Wednesday, April 11, 2012

What stocks do I recommend?

Following are the components of my portfolio:

Bond ETF's in order of maturity

BKLN/VVR  floating rate corporate debt
CSJ       Short maturity investment grade corporate bond
LQD     Long maturity investment grade corporate bond
HYG/JNK  mid to long maturity high yield (meaning "junk") bond
MHN    Long maturity NY muni bond

Stock ETF
PFF       Preferred stock portfolio (heavily weighted to financial companies)
SPY      S&P 500 Index fund

ETF's are exchange traded funds.  In their best usage, they can be cost efficient ways to get exposure to a diversified portfolio of assets.  For example, MHN is a mainly NY based muni bond fund that buys longer maturity bonds and boosts it's yield buy borrowing money in the short (1 week) duration and buying even more longer term bonds.  The net effect is it yields over 6% tax free in NY State, which to my thinking is an excellent return.  Aside from municipal default, the risk is that short term rates go up dramatically and the fund can no longer borrow at attractive rates.  Given that I think we are in a protracted neutral market environment, I believe this risk to be low.  The ETF structure is very helpful here because I can buy any odd amount of municipal exposure and it will be a diversified portfolio.  I'm willing to pay a fee for the convenience and diversification.  The alternative of finding individual bonds  and expense of buying "odd-lots" or small pieces of bonds would be higher than the fee I am paying to manage the portfolio.

Some ETF's can be costly in terms of the management fee - one should do their homework in determining what the fee is.  It can be found in the "prospectus" or in any of the financial websites like Yahoo or my favorite  As a rule of thumb, I look for fees less than 0.5%.  If I pay more than that, I would be looking for particular savings elsewhere.  The MHN ETF is in that camp.  Remember that we are looking for somewhere around 2% over inflation.  If I pay 1% in fees that makes the hurdle even higher!

The SPY is an attractive way to buy market exposure because they charge less than 0.1% to manage the portfolio.

All of the above securities pass my test for value in providing exposure.   But there are many ETF's which are very risky.  Highly leveraged ETF's are really short term trading vehicles because the cost of maintaining the leverage will erode value over time.  Don't fall for these instruments as a long term investor.  Some others charge high fees but don't really actively manage the portfolio.  If you are paying 1% management fee, there should be some reasonable activity and outperformance versus their stated benchmark (rare).

Yields can be high for a variety of reasons.  Usually if something seems too good to be true, it is.  There is risk involved.  Leverage (borrowing) is one obvious one, less obvious is the risk that the dividend it about to be cut because the underlying portfolio does not support the payout.  It pays to investigate.

Always review the daily trading volume (not jus the average) to see how much is trading.  Ideally you want to see volume every day and a good amount each day.  Another reflection of poor trading volume is what is called the bid/ask spread.  This is the difference between the "bid" price- the price you can sell a given amount of shares immediately and the "offer or ask" price which is the price at which you can buy shares immediately.  Check out in percentage terms what the spread is an make sure you are comfortable. A high spread menas that it will be costly to get out of your position if you change your mind or you need liquidity.

Monday, April 9, 2012

RANT Alert!

RIM is the poster child, for me, of what is wrong with putting too much into growth investing.  As far as I know, there has never been one payment to retail (post IPO) investors.  The only ones who made money for sure were market makers, investment bankers, the initial investors and, all importantly, the upper management.  And that from a company that has made profits!  Let's not forget the scores (thousands?) that didn't make any money.

Yes, if you were an astute trader you could have made money from the changing market perceptions of the future growth potential.  This is a difficult game, mostly because it is difficult to stay dispassionate when one has a position on.

And yes, there are exceptions, AAPL comes to mind, GOOG is perhaps another, but the jury is still out on them as only now has AAPL started paying dividends.  I understand the financial theory of dividends being a signal that the company has better projects to invest in and so the return for investors is higher if they reinvest all profits.  But in my view, even a token dividend would at least be an acknowledgement that there is some acknowledgement of the presence of shareholders and that this is not just an exercise in enriching the founders/upper management.

This comes to my mind mostly because of the Facebook hysteria (and now Instagram, $1 BILLION.  Really?).  Buyer beware.

Saturday, April 7, 2012

Current Portfolio Views

I just created a page with my portfolio returns.  Over the past few years I have benefitted mostly from making a bet on TIPS, municipals and corporate bonds.  My thesis has been, and continues to be, that we are in a protracted neutral environment.  The impact on company earnings due to the poor economic state has been offset by improvements in corporate efficiency -i.e. layoffs and better capital/technology use. As a result, I have felt that corporate bonds, be they high grade or "junk" are good bets.  Municipal bonds are good bets as well.  I believe that the "government" will not let a large municipality default.  Municipalities have a long road to hoe but I believe they will muddle through.  Long dated TIPS are still good value with real yields in the 1% area with the potential of a move to the 0.5% level.  The middle of the curve, however, is fairly priced.  Real yields in the 10 yr maturity area are negative and I expect them to not move too much.  At some point, sooner, rather than later, rates will move up and I think the likely reasons are going to be rising inflation expectations which would be good for TIPS.  Other reasons for yields moving up would be a lower risk premium for US bonds or rising real return expectations due to renewed growth.

While I am still comfortable with continuing the credit bet, I have started hedging out my risk to the absolute level of interest rates.  With the 10yr in the low 2's I don't feel there is a lot of risk to be short the government bonds in that maturity.  If I am wrong and bond yields do go lower, I feel that the yield curve will flatten (longer term yields will go down more) so my bond exposure is tilted toward the longer maturity spectrum.

