Stock Portfolio and Watch List Update for July 2012

Following are the activity from the previous month:

a)      Closed the following longs: Sold CPFL Energia (CPL), Citigroup (C), and Walmart (WMT) at profits of 4.92%, 7.21%, and 34.94% respectively. The sales had a combined portfolio impact of 0.86%.

b)      Increased/Added the following longs: Added one-third more to our holdings in Nokia (NOK) on 07/19/2012 at $1.82.

c)      Long Calls: None.

d)     Long Puts: None.

e)      Shorts: None.

f)       Short Calls: Closed short calls on Quality Systems (Sep 2012 45), Gold Miners ETF (GDX Jan 2013 59), Alcoa (AA Jan 2013 12.5), Nucor (NUE July 2012 43), Intel Corp (Oct 2012 27), and Microsoft (Aug 2012 31) for modest gains for a combined portfolio impact was 0.65%. We also established short calls against our entire Nucor long pong position (NUE Oct 2012 40 @ $1.1).

g)      Short Puts: Closed short puts on Apple (Sep 2012 550), CVI Energy (CVI Dec 2012 25), and Procter & Gamble (PG Jan 2013 57.5) for modest gains for a combined portfolio impact of 0.27%. We still have the CVI Energy 25 long calls open. So, the net effect of that transaction was conversion of the synthetic long position to a long call position. We also established short puts on Apple (Oct 2012 560 @ $22.60) on 7/3/2012 and Nucor (Jan 2013 34 @ $2.20) on 7/12/2012.

h)      Synthetic Longs: The Corning long calls (Jan 2014 12) were converted to synthetic longs by establishing short puts with the same expiry & strike price. The net cash outlay of the transactions stand at ~0.1% of portfolio.

i)        Synthetic Shorts: None.

The cash position in our portfolio is at about 36%.

Long/Short Portfolio Update:

The overall portfolio is 4.34% down compared to our cost-basis.

2012 Transactions Summary:

Excluding dividends, we have a realized gain of 11.01% in the portfolio YTD.

Option Position Updates:

Short Puts: Apple (AAPL Oct 2012 560 @ 22.60), ABB Ltd (ABB Dec 2012 15 @ 0.65), Quality Systems (QSII Dec 2012 30 @ 2.15), and Nucor (NUE Jan 2013 34 @ 2.20). The short puts together have a cash coverage requirement of about 40.5% of our cash position.

Short Calls: Itron (ITRI Aug 2012 40 at $4.20), Alcoa (AA Jan 2013 12.5 at $0.64), Dryships (DRYS Jan 2013 2.5 at $0.65), Clearwire (CLWR Jan 2013 1.5 at 0.35), and Nucor (NUE Oct 2012 40 at $1.10). The short call exposure is ~5% of the portfolio.

Long Calls: CVI Energy (CVI Dec 2012 25 @ 2.10).

Synthetic Longs: JC Penney (JCP Jan 2014 25) and Corning (GLW Jan 2014 12) with a net exposure of ~4% of portfolio and ~10% of cash.

Watch List: Assured Guaranty Limited (AGO), Air Products & Chemicals (APD), Bemis Company (BMS), Canon (CAJ), Dell Inc (DELL), Diageo (DEO), Emerson Electric (EMR), Forest Laboratories (FRX), Gafisa SA (GFA), Bank of Ireland (IRE), Jefferies Group (JEF), McGraw Hill (MHP), 3M Company (MMM), NovaGold (NG), Nestle (NSRGY), PepsiCo (PEP), State Auto Financial (STFC), Teva Pharmaceuticals (TEVA), Vivendi (VIVHY), and Whirlpool (WHR).

