The Hedgehog Fund

|
Includes: CHHYY, CLPBF, CNI, ECL, GPTGF, HASI, HCP, HOCPY, IARSF, KYO, NVS, PSPSF, SAP, SMSMY, STKL, SWGNF
by: T-Rail Investor

Summary

My Sustainable Portfolio looks like it could qualify as a true Hedgehog Fund.

When approached by a bull it continues to move in small steps on short legs (as vegetarians bulls do not pose any threat to a hedgehog).

When approached by a bear, though, it becomes a spiky ball. As such it gains momentum when pushed by the bear’s nose.

2014 YTD the Hedgehog Fund is up 18.6%.

In the April-update on my Sustainable Portfolio, I suspected that the tides may have changed this year and that simple investing in the overall stock market may not be the answer for those who seek above average returns. This is still my impression. Looking back at how my portfolio performed during the 2013 stock market bull run as it returned 2.7% and comparing this to the more impressive 2014 YTD returns of 18.6%, it came to my mind that I may be running a self-directed Hedgehog Fund.

Recap

Let us recap how my model Sustainable Portfolio/Hedgehog Fund does look like:

 

Target weight

lower thresh.

upper thresh.

Target weight

 

European large cap

13%

8%

18%

3.25%

3.25%

3.25%

3.25%

Novartis (NYSE:NVS)

SAP (NYSE:SAP)

The Swatch Group (OTCPK:SWGNF)

Coloplast (OTC:CLPBF)

European small cap

13%

8%

18%

3.25%

3.25%

3.25%

3.25%

Chr. Hansen (OTC:CHHYY)

Schaltbau Holding

Energiekontor

IAR Systems (OTC:IARSF)

International

15%

9%

21%

2.50%

2.50%

2.50%

2.50%

2.50%

2.50%

Canadian National Railw. (NYSE:CNI)

Ecolab (NYSE:ECL)

Sunopta (NASDAQ:STKL)

Hoya (OTCPK:HOCPY)

Kyocera (NYSE:KYO)

Sims Metal Managemt. (OTCQB:SMSMY)

REITs

8%

5%

11%

2.00%

2.00%

2.00%

2.00%

HCP (NYSE:HCP)

Hannon Armstrong (NYSE:HASI)

PSP Swiss Property (OTCPK:PSPSF)

GPT Group (OTC:GPTGF)

European long-term gov't bonds

17%

10%

24%

5.67%

5.67%

5.67%

Germany 12-42

Denmark 09-39

Finland 12-42

Gold

17%

10%

24%

   

Cash

17%

10%

24%

   
Click to enlarge

In order to earn my (virtual) carried interest as a Hedgehog Fund manager, there are two benchmarks that I have to beat at minimum: The post-tax returns must exceed German inflation and my portfolio must outperform a low-risk Permanent Portfolio, with the latter comprising the same constituents as the Hedgehog Fund with the exception of the stock allocation which consists of the S&P 500 EUR Hedged Index. Despite the mediocre returns in 2013, my portfolio delivered on both targets as the German CPI was as low as 1.4% and the Permanent Portfolio was even down by -2.8%. Beyond the two minimum goals, I follow a "do your best and accept the outcome" kind of approach, but I also track the general stock market, not least as comparator for my stock allocation.

2013 in the rear-view mirror

Let us break down the Hedgehog Fund's performance in 2013 by looking at its constituents' total returns multiplied by their respective weightings in the portfolio (all on a EUR basis):

Click to enlarge

At the risk of pointing out the obvious: The above given percentage points add up to the 2.7% mentioned above. What we can see immediately is that the 2013 performance would have been some 5 percentage points better without the gold allocation, i.e. at approx. 7.7%. In other words the hedgehog paid a hefty price for its hedge in 2013, but still moved forward on short legs.

2014 YTD

Now here is the equivalent graph for 2014 YTD (per 29th of August):

Click to enlarge

The comparison can give us some clues about where the markets are today: First of all, we can see on the right-hand side that gold and government bonds (even REITs) have made quite a comeback and are now contributing significantly to the overall performance. This is how the Hedgehog Fund can still generate attractive returns should stocks underperform: The spiky ball moves on when pushed by the bear's nose.

Secondly, it is notable that there are hardly any portfolio constituents in negative territory so far. While there is a lot of talk about deflationary pressures in Europe, this does not quite apply to the asset classes that I track. This, of course, is further evidence of how my EUR-denominated fund is linked to the value of the EUR. When the EUR is losing value, like now, it is great to own these assets but pricey to buy them. Last year the EUR appreciated and it was the other way round.

Stock market lagging behind

Talking about changing tides, we can also see how the stock market is taking a breather after its run in 2013. My two stock benchmarks, the S&P 500 EUR Hedged and the S&P Europe 350, are not only lagging behind my portfolio in the aggregate now, but also behind every single part of it with the exception of cash:

At the same time, I am not particularly worried with regard to my own stock allocation. In general terms, I will be buying more stocks when they are getting cheaper as rebalancing is part of the plan anyway. Also, the particular stocks in my portfolio had performed well by the time of my April-update and they have been doing even better by now. Energiekontor and IAR Systems have remained on the top of the gainers-list with total returns of now 117% and 64% YTD respectively. At the other end of the spectrum the losers' dragging has eased with SAP (-3.4%) and Swatch (-1.3%) now at the bottom of the list. Previous problem child Sims Metal Management is about to turn the corner (now 21% up) and has even resumed dividends.

Real-life issues

Moving away from the model portfolio that is assumed to be rebalanced annually to the targeted percentages, my real-life portfolio is not quite as neat and ideal. Whilst consisting of all the bits and pieces presented above, the proportions are slightly different. In order to make the Hedgehog Fund more manageable, I have defined lower and upper thresholds for each asset class below/above which I intend to rebalance. The thresholds are shown in the table at the top. All my real-life allocations are within the given corridors with the exception of cash which has a higher share in the total. This is somewhat ironic as I have just identified cash as this year's laggard. The issue here is that first and foremost I would have to add to my bonds, but I am very reluctant to make this move. The reason is fairly obvious: At current prices the given bonds will yield 1.7 to 1.8% pa. until they mature 25 to 32 years from now. By comparison, I can get 1.2% interest on a savings account at a bank and still have instant access if necessary. In this situation, I struggle to see any further upside or benefit to long-term bonds (with the exception of those that I bought at lower prices). The positive is that I have some dry powder to take advantage of opportunities as they arise.

Disclosure: The author is long NVS, SAP, SWGNF, CLPBF, CHHYY, IARSF, CNI, ECL, STKL, KYO, HOCPF, SMUPF, HCP, HASI, GPTGF, PSPSF.

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.

Additional disclosure: I am long Energiekontor and Schaltbau Holding as well (no U.S. listings).

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.