Saturday, May 22, 2010

New Era Value Investing: Chapter 8

As the chief investment officer at Fremont Investment Advisors, Nancy Tengler employed the value approach she describes in her book, New Era Value Investing.

Now that the selection of individual stocks has been discussed, Tengler turns to portfolio construction.

The first thing the investor should determine is the level of concentration in the portfolio. Tengler argues that fewer than 20 stocks are needed for proper diversification, but in her institutional portfolio she carries between 25 and 35 issues. This is due to the fact that clients are decidedly against volatility. Spreading the wealth around helps reduce volatility, even if it means putting money in one's 35th favourite idea rather than putting more money in one's favourite idea.

Tengler argues that the second most important aspect to building a portfolio is buying only the "best" companies. Effort in fundamental stock research aids the investor in this endevour.

Tengler further argues that investors should incorporate both RDY and RSPR (described in Chapters 3 and 4) rather than choosing one or the other. Often, one of these forms will be out of favour while the other can boost results. Furthermore, as the universe of RDY-type stocks declines, investors will still have the ability to apply the value framework by employing the newer RSPR.

Investors should also consider the correlation between issues in their portfolios. Some sectors will do well while others will stall, and so stocks with low correlation to other stocks in a portfolio provide protection against volatility.

Finally, Tengler shares how she maintains buying and selling discipline. She prefers to average into a stock, since she doesn't believe she can predict the bottom. She will start with a position that's around .5% of the portfolio, and spread her buys over time until she has accumulated an amount representing about 3-5% of the total portfolio. At no point can one single position occupy more than 6% of her portfolio, therefore she will begin to sell if the prices moves up such that this occurs. Once the price hits the sell level, she will look to exit her position completely lest the price drop back down. Tengler will also use stop-losses (using money management software) to protect from large one-day or one-week declines.

Tengler closes the chapter by discussing some of the mistakes she has made in her portfolio. The lessons that are illustrated in these mistakes are:

1) Beware of newly merged companies with different operating profiles (e.g. AOL Time Warner)
2) Beware of new companies with short operating histories

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