Where To Invest Now
Summary
- The Bitcoin variety, I don't think it will live. I think, we have two significant government agencies which will make sure it's going to die.
- At the beginning of this year, a lot of people spoke about the Fed put as something that was going to support markets, equity markets, obviously, I'm talking about now.
- There's a lot of talk about whether inflation is going to be with us for a sustained period of time, or whether it's just going to be just for the next 12 to 18 months, and revert back to a more normal level.
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Charles Van Vleet is no stranger to difficult markets, having spent his entire career in the banking and asset management world. Now, as CIO of Textron (TXT), he imparts decades of wisdom on how to navigate the choppy waters we find ourselves in today. Charles talks about his outlook on equities, the niche area of fixed income he finds very attractive right now and which digital assets he thinks are a zero versus those that are really here to stay.
Charles Van Vleet: The Bitcoin variety, I don't think it will live. I think, we have two significant government agencies which will make sure it's going to die. One agency is the IRS, the other agency is the NSA.
Jamie McDonald: Charles, thank you very much for joining us today.
Charles Van Vleet: Super to be here.
Jamie McDonald: Charles, if I get this correct, you are Chief Investment Officer of the pension investments at Textron, is that correct?
Charles Van Vleet: Correct.
Jamie McDonald: At the beginning of this year, a lot of people spoke about the Fed put as something that was going to support markets, equity markets, obviously, I'm talking about now. There's other commentary I've been reading recently that the Fed and central banks have had their time, and the impact they're going to have is not quite as material, and actually this idea of fiscal stimulus is much more relevant, because when we have a crisis, it won't be central banks that come to the rescue. It'll be another billion dollar, trillion dollar fiscal plan, which is going to help support markets. Do you think we have just pumped markets with too much fiscal stimulus over the last 10 years, because it's been unprecedented what's happened, and what do you think the knock-on effects are?
Charles Van Vleet: I was raised as a UC Berkeley economist, back in the late '70s, and there's only two kinds of taxes. One, the tax that you actually have to make out a check to the IRS, which tends to be a very progressive tax, through different structures. The other tax is called inflation, which is a very regressive tax. All too often, because we can't politically, or perhaps the elitists don't want to invite a progressive tax, they do the fiscal expansion to where it's paid for through the other tax, called inflation, which is very regressive. We're simply just paying for some of the monetary expansion of the last four years, because we didn't pay for it at the time through taxes. Now, we're going to pay for it through the other kind of tax.
Jamie McDonald: Yeah. That's actually the best I've heard it explained in a while, because a lot of people say to me, "How are we going to be able to afford all this fiscal stimulus?" The fact is, we're paying for it already, in higher prices.
Charles Van Vleet: If you think about the definition of capitalism, the definition of capitalism is making more and more goods at better and better efficiency, and productivity. Therefore, capitalism is falling prices. If I'm making more of it, with better productivity, it's a lifetime of falling prices. In fact, that's the history of the last 400 years of early capitalism, and more recently, capitalism as we know it, falling prices interrupted by periods of war. The only way to truly destroy supply and demand is war. Go out there and bury 100,000 people, and 100,000 tanks, and you've destroyed the supply side. You've destroyed a lot of the demand side. You will get inflation.
In other words, capitalism is falling prices interrupted by periods of war, and what are we getting right now? We're getting the COVID war. We're getting the Cold War. We're getting, potentially, a hot war in Ukraine. This cycle is no different than what we've experienced in the last 200 years.
Jamie McDonald: Let's start with the central banks. There's a lot of talk about whether inflation is going to be with us for a sustained period of time, or whether it's just going to be just for the next 12 to 18 months, and revert back to a more normal level. What about the central bank's ability to actually affect inflation? There are a lot of people who think that this is really just supply-driven, and what central banks do is really affect the demand side of things. What's your view on the central bank's ability to actually just bring inflation down?
Charles Van Vleet: They can bring it down through demand destruction. That's the only tool they have.
Jamie McDonald: Yeah.
