You are on page 1of 7

by: Alfred L. Angelici Vol. 4.

0 January 1, 2010

Investment Philosophy: “The Defensive Investor (or passive) investor will place his chief emphasis on the avoidance of serious mistakes or losses. His second aim will be freedom from effort, annoyance, and the need for making frequent decisions. We shall repeat here without apology - that the (defensive) investor cannot hope for better than average results. The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition - or by investing in commingled (mutual) funds utilizing professional administration of his investment program along standard lines.” — Benjamin Graham “The Intelligent Investor”

2010 Market Analysis:
After receiving multiple inquiries about restarting this newsletter, I have realized that there is indeed a demand for investment information that is unbiased by marketplace. fades This newsletter was and is meant to teach people how to invest wisely and defensively and to be able to intelligently create a plan that will help the reader evaluate and obtain his/her financial retirement goals. In this newsletter, I create and track the performance of a “hypothetical” Fund-of-Funds portfolio from available Fidelity retail mutual funds with the goal of outperforming comparably weighted Fidelity and Vanguard (timeline) fund-of-funds retail products. I also display the standard market Index results as a secondary guide for the reader to appraise their overall annual results. NOTE: In this Defensive investment style, I do not seek to best the major market indices, though during particular economic situations that is a realistic possibility. The reason for this strategy is plain to see, for a Defensive Investor seeks only to generate a “fair” return while keeping risk at a minimum. The Defensive Investor measures risk as “loss of invested money”; not (price) volatility as Wall Street views risk. The Defensive Investor seeks at all times to avoid buying into over-priced, over-hyped regions of the global marketplace. Unlike lemmings, s/he does not follow the crowd over the cliff to financial destruction. The Defensive Investor is a “contrarian”. The second component of this method is to utilize a “tactical asset allocation” strategy. This simply means that each year the Defensive Investor scans the macroeconomic environment to assess what the market may hold for the coming year, and then formulates an asset allocation plan to capture the greatest value. The environment provides sufficient information through everyday news and government reports available in the newspaper, TV, and Internet to allow her/him to make educated estimates of the overall direction of the US & global economies for the next 12 months (barring unforeseen wars, and "Black Swan" calamities). That in a nutshell is this methodology and is all I'm trying to share / teach you so you can avoid the pain of market crashes like the one just experienced in October 2008.

Alternative Retirement Plan:
In a past publication I attempted to inspire you to understand that while building wealth is important, knowing what to do with after it is built is even more important. Else, why build it? The main idea here was to have you see there is an alternative to spending your wealth away in retirement.
What most people do during their life-time is save a little and spends most of what they earn during their working years. They only amass a limited retirement nest egg which they then need to spend down in order to meet daily financial needs during their retirement years. I argue here today that there is indeed a better way. What is this alternative? Namely to amass a “Financial Engine” that will be big enough for you to put work to earn you a perpetual income in your retirement years. Today most of you, like me, work to earn money instead of having money work for us. So how does on calculate how much one must amass during one’s working life to provide a perpetual living wage? Answer: if we want to earn $100,000/yr in perpetuity we require a financial engine of $2,000,000 earning a minimum of 5% annually. (Derived from formula below…)

Desired Annual Income = SAVINGS Rate of Return (3% -5%) base required
So now the question is: How much does one have to save monthly, and for how long, to build a $2,000,000 financial engine? The answer to this is found by simply using a “Future Value” formula calculator. For a $2,000,000 financial engine, it would require saving about $1,380 per month and earning 8% annually for 30 years. I fully realize this is likely beyond the means of most Americans but the concept is still true, simple, and powerful. Lesson: Save as much as you can, as long as you can. As I’ve never heard any retiree complain that s/he had too much money! Also take note that Time is the biggest key to success in building wealth.
(End)

(Continued on next page)

2010 Market Analysis Contd:
Now, looking ahead at 2010 we see the following: new unemployment continues to decrease; the global stock market had wonderful 2009 returns; Christmas sales indicate the consumers are willing to spend again; inflation is still under control; Asian economies are on the rebound, China is experiencing 8% GDP growth, the U.S. dollar is depreciating due to excessive expansion (printing) of the money supply, and gold and oil/gas has doubled in the past year. With the S&P500 up nearly 25% YTD, what areas of the market should the defensive investor focus on in 2010 to minimize his/her risk while maximizing the return potential? Overall and 2010, I expect the global economies to continue to expand especially in Asia. And from the U.S. perspective I anticipate the U.S. dollar to continue to depreciate and global commodities to continue to reflect this through appreciating values. I further expect commodity prices to continue to appreciate due to strengthening global demand and politics. In light of increased global risks (Note: the easy money was taken off the table and 2009) I will set this year’s portfolio asset allocation to 60% stocks and 40% bonds and cash. I will hedge to fund against U.S. currency loss by investing in international funds held primarily in foreign currencies. I will further hedge the fund against significant commodity increases by holding in minority positions (weighting) a couple commodity-based funds. On the next page is a layout of a hypothetical fund using the defensive investor strategy and investing $100,000. Over the course of the year this fund’s performance will be tracked and compared against its benchmarks and the major market indices.
(End)

