David Darst

Uploaded by WealthTrack on 17.02.2012

CONSUELO MACK: This week on WealthTrack, a winning strategy for protecting your portfolio.
Morgan Stanley’s Chief Investment Strategist David Darst, a noted master of the art of
asset allocation, shows us the plays to keep your portfolio safe, next on Consuelo Mack
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Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. U.S. stocks, particularly
large cap ones, are starting to come back in favor after the equivalent of a year long
boycott by many investors. A recent Bloomberg poll of professional investors, analysts,
and traders found that 48% of them believe the U.S. will be among the best-performing
markets this year, the highest rating since the poll began in 2009; and its more than
twice the number who expect China and Brazil’s markets to lead the pack. As an asset class,
stocks overall are favored as well with 50% of the surveyed planning to add to stocks
over the next six months.
On the flip side, bonds are expected to be the worst performing major asset class this
year, and about 45% are planning to reduce their bond exposure. This is a far cry from
investment attitudes last year when stocks were shunned and bonds were embraced. It also
would have been a poor strategy to follow. Last year stocks were the big losers and bonds
the winners. But what does this mean for our portfolio longer term? That’s where this
week’s Financial Thought Leader guest comes in.
David Darst is Chief Investment Strategist at Morgan Stanley Smith Barney and a noted
expert on asset allocation, considered to be one of the most important components of
investing. David has written several books on the subject including Mastering The Art
Of Asset Allocation and his most recent best seller, The Little Book That Saves Your Assets,
a WealthTrack bookshelf recommendation.
As Darst points out broad diversification can stabilize portfolios even in volatile
times. Over the last ten years the difference in returns among asset classes has been wide,
ranging from compound annual growth rates of a measly three percent for the S&P to nearly
12% for emerging market debt, over 10% for real estate investment trusts to nearly 19%
for Latin American stocks as well as gold.
But what Darst believes investors should pay particular attention to is the correlation
among different asset classes- in order to manage the risk and reduce the volatility
in one’s portfolio, he recommends mixing in assets that don’t track stocks. Over
the last ten years, they include U.S. treasuries, managed futures, high quality corporate bonds,
treasury bills and foreign bonds. I began the interview by asking Darst if we should
rethink the central role that stocks have traditionally played in our portfolio.
DAVID DARST: Well, Consuelo, it's always a good idea to get your bearings, to evaluate
your mission, to evaluate the purpose of stocks. Good stocks, good companies, really represent
human endeavor, human aspiration for a better life. Stocks are basically building on this
human desire for improvement of the planet. Emerging markets, population growth. So you
want to basically make sure you're choosing the right kinds of stocks- stocks that have
We’ve talked over the years, you and I, you want to have these companies that have
good balance sheets, fortress-like balance sheets. Good cash positions, phenomenal managements
that can basically take what they know and put it into these emerging markets.
CONSUELO MACK: The benchmark asset allocation has been traditionally 60-40, that's the starting
point. Then what you do is you either ramp up or you ramp down from that kind of starting
point. So should stocks still be the predominant asset class in your portfolios?
DAVID DARST: Oh, that's a phenomenal question, Consuelo, because it's going to be affected
by, and it's going to be driven by, a person’s temperament, their age, whether their lifestyle,
goals, their income needs, what are they going to do with the money, in the end, is it savings
type money that they cannot lose? Is it money that's going to be set aside for children’s
college or for foundation? So I think stocks deserve a place. They are not an asset that
should be totally abandoned. 60% might be high.
DAVID DARST: But it depends on the person. Consuelo Mack, I know 78-year-old people who
invest like 18-year-olds. Okay? And they can stomach it and they've got the money, that
if the portfolio fell 50% it wouldn't affect them, mentally or lifestyle-wise. I know 18-year-old
people who should not be 60 or 80 or 90% in stocks, they should be basically husbanding
because they're trying to save a nest egg to do this or that, and not risk all of that.
So age-driven investing is not appropriate. It's your temperament, it's your tax situation,
it's the needs that you have. So 60% is the received wisdom, and we were all taught this
like catechism, Consuelo. We were taught this like dogma.
CONSUELO MACK: That's why I’m asking you, you are the master of asset allocation, David
Darst. Life, the world has changed. And we have many more assets to choose from.
