Where to Get Yield in Today’s Environment
In Part Two of our interview with Craig Van Hulzen, manager of the Iron Horse Fund (IRHAX), he discusses his firm’s separately managed accounts, and how he’s getting yield for his clients these days.
Kate Stalter: Craig, you had referenced the separately managed accounts. I also wanted to talk about that. Maybe just give us the 30,000-foot view of the investment process in that area.
Craig Van Hulzen: In a separately managed account format, most of the clients and families, and small institutions that we work with, we managed predominately all or all of somebody’s assets.
So in that format, we really take people through a three-step process, where we start with a risk budget or a risk allocation that’s proper and appropriate to that family or that mandate, and establish that investment policy.
Then we take them through the asset class allocation of how to currently weight that risk budget, so we’re essentially allocating what we call risk capital across opportunities of various asset classes. And then the final step is the actual security selection itself: What holdings to actually own within that asset class.
At the asset class level, we look historically at the current valuation of, say, for example, US stocks relative to its historic highs and lows, and then compare not only where the US stocks are relative to its own range, but then compare them to other stock or growth asset class options—small-cap US, developed international, emerging markets, and so on. And by doing that we get through to a dynamic or a tactical asset allocation process.
Kate Stalter: Say a little bit about how you do this. Is this through mutual funds, is it through ETFs—are there any particular vehicles that you’re using frequently these days?
Craig Van Hulzen: Well, it does depend on the client themselves. We believe that you should do everything as simply as possible, and as comfortable as possible for the end-user or for the client.
Depending on the size of the portfolio, the type of experience or securities that somebody may have used in the past, we will use either individual securities, mutual funds, or ETFs for a certain size portfolio that wants to be very efficient and targeted in where they allocate their assets.Â ETFs are a very good way to do that.
To get a lot of choice among high-quality managers, and access to a lot of managers in more of a portfolio that’s getting started up, or somebody who’s still accumulating their wealth and adding on a monthly basis, mutual funds tend to be a good choice there. For a lot of our separate accounts, because we are a money manager, we will also do individual security selection.
Kate Stalter: I also wanted to talk a little bit about the fixed-income side. Obviously, everybody’s watching the ten-year yield these days. What are you putting your clients into at this juncture, when you are looking at the fixed-income market?
Craig Van Hulzen: On the fixed-income side of the portfolio, it’s getting to be a tough spot. You’re getting paid very, very, very little for the highest quality bonds, and also very little for the short-term bonds—anything less than, say, five years.
At the same time, there’s a significant risk, obviously, in the global economy, especially centered in and around Europe. It appears there’s slowing going on in China, and we do, indeed, have a global economy.
So we think it’s a little bit of a tough spot in fixed income, but what we’re doing is moving just a little bit further out on the curve, into the seven-to-ten-year range, staying in the investment-grade category, but picking up enough yield to match, or at least get close, to long-term historic income expectations from a fixed-income asset class, offset against a certain amount of price risk.
So we’re in the middle end of the curve. We think seven to ten years makes more sense than the three to five years right now, and staying within the investment-grade area. The high-yield and low credit quality tend to be things that are cyclical and over-levered, and I don’t think we’re in the stage of the economic recovery where we want to have that much exposure there.
Kate Stalter: Craig, you were talking about getting the exposure in the seven-to-ten-year category. How are you going about this? With what instruments?
Craig Van Hulzen: I was speaking mostly to our internal bond work. What we’re doing there is we’re focusing on a couple of key areas.
One, we’re looking for businesses that would meet our fundamental criteria if we were going to buy their equity securities. and we’re looking for, therefore, low cyclicality, relatively low leverage of the balance sheet, and the chance for improving credit quality.
Corporations have had a chance to really take advantage of the zero-interest-rate policy, and the low interest rates. And a number of businesses and industries have used the last few years to lower their interest rate payments and refinance their debt, and get a little bit more on solid footing. So we’re looking for companies that have a chance to see that upgrade in their actual credit quality.
And then also, we’re looking for actions where businesses have looked at the crisis in 2008 and 2009, and changed some of their policies, changed their balance sheet, improved their business. So we’re looking for underlying internal business improvement in our bonds, as well as our stocks.
Kate Stalter: Can you name any examples of what some of these companies might be?
Craig Van Hulzen: Well, we think there seem to be a number of good opportunities in some of the oil and gas, and pipeline issues.
Some of the highest quality, high-tier financials in the intermediate term seem to be good opportunities, on a relative risk-reward basis. It really depends on the timing, day-to-day inventory, what’s available, and the certain areas that are actually improving.