In March 2014, I created the REVCO Growth & Income Fund based on the 4% plan. This hypothetical investment allocation was designed as a $1 million diversified portfolio geared to investors seeking both long-term capital appreciation and perpetual income growth.
The 4% Plan Summary
Under the premise of the 4% plan, which is to achieve a permanent income stream solution of 4% of the initial portfolio value (with YOY increases), assets are allocated into four categories: equities, bonds, commodities and cash. Also, the equities are further subdivided into five categories to ensure diversification: earth resources, U.S. dividend growth, global dividend growth, real estate (eREITs) and utilities (defined in a broad sense to include telecom, cable, tower REITs, marine ports, toll roads and airports).
The initial portfolio target allocations are outlined in the chart below.
Investors looking for income may find this portfolio suitable to provide monthly distributions, while long-term savers who are not interested in distributions may be more aggressive and/or reinvest dividends to mimic this strategy. For example, high-growth, low-yielding plays could be inserted into specific categories as long as the aggregate portfolio yield remains above 4%.
2014 REVCO Growth & Income Fund: Q2 2014 Update
From March 4, 2014 (fund inception, using March 3, 2014 closing values) to June 30, 2014, the REVCO Growth & Income Fund outperformed the S&P 500 in both capital gains and total return.
The fund appreciated 6.37%, or $63.7k, while providing monthly distributions totaling $10,200. The distributions here represent a 4.08% annual yield on the initial portfolio value of $1 MM. The total return here equates to 8.3% during the approximately 4-month timeframe since inception.
Regarding the S&P 500, the index returned 6.21% (less applicable fund charges). The SPDR S&P 500 ETF (NYSEARCA:SPY) provided two quarterly distributions in this time period, which equates to a 1.91% annual yield on the SPY March 3, 2014 closing price. When adding the SPY dividend distribution levels to the return of the S&P 500, the index total return in the same approximate 4-month time period is 7.16%.
When looking at the return, the REVCO fund only outperformed the S&P 500 by 16 basis points. In total return however, the fund outperformed the benchmark index by 114 basis points (assuming no fund management fees and no return on dividend distributions).
In percentage terms versus the S&P 500, the REVCO fund marginally outperformed the benchmark. When including the dividend distributions however, the fund greatly outperformed. This dividend outperformance heavily influenced a total return outperformance 15.9% greater than the S&P 500.
The Q2 2014 Fund Card
As of the end of Q2 the fund maintained 24 holdings, with a top 10 weighting of 60.2% and average position weight of 4.09%. As noted in the holdings chart below, the top five positions are ConocoPhillips (NYSE:COP), PIMCO Dynamic Credit Income Fund (NYSE:PDI), Apple Inc. (NASDAQ:AAPL), Cohen & Steers Infrastructure Fund (NYSE:UTF) and Kayne Anderson MLP Investment Co. (NYSE:KYN).
Below is the fund card, showcasing the complete list of holdings and portfolio weight, fact sheet, asset allocation analysis and distribution analysis.
Also to note, the only trading that took place since inception was:
1) sell all of VGPMX, a Vanguard metals & mining fund, and
2) initiate a new position in Ensco PLC (NYSE:ESV), another energy-related play.
The trade information is available here.
The stock, bond, commodity and cash target exposure versus current exposure are as follows:
The current asset allocation has shifted slightly, as to be expected in a simulated portfolio. The earth resources category outperformed the portfolio, and cash levels have nearly doubled to 1.9%.
Overall no major rebalancing is required, however, earth resources are over-allocated by about $11,000, as noted in the diversification analysis below.
Investor Distribution Analysis
The current portfolio value is now $1,063,724.93. As such, the investor distribution yield had dropped from 4.08% to 3.84% as monthly payouts have remained constant at $3,400/month. A raise to $3,500 can safely be declared and will be implemented at the start of Q4 2014.
The current portfolio payout ratio, as determined by the current investor distribution rate ($3,400) divided by the average monthly dividend gain ($4,473), is 76%. In this regard, cash continues to add to the portfolio value at an average rate of $1,073/month.
In addition, the monthly dividend fund holdings aggregate monthly yield is $2,119, representing 47.8% of the total portfolio yield. This balances out the cash levels on a month-to-month basis.
Also to note, the monthly dividend holdings coverage of the investor's monthly $3 income check.
The Complete REVCO Growth & Income Q2 Fund Analysis
Below is the general REVCO Growth & Income Fund analysis that includes the following three major statistics: 1) forward yield, 2) individual and aggregate fund premiums vs. 1-year average premium analysis and 3) the individual and aggregate earnings yield for individual stock & REIT selections (FFO yield inserted in place for REITs).
