Tag Archives: management

Concentrated Mutual Funds: Leaving Too Much To Luck

Summary The International Monetary Fund had raised caution on US mutual funds with large positions in high-yielding bonds that are issued by risky companies in the country or in emerging economies. To tap the low-rate environment, many mutual funds had stacked up these high-risk securities. Investors must note that mutual funds with a concentrated portfolio offer plenty of risks. The International Monetary Fund had raised caution back in September on US mutual funds with large positions in high-yielding bonds that are issued by risky companies in the country or in emerging economies. To tap the low-rate environment, many mutual funds had stacked up these high-risk securities. What this also indicates is a risk of concentrated holdings. While we are well acquainted with the benefits of having a diversified portfolio, investors must also note that mutual funds with a concentrated portfolio offer plenty of risks. The latest example of a mutual fund fiasco due to a concentrated exposure takes us back to the Valeant Pharmaceuticals (NYSE: VRX ) stock, which has seen a freefall since after mid-September. Eventually, Sequoia Fund (MUTF: SEQUX ) that has nearly 30% of its assets invested in Valeant suffered a nosedive. While this is one example, data from Thomson Reuters’ Lipper show that 13 other US equity funds (having over $1 billion worth of assets) have over 10% exposure to a single stock. Valeant’s Loss Drags SEQUX Down Valeant’s stock nosedived after it increased the price of two drugs (Nitropress and Isuprel) in Sept. 2015. Since Sept. 18, Valeant has slumped nearly 70%. Better-than-expected third-quarter earnings failed to halt the plunge, as allegations of debatable transactions with specialty pharmacies surfaced. Investors questioned the accounting and business practices of Valeant, in particular its relationship with specialty pharmacies. Valeant had issued a press release defending the accusations on its financial reporting and operations. The company clarified in its statement that it does not draw sales benefit from any inventory held at these specialty pharmacies. Valeant emphasized that its revenue recognition policy and accounting plan are in compliance with the law. However, these efforts were wasted as Valeant shares continued to decline even after a presentation in favor of the company by Bill Ackman, Chief Executive of Pershing Square Capital Management. Incidentally, Ackman is also the third-largest shareholder at Valeant. The stock’s slump affected its investors and the largest mutual fund holder, Sequoia Fund, ended up as a big loser. Since Sept. 18, SEQUX has lost 25.3%. Recent events related to this perhaps highlight the risks of concentrated holdings or investing too much in one stock. In late October, Vinod Ahooja and Sharon Osberg , two of the five independent directors of Sequoia Fund, resigned from the board. Separately, the fund house had to post a letter on its website to defend its significant investment in Valeant. The letter stated, “We have been asked by clients and friends why we own such a company. In our view, Valeant is an aggressively managed business that may push boundaries, but operates within the law… We believe the company will learn from the current crisis the importance of reputation and transparency to all stakeholders, especially the shareholders.” Focused Funds and Risks Focused funds are ones that invest in a limited number of companies, rather than having a diversified portfolio. The advantage of a diversified portfolio is that losses from certain investment instruments can be offset by gains in others. So the risk is diversified. However, for the concentrated or focused funds, the fate solely rests on the direction that the limited numbers of stocks are taking – either north or southward. A counter argument here is that well-chosen stock picks that are surging can also translate into significant gains for mutual funds. However, does that terminate the risk of the stock stumbling on hurdle and slipping into the bear territory? A case in point is Putnam Equity Spectrum A (MUTF: PYSAX ), which has 20.3% exposure to Dish Network (NASDAQ: DISH ). While in 2014 Dish Network gained 26.4%, PYSAX registered gains of nearly 3%. However this year, DISH’s 11.7% year-to-date loss of 11.7% is in tune with the 10.5% loss slump in the Putnam Equity Spectrum A fund. At the end of last year, Fairholme Fund (MUTF: FAIRX ) had almost half of its assets invested in American International Group, Inc. (NYSE: AIG ). However, Fairholme has diluted the holding to 19.59%, while 19.16% of its assets are invested in Bank of America (NYSE: BAC ) and 10.9% in Sears Holdings (NASDAQ: SHLD ). Funds with Above 10% Exposure to Single Stocks Some market experts are of the opinion that the purpose of a mutual fund is questionable when it has over 10-15% exposure to a single stock. However, we do have some examples of funds having at least 10% exposure to a certain stock. To begin with, Blue Chip Investor (MUTF: BCIFX ) has 30.8% of its assets invested in Berkshire Hathaway Inc. (NYSE: BRK.A ). While Berkshire Hathaway is down 9.6% so far this year, BCIFX has lost 3.4%. As of Jun 30, the total issues in the stock holdings for this Zacks Mutual Fund Rank #4 (Sell) fund was 14. Fairholme Allocation (MUTF: FAAFX ) and Fidelity Select Computers Portfolio (MUTF: FDCPX ) also have at least 20% invested in a single stock. FAAFX has invested 23.3% in Sears Holdings, while FDCPX has a 20.6% exposure to Apple Inc. (NASDAQ: AAPL ). FDCPX has also invested 9.2% in EMC Corporation (NYSE: EMC ). Year to date, Fairholme Allocation has lost nearly 7% while SHLD is down 33.7% in the same period. FDCPX has slumped 10.1% year to date. While Apple is up 6.3%, EMC has slumped 15.4% year to date. FAAFX has just 9 issues in the stock holding, FDCPX has 30. Both FAAFX and FDCPX carry a Zacks Mutual Fund Rank #3 (Hold). Separately, Fidelity Select Telecommunications Port (MUTF: FSTCX ) and Putnam Global Technology A (MUTF: PGTAX ) are two funds that have at least 10% invested in two separate stocks. Moreover, total issues in these stock holdings are also fairly high. FSTCX has invested 24.4% and 15.4% in AT&T, Inc. (NYSE: T ) and Verizon Communications Inc. (NYSE: VZ ), respectively. In case of FSTCX, year-to-date losses of respectively 0.2% and 3% for AT&T and Verizon were in contrast to the 2.5% gain for the fund. Perhaps, having 50 total issues in stock holdings helped to mitigate the loss. For example, among other holdings T-Mobile US, Inc. (NASDAQ: TMUS ) and Telephone & Data Systems Inc. (NYSE: TDS ) have gained 38.5% and 14.1 and FSTCX has invested 4.5% and 2.7% in them, respectively. FSTCX carries a Zacks Mutual Fund Rank #1 (Strong Buy). Coming to PGTAX, it has 11.9% invested in Alphabet (NASDAQ: GOOGL ) and 10.6% invested in Apple. Year to date, PGTAX has jumped nearly 12%, riding on Google and Apple’s year-to-date gains of 43.2% and 6.3%, respectively. PGTAX holds a Zacks Mutual Fund Rank #2 (Buy). So, taking a call to either invest in or abstain from concentrated funds depends on investors’ investment objective as the element of risk stemming from the direction of the largest stock holding decides their fate. While investing in PGTAX and FSTCX has proved fortunate, SEQUX, BCIFX and FAAFX have not been too lucky. Original post

Nondomestic Equity Funds Continue To Attract Money

By Patrick Keon In every year, except one, since the global financial crisis, nondomestic equity funds have experienced overall net inflows. The one exception occurred in 2012, when the group suffered $3.0 billion of net outflows. Conversely, domestic equity funds have had net outflows every year since the global financial crisis except for 2013, when the group took in just over $79 billion of net new money. This trend has been amplified so far in 2015. The gap between the two types of funds has never been so wide, with nondomestic equity funds experiencing positive flows of over $104 billion for the year to date, while domestic equity funds have seen almost $101 billion leave their coffers. The positive flows into nondomestic equity funds this year have been dominated by funds in Lipper’s International Multi-Cap Core (IMLC) classification; the group has taken in $72.2 billion of net new money, while International Large-Cap Core Funds (ILCC) and Emerging Markets Funds have contributed $14.1 billion and $6.1 billion of net inflows to the nondomestic equity funds’ total positive flows. The Vanguard Total International Stock Index Fund (MUTF: VGTSX ) has taken in the lion’s share of the net new money within IMLC, with net inflows of over $54 billion for the year so far. The activity within ILCC has been a little more widespread, with the Bridge Builder International Equity Fund ( BBIEX , +$2.3 billion), the Ivy International Core Equity Fund ( IVIAX , +$1.8 billion), and the T. Rowe Price Overseas Stock Fund ( TROSX , +$1.5 billion) contributing the most to the group’s total. Within the Emerging Markets Funds classification, there have been seven funds that have taken in over $1 billion of net new money for the year to date. The largest net inflows belong to two Fidelity funds: Fidelity Strategic Advisers Emerging Markets Fund ( FSAMX , +$3.5 billion) and Fidelity Series Emerging Markets Fund ( FEMSX , $2.7 billion).

