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Time To Diversify The Portfolio?

Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Nov 28 2019

Dear time-poor reader: Quality has proved the absolute winner in Australian equities, but has the time come to diversify through Value?

Time To Diversify The Portfolio?

By Rudi Filapek-Vandyck, Editor FNArena

As another calendar year is drawing to its natural end, time has arrived to once again reflect upon what might have been and what has actually transpired since the world was staring into the abyss this time last year. If not now then when, n'est-ce pas?

Last year an overconfident Federal Reserve, alongside other central bankers around the world, thought it had successfully manufactured an escape from the economic straight jacket that has kept economies into a slower-for-longer framework post GFC, with occasional bouts of threatening mini-crises along the way.

It looks like a strange aberration today, but the Fed actually thought it could continue to hike interest rates while also running down the size of its balance sheet and the world would never notice a difference. Odd.

Maybe the most apt description is the one I have been using in my on-stage presentations to investors throughout years gone by: in theory there is no difference between economic theory and practice, yet in practice there is.

Luckily, for all of us who participate in financial markets, central bankers quickly realised the error in their plans and policies and swiftly reversed into providing further support through abundant liquidity. More than 20% in equity markets return later, here we now are, still dependent on excess liquidity sloshing through the global financial system.

The key question has not changed: how on earth will we ever get off this drug?

This dilemma will remain on central bankers' mind as they worry about a distorted world, constantly in change, with long term future problems accumulating while politicians play the "nothing to see here"-game.

With the stakes this high, and answers so few the best advice anyone can provide to investors today is most likely don't feel too comfortable after what might turn out the best investment year post GFC.

Next year is bound to be different.


On the micro level, it appears growing parts of the investment community are preparing for a resumption of the so-called "reflation"-trade. These experts see global indicators improving. Some are even boldly predicting economic growth, inflation, bond yields and corporate profits will all noticeably rise as we travel through calendar year 2020.

And on the back of this resumption in global growth miners, energy producers, banks, building materials, contractors, cyclical industrials and discretionary retailers, even the agri-sector (as long as it rains), could turn into Must Have-exposures for investors looking for outperformance next year.

Count me among the sceptics.

This is not to say this narrative of hope cannot temporarily conquer the mindset of financial markets. It has done exactly that on multiple occasions over the decade past.

The most violent switch in market momentum occurred in the second half of calendar 2016 when stocks like Transurban ((TCL)), NextDC ((NXT)) and CSL ((CSL)) lost -20% in a heartbeat and CommBank ((CBA)), Woodside Petroleum ((WPL)) and BHP Group ((BHP)) lifted by similar magnitude at the same time.

But it never lasts for long. It didn't back then, and it hasn't on every other occasion, including in recent months.

Some of you, regular readers of my Weekly Insights, might think I am the closest to a typical Growth investor you'll ever meet. I never hesitate to warn that buying "cheap" stocks in today's environment is not necessarily the smartest thing to do. The truth is I am not your typical Growth investor. I am all about Quality.

One of the untold stories about the Australian share market post 2013 is that despite all the attention (and criticism) that has centred around Growth vs Value, Small Caps vs Blue Chips, Momentum and Overvaluation/Exuberance, the true outperformers have been that selective little basket of domestic High Quality companies including CSL, Macquarie Group ((MQG)), REA Group ((REA)), ResMed ((RMD)), Altium ((ALU)), and TechnologyOne ((TNE)).

CSL is now the undisputed number two for the local index, while Macquarie is inside the Top8, REA Group has climbed into the Top30 and TechnologyOne is part of the ASX200 too.

You don't get there unless you put in a consistent and prolonged outperformance against the rest of the market.

Starting from a Top Down approach that tried to incorporate most of the threats and challenges that have remained with the world and global markets post GFC, it has consistently been my view the best risk-reward investment strategy was through companies with exceptional qualities, including the ability to sustainably deliver for shareholders, no matter the weather out there.

Certainly, my research and managing the All-Weather Model Portfolio have made me truly realise the value of owning "Quality" in the share market. Not as a throw-away label too oft used by professional fund managers every time they discuss their top holdings or recent purchases, but "Quality" in the only sense it counts for long term, Buy & Hold investors: the ability to continue creating added value for shareholders, time and again.

The reason as to why this places me closer to Growth than to Value investors is because I quickly learned such High Quality stocks never trade at genuinely cheap valuations on the stock market. They are literally too High Quality for that. This is one key insight most investors misinterpret.

Assuming you are a longer term investor and your preferred holding period is "forever" (wink to all the Warren Buffett fans out there), then good investing seldom starts with a beaten down, kitchen-sink low valuation.

Good investing starts with discovering which companies on the stock exchange are the Special Ones. Then pick your strategy and your entry point, and don't get side-tracked by all the noise and movement around you.