DAVID DARST: Don’t we ever.
CONSUELO MACK: Many more investment choices to choose from. So therefore we no longer
have to be wedded to cash, bonds and stocks. With all of the asset classes that we do have
available to us, what should we expect from stocks versus the other choices that we have?
DAVID DARST: Consuelo, this is a great point.
CONSUELO MACK: It's a fundamental question now.
DAVID DARST: I think everybody needs to have diversification, okay? And diversification
means asset classes that zig when other asset classes zag.
CONSUELO MACK: So let’s talk about that, because again, this is all new and the last,
really, ten years, that unless we’re a high net worth individual or an institution, that
we have choices that we never had before. So what are the other asset classes that should
be in everyone’s portfolio, basically, as a starter?
DAVID DARST: Consuelo, and I hate to go to a sports analogy, but the world of professional
football, they have this saying that offense wins games. Defense wins championships. And
special teams win Super Bowls. Special teams is the kicking game, it's the punt return
game, it's the point after touchdown game. It is all of the other things, aside from
being on offense or defense, which is very, very important to win championships.
CONSUELO MACK: Right, having just seen the Super Bowl, we know what you're talking about,
DAVID DARST: Exactly. So what you want to have is some offensive assets. And they tend
to be stocks, U.S. stocks. But no longer, as you just said, not only just U.S. stocks.
There's Canadian stocks, there's United Kingdom, there's Great Britain.
CONSUELO MACK: All the emerging market stocks.
DAVID DARST: Emerging markets, right. You want to have fixed-income securities, you
want to have bonds. And that's to give some defensive characteristics to the portfolio.
CONSUELO MACK: So we just did the offense, which is stocks, to win the game. Now you've
moved to defense, right?
DAVID DARST: Defense is to win the championship, and that is, listen, 2008, when the stock
market fell 37%; a ten-year Treasury bond went up 20%. Last year, as you know this,
17% gain.
CONSUELO MACK: Ten-year, right.
DAVID DARST: A total return for the ten-year, and a 34% gain for the 30-year. So you needed
to have some of this in there to play defense. Last year was a very volatile year. There
were 69 of these big volatile, all-or-nothing trading days, as you know, which is more than
the total from 1990 through 2004 combined. So we had a lot of volatility.
CONSUELO MACK: So what is it that wins the Super Bowl? Just explain that.
DAVID DARST: Special teams. Special teams winning the Super Bowl involves the following:
people who had a little gold in their portfolios, back in 2008 when the market in the U.S. went
down 37%, emerging markets down 53% or more. Some assets fell 70 and 80%. If you had a
little gold, it prevented you from panicking about your good investments.
So you said that's the special teams. Special teams is psychological, too. So people called
me and said this great, big U.S. industrial giant has gone out of business, okay? I said
there's no way of that happening. The balance sheet, we’ve looked at it, everybody says.
Do you have any gold? Yes, I have a little gold. How’s the gold done? Well, we’ve
got a big profit in it. Then don’t sell the other one. Use this as a mental offset.
It's financial Tylenol. It gives you the calm and the peace of mind you need in times of
great market tumult, and great market turbulence. You need to have the sangfroid, the coldness
and the dispassionate ability to see through all this and remain calm. And that's what
these non-correlated assets like managed futures, which were up 14%, that's the index in 2008,
when the market was down so badly. Gold was up 5.8%. Inflation-protected securities did
well. So these things are non-correlated with the stock market, which I know has been a
theme that you've emphasized and repeated over and over. You want to have some things
that zig when others zag, and that's the special teams aspect.
The second big theme is you want to have rebalancing. And that's something that we discussed.
CONSUELO MACK: So let’s talk about rebalancing, when you do it, I mean how you rebalance.
Just tell me how that works.
DAVID DARST: There's been great work done by the CFA Institute, the Chartered Financial
Analyst Institute.
CONSUELO MACK: All right, which you are one.
DAVID DARST: Yes. And they've basically found that there's no magic bullet. So some people
do it by price. When something gets too high you trim it back. When it gets too low, you
buy more. We think you need to have a little leavening in there of human judgment, and
it's not always you alone. It might be you asking someone whom you trust, your Uncle
Frank, your Aunt Matilda, asking someone whose judgment you trust, does it make sense? Look,
Japan fell; Japan’s still down 70%from the peak; it was 38,000, it's 8,000/9,000 now.