Charles Van Vleet: Good point, they can do absolutely nothing about the supply side, in fact, perhaps make the supply side only worse. The supply side, given time, will respond. But, if they move too quickly on the demand destruction, and interesting, in this cycle, actually in most cycles, the market's doing that destruction for them. We've taken down $3.5 trillion worth of value in the stock market. We've taken down another $1 trillion in the crypto market. This is $4.5, $5 trillion, which represented demand for cars, and planes, and boats, and gasoline. The market's doing the lifting for the Fed, and I think that's very much by design.
Jamie McDonald: If you were to think back over the years, there are some commentators who think this feels a little bit like the year 2000, a little bit like a bubble has burst. Is that your view?
Charles Van Vleet: No, I think 2000 was... again, those were inflation run away, around the internet bubble. I don't see those kind of excess, but let's be honest, as Warren Buffett said, "We'll see who's now wearing shorts when the tag goes out."
Jamie McDonald: Right?
Charles Van Vleet: The tide is still in the process of going out. We've seen Archegos, which was a surprise. We've seen Tiger Hedge fund, that you're intimately aware with, as you know, is now officially gone, to gating, it's the first of the significant hedge funds. I think we'll see some more of this damage, but it doesn't feel like... the of the corporate and the personal is in such fine shape, this doesn't feel like a 2000 to me.
Jamie McDonald: We talked before about how having a diversified portfolio, being in certainly alternative investments, which I'm sure has done you very well, but there are a lot of people who are still in this 60/40 portfolio formula. Obviously, the performance this year has not been great at all. Do you feel that the 60/40 portfolio, as a model, is dead for a while, or do you think it can make a resurgence back?
Charles Van Vleet: You're a seasoned hedge fund manager yourself. The only difference between a credit bond and a stock is just simply around the cap structure you're participating. Equity are junior in cap structure, and the bond of that company are just slightly senior. Of course, the spread of that bond, and the price of that equity, are going to rise and fall together, they're cousins. I don't know that the 60/40 portfolio ever necessarily bought-
Jamie McDonald: Interesting.
Charles Van Vleet: That much diversification. I think that was all a bit of a, I don't want to say it was a myth, it was a magical period of time in the last 40 years, of just simply falling rates. As you know, better than anyone should, that's all been falling apart a little bit. That diversification between bond prices and stock prices is being challenged more now than we have seen, again, in 40 years. Both those prices going down together, that is.
Jamie McDonald : Charles, let's talk a little bit about your process. At Textron... are you allowed to say what size of assets you have under management?
Charles Van Vleet: Sure. We have about $16 billion total, about 10 of that's in defined benefit, the rest in defined contribution, U.S., UK, and Canada. We remain growth-focused, that is, total return-focused. We are not matching asset liability, in the industry, it's called LDI investing. We're investing for total returns, 116% funded, and glad to continue to grow that. To your point, this has been a more challenging year than most, but down 13% on the S&P is not a panic.
Jamie McDonald : Sure. You just mentioned there, actually, that you have the luxury of not being asset liability matched, so that gives you a lot more flexibility, in terms of duration. Can you explain a little bit more what that flexibility allows you to invest in, for example?
Charles Van Vleet: I think, Jamie, there's only four basic food groups to investing, it isn't that challenging. There's the bottom of the cap structure equity; there's the slightly senior to that, called the spread product; then, there's government rates, U.S. Treasury rates. Arguably, you could say, maybe currency is an asset class itself. Some people would push back at me and say, "Currency's not an asset class. It doesn't have any cash flow." We're really only down to three things. Of course, we have a thousand different kinds of bonds, and we have three or four different kinds of equity. We have developed rate markets in a dozen to two dozen markets. All the rest of this, there's just varieties of bonds, or varieties of equity.
Jamie McDonald: What about investing in hedge funds, private equity, venture capitalists?
Charles Van Vleet: We have all of those, but those are vehicles. Those aren't asset classes. Those are vehicles.
Jamie McDonald: I'm just thinking, in terms of... I imagine one of the things you are trying to do, and I'm not trying to say I know what you do, but is, not have correlation of one. You did say that bonds and equities are cousins, but you must look for diversification in other ways.
Charles Van Vleet: Sure.
Jamie McDonald: I'm wondering how you find that?
