The Covestor Concentrated Risk portfolio had a difficult 2013 after a good investment performance in 2012. In 2013 the portfolio lost 1.1%, while the S&P 500 index had its best performance in 16 years, gaining over 32%. So what went wrong in 2013?
I have stated from the start of this portfolio that my investment style may cause under-performance during speculative markets. Generally this is caused by a large cash position and my preference for value stocks, which tend to have lower volatility than growth stocks.
The Concentrated Risk Portfolio held close to 20% of its assets in cash for the majority of the year. In my opinion, this acted as an anchor on any performance the equity portfolio could generate. However, in down markets cash is king; at such times, having access to ready cash enables investors to scoop up bargains at very low valuations.
USG which was responsible for the vast majority of outperformance in 2012 was basically flat for the year. The portfolio sold its entire USG position in October after it was announce it had entered into a joint venture with Australian wallboard maker Boral. This was a very expensive joint venture, costing USG a half a billion dollars to enter into the Boral-controlled partnership in a very competitive Asian wallboard market.
The joint venture introduced a significant number of new unknowns to the future of USG that increased the uncertainty of my intrinsic value calculation. Since selling USG, the stock has rallied 20 percent, leaving a good chunk of money on the table, and outside of the portfolio. For the other stocks the portfolio held for the majority of the year, Wells Fargo (WFC) had market like returns, while Posco (PKX) was about flat for the year.
Going forward, I've positioned the portfolio defensively to patiently wait for undervalued opportunities to open up in the future. However, since I do not try to time the market, it's important to have some exposure to equities to prevent extreme underperformance, even though there no bargains available.
This forced me to add stocks in 2013 that were not cheap. I looked for stocks that were trading near their intrinsic values that had the potential for strong gains due to a change in the way markets view them.
Posco (PKX) is dependent on steel demand in Asia. This demand has been muted for the past couple of years as demand catches up to the supply from years of overbuilding.
I have no way of knowing this for sure, but assuming this trend reverses steel prices will rise along with PKX's share price. In my opinion, Posco's Finex manufacturing process gives it a low cost advantage over its rivals, giving it more capacity to suffer through down periods similar to the one it is going through now.
Pernod Ricard (PDRDY), and Philip Morris International (PM) have a strong dependence on emerging markets which did not perform well in 2013. In my opinion, a turnaround in emerging markets should boost the performance of these stocks, and over the long run these stocks should outperform the broader market.
Nestle (NSRGY) is a Swiss multinational that sells in hundreds of markets. It reports its earnings in Swiss francs, which has been appreciating in recent years against the currencies it sells in. I believe, in the future if this were to reverse, NSRGY's earnings would increase, providing a potential catalyst for market beating returns.
Coca-Cola (KO) has recently seen a challenging environment with health concerns over soda consumption. The government in Mexico has enacted an excise tax on soda with several other countries contemplating similar measures. This has caused underperformance of Coca-Cola's stock, and if these concerns prove to be overblown or KO can successfully migrate its drinkers to its other offerings, KO should rise.
In my opinion, Merrill Lynch Capital Trust III (MER.PP) provides a similar opportunity as the Bank of America Capital Trust stock I purchased in 2011. It has a quarterly dividend payment of $0.46 giving it a yield of over 7% at its current price.
Even with the new stock purchases, the Concentrated Risk portfolio is holding over 50% of its assets in cash. I am hoping that 2014 will provide some opportunities to deploy this cash at better values than were available in 2013.
Even if the market continues to melt up, the stocks the portfolio currently holds should, in my opinion, reduce the underperformance I saw in 2013 while providing potential upside surprises.
DISCLAIMER: The investments discussed are held in client accounts as of December 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
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