Morningstar 2008: “This time it’s different”

Mohamed A. El-Erian at the 2008 Morningstar Investment Conference

The opening address at the Morningstar 2008 Investment Conference in Chicago was given by Mohamed A. El-Erian, Co-CEO and Co-CIO of PIMCO.

Three weeks ago in Barron’s, he identified four major global trends:
• Realignment in global growth
• Return of inflation
• Structured finance diminishing the barriers to entry
• Wealth transfer among nations

His latest book, When Markets Collide (McGraw-Hill), describes the causes of the recent traumas in the financial system, and will be published this month.

Today El-Erian characterized investment infrastructure as undergoing a vigorous global retooling that will will affect the financial services industry as much as the individual investor. In front of a chart that depicted the market’s regard of Citi and Goldman Sachs as riskier than Brazil or Mexico, he hammered home the point that in our new, different world, smaller countries and institutions would have suffered more from recent dislocations in the markets. But now it is precisely the most sophisticated financial systems, particularly in the US and the UK that are suffering the most. Government policies are not up to the new challenges and have failed to act as circuit breakers in this new environment. “Just in time” risk management, as practiced by industry leaders, has failed.

el-erian portfolioThe US consumer faces headwinds because of the housing market, and the fact that a house can no longer be used as an ATM when home prices fall. Meanwhile, in emerging markets, consumers are getting richer and are building new middle classes and reaching new heights of consumption. Both these newly enriched consumers in India, China and Brazil, as well as the stressed US consumers, will be facing new inflationary pressures to which neither is accustomed.

The implications for investors will be to insist on clarity about their return expectations as well as risk tolerance. They will need to revisit asset allocations for secular robustness and choose among new investment management vehicles in the context of new configurations of risk.

PIMCO’s ways of addressing these phenomena include “constructive paranoia,” which consists of management constantly asking itself “What can go wrong?” and hardwiring mechanisms to second-guess its own conclusions.

Investors should not treat the recent behavior of the market as a “one-off” — don’t think we’re going back to business as usual. The crisis we are facing also involves opportunity, as long as investors don’t fall into the trap of narrowly framing asset classes.

Additional quotations: “The rest of the world will still outgrow the US.” “We are living in a world of permanently higher (and more volatile) commodity prices.” “Correlations among asset classes will change.” “The financial services industry must evolve from products to solutions.” “We [PIMCO] see 1-2 percent growth in the US economy for the next two years.” “This time is different, and I say that very seldom.”

Crystal ball alert: He also revealed that PIMCO is working on a forward-looking [!] index for the bond market.

The takeaway: Invest more heavily in both international equities and bonds as well as additional asset classes (see his portfolio above).


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