Q3's Portfolio Moves: Changes Adding Income, Culling A Loser, Adding A Hedge

by: Old Trader

Because I get a steady stream of inquiries about my portfolio, I decided to publish my holdings and performance on a quarterly basis from the start of this year. As I note in my profile, I run an absolute return portfolio, with the main criteria in order of importance being:

  • generate high yield/income,
  • preserve capital, and
  • increase capital.

Raging bull markets tend to not treat absolute return portfolios kindly, given the fact there's always a portion of the portfolio either in hedges, and/or positioned defensively. I believe that this tack is the most appropriate for a retirement portfolio.

Although I tend to run a fairly concentrated portfolio, I did add two new positions with the intent of generating more income / yield from the portfolio, one position as a hedge and eliminated one holding, bringing the total number of holdings up to 17 positions.

The position that was eliminated was the 8+% in Silvercorp Metals (SVM). Needless to say, this one will remain in my mind for more than a short time! While I'm still of the opinion that exposure to precious metals is advised via either ETFs/CEFs or miners, there's no doubt that my failure to exercise proper loss control in the case of SVM definitely hurt Q3 performance. I am aware of the controversy regarding the use of stop loss orders, and I tend to be somewhat agnostic on the subject. While I tend to use "mental" stops on core holdings, I'll place actual orders-- typically GTC trailing stops-- for positions that are intended as short term trades. The position in SVM had been slated as a core holding rather than a quick trade, so I chose to not place a stop order.

While it can be difficult to uncover alleged or potential fraud, the use of a trailing stop would have minimized the damage, and allowed the time to assess the situation-- to either reenter the position, or move on more or less intact. There have been past instances where I was stopped out of a position as a result of a "panic", but got back in after reassuring myself that the fundamentals were unchanged. The minor costs incurred, in terms of commissions, etc., are neglible to my way of thinking.

The first addition to the portfolio is Brookfield Infrastructure Partners (NYSE:BIP), which I wrote about here. As I note in that article, BIP is a MLP holding utility and infrastructure asset. I'm reasonably confident that the GP, Brookfield Asset Management (NYSE:BAM) will be successful in achieving its stated goal of raising distributions by 3-7%/ year in a sustainable fashion.

The second addition related to increased income generation is Western Asset High Income Fund II (NYSE:HIX). As its name implies, this CEF is focused on high yield debt. Currently, 80% of the portfolio is in U.S. corporate debt, although the fund's mandate does allow for exposure to emerging markets debt, as well.

Of greater importance to the income seeking investor is the fact that this fund eschews return of capital as a way of maintaining a steady dividend (which is paid monthly). According to Morningstar, all distributions for the last 7 years have been paid from income, and since the fund's inception in 1998, the fund only returned capital in 2 years, 2002 and 2003.

Finally, the last addition to the portfolio involved entering a position in SDS, my choice for hedging. I'm apprehensive about the possibility of a fairly notable pullback in the market, given conditions in the EU, combined with China's tightening to put a damper on inflation. Granted, news here in the U.S. has been somewhat of mixed bag. Some companies have beaten estimates handily, but others have disappointed-- either on revenues, on earnings, or both. If the EU slips into a recession-- as seems entirely likely, that can't help but have a negative effect on the prospect of U.S. multinationals.

It should be noted that the SDS position provides only a partial hedge. (Perfect hedges only exist in Japanese gardens, as the saying goes). It's sufficiently large to help mitigate the effects of a sharp sell-off, but not large enough to wreak havoc with returns, should my somewhat pessimistic outlook turn out to have been in error.

As of Sept. 30, 2011, holdings and weights were as follows, in descending order of weighting.

GIM (Templeton Global Income) 21.40%

MMP (Magellan Midstream Partners) 8.57%

TOO (Teekay Offshore Partners) 7.93%

JNJ (Johnson & Johnson) 7.36%

MO (Altria) 6.98%

SDS (ProShares UltraShort S&P 500 5.95%

KMR (Kinder Morgan Management) 5.87%

PVX (Provident Energy Ltd.) 5.78%

STO (Statoil) 5.76%

GG (Goldcorp Inc.) 5.45%

HIX (Western High Income) 4.69%

TEI (Templeton Emerg. Mkt. Inc.) 4.16%

BIP (Brookfield Inf. Partners) 3.63%

FTE (France Telecom) 2.40%

OTCPK:ESOCF (Enel SpA) 1.33%

O (Realty Income Corp.) 1.18%

Cash 0.30%

As of the end of Q3, the portfolio is down by 9.29% on a YTD basis, as opposed to the S&P's loss of 14.33%.

Disclosure: I am long all securities listed in the article.