Chuck Akre, manager of the Akre Focus Fund, believes that high unemployment, tight credit and rising food and energy costs will put a damper on consumer spending. Yet his fund’s largest holding, at 9.7 percent, is MasterCard Inc., the consumer credit card-servicing giant. The reason? Akre sees a growing trend towards paperless transactions, which he says will pay-off for MasterCard over the long-term.
Such thinking serves Akre’s fund well. The fund’s 23 percent return over the past year has bested 99 percent of its peers in the mid-cap growth fund category and done so with less volatility than the stock market. The Akre Focus Fund got its start in August 2009. It owns 29 stocks, with 70 percent of its $1 billion in assets in its top 10 positions -- mostly holdings of large and midsized companies. While Akre's fund is relatively new, he managed the FBR Focus Fund from 1997 through 2009, delivering a 12.4 percent annualized gain, compared to a 4.4 percent return for the S&P 500-stock index over the same period. Lewis Braham recently spoke with Akre who is based in Middleburg, Virginia.
Q: What is your outlook for the U.S. economy?
A: In the U.S. today, unemployment is over 8 percent. If you look at unemployment numbers that include those no longer collecting unemployment benefits and those who have given up looking up for jobs, the real unemployment level is somewhere in the mid-teens. With an economy where gross domestic product is two-thirds driven by consumer spending, you can’t have robust growth with that level of unemployment. Also, access to credit is improving, but it’s still not like it was in the 1990s or 2000s. Third, the experience of 2008’s credit crisis put people on guard and they do not want to have as much leverage as in the past. Those circumstances define a more difficult environment. We've used the phrase, “the constrained consumer.” Periodic increases in food and energy costs exacerbate the problem.
Q: Then what is the rationale of owning MasterCard and Visa in your portfolio?
A: Those are both worldwide businesses. MasterCard does business in 250 countries and currently 85 percent of global transactions are done via cash and checks. There’s a trend away from cash towards credit. That’s a huge macro force at work. Also, MasterCard gets paid a percentage of the absolute dollar amount of transactions, so it has an inflation hedge. If more dollars are spent because prices of goods have gone up, MasterCard’s revenues go up in tandem. Also, unlike American Express and Discover, Visa and MasterCard are not lenders, so they don’t have the credit risk of those companies. They also have profit margins north of 30 percent. The average American business struggles to make a profit margin in excess of 10 percent.
Q: Are you concerned about the competitive threat Verizon Wireless and AT&T pose by turning smartphones into credit cards?
A: A significant portion of mobile payment transactions actually go across the Visa and MasterCard rails. They’re agnostic as to what type of device you use. Verizon and AT&T just want a piece of the action; they've gotten some already. It will depend on how their security systems work and so forth. Who knows how it will shake out? But MasterCard and Visa are great businesses with great balance sheets that create lots of cash. Their problem is what they do with all their cash -- a good problem to have. It’s probably a problem you and I don’t have.
Q: So what do they do with their cash? A: They are buying back stock, paying dividends and acquiring some small businesses that have important technologies [which will help them compete in the mobile-payment business].
Q: Your second-largest holding is clothing retailer Ross Stores. Why?
A: Ross Stores, TJX Companies and Dollar Tree -- we’ve owned all three for a couple of years. They are businesses that bring goods to consumers at attractive prices. They have great skills as merchandisers and at the logistics of bringing goods to consumers efficiently. Ross has grown its footprint in retail very rapidly. These businesses have had free cash flow growth in the mid-twenties if not higher in the last five years. Even if we reduce our expectations to half that in the sluggish economy, they still have a bright future.
Q: In your latest shareholder report, you write that you’re not just worried about the constrained consumer, but about stagflation. That’s different from just a slowdown. Why are you concerned about that?
A: The government is spending far more than it’s taken in by adding debt to the balance sheet. Among the possible solutions to this problem are to grow your way out, which is highly unlikely in this environment. A second solution is to lower interest rates, but interest rates are on the floor as it is. The only logical solution is to devalue the currency so that the value of the debt, which is fixed, declines in inflation-adjusted terms relative to the size of the economy. Doing that will cause stagflation like the 1970s -- inflation plus the slow growth we already have.
Q: Do you have any hard asset plays in the portfolio to counteract inflation?
A: Leucadia National owns interests in coal, oil, iron ore, real estate and insurance. It’s selling at a price we believe is cheaper than the sum of its parts. Hard assets typically haven’t been our thing, but we like companies with pricing power, like MasterCard.
Q: How does a fund-holding such as credit-rating company Moody’s fit into this economic paradigm you’re describing?
A: Moody’s has significant pricing power because it’s part of an oligopoly of companies that provide ratings. And ratings are necessary for businesses and governments that need to raise debt capital. We just talked about a worldwide economy that continues to use and need substantial amounts of debt. So if you’re one of the very small groups of companies that enable that to happen, that’s a pretty good place to be.
(Lewis Braham is a freelance writer based in Pittsburgh.)
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