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Get Four
|  | DECEMBER 8, 2004
A Fencer's Stance on Investing James Melcher of Balestra Capital says one law applies to both fields: "Whatever feels right in your gut is wrong" Unlikely as it may seem, strong parallels exist between the sport of fencing and the art of successful investing. So says James Melcher, founder of Balestra Capital, who has been a hedge-fund manager for 25 years and is also a champion fencer. In both disciplines, "whatever feels right in your gut is wrong," Melcher explains. And in both, you need "a high level of self-control, particularly control over emotional reactions," he continues. Measuring his results, he reports that his fund of funds, Balestra Spectrum Partners, is up 85% over its six years. His global macroeconomic hedge fund, Balestra Capital Partners, is up 240% over the same period, and his two-year-old income fund, Balestra Income Partners, is up 46% so far. Looking forward, Melcher sees a market going sideways, "if we're lucky." Against that backdrop, he suggests defensive investing in such sectors as energy and metals, particularly gold, and in foreign markets such as Canada, India, and Russia. In his view, Russia's market will be one of the world's best performers in the next few years. These were some of the points Melcher made in an investing chat presented Dec. 2 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. AOL subscribers can find a complete transcript at keyword: BW Talk. Q: Jim, what's your outlook for the stock market into the new year? A: Well, I think we're certainly on a run here through the end of the year. The market is anticipating a fair amount of money coming in from pension plans. Companies can assume 8% on equities from now on if they want, going forward, but can no longer assume this on bonds. It's reasonable to expect in the first month or two of the new year, even into spring, that we'll be in a reasonably good market. A sudden shock, of course, could turn this on a dime -- I'd say a dollar, but it's only worth a dime now. But we think looking out into next year, if we're lucky, the market will be sideways, and if we're not so lucky, it'll go down a fair amount. It's more likely it'll go sideways, but we're quite cautious. Q: Jim, I hear you're a champion in fencing. How do you apply skills learned in fencing to your investing strategy? A: There are interesting parallels between the two. The reason is that fencing is the most unnatural of all sports. Whatever feels right in your gut is wrong. Particularly on my end of the sport of fencing, which is epee fencing -- as opposed to foil or sabre fencing, epee fencing is actually a strategic sport. There's no advantage in attacking -- it's much more defensive and strategic. To become a good epee fencer means to attain a high level of self-control, particularly control over emotional reactions. It took me a long time to learn how to do it, but I learned it well. And that's exactly what you need to be a successful investor. Q: Speaking of pension plans, as you did in your first answer -- I have a half million in 401(k). I'm 54 but intend to work about 10 more years. What do you suggest? A: Well, I would suggest that you move more toward defensive equities, and that you buy a chunk of gold, which you can do on the American Stock Exchange -- streettracks Gold Trust (GLD ). Each share is 1/10 ounce of gold. Gold is up substantially over the last few years in terms of the dollar. However, against the euro, it's up only modestly. Against the Canadian or Australian dollar, it's actually down. This isn't a speculative metal so much as it's currency. Throughout much of mankind's history, gold was money.... Gold now represents the safest currency while other currencies are being devalued. It's also a type of insurance against any disaster or calamity in our securities markets. On top of this, it represents potential profits independent of currency markets because it's a rare commodity, and investors are becoming increasingly interested in it. Q: What defensive equities would you recommend, specifically? A: Utilities always come to mind. I happen to think that, despite the fact that we've had an increase in valuations of energy stocks, energy stocks represent a combination of defensive and offensive characteristics. We feel that over time the world is running short of energy, and over the next few years we're going to see only a slight pullback in prices. They'll still be one of the best-performing industry groups -- if not the best-performing. And they're defensive in nature, because if you buy good stocks, you're buying assets. If you buy into oil services, you're buying into an area that's coming out of a 25-year decline but certainly isn't going anywhere. Something else to consider: Asia, particularly China and India, have shifted into high gear. Energy demand in Asia will be surprising all the experts in the time to come, and it's only logical to assume that, unless we discover a lot more major fields of oil and gas, the world will be energy-short five years from now. So we like oil-field service stocks very much. Beyond that, I think gold-mining companies, particularly Newmont (NEM ), are fairly valued. Newmont is down today but is a defensive stock as well. There aren't too many stocks that are defensive in a calamity, but some, like the financials, are very vulnerable. Food stocks would be O.K., but not food retailers like supermarkets (that's more of a competitive situation). The most defensive thing, of course, is short-term Treasuries. High-grade debt denominated in euros would also be a good defensive move. They pay a little more than Treasuries, but if you had owned them for the last year, you would be up around 11% or 12%. Q: How many hedge funds do you manage? What's your performance? A: I manage two hedge funds and one unhedged income fund. The first one is a fund of funds [Balestra Spectrum Partners], which this month is six years old and is up about 85% in the last six years. The second is a long/short hedge fund [Balestra Capital Partners], basically a global macroeconomic hedge fund, which is up approximately 240% in the last six years. The S&P in that time period is up about 7%. Both of these were up every year, even during the bear market. The third is the income fund [Balestra Income Partners], 25 months old, which is up 46%. It isn't leveraged and doesn't invest in junk bonds. Q: How can we