Charles Van Vleet: You tell me when. When things go pear shape, you've lived through a couple of these-
Jamie McDonald: The hedge funds never lose money, Charles.
Charles Van Vleet: Except for this year, because they're decidedly negative this year.
Jamie McDonald: Sorry, let me correct. That hedge funds aren't supposed to ever lose money.
Charles Van Vleet: Again, a hedge fund is not an asset class, it's a vehicle we invest in. Hedge funds, they do not have an asset allocation, hedge funds. It doesn't make sense. It's no more than to have an asset allocation to mutual funds, or ETFs. Each of those are vehicles with their unique characteristics. Yes, I have some hedge fund vehicles in the portfolio. It's not my preferred vehicle. I think there's a poor alignment of interest between the plan sponsor and the manager of hedge funds. I prefer a drawdown structure, a private equity-type of structure. I'm invested all those different structures. I'm invested all those asset classes.
I think, what you're trying to get back, what you're trying to get is, what is interesting today? If everything goes pear shape, in a real bad drawdown, how do I stay the furthest away from that pear shape? I think a great spot right now is real estate. I love real estate, a capital raise of $300 to $400 million, which is tiny, it's a tiny amount of real estate, which is extremely niche focused. For example, we are investing right now in a lot of cold storage, and data centers, and life science buildings. These are things where-
Jamie McDonald: Can you be geographical? Are there certain parts of America you prefer?
Charles Van Vleet: When they're that small, they tend to be pretty geographic focus. Life science, for example, these are buildings that are built specifically just for life science research. There's only about three or four places in the country, San Mateo, Cambridge, San Diego, where these buildings and workers like to -- they cluster together. These are very nichey.
Cold storage. Have you ever been to a cold storage? These are seven story buildings, which have no windows, have limited doors, they stage the food in three different levels. The truck comes, obviously, and it gets taken off into a room, which is zero degrees. Then, it's taken into the next room, which is minus 20 degrees. In that minus 20 degrees, there's no workers in there. There's only robots. These are robots which are lifting food up and down, on pallets, seven stories. It's amazing how all of us think nothing to get on Amazon tomorrow and say, "Gee, I'd really like some frozen peas and corn for dinner," In 20 minutes, it's delivered to. Do you have any idea of the logistics that goes into it? These are things which are demand in elastic. In a drawdown, people are still going to want the frozen peas and corn.
Jamie McDonald: Recession-proof areas.
Charles Van Vleet: Sure. You're still going to get on your cell phone, even in a drawdown and say, "Where's that photograph I took from seven years ago." You play around with it a little bit, and it pops up, and you go, "Of course, there it is." Do you have any idea what goes into building and maintaining a data center, so that you can pull down a photograph from seven years ago? In an environment like this, what you want is demand inelastic. That's going to be data centers, cold storage. You know what else it is? It's what I call our catch portfolio. We have an allocation, a dedicated allocation to chocolate, alcohol, and tobacco. Three jobs-
Jamie McDonald: Recession-proof.
Charles Van Vleet: I consume all three, I will pay any price they want for all three. These are recession proof, consumer staples.
Jamie McDonald: Did they do very well during COVID? I imagine they probably did.
Charles Van Vleet: People drink in good times, people drink at bad times. Yes, alcohol and tobacco's done fabulous. What I'm trying to draw at is, this concept of right now, to look for things which have that demand inelasticity, therefore, you have good pricing power on your product.
Jamie McDonald : Let's talk about credit markets for a bit. When you look at your credit portfolio, where do you see the greatest opportunity?
Charles Van Vleet: First lien loans. Leveraged, first lien loans. As you know, there's investment grade, above triple B and above, non-investment grade, below. I do not find anything attractive in investment grade lent, because you're-
Jamie McDonald: Triple B and above?
Charles Van Vleet: I don't like triple B and above in anything. We are solely focused on single A, single B, triple B, particularly in the first lien loan space. Those products are, as you know, CLO risk retention, CLO equity, which is basically a 10 time levered, first lien loan, and in BDCs, which is a two X levered, with daily liquidity, first lien loan. I have a lot of that. I loved spread space, I don't call those, nor do I model those, as fixed income. They are equity. I call my first lien loan, I model it as a Russell 2000.
