Disney Portfolio: Halftime Report

About: The Walt Disney Company (DIS), Includes: AWI, FDRXX, FICO, LAD, MSCI, OSIS, SPLK, SPY, XRAY
by: David Pinsen

In June, I presented a bulletproof, or hedged, portfolio around a position in Disney.

This portfolio was designed to last six months. Here, I show how it has performed at its halfway point.

So far, this portfolio is up 2.01%, with Disney currently its third-best performing name.

A scene from Disney's Tokyo resort (photo via Disney).

A Hedged Portfolio Around A Disney Position

In August of 2018, I wrote about the performance of a bulletproof, or hedged, portfolio built around a position in AT&T (T) in 2017 and presented a new one, which completed in February (each portfolio lasts for six months). Following that, I began presenting hedged portfolios built around other stocks, including Disney (DIS) in June. Let's see how our DIS portfolio is doing three months in, given the performance of the stock and the market, in general, since then. First, a reminder of how the portfolio was constructed and what it consisted of.

Constructing The June Disney Hedged Portfolio

We used the Hedged Portfolio Method to build a concentrated portfolio around DIS in June, starting with these premises:

  • You had $1,000,000 to invest.
  • You were unwilling to risk a drawdown of more than 20% during the next six months, so you wanted to be hedged against any decline greater than that.
  • You wanted to invest in a handful of names, including DIS, with a goal of maximizing your expected total return net of hedging costs.

These were the steps involved for those who wanted to do this manually (your returns would obviously have varied based on which approach you used).

Step 1: Estimate Potential Returns

The goal of this step was to find names that had the potential to generate high total returns to include alongside DIS. My site calculates its own potential returns by analyzing adjusted price history (which takes into account dividends) and options market sentiment, but you could have derived yours from Wall Street price targets or the price targets given by Seeking Alpha contributors you follow. Your initial universe could have been as big as Portfolio Armor's (the ~4,500 stocks and exchange-traded products with options traded on them in the U.S.) or something smaller, such as the Dow 30.

Step 2: Calculate Hedging Costs

Since you were going to hedge, gross potential returns were less important to you than potential returns net of hedging costs. To figure those out, you needed to figure out the optimal, or least expensive, way to hedge each name. We wrote about how to find optimal hedges here. For this example, you would have been looking for the cost of hedging against declines of 20% or greater. The lower the decline you were looking to hedge against, the narrower the list of names you would have been able to use.

Step 3: Rank Names By Net Potential Return

For each of the names in your initial universe that had a positive potential return, you would have subtracted the hedging cost you calculated in Step 2 to get a net potential return.

Step 4: Buy And Hedge

Here, you would simply have bought and hedged a handful of names that had the highest potential returns net of hedging costs. The automated approach shown below included a fine-tuning step to minimize your cash and another fine-tuning step to decide whether to hedge with puts or collars, but those four steps were the basics.

The June Disney Hedged Portfolio

Using the process outlined above, this was what our automated hedged portfolio construction tool presented us with:

Screen capture via Portfolio Armor

In addition to DIS, the site selected Armstrong World Industries (AWI), Fair Isaac (FICO), Lithia Motors (LAD), MSCI (MSCI), OSI Systems (OSIS), and Dentsply Sirona (XRAY) as primary securities, based on their net potential returns when hedged against >20% declines. The site attempted to allocate roughly equal dollar amounts to each of those names but rounded down the dollar amounts to make sure it had round lots of each stock.

In its fine-tuning step, it selected Splunk (SPLK) to absorb cash left over from the process of rounding down the primary securities. SPLK is hedged with an optimal, or least expensive, collar with a cap set at the current seven-day (annual) yield of the Fidelity Government Cash Reserves money market fund (FDRXX). The hedging cost of this is negative: The idea here is to get a shot at a higher return than cash while lowering the overall hedging cost of the portfolio and limiting your downside risk in accordance with your risk tolerance (to a drawdown of no more than 20%).

Performance Of The Underlying Securities Since

This is how the underlying securities in the hedged portfolio have performed since, unhedged:

Chart Data by YCharts

DIS has been the third best-performing name here since June 4, up 2.95% since. Assuming, for simplicity's sake, your portfolio was equally weighted and you held each position from June 4 until Wednesday's close, you'd be up 3.36% so far.

Performance Of The Hedged Portfolio Since

Here's how the hedged portfolio has performed so far:

The hedged portfolio was up 2.01%, while the SPDR S&P 500 Trust ETF (SPY) was up 5.3%. So, the portfolio is underperforming its constituent securities (unhedged) so far.

Why This Portfolio Is Underperforming Its Components

The main reason this hedged portfolio is underperforming its components (unhedged) is because the second-best performing security, Splunk, was hedged with a tightly capped collar, so most of those gains weren't captured.

Let's check back in a few months and see how our DIS portfolio from June finishes versus its components and versus SPY.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.