- Aside of performance and volatility, proper diversification and proper allocation/s are crucial. Don't bet too much on anything, no matter how "sexy" it may look.
- RIG's largest position has a 5.2% allocation and it's up 16.5% over the past six weeks (since inception date).
- At the same time, RIG's best/worst position is up/down 26.8%/18.3%. Luckily, allocation to the best is 6.5x bigger than allocation to the worst.
- Looking for a portfolio of ideas like this one? Members of Macro Trading Factory get exclusive access to our model portfolio. Learn More »
Happy New Year!
We hope that 2021 has treated you well, and we wish you that 2022 will treat you even better.
Rose's Income Garden ("RIG") is a portfolio runs by @RoseNose under Macro Trading Factory ("MTF"), with a focus on income (dividend stocks), quality (mostly large caps/blue-chips), and investing style (dividend growth, aka DGI).
When it comes to risk/quality, RIG also is committed for its average-weighted credit rating to be an investment-grade, i.e. not lower than BBB-.
Here's the distribution of RIG's credit ratings as at end of 2021:
Source: Rose's Income Garden ("RIG")
The main goal of the portfolio (aside of generating income through dividend growth and value investing) is to outperform the SPY on a risk-adjusted basis.
Although Rose is managing her portfolio for many years, the official inception date of RIG (under MTF) was Nov. 19 (closing prices), and so we only measure the performance since the portfolio turned official (i.e. six weeks in total).
There's No Return Where There's No Risk
We strongly believe that measuring a return without measuring the risk (taken to achieve that type of return) is meaningless.
If risk isn't part of measuring a portfolio, or an asset, return - it's likely that gambling or buying a lottery ticket are among the best investment one can make. Where risk (the potential for a loss) isn't measured, there's only room for absolute/maximum returns, no matter how bad are the odds.
When it comes to investing, there is no return where there's risk. Similarly, one can't announce a return without also announcing the risk attached to that return.
You top investment may have returned 1000%, but it doesn't automatically mean that it was a reasonable investment from a risk/reward perspective, just as winning a lottery ticket doesn't turn buying lottery tickets into an attractive risk/reward "investment."
Therefore, when it comes to portfolio management - whatever we do, whenever we do, wherever we do, it's combining and measuring both risk and reward.
Here's how RIG has performed compared to SPY over these six weeks:
- RIG: 5.21%
- SPY: 1.64%
- RIG: 0.91%
- SPY: 1.16%
Since inception, RIG has outperformed SPY by 3.57% (!!!) while taking a significantly lower risk!
While six weeks is indeed a very short period, we find it interesting (and we're very proud) that RIG has stood up for the challenge even though the SPY was up nicely.
Why so? Because obviously, when you run a portfolio which is value- rather growth- oriented, you may expect to underperform when the benchmark is posting an outsized return.
What is an "Outsized Return?"
Based on the S&P 500 historical data since 1928 (to 2021), the average annual return is about 10% (give or take).
We believe that a 50% excess return, i.e. a total return of 15% for the S&P 500 (or SPY for that matter) in a given year, should definitely fall under the category of an "outsized return."
If we agree that 15%+ is an outsized return for the SPY, there's a good reason to believe that RIG would:
- Underperform during years of outsized gains (SPY is up at least 15%)
- Overperform during years of outsized losses (SPY is down at least 15%)
The fact that a portfolio with only 6.6% allocation to Consumer Discretionary and Information Technology outperforms a benchmark that has a 41.9% (!) allocation to these two (of the most aggressive) sectors, while the market is posting outsized gains*, is remarkable.
*1.64% in 6 weeks = 15.14% in annual terms = 1.0164^(52/6)-1
Source: Rose's Income Garden ("RIG")
By the way, it's just as remarkable taking into consideration that RIG has a 26.1% allocation to Consumer Staples and Utilities, compared to the benchmark's 8.2% allocation to these two (of the most defensive) sectors.