So if you rebalanced, you would have been plowing more money into Japan that's been
dead for 20 years now. So you need to have an overlay of good judgment and good insight.
Not clairvoyance, not perfect. But is this thing going to be permanently impaired, which
Japan has been for a long time now, or is it a temporal thing that will basically flatten
out? So you had the tech stocks in the late 1990s. They got way up and it was time to
trim there. You had the energy stocks.
CONSUELO MACK: Let me stop a minute. So how do you determine, I mean it's like Japan,
of course in retrospect, we all get. The tech stocks, essentially when the tech stocks went
from whatever it was, a low double-digit or something in the S&P 500, up to what?
DAVID DARST: You do it by price or by time. You do it by price or by time.
CONSUELO MACK: Or by time.
DAVID DARST: So by time is once a year, you go and look at your allocation and you say
I’m supposed to be 40% in stocks. I see that stocks have dropped ten percent; now
I’m only 36%in stocks, let’s say everything else was the same. That means you take a little
bit of that and you put it back into the stocks to bring it back up to 40%. Similarly, bonds,
because they've done so well, bonds this past year, with stocks basically flat, bonds have
grown to be a part of the portfolio, and many people would say you know what? You need to
force yourself to trim. So it's a little bit like a clock or it's like the bell tolling.
Meaning once a year you need to sit down and look carefully at the portfolio. One of the
greatest things about rebalancing, there's no magic bullet. There's by time or there's
by price.
CONSUELO MACK: So it's a discipline. A regular discipline.
DAVID DARST: A discipline of making you sit down. My late father-in-law, whom I loved
dearly and love dearly, he would complain about his financial advisor. Thank goodness
he was not at our firm. I would not let him be at my firm for family harmony. I would
not let him be at our firm. And he would complain. And I said, you know, how often do you go
and visit this guy? And he said I haven’t seen him and 15 years. I said, You should
go into that office physically once a year, sit down, I don't care, 15 minutes, a half
an hour, an hour, and talk with him and also introduce yourself to the manager. Your service
improves when the financial advisor knows you know the manager.
CONSUELO MACK: Right. So is volatility here to stay, David?
DAVID DARST: I think volatility is basically driven by technology. It's driven by our institutionalization,
perhaps hedge funds, and people who trade rapidly. High frequency trading, computer-driven
trading. So volatility is here. But it can range, even last year, Consuelo, it ranged
from the volatility of the so-called Standard & Poor’s, it's called Volatility Index,
or VIX for short, it ranged between 17 and 44.
CONSUELO MACK: It's a big range.
DAVID DARST: It's a very big, wide range. Now, there's a saying in Chicago by these
folks who trade on these future markets there, who basically look like they're in a time
warp of the '70s because they're all walking around on platform shoes and wearing wide
ties and big, fat lapels. But that's another story. They have a saying called, when the
VIX is high, it's time to buy. And so the VIX got up to 38, in many of the crises. The
big crisis that we had in September of ’08- Lehman Brothers, Fannie Mae, Freddie Mac,
AIG, that big crisis- it went up to 80. So like everything in life--
CONSUELO MACK: When your life is high, it's time to buy?
DAVID DARST: When the VIX is high, it's time to buy. It got to be 80, but you could have
still lost a lot of money between September ’08 and March of ’09, which was when quantitative
easing came in. That is, the Fed says we’re not going to have any more failures. So there's
another one, that when the VIX is low, it's time to go slow. And that means, when it gets
down to 17, everybody’s very quiescent. And I think for most of the viewers, that's
a good time, when VIX is very high or when VIX is very low, it's a good time to reevaluate
the portfolio. Have a look at it. Just have a glance at it.