Risk & Volatility

By: tchotki – Marketocracy 100 member; forum posting

(Reprint)

Why is risk management critical? First let’s define risk as being exposed to uncertainty of meeting a goal. This permits risk a slightly broader definition than failure to meet a goal.
Imagine you had a friend whose father died five months and two weeks ago. His father was very wealthy and the estate owes significant taxes. Taxes are due in two weeks. The estate is cash poor and a planned sale of a nearby home recently fell through. The home is appraised at $100,000 and you happen to have knowledge of construction methods and you know the replacement cost is also about $100,000. He tells you he is dropping the price to $80,000 just to raise the needed cash. You offer him cash on the spot. It is July 1, 2001 and you and he walk down to the attorney's office and close on the property the same day. One block away, an identical house build at the exact same time also has a "For Sale" sign out and closes for $100,000 on the same day. One block in the other direction is another identical house, also built at the same time also with a "For Sale," sign out front. The owner raises the price to $110,000 to have a good negotiating position and plans on selling for $100,000. The first person to see it is so enthralled; he doesn’t bother to have it appraised, and hands over the $110,000 and settles on it the same day. All three parties have a goal of not losing money (property value). For convenience sake, no one borrowed money, as this would leverage the transactions. Six months later, Mylan Pharmaceuticals announces a plan to open a new plant in town and demand for property is high. Investors are moving into town in droves. On January 1, 2002, each party has their home appraised. The homes now appraise for $125,000. One year later, Mylan cancels its plans and has laid-off 5,000 local workers and transferred another 5,000 to New Hampshire. On July 1, 2003, the parties have their properties appraised again, and prices have collapsed. The homes appraise for $90,000.

U.S. Unemployment Chart

Who took more risk?
(Continued on Next Page)

Risk & Volatility contd.
“To me, it’s obvious that the winner has to be very selective. It’s been obvious to me since very early in life. I don’t know why it’s not obvious to very many other people.” – Charlie Munger (Warren Buffett’s partner)
The $80k buyer had three available price points ($80, $125, $90). This was the most volatile asset. The $100k buyer had the same points except for her starting value ($100, $125, $90). This was the midrange variance. The $110k buyer had the least variance ($110, $125, $90). “Risk” Evaluation Summary: If your risk measure is volatility (standard deviation), then the $110k buyer had the least risk as housing prices varied the least (+/-) from his original purchase price. If your risk measure was asset value -- the likelihood of making the highest profit -- then the $80k buyer took the least risk. That buyer exposed the smallest amount of money for a given amount of value. (It is important to think of this as a binomial distribution; namely -- there are but two choices for an asset: it meets goals {makes money}, or it does not meet goals.) I would like to point out that if you define risk in terms of uncertainty rather than chance of loss of value, or volatility, then the $80k and $110k investors took less risk than the $100k investor who bought the house at the risk-neutral price. Overall, the $80k real estate investor had the highest degree of certainty of ACHIEVING goals than the person who paid for the asset at the appraised (risk neutral) price of $100k or the person who paid the premium price of $110k. The $110k investor had the highest degree of certainty OF NOT REACHING his goals, due to the premium paid compared to either the investor at the appraised (risk-neutral) value of $100K, or the person who paid the discount price of $80k. (End) ----------------------------------------------------------NOTE: Warren Buffett has always focused his investments, arguing that while diversification may reduce volatility, it doesn't necessarily reduce risk. In fact, one modern day complaint cited against mutual funds is that they are over diversified. As shown above, a deliberate or inadvertent goal focused firstly on reducing volatility and only secondarily on increasing value, can actually lead to increased risk and/or reduced return potential!

Charlie Munger’s 10 Rules for Investment Success: 1) Measure Risk
All investment evaluations should begin by measuring risk, especially reputational risk

2) Be Independent
Only in fairy tales are emperors told they're naked

3) Prepare Ahead
The only way to win is to work, work, work, and hope to have a few insights

4) Have Intellectual Humility
Acknowledging what you don't know is the dawning of wisdom

5) Analyze Rigorously
Use effective checklists to minimize errors and omissions

6) Allocate Assets Wisely
Proper allocation of capital is an investor's No. 1 job

7) Have Patience
Resist the natural human bias to act

8) Be Decisive
When proper circumstances present themselves, act with decisiveness and conviction

9) Be Ready for Change
Accept complexity that cannot be removed

10) Stay Focused
Keep it simple and remember what you set out to do

YTD Model Portfolio Results:

