Sector Allocation – 2017

On a regular basis, articles are written regarding Sector Allocation. In a nutshell, this refers to the allocation of a portfolio across various business lines (industry sectors). There are several methodologies in use, but most use a risk tolerance/individual preference/age matrix to identify an investing strategy tailored to ones’ circumstance.

Last week I shared my International Allocation to close 2017, this week my focus will be how I allocated the portfolio between sectors.  This is a composite view as I don’t currently differentiate between US and international companies.  Also, my approach to investing likely differs from most in that I attempt to identify trends or situations that may prove to be profitable. Then I’ll run with the idea until the broader market adjusts its’ pricing. An example of this is Financials which represented 16.6% of my portfolio in 2015 on the assumption that it was ripe for consolidation. I added further in 2016 on the premise of rising interest rates. The market caught up with – and exceeded – my expectations with the election and hope for 2017 regulatory reform. I’m not much of a buyer now in this sector as frankly there remains little upside potential and I consider myself overweight.   I continue to hold with the expectation of rising dividends through the stress tests, CCAR cycle and further interest rate increases.

The downside of investing based on a thesis is – unless diligent – the portfolio can quickly get out of balance.  The upside is that if correct, you tend to beat the market.  One could say it’s timing based on external events.  So let’s first check my themes:

THESIS DRIVEN INVESTING

THEORY DATE TTL RETURN S&P RETURN
Small Banks 15 May 2014 76.1% 56.0%
Transaction Processor 29 May 2014 39.4% * 54.4%
Smaller banks 2 Sep 2014  60.6%  47.1%
Consumer focus 6 Jan 2015  72.2%  44.0%
USD weakness 25 Mar 2015  24.3% *  38.9%
Underlying Primerica assets 24 Dec 2015  22.2% *  38.4%
Coke bottlers 31 Oct 2016  19.7%  32.0%
Blockchain/China controls 14 Dec 2017   5.2%   3.0%
* indicates mergers or spins which distort reported returns.  Of these, only Primerica lagged the S&P.  The other laggard I suspect will be a beneficiary of the tax plan.

The ‘meat and potatoes’ of the portfolio resides in the ‘Anchor’ holdings which are targeted at 18% in total.  These three issues have lagged the target for a couple of years (and are currently about 13.5%) hence my renewed effort to increase my KMB, CLX and WEC holdings this year.

Two other components factor into my 2018 thought process – free trades.  In prior years, I performed a handful of trades in my brokerage account sometimes in 10 share increments, but more often in 25 or 100 share lots.  This was done to reduce the percentage paid in fees to a nominal amount.  My broker has placed 20 free trades in my account while Motif has implemented a no-fee option which I tested on Friday morning.  While these no-fee trades exist I will probably execute more – but smaller – transactions, essentially filling in some gaps in my smaller holdings.   This may also result in the sector allocation for 2018 seeing minimal improvement.

With the caveats out of the way, let’s take a look at my end of year sector allocations:
2017 EOY SECTOR ALLOCATIONS

SECTOR YE 2017 YE 2016
NOTE
Discretionary 24.36% 25.43% will be reduced to 11.47% with 2018 sector changes
Energy 6.46% 6.20%
Financial 32.18% 29.29% some of the increase could be considered Technology
Health Care 2.54% 3.72%
Industrials 5.27% 5.11%
Materials 0.68% 0.79%
REIT 1.88% 2.06%
Staples 12.34% 12.93%
Technology 7.19% 6.44%
Telecommunications 1.36% 1.55% will be increased to 14.25% with 2018 sector changes (Communications Services)
Utility 5.75% 6.5%
Sector changes on schedule for September 2018

Basically little change from last year – a little heavier in financials. I’m hoping my purchase strategy reduces this to some degree, but I’m willing to wait a little further into the rate hike cycle before getting overly concerned.  But it’s a little like herding cats – you get most of them heading one direction and invariably a couple dart another direction.

As I’m finished with my analyses for 2017, next week regular programming returns.

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Volatility Returns!

With the wild ride in the markets this week, I perused some of the community’s blogs to gauge the reaction.  While not meeting scientific norms regarding sample size, I was surprised by the lack of reference to the pullback in 66% of them – including ones with posts as recent as yesterday.  Perhaps it’s a lack of funds to take advantage or the deer in the headlights syndrome.  One blog, Fully Franked Finance, had a timely piece a few days prior which stated the importance of a ‘shopping list’ – as many others also encourage.  I too, engage in a strategy which emulates  the ‘shopping list’ strategy.  So, what were my moves so far this month?

