(Money Magazine) -- Few mutual fund managers could pull off what Robert Rodriguez did. During the tumultuous 2000s, his FPA Capital stock portfolio, which is closed to new investors, managed to earn an annualized 9% even as the S&P 500 lost money.
Rodriguez, 62, is known for thinking big: In early 2007 he laid out a detailed case for why housing debt could trigger a crisis. Now he's just as worried about the federal debt.
Rodriguez took a sabbatical in 2010 -- he traveled the globe, read about the fall of Rome, indulged his car-racing hobby -- and has returned to FPA as CEO, with an advisory role on the funds. He spoke with editor-at-large Penelope Wang; the conversation has been edited.
Now that you're back, do you have a different perspective on the economy?
I would say a lot of nothing has changed. Before I left, I was vocal about the difficulties that were going to hit the U.S. economy: the growing federal debt and the lack of meaningful fiscal reform. These issues still have not been addressed.
Meanwhile, banks are operating much as before -- "too big to fail" is continuing. Investors are still chasing after higher yields and loading up on risky investments. The search for safety in the wake of the financial crisis lasted maybe two years. Very little has been learned.
Won't the economic recovery help us grow out of these problems?
At best, we're facing a substandard recovery. It will probably take another eight years for the consumer to recover. But mainly I worry about the swelling debt of the U.S. government, which is ballooning faster than the economy is expanding.
We've been concerned about this as far back as 2003, when federal debt was $6.8 trillion, or about 60% of GDP. At that point we went on a buyer's strike -- we wouldn't lend long-term capital to a fiscally irresponsible borrower at low interest rates. And we haven't bought long-term Treasury bonds since.
Okay, we were eight years early. But now the ratio of debt to GDP is above 90%, about $14 trillion. This is not a sustainable trend. ("U.S. hits debt ceiling")
So you see rates rising, and bond prices falling. How big will the correction be?
Before my sabbatical, I told clients that if present trends in government continue, we will have another financial crisis within three to seven years -- by 2018. I still believe that. We still have time to start the process of fiscal rectitude. But the window of opportunity is shrinking because 2012 will be an election year, when nothing happens.
Since 2003 the 10-year Treasury bond rate has averaged about 4%. Over the next decade, I would say the odds of us staying in the sub-4% range are very low, and the likelihood that we could get yields north of 6% is considerable.
But it's hard to put a forecast together because when problems occur, they don't occur in a linear fashion. Take Greece. When the moment came that the emperor had no clothes, what happened to the Greek bond? It went from 4% rates to 10%.
As wary as FPA is of government debt, the New Income Fund hasn't been snapping up corporate bonds either. Weren't you tempted to buy beaten-down high-yield bonds after the crash? They did well.
We missed some opportunities, and I'll take responsibility for that. But I had serious concerns about the state of bondholders' rights. Look at how the GM and Chrysler bankruptcies were handled. The federal government interfered and made ad hoc decisions about who got paid, creating additional financial uncertainty. It was rule of man, not rule of law.
Today I think you have to have your head examined to be in high-yield bonds in general. There isn't enough extra yield there to justify the risk. As far as Treasury debt, we're not being paid to take the risk in intermediate- or long-term bonds, so we aren't going much beyond three-year maturities. We're sticking with one- and two-year bonds.
This conservatism has caused New Income to lag behind its peers in recent years. Have you heard shareholders complain?
What we've done over the past eight years is clearly explain to our investors why we keep maturities so short: the risk of rising rates, and that this policy will hurt returns at various times. But our main goal in New Income is to not lose money.
We also say, "If you disagree with us, you're free to leave." And people stuck with us; the fund grew. But then in the last year investor redemptions have picked up as the "risk trade" has become more accepted -- you know, selling bonds, buying stocks. (Ask the Expert: Low-risk retirement)
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