A Winning Fund Manager Shares His Strategy
Financial markets have become downright scary this year. As a result, many investors are wondering whether they should shift strategies. After several years of investment glory, should they play it safe and shun stocks…or avoid bonds…or turn it all into cash until things settle down?
To find answers, Bottom Line/Personal turned to a fund manager whose market strategies have worked well year after year through good times and bad. That’s why research firm Morningstar Inc. named David Giroux the Fund Manager of the Year in its Asset Allocation category for 2012—the category’s first year in the contest—and has named him as a finalist every year since.
Make Small Shifts
Investors who are faced with the prospect of a recession and/or bear market, which many investors fear is the case this year, often make huge portfolio shifts, in some cases going so far as to dump all their stocks and load up on US Treasury bonds. That kind of market timing allows you to feel safe for the moment but hurts your long-term performance.
No matter what is happening in the markets and the world, I maintain a variety of asset classes—primarily stocks, bonds and cash.
I set a range of how much or how little of the portfolio each type of asset can represent, giving me some flexibility to make tactical shifts.
Example: I keep 55% to 75% of the portfolio in stocks that appear to be undervalued. Although this means I could lose money in bear markets, it also allows me to be well-positioned for a recovery and to build wealth in bull markets. The remaining 25% to 45% of assets are in cash, bonds and/or other types of investments, such as convertible bonds, which are hybrids that include both stock- and bond-like features. This part of my portfolio provides a valuable cushion during volatile times.
I don’t make moves based on guessing where the overall market is headed. Instead, I search for the best relative values among the asset classes that I own in whatever environment I find myself.
Example: Back in 2007, I saw stocks that I owned soaring to high valuations. I lowered my stock exposure to 57% and plowed 10% of the portfolio into US Treasuries, which at the time were yielding nearly 5%. When the stock market collapsed in 2008, those tactical shifts helped my fund outperform the Standard & Poor’s 500 stock index by 10 percentage points.
Moves to Make Now
• Pare back stocks. I have reduced the stock allocation of my portfolio to below 60%, down from as much as 70% in September 2011. If a strong rally were to occur, I might reduce it further. That’s because the market has grown overvalued in the past few years, especially in 2015, when corporate earnings growth was flat. Typically, I might have moved that money into US Treasuries, which generate positive returns during most periods when stocks are negative. But I have been avoiding government bonds completely because yields are still so low that even a small rise in interest rates could generate negative bond returns.
• Build up cash. As a result of my cutbacks in stocks, about 15% of the fund’s portfolio now is in cash, a relatively high allocation. Cash gives me flexibility in volatile markets, as it could for small investors, too. At some point, either stocks will fall far enough to become attractive…or 10-year Treasury notes will get back to a more normalized interest rate environment (yields of 3.5% or higher), and I will be able to move into high-quality government and corporate bonds.
• Focus on large-caps. The stocks that I continue to hold are built for uncertain times. These tend to be attractively priced, large-cap stocks of companies that are leaders in their fields and that have steady revenues and earnings growth and strong recurring cash flow. These types of stocks will be hurt less than the broad market if the market continues to be weak but can profit if stocks overall rebound. My favorites…
Danaher (DHR) manufactures industrial products ranging from commercial water-disinfection systems to equipment for printing and coding consumer packaging.
Fiserv (FISV) provides backroom processing services for more than 13,000 banks and credit unions.
• Give extra weight to areas of the stock market that are likely to outperform the broad market. Health-care stocks were among the best-performing sectors of the S&P 500 last year. Some of them will benefit from ongoing catalysts such as the millions of new customers created by the Affordable Care Act. Historically, their earnings and their stock prices have held up well in rough times. While I have reduced my exposure to pharmaceutical firms, many of which have gotten pricey, I continue to focus on manufacturers of medical devices and diagnostic equipment. Health-care represents 14% of the fund’s portfolio, the highest of any sector. My favorites…
Becton Dickinson & Co. (BDX) is the world’s largest maker of medical surgical products such as needles and syringes.
Thermo Fisher Scientific (TMO) sells scientific instruments and laboratory equipment to clients in the life sciences and environmental industries.
• Consider dividend-paying utility stocks. Stocks in the utilities sector of the S&P 500 fell 8% last year as investors worried that they would start to look less attractive at a time of rising interest rates. But rates are rising slowly enough to allow the yields on utilities to continue to look attractive. And even in a volatile market, the stocks of large-cap utilities in states where regulators approve significant rate increases will provide good returns with relatively low risk. My favorite…
PG&E Corp. (PCG) serves nearly 10 million electricity and gas customers in central and northern California.
• Keep bond maturities short, and consider relatively high-quality junk bonds. Bonds make up nearly all of the remaining 25% of my portfolio now. About 40% are BB-rated corporate bonds—these are high-yield (junk) bonds that are near the top tier of junk bonds in terms of credit quality—with durations (a measure of sensitivity to interest rate changes) of less than five years. There is less chance of default with these than with lower-grade junk bonds, and the short durations help protect against interest rate risk. Right now, my BB-rated bonds yield in the 6% range, and prices are historically low because many were unfairly dragged down by the weak performance of energy- and commodity-related junk bonds in 2015.
I have lowered my allocation of convertible bonds to just 2% and will probably cut it even further. Convertibles can be converted to stock if their share prices rise, or they can be maintained as bonds, but lately their yields have become unattractive compared with yields on other types of bonds. I don’t expect that to change anytime soon.