Tag Archives: portfolio

The V20 Portfolio: Introduction

Summary The V20 Portfolio aims to generate annual returns of over 20% over the long term. This portfolio is highly volatile due to concentration. If you have a long-term horizon, the V20 portfolio may be for you. After multiple requests from readers and much deliberation, I’ve decided to reveal a portion of my portfolio which I’ve dubbed “V20.” A rather uncreative name, but I’ll get to that later. This sub-portfolio represents the core holdings (~70%) of my entire portfolio. If you are interested in the performance of my entire portfolio, you can view it at any time using the link beside my name. The main reason why I hesitated to disclose my holdings was because I do not want readers to blindly follow them without understanding the associated risks and goals. But with the recent market downturn, I believe that analyzing my portfolio right now could provide a lot of value. That being said, I must reiterate that you must understand the goals and risks of this portfolio and judge them yourself before taking any positions. Thus far I’ve been analyzing specific companies. With this series, I hope to shine a light on my portfolio construction strategies, as well as analyzing performance from a top-down perspective (looking at the portfolio as a whole). The weekly updates will identify whether there have been any significant events that could have impacted the portfolio and whether our original thesis remains intact. New or closed positions (if any) will also be announced. What Is The V20 Portfolio? The V20 Portfolio consists of stocks that I believe to have asymmetrical returns. In aggregate, the goal of the portfolio is to generate 20%+ return per year over the long term. The V stands for value, the style of investing that I abide by personally. What’s so special about the V20 portfolio? How does it differentiate itself from many other funds/portfolios that you see out there? I would say that one of the major differences is the return expectation. I am not aware of any mutual fund that aims for a return of 20% per year. These type of returns are typically only expected of alternative investment vehicles such as hedge funds and private equity funds. However, I believe that this performance goal is very achievable as a retail investor, if you can stomach the following risks. Risks First there is the volatility. To maximize expected returns of the portfolio, the holdings are not diversified (in the traditional sense anyways). There are typically 5 to 15 stocks at any given time, with skewed weights. Stocks with the largest upside will typically get the biggest share of the portfolio. Because of this set-up, volatility (defined as standard deviation of returns) will likely be much higher than an index such as the S&P 500 over any period of time. You must also accept price risk in the short and medium term. Price risk is the risk that holdings may be undervalued for an extended period of time even though there is still substantial upside. Because the portfolio holds many stocks that are out of favor, you must be willing to grit your teeth while the stock awaits a recovery. Risk In Action (click to enlarge) Here we have a graph illustrating the performance of the S&P 500 and the V20 Portfolio. As you can see, the portfolio has significantly outperformed the index this year. However, it wasn’t rosy all the time. At the beginning of the year, you can see that the portfolio drastically underperformed the index, almost losing 20% in a matter of weeks. To tie this back to the aforementioned risks, had you sold the portfolio then, you would’ve missed out on all of the subsequent gains. This is why I cannot stress enough that you must hold a long-term view if you want to invest in this portfolio. Who Is This Portfolio Suitable For? That answer to that question is ultimately for you to decide, but I do have a few suggestions. There are two general categories: investors who are building towards retirement and retirees who wish to pass on assets to family members. They may look different to you, but they are united by a common factor: a long-term investment horizon. In my mind, this is the critical success factor. By holding a long-term view, the aforementioned risks become irrelevant. To be invested in this portfolio, you must have no plans to withdraw the funds over the next five years at a minimum. This means that if you want to turn $40,000 into $50,000 by next year for a down payment on a house, this portfolio is not for you. If your child is going to college next year and needs tuition, then this portfolio is not for you. On the other hand, if you have excess income every month that you stow away at the bank earning 1% a year, then this portfolio may be suitable for you to create wealth over the long term. Portfolio Overview (click to enlarge) ACCO Brands (NYSE: ACCO ) You can read my previous analysis here . This company makes office supplies. Although there has been a shift away from paper-based products due to technological advancement and green initiatives, the company has delivered good results over the past couple of quarters. I admit that society is becoming increasingly reliant on electronics, however, I believe that things like binders (one of the products that the company makes) will remain prevalent in school and offices. To protect myself from