Portfolio Rule #8: Coping With Zero

Portfolio Rule #8: Coping With Zero

This will be a short piece, because what I have to say is simple. My portfolio rule eight requires me to make changes to the portfolio 3-4 times a year. Here’s the rule:

Make changes to the portfolio 3-4 times per year. Evaluate the replacement candidates as a group against the current portfolio. New additions must be better than the median idea currently in the portfolio. Companies leaving the portfolio must be below the median idea currently in the portfolio.

It’s a useful rule, but what if the search that I do doesn’t come up with any suitable candidates for purchase better than what I currently own?

That is what has happened in the second quarter of 2015.

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This hasn’t happened before.

I did my main search, and came up empty-handed. I then did about five additional searches that I never ordinarily do, but are other ways of sourcing portfolio buy ideas. Three also came up empty. One gave me an idea off of a spinoff happening later this month, and another idea that was kind of interesting, but made me edgy regarding margin of safety. The last search gave me four ideas that I am still working through, but none of them thrill me, for various reasons.

I know what my most marginal ideas are in my current portfolio, and I can honestly say at present I like all of them more than all of the remaining ideas I am still kicking around, minus the spinoff. (The key question on the spinoff is how cheaply it trades post-spin.)

After all of my searching, it makes me wonder from a bottom-up point of view whether the market isn’t overvalued. Top down, the market should return about 4.5%/yr over the next ten years, which is about the 87th percentile in terms of expensiveness.

A lot of money can be lost speculating on that idea, and I am not a market timer, so I will let others fight about that. This is just a straw blowing in the wind. Practically, it means this period I do nothing with the portfolio, most likely. It gets tougher if this repeats next quarter.

Your opinions are welcome in the comments.

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was 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. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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