25% Allocation To Apple – Too Much Risk?

Summary Apple remains my largest position at 25.9%. The portfolio risk factor is not necessarily increased with position size. Reflect your knowledge or confidence in a company with your position size. After releasing the details of my Young and Cautious portfolio , one of the most frequently presented criticisms is of the very high allocation to Apple (NASDAQ: AAPL ). My current allocation is just north of 25%. Company Current p/e Current yield Annual dividends ($) Portfolio weighting (%) Apple 13 1.75 110.2 25.9 Aberdeen Asset Management ( OTCPK:ABDNF ) 10.53 5.21 130 9.6 Bank of America (NYSE: BAC ) 13.07 1.13 5.8 2 Coca-Cola (NYSE: KO ) 27.47 3.08 36.96 5 DaVita HealthCare (NYSE: DVA ) 33.16 0 0 11.6 General Motors (NYSE: GM ) 13.24 4 72 7.5 Gilead Sciences (NASDAQ: GILD ) 9.78 1.61 46.44 11.9 McDonald’s (NYSE: MCD ) 24.64 3.12 27.2 3.7 Rolls Royce ( OTCPK:RYCEY ) 8.28 4.18 62.42 7.5 Transocean (NYSE: RIG ) n/a 4 100.8 11 Wells Fargo (NYSE: WFC ) 13.51 2.7 27 4 Note: Average Yield = 2.6% The following comments sum up the main criticisms of the portfolio, which can be found in Young and Cautious – One month on and First Portfolio review – Young and Cautious , respectively. (click to enlarge) (click to enlarge) Although I respect the views of many commentators and contributors, I do not accept that the best strategy for an active investor is to just divide your capital equally among a list of companies that you think might perform well, regardless of their individual valuations and business circumstances. I will set out below why a higher allocation in a common stock does not necessarily lead to higher overall risk for your portfolio, and specifically, why I have allocated such a large percentage to Apple. Risk Risk can be split up into systematic risk and company specific risk, or non-systematic risk. However, for the purposes of this article, only company-specific risk will be analyzed. When talking solely about stocks, it is undeniable that non-systemic risk can be mitigated through splitting your capital among a variety of common stocks. This leads many investors to argue that the best way to reduce risk is to evenly distribute your capital over all your holdings. For example, 10 stocks with 10% weighting, or 20 stocks with 5% weighting. Many writers disagree on the ‘perfect number’ that provides the best risk/reward scenario for an active investor. Arguments generally range from 10 at the low end, to around 40 at the high end of the scale. Anything higher than this leads to a significant amount of money spent through transaction costs, which will impact significantly depending on how frequently positions are bought and sold. A higher number of stocks in a portfolio would most likely warrant the need to just take on a more passive approach through using a cheap index fund, such as provided by Vanguard. The risk that is not mentioned when talking about diversification Apart from individual company risk and systematic risk, one of the most prominent risks inherent in over-diversification is yourself. Your knowledge and time has to be spread over a higher number of companies, undeniably leading to the risk of gaps in your knowledge. This could be not having enough time to go through each company’s quarterly reports and individual valuations. This inefficient manner of investing has the potential to lead to sub-par returns. In addressing this view, investment icon Warren Buffett has stated: Once you decide that you are in the business of evaluating businesses, diversification is a terrible mistake to a certain degree. His reasoning is based on the idea of the mistake of omission in investing: Big opportunities in life have to be seized … Doing it on a small scale is almost as big a mistake as not doing it at all. This is not a scarcely held belief of prominent investors around the world. Below you see how frequently a large position plays a role in those investors’ portfolios: Warren Buffett Wells Fargo 19% Kraft Heinz (NASDAQ: KHC ) 18% David Einhorn Apple 20.5% Carl Icahn Icahn Enterprises (NASDAQ: IEP ) 27.5% Apple 21% Bill Ackman Valeant Pharmaceuticals (NYSE: VRX ) 25% Air Products & Chemicals (NYSE: APD ) 18.8% Chase Coleman Netflix (NASDAQ: NFLX ) 22.9% Amazon (NASDAQ: AMZN ) 20.1% Although not all of the companies have performed well over the past year, most notably Valeant Pharmaceuticals, most of them have. This high allocation in a company would classify as a ‘conviction buy’, exemplifying each investor’s confidence in these respective companies. It is what separates them from the rest of the market, allowing them the opportunity to beat the market returns. Know your strengths Every investor has their own strengths. This is down to the fact that whatever their profession is, or if they have a strong passion for something, they will generally have a deeper knowledge of it. This gives them an advantage over the general public and can give them the edge when it comes to putting their capital to