Category Archives: My Portfolio

Fixed Income, Nov 2017

In this post I’ll go over my fixed income (FI) allocation as well as sharing the outlook and plan for navigating the next bear market. Currently, FI occupies 22.3% of the total portfolio, not counting 5.6% in cash equivalent (3.6% of the 5.6% is the emergency fund in a CD ladder, the rest actual cash). It has fluctuated between 22 and 24% over the past year and I may deploy some cash by year-end to get closer to 24% again. Detailed breakdown is shown in the table below.

My general philosophy is to treat FI as another source of return, contrary to the Boglehead/Bernstein teaching of taking risk in equities only, but consistent with modern portfolio construction methods such as risk parity, max diversification, min correlation, etc. What I ended up with is a “bar-bell” in risk profile where stable value funds in passive is counter-weighed by leveraged CEFs in active.

The stable value funds are in the 401K’s and have a combined yield around 2.5%. $PCI/$PDI/$PFN are Pimco taxable multi-strategy CEFs, and $BGB is a Blackstone bank loan CEF. The current yields are 8.65%, 8.76%, 8.96% and 7.98%, respectively. These four are in tax-advantaged accounts. Pimco has paid a year-end special in the past but I’m not too hopeful this year. $NAC and $PCQ are two CA muni CEFs in taxable accounts, currently yielding 5.12% and 5.38%, respectively, federal and CA tax free (though $NAC has some AMT). The Pimco taxable CEFs in particular have had good capital appreciation with total returns exceeding that of S&P in 2016/17. When comparing with benchmarks, I expect greater out-performance from my FI vs. $AGG than individual stocks vs. $SPY.

Above is a correlation matrix between the total stock market ($VTI) and the CEFs from PortfolioVisualizer.com. My rule of thumb is to assume a 0.4 correlation between the Pimco taxable CEFs and stocks. The muni CEFs show near zero correlation to stocks but don’t quite provide the negative correlation during a crisis. Therein lies the rub: the CEFs provide excellent returns during bull markets but are likely to drop along with stocks in bear markets. This lends itself to market timing where CEFs are swapped with treasuries, which is my plan for the taxable CEFs. The Pimco CEFs are “unproven” in bear markets. Even if they navigate skillfully, investors may still punish them, leaving exploitable discounts. These are opportunities not available in open-ended mutual funds. As for the muni CEFs, trading may not be worthwhile if the bear market is as brief and shallow as I expect. The $TNX (10 year yield x 10) chart below was shown two weeks ago. I’d like to re-balance “into” treasuries rather than “out of” existing holdings. The yield won’t go up in a straight line, however I’m expecting 2.8% first and then above 3% during this bull market.

The PortfolioVisualizer table also shows the volatilities of the CEFs which are on par with that of $VTI. When correlations vanish risk parity degenerates into volatility parity; when the volatilities are equal it degenerates again into equal weight. So the data is suggestive of replacing the cash portion of a Permanent Portfolio with $PCQ. I’ll write about this in a future post.

Towards the end of The Next Bear Market, I painted a rather bleak picture of an investment landscape where the equity risk premium has either diminished or disappeared due to “over grazing” by investors enamored with stocks and the performance assurance from passive buy-and-hold. Fixed income, properly leveraged, may offer a ray of hope in this new world. After all, the FI universe is far greater than equities both in size and variety. It may be the last refuge of active managers.

None of the above is investment advice, the standard disclaimer applies.

Individual Stocks, October 2017

The equity portion in my active strategy are all in individual stocks. For the sake of transparency, here is the list. Please note that this not intended as investment advice and you are urged to always do your own research and make your own decisions. I may conduct transactions with any securities without writing about them prior to or after the fact. No obligation to disclose is implied.

Right now are 30 stocks total. In my old nomenclature I referred to all dividend-paying stocks my “DGI portfolio” and the others as “growth stocks”. I no longer make that distinction since moving all of them to my taxable accounts and reducing current dividend payout became a consideration. Together these stocks account for over 60% of my active strategy or 33-35% of the total portfolio, its single largest component. They are mostly US large caps. Three (Baidu, Tencent, and BYD) are Chinese, while Silicon Labs ($SLAB) is the only mid cap.

