The more money that flows into a mutual fund, the more fees the fund company gets. That's why it's surprising when firms close funds that are beating their benchmarks.
In the case of deep value shop Tweedy Browne, this Wednesday the managers are shuttering their signature
Tweedy Browne Global Value and
Tweedy Browne American Value funds to new investors.
They're doing this even though the $6.7 billion global fund is up 2.62% this year, 5.5 percentage points ahead of the MSCI EAFE index, and the $660 million American fund is down 4.61%, 41 basis points ahead of the
Why close funds that are doing so well? In this case, Tweedy says it's making the move simply because stocks are "fully valued."
Bob Wyckoff, one of Tweedy's five managing directors, discussed the firm's thinking with
. He also let us know what it would take to open the funds to the public again.
What's behind the decision to close your funds?
The reason is that it's getting tougher and tougher to find stocks that qualify with our rigorous valuation criteria. Since the bursting of the tech bubble, a lot of the money that was in tech and telecom has shifted into "old economy," or value, stocks. The result has been that the formerly high-priced stocks got cheaper and the previously low-priced stocks became more expensive.
Today there is a compression of valuation in the marketplace, which means there is not a big difference between higher priced growth and the so-called value stocks. The compression has occurred at a valuation level that is not insane, just full from our point of view.
What P/E levels are you talking about? What do you mean by full?
Everybody has their own valuation levels. But back in 2000 when the bubble burst, the median P/E for the S&P was around 13. The median means that if you rank the 500 stocks and pick the one in the middle, it would have a P/E of 13 or 14.
But while the median P/E was around 13, you also had some insane valuations in the tech sector -- like
at over 140 times earnings -- which were bringing up the overall P/E of the market to between 25 and 30. That meant that half the index was pretty cheap.
With the resurgence in value stocks and with the collapse of tech and telecom, we now have a median P/E that is closer to 18 times earnings. That means the deep value segment of the market has risen. And if you are like us and require a 30% to 40% discount from a cautious level of real world valuation, you just can't find stocks to buy.
So the idea flow has come to a crawl and we have become net sellers of securities. Cash is building in the funds, upwards of 20%, and we feel that in this environment it would be irresponsible to keep our funds open.
I'm not sure if this is a bearish or bullish argument for the overall market. What do you think?
We don't make any market forecasts. But I don't think we are going to fall off a cliff in terms of valuation. We just think prices are pretty full. The normalized P/E for the S&P 500 over very long periods of time is somewhere around 14 or 15. So if the P/E today is slightly above that level, we are not in an insanely expensive territory. We are just fully valued, which makes the risk higher for value stocks. But we don't hypothesize a big correction in the future.
If value is expensive, does that make growth stocks cheap?
I think the growth guys are saying that. They are making the argument that the kinds of companies they like are trading at only a modest premium to the multiples of value stocks. That suggests to them that their stocks may be cheap. But a deep value manager might say both value and growth are too expensive.
In your American portfolio you have a few stocks that have been under a bit of scrutiny lately, like MBIA (MBI) and Freddie Macundefined. What's your rationale behind holding these names?
We've owned Freddie and MBIA for quite some time. When the accounting scandal broke in Freddie a while ago, we did a tremendous amount of work here looking into the company. When the dust finally settled we came to the conclusion that it still looked reasonably cheap. There are people out there who believe the growth rates of these companies have to slow, and I think that's true. But from the current valuation levels, even if the growth rate slows it still looks good.
In terms of MBIA, they have come under a lot of scrutiny of late by Eliot Spitzer over a few transactions. Again, we have done a lot of work on our own, looking at those transactions in order to get comfortable with them. They had a modest earnings restatement, but some of the current management were not even around when some of these transactions occurred. We are comfortable with the stock. They are one of the dominant municipal bond insurers out there and we think it's trading at a reasonable level.
You also own Pfizer (PFE) , which, along with other members of the drug sector, had some problems last year but lately has been seeing some renewed interest among investors.
Actually, we inherited a position in Pfizer through our position in
when the companies merged some time ago. We think it's one of the cheapest diversified drug companies at a forward P/E of 13. Pfizer has a terrific array of drugs. There is no question some of them will be under patent pressure in the years ahead, but we are going to stick with it.
I'm just taking a look at Tweedy's global fund, which is outperforming the U.S. fund year to date, and it looks like you own a lot of companies based in the Netherlands and Switzerland. What are the Dutch doing right that the U.S. isn't?
We don't make country allocations. That's not the way we invest. We invest bottom-up. It all starts with valuation. We are driven by price.
That said, we are comfortable looking in markets such as Switzerland and the Netherlands. We think they do a good job industrially. Our largest position in the global value fund is the Dutch bank
. We also own
, which are based in the Netherlands.
We've always had fairly significant exposure to the Netherlands and Switzerland. And as you know, we are long-term investors. Turnover here is pretty low at Tweedy.
So what would it take to reopen the funds?
I don't know what will happen to create idea flow externally. But it could be a combination of a market correction or a significant improvement in fundamentals. Or just greater volatility within the market, where the compression of valuation we talked about might widen. Just because we view the market as being fully valued does not mean there are not cheap stocks out there. We just need a little more divergence between stock prices in the market.