a potential secular decline, I’ve allocated only a modest portion of the total portfolio to this stock. magicJack (NASDAQ: CALL ) As you can see, magicJack constitutes a significant portion of the current portfolio. You can read my analysis on the company here . Since I wrote the article in April, the stock has appreciated by around 25%. I think most people would be happy with a 25% return in less than six months, and may even sell the stock after a nice run. However, I believe that there remains substantial upside to this company, so I will keep the current allocation until fair value is reached or close to being reached. Due to the large amount of cash on the company’s balance sheet (which cushions its downside), I believe that the stock is relatively safe; hence, I’ve allocated a significant portion of assets to this stock. Conn’s (NASDAQ: CONN ) You can read my latest analysis here . Conn’s is one of my high conviction ideas. The company is a consumer retail company with a spin. Its primary customers are credit constrained (i.e. low credit) consumers. I think after the last financial crisis, investors have become automatically fearful when credit-related companies report increasing delinquencies. What they miss is that this is something that the management can easily control. Over the past couple of quarters, the management has significantly tightened credit policy in an attempt to decrease bad debt expense, all the while increasing sales. After the recent decline, I believe that there is once again significant upside for this stock, which is why I’ve put a large chunk of the portfolio in Conn’s. Dex Media (NASDAQ: DXM ) This is one of my more interesting holdings. There is a big chance that the company may go bankrupt. So why am I holding this you ask? Despite a declining business, the company is still generating a significant amount of cash ($136 million of cash form operation in H1). Given the low capex requirement ($4 million in H1), it is literally a cash cow. The only problem is that the company is saddled with debt, which stood at $2.2 billion at the end of the second quarter. Almost all of it will be due by the end of next year. There is absolutely no way that the company can afford to pay all of it out of pocket, so its future depends on whether the lenders will refinance. At the current price, the market is essentially betting that the equity holders will be completely wiped out. I, on the other hand, remain hopeful that the restructuring process will extend the bond maturities. Of course, this is a highly risky investment, as I could lose everything. For that reason, I’ve allocated only an extremely small portion of my portfolio to this stock. Intelsat (NYSE: I ) This is a satellite company. Similar to Dex Media, the company has a significant amount of debt. The difference is that the company remains profitable. There are significant barriers to entry, so I believe that the company can maintain its profitability. The problem is that it is fairly sensitive to rate increases. If the Fed raises interest rates, then it would cost more for the company to roll over its bonds. As it stands, however, I see substantial upside for this stock given the current financial profile. Nevertheless, the debt is a concern, so I’ve allocated only a modest portion of the portfolio to the stock. Perion Network (NASDAQ: PERI ) Perion Network is a technology company. Through its products, the company provides ways for software publishers to earn revenue by linking search results from major search providers such as Google and Microsoft. The products themselves are a bit dubious, with some critics calling them adwares. While the company is profitable, the stock was hit hard when Google decided to upgrade Chrome to enhance security, which prevented many of Perion’s products from being installed. However, I believe that the company’s products will continue to provide its partners (e.g. Microsoft) with search volume and are still a unique way for software publishers to monetize their content. Similar to magicJack, the company also has a large cash balance, which will protect losses in the short term. For the above reasons, I’ve decided to make it my third largest holding. How The Holdings Fit Together There is always systematic risk. This is the type of risk that I have no control over (e.g. a sector decline). However, I’ve tried to minimize this risk by diversifying my holdings into uncorrelated sectors. I believe that none of my holdings are tied to a single common factor that could influence their values. ACCO Brands manufactures office supplies, magicJack is a niche communication company, Conn’s is a sub-prime retailer, Dex Media is an advertising company, Intelsat is a satellite company, and Perion Network is a niche technology company. As you can see, none of the holdings have a clear overlap. However, I must admit that every stock will be influenced by an economic downturn. This goes back to the idea of systematic risk. Unfortunately, pretty much everything is tied to the economy, so I’ve decided to accept this risk for now. The second risk I want to talk about is a bit more elusive. I’m talking about the idea of permanent capital loss. Buffett supposedly said the following words: Over the years, a number of very smart people have learned the hard way that a long stream of impressive numbers multiplied