EuroBusiness Media (EBM): Philippe Investment Management, and its European subsidiary PIM Gestion France, have just announced a strategic partnership with Seabridge Investment Advisors of the U.S. Garnett Keith, welcome.
Garnett Keith (GK): Thank you, Adrian.
EBM: You are the CEO of Seabridge Investment Advisors, whose specialty is yield growth asset management. We will talk about that in just one second. But first, could you give us a bit of background and history about yourself as an investment manager?
GK: Well, Adrian, I guess I am best known in my forty-odd years as having been the chief investment officer for Prudential for a dozen years. More recently I have been the trustee with the Howard Hughes Medical Institute that overseas the investment operations of our $16 billion endowment. But for purposes of working with the Philippes, this is Seabridge Investment Advisors, which is my family office and investment company. It has been in business since 1996 and invests in a number of styles, and one of our more unique and successful styles is what we call 'yield growth' investing.
EBM: We will talk about that in just one second. But first, what is the nature and context of your partnership with Philippe Investment Management?
GK: Well, I have known the Philippe family since the 1960s. I have been a trustee of one of their global trusts for twenty years. I have been on the board of PIM for a shorter period of time, but a number of years. And as I have known Béatrice, and looked at what they are doing, and what we are doing, I have seen a lot of complementarities, and things they are doing that we don't do - some things that we are doing that I think could be interesting to their clients. And, as we discussed it, 'yield growth' is one of the things that we do that is not well known in Europe, and she thought it might be interesting here. So we are putting out this jointly sponsored product.
EBM: Well, precisely, let's talk about your 'yield growth' asset management strategy which has been so successful. What is the exact concept and objective of 'yield growth' asset management strategy?
GK: Well, the goal of the strategy is to try to provide a return over a full market cycle that is almost as good as one could get by taking a full equity risk. We hope to dampen the volatility over the cycle so that the risk will be less than that of the stock market, and we have been pretty successful at doing that. We have been able to catch most of the upside of the market, and only a smaller portion of the down part of the market. We do that by investing in pro-cyclical things when the world economy is expanding, and in interest rate-sensitive things when the economies are contracting, because in that period the central banks are cutting rates, interest rates are going down, and the interest-rate-sensitive stuff goes up. So by shifting among the universe - we don't shift every stock in the portfolio, but by shifting, depending on where we are in global cycles, and then looking at different parts of the world, what is happening in the U.S. or in Asia or Europe - we can put together a portfolio of 40-50 stocks out of a universe of, say, 1,500 that we follow that can give us a good return.
EBM: So, what has the track record been of this particular strategy these past couple of years?
GK: Since we started it in about 1998, it has done about 15% compound gross, a hair less than that due to fees. And in that period, whether it is the global bond markets or the S & P 500 or the MSCI World, they have performed significantly below that. I am not sure if we can repeat that, in all candor, because we happened to catch a couple of things exactly right in this cycle: the decline in interest rates early in the cycle, the expansion of cyclicality late in the cycle. We hope to, but I am old enough to recognize you don't catch every cycle exactly right. And so we would hope we can provide a low double-digit return with much less volatility than the equity markets.
EBM: Would you say that yield is the main driver of your investment strategy?
GK: I would not say yield is the main driver; it is an important component. But there are periods when interest rates are rising, as they are at the moment, where we reduce the yield component and increase the growth component, because the markets treat yield as a growth bond. This is an income stream, and at higher interest rates it gets discounted at a higher rate, and the price goes down. So whereas in a period where we think interest rates are declining, the portfolio might have 7 or 8% yield, and 6 or 7% built-in growth, now it may have 3 to 5% yield and we are looking for double-digit growth, so that the growth component can carry during a period when the global central banks are tightening rates.
EBM: Could you tell us a bit more about how you go about choosing your investment universe? For example, it is striking to see that you invest in MLPs, Master Limited Partnerships, or CRTs, which are Canadian Royalty Trusts, or even high yield bonds. So could you tell us more about the choice of your investment universe?
