More Tools in Our “Tool Belt”
In recent years global stock and bond markets have been volatile – at times generous and at other times less so and nerve racking. Such is the history and future of financial markets. Over the past few years, the majority of performance from the stock market has come from large US companies and international stocks. In the bond market it has “paid” to be in high quality bonds as opposed to alternative types of fixed income. Fortunately, these asset classes are part of our “signature” investment style. However, in future years, these trends are sure to change, as they have throughout history. We want to make sure that when they do, we adapt and do what we can to enhance your long-term portfolio performance. There are a few “tools” we can use along the periphery of your portfolio to embrace these changing trends.
As you know we pride ourselves on the use of individual securities – individual stocks, bonds, REITs, etc. and as a team we have no interest in abandoning this expertise. In fact it is one of the criteria that sets us apart from most other firms on Wall Street and provides you transparency in terms of knowing what you own and cost efficiency. However, when it comes to entering a segment of the market that looks very appealing from a performance perspective – let’s say smaller faster growing companies – we are unable to invest significantly in some of these individual stocks due to what we call “liquidity” constraints… there are simply not enough shares of stock for us to buy for you without significantly moving the price, which could inhibit your performance. Given our current investment style, this might prevent us from providing you exposure to what could be some compelling values in the future, which could enhance your performance.
A solution to this challenge is to use – when necessary and sparingly – exchange traded funds (ETFs) to “fill in” these missing areas. ETFs are basically baskets of certain segments of the stock market, such as a group of smaller, faster growing companies. These securities provide a solution to our liquidity challenge since they are diversified across a number of stocks within the basket and trade millions, if not tens of millions of shares each day by other institutions – providing us easy entry and exit – as opposed to trying to do so with individual securities. ETFs, just like individual stocks, offer investors upside potential as well as downside risk. In past years we have limited the use of these tools given their added cost. However, as the ETF universe and industry has grown, the costs have collapsed providing value and potentially better performance for all investors.
We believe that in the future, segments of the market, such as small stocks or foreign bonds, will provide enhanced performance for your portfolio and that the use of ETFs for some select segments will make it easier and more efficient to capture. Again, we envision that the bulk of your stock and bond portfolio will always be individual securities, as has been our style for over 25 years, but in the future some of these ETF tools may provide additional and enhanced performance along the “edges.”
We anticipate that these additions may be at most 15-20% of your portfolio – and typically much less. As with our individual securities, such as your stocks, we will still incorporate stop loss orders on your ETF positions, thereby mitigating the risk of any one security or ETF declining catastrophically. The addition of ETFs should further diversify your portfolio – lowering your overall risk while enhancing your return – our ultimate goal!
As you know we manage your portfolio separate from other clients, so it can be tailored specifically to you. If you feel that the use of ETFs does not suit you, please respond to this email and we will make sure to exclude your portfolio from these additions. If you have questions about this change feel free to reach out so we can discuss further.
As always, our team continues to look for ways to enhance your portfolio’s performance and manage risk. If you have experienced any changes in your financial circumstances or would like to review your portfolio please let us know. We hope you find these thoughts helpful.
Your Team at Main Street Research
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