In the table, gain/Loss is for price only, based on the cumulative sum paid on all lots. Dividends are not counted. The holding periods vary. Some like Aqua America ($WTR) which is my wife’s and the first lot was acquired in 2003, others a few months ago. Gain/loss information is provided as an illustration that I don’t tolerate deep losses without some conviction in the stock. The overall dividend rate is under 1.5%, less than that of SPY and VTI (about 1.9%).

Many stocks are colored red which is used to indicate strong conviction or “tax handcuff” such that they are not candidates for near term trades. As stated previously in other posts, the only stocks that I more or less made up my mind to sell are in energy. They happen to be in an up-swing so I’ll wait for that momentum to wane.

The relative weights are quite random at this time. There are two schemes under consideration: one is equal weight (1/N); the other is to have two groups, equal weight within each group but one group at a higher level to reflect a greater conviction or expected return. Currently all but three stocks are in round lots. It makes option trading easier but strict conformation to to a weighting scheme more difficult. Overall this is not something that I lose sleep over.

I monitor the sector weights but do not set a target. The overweight to tech and to a lessor extent, financial, is consistent with my overall market view. As the market cycle evolves that will change, but we’re talking about a time frame of years. There are plenty of other tools in my arsenal.

I have only been tracking the individual stocks as a whole since April so there isn’t enough of a track record to make any conclusions. So far they are +2% vs. SPY. My target is to simply match SPY so I’m quite pleased with that. Owning individual stocks allows the lowest cost of ownership (< 1 basis point per transaction at InteractiveBrokers vs. ~5 basis points per annum through index funds), opportunity for TLH, and greater income generation potential by selling option premium. However, I have no edge outside of US large cap so in index funds are a cheap way go get exposure there. In the passive accounts I'm 50/50 US/International and tilting small and EM. Arguably I could use even greater tilts than what I currently have.

So there it is, all my individual stocks. Please note again that None of the above is investment advice, and the standard disclaimer applies.

Portfolio Review July 2017

This is my second portfolio review on the verge of the one year anniversary of this blog. The inaugural edition can be found here. Some background can be found here and here.

Overview

First of all, I want to update the table in the Financial Independence Progress Report.

The portfolio is well on its way to achieving the moderately aggressive goal of “Financial Security” by the end of this year. This milestone is defined as having 20X in the “Total Invested”; where X is, with some padding, the projected post-retirement annual spend. I’d still have a mortgage balance but 20X is such that even if I were to lose my job we would still be able to survive. There would be some painful belt-tightening but at least we wouldn’t end up in the street. YTD, the portfolio has already matched last year in percentage gains (10.87%) as calculated by the simple Dietz method. It’s currently positioned to take advantage of accelerating gains, especially in technology stocks.

“Total Invested” in the table includes the “Total Portfolio” as tracked in this blog as well as the 529 accounts for my daughters and the cash value of a small pension from my wife’s previous employer. “Total Portfolio” is about 90% of “Total Invested”. Networth is defined as “Total Invested” + home equity. We don’t own any investment real estate. I also find it too cumbersome to track the worth of miscellaneous items. The two pie charts below break down the location of various assets.

We’ve always maximized contributions to tax-advantaged vehicles for as long as I can remember. Since my wife is a SAHM these days, current contributions are for my 401K, HSA, and two backdoor Roth IRAs. The backdoor Roth is one reason we kept my wife’s 401K with the previous employer, besides the outstanding stable value fund and other low-fee index vehicles there. Taxable is just shy of half of “Total Invested”, to be drawn upon in early retirement. In a typical year, our taxable contribution outweighs the tax-advantaged kind by some margin, but it does vary since a large part of my pay is incentive-based. Unfortunately I already know 2017 will be leaner than any of the 3 previous years — that I’m still confident about hitting the year end goal is testament to the strength of this market.

Portfolio Strategy Diversification and Asset Allocation

There are two ways to cut across the total portfolio, the first is by different strategies, whether active or passive. Passive stands at just over 40%, active at 56% and the emergency fund (EF) occupies 4%. During the past year, I moved a portion of EF into active accounts due to higher confidence about my position with my employer. The EF is equivalent to about 10 months of current expenses, including potential outlay for medical insurance if I were to be laid off. Total portfolio returns are calculated with cash drag from the EF. The total portfolio and its subcomponents are compared against the benchmark 60/40 SPY/AGG each month.