GK: I guess I would say we start out with a global growth at a reasonable price universe. There are various countries around the world that just provide a higher yield component: the UK, Hong Kong, Singapore, Australia, just to name a few. We add to that other themes. One of the themes has been oil and gas, and that is particularly advantageous for the Canadian Royalty Trust. Canada has a lot of their hydrocarbon reserves in the form of Royalty Trusts, and you are really buying an income stream out of those Royalty Trusts, and when the price of oil is going up the income stream in those Royalty Trusts is expanding very fast, and so we have been able to capture that in our holdings for the last year or two. Royalty Trusts are not taxed at the corporate level, they are like a U.S. REIT, and that also benefits because you are getting the full increase in value flowing through the holder, rather than losing some of to the taxation of the local government.
We have invested in Master Limited Partnerships in the U.S., which are generally the vehicles that own the energy infrastructure in our country: the gas pipelines, the fractionation stations that are taking the natural gas liquids out of gas. And the value of those has been going up very rapidly in the last few years, and we have benefited from that.
So we look around thematically to see what's happening, and then we are looking for vehicles that give us a nice income stream, but some built-in growth to follow the overall purpose of the portfolio.
EBM: You also tend to invest at times in high-yield bonds. Why do you do that?
GK: I worked for five years as a bond leverage buy-out analyst at Prudential, so in a way this is coming back to roots: taking apart the cash-flow of companies that are working close to the limits and saying, "Can these guys make it? Or are they not going to make it?" When between 70 and 80% of the U.S. corporate structure - by number of corporations, not by market cap - are not rated Investment Grade, when interest rates spreads - the difference between treasury bonds and what those people have to pay - are very high, we know that the central bank has to re-shrink those spreads or it can't get the economy going again. So in 2002 when there was an 1,100 basis point spread, we said "Alan Greenspan is not going to restart this economy, unless he can bring those spreads down", and therefore betting on well-selected high-yield bonds is a safer bet than betting on the equity market. Happily, Alan Greenspan was able to do that, and that bet paid off in about 18 months. During that period we had a number of high-yield bonds in the portfolio, but as their prices began to head back toward par we peeled those out and went into more equity-kind of holdings. But in the meantime we were getting 11, 12 or 13% income streams, plus the appreciation of the bond as it moved back to par. So that was a very rich period for us.
EBM: How would you describe the added value of your strategy for the professional or sophisticated investor?
GK: About 75% of our clients are investment professionals. They are also in the investment business themselves, so I am having to explain this to sophisticated investors every day. Probably the most sophisticated investor we have, a man who has been very successful in several kinds of investments, and now runs a major private equity firm in the U.S., just took a big chunk of money out of his municipal bonds and put it in yield growth, simply because he said "Hey, I am getting at least as much return as I was in munis as I am getting 7 or 8% growth to add to that". I think just those fundamentals are attractive, but this investor, if you understand he was taking it out of municipal bonds, was taking it from the more conservative investment he makes. A really sophisticated investor doesn't bet every nickel on very aggressive stuff; he has a range of investments in his portfolio, some conservative, some more aggressive. Yield growth fits toward the more conservative end of your overall portfolio, and for that end its return in the past has been extraordinarily good. We hope it will be good in the future, but at least in the past it has been a very nice payoff.
EBM: And finally, to wrap it up, what is your outlook for the coming months?
GK: I am relatively cautious. We hold a good bit of cash in portfolios: in most of our yield growth portfolios we have between 15 and 20% cash. And the reason is when the central banks are raising interest rates, it's a difficult period for securities. We have been rolling out of some of the more pro-cyclical holdings, trimming them as they have gone up, and I think it is still a little too early to invest in the counter-cyclical interest rate-sensitive securities. And if we have some major "accident", some big hedge fund goes bust or something, and the markets really take a dive, I am quite happy to have a strong cash position that lets us go and buy the sound companies that we will want for the following five years or so.
EBM: Garnett Keith, CEO of Seabridge Investment Advisors, thank you very much indeed.
GK: Thank you, Adrian.
