What's your read on the market, and how is Total Return Fund's newest iteration adapting to it?
We have two huge risks facing the market. We're in a place that's very unusual compared to the past 20 or even 30 years, where the base case was moderate economic growth, moderate inflation, relatively stable policies from Washington, D.C. Now, that's the least likely outcome. We're either going to have serious, ongoing government support which a lot of people think ultimately means inflation, or else we're going to have weaker economic growth and further default problems that face the debt market. So both of those risks have to be contemplated. The way to do that is put together a strategy that splits the portfolio into ways of generating good cash flows from both parts of a portfolio, but have offsetting risks. You need a strong amount of government guaranteed [mortgage] credit in a portfolio. It's still a beneficiary of fear of risk and benefits during times of flights to quality. We have half of our investments in government guaranteed credit, and we own them for the long term. A lot of investors haven't been allocated there because yields are low and they think things could get bad with inflation fears. The truth is that part of the market has been the best performing sector this year. A lot of people miss that.
On the other side, if inflation fear comes true, that part of the portfolio will do badly. So, the other half of the portfolio is in mortgage credit that's priced for high default. If there's going to be high default, we'll still walk away with pretty good returns because it's a professionals market, and a lot of people just have no idea how to approach it. It's by far the cheapest part of the credit market if you want to take credit risk, and my view is that if you buy the junkier stuff where lots of loans are not performing, if the economy does better, housing does better, and there's some inflation, well, it's pretty easy to believe that assumptions of Depressionary default rates would ease up. As a consequence, the prices of those securities, which we're buying at 50 cents on the dollar, would go up. Where they're priced today basically contemplates something like three-quarters of all the borrowers openly defaulting. If that doesn't happen, because a better economy and inflation bails out the housing market, these securities go up.
What are your default assumptions?
If you look at '06-'07 vintages, prime mortgages will probably have at least 20 percent of the loans defaulting, possibly higher absent some sort of massive rescue for the entire mortgage borrowing market. Alt-A [loans] from '06-'07 could easily be 50 percent and maybe higher. Subprime, I'd basically be surprised if less than 80 percent defaulted. Older vintages will be extraordinarily dependent on where home prices go from here.
Is a mortgage bailout agenda possible from Washington?
The elephant in the kitchen is the 7 million loans that are not performing right now that are not in foreclosure. There's homeowners living there, and they're not making payments. The first policy response was obviously the least effective one. It was a moratorium on foreclosures. That doesn't exactly solve the problem. It actually does the opposite. It might feel good for those 90 days or whatever those things are enforced for, but it just encourages more defaults. The objective of the government, the real estate industry, and the banks are to get these 7 million people to start paying again. The only answer that has a chance is maybe to cut the amount they owe.
Any new funds on the horizon?
We will offer another mutual fund fairly shortly. We have high demand for it. It's an opportunistic, broadly invested fund-stocks, bonds, currencies, commodities, long-short, you name it. A lot of people have followed my work for quite a few years and have noted that relative to those global macro themes, I've been more right than wrong by a lopsided percentage.
Do you think demand for that sort of complex go-anywhere fund is like that to grow among retail investors?