The Investment Process and Portfolio Management

If you’re interested in learning more about how I carry out my personal investments, this is the place to begin. My process and strategies have been formed over the last few years and I’ll still continue to improve as I learn more. The overall process is fairly straight forward. First is the idea-generation where investment opportunities can come from word-of-mouth, what I see on TV or in the media, or an actual explicit screening process where I enter in some criteria in Yahoo Finance (for example) in order to slim down the possible investment universe. Next, when I’ve identified opportunities I want to look further into, I begin the equity analysis stage. This stage utilizes an equity analysis model I built which I talk about in detail in here. After I have analyzed a company and I believe it is attractive, I will add it to a watchlist so that I can keep an eye on the company. The point here is not to jump into the stock right away, but watch the price closely until I think the opportunity is actionable (I’ll describe in greater detail). Finally, with watchlists put together, I utilize a solver and an efficient frontier to determine the best allocations to each security in my watchlist. This is my most recent addition to my process, as opposed to determining some arbitrary nominal amount to invest in a security. If this stuff interests you, keep reading. The article will go into this process in greater detail, which I follow to make personal investments and manage my portfolios.

One, Two, Three Strategies

I manage my personal investments via three separate strategies; three separate portfolios. Why? With each strategy, I follow different guidelines, principles and constraints that impact the investment choices. This gives me more flexibility within my investments so that I don’t have ‘style drift’. If an investment opportunity doesn’t fit the style of one strategy, it’s likely it will fit the style of another. The first is my basic value investing portfolio which I benchmark to the S&P 500 index. I generally get my stock ideas here from Berkshire Hathaway’s publicized holdings (quarterly) or other billionaire portfolio’s that can be accessed online. Not only is it a great way to slim down the possible investment universe, it gives me confidence that someone like Warren Buffet holds the stock too. The basic principles I follow here are finding discounted stocks (relative to their market price) that generate sustainable free cash flow, driven by a strong, sustainable competitive advantage (think Apple with it’s network effects). The second strategy is one I call Global Macro Outlook. While my first strategy is very much a bottom-up approach focusing on fundamentals, this strategy is more top-down and speculative. I allocate capital within this strategy by monitoring global macro events or factors, and I mainly use ETF-vehicles rather than individual securities. For example, the recent (September 2018) currency and economic crises in Turkey and Argentina is an exciting possibility for some exposure to these countries (through iShares ETFs). Another example would be allocating to a market’s consumer staples ETF at a later/ending stage of an economic cycle. There is little fundamental analysis that goes into this strategy. It’s a strategy that I can be a little more adventurous with. Finally, my last strategy is a shareholder yield strategy that focuses on delivering consistent income (dividends or fixed-income ETFs). This strategy still utilizes my basic principle of finding discounted stocks, but I focus more on dividend yield and sustainability in using FCF for distributions rather than other characteristics.

Determining Which Stocks to Invest in

As mentioned in the beginning, I use an equity analysis model (Excel) in order to determine whether or not I’d like to buy shares in a company. My model utilizes financial, ratio, and discounted cash flow analyses, while looking at companies’ competitive advantages and the industry as a whole. Each time I perform analysis on a company, it is always done within a peer group for context. For example, if I’m looking at General Mills (GIS) within the Packaged Foods industry, I’ll also analyze Campbell Soup (CPB), Kellogg (K), and Conagra Brands (CAG) with it. This gives the company’s ratios more meaning when I can see General Mills’ capital structure relative to its peers, as an example. One of the main parts of the model is trying to determine an intrinsic value based on the future cash flows of the business. I don’t like to place emphasis on my forecasting abilities, therefore I use conservative growth rates and discount rates. I also pay attention to key fundamentals or characteristics such as earnings multiples, FCF yield or dividend yield in a time-series. This helps me identify if the stock is currently expensive or cheap relative to its historic measures. Finally, I like to end the analysis by putting the four companies on a scorecard, paying attention to profitability, efficiency, dividend policy, leverage and multiples. I will also write a small one-page report on each company so that I may come back to the analysis and keep a reference library for myself. While I’m confident that this model is far from perfect, it’s important to me to know what I’m buying and determine whether or not I’m buying the stock at an expensive valuation, relative to its peers and its historic measures.  Another additional resource I’ll take is utilizing analysis reports provided by analysts online or via Bloomberg terminal.

Portfolio Construction and Management

Once a stock has passed my analysis stage, I always put it on a watchlist to give myself time. I will never jump right into an exposure. This is mainly because I like to give myself some time to distance myself from the emotion I built up during the analysis stage. Sometimes when I’m analyzing a stock I can get excited about the prospects that I’m seeing. Time helps me get a better grip on the analysis behind the company. As I build a watchlist up, I’ll watch the price- and market-action to see what’s going on. Should something happen that does not materially impact the future earnings of the company, while also impacting the stock price negatively, I’ll usually take the chance to purchase some shares and begin the exposure. However, as mentioned, the latest addition to my process is determining an appropriate allocation to each security using an efficient frontier solver (Excel). When I have a watchlist with some amount of securities I’m planning on investing in (for a certain strategy/portfolio), I will get the historical price/return data and find the return, risk and correlation data to use as assumptions in the solver. The solver uses these assumptions to put together portfolios with different asset allocations, with the objective of maximizing the sharpe ratio of each portfolio. Once the risk-return curve is built, I can select the portfolio that I believe is best at this given time, and begin moving towards the security positions/exposures. I believe this is much more formal, effective process for determining amounts to invest in each security. Rather than investing $300 in stock X, for example, I can determine a dollar amount that fits in with the portfolio as a whole. Then I can slowly work to getting to that position. This is the portfolio construction phase. However it doesn’t stop there. Monitoring and rebalancing when necessary are necessary steps to maximizing performance. If I treat the solver’s asset mix as my policy asset mix, then I sometimes rebalance to the portfolio back to the policy mix.

Putting It All Together

This is the general process I follow when making personal investments. Given the last 10 years or so (since the Global Financial Crisis) has been an unprecedented era of ‘easy money’ and low interest rates, generating positive returns have been relatively easy. However, now that central banks are beginning their tightening cycle and path to normalization, achieving performance (relative to a benchmark) will become tougher. For me, this makes following a formal process even more important. I see the benefit of having three separate portfolios and strategies being that no matter where we are in the economic cycle or what’s happening in global financial markets, one strategy may be able to benefit. I’ll always believe that performing my own analysis is an important step in any personal investment portfolio that should not be overlooked. Finally, portfolio construction and management is the final step that puts the pieces together. If you have any questions or comments, please let me know!

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