Nick's Portfolio Review Q1 2018

Readers have been asking about my holdings - here's a quick snap shot of my portfolio at the end of Q1.

It’s been a few months since I’ve written a portfolio overweight piece and since several readers have asked for one recently, I figured the end of Q1 was a good time to step back from the individual company microscope and take a broader look at my holdings. Ever since volatility struck the markets beginning in late January, I’ve been much more active in my portfolio management. Some of these maneuvers have been reactionary to what I see as a significant shift in broader market sentiment. After a couple years of extremely smooth sailing, I think recent volatility has uncovered an apparent crack in the current bull market’s armor. I’ve been somewhat concerned about the longevity of the post-recession bull market run for awhile now; however, I’ve also realized that it didn’t make much sense to fight the passive investing/algorithmic momentum to the upside. Because of this I maintained an outsized equity weighting even though multiples were rising. But now I think times are-a-changin’.

It’s hard not to imagine that we’re nearing the end of the current cycle nearly a decade into a bull market run and now that volatility has reared its ugly head, I’ve become much more defensive, focusing more than ever on preserving capital and protecting gains by staying disciplined to my value oriented principles. I won’t be covering individual trades that I made during the quarter in this piece; I’ll cover those in more detail in the upcoming March monthly update. Instead, I will be giving a list of my holdings and their respective weightings within my portfolio and some commentary on the reasoning behind those weightings. I will also provide a snap shot of my dividend growth history.

So, without further adieu, let’s get into the meat of the portfolio.

Because of my focus on wide moats, cash flows, and reliable dividend growth histories, the majority of my holdings fall within the U.S. large cap space. Oftentimes readers/followers ask me why I don’t have more small cap exposure as a younger investor, noting that small caps typically have more growth potential than their mid/large cap brethren. While this may be true, I suspect that these investors require a tad bit more speculation than the large cap competitors with better analyst coverage and more flexibility due to large cash flows/cash pools. I’ve said this before numerous times, but it applies well to the small cap versus large cap discussion: it’s not my goal as a portfolio manager to shoot for the moon and become a billionaire. The competitor in me does hope to beat the broader markets year in and year out, but with that being said, I’m also realistic. I have beaten the markets more often than not (cumulatively over the past 5 years); however, these beats are relatively small.

I’ve been happy with my portfolio’s performance thus far in 2018. Although I’ve managed to keep up with the market during the strong bull run, when putting my holdings together, I hoped that my low beta/defensive names would lead to especially large outperformance during bear markets. The S&P 500 is down 2.93% on the year as I write this. The Dow Jones Industrial average is doing even worse, down 3.68%. Well, my portfolio is the relative winner here, down only 2.52%. Sure, 40 bps isn’t a great amount of relative alpha to the SPY, but it is outperformance and I suspect that this gap would widen if the market fell further.

What I’ve done with my holdings, in a nut shell, is create a fund that closely mirrors the S&P 500 in terms of capital appreciation expectations, while offering me a yield that is higher than the S&P 500’s with better dividend growth prospects to boot. My portfolio yields ~2.15% right now compared to the SPY’s 1.85% yield. I’ve been able to generate double digit dividend growth portfolio wide in the past and I expect for that trend to continue into the future. While I may not post tremendous outperformance on an annual basis with this model (thus far, my best annual alpha relative to the SPY was ~+7% in 2015) I do wholeheartedly expect to compound my passive income at a much higher rate than someone would who was passively invested in the SPY. At the end of the day, even though I invest a small percentage of my savings into non-dividend paying high growth names, my ultimate focus is my passive income stream; that’s how I’ll reach my long-term financial goals and ultimately measure my success as an investor.

With that being said, my U.S. large cap exposure is nearly 71%. For the sake of this piece, I’ve broken down this weighting further into 3 subsets: large cap core, large cap value, and large cap growth, coming in at 26.09%, 21.11%, and 23.47%, respectively.

Outside of the large cap breakdowns, my next largest basket exposure is cash. Right now, my cash position makes up 13.09% of my portfolio. This is my highest cash weighting in quite some time. Coming into the year I was pretty bullish on the market’s overall prospects with the benefits of tax reform coming down the earning’s pipeline. The volatility in late January/early February came as a surprise to me. I made some buys and sells during the peak of the volatility, locking in profits on relative winners and re-allocating those funds to undervalued names; however, I realized that I didn’t have the dry powder available to take advantage of market weakness to the extent that I would have liked to. When the market rebounded in late February and early March, I took steps to take profits on overvalued positions. I’m feeling much better about my flexibility moving forward for with nearly double the amount of cash.

International Equity

Up next, we come to international equities at 10.12%. This is an area of the market that I’ve tried to increase exposure to over the last year or so as a diversification measure. As the U.S. markets ran up, valuations overseas became much more attractive on a relative basis. Lately, I’ve taken profits from several European names and re-allocated those funds farther East, towards Asia. I’m especially bullish on the big Chinese internet names; I think these companies possess some of the best tech in the world and while the Chinese government is a potential concern, on the flip side of that coin in light of recent events, I think it’s actually more likely that big tech in the U.S will face more regulation. China wants to be viewed as a world power and the easiest way to do that in the digital age is to have dominating tech (I took profits on a couple of European ETFs because of that continents lacking technological expertise).

Real estate

After international equities, my next largest sector allocation is real estate, at 4.87%. I’ve had really good fortune when it comes to trading in and out of REITs, primarily using yield thresholds as buy and sell signals. This is a sector that I reduced exposure to a few years back, taking profits as valuations ran up to unjustifiable heights (which pushed yields down below levels where I felt comfortable in the REIT space). Well, throughout much of 2017/2018 the REIT sector has experienced weakness and with yields crossing my target thresholds, I’ve been a net buyer recently. I did sell off a couple of relatively underperformers in this space, taking a capital loss one one of them (Omega Healthcare Investors (OHI)) because of issues with frozen dividends, but for the most part, I like owning these names as contrarian, high yield picks that I suspect will act defensively should economic growth slow.

Before I move on, I should note that when it comes to high yield plays, I’ve historically liked REITs more than utilities. However, the utilities have sold off alongside the REIT names over the past year or so and I’ve got my eye on a couple names in that sector to add to the portfolio as well.

And finally, we have my mid-cap and small-cap exposure. Frankly put, these names have very little bearing on my overall portfolio. There are some names here that I really like, but generally, they trade with premium valuations which has prohibited me from increasing my weighting.

And finally, we arrive at my absolutely favorite graph to look at: my monthly dividend growth stats produced over the last four years or so. This graph gives me concrete proof that my strategy is working. It’s fun to watch the compounding process take place over time. Just about every month I watch as my dividend income climbs and I track the percentage of my bills/mortgage that I could theoretically pay if I was to enter into the distribution phase of a DGI portfolio’s life span today. As I’m able to check more and more boxes off of the lifestyle expense list with my passive income, I sleep better and better at night. It’s fun to watch the compounding process take place over time.

So, there you have it: a fairly clear snap shot of my current holdings. For those of you who’ve recently asked me about my overall portfolio, I hope this is what you had in mind. Best wishes all!