Cash holdings in an investment portfolio - strategies to squeeze income

It is customary for investors to hold sizable amounts of cash in their portfolios. This cash-hoard is especially beneficial to investors when the market is over-extended and/or uncertain:

1. Keeping the powder dry: Dry powder ensures opportunity to swoop for the kill when the conditions are right. Such opportunities do come by every few years and cold hard cash is required to place significant bets that can pave way for later rewards. Margin funds available in a brokerage account should not be considered for this purpose as the high interest rate takes a generous chunk from the returns – in fact, it is recommended to steer clear from margin funds as far as possible, independent of the market conditions.
2. Buffering correction impact: A popular investment strategy is staying fully invested on the long-side. More often than not, if the market experiences a 20% correction, the portfolio mirrors that to a large extend. But this correction impact could have been lowered had a percentage of the portfolio been in cash. For e.g., consider a $100K portfolio fully invested in a total market index fund. A 20% market correction reduces the portfolio value to $80K. But, if 20% of the portfolio was in cash, the value would go down only to $84K buffering the impact of the correction.
3. Trouncing the market average performance: Aspiring to stay fully invested when the market is valued at a significant discount to estimated fair values and raising cash when the margin of safety goes down is a surefire way of beating market averages. Investing the cash-hoard when the margin of safety is compelling has the advantage of the newly invested funds giving a much higher ROI compared to the rest of the portfolio. In effect, the overall portfolio gets a significant boost that should help beat the averages.
4. Realizing absolute returns: Rather than market tracking strategies, a variation on the above is to hold cash with an eye towards realizing absolute returns. Holding cash allows one to go long when the market is in the doldrums thereby allowing focusing on absolute returns. Further, extending such a strategy to going for selective selling of over extended securities raises cash thereby allowing one to reload for an eventual market downturn.

The cash hoard is not without downsides – the obvious one is that it is tough to beat inflation in that part of your overall portfolio. Independent of the interest rate environment, keeping your cash hoard liquid while earning a good return on it is a holy-grail.

Below is a look at the common options available within US brokerage accounts:

1. Money-market sweep: Typical brokerage money market sweep accounts offer dismally low interest rates – in the 0.05% range for our TD Ameritrade and E*Trade brokerage accounts – i.e. a $100K average cash balance in the portfolio will give a grand total annual return of ~$50. In a higher-interest rate environment, they might offer faintly better returns, but nothing of substance. The advantage with the money-market sweep offering is that generally sign up is not required and the balance is very secure – FDIC or SIPC coverage exists on balances up to $250K kept in a sweep vehicle. Certain brokerages also offer double the coverage (up to $500K) as they distribute the cash held between two bank accounts which each offer $250K of coverage. 
2. Savings account sweep: Savings sweep accounts offer substantially better interest rates but still  well below prevailing inflation rates – in the 0.25% range for our TD Ameritrade and E*Trade brokerage accounts. The balances kept in such accounts offer similar protection as money-market sweep offerings making them also very secure. The downside though is that transfers back-and-forth can typically take upwards of a day, depriving one of the ability to take advantage of a market spike.
3. Fixed deposit account based mutual funds, Mutual funds indexed to treasury bonds, and other AAA rated bond funds: These generally offer an income stream upwards of 2% making them a good option for US residents. High quality muni bond funds are another option suitable for taxable accounts. One disadvantage is that capital preservation is not guaranteed - one can minimize this risk by going with high-quality (AAA rated) options with low duration. Restrictions in purchasing US mutual funds by non-residents are a stumbling block for non-resident US citizens. For non-residents, there are a number of ETFs that offer similar risk/reward. Floating-rate income trust ETFs (EFT, BSL, PPR) that invests in senior secured floating-rate loans, MLP ETFs (NTG, CEM, EMO), etc are other choices although preservation of capital is only a secondary objective for such products.
4. Arbitrage: This strategy requires a global trading account as opposed to a trading account for US markets only. Global trading accounts allow transferring money and investing in major global markets. This opens up arbitrage opportunities – basically, one could transfer a portion of the assets to another currency which offer better interest rates and if the exchange rate remains stable during this capital allocation, you come out ahead compared to holding the money in USD which offer meager rates. Transaction & transfer costs can both reduce the returns and capital risk is a concern as well...
5. Stable high-yield stocks: These offer the best potential returns but with the downside that capital preservation is subject to the vagaries of the market. Even so, investing in dividend paying stocks with a high margin-of-safety is a far better option compared to many of the alternatives. A variation on this strategy is combining long-dated protective puts with short-term (~90 days)  near-the-money covered calls: the strategy provides downside protection with funding for such protection covered by the cash realized from the calls. Keeping a list of such stocks and picking from them on a perpetual basis to implement this strategy can work very well, especially in a low-interest-rate environment. An example using General Electric (GE) stock showed a projected income stream of around 11% annualized with minimized risk because of the protective puts: The stock currently trades at $16.80. Long-dated puts two years out are priced in the $3.80 range while short-dated calls three months out are priced in the $0.78 range. The difference between the defensive put premium and the cash realized from the covered calls should be in the $1.22 range based on a calculation that assumes constant stock price over the period ($0.78*8 - $3.80 = $2.44/2 = $1.22). That is an annualized return of ~7% and the stock is yielding ~4% giving an almost guaranteed total return of ~11%. 

