Income Builder through Value Investing
First Eagle Global Income Builder Fund
Kimball Brooker, Sean Slein
Author: Ticker Magazine
Last Update: Apr 05, 10:34 AM EDT
|Valuation drives everything, according to Sean Slein and Kimball Brooker, portfolio managers of the First Eagle Global Income Builder Fund. Investing with a perceived “margin of safety” in equities and fixed income, the fund aims to provide both current and future income. With a flexible, bottom-up approach, the team can go anywhere it concludes there is value—including cash—while keeping a steady focus on avoiding the risk of capital impairment.
“The fund seeks to provide income for today and tomorrow, and there’s a tradeoff between the two. If we over-rely on higher-yielding securities, we expose the fund’s investors to the potential risk of capital impairment. We need to be extremely disciplined.”
Q: What is the genesis of the fund?
The origin of the fund is related to the aftermath of the financial crisis. When interest rates plunged to unprecedented levels by historical standards, we had requests from investors to help them manage through this repressed-interest-rate environment. The mutual fund was established in 2012 with the basic idea of a portfolio of bonds and equities that can seek to provide both income generation and, most importantly, wealth preservation.
In addition, we believe the fund may meet the needs of many in a particular demographic group. As investors get older and transition from the gathering phase to the harvesting phase of their investing lives, the natural demand for more income arises. This fund may help some in that group to potentially fulfill those needs.
The fund represents a combination of dividend-paying equities and fixed income. As the name suggests, the goal is to build income, so we seek to manage the equity portion to not only provide current income potential, but also to potentially grow the corpus of the fund and drive the potential for future income. The aim of the fixed-income portion is to provide most of the current income. Overall, the goal is to achieve meaningful and sustainable income today and into the future.
Q: What core beliefs drive your investment philosophy?
Our philosophy and beliefs are influenced by value investors, in particular Benjamin Graham. His concepts are near and dear to our hearts and permeate everything we do. One of the most important concepts of Graham is the notion of investing with a so-called “margin of safety”. We feel that it is important to seek to invest at what we believe is a discount to the value of both equity and fixed-income securities in an attempt to protect the fund’s investors’ capital.
We also look for factors that are not necessarily quantitative, like the quality of the management of the company, the position of the business within its industry, or the quality of the covenants in fixed-income securities. But the core of what we do is striving to invest with a “margin of safety,” because valuation really drives everything.
Q: How is the fund different from its peers?
Because of our focus on loss aversion, the fund would hold cash (and cash equivalents) if we fail to find suitable investments that meet the requirements of our discipline. Cash is the residual of the investment process, and when we decide to hold cash, we view it as deferred purchasing power for the future. When we do find suitable investments from the bottom-up perspective, we can take that cash and deploy it as we move forward.
Another important feature is that we are quite flexible, and we don’t have a top-down view about how to allocate capital. Our process is very much driven by security selection. When we find something that meets our requirements, we are happy to invest. But if that’s not the case, we are very willing to wait, and we would typically wait in cash and cash equivalents.
I think that our benchmark agnosticism, our flexibility, and the go-anywhere approach are quite unique and make us different from our peers. We deploy capital where we find value, but when investment ideas are few and far between, we’ll wait for better opportunities.
Q: What is your definition of value and your approach to uncovering it?
No investor would want to overpay for a security and, in a way, all investors think of themselves as value investors. Our understanding of value investing is that our primary mission is to avoid permanent impairment of capital. That notion is very important to us, but isn’t necessarily shared by every investor.
Because the fund is a flexible, go-anywhere fund, we don’t feel constrained by targeting investment exposure to certain sectors, geographies, asset classes or yield. We believe that when artificial constraints are imposed upon a fund, they open the door to the potential of overpaying for an asset. In an environment where prices are going up, multiples are expanding, yields are compressing and spreads are narrowing, investors targeting a particular level of yield could end up incurring more risk for the amount of return that they are receiving.
Because loss aversion is so important to us, we are not willing to tolerate investing lower in the credit spectrum for greater yield or paying a greater multiple for equity due to some artificial constraint. That discipline helps us to stay true to the investment philosophy.
The fund seeks to provide income for today and tomorrow, and there’s a tradeoff between the two. If we over-rely on higher-yielding securities, we expose the fund’s investors to the potential risk of capital impairment. We need to be extremely disciplined. We want to avoid exposures that other managers appear willing to tolerate in their pursuit of yield.
Q: Would you describe your investment process? How do you search for ideas?
We make some use of quantitative screens, but we also employ other methods to come up with ideas. The investment process is very much about valuation and quality. We are bottom-up managers. We eliminate securities that we find expensive or of lower quality, because that would translate into higher risk of loss. We don’t feel the need to invest in every company in an index. If there are securities that come across our desks that don’t make sense to us, we don’t have to own them, and we won’t own them.
Q: How do you make decisions on your geographical allocation?
We are agnostic about where a company is domiciled. There are many good companies all over the world, but we are more cautious about certain jurisdictions from a legal perspective. Otherwise, we are open-minded and willing to look anywhere.
At the moment, the bulk of our fixed-income investments are in the United States and that exposure is a function of the global interest-rate environment. In the equity portfolio, we are more skewed towards international companies, which, again, is a result of the bottom-up approach.
Q: What is your allocation between equities and bonds?
We don’t have a preset determination for the split between equities or credit, but we need exposure to both asset classes to seek to meet the objectives of the fund. We need a significant exposure to equities because our goal is to provide meaningful and sustainable current income and also to grow income into the future. We aim to provide that growth on an inflation-adjusted basis, and the portfolio would typically have between 40% and 55% equity exposure.
The aim of the fixed-income component is to provide the majority of current income and we would typically allocate between 35% and 50% to it. However, when we populate the portfolio, we evaluate fixed income on an absolute basis versus cash. The important question is if it makes sense to deploy capital in this fixed-income security with this maturity, level of duration, and credit risk, versus remaining in cash and looking to deploy the cash later. The same applies to equities.
Q: Could you give us some examples that illustrate your research process?