Wise Money - Local Focused Investing, February 2, 2019
Ron Kaliebe interviewed by Garwin Lenander
Ron discusses the history of Mairs & Power, insights into the firm’s investment style, and their take on the current market.
Kaliebe on Mairs & Power
Kaliebe on bonds
Kaliebe on the economy
Mairs and Power been around since the 1930s We are about $9 billion under management. We have a very interesting investment style especially on the equity side. We are what's called multi-cap regional tilt.
Multi-cap means we'll invest in large companies, medium sized companies, and small companies. A lot of our small and mid-sized companies grow into the large category.
As an example, in Mairs and Power growth fund about 60 percent of the stocks are from the upper Midwest. The second feature is our turnover. Our turnover is anywhere from 5 to 10 to 15 type percent that level. So, what does that mean? That means you're holding stocks in the portfolio for years maybe even decades.
We are really in a rent a stock culture now where if you look at some of the turnover in some of the mutual funds you might find 100 percent turnover.
We invest in companies and we watch them and watch for the theory of why we invest in them play out over time. Our shareholders have been rewarded for that, so low turnover.
Lastly, we're mindful of taxes. So, the low turnover realizes that we will have less cap gains.
I also get a lot of questions when I say that regional approaches. In the upper Midwest we had a lot more Minnesota companies but as our companies got acquired, and we have less IPOs in Minnesota, we branched out to Wisconsin, North and South Dakota, Iowa, Illinois. We've looked at companies in Nebraska, Ohio, Michigan.
When you look at all of that you're going to find that there's probably about 500 companies that you could invest in. So, there's a big pool yet remaining in the Midwest that we can invest in. But we have to go to the West Coast for technology in some cases, we have to go to the East Coast for pharmaceuticals. But we believe that in the upper Midwest we have a lot of great companies, why not invest in them.
In the last week or two Mairs and Power has been out at Donaldson. So, Donaldson is one of our investments.
Tell people who Donaldson is.
Donaldson is a company that's on Highway 35W and 94th Street. A great company in your backyard in Minneapolis and they make filters and they're doing more initiatives into liquid filters. So, we had a team out there and we visited them and tried to understand how is the diesel filter product working and how deep is that market? We recently had Lindsey, which is a Nebraska irrigation company come in. The management came in, now they're facing some headwinds.
The ones with the big booms that irrigate?
Yes. And they came in and we got a chance to talk to them about AG prices and corn in particular, steel tariffs.
And then, another example is 3M. So, 3M recently, a few months ago had an analysis day. So, one of our managers and myself spent a whole day at 3M listening to their vice presidents and their CEO talk about what's going on in the world. What are they doing in safety? How is their dental business?
And then, the night before they had about 13 stations and they had a lot of their scientists there. So, we spent basically, several hours talking to their different scientists. So that is the Mairs and Power home field advantage.
You can jump in the car and be in a lot of your clients right away if you need to.
Well, investing is a mosaic. Here's the other thing is when you invest locally you find that maybe your neighbor is an engineer. You go to your church and they have someone there. You get a sense of how the company is doing.
I think last year's number, 2018 we visited 161 companies. Our team. So that's exposure to management or taking a tour or having a one on one meeting with them.
So, if you like old-fashioned investments, which means a fundamental analysis I think you should take a peek at Mairs and Power because we invest the way investment professionals have done for many, many, many years. Which is understand your companies, visit your companies, read their financial statements.
Sure, we have other things we look at but it's a lot of pick and shovel work and that’s what we do.
ON THE BOND MARKET
Now, we've been talking about investing one of your specialties is the bond market.
Why would anybody buy fixed income monies?
Well, that's a good question. So why people invest in bonds it's generally stability.
Another thing, stocks, they have dividends but dividends are a declaration of the board whereas a bond is a contractual agreement
And we just met with a customer just yesterday and she wanted to dedicate, basically, she has a liability two years out. She didn't want to take market risk in the stock market so we bought a bond that matched her liability. So, bonds have the ability to immunize, to dedicate against a liability.
So, it's stability, income, and sleep at night factor.
At Mairs and Power we don't have, I can't think of any defaults we've ever had. The reason we like individual bonds is because they mature. So, what that means is they're rolling down the curve. So, as they roll down the curve, the visibility becomes stronger and more certainty if you will. And then, at maturity, the portfolio manager and the client– have an opportunity to think about what they want to do with that principal.