invest in your funds? Or find more info? A: First of all, you can call (212) 768-9000 -- Balestra Capital. But there's a caveat: We do have a $1 million minimum. Q: What about commodity mutual funds as part of a diversified portfolio? If so, what percentage? A: It's a good idea. The world has seen a normal 20-year decline in prices up until two years ago, and we're early in the new expansion phase. I'd suggest investing in commodity funds, those that focus on energy and metals -- not agricultural commodities, since those can go anywhere year by year, or even day by day. For 20 years, fewer mines were being found and dug, fewer oil fields being discovered and drilled, and as a result we've gotten behind the curve on those...but you should not think that it's going to be a straight line up. Commodities are highly volatile on a virtually day-by-day basis. It's a different market from equities or debt, and one should take a long-term view with a lot of patience if you're going to operate in this market. Therefore, as a percentage of your overall investment portfolio, anything from 10% to 30% would be appropriate, depending on your personal circumstances. Q: What do you think of technology stocks? Do you own any? A: We're reasonably heavily positioned in technology, having mostly sold them short. We own a couple of computer security companies. The biggest is Symantec (SYMC ), which we've owned for a while and have had this stock almost double. The other is a smaller company, Tipping Point (TPTI ), which has more than doubled. Because these stocks have come up quite a bit over the last three months (we've only owned TPTI for four months), we would advise caution when buying them, but the trend for computer security companies is up. The growth of attacks on computer systems, government and corporate, as well as personal systems, is at an exponential pace.... Most of the information-technology area is still overpriced -- there's overcapacity and inventory problems worldwide, and these securities are overpriced because of their past great results in the late '90s. The average investor in computer stocks today is an example of what Oscar Wilde called the triumph of hope over experience. Q: What do you think of the weak dollar? Have you bought or sold anything recently based on the dollar's fall? A: Well, we've been hedging against the dollar for about 2 1/2 years now. As a matter of fact, in our hedge fund we're basically totally out of the U.S. dollar and have been for a while. I don't see that zero exposure changing for a while. It has been clear to us for many months that it has become an official policy of the Administration to allow the dollar to devalue. Therefore, we've hedged any U.S. securities against the dollar, and we hold very substantial foreign securities. Q: Can you tell us more about the foreign securities your funds are holding? A: Sure. We're moderately invested outside the U.S. but plan on expanding that. We've been a little cautious in recent months, making sure the Chinese economy won't go into a tailspin. We're in Russia and have been for six years -- bought into Russia starting in 1999, a few months after the market crashed. I think the Russian stock market going forward will be one of the best-performing markets for the next several years. We're participating in Russia primarily through a mutual fund, Third Millennium (TMRFX ). It's an open-end fund, and it's liquid -- we can get in or out if we want. It was rated by The Wall Street Journal last month as the best-performing mutual fund in the U.S. in the last five years. A year and a half ago, it was chosen by Value Line as the overall best mutual fund in the U.S. for the previous five years, based on performance and other factors. I'd like to add I'm a co-founder of that fund and own a portion of the management company personally. India we're investing in through the NYSE fund India Foreign Network (IFN ). This is a closed-end mutual fund and currently sells at asset value. We think this is a good opportunity -- it's very difficult to buy stocks in India. It's a long-term play we're very confident in. Someone who buys this should ignore price movements of this, and of our market as it pertains to this, and just look out three to five years. Canada is a major investment area for us. It has been for over two years. We own Oil & Gas Royalty Trust. It's a high-yield instrument, yielding about 11%, and is a play on the Canadian dollar as well. Enerplus Resources Fund (ERF ) is a perfect example of something that fits our strategic overview. Bear in mind that a portion of the yield on this, and other similar securities, is tax-free, representing a return of capital. That oil and gas trust makes sense only to the extent that management can continue producing new properties. Q: You've mentioned a few stocks earlier in energy and metals -- what's your favorite pick right now? A: Some of my most favorite stocks are very small, so I'll mention a few, but I urge significant caution when buying them, because they're very thinly traded. I like several small ones because they seem to have a strong market position -- a franchise, if not a monopoly. One of them is Scientific Learning (SCIL ), hard to buy because the management doesn't want to sell! This is a company that has developed a scientifically proven method that's being used more and more in schools across the country to basically treat dyslexia.... SCIL is not trading on the NASDAQ -- they're on the pink sheets but should be back soon. Another would be Diomed (DIO ). They've developed a bit of procedure for removing serious varicose veins. This isn't for cosmetic purposes -- it supplants a surgical technique that has significant side effects. This procedure, using a laser, is done on an outpatient basis with a fraction of the cost of the surgical procedure. It's growing rapidly. We also think the subprime auto loan business is attractive. You want to buy a few to spread your bets. Consumer Portfolio Services (CPSS ) is a good one, but another thin stock. They recently switched to standard accounting and make loans on autos that are subprime with very strong margins. We think it's an area that will do well, particularly at a time where the average consumer is overextended financially. So many more car buyers are now rated as subprime. This substantially increases this company's market.  Edited by Jack Dierdorff
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