Committing Reserves - Weekly Blog # 547

Mike Lipper’s Monday Morning Musings

Committing Reserves

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

Any student of military history will be presented with the reasons why important battles were won and lost. Often the critical decision was when and how reserves were committed, both in defensive and offensive phases. The same thing can be said for managing portfolios. The standard battle structure used by the US Marines for maneuver units is, two up and one back, plus support units. On offense, reserves are committed to replace the tiring front line units so that fresh troops can pick up the pace of an attack. On defense, if the front line forces are pushed back, troops held in reserve are committed to stop the breakthrough, where enemy's troops are expected to be tired and somewhat disorganized. The keys to committing reserves are the factors of time, surprise, and location.

Applying these military lessons to portfolio management, the following principles come to mind:

1. Reserves need to be of sufficient size to maintain or regain the momentum. The two up and one back suggests that reserves should be in the range of 1/3 of the active forces.
2. Reserves should not be committed piecemeal, as they lack sufficient force to accomplish the main objective.
3. Reserves should not be committed too early, suggesting a 25% decline from the prior peak might give sufficient space to pick up bargains.
4. After committing reserves, be prepared to assign additional assets in order to preserve critical resources.

Husbanding Reserves
This week both Goldman Sachs and Morgan Stanley reported unexpectedly good earnings, which the market treated positively. In carefully reading their release and listening to their conference calls, there were some cautionary notes. Both are watching very closely for any weakness in their credit extensions.

Awaiting Direction
Along with other money managers, flows were slower than earlier periods. Modest earnings gains are expected by various analysts. The biggest gains are expected for the Russell 2000, which may be influencing the proportion of firms becoming profitable.

The average Large-Cap growth fund is up +9.09% YTD and +12.72% for five years, with both exceeding the average S&P 500 Index Fund performance of +4.78% and +11.52% respectively. The period of superior performance for index funds may be over for a while.

Major Commitment
Finally, on Thursday there was the announcement of Mass Mutual selling Oppenheimer Funds to Invesco for approximately $5.7 Billion, largely in stock.

In looking at the price, there are two interesting points. First, the rumored price was $5 billion in cash. This is roughly equivalent to $5.7 Billion in stock, in my opinion. Second, the seller wanted to stay invested in the mutual fund business. I view both as a vote of confidence in the business. Invesco has good distribution capabilities in Europe and Asia, which may be effective in selling the Oppenheimer Funds.

 Mass Mutual as a knowledgeable seller becomes the largest shareholder in the combined company and obtains a board position. They like the outlook for the business but probably don’t like the outlook for Oppenheimer’s retail fund operation. Mass Mutual has retained their ownership of Barings, an institutional player.

My clients and I own positions in a number of their domestic and international fund management companies.

Prudential Needs Smaller Reserves
Prudential Insurance is no longer labeled as a SIFI (Strategically Important Financial Institution) It did not have to contort itself as Metropolitan Life did to shed the title, it just had to be more patient and work Washington well.

Risk Management, not a Perfect Defense
Risk appears to be singular but in reality it encompasses a number of known and unknown risks. This multiplicity of risks makes it difficult to model as a single risk factor. This is particularly true due to a growing list of unknown risks. Thus, there is no such thing as a riskless investment.

Some Portfolio Managers Reduce Market Risks
The following brief comments are derived from reading the quarterly institutional reports from T. Rowe Price and Wasatch Funds, that we and our clients own. They are derived  from portfolio managers who also look at broader issues that may be of interest to our subscribers.

1. In the third quarter and continuing into the fourth quarter, security valuations didn’t seem to matter much. High Price/Earnings ratio stocks outperformed those with lower Price/Earnings ratios.
2. Investors remain complacent to the potential of future shocks.
3. A number of portfolio managers are pruning their portfolios by selling into strength.
4. At least one perceptive portfolio manager is taking advantage of the fall in Chinese stocks prices by broadening and deepening her commitment to non-tech Chinese stocks.
5. Concern for the housing outlook favors beneficiaries of short-term and longer-term lower commodity-priced inputs.
6. Trimming some Software-as-a-Service stocks.

In our private financial services fund I personally own shares in the publicly traded T. Rowe Price stock.



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