Investing In The COVID-19 Era

Summary

• I'm a passive index fund investor - albeit one who (mostly) never buys index funds.
• How do you know the difference between discipline and consistency, on the one hand, versus stubbornness and inflexibility, on the other hand?
• How the COVID-19 era changes my investment approach.

I'm an index fund investor. I passively hold a reasonably static portfolio that's diversified across companies, industries and asset categories. It happens to be I who created the particular index that I invest in (which doesn't make it any less of a passive index fund than some of its better-known, commercially-available brethren). The only real difference that I can see between the Pancake Industrial Average and a fund like the Vanguard S&P 500 Index (VOO) is that unlike the latter, the Pancake Industrial Average was tailored specifically to suit me, my beliefs, and my investment values.

For the most part, I've found it easier to be a passive investor with an index that I both control and understand as opposed to an index that someone else created using criteria I don't know, understand or possibly even agree with. In life, there is much to be said for knowing exactly what you like... and making a point of going out to get it. The S&P 500 is packed with companies that I'd rather not own - companies burdened with gobs of debt, constricted by slender profit margins, dispensing inferior products or services, hounded by frustrated and irate customers, and that face competition akin to life on the African Savannah during the dry season. Uhhhh, no thanks. I built the Pancake Industrial Average to spare myself from all that and focus on only owning companies that I personally feel are likely to satisfy more or less the exact opposite set criteria. Most of the time, having my own personal set of index criteria buffers the urge to panic-sell when prices are dropping. And as with any long-term passive index, the Pancake Industrial Average is the financial equivalent of a roach motel: companies check in, but (mostly) never check out.

But with all that being said and done, COVID-19 has changed everything for everyone - including me. The bedrock of facts and investment premises upon which they are built is just as shifting and unstable as life itself and no investment approach, passive or otherwise, receives special dispensation from the need to adapt to the times. I've had to reconsider whether or not certain companies still satisfy all the criteria for staying in the Pancake Industrial Average. In fact, the COVID-19 crisis is so monumental in scope that I've even had to reconsider my fundamental selection criteria as well. The challenge is that a passive index fund must balance the desire for consistency with the need for flexibility.

Like you, I'm still learning how to do that, but I'll give an example of how I'm trying to strike a tolerable compromise. One of the criteria that I use for my personal index fund is that I select companies that sell timeless goods and services that are always in demand irrespective of economic conditions. The COVID-19 crisis taught me that such an investment criterion isn't sufficient: I need to consider whether the customers and clients are always willing and able to pay for those goods and services. Everyone always needs a place to live, but as we've seen over the last month, that doesn't mean they'll always pay the rent. I need to ask what sorts of products can and will they pay for?

That's when I started thinking about my grandma who grew up in the Great Depression and who also had a notorious sweet tooth. Do you know that she used to carry a handful of Tootsie Rolls at the bottom of her very large and very expensive handbags? Why Tootsie Roll (TR)? I guess it was because even in the middle of the Puerto Rican summer, on the shade-free hilltop fields leading up to the ancient fortress of El Moro (a place aptly described as "the Anvil of the Sun"), Tootsie Rolls do not melt. As meticulously cautious about her spending as my grandmother generally was, the price of Tootsie Roll is something I never heard her utter so much as even once during her lifetime. In that regard, I'm sure that she must have been a typical Tootsie Roll eater. Tootsie Rolls are cheap enough that the price doesn't matter (at least not to someone who has a taste for brown-tinted, corn-syrup-enhanced carnauba wax).

By the way, can anyone out there tell me whether there are any candy products that compete with Tootsie Roll? I might be wrong, but I think that Tootsie Roll monopolizes the curious little candied wax niche that it occupies. Come to think of it, that actually sounds like another good criterion for the Pancake Industrial Average: own companies that consistently and profitably dominate their particular market.

Here is how the Pancake Industrial Average is currently comprised:

The question of the day is, would adding more TR shares to the Pancake Industrial Average mark a dramatic departure from my overall approach, or would it simply amount to an adaptation to the times? One way that I try to answer that question is to use the backtesting tool on Portfoliovisualizer.com to see what impact that addition would have had on the overall risk and returns for the index. Turns out, not much.

Here's what would have happened if TR had been included in the Pancake Industrial Average for the past four years: annual rate of return of 10.71% and annual Alpha of 3.17%.

And here's what would have happened if TR had not been included: annual rate of return of 10.68% and annual Alpha of 3.13%.

I think these numbers demonstrate that adding shares of TR to the Pancake Industrial Average represents a timely adaptation to my selection criteria, rather than a wholesale departure that would make me question my credentials as a passive index fund investor. That's the balance I'm looking for. Sticking to my guns through up and down markets, but evolving my investment approach to better fit the COVID-19 era.

Disclosure: I am/we are long TR. 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.