SciPre portfolio : Apr 1, 2017

Here’s what the SciPre portfolio looks like as of 4/1/2017.

Asset class Ticker Allocation
Australia stock EWA 4.0%
Brazil stock EWZ 4.0%
Chile stock ECH 4.0%
China stock FXI 4.0%
Commodity basket DBC 5.0%
Egypt stock EGPT 4.0%
Emerging Markets local bond EBND 10.0%
Emerging Markets USD bond VWOB 10.0%
Global value GVAL 4.0%
Gold GLD 5.0%
Gold miner stock GDX 5.0%
Greece stock GREK 4.0%
Hong Kong listed China stock FXI 4.0%
Intermediate-Term Corporate bond VCIT 5.0%
Italy stock EWI 4.0%
Nigeria stock NGE 4.0%
Poland stock EPOL 4.0%
Russia stock RSX 4.0%
South Korea stock EWY 4.0%
Spain stock EWP 4.0%
Turkey stock TUR 4.0%
Total 100.0%

First things first. I do not recommend this portfolio to anybody. Each individual’s risk appetite is specific to that individual, and one portfolio could not possibly serve all.

The portfolio above is different than the one posted on 1/1/2017 in a few ways. Equity (stock) exposure is reduced. The portfolio has more bonds and now includes exposure to a commodity basket. This is a move towards safer assets, and also leads to greater diversification. The portfolio is also exposed to China now, mainly because Chinese equities are significantly undervalued on some key metrics.

As before, allocations are deliberately simplified.

Finally, the tickers are usually those of ETFs that serve the mentioned asset class. I include tickers so that the perfomance of the SciPre portfolio can be tracked. I am not recommending these specific ETF products. In each asset class, there may be mutual funds and ETFs that have lower costs or more desirable features.

Disclaimer: The opinions expressed here are mine alone. I am not offering advice or recommending any product. I may own some of the asset classes and tickers mentioned above, but may not own others. Consult your financial advisor befor making financial decisions.

Of tenbaggers and 100 baggers

A tenbagger is an investment that grows tenfold. A 100-bagger is – you guessed it. I recently read a book with the title 100 Baggers: Stocks That Return 100-to-1 and How To Find Them. I save such books for long flights. 🙂

Searching for tenbaggers or 100-baggers isn’t a substitute for a sound investment plan, but the book highlights the importance of being patient with investments. It is extremely hard to predict which stocks will do the best in the long run. Taking quick profits is a sure way for an investor to ensure that none of his/her positions will ever grow very big. My words lack the eloquence with which Peter Lynch said it in his book One Up On Wall Street:

“The point is, there’s no arbitrary limit to how high a stock can go, and if the story is still good, the earnings continue to improve, and the fundamentals haven’t changed, “can’t go much higher” is a terrible reason to snub a stock. Shame on all those experts who advise clients to sell automatically after they double their money. You’ll never get a ten-bagger doing that.

Frankly, I’ve never been able to predict which stocks will go up tenfold, or which will go up fivefold. I try to stick with them as long as the story’s intact, hoping to be pleasantly surprised. The success of a company isn’t the surprise, but what the shares bring often is.”

Sage advice from an all-time investment great. According to Wikipedia, Lynch averaged a 29.2% annual return between 1977 and 1990, more than doubling the S&P 500 market index.

The author of 100 Baggers suggests an alternative he calls the “coffee can” method. The name is a throwback to a time when stocks were paper certificates. The idea is to stuff certificates into a coffee can and store it in a place where it will stay forgotten for years – quite the opposite of the “online brokerage” method where we can watch the fluctuations of our wealth all day long.

The outcome of the coffee can method is pleasantly often the following. Most stocks do unremarkably, but a few do reasonably well, and one does extraordinarily well making the returns of all others look paltry by comparison. The book has some entertaining anecdotes revolving around this theme.

SciPre Portfolio : Jan 1, 2017

Here’s what the SciPre portfolio looks like as of 1/1/2017.

Asset class Ticker Allocation
Australia stock EWA 5.0%
Brazil stock EWZ 5.0%
Chile stock ECH 5.0%
Egypt stock EGPT 5.0%
Emerging Markets local bond EBND 10.0%
Emerging Markets USD bond VWOB 5%
Global value GVAL 5.0%
Gold GLD 5.0%
Gold miner stock GDX 5.0%
Greece stock GREK 5.0%
Hong Kong listed China stock FXI 5.0%
Intermediate-Term Corporate bond VCIT 5.0%
Italy stock EWI 5.0%
Nigeria stock NGE 5.0%
Poland stock EPOL 5.0%
Russia stock RSX 5.0%
South Korea stock EWY 5.0%
Spain stock EWP 5.0%
Turkey stock TUR 5.0%
Total 100.0%

First things first. I do not recommend this portfolio to anybody. Each individual’s risk appetite is specific to that individual, and one portfolio could not possibly serve all.

