It was a very quiet week, not surprisingly. The models ended the year looking like this:
Top 20 was up slightly on the week, while its benchmark, the S&P 500, also increased marginally. I was happy with the performance on the week, as small-caps were down, which should have pressured us. We had 5 names decline 2-4% and 4 increase by 2-4%.
CG/B and its benchmark (60% stocks and 40% bonds) both declined very modestly on the week - bonds were a bit weak. The model saw one weak performer - CALM, which pulled back after disappointing earnings.
Top 20 Review and Outlook
Top 20 had a decent month, outpacing the S&P 500. Its bias towards smaller names would certainly explain some of that performance. I was impressed with our stocks, as they had such a strong November that I thought there might be some reversion. We did take a lot of profits and reposition, though I am not sure that really helped. For the quarter, as you can see in the table above, Top 20 rose an astounding 24%, well ahead of the 10.76% that the S&P 500 logged. For the year, the model scored a total return of almost 52%, beating the market by 36.8%.
The model is currently positioned with just 1.3% cash. I had mentioned that I expect to carry a more normal 3-5% in the days ahead. As a reminder, I don't use this model to time the market - it is always fully invested. I restrict it to a maximum of 10% cash. As far as sectors, we have two very big overweights: Industrials at 31% and Technology at 29%. Other sector weightings are Healthcare at 13% (slightly ahead of the S&P 500 allocation to the sector), Financials near 10% (5% underweight), Consumer Discretionary near 10% (close to market weight), Energy at 5% (underweight) and Materials at 2.6% (market weight). We have no exposure to Telecom Services, Utilities or Consumer Staples. The first two are small sectors, while the latter is a little over 10% of the market. From a sector weighting, we are set up for continued growth and cyclical recovery without inflationary pressures.
In terms of market caps, we are all over the place. Our smallest name is under $200mm, while we have 2 names over $100bln. The median market cap is $1.2 billion. The 5 Large-Caps are concentrated in Health and Technology primarily, with the last one in Financials. Our median PE is 13X, while our balance sheets continue to be very strong - just 3 names have more debt that cash. We also have many stocks trading not too far from tangible book value (median value is 2X). While we are "aggressive" in some of our exposures, we are structured with substantial downside protection from our low valuations and strong balance sheets. Only 4 of our 20 names were in the portfolio a year ago, so, as you probably know, we will restructure the portfolio as the situation changes in the weeks and months ahead. A final note: The portfolio-weighted return of our current holdings for 2010 was -3.9%, with the median return of 1.4%. To those of you buying the model (or holding it) today, you aren't buying inflated stocks - we have repositioned to take advantage of what will hopefully prove to be opportunities in the future. My current expected return for the model is 49% (based on all of the stocks hitting my targets a year from now). This is in the context of what I expect will be a good year for stocks - my forecast is +20%. If we achieve this type of performance, it will be ahead of my long-term expectations of 12-20% better than the S&P 500.
Conservative Growth/Balanced Review and Outlook
CG/B had its second consecutive month of beating its benchmark by 3%, ending the quarter 6.6% ahead. We were helped by being very underweight bonds, which fell on the quarter, and being overweight stocks. For the year, the model increased in value by almost 27%, which trounced the combination of stocks and bonds by over 15%.
The model is currently structured with just under 67% exposure to equities, 19% bonds and 14% cash. We carried our equity exposure during most of the quarter near 75%, which is the maximum, but we took profits (really it was reducing risk) late in the quarter. Our bonds, which are constrained to 10% minimum and 50% maximum against a 40% neutral weighting, are substantially higher than where they were last quarter, as we reduced our underweighting. I am not very bearish on interest rates, at least over the first half of the year, but we could get an opportunity to add in the coming weeks again. As I am bullish on stocks, 8% of that 14% in cash is reserved for future stock buys.
The bonds that we hold are ETFs, mainly one that replicates the index against which we are measured. 4.6% of the exposure is in an ETF that covers just the mortgage portion of the index, which is a bit defensive. Looking at the stocks, we are a lot more balanced than the Top 20 in this model. Our largest exposure (as a percentage of the equities and not the whole portfolio) is also Technology, but it is 23%, just slightly ahead of the market weighting. Other exposures include Healthcare at 21%, Consumer Staples at 19%, Financials at 13%, Consumer Discretionary at 10%, and Industrials, Utilities and Energy all at about 5%. That's 8 of the 10 sectors covered (no Materials or Telecom Services, both extremely small parts of the S&P 500).
