Morningstar Advisor - June/July 2009 - 19

correlation to bonds and low correlation to stocks. Therefore, combining these assets can often produce a more appealing risk and return trade-off. In addition to the portfolio diversification benefit, commodities have other characteristics that make them an attractive asset class to include in a portfolio. Namely, commodity returns tend to increase in periods of high inflation. For example, when the demand for goods and services increases, their prices tend to increase. As a result, the prices of commodities used to produce these goods and services rise as well. Commodities are often overlooked in an investor’s asset-allocation decision. Adding a commodity allocation to your clients’ portfolios could serve them well. suggests that companies outside food and energy have pricing power.” Also, the Personal Consumption Expenditure Index has experienced positive growth compared with a year ago, and the only components that have declined in price are motor vehicles, furniture, food, and energy goods. All other prices have been increasing. “Again, this suggests that companies in many sectors have pricing power,” Gambera writes. As a whole, the scale is tipping toward inflation coming back in the near future, Gambera says. How soon? “As soon as the economy gets back on its feet and the prices of food and energy return to their historical averages.” Morningstar director of equity analysis Haywood Kelly sounded a warning on REITs. In a post on the MorningstarAdvisor.com Markets & Economy blog, he sums up Morningstar analysts’ view of the industry. “On average, we believe REITs warrant very high uncertainty (large margins of safety to our fair values before purchasing),” Kelly writes, “because of capital scarcity, leveraged balance sheets, development pipelines, joint ventures, falling rents and asset values, and general economic weakness.” Most REITs are no longer a reliable source of income, he writes, and if stock prices track fundamentals, it could be years before significant capital appreciation is realized. “Investors must be selective when investing in this space. Bankruptcies appear likely,” Kelly continues. “The point about REIT common shares being optionlike investments means these shares will be extremely volatile in 2009. They’ve rallied big over the past month, but could give up those gains in a heartbeat.” Deflation? Evidence Points to the Contrary Goldman Sachs economist Jan Hatzius argued in March at the Morningstar Ibbotson Conference that deflation is likely. Many observers, including some bond fund managers, have also spoken about deflation being a long-term problem. Michele Gambera, the chief economist in the research group at Ibbotson Associates, doesn’t agree, and he states his position in a post on MorningstarAdvisor.com’s new Markets & Economy blog. “What are the odds that we’ll face an era of deflation? I say they’re long,” Gambera writes. He says that there is evidence in inflation indexes that companies currently have some pricing power, which should ease deflation worries. True, the Consumer Price Index was negative (compared with 12 months earlier) in December, February, and March. (It was slightly positive in January.) “However, if we look at the so-called core CPI, prices have been stable around 1.7% to 1.8% during these months,” Gambera writes. “This Rich Get Richer: Berkowitz’s American Express Stake Senior fund analyst Michael Breen saw another example of Bruce Berkowitz’s investing acumen in a recent 13F filing. The filing shows Bruce Berkowitz’s Fairholme Capital established a quarter of a billion dollar position in credit-card firm American Express AXP in late 2008. American Express’ shares jumped after the firm beat Wall Street’s diminished expectations, and they are up more than 45% for the year to date (as of May 6). “Berkowitz isn’t perfect, but he has had exceptional timing with most of his purchases and sales over the years,” Breen writes in a post on the MorningstarAdvisor.com Markets & Economy blog. “I get paid to follow him, and you’d think I’d learn something along the way. But I bought American Express earlier in 2008 and I’m still underwater.” Seven Buffett-Inspired Funds We Believe In Just in time for Berkshire Hathaway’s annual meeting in May, senior fund analyst Michael Breen put together a list of funds that are true to Warren Buffett’s investment principles and share his long-term commitment to shareholders. Sequoia SEQUX This is the granddaddy of all Buffett-inspired funds. Bill Ruane and Richard Cunniff started Sequoia in 1970, mostly as a vehicle to absorb investors sent over by Buffett himself, who was folding his investment partnership. It has never wavered from the Graham-inspired underpinnings it shares with Buffett. Fairholme FAIRX In late 2008, manager Bruce Berkowitz and his Gloomy Days for REITs After the bankruptcy of General Growth GGWPQ—the biggest real estate investment trust bankruptcy so far—and attending a meeting put on by Morningstar’s REIT team, MorningstarAdvisor.com 19

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Morningstar Advisor - June/July 2009

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