DI Model Portfolio: (60% Stocks / 40% Bonds & Cash)
60% Stocks 26% LrgCap Fund Description & Symbol Original Price $11.34 $27.89 $28.45 $48.48 $8.58 $11.21 $8.62 $10.81 $1.00 No. Shares 1764 537 175 206 1749 892 1161 925 10005.29 Original Cost $20,003.76 $10,012.51 $4,978.75 $9,986.88 $15,006.42 $9.999.32 $10,007.82 $9,999.25 $10,005.29 $100,000.00 Target Mix 20% 10% 5% 10% 0% 15% 10% 10% 10% 10% 100% Current Value Return %

0% MidCap 11% SmlCap 30% Bonds

Int’l Capital Appreciation (FECAX) China Region Fund (FHKCX) Select Natural Resources (FNARX) Fidelity Canada Fund (FICDX) None Int’l Small-Cap Opportunity (FSCOX) Inflation-Protected Bond (FINPX) Capital & Income (FAGIX) Strategic Income Fund (FSICX) Cash Reserves MMF (FDRXX)

10% Cash Return Totals

(A) Investments results based on a hypothetical $100,000 portfolio invested at end of trade day, December 31, 2009. (B) Your results may differ depending on how closely you follow or differ from either of these models and the exact date you initially invested in each fund.

“Take your life into your own hands, and what happens? A terrible thing: no one to blame.” - Erica Jong

2005 YTD Fund Returns for Core and Other Recommended Funds
(December 31, 2009)

Stocks:
Large Cap

International Capital Appreciation (FECAX) China Region Fund (FHKCX) Select Natural Resources (FNARX) Fidelity Canada Fund (FICDX)

… “International Capital Appreciation” is our CORE Large Cap international growth investment. In general, international funds continue to outperform US (domestic) funds since 2004; especially due to the run-away printing and spending of the U.S. currency. With The Fed’s extreme preference for excessive “liquidity”, international continues to outperform. ...”China Region Fund” is an international investment holding what is arguably the biggest growth region in the world today. China’s GDP growth rate averaged ~ 8% in 2009. And while the fund returns here were significant in 2009 (~ 64%), I believe we can expect above average market returns again for here 2010. ...”Select Natural Resources” is purely a commodities hedge for the DI portfolio. A hedge against significant increases in oil, gas, paper, precious metals (e.g. gold & silver), industrial metals (e.g. copper, iron), etc. ...”Fidelity Canada Fund” is another hedge investment in both currency and commodities and offers nearly all the benefits of investing in South American / Latin America without the political risks. This is protection from a depreciating U.S. dollar decrease, and global commodity price increases.

Mid-Cap

None Selected for the 2010 DI portfolio.

Small Cap

International Small-Cap Opportunity (FSCOX)

... "International Small Cap Opportunity" fund is the CORE small cap investment for the model portfolio. The fund provides a currency hedge against a declining U.S. dollar and exposure to emerging young companies in major world markets.

Bonds:

Inflation-Protected Bond (FINPX) Capital & Income (FAGIX) Strategic Income Fund (FSICX)

...”Inflation-Protected bond” fund is a CORE investment holding that offers a hedge against inflation should it raise its ugly head again in the near-term. Inflation-indexed bonds provide balance and safety in a rising interest rate environment. …”Capital & Income” fund is an investment that is meant to take advantage of an improving global economy. For as the economy improves it should also improve the credit worthiness of the companies owing these “junk bonds”. Any marked improvement in the debtor company’s ability to pay on its loans should improve their value. High yield bonds tend to act more like stocks than bonds; at least until their credit ratings return to “commercial” grade. ..."Strategic Income Fund" is an investment in a broadly-diversified bond fund with an expectation for above average returns based on its spectrum of global investments and credit ratings.

Cash / Money Market Cash Reserves MMF (FDRXX)
...Why invest in a Money Market Fund (MMF)? Answer: for flexibility to invest quickly in existing or new, compelling opportunity areas without having to move out of any existing positions to do so.

Detailed Economic and Global Outlook as of May 2005...
Positive Highlights: US GDP for the third quarter was US Unemployment at 10.2% Leading US Economic Indicators continue to improve Job losses slowing significantly (but still negative) Resurgence in the advancement and research into alternative and green energy sources Risks & Concerns: Crude oil moves back to $75.00/bbl Gold prices at $1,095.90/oz Dollar headed for greater declines value Petro-politics a significant global issue in today’s world Terrorism increases as oil regimes get flush on oil sales Iran, world’s largest terror group supporter, continues to defy United Nations IAEA cease-anddesist order for 3 years now, and quickly approaches ability to possess nuclear weapons

Summary:
As Defensive Investors, it is always important to err on the side of caution and maintain a low risk exposure to potential and real economic and financial threats. I believe that while the current, global economic outlook for 2010 is positive, there exist clear signals to remain vigilant & prudent in order to protect in one’s hard gained wealth.

Happy Investing!

“The underlying principles of sound investment should not alter from decade to decade, but the application of these principles must be adapted to significant changes in the financial mechanisms and climate (of the day).” Benjamin Graham