Kevin's 'Triple Threat' Portfolio: FY 2018 Review

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Includes: ACC, AMC, AMD, APLE, ARI, CBL, CIO, DEA, ENB, FLCH, GE, GIS, HUYA, IJR, LADR, M, MO, MRVL, OHI, QQQ, RIG, ROKU, SIRI, SYMC, TWTR, VCLT, VEA, VER, VOO, VWO
by: Kevin Cavanagh
Summary

My real money portfolio looks dramatically different than it did a few months ago as I begin to execute the next stages of my portfolio building process.

I’ve established a base of index funds with a 30+ year time horizon.

I’ve also started selling put and call options. To close out 2018, I sold 25 options that expired, resulting in premium gains of $1,166.00. Five puts were exercised.

I’ve sold out of my first two stock positions and take a look back at the investments.

A New Way Forward

In my portfolio introduction in May 2018, I introduced the first phase of my portfolio building plan which started in February 2017. This “base” included high yield REITs which supplied me with around $5,000 in cash dividends per year. I contributed $65,000 to this phase, picking some high-risk, small-cap names (e.g., City Office REIT (CIO), Easterly Government Properties (DEA)), some high-risk, speculative names (e.g., CBL & Associates Properties (CBL), VEREIT (VER), Ladder Capital Corp. (LADR)), and generally at least what I considered best-in-breed names (e.g., Omega Healthcare Investors (OHI), STAG Industrial (STAG), Apple Hospitality REIT (APLE), American Campus Communities (ACC)).

With this $65,000 base down, I looked for ways to expand and grow my portfolio outside of the REIT sector. I began to wrestle with a question that I imagine most investors face at some point: how many individual securities can I realistically hold at any given time and still maintain the level of due diligence that I feel is needed?

One of my stated hopes from the portfolio is that one day it generates $150,000 in annualized dividends. I started doing simple math, and assuming a weighted dividend yield of 5% (which is being generous), that would mean $3,000,000 worth of stock. My average cost basis is $5,000 which would mean managing a portfolio of 600 stocks. That does not sound fun or practical.

This realization ultimately led me to question how to manage this portfolio not just in the short term but in the long term as well. While I admittedly was hard on myself for not thinking of this "problem" sooner, I’ve never been one to ruminate too long when I have the self-awareness to fix the problem. Ultimately, this led me to the decision to make routine contributions into low-cost index funds. That would give me the best of both worlds: some actively managed stock picking and a passive investing section of the portfolio that will grow over time with the market.

While the thought of managing too many stocks was the reason I ended up looking into establishing a base of index funds, I still had the time and interest to grow the individual stock portion of the portfolio as well. Given my bias towards income generation, selling put options to get into stocks of interest and selling covered calls once in them felt like a natural phase for me to explore. I became extremely interested as I began to do more research, as this opened my eyes to the ability trade into higher-risk growth stocks I had previously avoided. I began to expand my research horizons and built out my watchlist. I’ll review my 4Q 2018 options action later.

The Index Fund Section

Time Horizon: 35+ years (My age: 31, My wife's age: 28)

Risk Tolerance: High

Target Portfolio

US Equities: 70-80%

International Equities: 20-25%

Bonds: 5-10%

Portfolio as of 12-31-2018

US Equities: 72.87%

International Equities: 19.86%

Bonds: 7.27%

Because this article will serve as an introduction to this section, I will break it down a little more than I will in future updates.

The Building Phase

Building the index fund section took a lot more work than I thought, as there were many more options out there than I realized. I briefly considered 100% equities, but ultimately found a bond index fund that I liked in the Vanguard Long-Term Corporate Bond Index ETF (VCLT).

VCLT: The fund holds long-term investment-grade corporate bonds at a 0.07% expense ratio and distributes a monthly dividend. I ended up selecting VCLT over a more generic bond choice like the Vanguard Total Bond Market ETF (BND) because it correlates more positively with the overall market (8-year chart shown below). Because the fund holds corporate bonds, drops in the market can impact VCLT more so than a typical bond fund. For the long term, I view VCLT as a nice 4.5% monthly player that can make up 5-10% of this portion of the portfolio. I expect to buy 2 shares of the fund a month going forward.