Please note that as stock funds may have bond holdings, these weightings affect total stock/bond portfolio percentages. This will be discussed later in this article when asset category breakdowns take place.
As noted above, the aggregate stock fund premium is listed at -4.07% and the aggregate bond fund premium is 0.24%. To add these categories together, the aggregate fund premium is -1.98%, and when adjusting for the total portfolio value the aggregate portfolio premium is -0.92%.
As such, the portfolio NAV as of the end of Q2 2014 is $1,073,648.42 (with actual premium at -0.924277), representing $9,923.49, or about 0.93% in additional assets.
Macro Issues Affecting Portfolio Value
Two major concerns that have impacted markets in the first half of 2014 are the increased demand for U.S. debt, as seen in the 10-year Treasury yield, and the heightened risk for EM currency and asset holdings, as noted in the January 2014 EM currency and stock index returns.
As seen in the chart below, the 10-year has bounced around since February, however the trend remains intact as the yield at the end of Q2 was 2.516%, a far cry from the approximate 3% yield we started the year with.
Click to enlargeAs rates have declined, reversing the theme of "rising rates," domestic yield-sensitive securities such as bonds, MLPs and REITs have done well. As measured by the iShares Core U.S. Aggregate Bond ETF (NYSEARCA:AGG), the Vanguard U.S. REIT Index (NYSEARCA:VNQ) and the UBS Alerian MLP Infrastructure ETN (NYSEARCA:MLPI), each category has risen during this time of declining bond yields.
Discussed in the February 2, 2014 article, Currency Risk To Push U.S. And European Stocks Higher, a lower demand for EM currency and stock exposure coincided with an increase in demand for U.S. treasuries. The "currency risk" thesis followed that as a macro theme, investors should reduce risk by avoiding EM and commodity nation stocks and purchase non-Yen reserve currency nation/zone stocks. In addition to this, stocks with major EM exposure were not recommended.
In viewing the aggregate reserve currency nation stock market performance, the U.S., eurozone (NYSEARCA:VGK) and Switzerland (NYSEARCA:EWL) performed positively, while the UK (NYSEARCA:EWU) was flat (up 4.9% with dividends, however) and Japan (NYSEARCA:EWJ) was negative in the first half of 2014.
After the currency risk theme developed in February 2014 following the January 2014 downside performance that hammered many EM stocks and currency values, the reserve currency nations did even better, with all country/reserve currency zones in the black.
In both time periods, the S&P 500 outperformed the other global reserve currency countries (UK, Switzerland, Japan) and the euro reserve currency country zone as measured by Europe. With a majority of equity exposure in the REVCO Perpetual Income Fund represented by the U.S., fund performance was enhanced.
Regarding EM stocks, the S&P 500 outperformed EM equities as measured the iShares Emerging Market Index ETF (NYSEARCA:EEM) in the first half of 2014.
It can be noted that since the beginning of February 2014, the total Q1-Q2 performance of EM stocks was greater than the U.S. stock market performance. This comes with added risk, however, which is a burden that perpetual income investors are keen to avoid.
2014 Investor Outlook - Pessimism Equates To Opportunity
With fears of a market correction rampant throughout the news media, market upswings have been tempered as investors are not fully invested in stocks and put money into protection in the form of cash and options.
This lack of enthusiasm in this U.S. bull market, which is backed by QE-Infinity and stable economic growth (with the exception of Q1 2014 attributed to the adverse affects of extreme weather conditions), showcases that the market has room to advance on the upside when using the Howard Marks bull-market theory. With such pessimism present, it could be stated that the current market is between the first two states of the bull market.
As domestic equity valuations are not stretched by any means and bond funds continue to create alpha by efficiently taking advantage of the steep yield curve, the fund is encouraged to take part in both the U.S. and European reserve currency equity and bond markets, while limiting exposure to EM, Japan and commodity nation markets.
Further Reading: The 4% Plan
For ease of reference, here are the links to the 4% plan articles, as well as the initial portfolio card for the $1 million perpetual income portfolio.
$1 Million Perpetual Income Portfolio Articles:
The $1 Million Perpetual Income Portfolio (March 5, 2014)
The $1 Million Perpetual Income Portfolio: ETF Edition (March 14, 2014, sister fund with ETFs only)
The 4% Plan Articles:
The 4% Plan - A Permanent Income Stream Solution (Sept. 20. 2013)
The 4% Plan - Building Your Bond Position Now (Oct. 25, 2013)
The 4% Plan - Updating Your 2014 Equity Position (Dec 24, 2013)
The 4% Plan: Adjusting Your Sails For 2014 (Dec. 28, 2013)
The 4% Plan: March 2014 Allocation Update (Feb 28, 2014)
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.