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Jan 2018 Update

The market came out of the chutes and barely looked back this month, the catalysts being the realization of the tax plan’s impact on corporate earnings and few earnings reports being significant disappointments.  The lower tax rates started trickling  into paychecks (average about 3.5%) but the average gas price nationwide increased by roughly 5% primarily due to the weakness in the US dollar  (caused in part by the prospects of increased deficits from the tax plan that haven’t been offset by jobs, productivity or GDP gains yet).  At least we can watch commercials touting unrealized benefits even though it is way too early for any tangible impact to  be realized.  Kind of makes me wonder a little.  For the month, the S&P index increased by 5.62%% while my portfolio value increased by merely 3.81% putting me behind by 1.81% to start the year. Continue reading

The ‘New’ Xerox

Nothing like trying to wrap your head around a convoluted deal before the first cup of morning coffee.  This one is likely tailored to provide an exit strategy for activists Carl Icahn and Darwin Deason.  The end result is that Fujifilm Holdings (FUJIY – 4901.TSE) will acquire majority ownership (50.1%) of Xerox (XRX).  This will be accomplished by Fuji Xerox first buying Fujifilm’s 75% stake in the current Fuji Xerox / Xerox joint venture followed by Fujifilm buying 50.1% of ‘new’ Xerox shares.

When completed (July/August 2018), the entity will retain the Fuji Xerox name, be traded on the NYSE (probably XRX) and shower existing Xerox shareholders with an estimated $9.80 special dividend in addition to a minority ownership stake.

Even though this combination is of two troubled companies, with cost cutting and synergies this could evolve into an interesting arrangement – particularly if R&D is applied more towards emerging technologies (think the AI/AR space).  The other question is the dividend scheme where Xerox pays quarterly (Jan/Apr/Jul/Oct) and Fujifilm pays on an interim/final (Jul/Dec) cycle.  The old Xerox annual dividend rate has been affirmed on a continuing basis.

While I already obtained what I was after in this investment with the prior Xerox spin of Conduent (CNDT), with the special dividend this moves from a slight loss on the books to a 5.3% gain.  I’ll continue to monitor this one as it progresses but my guess is this will be my first Japanese holding albeit gained through a back door approach.

Johnny-come-latelies

Generally I refrain from back-to-back posts with similar topics but decided to make an exception this week as the moving parts have kicked into high gear.  My post last week addressed my uneasiness with cryptocurrency as well as my interest in the underlying blockchain technology.  It appears that my view has some support as two blockchain ETFs debuted on January 17th (BLOK and BLCN) and one January 25th (LEGR).  This should be followed by KOIN next week.  Horizons and Harvest (HBLK) also have ETF applications pending.  Grenadier penned a piece on Seeking Alpha that did some analysis on the first two.  Four of LEGR’s top five holdings are included in either one or both of the originals so it will probably be similar.  David Snowball highlights this sentiment in his piece There’s no idea so dumb that it won’t attract a dozen ETFs stating, “…there are no publicly traded companies that specialize in blockchain; there are mostly companies with a dozen other lines of business that have some sort of efforts going into blockchain.”  This is 100% correct.

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My Views on Crypto

There have been many times where my opinion of cryptocurrency and blockchain have been sought.  My thoughts have always been – and continue to be – that blockchain holds promise while Bitcoin and most of the other cryptocurrency contenders have little merit.  Point of fact being I did add to my blockchain centric investments last month while refusing to play in the pure cryptocurrency sandbox.  With the current euphoria I decided this week to at least frame my position a little while noting I could be either wrong, premature or both.

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Let The Spend Begin

Curious minds have pondered the meaning of the Great Tax Reform Act of 2017, properly known as the Tax Cuts and Jobs Act of 2017.  The debate has centered on whether repatriation or employee salaries or buybacks or dividend increases or debt repayment or capital investment.  Until Walmart, announcements have centered on bonuses or hiring pledges.  Not wages.  Not anything, really, that is a truly lasting benefit to the working stiff.

 

And this week is no different.  In a nod to the roughly 50% of population that own stock, Thursday, DST Systems announced they were being acquired by SS&C Technologies Holdings in an all cash deal valued at $84 per share.  While M&A activity is not an unexpected byproduct of the tax bill, there were two noteworthy items in the release.  The first being SSNC’s deal financing being a combination of debt and equity.  Current SSNC shareholders will be facing some level of dilution.  The second item is that the “significant leverage” will be attenuated through “cost synergies to stem from data center consolidation and reductions in corporate overhead”.    This sounds like code words for force and facility reductionAre there that many data centers on the company books?

Not being a SSNC shareholder (current or apparently future) appears to be a blessing in this merger.  As a DST shareholder I will be happy to tender my shares (and vote my proxy in favor of) the deal.  My only regrets are two: 1) Kansas City (for which I have a fondness) losing another company’s headquarters , and 2) that I didn’t own more shares.

My shares were purchased in four tranches with an average (post split) basis of $62.71.  Total gain will be $21.29 per share or 25.3% total gain (annualized average gain would be about 11.7% depending on when it closes).  Not too shabby a return and a good start towards equaling last years’ results.  The merger is expected to close in the third quarter.

The only other negative is the (new) tax impact with these gains likely locking me into the higher bracket I was attempting to avoid.  My philosophical observation being unless you’re extremely wealthy, the best way to avoid taxes is to make no money.  A theory to which I don’t subscribe!