(Source: StockCharts.com)

US Equities: I ended up selecting the the Vanguard S&P 500 ETF (VOO), Invesco QQQ ETF (QQQ), and the iShares Core S&P Small-Cap ETF (IJR) as the funds to make up this portion.

VOO: Needs no introduction. For the novice in me, I still researched if there was a "correct" S&P 500 fund to get into. Aside from picking VOO/IVV over SPY, it seems everything else is equal. I ended up going with Vanguard’s VOO as I picked other Vanguard funds.

QQQ: Having a heavy technology exposure is something I want for the next 35 years. Apple (AAPL), Microsoft (MSFT), and Amazon (AMZN) make up roughly 32% of the QQQ, while they only make up 10% of VOO. QQQ ultimately beat out the Direxion NASDAQ-100 Equal Weighted Index Shares ETF (QQQE) and the First Trust Nasdaq-100 Ex-Tech Sector Index ETF (QQXT), as it was market cap-weighted rather than equal cap-weighted. The 10-year annualized return for all was also a consideration. For those wondering, 19.20% for QQQ, 17.65% for QQQE, and 15.70% for QQXT. All percentages are based on 12/28/2018 closing.

IJR: This fund tracks a market cap-weighted index of small-cap US stocks. The 600 stocks that make up the fund represent about 3% of the available market. I picked IJR over the SPDR S&P 600 Small Cap ETF (SLY) and the Vanguard S&P Small-Cap 600 ETF (VIOO) because it was the same exact thing with a lower expense ratio. The real decision seemed to be IJR versus IWM. IJR tracks stocks that are ranked 901-1500 in market cap, while IWM tracks stocks that are ranked 1001-3000 (also known as Russell 2000). The thought process here was simply that IJR had more established companies in the pool, and I wasn’t sure if the additional companies inside of IWM was worth the extra risk. I did some research and found that IJR has outperformed IWM at the 3-year (8.22% to 6.28%), 5-year (5.95% to 4.16%), and 10-year (13.89% to 12.35%) benchmarks. All percentages are based on 12/28/2018 closing.

(Source: StockCharts.com)

International Equities: I ended up selecting the Vanguard FTSE Developed Markets ETF (VEA), the Vanguard FTSE Emerging Markets ETF (VWO), and the Franklin FTSE China ETF (FLCH) as the funds to make up this portion.

VEA and VWO seemed likely pretty standard options to gain exposure to developed and emerging markets, respectively. As seemed to always be the case, there were 3-4 others that did the exact same thing but charged more and had worse performance. EFA (Blackrock’s Developed Markets Fund) had a 0.32% expense ratio compared to 0.07% for Vanguard, while also underperforming the 10-year benchmark, 6.20% - 6.41%. All percentages are based on 12/28/2018 closing.

I did find myself wondering if international exposure was really needed and/or beneficial. Take a look at the last eight years of VOO, QQQ, IJR, VEA, and VWO:

(Source: StockCharts.com)

I did some further research beyond this chart and found out that from 2005 to 2008’s peak, VWO went up 125%, compared to SPY’s 25% return in the same time period. So, there have been times when international markets have greatly outperformed. I also found enhanced yield in VEA (3.37%) and VWO (2.90%) compared to VOO (2.08%), QQQ (0.92%), and IJR (1.59%). I would love to have a discussion in the comments about how others deal (or don’t) with international exposure, as it was something I went back and forth on.

Finally, FLCH. I wanted long-term exposure to the Chinese market that has fallen 30% this year. I am extremely bullish on Tencent (OTCPK:TCEHY) and Alibaba (BABA), and considered buying individual positions in October. Rather than go in that direction, FLCH stood out as a new (less than 1-year-old) ETF with an extremely low expense ratio (0.19%) to give me exposure to both stocks and the Chinese market in general. Tencent and Alibaba make up roughly 27% of FLCH. 38% of the fund is in technology and 30% is in financials. I will have to be more mindful of this ETF, since it is so new. The volume in FLCH is light, which leads to awkward buying at times.