Before going into each of the passive and active strategies, there is another, more conventional way to look at the overall asset allocation. By that measure I’m at 56% equities, 24% fixed income, 12% precious metal (PM) bullion and miner (miners are not counted towards general equities), 6% cash (includes EF and undeployed cash in active accounts), and finally 2% other that includes cryptocurrencies and options (marked to market). It is difficult to gauge the risk level of this portfolio using conventional stock/bond metrics. 56% equity is very conservative for my age; 24% fixed income + 6% cash is in-line with main stream recommendations. But the fact is I’m already close to the far end of my risk scale since there are assets that are, shall we say, quite volatile. I’m currently underweight PM, 12% with partial hedge vs. 15% target. In addition, I may take on additional option positions. These changes should be completed by the end of August.

Passive Accounts

Passive accounts is where I use Vanguard or equivalent index funds for the equities including REITs. The discussion in May is still current. Target allocation is 55% equities, 30% fixed income (stable value funds only) and 15% PM (mostly bullion). At the start of each year, I conduct a review and set the asset allocation for the rest of the year. Mid-year changes are allowed as long as they are part of the yearly plan. Changes are usually in 5-point steps and there is a maximum swing of 15 percentage points from equities to fixed income. I’m already at the most aggressive stance in my passive accounts and cannot take on any further risks.

Within equities I take a mild slice and dice approach. US is slightly tilted to small and international moderately tilted to EM. The split between US/international is 50/50, and there is a dash of REITs since I don’t have any in my active accounts.

Active Accounts

The active accounts are purely discretionary. They are currently allocated at like this: PMs, 11% actual vs. 14% target; fixed income CEFs, 22% target and actual; growth stocks, 14% actual vs. 15% target; DGI stocks, 45% target and actual; other, 4% actual and target; and cash, 3.5% actual vs. 0% target. Among these categories, I expect the “other” which is cryptocurrencies and options to drift away from the target and I’d be quite alright with that.

In a previous post I spoke of structuring the portfolio to take advantage of both asset bubbles and the supposedly “normal” markets. Given the very nature of bubbles the portion devoted to them needs to be small. Right now that function is taken up by the “other” category which is a combination of cryptocurrencies and directional option combos on tech stocks. My posts on cryptocurrencies can be found here. They are known for extreme volatility. For example, the daily volatility of bitcoin is over 4%, or about 4 times that of gold. Other coins such as Ethereum are even more volatile. So to make the volatilities equal the cryptocurrency position needs to be less than a quarter of the gold position, assume zero correlation. Although I have been writing more about cryptocurrencies lately, larger return potential ought to lie in the developing tech bubble, most likely with AI as the major meme. My chosen vehicles here are option combos that offer high leverage. Similar option strategies were discussed here. Besides cryptocurrencies and tech stocks, I also expect PMs develop into a full-fledged bubble but maturing after the tech stocks.

The rest of the active accounts is geared towards a “normal” if growth-biased market with the same broad categories as passive: PMs, fixed income, and stocks but with more risk. For example, miners, i.e. GDX/GDXJ are a large part of PMs, and they are leveraged to gold price by a factor of 3-4. Fixed income consisted of all leveraged CEFs, which are diametrically opposed to the stable value funds in risk. One major portfolio shuffle this year was to reduce the muni allocation, as it was one source of the major hit last November, increasing taxable CEF allocation in tax-advantaged accounts and move all DGI stocks into taxable accounts. The taxable CEFs have had outstanding performance YTD. This too will one day pass I’m sure, but for now the CEFs are the most reliable performer I have.

At a combined 60% of the active accounts, the actively picked stocks are the largest segment in my portfolio. Performance of the DGI stocks have been tracked since blog inception and I found them rather disappointing to tell you the truth. After the portfolio shuffle, the growth stocks are also being tracked and so far the combined performance just about matches that of SPY. That underscores again how difficult it is to beat the index. I have given myself all the advantages of low cost (one time transaction fee much less than 1 basis point), long holding period, balance between diversification and concentration (~30 stocks total). Of course, there is still the issue of positive skew to contend with. The main advantages I can really see for active stock picking are:

  • More opportunities to sell options
  • The blended dividend rate of the DGI and growth stocks are currently under 1.6%, lower than that of SPY or VTI, so there is some tax savings.
  • It potentially allows me to be more nimble when the market peaks.