The third discipline- so there's diversification, there's rebalancing, and the third one- which
is very, very important, is risk management. And many folks, I think part of the reason
that stocks have been called into question at the beginning of this, you talked about
are stocks what they used to be. Nothing is what it used to be, number one. The end of
the world, as we know it, is not the end of the world. This is the end of the world as
we know it; we are moving into a new era. Our children, our grandchildren, are going
to shock the world. American kids are going to shock the world by all the good things
they bring. They're going to bring cures for cancer, they're going to bring alternative
energy, they're going to bring this incredible amount of conventional energy. You've got
the Utica shale, you've got the Marcellus shale. And there's controversy there. In the
British sense, there's controversy. There's controversy over whether you can do this drilling
and this fracking.
But what I’m driving at here is risk management is very important as a discipline. And that
means having an adequate amount of cash. Many people say cash is not an asset. I have said
for years cash is an asset, tell that to the Japanese investor who had his money in cash,
or her money in cash, for the last 20 years, while the market’s done nothing; it's been
fine. So cash, bonds, stocks, alternatives. But part of the risk management is number
one, having good quality assets.
CONSUELO MACK: Does quality matter now more than it did in the last year or two?
DAVID DARST: I think quality matters now, because, basically, markets don’t change
when fundamentals change. Markets change when beliefs change. And right now, the past year,
this is 2011/2012, have basically been a crisis of confidence, a crisis of faith, a crisis
of belief in our leaderships. And that means that we lack faith, trust, confidence. And
right now, you need to have more than ever, diversification, risk management, which is
adequate cash, adequate two-year bonds.
CONSUELO MACK: And what percentage of management assets, of defensive assets? Higher than you
normally would have?
DAVID DARST: Yes, we’re above normal.
CONSUELO MACK: Whatever your normal is.
DAVID DARST: We’re above normal in cash, we have a little bit extra in cash, a few
percent more in cash. A few percent more than normal, Consuelo, in two-year bonds, which
are cash-like.
CONSUELO MACK: All right, so a few percent more, not like ten percent more, but a few
percent more.
DAVID DARST: You know, here’s an example: our managed futures, our cash and our two-year
bonds. If you take the three of those, the normal for those is 11%. Right now we’re
21%. Combined.
CONSUELO MACK: Oh, doubled.
DAVID DARST: We’re doubled, that's right. So we have seven, seven and seven. Seven percent
in cash, seven percent in two-year bonds, seven percent in managed futures. The normal
for that is three, three and four; 11. So we have this defensiveness. The caution built
in because of the dysfunctionality, the policies have not coalesced yet. We haven’t gotten
enough crisis for people to start shouting, “enough is enough, no mas, let’s basically
pull together.” That will happen. But we don’t think it’ll happen 'til things,
perhaps, deteriorate further. U.S., Europe, wherever.
Secondly is the deceleration in the economies in Europe, they're going to basically, we
think, in 2012, be in recession. The United States, we believe, is skirting. It's not
recession yet, the numbers have been pretty good lately. But we think there is a risk
of that, because you're going to have taxes go up in 2013- end of the Bush Era tax cuts,
end of the payroll tax holiday, and basically imposition of the Obama Care health tax going
up on that. So our economist, Vincent Reinhart, he believes that that will cost the U.S. GDP,
that fiscal pothole- now it's possible that Congress could change their minds in an election
year. I would hope so- he says it will clip the U.S. GDP by two-and-a-half percent.
CONSUELO MACK: That's huge.
DAVID DARST: So what would have been a four, four-and-a-half number, it's going to be more
likely, in his opinion, a one-and-a-half to two number kind of thing. He’s got 2.2%
as his single point estimate, but with downside risks if these things don’t come to pass.
CONSUELO MACK: Let me ask you about the guerillas that you talk about, these gorilla companies.
Which gorilla companies should we own? What kind of gorillas are you talking about?
DAVID DARST: Well, consumer staples companies is number one. This means Coca-Cola, this
means Pepsi; this means Proctor & Gamble in the household products area. This means Colgate,
which we mentioned before. This means Nestle; this means McDonald's, believe it or not,
okay? They're making a much more healthy menu, and they have a global footprint.
CONSUELO MACK: Global domination, dividends, free cash flow.
DAVID DARST: Dividends, good free cash flow. Secondly, you want to have some healthcare.