Accumulating Positions

Thanks to Robinhood, I’ve been able to buy into these ETFs slowly rather than jump in all at once. This allowed me to cost-average in during the slumps in October, November, and December. Here is where the index fund portfolio stands as of now:

(Source: Author’s Chart)

The Individual Stock Selection

Time Horizon: For REITs, 5+ years. For non-REIT stocks, less than 5 years. While both are subject to changing fundamentals and performance, this is the general expectation.

My goal when starting this section was simply adding REITs that paid a high dividend (which I took in cash) which I thought were sustainable for the long term. When I first started, I didn’t consider the company’s track record in growing the dividend nearly as much I should have. If I do end up rebalancing the REIT portion, I will look for dividend stability and growth.

In Q4, I started selling puts and calls on non-REIT stocks to branch away from being so focused on one sector. While I’ve enjoyed selling puts and covered calls, it does mean that my time horizon for some of the stocks could be shorter, which has made me think harder about exit prices. Thus, in general, I would stamp the REIT “base” as a stable, long-term commitment, while my other positions you will see below could end up being short-term or long-term depending on my entry/exit strategies.

This is also why I’ve stamped the portfolio as the “triple threat” (e.g., index funds, REIT base, and put/call options). Everyone needs a cool portfolio name.

Portfolio Buy/Sell Action Since Last Update (08/17/2018)

(Source: Author’s Chart)

Apollo Commercial Real Estate Finance (ARI) Scorecard

Bought 285 ARI at $17.54 on 02/07/2017

Sold 285 ARI at $18.50 on 10/25/2018

Brokerage Fees: $13.95

Realized Gain/Loss: +$259.65 (+5.18%)

Cash Dividends Collected: +$786.60

Total Gain/Loss: +$1046.25 (+20.87% // 11.80% annualized)

Transocean (RIG) Scorecard

Entry: $0.10 Put Option ($7) on 12/21/2018

Exit: $0.08 Covered Call Option ($7) on 12/28/2018

Brokerage Fees: $0

Realized Gain/Loss: $18 (+2.57% // 134% Annualized - distorted, 7-day trade)

Selling out of ARI came down to the fact that I also own LADR, so I was awkwardly hanging on to too much commercial real estate exposure. Yes, I realize the irony of saying that given the entire portfolio (was) REITs. LADR and other ARI competitors (Blackstone Mortgage Trust (BXMT)) are also delivering exciting quarter after exciting quarter, raising the dividend, and giving away special dividends. I was growing increasingly concerned that ARI may soon cut the dividend, as management said in June 2018 they were “going to look at it closely” in the months ahead. All this in a year they have record loan originations. I am also very bearish on New York real estate (where ARI is predominantly located) over the next three years.

Overall, I took in a 20.87% gain (including the dividends) in a little under 2 years. While I never considered tracking my stock performance against the S&P 500 when I started in 2017, it’s something that I understand a little more about now. Using my trusty S&P 500 calculator, from February 2017 through October 2018, the S&P 500 with reinvested dividends was up 24.53%. So, while a gain in ARI, a slight underperformance there.

RIG was a short-term trade, as I continued to explore options trading (more on that shortly).

Let’s pivot and take a look at the current holdings of this portfolio and check in on them.

The Current Stock Portfolio

(Source: Author’s Chart)

Prior Divs = Dividends received prior to 2018.

I’ll provide commentary on the non-REIT additions in the next section.

December 15th was the day the bottom fell out for the majority of this portfolio. One day prior, the portfolio was a sea of green, up 2.5% and hanging on to gains for the year. REITs and utilities ended up being the last sectors to fall on December 15th, turning the spreadsheet an ugly red color on a day the entire portfolio dropped by $4,000.

