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Fund Family Shareholder Association
Our global portfolio has no more than 100 holdings in it. So we are
only investing in maybe 5% of the companies we see each year.
Of the 100 stocks you say you own, are they equal-weighted in
your portion of the portfolio?
We say that typically we will own between 70 and 120 holdings, and
it just so happens for the last three or four years we have been in the
high 90s. Personally, I try to keep it below 100. If we get up to 101, I
have a look and say there’s a danger here of creep. We want a range of
opportunities, but we don’t want a long tail of very small holdings.
Are they all the same size? No. We tend to let our winners run, so if it
starts at 1% and performs very well, it might get up to 3% or 4%. So our
largest holding at the moment I think is about 3.5% of the portfolio. The
smallest size we ever buy is 50 basis points—half a percent. Those typi-
cally are where we see risk/rewards are more extreme—a wider range
of outcomes. We call them incubator holdings. They are the stocks that
could go up fivefold but could also fall by 90%. Typically they are about
20% of the portfolio, and that’s probably where our best investments will
come from, but also where our worst investments will come from.
A year and a half or maybe two years ago, you were buying com-
panies like Weight Watchers and Tesla as both disruptors and
social media plays. Weight Watchers has been a big disappoint-
ment. How did some of the others work out?
What we look at every day and every month is, what is the best
combination of opportunities available to us in the markets? Weight
Watchers, we bought as one of our incubator holdings, saying, if they
could get the social media side of it to work, they could make a huge
amount of money. We saw it as an asymmetric return. What happened is
that they haven’t made progress, and we’ve sold that.
Tesla is still a disruptor; it’s just the stock price has gone from $35 to
$200. We have made multiples of our investment in only 12 months and
we’ve trimmed it at least twice. It also started as an incubator, because
18 months ago you didn’t know if they could launch the Model S and if
anyone was going to buy it and at what price. We cut and slice the port-
folio in any number of ways, but we think about 25% of the portfolio is
in what we would call an innovation theme.
We look at it through a lot of different spectacles. What we tend not to
look at is geography, because we think geography has no information in it.
We look at the portfolio through a growth prism—what sort of growth
is this expected to produce? But we also look at where the growth is
coming from. We reckon about 40% of our portfolio is economically
agnostic. It is not going to be a victim of next quarter’s GDP trends. So
that’s an Amazon or a Samsung—the sort of companies that are based
on innovation—even a tobacco or a consumer staples company. Coca-
Cola, which we don’t own in the portfolio, but it’s economically agnostic.
Of the remainder, approximately 40% of the total portfolio is tied in with
economic growth and recovery in the Western world and Japan because
it behaves like a mature economy. So improvements in the U.S. economy
or recovery in Europe—that’s covered by about 40% of the portfolio.
The last 20% is exposed to emerging market trends. Now, as I said
they are not all listed or quoted in emerging markets, but the main drivers
are emerging markets. In that bucket we would have Colgate-Palmolive—
U.S.-listed, but the main driver of their profits is emerging markets, in par-
ticular Latin America. So for us Colgate is an emerging markets exposure.
So that’s the sort of balance we’ve got across our 100 stocks. 40%
doesn’t really care what the economy is doing. 40% is now aimed, focused
on the Western world. 20% is on emerging markets. Four years ago, the
emerging markets was over 30%, probably close to 40%. So that shows
how over four years the opportunity set, in our eyes, has changed. It used
THE NEXT BEAR MARKET
in small
stocks is right around the corner.
SmallCap Index
gained 37.6% last
year and carried that momentum into
2014 as the early leader out of the gate.
On March 4, SmallCap Index notched
a new high-water mark with a gain
of 4.5% for the year. The small-cap
focused
Explorer
got off to a quick
start, up 3.6% through March 4. C
apital
Opportunity
, which holds a handful of
small-cap stocks, leapt out to an 8.2%
gain to start the year. At the same time,
large-cap stocks were struggling to keep
pace, with
500 Index
up just 1.7% and
MegaCap ETF
up only 1.5% through
March 4.
Dividend Growth
was also
slow off the starting block, up only
0.9% through early March.
Since then, it’s been a differ-
ent story. Through the end of May,
SmallCap Index is 3.0% off its early-
March high. Explorer is off 5.7%, and
Capital Opportunity has declined 1.9%
since March 4. Over the same period,
500 Index has actually gained ground,
up 3.1%, and recently notched a new
high on May 30. Dividend Growth
has also continued to grind higher, up
2.7%.
Before you bail out of small-cap
stocks, let’s put this recent correction
into perspective. The first graph on
page 7 plots SmallCap Index’s calen-
dar year returns as well as its largest
intra-year declines starting in 1990.
(Remember, SmallCap Index was
originally an actively managed fund,
and only became an index fund at the
end of 1989.) Looking back over the
past 24 years, small-cap stocks experi-
enced an average decline of 18.7% per
calendar year. Yes,
on average
, inves-
tors in small-cap stocks can expect to
experience a (near) bear market every
year!
Despite these regular drawdowns,
small-cap stocks have delivered posi-
tive returns in 17 of the past 24 cal-
endar years, gaining 12.8% on aver-
age. With a drawdown of 6.2% and
counting in 2014, we’ve already sur-
passed last year’s 5.9% decline, which
was the second shallowest in the past
24 years. Could the current pullback
in small-cap stocks turn into a full-
fledged bear market decline of 20%?
SMALL CAPS
Beware the Bear
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