by a single zero always equals zero. How do I apply this to my portfolio? Well, I believe that there are stocks whose potential upside is exceeding large; however, they are highly risky in the sense that it would be possible to lose everything. One such example in my portfolio is Dex Media. As mentioned earlier, there is no doubt in my mind that the company may go bankrupt over the next couple of years, which is why the company is trading at a depressed valuation in the first place. Nevertheless, I believe that the upside is extremely attractive should restructuring yield favorable results. There are a variety of factors in play here, but I will save those for another time. The bottom line is that I may lose the entire invested amount in Dex Media. Going back to Buffett’s quote, an easy way to get “impressive numbers” would be to invest your entire portfolio, so that should events transpire in your favor, you could achieve returns that would be out of this world. However, by doing so, you would be setting yourself up for the possibility of permanent capital loss if things don’t turn out the way you expect them to, and this is what I strive to eliminate from my portfolio. In the V20 Portfolio, you can see that DXM only constitutes a very minute (1.1%) portion. This means that I’ve limited my upside, but the portfolio will still enjoy a nice boost should the stock appreciate significantly, and I can sleep soundly even if the company goes bust. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

ETF Issues: What You Don’t Know Might Hurt You

ETFs can be great options for investors. But you have to know what you are buying. iShares, for example, isn’t making that easy, though it’s doing the best it can. Exchange traded funds, or ETFs, are an incredible work of human ingenuity. They are pooled investment vehicles that trade close to net asset value while being traded all day long. And while there are good reasons to like these hot products, there are also reasons to dislike them. And a single data point provided by iShares shows one of those reasons. I don’t hate ETFs To start, I don’t hate ETFs. I just don’t like them as much as most investors seem to. And certainly not as much as Wall Street does, based on how many ETFs have been brought to market in recent years. Yes, they are cheap to own and provide quick and easy diversification. But it’s so easy to buy an ETF that people aren’t looking closely enough at what they are buying. That may not matter much if you pick up the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), a clone of the S&P 500 Index. But with more and more esoteric ETF product being created by rabid Wall Street salesmen, taking the time to get to know what you own is starting to matter more and more. For example, I recently wrote about the fine print in the prospectus of the Global X Yieldco Index ETF (NASDAQ: YLCO ). Essentially, this ETF is focused on buying 20 stocks in a new and niche sector that doesn’t really have 20 stocks to buy. YLCO is all about the story, not so much about the substance, in my eyes. Maybe YLCO will be a great ETF at some point, but right now it’s a risky proposition that all but the most aggressive investors should avoid. So, yes ETFs can be good. But Wall Street has been perverting this goodness in an attempt to make a buck. iShares isn’t evil But don’t think it’s only exotic fare about which you need to be concerned. Even more “normal” stuff can lead you astray. For example, the iShares NASDAQ Biotechnology ETF (NASDAQ: IBB ) has some problems of its own. Now iShares is the ETF arm of giant asset manager BlackRock (NYSE: BLK ). And, for the most part, BlackRock is a stand up company. But that doesn’t mean every product it sells is a good investment option. For example, a quick look at IBB’s overview page shows a P/E ratio of 25. That might not be too surprising given that biotech companies are high growth. You wouldn’t expect a P/E of 10 for this group. In fact, you might even say it’s on the low side for the sector, which is known for housing money losing companies looking for a big score via the creation of new drugs. Which is why you should click the little information icon next to that P/E stat. That’s where you’ll learn that the P/E ratio doesn’t include companies that don’t have earnings. So, essentially, the P/E really tells you less about the ETF’s portfolio than you might at first believe. Interestingly, the same issue pops up throughout iShare’s data on P/E. For example, the iShares U.S. Oil & Gas Exploration & Production ETF (NYSEARCA: IEO ) has a P/E that’s listed at a little over 8. With 70% of its assets in the oil and gas exploration sector, where companies are bleeding red ink, you have to step back and wonder what’s going on. A low P/E makes sense for an out of favor sector, but does that average really tell you the whole story? The thing is the warning about P/E is a standard disclosure on the iShares site and holds true for everything from a niche biotech fund to the company’s S&P 500 Index clone. And iShares really isn’t doing anything malicious. It’s a database issue. You can’t calculate a meaningful P/E if a company doesn’t have any E to work with. So in order to get the job done, in this case calculating an average P/E, you toss the garbage numbers. And, thus, you create a P/E by using only those companies with