The last point is purely hypothetical for now. At any rate, I don’t expect any appreciable out-performance over the index. Below is the sector weight vs. that of S&P. This is something I monitor only, the market weight is not being viewed as a target. If anything, I’m interested in avoiding the under-performing sectors such as energy. Even though the energy sector may have reached a short-term bottom, I’m not optimistic about the secular trend, at least as far as the most vanilla holdings that I have: Exxon and Chevron.

So that’s it, a comprehensive view of the current portfolio. It feels like the major pieces are all in place. With luck, we’ll have the wind behind us for the next 12 months and I’m stoked to see how far it can go.

Investing Philosophy

I’ve been meaning to update the my portfolio post which is linked under the “portfolio” navigation tab, but I’m in the process of deploying cash as part of the on-going correction. So I figure I’ll write a separate post about my investing philosophy.

Below is a list of the basic tenets that I try to follow:

  • Long biased
  • Globally diversified
  • Minimize taxes and expenses
  • Diversify sources of return
  • Strategy diversification
  • Market timing according to cycles of years of duration or longer
  • Use options to generate income and smooth the ride

The first three bullet points are in the “main stream”. As a rule, I don’t have a regular “cash” allocation in either passive or active strategies. Instead, there is a separate emergency fund component in the total portfolio. I’m also far more comfortable being long than short. In the passive accounts at least, I maintain a 50/50 US/international split in equities, although the composition such as large/small US equity or international developed/EM can be fluid. To the third point, I maximize tax deferred contributions every year, including back-door Roth. All assets in the passive accounts are tax-advantaged with the exception of physical PM bullions. In the active accounts, the taxable fixed income CEFs are in tax advantaged as are about half of PM miners and bullion funds. Expenses are minimized by using best-of-breed funds for each asset and doing everything myself. In passive accounts, that means Vanguard index funds/ETFs or equivalent. For individual stocks, I use InteractiveBrokers where the commission is usually under 1 basis point, and partially covered by the interest from security-lending. My expense ratio for holding stocks is at least one order of magnitude less than that of the lowest cost index funds.

The fourth point “diversify sources of return” motivates me to look beyond the traditional stocks and bonds. It’s the reason I have a significant allocation to leveraged fixed-income CEFs (target 24% of active). Taxable multi-sector CEFs have equity like returns and volatilities but are no more than 40% correlated to equities (e.g. VTI, correlation is period dependent, cf. PortfolioVisulizer.com). Leveraged muni CEFs provide tax-free income and even lower correlation to equities (same comment as before). In contrast, sub-sectors within equities are correlated to whole at 90% or above. In the context of mean variance optimization, assets with reasonable returns AND low correlations are extremely valuable in portfolio construction. This is contrary to the Bill Bernstein view that one should take risks in equities and fixed income is for safety — a view that unsurprisingly leads to equity dominated portfolios and equity dominated risk profiles. Note that when the fixed income allocation is viewed across my entire portfolio, the risk profile is a “bar-bell”: stable value funds in passive and leveraged CEFs in active. Diversification is also a reason behind my overall 15% allocation to PMs which I discussed here. The blog post by Charlie Biello is highly recommended — I think of it every time I read a straw man attack on gold along the lines of: gold is thought of useful as an inflation-hedge, data shows it is not; therefore gold is useless. Another often-heard objection is based on the inclusion of gold’s return data just 1975 when gold ownership was again legal despite data from PortfolioCharts shows gold’s ability to lower volatility from multiple starting and ending dates. From a portfolio construction perspective, the only requirement for the inclusion of gold is the low correlation to other assets. I haven’t seen any evidence or prediction that this correlation is going to change in the future.

The fifth point “strategy diversification” speaks to my adoption of both passive and active approaches. The passive/active debate is all the rage in financial media today. Passive is clearly winning and the shift is far from over. Lower fees is undoubtedly beneficial to the investing public. However in so far as the democratization of investing makes it easier to invest and funnels more capital to assets, their valuation must rise thus suppressing future returns. A recent post from the always-insightful PhilosophicalEconomics discussed from a similar perspective. As passive grows in dominance, another danger is the synchronization of investor’s emotional response to market declines. This is a major reason I employ both passive and active strategies so as to be able to hedge from within the active accounts when the time comes. I also try to avoid the most obvious pit falls in active, i.e. high fees, lack of diversification, to at least give myself a shot at beating my benchmark.

