First Eagle’s Global Fund (SGENX) is its flagship fund, with over $45 billion in assets. Its mission is to seek long-term growth of capital by investing in a range of asset classes from markets in the United States and around the world.
Since inception (1/1/79)1 , it has re-turned 13.35% annually, versus 9.50% for the MSCI World Index. Over the last 15 years, it has been in the top 2% of its peer group, as well as in the top 5% for 10 years and the top 15% for 5 years, based on Morningstar data. It was the winner of the Lipper Best Flexible Portfolio Fund Award for 2015. Its managers are Matthew B. McLennan and Kimball Brooker, Jr.
Advisor Perspectives Editor in Chief Robert Huebscher spoke with Matt and Kimball on January 14.
Bob: In a panel discussion back in June, Bruce Greenwald, who is a senior advisor to your firm, made a number of assertions. I am going to ask you about each of them and how your portfolio is structured to potentially benefit from them. The first one is that manufacturing is dying and that is creating chronic deflationary pressure.
Matt: Bruce was making the sim-ple point that factory automation is reducing the need for labor in manufacturing. When he said man-ufacturing was dying, he wasn’t intimating that we are producing less things, just that it is taking less labor to produce those things. The analogy I draw here is if you went back in time a century or so ago, jobs moving out of manufacturing into services. It takes time to re-train people. That has produced a persistent tendency for countries in that region to try and deval-ue their currency versus the dol-lar, which in turn has produced a structural current-account deficit in the United States. The quest for many people were employed in some form of agriculture. Today it is a low single-digit percentage of the economy, but we are still eating well, perhaps too well. Jobs moved from the agricultural sector to man-ufacturing sector throughout the course of the early part of the last century. Of course, during the last generation, it has moved progres-sively to the services sector.
Factory automation is a very pow-erful source of ideas for our fund. We’ve seen that in the proliferation of robotics, pneumatic systems, electrical sensors and the like. In fact, if you look at our portfolios, we have benefited from this trend through the ownership of some of the leading franchises in this area.
The decline of employment in manufacturing is having a sec-ond-order effect on global sys-temic imbalances. Part of that is driven by the fact that many of the Asian economies have built their economic miracles on manufac-turing models fueled in large part by subsidized exchange rates. As they’ve grown rapidly through manufacturing and moved a lot of people from poverty into employ-ment in manufacturing, they pro-spectively face the headwind of growth through manufacturing in Asia is fueling a savings shortfall in the United States.
But the essential point is that factory automation is really taking root. Ini-tially it was robotics for cutting and welding tools and for basic things like painting. But as sensing technol-ogies improved, and software and robotics capabilities improved, there is the prospect of automation creep-ing into the assembly stage of manu-facturing where most of the jobs are. This trend is going to be with us for quite some time; we are still in the early days of those pressures.
Having said that, looking forward a generation from today, I believe it may take a lot fewer people to produce what we are producing now, which should free up re-sources for other productive enter-prises. It just won’t necessarily be a smooth journey, particularly for those economies that have built their economic strength on manufacturing.
Bob: The second trend is that service businesses are local in nature and therefore may grow to be able to earn attractive rates of return.
Matt: I made the observation that employment is moving from manu-facturing to services. When people think of services, often what comes to mind are very simple things like teaching, public relations, child care, private event management, restaurants, local IT services and the like. But those are not neces-sarily the kinds of businesses that generate attractive returns, be-cause they are competitive.
When we think about service busi-nesses that have the ability to gen-erate attractive returns on capital, we are very focused on businesses that have local economies of scale. Those businesses are orders of magnitude larger than their near-est competitors, which makes it more difficult for new entrants to come into a market. We also focus on service businesses where there is a high degree of customer cap-tivity, or stickiness, because it in-creases the cost of a new entrant coming into those markets.
We have a range of investments both overseas and in the United States in areas such as telecommu-nications, such as KDDI, a scaled provider of mobile and broadband connectivity in Japan, and Secom, also in Japan, which dominates in the commercial services arena for providing alarm, security services for corporations and homes. In the United States, we own Comcast, which dominates bandwidth provi-sioning essentially in the markets in which it competes. We own some of the big tech majors, like Oracle and Microsoft; even though they are global in nature, their dominance is local and rooted in sales force den-sity and customer standardization.
When we look at businesses we try to identify those that have local econo-mies of scale and sticky customers. Many of these businesses are not traditional manufacturing business-es. You may have elements of their business that don’t require tangible capital investment, but rather where things like brand and process know-how matter. These businesses can potentially generate very attractive returns on their tangible capital.
Even in the world of what you would traditionally think of as industri-als and manufacturing, local mar-ket dominance matters. Think of a company like Flowserve in pumps, valves, and seals. Even though you wouldn’t think of them as services, they have material aftermarket businesses that require density of distribution and dealerships, with aftermarket servicing capability that enable them to potentially get attractive returns on their capital.
Bob: The third trend is that the lower 85% of households in terms of wealth have a negative savings rate, and it’s the remaining 15% who are accumulating. That’s a catastrophe waiting to happen because so many households have a negative savings rate.
Matt: What Bruce was referring to is the fact that if you look at the overall savings rates, it has drift-ed up from the low levels of the mid-2000s to just above 5%. The debt-service ratios seem to have improved. But when you look be-neath the surface, debt-service ratios look attractive because in-terest rates have been repressed. The actual level of debt-to-income remains fairly high.
Secondly, even though savings rates are above 5%, the top 15% of households probably save close to 40% of their income. All the sav-ings is coming from the top 15% of households, which implies the bottom 85% of households are net dis-saving. This is a problem be-cause it leads to recurring balance sheet vulnerability in the economy.
If you go back to the discussion that we had earlier about the growth of manufacturing in the Asian economies through subsidized exchange rates and the flow-on effects of that to current-account deficits in the U.S., a current-account deficit simply means that we have a struc-tural shortage of savings relative to investment in our economy. It is showing up in the lower income households of the United States.
We are seeing that household sav-ings and corporate profits have done okay when the government runs fiscal deficits that are larger than the current-account deficit. That means there is a surplus in the private sector. That can work for a short while, but if you consistently try to run fiscal deficits larger than your current-account deficit in or-der to promote corporate profit and household savings, you are also go-ing to impair the sovereign balance sheet of the United States. The U.S. ends up with an unfavorable gov-ernment debt-to-GDP ratio and lower real returns on its government debt as policymakers resort to in-terest-rate repression in an effort to improve debt-servicing capabilities.