Higher growth expectations could lead to a rise in rates but that would be good for stocks.  At current levels of interest rates and stock earnings yields, stocks are cheap (see previous posts). Solid companies with good dividend histories are good investments.  "Growth" companies are more speculative.  I have missed the Apple boat despite my feeling they are one of the best companies in the world.  I have difficulty buying the stock at this stage but I have not put it out of the realm of possibility.  Google is another speculative name that is probably a reasonable bet.  Despite their high prices, these two companies valuations are not over-inflated.

Buying stock exposure with call options is a good way to go right now as the market is not putting a big premium on options.  It is important when you do buy options that you buy strikes that are in reasonable range.  I would rather spend my option premium on fewer at-the-money options than a larger quantity of options that have a very low likelihood of paying off.  In addition, I would stick to the simplest options you can find.  Higher levels of complication add to the cost paid to Wall Street.

Tuesday, April 3, 2012

Above is a graph of realized yield from owning the S&P 500 vs the 10 year treasury for any given year.  In the case of the treasury yield I used the average for the previous year as a proxy for what you might expect in the coming year.  Importantly, I am not including any capital gain or loss from yield changes.  For stocks the yield is comprised of actual earnings for the next year plus the dividends paid out.  As with bonds, I have not included any capital gains/losses from changes in the value of the S&P.

The orange column represents 2012 with a best estimate from Yardeni Associates or about $105 in S&P earnings and about 2% dividend yield.  The dashed line represents the average for the whole 50 odd year sample.

I bring this up because I feel it is important to place some longer term context of what one should expect from stocks vs bonds.  In addition it frames my way of thinking of stockholders being the owners of businesses.  Investors should think like owners and not traders, in my view.  Ask yourself why you own stocks?  Sure, you want a claim in a growing business, but what if they never paid anything to the owners?  What would that be worth?  It's not as silly a question as it sounds on the face of it.  Think of all the "growth" companies that go bust.  At least if they paid something to shareholders there would be some   tangible value and, very importantly, it is harder to play accounting tricks when actual cash is being paid out.

Again, I think growth stocks play a role in a portfolio, but for the investor it is wise not to overload.

Getting back to the yield picture, buying stocks in the late 90's early 2000's was a gamble on growth.  I think we are now in a more healthy period for investors where there is more balance to equity returns.  Even at current levels of the S&P ~1400 the prospective yield premium is in the high 6's and at that level one should have a reasonable exposure to stocks if not a bit of overweight. That does not mean you have to be there immediately, remember this is a long term game.

Monday, April 2, 2012

My Investment Process

Investing is never easy.  It is logical to seek help in navigating the investment waters.  However, as a business, the investment biz has few peers in terms of profitability.  Why, because professionals have benefitted from complicating the process over time - by refining and dividing investment decisions into ever more specific goals.  No longer is it good enough to be a "hedge fund" manager, one could be an "event driven credit oriented small cap manager".  How much do you put into that idea, if you can even figure out what it is????  The more obscure the technique, the higher the "economic rents" paid to the activity - i.e. more money for the manager.  It is my opinion that it doesn't have to be that way.  Often the best ideas are the most evident.  What we have to move away from is thinking of the big score - the one investment that will carry us into a comfortable financial position.  Investing truly is an incremental activity where good decisions will bear out over time.  Now, that doesn't mean everything will always work out - that "cheap" stock that you bought may remain "cheap" longer than you can remain solvent!  A good manager will recognize that they are wrong and take action - move on to the next idea.  The key is not putting so much into one idea that it blows you totally off course.

In a costless world, one would hire the best manager for every type of investment decision, while being careful not to split the portfolio too finely.  An example:

an asset allocator to decide how much to put into stocks bonds and cash
a stock allocator to decide how much to place in value and growth orientation portfolios
a stock picker for the value portfolio
a stock picker for the growth portfolio
a bond allocator considering the weighting of government vs credit
a bond picker for the government bonds
and, well, you get the picture.

The problem with this approach, aside from the difficulty of ascertaining which is the "best" is, in a word, fees.

Many economic studies have shown that fees usually more than offset the value added from the manager's skill.  This has led to the, justifiably, wide-scale adoption of index strategies and the stunning growth of a marvelous company called Vanguard Investments.   While this can take care of some portion of the total portfolio investment process we are still left with MAJOR decisions in the allocation department.

My investing method is based on a total portfolio approach.  I think it is putting too much burden on the non-professional investor to have to figure out how much to put into specific strategies.  If I were to put a label on my philosophy it would have a value slant - I actually care about current earnings and dividend payouts.   There is a place in the portfolio for more speculative growth stocks, but, again it should be up to your manager to decide how much.  I am usually preoccupied by asset allocation, how much I put into stocks vs credit (bonds) vs government securities and cash, rather than by picking individual stocks.    

My target is to beat inflation by 2% net of fees.  My research has shown me that is the level of return that I need to earn to have a reasonable chance to be financially independent.  There are many assumptions that go into this conclusion (I will look to post this model for anyone's use, in the future).  The primary assumption is that I look to receive a little less than 2% from my investment portfolio on a yearly basis to fund my expenses.  If anyone were to ask me what they can invest in to make money I often point out that the only sure fire way to earn more money is to spend less.  This is not a glib response, it is based on statistics.  Investing is a probabilistic game, there is an expectation of return but there is a whole range of possible outcomes over every given horizon.  Spending is, to some extent, controllable whereas investing is completely to chance.  Perhaps you can move the odds in your favor a bit, but it's chance nonetheless.

My goal for this blog is to provide one person's perspective on the investment world, maybe spark some ideas and hopefully help readers make a few better decisions over time.  I welcome discourse and I will try to back up my statements with some tangible evidence.  I offer no guarantees that anything I say will work out.  What I CAN guarantee is that, for better or worse, the ideas I express in the blog will reflect what I am doing with my own money.