In our Growth and Value model portfolio, which I have steadfastly maintained for 20 years, I discuss every purchase or sale so those who see it can go back and re-visit what I was saying and, more importantly, doing at any given time. Transparency counts. Honesty counts.
Because we are closer to the end of this bull cycle than the beginning, I have been reshaping the portfolio this year for protection even if that means we make a little less – but protect what we have made!
Here were my comments to subscribers after the market closed yesterday…
MY POSITIONING 10 OCTOBER WITH THE DOW DOWN 831
I will take a look at how the markets respond to today over the next couple days. If I conclude we need to continue or shift to value we'll do so. But as I said in a letter to clients today, even the one-day 22% decline of October 19,1987 didn't change the market direction. (And that was 22% in one day, nearly 7 *times* as big as today's decline.) That's right, in 1987 the market finished the year up.
No one knows if something similar will happen this time around. I stand by my oft-stated conviction that October will continue to be volatile, mostly because of the stakes of the upcoming mid-term elections -- now just three weeks away.
IF the House and Senate remain committed to the pro-business and reduced regulatory burden policies of the current administration I imagine today's market action will be seen as just a scary, and not long remembered, day. If the balance of power shifts... we'll have to cross a different bridge.
Here is how we are positioned no matter what. 40% of the Growth & Value Portfolio is long and in ETFs and equities, mostly US (35%) but some international (5% -- currently not only all Developed Markets – no emerging at this point – but all in Canada.)
My biggest international position is Franco-Nevada (FNV), in my opinion the best “royalty” firm in the world. They are in essence a bank – they lend money to precious and base metal miners and oil drillers. Unlike banks that take their “payback” as interest on the loans FNV, as well as Wheaton Precious Metals (WPM), Royal Gold (RGLD) and others, takes it as a percentage of the resources discovered. It is a brilliant business model that has been highly successful. When the S&P 500 was down 3.29% on Oct 10th, FNV was up 0.54%.
My biggest 5 positions in US equities at the beginning of the month were the Invesco S&P 500 Equal Weight Technology ETF (RYT) which was hammered on Oct 10th – except it didn’t hammer us. I had a tight 4% trailing stop on the shares. We are now out of this position well before the total decline. [All these actions as well as those which follow are fully disclosed at our subscriber site here. Since we offer a free trial you are welcome to see them for yourself with no obligation to join.]
Our #2 position in the model, the Communication Services Select Sector SPDR Fund (XLC) and # 4, the WisdomTree US MultiFactor ETF, were also hit hard. However, both had tight trailing stops as well! And our #3 largest position, the ProShares Short High Yield ETF, and #5 largest, the ProShares UltraShort Lehman 7-10 Year Treasury ETF, held like a rock. (These are inverse ETFs, an ETF that benefits when rates rise and the underlying Treasuries or bonds go down.)
I am not citing these actual transactions to suggest what someone should have done, nor to trumpet my good fortune in constructing this portfolio. I am inviting you to see it for yourself, to consider its merits, and to respond via comments if you see flaws in the methodology (the most obvious being that I could be whipsawed more than once if the trailing stops are too tight, of course!)
That methodology can be expressed rather simply: build a relatively non-volatile foundation and then place stops on those more volatile common stocks that form the top of this investing pyramid.
How can I consider an equal-weight tech ETF and an ETF that bets on rising rates to be non-volatile? I don’t! All I have mentioned thus far are the straight equities and ETFs in the portfolio. The 60% that defines the base consists of Cash (currently 17%), Foundation Income (another 17%) and Smart Beta and Alternatives funds (currently 24%).
The Foundation Income comes from funds like Semper MBS Total Return Fund (SEMPX) and PIMCO Mortgage Opportunities and Bond Fund (PMZAX). Funds like these have virtually a nil Beta to the stock market. Indeed, on Oct 10th, neither of them dropped a penny – and their lovely dividends just keep accruing no matter what the market does, contributing cash to our portfolio with each monthly pay.
I won’t dwell on the type of funds I have placed in our Smart Beta asset category because you have only to review the article I wrote about AlphaCentric Income Fund (IOFIX) here for a complete understanding of the type of fund I place in this part of the portfolio. (It won’t be hard to find – of the hundreds of contributors and thousands of articles on SA every month, I seem to be the only one who has ever written about this amazing fund.)
If you decide to visit my Investor’s Edge ® site on the SA Marketplace, even for just a quick look, I suggest you read my August 16 subscribers-only article on Holbrook Income (HOBEX), another prominent smart alpha play – in this case using TIPs and other ways to profit from rising rates.
I know this is not the typical SA article, which I myself have written on most occasions. (Buy ABC for the following reasons; sell XYZ for these reasons; etc.) Indeed, this article may never see the light of day, depending on whether the SA editorial guidelines call only for “take this action” articles.
However, I think this is an important enough discussion that I am willing to divulge these names and, if you visit the Investor’s Edge ® site, the whole tamale. My portfolio isn’t perfect nor will it ever be, but it will give you a point of departure for your own portfolio strategy.
What I am trying to do here is suggest that you create a gestalt – you look at the whole of a portfolio. It can be one you take the time to create or it can be one I or someone else has established. Either way, the idea is to accept that markets go up and down, plan for volatility by creating a mix of asset classes and different categories of investments, and be willing to part with your choices if The Market decides to unwind them for you.
I wish you good investing in this most “interesting” of times…
Disclosure: I am/we are long FNV, PST, IOFIX, HOBEX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.