I think the healthcare stocks got beaten down during the whole Obamacare debate, but they
have good dividends, they have very, very strong balance sheets. The pipeline emptied,
now it's refilling as they acquire these biotechnology companies. So there you’re talking about
Johnson & Johnson; there you're talking about Pfizer; they're you're talking about Novartis,
which is the big Europe-based, Swiss-based giant, which has significant operations in
the United States. There you're talking about AstraZeneca; there you're talking about GlaxoSmithKline,
GSK, in the United Kingdom. Both of those stocks, Consuelo, yield 5.5%. So you want
to have some yield in the portfolio, and this balance sheet strength and this global footprint.
The third area is technology. And there you've got the Apples of the world; there you have
the IBMs of the world; there you have the Oracles of the world. Those would be the kinds
of companies. Qualcomm, which we’ve talked about, Qualcomm is basically to the smart
phone what Intel was to the personal computer.
CONSUELO MACK: Which is fascinating.
DAVID DARST: And that means that it's the basic ability of the smart phone to do everything
it does for us today.
CONSUELO MACK: It's a Qualcomm component?
DAVID DARST: That's not a phone, by the way, that's a computer with a phone attached, Consuelo.
And a mobile computer, to be exact. So we want to own Qualcomm longer-term. We had this
big report called the Mobile Internet, which you recall, it's about two years old now.
It emerges off of every page that you need to have exposure, just as you had exposure
as the PC revolution came up, through Intel, no matter whether it was Apple or IBM or Lenovo
or whoever- by owning Intel, you had the processes going into this. And this is similar. The
ability of these mobile Internet devices to do what they do is enabled by Qualcomm.
CONSUELO MACK: Final question: One Investment for long-term diversified portfolio- what
is it that we should all own some of in a long-term diversified portfolio?
. DAVID DARST: Consuelo, I think a stock that
our analysts at Morgan Stanley Smith Barney like a lot, and that I like a lot, is Williams
Companies, WMB is the symbol. Now, Williams Companies, as you know, on December 31st of
2011, spun off their energy exploration and production businesses. That’s where they
go looking for oil and gas. And that's a separate company. This is about a $16 billion market
cap company; sales are about $10 billion a year. They have exposure to this tremendous,
as you just mentioned, the energy sufficiency of the United States, and the infrastructure,
the pipelines, the storage, also to some of these fields- they have exposure to this,
and it's expected they're going to invest $8 billion in new equipment between now and
2015 to basically build the highways for this natural gas, natural gas liquids, NGLs, and
crude oil to travel through.
The stock yields right now 3.8% is the projected yield for 2012. It's got a very, very strong
balance sheet, very, very solid management, and it is one of the leading companies in
the energy infrastructure, and we think that's going to be a theme that's going to have some
consistency and it's going to have staying power. And so that's why it would be my favorite
right now.
CONSUELO MACK: David Darst, we have covered a lot of territory, as only you can in a short
period of time, so thank you, David Darst, so much for being with us on WealthTrack.
DAVID DARST: Thank you for having me, Consuelo.
CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one
suggestion to help you build and protect your wealth over the long term. This week’s Action
Point is: Consider David Darst’s Super Bowl strategy for your portfolio. Darst says there
are three essential elements. For your offense, to move the portfolio forward, you need what
he calls the gorilla stocks: dominant global players with great balance sheets and growing
dividends. For defense, he recommends high quality corporate bonds or munis, which will
provide support and stability. Darst’s third component, the “special team” of investments,
are the non-correlated assets that behave independently from stocks. They are investments
that we cover frequently on WealthTrack: cash, short term U.S. treasury bonds, TIPS, which
are U.S. Treasury Inflation Protected Securities, and gold.
For more sophisticated investors, Darst would also consider carefully selected managed futures
funds. The football cliché is offense wins games and defense wins championships. In reality
you need both plus some special elements to win the Super Bowl. It appears the same rules
apply to portfolios.
I hope you can join us next week, we will be talking with Financial Thought Leader,
MIT professor and money manager Andrew Lo about his views on investing and his highly
regarded alternative investment mutual funds. If you want to see our WealthTrack interviews
ahead of the pack, subscribers can do so 48 hours in advance of broadcast. To sign up,
go to our website, wealthtrack.com. You can also watch previous WealthTracks and find
past One Investment and Action Point recommendations. And that concludes this edition of WealthTrack.
Thank you for watching and make the week ahead a profitable and a productive one.
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