earnings. Which, unfortunately, biases the number you have just created so that it may offer a misleading picture of the portfolio. So I’m not hating on iShares, there’s not much else it could do to provide site-wide data. And at least it goes the extra step of disclosing this little problem. But it should make you step back and take pause. If you own that biotech fund or the oil and gas fund, the stats you are using to validate your purchase may, in fact, not be reliable. This issue can be found at open-end mutual funds, too, so don’t think ETFs are the only problem child. The best example comes from Morningstar. This research and data house is very open about the way it calculates most of its data, you just have to look. And when it comes to average P/E, they have a workbook available that explains, “If a stock has a negative value for the financial variable (EPS, CPS), the stock will be excluded from the calculation.” EPS is earnings per share and CPS is cash flow per share. So any site that uses Morningstar data will be impacted by this issue… like Fidelity (read the fine print at the bottom of the data page). The question is to what degree is there a problem. In some cases it’s a minor issue. In the case of IBB, roughly half of the ETF’s holding don’t make any money and are excluded from the P/E calculation, according to The Wall Street Journal . That makes the P/E figure provided by iShares pretty much useless in my eyes. And it points out yet another problem that ETF investors may not realize when they buy what is currently a hot Wall Street product. Know what you own For many investors ETFs are seen as a short cut. A punt option that doesn’t require much thinking. In many cases that’s true, but in many others it isn’t. Which is why knowing what you own is so important. Can you accept the average P/E for an S&P 500 Index fund at face value? Yeah, probably. But what about an ETF honed in on an industry that’s filled with money-losing companies, like biotech? I don’t think that passes the sniff test. You’d be better off doing a little more digging into the portfolio to get a good understanding of what’s in there. Again, I don’t hate ETFs. But they are so popular and have been pushed so hard by Wall Street that I fear investors don’t have any clue what they own. Too many people have been lulled into complacency by slick marketing and an avalanche of new products. I don’t think that’s a story that ends well. If you own an ETF, I recommend taking a deeper dive just to make sure you really own what you think you own.

This Is One Heck Of A Great Bond ETF

Summary The Vanguard Long-Term Bond ETF does everything right. If investors could only hold one bond ETF, this one would be a very strong contender for that spot. The fund offers solid income, a low expense ratio, and negative correlation to most major equity classes. If you don’t like this ETF, tell me why, because I do not see a single weakness here. This is a great ETF. There are only a few ETFs that really catch my eye as I’m researching them. This is one that immediately stands out for being absolutely exceptional. It has pretty much everything an investor could want for a bond ETF. I’ve shown a strong preference for funds that I can trade without commissions from my Schwab account because it makes frequent rebalancing more appealing. I would love to see this fund show up on there, but I don’t expect Vanguard funds to show up on the Schwab list at any point. For investors that have access to free trading on Vanguard ETFs, look into using the Vanguard Long-Term Bond ETF (NYSEARCA: BLV ). This ETF comes with everything I want (except free trading) and nothing I don’t want. Let’s go through the fund. Expense Ratio The expense ratio is only .10%. That is beautiful. Just try to find a way to complain about a long term bond fund with over 2000 different holdings and an expense ratio of .10%. This is ideal. Characteristics The fund is offering a fairly respectable yield to maturity of 4.2%. In the last decade investors may have scoffed at the idea of 4.2%, but in the new normal this is great. Some investors may expect yields to increase, but I doubt the Federal Reserve can pull that rabbit out of the hat when other countries have lower rates. An increase in domestic rates would result in a surge of cash inflows to the U.S. as foreign investors would seek dollars to buy up the higher yielding treasury securities. The resulting appreciation of the dollar would slam domestic employment and contradict one of the two dual mandates of the Federal Reserve. Until we see some major changes in the world economy, 4.2% is a fairly reasonable yield. Types of Bonds The Vanguard Long-Term Bond ETF is structured precisely how I would want it to be structured. The holdings include some foreign exposure without a very large allocation and a mix between industrial bonds and treasury bonds. Despite a strong allocation to treasury securities, there are no Agency MBS or Commercial MBS. Investors wanting access to those securities can acquire them on leveraged basis at a substantial discount to book value by buying mREITs. I see no reason to pay book value, but I would like a long term bond ETF with a heavy emphasis on high quality debts. Credit Quality The holdings are all solid. This is investment grade debt with a significant portion being treasury debt. This is a very solid