In terms of market caps, we have substantial Small-Cap exposure, but it's not as extreme as Top 20. Our median is over $8 billion, with an average of over $42 billion. We do have 2 names that are below $200mm and another below $1 billion. The median PE ratio is about 14X, with the portfolio-weighted PE at 13.7X. Our dividend yield is about 2.2%, which is above the market. Our balance sheets are very strong, with the median company having just slightly more debt than cash. Even our portfolio-weighted net debt to capital is just 8% compared to about 30% for the S&P 500. 1/2 the names have more cash and short-term investments than debt, and, if one includes long-term investments, then the vast majority are net cash positive. Like Top 20, our stocks aren't run-up as much as the market. On a portfolio-weighted basis, our stocks that we currently hold advanced 2.4% in 2010.
I hope that the very conservative nature of this portfolio is evident from the characteristics I described. We have good economic sector diversification, exposure to a very broad range of market capitalizations, strong balance sheets and moderate average underperformance over the past year. A few of the names are currently overbought (5 moderately and 1 significantly) - hence the recent throttling back of our exposure. My goals in this portfolio are to beat the combined index by 8-12% a year. It's less than my goals for Top 20 due to the fact that we don't really add any value in our bond selection (we index) and that our opportunity set is smaller (stocks have to be "conservative"). As a reminder, we should expect to fare best relatively in down markets, to do ok in flat markets and to lag in strong markets. Thus, I was very pleased with 2010's performance. We had good stock selection, but it our avoidance of bonds and commitment to stocks above a neutral exposure that contributed as well.
2011 may prove more challenging, though I do continue to believe that conservative dividend paying stocks are cheap to bonds. As I form my expectations, I see our hurdle-rate for 2011 as about 13% - stocks (60%) should rise 20%, but bonds (40%) will probably return about 2-3% (maybe less). Our current stock holdings have a portfolio-weighted expected return of 30.4%. Assuming we hold 70% all year, that gets us a 20% return. The bonds will add a little and the cash nothing. Thus, we could be challenged to hit my minimum goal of 8% above the combined index. With that said, conservative investors should be pleased if we are able to deliver a return close to a strongly-rallying S&P 500 with a portfolio that has no more than 75% exposure to stocks. It will prove to be a great reward relative to the risk if it plays out as I expect.
Final Thoughts
I believe that our subscribers who read my weekly comments have a good feel for the process that goes into running these models. If so, they probably have confidence that our strong performance over the past few years isn't random. I hope to share some more details in the coming weeks. I assure you, it's a lot of work. I am very lucky, as my consulting business (to investment firms and financial consultants) allows me to leverage the experience and information from my many clients as well as to test out my ideas.
I also want to let everyone know that we hope to unveil a new website soon, so stay tuned. The beta version has a much better look and is easier to navigate. If anyone has any recommendations, this would be a great time to let us know what you would like to see.
Finally, I want to share some ideas about overcoming some of the "pitfalls" of our model, which is really just one: high turnover. Each of our subscibers has different circumstances, and I can't take into consideration everyone's needs all of the time. Some don't mind the turnover - no tax problem because it's in an IRA and no commission problem because the account is large enough that it is immaterial or perhaps they have a lot of "free trades". Allow me to elaborate. I don't turnover just for the sake of turning over our portfolios. I try to be as sensitive as I can to taxation and commission issues, but I am trying to maximize performance (as well as reduce risk in CG/B). Period. If you agree with my constructive outlook for 2011 and are concerned about tax consequences, you should consider using your IRA or a tax-deferred account for the model. If you have a small account where you are implementing the model (<$50K), or even a larger one, you might look into finding a brokerage that will give you free trades if you move your account there. With that said, even on a $50K account, I don't expect that the total burden of commissions would be more than 5% of the account, so if we hit the goal of beating the market by 12% or more, it still beats an index fund. If anyone else has any ideas on the turnover issue, I would appreciate your thoughts.
I thank you for your support in 2010 and wish all of our subscribers and free-trialers a very successful 2011.
P.S. For both models, you can click the following link to see monthly performance since inception: Download Performance to 12-31-10
Comments