This article will form the basis for the recurring monthly update about the state of my portfolio. A portfolio that, as I like to believe, contains several stocks that should form the basis for all Belgian investors.
More important, as I have beaten the BEL20 (Belgian stock market index) ever since I started investing (should be said it's only three years ago), I like to share my way of portfolio selection. It involves statistics through correlations and cluster analysis and hedging through options, next to fundamental analysis.
Enjoy! You can follow me to stay updated.
The purpose of the portfolio
What I look for in my portfolio today is low variance. Several economic indicators have turned bearish, and the probability of a market downturn seems relatively high to me. However, I do not wish to step out of the market, as it could very well be possible that the market goes up for another year, maybe more. I thus seek to build a portfolio that is crash-resistant, while still having upside potential. There are several ways to accomplish this "dream".
One possible way is to buy call options on the index, for a small percentage of your portfolio, and roll them over. This way, you can only lose the premium you paid, while the upside is endless.
Another possibility is to buy low-beta stocks. Such stocks are less volatile than the index, hence suffering less following a market drop.
Furthermore, one could apply a long-short strategy. Preferably, you apply this strategy on individual industries, going long on the best stock in the industry and shorting the worst. If markets drop, you will recover your losses with that short. In the long run, if you picked right, the long stock will outperform the short one, and you'll make a profit.
But there's more. You could just buy and hold a portfolio of stocks and write calls on them. This limits your upside, while your downside is unprotected. However, if the market only drops 2-3% in a month, this drop can very well be compensated completely by the premium you received for writing the call. If you write a call at a strike price of 5% above the spot price, your potential earnings can be as much as 5%+premium in a month's time. This should be sufficient for investors who fear the end of a bull run.
So, my strategy is a combination of all of the mentioned strategies, except for buying calls, as I believe it is hard to have the discipline to sustain this strategy when it is not working out, harder than any of the other strategies I mentioned.
A portion of my portfolio consists out of stocks with low beta, supplemented by some cash. This should be at least 35% of the total portfolio. Biotech is an excellent buffer as well, as it is less (not) related to the economic cycle.
Another portion of the portfolio is stocks on which I write covered calls. I like these stocks to be more volatile, as I will receive higher premiums on such calls. At the same time, it allows me to profit from a market increase. The proportion should not be too big either, as that would expose me to a market downturn. This proportion should not exceed 30% of the portfolio.
Third, long-short strategy. This proportion should be around 15% of the portfolio, as it is a pretty risky strategy in the short term and can lead to quite some volatility. However, as I said, in a market downturn this part of the portfolio has an expected loss of 0.
Finally, some stocks with a large safety margin, preferably yielding 3/4%+. High-dividend stocks should drop less as well, while they provide me with an additional cash flow next to my options income. This should form 20% of the portfolio.
The stock portfolio
|Covestro AG O.N||42.39||50||2220||5.6%||0.68|
|CA Immobilien Anlagen||31.05||130||4036||10.1%||0.08|
|MercadoLibre Inc. - C||571.13||4||2285||5.7%||1.45|
|ING Group N.V.||9.33||200||1867||4.7%||1.35|
|Royal Dutch Shell||25.42||100||2542||6.4%||0.82|
'Price' is the current price of the stock, and also the price which I paid for the stock, as this is the first article, and we start evaluating from this point on.
The low-beta stocks are OL Groupe (OLG.PA), on which I wrote this article. A beta of 0.03 is perfect, while the company is set to make a giant profit and has a P/B of 0.55. Furthermore, the REIT 'CA Immo' (OTC:CAIAF) has a beta of only 0.08, while book value and funds from operations are growing very nicely, as discussed here. Payton Planar has a beta of 0.4, low enough. The company is well-run, has a P/E of 10, and it is my belief that it will know many more years of strong growth. Last, I have added Sofina (SFNXF), which is by far my favorite holding.
Combining these stocks with my cash buffer and Belgium's three best biotech companies make for a total proportion of 41% of low-beta assets.