ETF to have in your portfolio if the market starts tanking. I put together a demonstration of the role BLV plays in a sample portfolio. Building the Portfolio The sample portfolio I ran for this assessment is one that came out feeling a bit awkward. I’ve had some requests to include biotechnology ETFs and I decided it would be wise to also include a the related field of health care for a comparison. Since I wanted to create quite a bit of diversification, I put in 9 ETFs plus the S&P 500. The resulting portfolio is one that I think turned out to be too risky for most investors and certainly too risky for older investors. Despite that weakness, I opted to go with highlighting these ETFs in this manner because I think it is useful to show investors what it looks like when the allocations result in a suboptimal allocation. The weightings for each ETF in the portfolio are a simple 10% which results in 20% of the portfolio going to the combined Health Care and Biotechnology sectors. Outside of that we have one spot each for REITs, high yield bonds, TIPS, emerging market consumer staples, domestic consumer staples, foreign large capitalization firms, and long term bonds. The first thing I want to point out about these allocations are that for any older investor, running only 30% in bonds with 10% of that being high yield bonds is putting yourself in a fairly dangerous position. I will be highlighting the individual ETFs, but I would not endorse this portfolio as a whole. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. Because a substantial portion of the yield from this portfolio comes from REITs and interest, I would favor this portfolio as a tax exempt strategy even if the investor was frequently rebalancing by adding new capital. The portfolio allocations can be seen below along with the dividend yields from each investment. Name Ticker Portfolio Weight Yield SPDR S&P 500 Trust ETF SPY 10.00% 2.11% Health Care Select Sect SPDR ETF XLV 10.00% 1.40% SPDR Biotech ETF XBI 10.00% 1.54% iShares U.S. Real Estate ETF IYR 10.00% 3.83% PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB 10.00% 4.51% FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT 10.00% 0.16% EGShares Emerging Markets Consumer ETF ECON 10.00% 1.34% Fidelity MSCI Consumer Staples Index ETF FSTA 10.00% 2.99% iShares MSCI EAFE ETF EFA 10.00% 2.89% Vanguard Long-Term Bond ETF BLV 10.00% 4.02% Portfolio 100.00% 2.48% The next chart shows the annualized volatility and beta of the portfolio since October of 2013. (click to enlarge) Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. You can see immediately since this is a simple “equal weight” portfolio that XBI is by far the most risky ETF from the perspective of what it does to the portfolio’s volatility. You can also see that BLV has a negative total risk impact on the portfolio. When you see negative risk contributions in this kind of assessment it generally means that there will be significantly negative correlations with other asset classes in the portfolio. The position in TDTT is also unique for having a risk contribution of almost nothing. Unfortunately, it also provides a weak yield and weak return with little opportunity for that to change unless yields on TIPS improve substantially. If that happened, it would create a significant loss before the position would start generating meaningful levels of income. A quick rundown of the portfolio I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Health Care Select Sect SPDR ETF XLV Hedge Risk of Higher Costs SPDR Biotech ETF XBI Increase Expected Return iShares U.S. Real Estate ETF IYR Diversify Domestic Risk PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB Strong Yields on Bond Investments FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT Very Low Volatility EGShares Emerging Markets Consumer ETF ECON Enhance Foreign Exposure Fidelity MSCI Consumer Staples Index ETF FSTA Reduce Portfolio Risk iShares MSCI EAFE ETF EFA Enhance Foreign Exposure Vanguard Long-Term Bond ETF BLV Negative Correlation, Strong Yield Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion BLV offers a clear negative correlation with each asset except for short term TIPS (no surprise, high credit quality) and equity REITs. The equity REITs in IYR have a slight positive correlation with BLV which is caused at least in part by the fact that BLV is holding some high credit quality non-Agency debt. Since a substantial portion of the debt is still corporate in origin, it has a higher correlation with equity REITs than it would if it were pure treasuries. Despite that, the ETF still has a very clear negative correlation with other equity assets classes. Normally that kind of negative correlation requires midterm or longer treasury securities, but most of those funds have very limited yields. That isn’t any surprise either since the demand for extremely high quality debt (treasury securities) has pushed the yields to extremely low levels. By incorporating investment grade corporate debt the total portfolio for BLV is able to offer a respectable return so that the fund offers investors a material amount of income along with a negative correlation that results in total portfolio risk being materially reduced. This is what a bond fund should look like. Vanguard is known for high quality and low cost funds, but this fund is downright exceptional.