Regarding specific securities, CBL continues to massively disappoint. I’ve touched on my decision to hold it in my last update so as to not spend too much time on it here. Perhaps this investment is exposing a major weakness I have - not knowing when to sell a stock deep in the red. There is a part of me that still feels the decline here is grossly overdone. It will sit here for now. I imagine a massive chunk of my $1088 dividends in CBL this year is coming back to me as a return of capital for tax purposes, and that will reduce my overall cost basis. CBL provided a small return of capital last year.

LADR continues to impress me. Management really seems to be taking all the right steps to compete in a competitive space. Twice this year, the company has raised capital by issuing new equity, lost 3-4%, and twice the stock recovered within 4-5 trading days. I continue to be bullish on LADR moving into 2019.

OHI has also continued to be a massive superstar. I’m most interested, with tenant issues seemingly resolved if the company will resume improving the dividend as it did for so long (I bought OHI the quarter before it paused the dividend hikes.)

Here is a snapshot of how all the REIT stocks have performed since my last update on August 17th:

(Source: Author’s Chart)

The Options Section

Time Horizon: In general, less than 5 years.

Initial Funding: $20,000

Targeted Allocation: Roughly 50% on 3+% dividend payers. Roughly 50% on riskier names I see growth potential in.

I have experimented with selling put and call options at various lengths ranging from one week to seven weeks. While the one-week options were helpful during a volatile 4Q and made possible by Robinhood, I think 3-4-week time horizons will be more my speed going forward just from my own time availability. Here are my put/call options guidelines I have for the portfolio, as well as some real-life examples from this past quarter:

Dividend Stocks

Entry: 3-4% lower than where it currently trades, with a 1-2% premium received (12-24% annualized).

Higher Risk, Growth Stocks

Entry: 7-10% lower than where it currently trades, with a 1-2% premium received (12-24% annualized).

To be clear, I’m not just throwing a dart at stocks and trying to get in at a low price. After doing some due diligence on General Mills (GIS), I picked $40 as an entry price because that represented a 4.9% dividend yield and a stock that traded at 12x forward earnings.

Here are some example trades to showcase the guidelines set above:

11/26/2018, GIS was trading at $42.38. I sold a $40 put for $0.50 expiring on 12/21/2018.

5.61% downside protection for 1.25% return (18.26% annualized)

12/11/2018, ROKU was trading at $37.19. I sold a $34 put for $0.34 expiring on 12/14/2018.

8.57% downside protection for 1.00% return (annualized figure distorted - only 4 days)

My options trades since October have included a variety of names in a variety of industries.

Among the 3%+ dividend players: Altria (MO), GIS, AMC Entertainment Holdings (AMC), Macy's (M), and Enbridge (ENB).

Among the “riskier” names: Sirius XM Holdings (SIRI), Symantec (SYMC), General Electric (GE), Roku (ROKU), Twitter (TWTR), Huya Broadcasting (HUYA), Advanced Micro Devices (AMD), Marvell Technology Group (MRVL), and RIG.

SYMC and SIRI were assigned to me after the downturn in October. MO was assigned to me at $60, after it dropped like a rock from $65 to $53 on the back of some news from the FDA. GIS dropped from $44 to $37 during December. ROKU also fell to me during the December downturn. To respect everyone’s time, I’ll always talk less about the options that expired and a little more about the exercised stocks by giving a quick investment thesis and price target.

SIRI: I am bullish on the Pandora merger. I believe the stock is undervalued at my entry at $6. It has lost a Pandora’s worth of market cap since announcing the merger. My target price for the stock is $7.75. I will sell covered calls at $6.50 / $7.00 for some extra premium. I have added $70 in covered calls since owning the stock. The highest analyst estimate on the Street is $8.00.

SYMC: I am bullish on the technology security sector in general. I believe SYMC is best-in-breed in that sector. I was slightly concerned about their lack of mobile presence but was happy to learn about the acquisition of a company that does just that. I think the drop from $29 to $19 in a day on an audit investigation was crazy. My target price for the stock is $30. I will sell covered calls at $23+ for some extra premium. I have added $36 in covered calls since owning the stock.