work. This can be reflected in your portfolio. For example being a student has its perks. Many trends over what is popular originate from this age group. This could be said with regards to Apple, Facebook (NASDAQ: FB ) and Nike (NYSE: NKE ). What is popular with this age group has a tendency to spread to other age groups to create the norm. Looking back at Facebook, I grew up alongside the likes of Bebo, MSN Messenger and MySpace. My age group saw a shift from these social networking sites to Facebook, because we were causing the shift. Examples such as this give investors of certain age groups, professions, or hobbies that advantage in the market. This is one of the reasons why I am still so bullish on Apple. Regardless of what some financial news websites publish about Apple losing it’s ‘shine’ or ‘cool factor’, it is evident that Apple still has the backing of its supporters. It only takes a trip to any university library to see the momentous number of Apple products being used by students, who are in effect the future. For example, the Mac lineup has been of great popularity. Many students are making use of their university discounts and either upgrading from the previous model or other brand laptops. Growing up, these students will see Apple as the norm and are more likely to continue using their products. On the contrary, there are many areas where my knowledge lacks. This could come down to being young, lack of interest in the subject matter, or just plain ignorance. This is absolutely fine. It just means I don’t invest in these areas. If I invested in these areas for the sole reason of ‘achieving diversification’, I would be opening myself up to a great deal of risk. This is just not necessary. When opportunities are present, grab them by the horns The second part of investing in your strengths is investing at the right price. There are many companies I see doing well. Nike and Starbucks (NASDAQ: SBUX ) are both companies I want to own, just not at these prices. There is too much optimism built into the stocks. On the other hand, Apple is a company I understand well. I have a strong insight into how my generation sees their products and services over their competitors, and most importantly, the valuation is cheap. Valuation The company stands at a huge discount to the overall market. Apple’s trailing P/E ratio stands at just under 13 while the forward P/E is 11. This represents a 41% discount to the current ratio of the wider market, currently standing at 22. Apple is priced for a deceleration in earnings, while it is posting ever-growing earnings. The last earnings report showed EPS growth of 38% over the previous year, with guidance showing further record earnings for the near future. An earnings growth that surpasses the wider market. In addition to this, I believe Apple has in recent years been paving the way to become a future dividend champion. It is managing to consecutively increase dividend payments to shareholders year over year, while maintaining a low payout ratio. Currently, the dividends to shareholders represent only 21% of total earnings. This gives the company a great deal of room to increase payments several years from now. On top of this, Apple stated in April of this year that the share repurchase program would be increased to $140 billion. What are my risks? Having over a quarter of my capital in one stock does mean that if the share price drops significantly, this will drag down the portfolio significantly. Bill Ackman has recently been a victim of this, as Valeant has dropped like a rock after allegations of price gouging surfaced. This has led to him suffering a severe loss of capital and significant underperformance to the market. To compare this to Apple would be unfair. Apple has many factors that give it a large margin of safety to prevent this. First of all, almost a third of the entire market capitalization is made up of cash and equivalents, and this continues to grow. This allows Apple to raise cheap cash in corporate bonds to facilitate large share repurchases. Secondly, Apple’s great P/E discount to the wider market and higher growth rate provides a safety buffer, as it is already priced for no growth. The only time I will reduce this high allocation is if either of two things happen: Earnings begin to fall, or the share price rises resulting in a P/E ratio similar to the wider market. Conclusion Everyone has their strengths in investing. This means having a high allocation of your capital in one company will carry different risks depending on who owns that particular company. When you have the opportunity to own a good company trading at a cheap valuation that you have a deep understanding of, allocate more capital to this to increase your chances of outperforming the rest of the market. Thank you for reading. If you have enjoyed reading this article, or want to follow the progress of the ‘Young and Cautious’ portfolio please hit ‘follow’ at the top of the page. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.