Jamie McDonald: That's interesting.
Charles Van Vleet: My BDCs, I model it as a 1.5 Russell 2000. Just because it's called a bond, it's not a bond.
Jamie McDonald : I must admit, I am very much enjoying your honesty about this. There are so many people who are so formulaic, and stick to the rules about which asset classes are which, but you seem very keen to boil things down into a much simpler version.
Charles Van Vleet: On a six month horizon is a real estate? It's I don't care what things are called. I care what they act like, what they behave like.
Jamie McDonald: Right.
Charles Van Vleet: REIT acts like a 0.8 S&P. What does converts look like? Converts are 0.7 S&P's. A lot of my peer group will calculate this thing called hedge ratio, or insurance companies calculate hedge ratios. They will throw their converts into their hedge ratio. That's ridiculous. A convert's not a bond. It's a 0.7 S&P. People need to be a little bit, to your point, a little bit more honest about what it is, not what it's called.
Jamie McDonald: It sounds like you have more flexibility. You do have that advantage of having the flexibility of being able to put things in different buckets, considering your position at Textron. How do you feel about the world of digital assets? Is it a world which you are embracing? Do you think it has a potential for a large allocation? What are your thoughts today?
Charles Van Vleet: Your preamble question was about how I feel about cryptocurrency. You put this, definitely, into digital assets.
Jamie McDonald: Well, I-
Charles Van Vleet: You know this space well. As you know, there's three kinds of coins. Central bank coin, there's definitely a place for that, in my opinion, because that's an easy way for the government to distribute. Don't we wish we had that in 2020, when we were distributing PPP funds?
Jamie McDonald : Yeah, or the fiscal stimulus checks.
Charles Van Vleet: You give people money. 10% of the country is not banked. A digital central bank coin, there's some concerns, but definitely. Then, we have stable coins. If it's a stable coin, that's one to one backed, I guess there's a place for it. I don't see what the point is. It should be regulated, as you know, as a money market. These algorithmic-driven coins definitely should go away. They have gone away, Luna and Terra being two of the largest. The third coin, which is the crypto, the Bitcoin variety, I don't think it will live. I think we have two significant government agencies which will make sure it's going to die. One agency is the IRS, the other agency is the NSA.
Jamie McDonald: I think the Bitcoin bulls may say back to you, "How can they make it go away?"
Charles Van Vleet: Just strangled to death. In the next two years, we're going to find a Martha Stewart of tax evasion, because they didn't report their Bitcoin transaction.
Jamie McDonald : That's a good point.
Charles Van Vleet: My, assistant, she bought some Bitcoin, and she pushes back at me. She says, "Charles, why can't I just go spend my Bitcoin on a car? Why would I have to report to the IRS? I'm just buying a car with my Bitcoin.
I said, "Because the IRS looks at it as a commodity. If you pay for your car with gold, you're welcome to do that. The IRS would say, "What was the basis that you bought that gold, and what was the value of when you exchanged that gold for a car," and you've got to pay tax. That's the definition, currently.
The IRS is going to strangle this baby, and they're going to find a Martha Stewart of tax evasion, somebody high profile, name recognition, and throw the book. Now, the other agency, of course, is the NSA. It is dangerous to have this type of ransom currency out there, floating around. I would feel differently if I was in Venezuela right now, if I was in Iraq right now, if I was in Ukraine right now. I would want to have a place to go store and hide my wealth, but here in the U.S., it's not going to last.
Jamie McDonald: How do you feel about the very quickly growing market of NFTs? Do you feel that's an area-
Charles Van Vleet: Fantastic. NFTs, where I think it's really going to have wonderful value is to the visual arts community.
Jamie McDonald: Okay.
Charles Van Vleet: The auditory arts, the music industry, have always been able to be paid royalties. They produce something, and they can get an ongoing stream of royalties. In the visual arts, there's never been that opportunity.
Jamie McDonald: Right.
Charles Van Vleet: I think it's very exciting for the visual art community, for people who buy, sell, trade NFTs, and for an ongoing royalty stream to go back to the artist.