Second, the SciPre portfolio combines ideas of valuation and diversification across asset classes and geographical regions. I have put much thought into the design of this portfolio. However, allocations are deliberately simplified. Future posts will illustrate many of the ideas that went into this portfolio’s construction.

Finally, the tickers are usually those of ETFs that serve the mentioned asset class. I include tickers so that the perfomance of the SciPre portfolio can be tracked. I am not recommending these specific ETF products. In each asset class, there may be mutual funds and ETFs that have lower costs or more desirable features.

Disclaimer: The opinions expressed here are mine alone. I am not offering advice or recommending any product. I may own some of the asset classes and tickers mentioned above, but may not own others. Consult your financial advisor befor making financial decisions.

The SciPre portfolio

Starting Jan 1, I will post a portfolio of financial assets – stocks, bonds, mutual funds, ETFs etc. – on this blog.

The portfolio will be based on principles of global asset allocation, combined with my understanding of valuation. The portfolio will be investable. I will deliberately keep the portfolio’s composition simple.

The portfolio will be updated quarterly i.e. on April 1, July 1 and Oct 1. I may update in between these dates if markets move sharply, but this should be relatively rare.

SciPre renamed SciPre

When I started writing this blog, the name SciPre was short for Science of Prediction. But investing is very little prediction. Predicting markets, such as the timing of crashes, is extremely hard to pull off with any consistency. To quote Warren Buffett: “The only value of stock forecasters is to make fortune-tellers look good.”

Rather, investing is a lot of preparation, and in times of risk… preservation. There’s an element of prediction too, but it’s a small piece. I was on a flight last night when I decided to rename my blog from “SciPre – Science of Prediction” to “SciPre – Science of Preparation”.

Where should I invest?

Should I invest:

  • In a bank account?
  • In a home?
  • In stocks?

This question has no simple answer, but it has an answer. Moreover, it is possible to simplify the key elements of that answer. This post is about explaining how different investments can be compared. A word of caution. It is said that a little knowledge is a dangerous thing. It is not the “knowledge” that is dangerous. When a little knowledge brings with it a great deal of “confidence”, that overconfidence can cause a person to take outsized risks and ultimately bring misfortune. Bear in mind that what I say here is a deliberately simplified answer to a difficult question.

Let’s start with the bank account, as this is the simplest investment. Let’s say you put $100 into a savings account in a bank, and the bank pays a 2% interest rate. The $100 is called your principal, and the $2 you will earn in a year is the return on your principal. The chance that you will lose your principal ($100) is small. It can happen, e.g. if the bank shuts down and your account is not backed by the government, but this happens rarely. In the United States, the FDIC protects investors against loss of deposits from bank failure to a significant extent.

How does the bank account above compare with a home? Just as we can put $100 into a bank and earn interest, we can similarly buy a home and earn rent. A two-bedroom, one-bathroom apartment in San Francisco could cost $1 million to buy and $40,000 a year to rent. The rent-to-price ratio is therefore $40,000/$1,000,000 = 4%. If I had a million dollars in cash, I could buy such an apartment and earn a 4% return in the form of rent. This basic idea is simple. Now, let’s get into the weeds. Unlike a bank account, where the principal is fixed, the value of a home can change. Home values usually increase over time, but sometimes they fall like they did when the US housing bubble burst. There are maintenance costs and a variety of taxes (and some tax benefits) associated with homes. Homes are also illiquid, meaning it is not always easy to buy or sell a home.

How about stocks? A stock or a share represents partial ownership of a company. If a company has one million shares, and each share is worth $10, then the company is worth $10 million, which is called the company’s market capitalization. If this company earns $1 million in a year, then the earnings per share is $1 million / 1 million shares = $1/share. The ratio of earnings to price is called the earnings yield. In this case, it is $1/$10 = 10%. Stocks carry many risks, including the risk of going down to zero, and prices that fluctuate daily. Besides, even though the share in this example has an earnings yield of 10%, that 10% is not paid back to the shareholder. Some part of it (or none of it) may be paid out in the form of a dividend to the shareholder. In the example above, if the company chooses to pay 20% of its earnings (20 cents per share) to shareholders, then it has a dividend yield of just 2%. Some investors attach more importance to the dividend yield, which is what they are being paid “now”, than the earnings yield which is reinvested in the company. This example is over-simplified, but it illustrates the idea that money earns return when invested in a business.

The annual interest rate in a bank account, the rent-to-price ratio of a home, and the earnings yield of a share represent the same idea for different investments – the idea of return on investment.

Going back to what I said about a little knowledge, it would be dangerous if the message you take away is that one can compare a bank account, a home and a share of a company based on their return on investment alone. The risks are totally different, so such a comparison would not be apples-to-apples. That said, I find it helpful to compare investments using their long-term expected return, which is what one might reasonably expect if holding the investment for many years. This isn’t easy to calculate, but great minds (including some Nobel laureates) have worked on it, so it’s at least partially understood. I’ll talk more about this idea in later posts.