(Fortune Magazine) -- In an era of specialization, world allocation funds take on a challenge that verges on hubris: All it requires is deep expertise in stocks, bonds, and other securities in virtually every market on the face of the earth.
One such fund, BlackRock Global Allocation (MDLOX), has pulled it off so far, spawning a recent wavelet of imitators. In the past decade it has averaged 8.4% annual returns (after sales charges), compared with 2.2% for the FTSE World Index.
That track record has earned manager Dennis Stattman and his 24-person team some $61 billion in assets, which they have deployed among more than 700 securities. Stattman tells Fortune how he keeps the massive ship on course. Edited excerpts:
Part of the appeal of a world allocation fund is the flexibility to limit risk in years like 2008, when you lost a relatively modest 21% while the FTSE World Index fell 42%. How did you do it?
We came into 2008 with limited exposure to the U.S. consumer and to financials, and with a decent amount of cash. We had significant exposure to gold, and we held Treasuries. In our fixed-income portfolio, we took very little credit risk until we began buying convertible bonds in autumn.
Conversely, the fund can lag in boom years, like 2009. Is that intentional?
This fund was created partially as a reaction to the terrible experiences people had in the 1987 stock market crash. The idea was, if people had been more careful with their asset allocation, they wouldn't have had as much exposure to the market when it was expensive.
We tend to be risk-averse. For example, in the early '90s, when the popular idea was to put money in Japan, we were overweight European equities and small-cap U.S. stocks. When the tech and telecom bubble came to a boil in 1998, we were in REITs, energy stocks, Japanese equities, and dollar-denominated emerging-market debt. Chasing the hottest thing is not how people reach their investment goals.
How bullish are you on the U.S. recovery?
In some ways I'm always bullish on the U.S. economy because we have a remarkably productive workforce. But we've gotten hooked on cheap credit and leverage. We built an unsustainable growth model. I'm afraid the adjustment period is going to be a long one, and the recovery will be intermittent.
If you aren't confident of a quick rebound, why do you own so many U.S. stocks?
Because you don't have to have a rip-roaring economy to have a good stock market. What you need is abundant liquidity, corporations that are able to react to the environment, and a belief on the part of investors that things are getting better, not worse. All of those things are in place.
In the U.S. we're going for higher-quality, more predictable, higher-dividend-yielding stocks than we might have gone for at this point in the past. We're overweight health care and telecom; those offer modest valuations and relatively predictable earnings. Some offer better dividends than long-term Treasuries. Our top holdings include Bristol-Myers Squibb (BMY, Fortune 500) and AT&T (T, Fortune 500). We're still very cautious on financials and the consumer.
Do you think that emerging-markets stocks are entering a bubble?
We're seeing financial markets that are very different from anything we've experienced before. Unfortunately, none of us know how this is going to end.
We can be pretty sure that some prices, including those in emerging markets, will at some point go through a period of upset.
I do believe the fundamentals for economic growth are superior in developing economies. They have more citizens with unmet needs and the production capacity to shift from exports to domestic consumption. These are underdeveloped areas of the economies, so there are fewer easily accessible pure plays.
We own Hypermarcas SA, a Brazilian company that manufactures and markets a wide range of consumer product goods, and CBD (CBD), a Brazilian food and electronics retailer. There are also global consumer product companies that have emerging-market businesses, like Mead Johnson (MJN), a U.S. company that generates 55% of its sales in emerging markets.
BlackRock Global's top holding is the SPDR Gold Trust (GLD). Does that mean you're anticipating inflation?
Gold isn't actually a good inflation hedge, except over very long periods. What gold represents today is a hedge against the uncertainty of the value of the dollar. It's also one way to attempt to store value when currencies are being managed in a fashion that discourages confidence.
Long term, I'm very worried about inflation. We are very underweight long-term, fixed-rate, and dollar-denominated debt. We're also moderately overweight energy, because we think oil is going up due to both a broadening of demand and because it's getting more difficult to find new reserves and bring them to market.
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