Now, if you still insist that six weeks is nothing, let us just say this:
- We fully agree.
- Rose's portfolio total return for 2021 was 29.9%, better than the SPY's 28.6%.
Once again, it's important to emphasize that we believe it's unfair to use (good or bad) numbers that were recorded prior to RIG becoming an official and integral part of MTF.
Instead, we are willing to make the following (scientifically-proven) conclusion: Being part of MTF is only doing well for RIG...
Pay attention that even though Rose's portfolio was underperforming SPY in absolute terms prior to joining MTF (24.6% vs 26.9%), it was still overperforming on a risk-adjusted basis, which is the ultimate goal, as stated above.
Diversification helps managing risk and reducing the volatility of a portfolio's/an asset's price fluctuations.
There are all sorts of "magic numbers" regarding the number of stocks held above which a portfolio's risk is no longer being affected (by adding more stocks to it).
A commonly-used number is 30, based on a study by Lawrence Fisher and James H. Lorie from 1970 that found that a randomly structured portfolio of 32 stocks could reduce the distribution by 95%, compared to a portfolio that holds all stocks traded on the NYSE.
Some even go with a number as low as 15-20 stocks to suggest "proper diversification".
At the end of 2021, RIG holds 86 positions across all 11 sectors.
(That includes 1 close-end fund which is multi-sector in nature.)
|Sector/Segment||No. of Positions|
|Total number of positions:||86|
We may argue (until the end of days) what is the "right" number of stocks in a portfolios, however there are two things that can't be disputed:
1) Even if the marginal effect (of risk reduction) is minimal after already holding 30 stocks in a portfolio, risk is still going down with every stock which is being added.
You may claim this doesn't worth the effort, but you can't dispute the math behind it.
2) For many investors, holding more stocks equals having more fun. As Rose always say to those attacking her for having "so many positions":
- It suits me.
- I'm enjoying it.
- If it ain't broken, no need to try and fix it.
The stock with the largest allocation (5.2%, including a gain of 16.5% since inception) is AbbVie Inc. (NYSE:ABBV).
Btw, the second largest position is cash, and the smallest position is Kraft Heinz Co (KHC) with a mere 0.1% weighting. I can only guess this is Rose's tribute to (or mocking of?) Warren Buffett...
Before we talk more about ABBV, let us also add that from a macro perspective, we're bullish on (thus overweight) Healthcare going into 2022.
Not only is it one of the most attractively-valued sectors, with the third-lowest premium compared to the 10-year average (Only Materials and Energy come ahead)...
... but if you zoom in, Biotech (with a forward multiple of 10.9x) and Pharma (with a forward multiple of 13.2x) are looking very attractive, in absolute terms.
That's exactly what leads us to one of our top healthcare picks: AbbVie.
First and foremost, even before the fundamentals, it's important to note that ABBV is looking very strong on the chart, with the stock:
- more than doubling since the March 2020 lows.
- trading at the very top of the up-trending channel.
- breaking the major (previous) resistance of the early 2018 highs (~120)
While we can't rule out some pullback, let's not also forget that the stock had gone through a correction very recently when if fell 13.14% in a matter of less than 3 weeks - from as high as $121.53 (on Sept. 1, 2021) to as low as $105.56 (on Sep 20, 2021).
This correction was a result of a decision by the FDA to add new and updated warnings on Janus kinase (JAK) inhibitors, including Rinvoq (upadacitinib) marketed by AbbVie. However, since then, the stock has not only fully recovered but is has doubled up on that decline.
Why do we pick these two companies? Not only because they are all mega-cap stocks, but because unlike ABBV, both PFE and MRK are very much affected by COVID (for good and for bad), creating a lot of noise, while ABBV is mostly watching the pandemic from the sidelines.
One of the most impressive things about ABBV is that the business keeps progressing and improving.
AbbVie is the company which is going to make the biggest improvement from a pure valuation perspective.
That's true when comparing forward to TTM P/E ratios.
