Investing Is Still About the Whole Portfolio -- 2006 Review

If you want to do some background reading for this article, here are four articles of mine that you can read:

A Value Investor's Plan for 2006

Evolution of a Value Investor's Portfolio

Investing Is About the Whole Portfolio

Evolution of an Investment Style

These articles get at the core of my beliefs about the market and how they have worked for me since mid-2000. This article is intended to give you an update of my portfolio, explain what went right and wrong in 2006 and give some idea of where I am headed in the future.

What Went Wrong?

I believe that avoiding errors (risk control) is the key discipline in investing, even greater than that of finding opportunities. Too many investors take risks that they don't understand well, and then they leave the game when things go wrong, which often would be the best time to invest more. Avoiding overly speculative situations should be goal No. 1 for retail investors. Alas, it is as rare to see retail investors do this as to see kids practicing defense on a basketball court. Offense is a lot more fun.

For my broad market portfolio, here are my top 10 failures in 2006:

Top Ten 2006 Failures
Pfizer	0.00%
St. Joe	-0.10%
Apache	-0.10%
YRC Worldwide	-0.10%
Sara Lee	-0.10%
Valero Energy	-0.20%
Cimarex Energy	-0.30%
Helmerich & Payne	-0.30%
Anadarko Petroleum	-0.30%
Fresh Del Monte Produce	-0.80%

The percentages indicate the effect that these companies had on my portfolio on the whole. Half of these are new additions to the portfolio, so the losses aren't material to me. Fresh Del Monte (FDP - commentary - Cramer's Take) is cheap, but earnings have been wanting, and energy-related costs drag on them. Apache (APA - commentary - Cramer's Take) and Cimarex (XEC - commentary - Cramer's Take) are cheap finders of oil and natural gas, but with prices falling over the past year, though they are cheap, they have lagged.

Sara Lee's (SLE - commentary - Cramer's Take) turnaround is still progressing, but it has not made significant progress in the stock price. St. Joe (JOE - commentary - Cramer's Take) is a stock you tuck away for a decade -- the value of the land is worth far more than the stock price, but the realization of that value is slow. I'm not worried about underperformance here.

Industry Breakdown
Foreign Diversified	0.30%
Staples	0.30%
Health Care	0.00%
Real Estate	-0.10%
Transportation	-0.10%

When I look at industries, I don't have that much to complain about. My losses were minor and readily offset by my gains. 2006 was a really good year for the broad market portfolio.

In my insurance portfolio, readers of RealMoney know my losses well -- PXRE (PXT - commentary - Cramer's Take) and Scottish Re (SCT - commentary - Cramer's Take). I've talked about those before; beware weak balance sheets and opaqueness.

What Went Right?

Winners for 2006
Companhia De Saneamento Basico Do Estado De Sao Paulo	2.10%
Industrias Bachoco SA	1.60%
Lafarge SA	1.50%
Ameron International	1.40%
Marathon Oil	1.40%
Allstate	1.20%
Anglo American	1.20%
Sappi Ltd SA	1.20%
Grupo Casa Saba SA	1.10%
Gold Kist	1.00%

Are there common factors in what went right for my companies in 2006? Well, maybe. Six of my top 10 were foreign companies. Though I have had an overweight in energy, only one of the companies on this list, Marathon (MRO - commentary - Cramer's Take), was involved in energy. One company was taken over: Gold Kist.

It is difficult, aside from the foreign weighting, to find common factors here. In general, I had a bunch of cheap companies. The ones that outperformed had positive surprises. This is just another example of how in value investing, positive surprises have big payoffs, while with negative surprises, negative payoffs tend to be muted.

Winning Sectors for 2006
Financials	4.80%
Materials	4.50%
Industrial	4.30%
Agriculture	3.30%
Energy	2.50%

As for sectors, my returns came from a wide number of areas. The financials included Allstate (ALL - commentary - Cramer's Take) but also had three foreign banks and a mortgage REIT, all of which did well. Materials were all over the place, ranging from mining to timber to chemicals. Industrials involved names such as Ameron International (AMN - commentary - Cramer's Take), John Deere (DE - commentary - Cramer's Take), Johnson Controls (JCI - commentary - Cramer's Take) and SPX Corp (SPW - commentary - Cramer's Take). Agriculture was largely protein names, two of which obtained a buyout, Gold Kist and Premium Standard. Energy? Too many to name ...

For a fellow working at a hedge fund, I am decidedly boring when it comes to stock selection. I don't change my views often; the insurance portfolio benefited from all of the names that it had, but Assurant (AIZ - commentary - Cramer's Take), MetLife (MET - commentary - Cramer's Take) and Allstate led the pack.

The Portfolio

In the interests of disclosure, here is the entire portfolio. It is equally weighted, with the exception of Allstate and the Japan Small Capitalization Fund (JOF - commentary - Cramer's Take). They have a 1.5 times weight.

Click here for larger image.

Where to Go From Here?

2006 was a good year for me, with 104 trades, 53 names, 35 positions on average, 11 losses and 42 gains.

I don't have a clear view of where to go from here. I know that those who write for the investing public are supposed to sound definite and give a sharp answer, but I don't see a lot of easy cheap ideas at present. My energy overweight is the most notable aspect of my portfolio. Beyond that, I would simply say to keep the valuations cheap and the balance sheets strong. Good advice almost always, and particularly so when stocks in aggregate are fairly valued, amid a challenging macroeconomic environment.

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At the time of publication, Merkel and/or his fund was long St Joe, Apache, YRC Worldwide, Sara Lee, Valero, Cimarex, Helmerich & Payne, Anadarko Petroleum, Fresh Del Monte Produce, Scottish Re, Sappi, Grupo Casa Saba, Allstate, Lafarge, Industrias Bachoco, Companhia De Saneamento, Assurant, MetLife and SPX Corp, though positions may change at any time.

David J. Merkel, CFA, FSA, is a senior investment analyst at Hovde Capital responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. Previously, he managed corporate bonds for Dwight Asset Management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Merkel cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

Analyst Certification: All of the views expressed in the report accurately reflect the personal views of the research analyst about any and all of the subject securities or issuers. No part of the compensation of the research analyst named herein was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the research analyst in this report.

Merkel is employed by Hovde Capital Advisors LLC (the "firm"), a registered investment advisor with its principal office located in Washington, D.C. The Firm and/or its affiliates have or may have a long or short position or holding in the securities, options on securities, or other related investments of the issuers mentioned herein.