Sunday, February 22, 2015

Investment Strategy & Tactics


Developing the best strategy and tactics for our clients’ investments is never far from my mind. Thus, Saturday night at the annual birthday dinner for George Washington at Mount Vernon,  I listened to and spoke briefly with David Rubenstein, the co-chair of the Carlyle Group, a very generous contributor of his time and fortune to numerous non-profit organizations.

This was the second time in the last couple of years Mr. Rubenstein spoke at this dinner.  During the first he discussed his $10 million donation to Mount Vernon,  a non-government supported charity to maintain the General’s estate and the legacy of his incredible contribution to the success of the United States. In the Saturday evening keynote discussion Mr. Rubenstein labeled George Washington as an inventor which in today’s consciousness is higher than general or president. The three “inventions” that he is crediting George Washington with were: 

(1) The creation of the first organization that the thirteen very separate colonies had was the American Army, which when paid and equipped were much poorer than the various colonial militias.

(2) The political drive to create the US Constitution which for the first time created an executive government ruling with the consent of the Senate.

(3) The rotation of power; setting a precedent in declining a third term or life-term as President.

Translating David Rubenstein’s three Washington’s inventions into investment focuses I came away with the following thoughts:

To win a war of independence it is necessary to have sufficient sized forces to eventually win the war even though various battles may be lost.

What was not lost was the battle for survival. The second invention, while written by others, was adopted by the Second Constitutional Congress chaired by George Washington and stressed the need for controls and appropriate consultation without great interference with executive execution.

You will see these inventions are similar in logic to part of our development of L Timespan Fund  Portfolios TM (Lipper Time Span Portfolios) but before we discuss one of these portfolios, we should recognize that this past week demonstrated that the surge that was mentioned last week has begun.

The surge

In last week’s post I discussed the one main missing element to the surge that can lead first to a significant price performance of 20%+ (which will be followed by a larger decline). During the week both the Dow Jones Industrial Average and the Standard & Poor’s 500 went to new high readings. European stock indices are at a seven year high, Japan’s market is also at a high point and the UK’s FTSE 100 is only 15 points away from a new high. These global price moves suggest that many investors are showing profits in their aggregate portfolio. Many investors with cash on the sidelines or invested in bonds are very likely to be worried that they are being left behind and will commit to purchasing stocks or equity funds of various types.

To create the desire to buy at elevated prices one needs to have increasing confidence in the future.  My old firm, now known as Lipper Inc., a ThomsonReuters company, has four separate growth fund classes based on the average market capitalization of the stocks in their portfolios. In a market where last year’s big long-term winner (Government bonds) are essentially flat through the 20th of February, the four growth fund averages on a year to date bases are up between 4.18% and 5.16%. A tight performance group of leaders, the four Small Company Growth fund groups are slightly behind. (I expect that some time during this surge they will lead.)

While performance numbers may be a spur to some, many others need an enthusiastic story to lure them into the marketplace that has already seen a significant advance. The classic case is Apple which I have owned for many years, but have no special knowledge about. Carl Icahn, currently a multi-billion dollar owner of the stock, has been publicly touting an eventual price of $216 compared to the current price of about $129. The media is jumping on with a story in this week’s Barron’s suggesting that the stock could rise 25% this year. Others state that the stock is selling at a discount to its value with the forward price/earnings ratio of 14.7 times. I have no idea whether any of these projections will come true, what I am focused on is that these and similar stories on some other stocks can be the propulsion of enthusiasm which is needed to create a major top.

To me, the surge is on. Be careful how one dismounts this animal, many have done it unsuccessfully.

Creating successful portfolios through science and art

For a long time I have been constructing investment portfolios for institutions and individuals, often using tools that David Rubenstein credits George Washington with as his inventions. One of our readers, a professional portfolio manager has asked how we would construct our time series portfolios. Thus this week I will outline, in many ways the single most important of the portfolios, the Operational Portfolio.

All of the time span portfolios should be viewed as platforms that within their bounds can have aggressive or defensive positions or some combination of them.

Great portfolios are the results of the interplay of science or if you will, numbers and ratios as well as future-oriented judgments. All great artists be they musicians, sculptures, or painters use both schools to reach the desired result.

The Operational Portfolio is designed to meet the current year’s estimated spending requirements and a reasonable guess as to the following year’s needs. In all likelihood these needs will consume all of the capital and income of the portfolio. Even under the best of circumstances surprise demands for spending will occur. Thus all investments in the Operational Portfolio must have weekly, if not daily liquidity and therefore should be reported weekly to the authorized spenders. Because of liquidity concerns at least half of the portfolio should have stop loss orders or similar arrangements, such as  “Good ‘til Cancelled” (GTC) which should be monitored at least weekly.

Clearly this Operational Portfolio is critical to the current needs of the beneficiaries. One can assure more comfort to these spenders and their guardians by increasing the size of the portfolio. However, any increase in size of the Operational Portfolio will decrease the capital to be invested longer-term at higher returns. This may well be the place where George Washington’s type of skills are needed to produce the most effective compromise for the good of the whole effort.

I have said that these Timespan portfolios are platforms which can be populated with various combinations of aggressive to defensive securities. The defensive issues could include US Treasury Bills of various maturities, insured deposits of sound banks and the highest quality portfolio of commercial paper. The aggressive securities could include short-term loan participation portfolios, some broadly based index funds and perhaps some ETF-like vehicle that has a larger mutual fund (which could provide liquidity to the ETF if there was a redemption run on the ETF) and Foreign US dollar pay or hedged short-term foreign treasuries. Populating the specific portfolio for the client is where the art form will shine.

The other three Lipper time span™ will be discussed in future posts.

Question of the week: Do you see signs of a surge?
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