Related Posts:

• Cash holdings in an investment portfolio - strategies to squeeze income for value investors
• Kelly Criterion based Strategies for Value Investing
• Covered Call Strategy for Stable Income Portfolio
• Basics of Options and Futures for Value Investors
• Basic Options Strategies for Value Investors
• Basic Futures Strategies for Value Investors
• Short Selling Strategy for Value Investors

Last Updated: 04/2012.

David Einhorn's Holdings - PART III

This article is the final piece of a 3-part series. (Click here for Part 1 and here for Part 2).

Some very public short-selling made David Einhorn a familiar name starting in the early 2000s. But Greenlight Capital’s shorting acumen was evident from the late 1990s. Read more at Seeking Alpha...

Tracking David Einhorn’s Greenlight Capital Holdings - PART 1

Greenlight Capital was founded in May 1996 by David Einhorn and Jeff Keswin who were colleagues at SC Fundamental Value Fund (a hedge fund). The initial plan was to raise $10 million but raising capital proved formidable as the public was unwilling to warm up to a couple of money managers with barely two years of real-world experience. Read more at Seeking Alpha...

Tracking Stocks in Mohnish Pabrai's Investment Funds - Part II

This article is Part 2 of a three-part series. The first part can be accessed here.

At the Pabrai Investment Funds annual meeting of 2004, Mohnish Pabrai described his evolution as a focused “special situations” based value investor. Read More at Seeking Alpha...

401K & Retirement Accounts 2009 Performance Summary

The total return this year was 34.84%, almost equivalent to the returns last year but in a positive direction. The performance compare well with the returns of domestic indexes, which are up around 30%, emerging market indexes, which are up around 75%, and other developed markets, which are up about 25%. We started the year with an allocation of 40-43-17 among Domestic, International, and Bond Funds respectively. We did several allocation changes during the year – a minor shift to 40-45-15 as the market bottomed in early March followed by several shifts in the May-August time frame to reach a more conservative allocation of 37-34-29.

Below is our current portfolio:

Symbol	% of Portfolio	Fund Fees	Fund Return 2009 (After Fees)	Comments
ABF Small Cap Value (AVFIX)	4.86	0.82	41.94	A Small-cap value fund with about 1.2B of total assets under management.
Artisan Mid-cap Value (ARTMX)	2.40	1.21	57.20	A mid-cap value fund with about 3.7B of total assets under management.Top 10 holdings account for 30% of assets.
Dodge & Cox Stock Fund (DODGX)	6.67	0.52	34.42	A Large cap value fund with a history of outperforming the S&P500 index. Has very low turnover ratio. The fund is very big (~70B) and so outperformance may be harder to come by going forward.
Fidelity Diversified International Fund (FDIVX)	18.23	1.00	37.05	Diversified large-cap international growth fund. This fund is very big at over 58B. Turnover is at 58%. Has a history of outperforming its related index, the MSCI EAFE.
Fidelity Small Cap Stock Fund (FSLCX)	5.34	0.95	70.85	None.
Fidelity Low Priced Stock Fund (FLPSX)	3.65	0.83	43.68	None.
PIMCO Total Return Fund (PTTRX)	16.55	0.52	7.14	None.
Misc.	0.14	0.00	0.00
Calomos Growth A (CVGRX)	3.66	1.22	57.16	A 12B large cap growth fund. The top 10 holdings represent about 27% of assets.
Schwab S&P500 Index (SWPIX)	3.02	0.36	28.92	An index fund that tracks the performance of the S&P500 index benchmark.
William Blair International Growth (WBIGX)	3.49	1.67	46.18	A 5B large cap international fund with between 10 and 25% exposure to emerging markets.
Vanguard Pacific Stock Index (VPACX)	4.11	0.27	23.00	An index fund that tracks the performance of the MSCI Pacific index benchmark.
Vanguard Inflation Protected Securities (VIPSX)	9.22	0.20	7.54	Invests in inflation indexed bonds (primarily US) with maturities between 7 and 20 years.
Vanguard Emerging Market ETF (VWO)	7.18	0.25	78.49	None.
Fidelity International Real Estate Stock Fund (FIREX)	0.89	0.96	37.50	None.
Fidelity Small Cap Growth Fund (FCPGX)	3.45	1.09	49.82	None.
Fidelity Select Technology (FSPTX)	1.85	0.88	96.94	A sector specific fund focused on large cap technology stocks with about 2B in assets under management. Top 10 holdings account for 45% of total assets.
Fidelity Select Health Care (FSPHX)	2.01	0.87	34.59	A sector specific fund focused on large cap healthcare stocks with about 2B in assets under management. Top 10 holdings account for 38% of total assets.
Cash and Money Market	0.11	0	0	None.
Pension Plan	3.16	0	3.70	Company Fully Vested Cash Balance Pension Plan.

