Fund manager Q&A: USAA's Matt Freund defends holding cash

Staff Writer
Columbus CEO

NEW YORK (AP) — Sometimes the best choice is to make none at all, particularly when all the options look risky.

So if you're deciding whether to invest in stocks, bonds or something else, remember that you could leave some of it in cash. So says Matt Freund, chief investment officer of USAA's mutual funds.

He says stocks are likely due to deliver lower returns than before, maybe 7 percent annually, partly because of how high their prices have become relative to corporate profits. And as the Federal Reserve gets closer to raising interest rates, Freund expects price swings for stocks to get bigger. Bonds, too, are likely to get more volatile.

Instead of taking on a lot of extra risk for only a little bit more return, the right choice may be to get more conservative, says Freund, who manages several bond mutual funds. He recently talked about why it can make sense to stash some cash under the mattress. The interview has been edited for length and clarity.

Q: How much more volatility should we be expecting once the Fed begins raising rates?

A: We've already seen it. We saw it in August, when people were trying to make a huge news story about a 10 percent decline for stocks. I think it is going to get worse. I think these sorts of 5 and 10 percent corrections are going to be much more commonplace. They're not going to be as newsworthy.

Q: Aren't stocks supposed to do well, even after the Fed starts raising rates?

A: Everybody talks about how stocks typically don't peak until two or three years after the Fed begins raising rates. Is that going to happen this time? Is it safe for stocks? Well, we're not sure, but I suspect that it's not.

Typically, when the Fed raises rates, the economy is accelerating. And at USAA, while we're not calling for a recession, we're not calling for an acceleration either. We think we're going to be seeing more of the same, where the economy is kind of grinding along at very modest growth.

Stock valuations today are not cheap, and they are (based on the assumption that) economic activity will return to normal, will accelerate.

Q: So stocks don't look like the better investment versus bonds?

A: People implicitly make the assumption that the market owes them a good choice.

People always talk about how you need to buy stocks today because they're a TINA - there is no alternative. And I completely disagree. Stocks may beat cash or bonds. But that doesn't mean you're being paid for the risk, and that doesn't mean it's appropriate for you and your time horizon.

Q: What kinds of investments do you like?

A: I actually do like high-yield.

Q: Don't managers of high-yield bond funds always say they like high-yield?

A: If I gave you the choice of two asset classes, and one was going to earn 7 percent and be really volatile, and the other was going to earn almost 7 percent but with a lot less volatility, which one is better? I think that for the same returns, take less risk.

Q: I assume the first choice is stocks, and the second is high-yield bonds. Can they really produce nearly 7 percent returns?

A: The high-yield index is yielding close to 8 percent. After expenses, it's close to 7. So then you have to worry about defaults and price swings. If you're investing for three to five years, I think the ballpark is in the low 6 percent to high 6 percent for returns.

Q: And stocks don't look good at all?

A: Let's say that you are the perfect, rational investor who invests without any emotions. Or you're going to program the computer to do it. If you told the computer, "My time horizon is five years or 10 years," it would put you in stocks. It would put you in emerging markets.

But if you said, "Look, I'm really a six-month investor," the offered returns don't compensate for the risk, and it would keep you out of those markets.

Q: Do you really think people are investing in stocks with expectations to hold for just six months?

A: People are exceptionally short term. Maybe it's for a year. But look at all the articles that happened in August. It was a 10 percent correction. It was long overdue. It was no big deal. But it created a lot of worry and angst.

Q: That advice wouldn't have been any different 10 years ago, though, right?

A: Yeah, but people always seem to forget it. There's nothing wrong with holding some cash.

Imagine you were that lucky person who was sitting on a big stockpile of cash in August. Everyone is running for the door. You would have been very well rewarded for putting that money to work. But how do you get that dry powder? You have to pull back when the market feels good, and that's times like now.