Sharpening your portfolio managing skills
As we enter year five of the global recovery, we may need to hone our portfolio manager skills.
According to Investopedia, a portfolio manager is the person or persons responsible for investing a mutual, exchange-traded or closed-end fund’s assets, implementing its investment strategy and managing the day-to-day portfolio trading.
Today many private investors are managing their own portfolios because they now have access to the same information at the same time as do industry professionals. I assume most private investors are not active traders engaging in various market-timing strategies but rather just remaining invested through a collection of stocks that may resemble a portfolio.
There are a few things the portfolio manager is trying to do.
Participate in a rising market: The broader stock indices tend to spend more time advancing than declining and so the portfolio should be for the most part, fully invested. I have seen many portfolios whither on the sidelines because the portfolio manager reduced equity exposure only to watch in horror as the markets moved ahead without them.
Maintain some degree of diversification: It is important not to over diversify. When the portfolio owns every component of the S&P/TSX60 index you become the market. This is an OK strategy if you do little analysis, but you will never “beat the market” by over-diversifying.
Avoid sector concentration: A selection of 50 commodity sensitive stocks such as base metals and crude producers is not a diversified portfolio. We need some variation in the asset mix such cyclical stocks, financial stocks and industrial stocks in order to avoid too much component correlation. Remember that birds-of-a-feather tend to fly together.
Rebalance the portfolio: A winwin strategy because we can increase the returns and reduce the risk. Quarterly rebalancing is basically a mechanical process that forces us to stick to the original portfolio weights by reducing components that have advanced and direct the proceeds into the components that have declined.
Now comes the hard part, seeking Alpha.
According to the Canadian Securities Institute, Alpha is the measure of a manager’s skill in adding value by taking active risk. In other words, you as portfolio manager, are trying to beat a relevant benchmark such as the S&P/TSX Composite by tilting the portfolio to overweight positions in more volatile sectors when deemed appropriate. An example would be a temporary reduction in exposure to utilities and a temporary increase in exposure to materials.
One strategy to add Alpha is to seek out the current dominant theme. The dominant theme is a period of rapid expansion of an industry group due to innovation or in reaction to changing economic conditions. Investors and portfolio managers who can correctly identify and ride the dominant theme will likely generate several quarters of above market returns. The first modern dominant theme was the new economy technology boom of the 1980s and 1990s that followed the 1973 Arab Oil Embargo. We had the introduction of the PC and the Internet thanks to the humble beginnings of Cisco Systems Inc., Intel Corporation and Microsoft Corporation. Dumb automobiles became smart thanks to fuel injection and computers. The second modern dominant theme was new millennium emergence of the global economy and the resulting commodity price boom that ended abruptly with the global financial crisis bust of 2007 — 2008. The subsequent recovery from early 2009 has exposed several new dominant themes.
We have had the U.S. housing recovery and the subsequent rebound of the housing and lumber stocks.
We have a boom in the aerospace and transport sector driven by a mix of high energy costs and a travel/consumer boom which has the major airlines upgrading their fleets along with municipalities upgrading their transit networks.
We have an energy infrastructure boom trigged by private and public entities converting from dirty, expensive energy to cleaner and cheaper natural gas.
Food and water demand have grown over the past several years, driven by the expansion of the global economy.
On the subject of food, our chart this week is that of the weekly closes of the BMO Agriculture Commodities Index ETF (ZCA) plotted above the CBOT wheat price in cents per bushel.
According to BMO, the Agriculture Commodities Index ETF has been designed to replicate the performance of the S&P GSCI Agriculture Enhanced Capped Component Index which holds “soft” futures contracts to include cocoa, coffee, corn, cotton, soybeans, sugar, wheat and so on.
The price correlation between the ZCA and wheat is obvious and so are the current bullish higher lows which suggest a pending new advance in the grain complex. The Alpha is found if the food group ignores any setbacks in the broader equity markets.