Now a bond fund never matures. It could be a short bond fund, a long bond fund, or a medium bond fund.
Like a mutual fund.
Yeah. So, there's many, many type bonds out there. There's government bonds, there's agency bonds. We usually mainly use corporate bonds at Mairs and Power. we're a high tax state so we have a lot of tax-exempt issuers and the yield curve on the tax exempt is generally positive, which means as you go out in time, you get more interest rates, the credit quality is very strong. I think we've only had one general obligation default since the 1930s.
We have many good revenue bonds such as colleges, such as public power organizations. So, there's many opportunities to build a nice portfolio that's exempt from federal and state taxes.
All right, let's go back to tax exempt bonds, explain those to people because that's always something that people are confused about.
Sure. Well, we're broadcasting from Egan, so Egan has the ability to sell general obligations. So, if you look at the indenture or the contract of the bond, a general obligation means that it is the obligation of the City of Egan. So, buried in there it says we have the ability through property taxes to raise taxes to the level of covering debt service.
So those obligations are issued.
So, on a risk adjusted, tax adjusted basis, tax exempts make sense for a lot of people.
You got to look at your own situation, talk to your financial planner or whoever does your taxes, or your CPA and say wait, what's my tax bracket? How does this fit in what I'm trying to do?
Minnesota has, do they have double exemption here in Minnesota?
We do. I mean if you're buying a Minnesota bond you don't pay Minnesota taxes. If you buy out of state then you're subject to paying a state tax on that. So, I, again, check with your tax planner or your tax preparer but I'm sure if you're in a high tax bracket you should look at tax exempts.
And they're not a trading vehicle, in my opinion, and the reason is the difference between the bid and the ask is the price they offer to you and the price they would pay.
So, I would say when it comes to a bond portfolio and a tax-exempt portfolio assume that you're going to hold that to maturity.
You're going to hang onto it. This is not put and take stuff.
Yeah. And then, when you're doing it, you know, look at some of the basics. You want to look at what's the rating, what's the city, is it understandable? Is there call risk? Most tax-exempt bonds have some callability so you want to make sure that you're not buying a price much higher than they could call away from you because then you would have a capital loss.
ON THE ECONOMY
Let's talk about the economy. What's happening in the United States economy?
Sure. Well, the United States economy has been on a good run. It's been declining interest rates help create economic activity. But we've seen the Federal Reserve actually now starting to increase rates. So, if you look at auto loans that's a higher rate. Look at mortgage loans they are higher.
So, we're starting to see pockets of softness in the United States. But if you look at our overall economic activity, we're settling in at about a two and a half percent run rate, if you will. That's less than three but it's not, if we can keep two and a half going, that's great.
We've, created a lot of jobs since '08. We've created probably 16 million jobs. We now have 153 million people working. That's great. Participation in the labor force is finally coming up a little bit. Our unemployment rate is at four percent it was a little lower than that and the reason it’s going up is ‘cause more job hunters are in the marketplace and that's how they measure that.
So, the economy is not robust but I would say solid.
Okay. Now one of the big things we hear constantly about how China is going to overtake us and run us off the market.
What's your thoughts about China in the market, in the investment market?
Sure. Well, first of all, we are the largest economy in the world a $20 trillion type economy. China is $12-$13 type trillion. They're growing at six percent, we're growing at two percent, if you run the math, eventually they will catch us.
But we are a service economy about 70 percent of our economy is tied to the consumer. China is an industrial production type economy and industrial production is very sensitive to economic growth. So, China is slowing. They tell us that they're growing at about six and a half percent so it's not a recession. But if you look at China, they have created a lot of debt. So, they have a debt issue.
So, what is going on right now is essentially a battle of tariffs. So, there's discussions and tariffs that are going to go in place on March 1, and China has done some retaliation.
I have no crystal ball but the tariffs have caused uncertainty with investors. They've caused uncertainty with companies that we invest in. When we talk to managements, they say we're a little less reluctant, let's kind of see how some of this resolves out.
We need some issues to be resolved and I don't, I don’t know how this is all going to go but that's kind of been an impediment right now.
So, the China, I'd never heard it explained that way before so China is really a different type of economy than the United States.
Well, China has a plan 2025 where they want to be more of a consumer type economy. But right now, they're very dependent on exports and the United States has been a beneficiary of China's entry into the world and they've helped keep our inflation rate low because of their constant cost of production is down.