The option portfolio - covered calls
I hold positions of Faurecia (OTCPK:FURCF) (OTCPK:FURCY), Aperam (OTC:APEMY) (OTC:APMSF) and Covestro (OTCPK:CVVTF)(OTCPK:COVTY) as my cyclicals, combined with Dutch bank ING (ING) and Belgian bank KBC (OTCPK:KBCSF)(OTCPK:KBCSY). These stocks have been pretty volatile and are all beaten down.
I write calls on Aperam and Faurecia. I do however not own 100 stocks of Faurecia, which could impose extra risk on my portfolio. Further down, I will explain why this risk is limited, however. Here you find the list of written calls:
|Underlying stock||Type||Amount||Maturity T||Strike||premium|
|Aperam||Call||-1||20 SEPT 19||26.00||0.17|
|Royal Dutch Shell||Call||-1||20 SEPT 19||26.00||0.14|
|Telenet||Call||-2||20 SEPT 19||44.00||0.31|
|ING||Call||-2||20 SEPT 19||9.80||0.08|
|Faurecia||Call||-1||20 SEPT 19||50.00||0.27|
I receive €149.00 worth of call premiums and have paid €7 worth of commissions to my broker (€0.85 per option contract). This nets me a net 'income' of €142.00 for this month. I have not added this amount to my cash position, as I will only do so at contract expiry.
The options do limit my upside potential, but as I have covered in this article, a covered call strategy outperforms the market in troubled and/or volatile times.
For my long-short strategy, I am short on Telenet (OTCPK:TLGHF) (OTCPK:TLGHY), as it is the worst-positioned telecom stock out of the three in Belgium, in my opinion. You can read my full analysis here on Seeking Alpha. This was the conclusion of the article:
I will keep on writing calls on Telenet until it has dipped below €40. Currently, the stock stands at €43, so we still have some runway.
Updates about the holdings
None, as this is the first article.
Statistics based on the portfolio are impossible, since we have not seen any returns yet. Next month, I will address the risk/reward ratio of the portfolio.
Regarding the holdings, I would like to give you some correlation matrices. First, for the cyclicals in my portfolio, Aperam-Covestro-Faurecia. It should be clear that these stocks are very much correlated to one another, which allows me to write a non-fully covered call on Faurecia or Covestro.
I do not like to see too much correlation among the stocks in my portfolio, as this can lead to large unexpected losses. This, in my opinion, is even more important than beta. If you have low beta stocks that are all very much correlated to one another, you could still have large swings in your portfolio as all your stocks move in the same direction, all the time.
That's why I like my "Biotech Big Three" so much. They all move relatively unrelated to the stock market, while also being uncorrelated amongst each other. Bad news for one biotech company is thus not likely to hurt my two others.
Furthermore, KBC and ING are well correlated amongst each other, but with no single other stock in my portfolio. Shell is slightly correlated with my cyclicals (+0.30/0.35), but nothing to worry about. Sofina, CA Immo, Payton, Kinepolis all sail their own course, which is absolutely lovely. Last, Microsoft (MSFT) and MercadoLibre (MELI) are strongly correlated as well, which is why I limit the amount of 'tech-companies' to just these two. Even though tech companies should not be included in my portfolio following my strategy, I believe both companies have too much upside potential to not include in anyone's portfolio. They thus form a risk I'm prepared to take, even in the literal sense.
Next month will be more packed with company-related information and a performance update of the portfolio. For now, I am very well hedged against a market downturn, and I could even strike some deals as I sit on a cash position of 13.1%. If Shell or my cyclical stocks would continue to increase, I will have to use that cash pile, however, to buy back the covered calls. But that would mean that I would have made 6%+ in 2 weeks' time on those stocks, which would be great.
Last, we will have a look at the cash flow next month. There are dividends to be paid out, just as we will collect once again our call premia. See you next month! Be sure to follow me to stay updated.
Disclosure: I am/we are long MELI, MSFT, CVVTF, ING, KBCSF, RDS.A, FURCF, APEMY, ARGX, GLPG, SFNXF, CAIAF. 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.