MO: I am bullish on the company management. I wanted to add companies to the portfolio I felt were undervalued and ready for the next recession. MO ended up being one of the major names I liked for that. The stock has fallen hard on FDA news and hefty acquisition prices. While I have been selling covered calls on SIRI and SYMC, I’m less likely to do that here, as MO’s dividend growth has been great and (more importantly) it’s so far below my entry price, it’s not worth it until it recovers closer to my entry.

GIS: Recession-proof with a 5% yield at my entry price. The company's debt load seems manageable based on free cash flow. While I do think it overpaid for Blue Buffalo, I respect its efforts to grow. Based on forecasts from management, I think the dividend should resume growth in 2020. I will sell monthly covered calls on this in 2019 starting at $42.50-45.

ROKU: The riskiest of the names. Simply put, I believe it’s the future of TV. While I’m mindful that my beliefs about the future don’t necessarily justify a good stock, I think company management has really delivered every quarter since coming public. Going to $77 was way too far, too fast, and I’m happy to have gotten it where I did. I do plan to sell monthly calls in this name. Because of its high growth potential, I can get a much higher strike price for my desired 1% premium. ROKU currently trades around $31, and the January 25th $40.5 call is currently going for $0.40. I will probably look to execute that on the first trading day of 2019.

The Overall Portfolio

Three final tables to summarize everything. First, the overall performance broken down by year:

(Source: Author’s Chart)

Dividends and options premiums in 4Q propelled the portfolio to outperform the S&P 500 with dividends reinvested (-3.78% to -4.38%), although this is hardly a victory lap. I continue to learn a lot about myself and my own biases two years into investing. I’m excited for 2019.

Second, the dividend and options 2018 recap:

(Source: Author’s Chart)

Red: Stock sold.

Gray: Did not own the stock these months.

And finally, the expected dividend outlook in 2019:

(Source: Author’s Chart)

2019 Outlook

While I am “in the red” my first two years in the market, I have learned a lot. Losing 5.39% in 2017 (a year in which the S&P 500 gained 21.83%) was my own inexperience, as I got my feet wet. I believe I only owned 6 stocks in total, with $10,000 / $35,000 being given to CBL. In 2018, the portfolio lost 3.78% (with dividends and options premiums) and the S&P lost 4.38% (adjusted for dividends)

For 2019, I am carrying $8,300 in cash into the new year. I would expect another $11,000 in contributions in 2019 from my "side gigs", which will take the portfolio contributions to $100,000. The $4600 in expected dividends will remain in the account. My game plan at the moment is to build the index funds portion up to a much more substantial and meaningful portion of the portfolio.

One thing I am being mindful of is not being caught flat-footed in a hypothetical full-fledged bear market with no cash to put to work. I still think the S&P 500 ends 2019 closer to 2700 (+8% from the close of this year). 2350 is a level that values the S&P 500 at a 14.5 multiple with 0% growth in 2019. That’s a "worst-case scenario" valuation, in my eyes. I think China-US tensions will get resolved in a smaller deal than POTUS wanted but will still allow him to claim "victory". That, in and of itself, should push the market higher.

I'm still curious as to how others handle "cash" for possible bear market downturns. I could imagine some folks preparing for a bear market but then it doesn't come.

Finally, my wife and I are planning on buying our first house, and we have been stockpiling cash for a 40% down payment. So, the contributions to the account in 2019 are likely to be much less than in 2018 and 2017.

Tracking My Portfolio Progress

Here are all of my portfolio updates to date in the event anyone is interested in how the portfolio has been shaped over time. I will (in time) eventually leave the last 8 quarters here.

2018: 1Q // 2Q // 3Q and 4Q (this article)

Disclosure: I am/we are long VOO, QQQ, IJR, VEA, VWO, FLCH, VCLT, OHI, LADR, STAG, MO, ACC, CIO, ARCC, VER, IRM, APLE, DEA, GIS, ROKU, SIRI, CBL, SYMC. 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.