So, we've been a beneficiary of worldwide trade. So right now, if you look at gross domestic product probably about 55 percent of it is related to trade. And when you start talking tariffs, tariff essentially is a tax and it causes uncertainty, it causes hard feelings, it causes retaliation. So, we need to work through these headwinds and I think that would be then we would get a lift in growth.
The Fed has raised the interest rates a couple times in the last year or three times or four times. Talk about that a little bit in terms of what you do and how it affects the economy.
The Federal Reserve actually started inching up rates at around the end of 2015. And the Federal Reserve really controls the short interest rates. They don't control the long interest rates. So, as we sit here today, the fed funds rate is about two and a half, is two and a half percent. Fed funds rate is basically, the rate that banks kind of lend to each other.
It's a very short rate. So that rate then affects other rates. So, what is happened is the fed has raised rates to two and a half percent but interest rates have not gone up. The longer part of the market as measured the 10-year and the 30-year have been pretty flat, if you will.
So right now, a 10-year treasury is at 266, a 30-year treasury you can go out another 20 years and get only three percent. A two-year treasury is at 250 today. So, a lot of numbers but the long and the short of it is that's a very flat yield curve. Why does anybody care about a flat yield curve? A yield curve is a predictor in many cases, not all cases, of future economic activity. Because interest rates are low very long out that part of the curve is saying slowing economic growth.
In this current environment they yield curve as far as treasury is 250 for a two-year, three percent for a 30 year that is pretty flat. So, it's an uncertain time. The bond market is saying uncertain. The stock market in 2019 has been kind of happy days are here again.
What about inflation? Inflation has been really under control.
Mm-hmm. And that's the fed is looking at that. They have two mandates, full employment, we're at four percent unemployment rate that's by most economists a full employment measure.
And our inflation rate is about two and a half percent, which is pretty close to the two percent they try to target for. And you ask well, why hasn't inflation been low? Well, some of it is. Things like the internet, price discovery is such, is easier. If you're out shopping for a car, a book, or things like that you can do price discovery.
The other thing is the economic reality of the world. There’re more and more players, more and more countries that want to be in the economic game. They have labor to offer and so, a lot of labor around the world is a lot less than the labor in the United States.
So, there's a lot of macro factors that have forced to kept our interest rate and our inflation rate low.
My words of wisdom as far as investing is always think long term. There's a lot of noise that impacts the price of securities and if you can weather the storm and there'll be storms whenever you're invested.
Always will be storms.
I believe you'll be rewarded for it.
Stock market has been kind of volatile. Why, what's going on with the market?
Well, let's see, I think the most recent volatility has been because earnings are slowing. If you looked at 2018 the first two quarters, we had the tax cut and a couple of profits, the quarterly profits as measured by the S&P were up 20-ish type percent. So, we're slowing so that's been one thing.
October 3 the president tweeted that he would think about replacing the Federal Reserve Chairman Powell. That's never happened. Volatilities increased.
Economic activity around the world is slowing so that's another reason. but volatility is also another code word for opportunity.
And how would that, how would that be opportunity waiting for an investor?
Well, you might identify good companies that you want to buy and when people are panicking and running for the exit that might be a good time to pick them up.
Opinions expressed are those of the interviewee or Mairs &Power and are subject to change, are not intended to be a forecast of future events, a guarantee of future results, nor investment advice.
As of Dec. 31, 2018, Mairs & Power had assets under management of $8.5 billion.
An investment in the Funds involves risk, including loss of principal.
ALPS Distributors, Inc. is the distributor for the Mairs & Power Funds.
AG – agriculture
Capital gain (cap gain) – Capital gain is a rise in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price. The gain is not realized until the asset is sold.
Dividend – A dividend is the distribution of reward from a portion of company's earnings and is paid to a class of its shareholders.
Federal Reserve (Fed) - Founded by the U.S. Congress in 1913, the Federal Reserve System is the central bank of the United States.
IPO - The process of offering shares in a private corporation to the public for the first time is called an initial public offering (IPO). Growing companies that need capital will frequently use IPOs to raise money, while more established firms may use an IPO to allow the owners to exit some or all their ownership by selling shares to the public.
Yield curve - A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates.
S&P 500 - The S&P 500 is a stock market index that tracks the stocks of 500 large-cap U.S. companies.
Turnover – Turnover is the percentage of a portfolio that is sold in a particular month or year.