Robert Arnott is deeply skeptical of those who say stocks are on a sustained winning streak. Arnott, who manages two hedge fund–like mutual funds for $756 billion, Newport Beach, California–based Pacific Investment Management Co., likes to point out that equities sometimes lag behind other asset classes for long periods of time. He’s so convinced that the market is in one of those stretches that he’s keeping less than 10 percent of the assets of the funds he manages — the $11.7 billion All Asset fund and the $1.6 billion All Asset All Authority fund — in equities. Both are cheaper alternatives to hedge funds.
The long-only All Asset fund invests in commodities, Treasury Inflation-Protected Securities (TIPS) and certain other asset classes beyond plain-vanilla stocks and bonds. It had only 11 percent in stocks at year-end, compared with 57 percent for the average moderate-allocation fund, according to investment researcher Morningstar. This approach placed the fund’s performance in the top 5 percent of its category for 2008, when it lost 16 percent, versus the group’s average decline of 28 percent. All Asset All Authority is set up to leverage up to 50 percent of assets and use as much as 30 percent on short sales. It was down 6 percent last year, “a home run for a long-biased fund,” Arnott boasts. That’s because it had zero net exposure to equities, which, of course, tanked. A Morningstar report praises the performance, saying: “That result was not achieved fortuitously but rather stems from Arnott’s approach and his skepticism of the level of risk many investors take in the equity asset class.”
Arnott, the founder and chief executive of Research Affiliates, a quant shop in Pasadena, California, with $30 billion in assets (including the two Pimco funds), is known for being contrarian and for its “tactical asset allocation,” another quality of hedge funds. He contends that market capitalization–weighted indexes, by their very nature, are skewed toward overpriced stocks, leading to lackluster performance. Instead, he favors a strategy called fundamental indexing, which assesses companies by cash flow, sales, book value and dividends. He maintains that U.S. stocks still aren’t cheap. Alternative fixed-income assets like high-yield and emerging-markets bonds recently made up the biggest component of his Pimco funds.