For 2010, we expect a minor reallocation to the portfolio. An update will follow. If the market rallies further as the year progresses, we will continue to shift more into bonds and vice-versa.

A Peek Into Our Roadmap to Financial Independence

As discussed previously, frugal living, reducing expenses, investments guaranteed to beat inflation, and passive income generation are key issues on one’s road to financial independence. Each of these contributes to either:

1. Reducing the amount of money required on a monthly basis, and
2. Generating income to offset living expenses.

Having been in the software industry for over 15 years, and having worked full-time at it we are aware that though stressful at times the jobs are well-paying and intellectually challenging. Simultaneously juggling the responsibilities involved in bringing up two young children in elementary school has flavored and toughened us. The never-ending slew of layoffs in the recent years, not isolated to just our industry, has been gentle on us. It has always been our dream to resourcefully manage time until the nestlings confidently take to the sky.

Bay Area living, in an excellent elementary public school district comes with its own suite of out sized living costs to which we are not immune . A residential area with excellent schools and low housing costs is a holy grail. Below is a look at our expenses in a typical month:

• Housing (Mortgage, HOA, Property Taxes) – 65%
• Basics - Food, Fuel, Attire, Utilities, etc. – 12%
• Travel and Entertainment – 10%
• Children's schooling, training, and misc. – 7%
• Others - Insurance (housing, personal, auto), Home Maintenance, etc. – 6%

For minimizing expenses beyond what can be achieved through frugal lifestyle, relocating to a lower-cost area has been on our radar for a long time. Frugal lifestyle has helped us build liquid investments but income generation (dividends and interest) from the same are petite compared to our salaries. Another diminutive source of revenue is this blog and together they account for the bulk of our passive income which is woefully very modest now.

Our plan to achieve financial independence can be summarized as follows:

• Relocate to the South of India (our native soil). Infrastructure is practically non-existent there, when pitted against Western standards, but the area offers some distinct advantages and below are a few highlights:

1. Lower living costs.
2. Proximity to our extended family.
3. Immediacy to growing areas of the world.
4. Opportunity to experience global living thanks to our US citizenship.

• Our primary residence there will be the house we bought outright a few years ago. Housing which accounted for 65% of our monthly expenses in the Bay Area should then account for a much lower portion of our total expenses – zero mortgage, much lower HOA and property taxes.
• The children will be attending private school and that is one area where the costs will be significantly higher than in the Bay Area. The kids now attend free public education and the decision to private school them comes with a higher price tag, although it will be less than private schooling in the US.
• As for passive income – slowly, but surely we have been adjusting our stock portfolio toward investments in companies with consistent dividend growth. By selling our house and realizing the equity tied up there, we should be able to increase the size of our stock portfolio, thereby increasing dividends (passive income). Developing other streams of passive income as time allows is always in the offing.

We hope to pull this strategy off in the next six-months around the coming school year. As with all ventures there are several unknowns and uncertainties:

• How well will we deal with the new environment?
• How long will it take before the avocation becomes a vocation?
• How successful will our passive income strategies pan out to be?

There is no denying the comfort zone we are in currently. But, it is our gut feeling that this opportunity will cease to exist, once the kids start middle school and that justifies this timing.

Last Updated: 12/2009.