Saturday, February 20, 2016

Diversification and bargain hunting

Last week we talked a bit about what to do in a bear market. Also, remember that I have been concerned the last couple of years about the length of this bull market and recommended building cash. People like Warren Buffett seem always to have plenty of cash and employ some of it when they see truly good investment opportunities. If there are, in their opinion, no good buys, they prefer to sit on their hands. Warren calls it “Benign neglect, bothering on sloth”. Really, “it pays to be informed” but that doesn’t mean that you must act every week or month.
You may say that having lots of cash on hand makes you an underperformer to the markets.  But this is comparing apples and oranges. For example, my portfolio is nearly 50% real estate – most in Calgary – so how does my portfolio performance compare to a market index and should I compare with the TSX or with the S&P500.  You see how ridiculous it is to compare your performance with one specific asset class in one particular region or continent? So you underperform the TSX because in 2014 it went up say 11% and you held 20% cash and thus even if your portfolio was 80% TSX stocks your portfolio would have underperformed. Assuming you earned nothing on cash – your performance would have been ‘only’ 11x0.8 + 0.2x0= 8.8%    Last year the TSX was down, what 9%?  So then, with 20% cash your performance would have been 0.8x (-9) = -7.2% Hè! Your portfolio outperformed the TSX in 2015 by 1.8%!  See how ridiculous it is to compare your portfolio performance with that of the TSX?  After all, your portfolio is a lot more diversified than just the stocks of the TSX.
So, my stock holdings are diversified over Canada, the U.S., some in Europe and a tiny bit in Asia. Then I own Calgary real estate which was flat last year and may decline this year.  Because of Calgary’s dependency on oil, I lowered my investments in oil stocks over the last number of years and last year I sold off nearly all – some at large losses. But in my quest to balance my portfolio I also cashed in on some large gains (e.g. from Brookfield) to neutralize my capital gains taxes (BTW I own Brookfield and related investments for over 20 years). I also started to diversify into gold in recent years and that is paying off as well right now. Although it still is far less than 5% of my stock portfolio, let be 10% of my overall portfolio as some gold bugs advise. Not that I do everything perfect but my overall portfolio was virtually unchanged in 2015. Definitely not booming but then I am still learning after more than 30 years investing. In fact, I am still learning every day as a geologist after doing that for nearly 45 years!  Yes, it is currently not a lot of fun working in Calgary’s oil patch but it is definitely interesting.
I digress. First of all, you may hear portfolio managers of BNN stating: “I am always fully invested in the market because that is what my clients hire me for”. To some degree this is true – because the statement comes from a manager of a fund that invests in North American stocks and his job is to outperform the S&P or TSX!  Fund managers who are investing in resources, may take a completely different take and may say that she is 70% in cash today because this sector is very cyclical and if she doesn’t take profits at the top of the resource cycle all gains will be wiped out! So when you listen to their advice better know where they are coming from when trying to emulate their advice.  I follow a lot of investment newsletters and one of the most difficult things to deal with are the conflicting views of these letters.  One letter is for day traders and another is for retirees – two entirely different worlds and their ideas are based on these different worlds. You the individual investor will have to describe your own world which may be an amalgam of all those different views you read about. So, what for you may be a good performance may compare to others as quite mediocre but that is like comparing apples and oranges.  So track your own performance and look at your portfolio’s different components and try to continuously improve without getting an inferiority complex when you hear the ‘performance’ of the gurus who probably only mention the returns of the best fund they manage. ‘See behind the curtain’ is a favorite saying by Don Campbell, one of Canada’s most popular real estate experts. That is here a very appropriate statement.
So, what about the diversification of my current stock and bond portfolio – it is said that a diversified portfolio should have no more invested than 5% in one single stock. So does that mean that one only holds 20 stocks?  Far from it, using my own portfolio and how it has evolved over the years, my top 10 holds range from 3 to 10% with 10% being cash and the next runner up (7%) in money market funds.  The remaining holdings range from 3 to 7% and I have been reducing the ones above 5% lately adding to cash.  Cash is also coming from dividends that I typically do not reinvest automatically but accumulate for new or increased investment positions. The runner up 10 holdings (the top 11 to 20 ranked holdings) range in size from 1.8 to 3% (average is 2.3%). These are holdings that mostly have proven their performance and to whom I may add when their prices are right until they become part of the top 10. Then I have another 10 stocks (holdings ranked 21 to 30 which comprise between 0.8 and 1.8%, averaging 1.2% of the total stock and bond portfolio.  These are a combination of misfired investments and up-and-coming (i.e. recent) investments.  The misfired investments have not yet triggered their stop loss sale or I decided to hold on any way (not always wise). The most important of these top 21 to 30 holdings are the new investments.  So when I think a stock is good I do try not to buy everything at once – scaled buying is the official term – but I still want to make sure that there is enough that the position has an impact on overall portfolio performance.  
For example, right now I think we’re at the bottom of various commodity cycles and there is also a general stock market correction going on.  So, I feel it may be the time to buy energy stocks. Last December I bought a bit of Crescent Point (200 shares) and was planning to buy more later on – a tiny balloon in the oil storm. Within a month the stock lost 8% of its value and I felt that I had very little tolerance for even losing 8%.  I sold before it triggered the 25% stop loss.  This week, I became more and more convinced that we have reached the bottom of the oil cycle, CNRL has quite a solid balance sheet and I talked with oil patch workers in Calgary about ‘how business is going’ – not insider information but just general impressions including my own.  Calgary lies in shambles, there is blood in the street in terms of layoffs and a fair number of companies are bankrupt or in the ‘zombie stage’.  Their cash flow is barely enough to service their debt and pay for their G&A.  There is no money for repairing broken down wells; many pools produce at negative ‘net back’ (well revenue minus royalties minus operating costs and transportation). So there is no new drilling and pools get shut in. Talking about Deadman walking!  The only reason many of these companies are still functioning is because somebody has to manage the creditor’s oil and gas properties and those creditors don’t have the expertise. So what’s the use of calling the loans? Yes this is the time of blood in the streets – can things get worse?  Yes but… by how much?  The chance of upside is much better. So its time to nibble at the stocks of the best companies. I bought a bit of CNRL and probably will buy more during refinery maintenance season when we’ll likely get some more price scares and opportunity to buy cheaper. I have put a maximum limit on my total oil and gas holdings at 5% (for now) and I’ll be filling those positions over the next few months. I expect those stocks to have the potential to double or even triple over the coming 3 to 5 years.  So 5% could grow to 15% just through appreciation (assuming the rest of the portfolio does nothing).  I consider that meaningful.  

This is what I call an appropriate approach for my diversified portfolio.  The TSX index has typically 25-30% energy stocks – so being an oil industry worker, 15% of portfolio value seems to me an acceptable proportion. We’ll see when we get there. In the meantime, I wish you good bargain hunting.

Please, Note. This blog does not make specific stock recommendations. This post just tells how I try to manage my stuff.

No comments:

Post a Comment