Top ten Yabby Blessed stocks in global developed markets

Compounders are those stocks in the keeper category for the core of your portfolio. Here we use the profit-and-loss indicator to surface some fresh opportunities.

The Savvy Yabby is always on the lookout for opportunity.

There is another sell-off on right now, which provides many trading opportunities.

When markets are down broadly look for good entries on long-term buys.

These are the stocks that may not be very well-known, or in the newspaper headlines, but which nonetheless represent good investment opportunities.

I will deal with more opportunistic trade ideas in forthcoming notes, but these market conditions can be ideal times to deploy cash built up from dividends.

We all have to retire someday, and the Yabby has a super-crustacean lair to fund.

Now that is a lair properly fit for a super-crustacean.

This note provides an opportunity to share tips and tricks on portfolio construction for the creation of a suitable balance of growth, income, and opportunistic trading.

There is a mix that suits everyone, and only you can properly determine what balance is right for your circumstance. However, the general principles can be shared.

Diversification by investment opportunity

I have been involved professionally in the financial markets for almost thirty years, and as a portfolio manager for the last sixteen years. Privately, the Viking and I have been investing in global equities since before I got my first job in finance.

If you spend long enough doing something, you will probably learn a thing or two.

Here is what I have learned:

• If you are right a little more than you are wrong, you will be okay.

• If you hold on to your winners, and cut your losers, you will do better.

• If you refocus regularly, on core winners, you can run profits tax effectively.

There are many types of investment opportunities. Some are slow burn, and some are fast burn. Some are tilted towards income. Others are tilted towards growth.

Overall, it pays to hold a balanced mix of income and growth-oriented investments, and to allow yourself a budget for switching between ideas over time.

However, every time you sell a long-term winner you will likely realize a tax obligation, which is capital that leaves your hands for the government.

This capital is no longer working for you to compound your investments.

For this reason, it pays to have a portfolio with a good chunk of capital allocated to long term holdings. The unrealized gains on winners can sit free of capital gains tax until you sell them. Depending on your tax status, and jurisdiction, the benefits of compounding can be very significant. This is where you core portfolio lies.

How much you allocate to core long-term holdings will depend on your individual investment goals, and your liquidity requirements.

It is not possible to give a generic answer to the question of how much. However, we can get some idea from the general rate of market turnover.

Generally speaking, most global equity markets turn over a dollar volume of trade that is between one half and twice the market value in aggregate.

Since you buy and sell at both ends of the trade, the average holding period of a stock is one half of the ratio of the market capitalization to annual traded value.

In simple terms, if a market was worth $1T and trade $500B per year, the average time that investors hold their stocks is one half of $1T/$500B/year or one year.

For higher turnover markets, like technology stocks, the turnover might be $2T traded for every $1T of market value. That works out at 1/2 of $1T/$2T/year or three months.

When you think about it, that is pretty nutty.

If you really believe that technology is the future, then why should the market average holding period for such stocks be just three months?

It makes no sense, unless you are a broker clipping the trade ticket.

Patience is the ultimate investor virtue

That is the lesson for this note.

Don’t blindly follow frenetic market trading.

Keep some capital in long-term holdings and tend that as you would a Bonsai Garden.

I took up Bonsai as a new hobby to help me slow down.

This famous Bonsai tree "Kenshin Tōge" is thought to be 800 years old.

Don’t get me wrong.

You do need to trade portfolio assets dynamically to properly manage them.

However, when you are onto some winners, that are working for you, don’t forget to keep them watered with top-ups and a bit of pruning in that part of the garden.

Grow your cash stash from dividends to keep the garden growing.

At all times, be alert to new opportunities that might develop on this happy course!

Remember the old Japanese Proverb: “Even Monkeys fall from trees!”

Saru mo ki kara ochiru!

You can be the most talented investor ever, but you will still make some mistakes. The road to success is to take educated guesses on informed risks and to limit any fall.

Diversification by number of holdings

When you feel you have made a mistake, correct it. You can always do this by selling a stock, but that will not help if you are too narrowly concentrated in just a few stocks.

Holding more stocks limits the selection risk but multiplies your workload

The right number of holdings is likely somewhere between fifteen and fifty.

The reason to choose the low or high end of that range depends.

The right number depends on your goals, the portfolio size, and your style.

When you have a very few individual stocks there is a lot at risk in any one position

When you have a large number, there is less at risk, but it is more time-consuming.

I have run global portfolios with as few as thirty stocks and as many as three hundred. The right answer depends on many factors, but there is a trade-off involved.

Fewer stocks make for less work but higher decision risk.

The sweet spot for most investors is somewhere between twenty and thirty stocks. The lower end is more feasible if you also hold Exchange Traded Funds (ETF).

For instance, you might own a diversified world equity ETF like the Vanguard Total World Stock ETF, which provides exposure to 9,900 stocks for a 0.07% fee.

The stocks involved are drawn from both developed and emerging markets, and you get the lot in one trade, which may only cost you $1 on Interactive Brokers, or $0 on any no-fee platform that makes money from the trading spread.

Obviously, you can take a bet on the world being here in thirty years, and create a solid, if boring, core index exposure to global equities.

You could also add suitable fixed income ETFs to reduce overall risk.

With perhaps four or five ETFs, you can get your core index exposure set.

However, this might be boring to you. Perhaps you also favor holding some capital growth opportunities in earnings compounders, some stocks for the long run.

If you pick five or ten of those, you are up to fifteen holdings.

Now think about adding some dividend yield plays, and small caps.

Run these designs on a cafe napkin, and you are most of the way there. Remember to budget your portfolio allocations by decision risk, workload, and objective.

Choosing the Vanguard Total World Stock ETF is low decision risk.

The World will still be here in thirty years, and most likely Vanguard. I would feel fine with 20% to 30% of portfolio invested in such a security. If I were worried to spread risk among providers, I could choose to add a State Street, or iShares ETF.

Choosing a tiny minerals explorer looking for rare earths in Africa has a high decision risk. If I were to allocate 1% to that, I could easily lose all of it. This end of a portfolio will need more positions, perhaps twenty or more, to limit the risk in each.

You get the idea. It helps to distinguish positions by the type of decision risk, and the likely magnitude of the downside. Single stocks can go to zero. The World less so.

Constructing your research funnel

Once you have sketched your napkin plan, for what shape your portfolio might take, the different buckets, how much to put in each, and how many holdings in each, you can turn to working out how to identify which holdings to buy.

That sounds like a good topic for a newsletter :-)

I will elaborate over time, because there are many (good) ways to approach this. For this note, we are in the middle of a global correction, where I think markets are ripe for what the trade calls sector rotation. This is a gradual process of moving money from those corners of the market which are topping out towards the new leaders.

You never know where the new leadership will be, for sure.

Once the market has decided, you have your headlines for the next bull market.

However, at this time, we can start looking for the new buy and hold opportunities for the core portfolio. Since we are not sure, we don’t need to buy at maximum size, or even buy at all. The main thing is to be alert and to start building your watchlist.

The main tip from this newsletter, is the value of effective portfolio screening.

The method I will show you now is one of my favorites for initiating stock research.

I call it the Keynes Beauty Contest method for finding Undiscovered Beauty.