To those who now are confused, insulted, or both I have one simple message: read the two quotes below. They are from Charlie Munger. Yes, that Charlie Munger. Then tell me again where my analysis and observations are different from Charlie's?

"If you're right about the companies, you can hold them at pretty high values."

"Over the long term, it's hard for a stock to earn a much better return that the business which underlies it earns. If the business earns 6% on capital over forty years and you hold it for that forty years, you're not going to make much different than a 6% return – even if you originally buy it at a huge discount. Conversely, if a business that earns 18% on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result."

Je suis Charlie.


While the virtues of owning High Quality companies have become irrefutable to observers who pay as close attention to the share market as I do, if one's focus is solely on such companies occasionally there are disadvantages too.

I still vividly remember September 2016 through to January 2017 when buying instantly dried up for just about every single stock present in the All-Weather Model Portfolio, as well as the stocks I chose to add.

All the market could think of was buy resources, buy banks, sell yesterday's winners. It's a tough call to stick to the long term strategy when short term everything seems to go awry.

Plus, of course, I could be wrong about the validity, timing and duration of the next reflation trade. Maybe governments around the world are truly and genuinely prepared to support their central bankers' effort through significant investments in infrastructure and tax reform. Maybe Modern Monetary Theory is the most effective response to the liquidity quandary the world is facing. Maybe inflation does come roaring from out of nowhere in a few months' time. Maybe Xi and Trump can truly stitch together a genuine growth boosting armistice.

Maybe at a time when market positioning is once again extremely one-sided, and there is latent desire by the professional community to have that rotation into "Value" stocks, maybe this is also the right time to re-think the concept of portfolio diversification?

We all like the idea of backing winners, and to continue backing winners, but this may not be as easy as it sounds when rotation arrives, gets interrupted, founders and tries again. Which is essentially the scenario that has been on display inside the Australian share market since September.

One complicating matter for investors in local equities is, of course, the extremely polarised domestic economy, supported by a hesitant RBA while the government in Canberra remains focused on delivering the promised budget surplus, while parts of the country are suffering from drought and fires, which festers an environment that is forcing companies to issue profit warnings. The most commonly heard warning remains: avoid the booby traps!

For those investors whose portfolios are too much weighted towards Growth and/or Quality stocks, and that are currently contemplating re-adjustment, the goal has to be to seek diversification without taking on board too much risk. In practice this means adding "Value" stocks that are less likely to issue a profit warning or other forms of negative news.

As far as the All-Weather Model Portfolio is concerned, not all included stocks have performed in unison over the year past, and this now means portfolio diversification has been achieved by holding on to stocks such as Amcor ((AMC)), NextDC ((NXT)), GUD Holdings ((GUD)), Link Administration ((LNK)), and Reliance Worldwide ((RWC)).

On various days, it's truly fascinating to observe how market momentum departs the likes of CSL, Viva Energy REIT ((VVR)) and Macquarie Group, but also Xero ((XRO)), Altium and Appen ((APX)), and seeks returns through Amcor, Link Administration and Ramsay Health Care ((RHC)) (and various variations as every week progresses).


In terms of portfolio performance, this second half of calendar 2019 has largely reversed the outperformance of "Value" coming out of the late 2018 bear market; this despite repeated effort by market participants to trigger market rotation and keep it going for longer.

Look no further than the (out)performance of the FNArena-Vested Equities All-Weather Model Portfolio to support the above statement. Note this includes the Portfolio holding on to smaller cap technology stalwarts that have been under heavy attack since September.

For the near five months up until Friday, November 22nd, total Portfolio return ex-fees had accumulated to 7.63% against 3.22% for the ASX200 Accumulation index.

Separated by month, the respective returns clearly show the market swings between Value and Growth/Quality:

All-Weather Model Portfolio
-July 2.95%
-August 0.47%
-Sept 0.88%
-October 1.31%
-Nov (22) 1.82%

ASX200 Accumulation Index:
-July 2.94%
-August -2.36% (minus)
-Sept 1.84%
-October -0.35% (minus)
-Nov (22) 1.19%

Investors should also note the All-Weather Portfolio has been de-risked (we believe) by adding some exposure to gold and to ASX-listed yield instruments that have a low correlation to the share market in general. Plus we always hold some cash. The comparison between All-Weather Portfolio and the Index is thus not apples for apples, 100% equities on both sides. It's closer to 75% equities versus 100% Index.

The experience since early 2015 (the Portfolio is nearly five years old) has been that a reduced exposure to the share market, as a risk reduction strategy, does not impede outperformance. Calendar year-to-date the return is 21.81% versus 23.58% for the Index.

Special Note: Weekly Insights next week will be the final one for this calendar year. It shall return late January/early February to help you preparing for the February reporting season, and beyond.

Rudi On Tour In 2020:

-ASA Hunter Region, near Newcastle, May 25

(This story was written on Monday 25th November 2019. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: or via the direct messaging system on the website).



Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.

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