By Courtney Darby
In this issue, we profile SB Capital and Income Fund, a diversified mutual fund with a large REIT weighting. Fund manager Mark McAllister shares his thoughts on market returns, how REITs fit into his investment strategy, favorite sectors and his rise to fund manager status.
SB Capital and Income Fund has a long-term objective of outperforming the S&P 500 with substantially lower volatility than the actual index. The fund holds a variety of investments including REITs, stocks, convertible securities (both convertible bonds and convertible preferred stocks), various fixed-income asset classes (including high-yield investment grade, and asset backed bonds) and derivatives.
*Data as of Oct. 31, 2003 for Class A shares, unless otherwise noted.
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McAllister says charting market returns for the next 12 months is difficult, but his forecast looks promising.
"We are in high single-digit to low double-digit territory at least in the next 12 months or so. We've had a very powerful rally in the broader equity market (primarily the S&P 500)," McAllister says. "If you look at where multiples stand today, they certainly don't look very cheap. The market is trading at about 18 times 2004 earnings estimates. While I think estimates are going to go up some more, the market multiple is fairly full, especially given where interest rates are."
McAllister says that investors should be expecting about 8 percent to 12 percent equity market returns for the next four to six quarters. He also doesn't foresee a significant market dip in the future, given strengthening economic fundamentals.
"I don't see a dip in the sense of a lasting retreat. I think there are underpinnings now in place for the market to be constructive going forward. Because the wheels of the economy are starting to grip more firmly and because of all the stimulus that is available both from fiscal policy and monetary policy, we're not likely to see a whole lot of bad news coming out of corporate America," McAllister says. "The earnings numbers are pretty powerful, third quarter was good, and I suspect we'll have a good fourth quarter."
Nothing has undermined McAllister's long-term confidence in REITs, rather, as he likes to put it, he has a "soft spot in his heart for dividends" and REITs are the perfect solution.
"REITs fit very well in our strategy. They have low correlation with other major asset classes and give us a diversification benefit that helps to dampen volatility in the portfolio," McAllister says, adding that he does adjust his REIT portfolio weighting depending on their valuation relative to other asset classes. "Even though I don't manage the fund to buy only dividend-producing stocks, dividends are here today and they're tangible. With REITs there is real underlying yield support at the end of the day for valuations."
REITs like ProLogis (NYSE: PLD), AMB Property Corporation (NYSE: AMB) and PS Business Parks, Inc. (NYSE: PSB) are among McAllister's expected top performers in 2004. He likes ProLogis and AMB because of the way both companies are financed, as well as their global diversification. PS Business Parks is attractive because of its strong management team, McAllister says.
"I also like iStar Financial, Inc. (NYSE: SFI) because I think the company is extremely well-run and likely to get an investment-grade rating in the near future, which will lower its financing costs. The credit culture is excellent and they can take advantage of all parts of the capital structure," McAllister says. "Because of the quality of the portfolio and the relatively modest premium to net asset value (NAV), I like Federal Realty Investment Trust (NYSE: FRT). I think the company's portfolio is probably the best overall in the strip shopping center sector."
Aside from REITs, McAllister is also bullish on the basic materials, capital goods, energy and integrated oils sectors.
"We saw a real strong sign the economy was starting to accelerate right at the beginning of third quarter 2003, so we allocated significantly more dollars to basic materials producers and capital goods manufacturers. We also like parts of the energy market, especially the integrated oils which are trading at a significant discount to the market multiple, throw off tons of free cash flow and have healthy dividends in the 3 percent to 4 percent range," McAllister says. "We also like the Gulf of Mexico natural gas drillers, the people who are leasing out rigs for others to explore for natural gas. Looking out through the winter, we're likely to end up with a pretty tight situation in natural gas and the prices should hold up for awhile."
While his interest in other sectors may fluctuate, the real estate industry has played an integral role throughout McAllister's career. After graduating from St. John's University with a B.S. in accounting and earning his M.B.A. at New York University's Stern School of Business, he landed an accounting job and realized he didn't want to be an accountant for the rest of his life.
"After I graduated from NYU I started working at Metropolitan Life in its real estate portfolio management group. That's where I got my first exposure to the industry," McAllister recalls. "I started there in 1987 and became more interested in broadening my career horizons. In 1992, I began the CFA program and became more interested in REITs. So, in 1994 I responded to an ad in the NYSSA (New York Society of Security Analysts) Bulletin for a REIT analyst and it turned out that it was with Cohen & Steers Capital Management. That's where I really learned the industry."
McAllister left Cohen & Steers in 1998 when he was recruited to help start a real estate securities business for Jones Lang Wootton. However, that company merged with LaSalle Partners and then became known as Jones Lang LaSalle. Once the transition occurred, LaSalle already had a well-managed real estate securities business of its own and he parted ways, McAllister says. In 1999 he was hired at Salomon Brothers Asset Management, an affiliate of Citigroup Asset Management, to cover REITs, gaming, lodging and other leisure areas. As McAllister got more involved in portfolio management he was eventually promoted to manager of the SB Capital and Income Fund.
"We went through some restructuring here and I became sole manager of this fund in May 2003, although I've been working on this fund for about four years now," McAllister says.
One of the things McAllister enjoys about the position is the continual challenges.
"I enjoy the diversity you get exposed to on a daily basis. It's not like sitting in a factory stamping out widgets in the same way. [My job] is literally different every day."