Jamie McDonald: Just taking NFTs a step further, do you think that tokenization is an inevitable and very efficient way of the financial system to run?
Charles Van Vleet: Yes. Think of how many times all of us have gone onto Google, looking for an image of something, and it has "Getty images" splashed across the front of it. Getty images is just simply an NFT by a different method.
Jamie McDonald : Right.
Charles Van Vleet: They have a whole army of lawyers who are basically enforcing, "You can't use that image at your company conference without paying me a royalty." This is going to make it much easier, and democratize that process, to take that visual image and be paid for it.
Jamie McDonald: Lastly Charles, if I may, just one more topic, and tie two things together, which is, do you think that we're in a period of sustained de-globalization, some on-shoring that's happening, and what kind of impact do you think that's going to have?
Charles Van Vleet: Yeah. I love the way Janet Yellen put it, she said, "This is not offshoring, on-shoring, it's friends shoring." I no longer need to buy my copper necessarily from the cheapest supplier, but from the one I am most politically and friendly aligned, that I have confidence. Elon Musk was musing, not too long ago, "Gee, maybe I should go buy a lithium mine." What's going to happen is, more vertical M&A. What saved Tesla, and what saved Apple, was the fact that they started making their own chip.
Jamie McDonald: They own the supply chain.
Charles Van Vleet: Don't you think that Ford and Stellantis are sitting around, say, "Darn, I wish I had thought to make a stupid chip that cost a nickel," Ford has had to stop production at times, over the last two years. We're going to see more vertical integration. We're going to see more friend shoring. We're going to see more inventory buildups. Yes, all of this is a little bit of grist in the mill of lower prices. If I think of the last two years, we've had two big events here. We've had the COVID event, and now, we've had the Ukraine event. By far, the biggest, with lasting impact, is Ukraine. No matter how this ends, the peace dividend is dead. We've had 30 years of the peace dividend. What does that mean? For 30 years, I was able to buy my inventory from the cheapest source. For 30 years, the government's been able to focus on butter, not guns.
For the next 30, it's going to be back to guns, and less butter. Everybody's going to want to have military independence. Everybody's going to want to have food independence, they're going to want to have energy independence. Clearly, we go back to the day where, for instance, as you know, the U.S. stopped mining rare earth over 30 years ago. We have one rare earth mine down in Southern California. Rare earths are not rare. As you know, they're abundant. But, to extract the rare earth material out of the soil is extremely environmentally damaging, takes dozens of acres, and a horrible process.
The U.S., correctly, 20 years ago, said, "We don't want to do this. Send this to China, let them do it well." Now, if we are less confident of that supply chain, and rare earths are coming from China, we're going to have to reopen that California plant. In other words, the government's going to go back to saying, "I'm going to give you a subsidy in money, or give you a subsidy in regulatory comfort, maybe we're going to get back into the business of mining for copper, mining for rare earth, and mining for-"
Jamie McDonald: I think the Biden Administration already is doing that with the rare earth.
Charles Van Vleet: What that means is, we could end up in, 10 years time, with an abundance, an oversupply of copper and rare earth, because every country's going to say, "No, I want to have," as you know, right now, 80% of the world's chips come out of Taiwan. Everybody said, "Wow, this was a mistake." Every country in the world right now is out there to produce its own chip factory. It takes 10 years to get those up and going. In 10 years time, we're going to have an abundance of chips.
Jamie McDonald: Yeah.
Charles Van Vleet: It's just going through these inventory cycles. I think, just as we're going to have an abundance of chips, oversupply, we'll have an oversupply of copper, and rare earth, and these other things as well. This is all part of the impact of the death of the peace dividend. Again, my son, I've been able to live a career 40 years for this globalization. He might go through his career of de-globalization, but it is three steps forward, two steps back. It's all still forward in globalization, but yes, we're taking a step back for a couple of decades.
Jamie McDonald: Charles, there were so many nuggets in this conversation, I can't wait to watch it back. I just want to say thank you so much for your insights today.
Charles Van Vleet: Thanks for having me.
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NSA… not NASA!