's much smaller, it's much more efficient, much of it has just gone away forever. It's not going to be the recovery driver that it used to be. In the housing industry, we've got a huge amount of overhang inventory and more coming. It is going to take a while to burn that off. Inflation is not a problem today. But we have an awful lot of commodity inflation right now.
When you look at inflation as measured by the Government, it measures our inflation by the Consumer Price Index (CPI). CPI has several components that are tied to housing. Both rental housing and single-family ownership of housing probably make up 40% of CPI. Then you also have a large component of CPI tied to labor and wages. While housing prices have gone down and wages have been flat, inflation as measured by the Government, CPI appears to be nonexistent. But for the public, for you and I, the price of gasoline is higher today than it was two, three years ago, the prices of all the basic commodities, the grains, all the agricultural commodities have been extremely strong this last year. The metals and other industrial inputs, such as copper are all higher and will eventually inflationary in the manufacture process.
When you factor in a lousy housing market and a very soft labor market, they kind of offset one another, but we will have inflation down the road. It's not around the corner, it's not in the next six months, but inflation will come back solely because of these economic factors and monetary policy. Inflation cycles and rates will go higher.I think our style fits well with what's on the economic horizon in this country. When the economy recovers, we will begin to see inflation come back in this marketplace and we will see rates trend higher. In that environment, you want your fixed income component of your portfolio to be in short-intermediate maturities and high credit quality.
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