First Eagle: “Passive Investing Could Prove To Be An Expensive Mistake”Advisor Perspectives
First Eagle’s Global Fund (SGENX) is its flagship fund, with over $55 billion in assets. Its mission is to seek long-term growth of capital by investing in a range of asset classes from markets in the United States and around the world.
As of April 30, 2018, since inception (1/1/79), the Fund has returned 13.15% annually, versus 9.67% for the MSCI World Index. Over the last 15 years, it has been in the top 2% of its peer group, as well as in the top 4% for 10 years and the top 10% for 5 years, based on Morningstar data. It was the winner of the Lipper Best Flexible Portfolio Fund Award for 2015. It is rated 5-stars by Morningstar. Its managers are Matthew B. McLennan and Kimball Brooker, Jr.
I spoke with Matt and Kimball on May 1.
The First Eagle Global Fund is described as a go-anywhere, multi-asset fund. Tell me more about its flexibility and the key tenets of your investment philosophy.
Kimball: Our investment philosophy centers on the notion that the protection of wealth is the most important ingredient to the long-term creation of wealth. We are bottom-up investors, so we underwrite each investment on its own with the primary objective of avoiding permanent impairment of capital.
We focus on two criteria when we select investments for the Fund.
The first is price. When we think about investing in a security, we are always looking to do so at a discount from what we estimate the business’s intrinsic value to be. That is a very important part of what we consider to be risk management, because we realize that bad things can happen to companies or the economy, or we can make analytical errors. We always want to have a buffer between what we pay for a security and what we think it is worth.
The second criterion is the persistency of the business – the durability of a company. We review things like its market position, its balance sheet and the quality of its management to satisfy ourselves that, if and when trouble comes, the business is likely durable enough to survive and hopefully thrive.
In terms of the flexibility that you referenced, we have the ability to look across market caps and geographies. On the one hand, having the ability to look at businesses in different industries or geographies and across the capital structure increases the likelihood that we will uncover something that fits our investment criteria.
At the same time, that flexibility allows us to avoid certain pockets of the market. We construct our portfolio from the ground up, without regard to a benchmark. From time to time there are entire regions or industries that fail to meet our investment criteria. If that is the case, we just avoid them. In the past, there have been periods of time where we’ve been out of industries or regions.
Sometimes what you don’t own can have an important or even larger impact on returns compared to what you do own. Flexibility is very important to us.
You don’t have a strategic allocation to cash, rather it ebbs flows with opportunities in the market. Given your current level of around 20%, does it mean the opportunities are few and far between?
Matt: As Kimball alluded to, we like to take money out of cash and invest it in securities only if we see a suitable margin of safety. That is to balance the price, the opportunity, the underlying persistence of the business and the character of management. We have the benefit of looking globally, and across market caps and capital structure to identify opportunities. There is usually something to do.
Having said that, there are some environments that we would describe as appearing to be “opportunity rich.” An example of that would be in the wake of 2008 and 2009; valuations were broadly depressed across most industry groups. There were plenty of opportunities to put money to work with, in our view, a margin of safety. Perhaps not surprisingly, our cash levels were pretty low back then.
But then there are other environments throughout the business cycle where confidence is high around the world and where many industries appear not only fully valued but doing pretty well, and have high margin structures. It becomes more difficult to identify opportunities to put capital to work. Our cash levels peaked at around the 20% level back in 2007, at the peak of the prior cycle.
At the end of last year cash was getting up to around 20% as well. It is slightly lower today at around 18%. The recent market volatility has helped us identify some opportunities. But you are absolutely right that the higher cash level is signifying that because we keep to our absolute investment standards one security at a time, there may be an environment where we are trimming some positions that have exceeded our sense of intrinsic value and it is more difficult to redeploy that cash in new positions.
The ebb and flow of the cash position is not based on top-down considerations. There is no view of where the market is going to be in 12 or 18 months. It is based on the bottom-up opportunity set. A higher-than-average cash level signifies that we are in a scarcer opportunity environment.
One other thing you said in your question is we don’t have a strategic allocation to cash. This is an important observation. We are very long-term investors. We typically have a decade-long cycle time for the Fund’s investments. We think through the business cycle. That means that the Fund’s portfolio turnover is pretty low – slightly above 10% typically. If we wound up having 30%, 40% or 50% in cash, it is unlikely that we would have the option value of putting that cash to work in a better environment given the low turnover. It would become a strategic allocation to cash.
Over time, to seek to protect the Fund we strive to identify businesses that can keep pace with nominal GDP and money supply growth, and have the potential to generate free-cash flow along the way. Unfortunately, in a world of excessive leverage, the real rate of return on cash has been very depressed. If you had a strategic allocation to cash, that would not protect your wealth relative to the growth in nominal incomes and money supply. Cash is there as deferred purchasing power for the Fund. We intend to use it when we believe there is a more propitious moment within the business cycle.
Read the full article here by Robert Huebscher, Advisor Perspective