The sixth point “market timing” is perhaps the most controversial. My reasons were laid out this post. The primary objective is to avoid large draw downs in preparation for early retirement within 10-12 years. If my portfolio should suffer a 30% draw down, there would be a significant impact on the quality of retirement or alternatively the retirement date. I haven’t been able to find a static asset allocation that provides adequate protection while simultaneously provide a high return – that pretty much captures the main dilemma facing all investors. A more diverse allocation can reduce the size of the hedges necessary but no static allocation can ever be truly “all weather”. I believe the solution is market timing but only at the right intervals. The tools I rely on are a specific equity pricing model and technical analysis. A second objective of market timing is to enhance returns. I have been say since last November that we’re entering a blow-off phase in the stock market; the view reinforces my long bias and allows me to increase my equity exposure from a baseline of <50% overall. My current projection for the market top is S&P 3000+ sometime around Q4’18 to Q1’19. I also see PMs in a bull market which gives me license to go above a baseline allocation of 10% gold bullion to include silver and mining equities that are leveraged to gold. My current view is that PMs will top after equities, probably later in 2019. Gold should be over $3500 and has a good shot at $5000/oz.

Lastly I use options to enhance returns. More opportunities are provided by directly owning individual stocks than an index as the parts will move more than the whole. I’m a premium seller since it’s known that realized volatilities are lower than implied volatilities. I predominantly sell margin/cash secured OTM puts on stocks I’d like to own while use technical analysis for entry points. From time to time, I also use options for leveraged longs as discussed here.

So there you go, these are the seven tenets that guide my investing decisions. People attach an almost religious fervor to their chosen investment approach, so I’m not out to convert anyone. It is a human condition that no amount of back testing or modeling can predict the actual returns which will only be known at the end of our investing lives by which time it’s too late to change. I have made peace with my path and will accept anything that comes my way.

Performance Tracking January 2017

For calculation methodology see earlier post

2017 started with a bang — precious metals performed well even though it was looking to retest the 2015 lows at the end of last year. Since PMs are the main drivers in the “tracking error” (I hate that term!), my portfolio did well relative to the overall market. The S&P also had a good month, gaining 1.79% while the bonds gained 0.21%, meaning the benchmark 60/40 portfolio picked up 1.16% for the month.

Passive Portfolio

The total passive portfolio gained 2.11%, the portion outside of the 15% allocation to PMs gained 1.34%. In this post, I outlined my plan to increase the equity allocation by 5%. I’m about half way done. Funds has already come out of TBM but has not been added to equities just yet. The market has been directionless for a long time. Since the model has a low in February and I know it can’t be timed perfectly, I have already started to transfer funds slowly. I can only access the emerging market index fund, VEMAX, in a Roth IRA at Vanguard and the space is limited. Hence I had to dial down its allocation by 1% and shift to VTIAX. The allocation for the rest of 2017 looks like this:

Active Portfolio

The overall active portfolio gained 2.37% despite the drag from DGI whose main culprits were victims of presidential tweets and Target. Large changes are being made in FI: reducing muni CEFs in taxable and adding to taxable CEFs in taxed advantaged. I’m using this opportunity to cull back certain dividend stocks.

Plan and Forecast

Transition to my AA is straight forward and should be completed by the end of February. In the active portfolio, the goal is to maximize tax advantaged space for taxable CEFs. Consequently, dividend stocks will all end up in taxable. Tax considerations alone forces me to favor stocks with high dividend growth over high current payout. Currently, the blended payout ratio for my DGI stocks is 2.74% vs. 2.03% for SPY and 2.93% for VXUS. I expect this ratio to come down further. I’ve also started positions in MKL, aka “the baby Berkshire”. It doesn’t pay any dividends so doesn’t count towards DGI. I’m taking my time to buy the taxable CEFs as they have all been on a good run — patience is definitely a virtue. This process may continue well into March or April.