And that's also true when comparing forward to TTM EV/EBITDA ratios.
At the same time, ABBV is paying a significantly higher dividend yield.
Based on forward divided yields:
- ABBV: 4.17%
- MRK: 3.58%
- PFE: 2.93% (and that's after all that extra cash flow that Pfizer is generating out of COVID vaccines and pills)
No wonder investors like ABBV better.
After all, looking at the past 2.5 years (since Independence Day of 2019), while MRK (mostly) and PFE (until recently) have been "dead money", ABBV has kept its shareholders happy, with a nice, steady, trajectory.
We're not saying ABBV will do the same forever, but as the old saying goes: Rose(Nose) knows (what she's doing)
Keep the Winners Big and the Losers Small
Easier said than done, of course.
Luckily, the portfolio weight of SBLK is 6.5x as big as that of MAC.
Recall that while nowhere near the extent of other, way more noisy/famous stocks, MAC was (perhaps still is) part of the "Memes".
(To make it very clear: Neither GME nor AMC have been part of RIG at any point in time.)
Don't get us wrong: We're not suggesting that we've a magic power to assign larger allocations to winners and/or smaller allocations to losers. Had we have such a power, we wouldn't pick losers in the first place. (Furthermore, we only have a "Macro Teller", not a "Fortune Teller" in charge...)
We do, however, wish to emphasize how important proper diversification and allocation (two separate things) are.
Way too often we bump into portfolios where there are some very high allocations to no more than a handful stocks (sometimes even a single stock).
One may argue what is "proper allocation", but we trust vast majority of investors would agree that:
- Less than 15-20 is risky.
- Putting 50%+ into <= 5 stocks is risky.
- Putting 10%+ into any single stock is risky.
And yes, that is true even you're one of the best/largest/most appreciated company on planet earth.
SPY's top-15 holdings make up for 34.72% weighting in total:
|GOOGL||Alphabet Inc. Class A||2.17%|
|GOOG||Alphabet Inc. Class C||2.01%|
|FB||Meta Platforms Inc. Class A||1.99%|
|BRK.B||Berkshire Hathaway Inc. Class B||1.35%|
|UNH||UnitedHealth Group Incorporated||1.17%|
|JPM||JPMorgan Chase & Co.||1.15%|
|JNJ||Johnson & Johnson||1.11%|
|HD||Home Depot, Inc.||1.07%|
|PG||Procter & Gamble Company||0.98%|
|V||Visa Inc. Class A||0.90%|
- Always remain within your comfort zone.
- Stick to what is working for you, and what you like.
- Make sure you enjoy your work, not only working to enjoy out of work.
Having said that, may we add the following on top, not instead:
- Have a plan. Set a strategy.
- Stick to it. Fine-tuning is perfectly, well, fine...
- Measure risk, not only return.
- Make sure you're being compensates against the risk you're taking.
- Don't put too much in any single asset/basket.
- Diversification is key. It works with as little as 30 stocks, but 86 is just fine too.
- Proper allocation is done per asset-class, per sector, and per security. One mustn't come on the expense (or instead) of the other.
- It's not easy, but let the winners win for long/er and cut the losers short.
- It's even less easy, but try to keep the winners big and the losers small.
- Make a genuine effort to make 2022 you best year ever!
And we wish you from the bottom of our hearts to succeed in it.
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This article was written by
The Macro Teller has over 30 years of investing experience, including 25 as an investment manager. He holds a BA in Accounting and Economics, as well as an MBA in Finance. He is a licensed CPA and had been a licensed investment advisor in various countries, including the US (Series 7 & 66).He runs the investing group Macro Trading Factory along with his team where they offer two easy to follow portfolios: Funds Macro Portfolio and Rose's Income Garden. Although the two portfolios are very different they share the same goal: Outperforming the market SPY on a risk-adjusted basis. Learn more.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of ABBV either through stock ownership, options, or other derivatives. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.