The V20 Portfolio Week #23: The Role Of Active Management

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Includes: CALL, SPY
by: General Expert

Summary

The V20 Portfolio declined by 3.5% while the S&P 500 climbed by 1.1% over the past week.

When you spot imbalance in the portfolio, you must act. The lazy approach is not the optimal approach.

MagicJack remains undervalued, even if new initiatives fail.

The V20 portfolio is an actively managed portfolio that seeks to achieve an annualized return of 20% over the long term. If you are a long-term investor, then this portfolio may be for you. You can read more about how the portfolio works and the associated risks here. Always do your own research before making an investment. Read the last update here. Note: Current allocation and planned transactions are only available to premium subscribers.

After a volatile week, the V20 Portfolio declined by 3.5% while the S&P 500 (NYSEARCA: SPY) appreciated by 1.1%. It would appear that the recent rally in oil has injected some new life into the market.

Why You Should Be Active

I thought it might be interesting to provide some anecdotal evidence that supports active management. Over the last couple of years active management has taken a lot of flak for underperformance. What I will discuss is not proof that active management works all the time (I really don't think that is possible), but some supporting anecdotal evidence.

Let's start with this question. What would happen if I construct a "lazy" portfolio and just sit and wait? The results are telling.

The chart above compares the lazy portfolio, the actively managed V20 Portfolio, and the S&P 500 ETF. While the lazy portfolio initially outperformed the index much like the actively managed portfolio, it failed to provide much value at the end.

Surprisingly, the lazy portfolio did outperform the V20 Portfolio for a little while, that is until market volatility kicked in during the second half of 2015. Why is this the case? Why did the lazy portfolio outperform the market at the beginning but gave up the gains as time passed? The simple reason is that at the very beginning of 2015, the lazy portfolio in fact had the same allocation as the V20 Portfolio. In other words, the allocation was as optimal as the actively managed portfolio. But when the V20 Portfolio sold shares as the portfolio appreciated, the lazy portfolio didn't take any action. "Unfortunately," my timing wasn't perfect, so the rally continued for a little while, which was when the lazy portfolio outperformed the V20 Portfolio. However, as the market sentiment shifted, the lazy portfolio was not able to adapt to the changing conditions. It was not able to accumulate shares when they fell nor sell when holdings rose in value.

The important thing to note here is not that one should trade his or her holdings, but that if one is vigilant enough to spot an imbalance in the portfolio, it is critical that one takes action.

Portfolio Update

Next week, MagicJack (NASDAQ: CALL) will report earnings. After the last earnings call I stated that MagicJack was becoming more reliant on growth. The good news is that the company recently announced the execution of two initiatives whose impact will be seen in several quarters. The bad news is that many investors may see this as additional uncertainty. Is this indeed something to worry about?

The Movistar deal doesn't require much upfront cost from the company, but the SMB initiative is going to cost the company $10-12 million in 2016. The management believes that it can deliver double digit growth and achieve initial annual revenue of around $17 million. Should the SMB initiative work out, then it won't be a bad deal. As with any new product, the SMB initiative has its risks. However, even if this whole project goes down the drain, I still think that MagicJack is undervalued. As of Q3 2015, the company had $80 million in cash. Subtracting that amount from the $121 million market cap, we arrive at a valuation of $41 million for its future cash flow. Based on 2015's performance alone, the company will generate over $20 million per year. Of course, that is not to say that future performance will be similar. Sales of devices have been declining. However, I find it difficult to justify the current valuation even if the current trend of declining sales continues. Now, if we combine the aforementioned growth initiatives with the existing valuation, then it becomes clear why I believe MagicJack remains a good investment.

Performance Since Inception

Disclosure: I am/we are long ACCO, SAVE, I, CONN, DXMM, CALL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.