This is the editorial of our monthly Quant Value Investment Newsletter published on 07-05-2024. Sign up here to get it in your inbox on the first Tuesday of every month.
More information about the newsletter can be found here: This is how we select ideas for the Quant Value investment newsletter
This month you can read my best ideas on how to rebalance your portfolio.
But first the portfolio updates.
Portfolio Changes
Europe – Buy Two – Hold One – Sell Two
Two new recommendations this month as the index is above its 200-day simple moving average.
The first is a family controlled German medical and safety equipment provider trading at a dirt-cheap Price to Earnings ratio of 8.5, Price to Free Cash Flow of 7.5, EV to EBIT of 5.6, EV to Free Cash Flow of 8.2, Price to Book of 0.7 with a dividend yield of 3.6%.
The second is a high yield, debt free French media company trading at Price to Earnings ratio of 9.3, Price to Free Cash Flow of 5.5, EV to EBIT of 4.5, EV to Free Cash Flow of 4.1, Price to Book of 0.9, and it pays a dividend of 5.9%.
Hold One
Continue to hold Höegh Autoliners ASA +116.9% (recommended May 2023) as it still meets the portfolio’s selection criteria.
Stop Loss
Sell Shoe Zone PLC at a profit of +12.4%
Sell Stellantis N.V. at a profit of +21.0%
Strabag SE update
Strabag SE on 16 June 2023 decided to implement an ordinary capital reduction of €9.05 for the purpose of distribution to shareholders. The conditions for the reduction and its payment were fulfilled in March 2024.
The company approved a second acceptance period (from Tuesday, 16 April 2024 until 14 May 2024, 15:30 CEST) to have the distribution securities you received converted into cash.
You can read more here: Strabag SE payment of the cash distribution from the capital reduction.
I looked at the offer and decided to take the cash and not keep the capital reduction right shares the company issued.
Please look at the documentation and decide for yourself. But remember you must reply by May 15.
North America – Buy Two – Sell Two
Two new recommendations this month as the index is above its 200-day simple moving average.
The first is a US-based apparel manufacturer trading at a Price to Earnings ratio of 7.4, Price to Free Cash Flow of 2.3, EV to EBIT of 5.0, EV to Free Cash Flow of 2.6, and Price to Book of 0.8. The company does not pay a dividend but bought back 3.7% of its shares last year.
The second is a Canadian furniture retailer trading at a Price to Earnings ratio of 10.7, Price to Free Cash Flow of 7.1, EV to EBIT of 9.5, EV to Free Cash Flow of 8.3, Price to Book of 1.5 and it pays a 3.0% dividend.
Sell Celestica Inc. at a profit of +317.5% as it no longer meets the portfolio’s selection criteria.
Stop Loss
Sell FONAR Corporation at a loss of -27.5%
Asia – Buy Two – Sell Two
Two recommendations this month as the index is above its 200-day simple moving average.
The first is a debt free, growing Japanese clutch manufacturer trading at Price to Earnings ratio of 7.5, Price to Free Cash Flow of 4.1, EV to EBIT of 2.2, EV to Free Cash Flow of 1.4, Price to Book of 0.6 with a dividend yield of 3.0%.
The second is a debt free Hong Kong event management company. It is currently trading at a Price to Earnings ratio of 8.9, Price to Free Cash Flow of 4.6, EV to EBIT of 3.8, EV to Free Cash Flow of 2.8, Price to Book of 0.9 with a 4.9% dividend yield.
Sell Two
Sell Southern Cross Electrical Engineering Limited at a profit of +99.2% and MITSUI-SOKO HOLDINGS Co., Ltd. at a profit of +18.9% as they no longer meet the portfolio’s selection criteria.
Crash Portfolio – Sell One
No new Crash Portfolio ideas as most markets have recovered.
To date the 15 Crash Portfolio ideas, recommended between August 2022 and May 2023, are up an average of 35.8%!
Stop Loss
Sell Fukuda Denshi Co., Ltd. at a profit of +61.1%
How to Rebalance Your Portfolio
A subscriber recently sent me a good question on how to rebalance his portfolio and I thought it is something that may also interest you.
Here is his question:
I have a question about rebalancing – when you rebalance/rotate positions out and in how do you deal with sizing? Assume I have a portfolio of 20 positions of 5% each initially, when I rotate a position out and buy another one, the position I rotate out will most probably be less than 5% (or maybe more if it performed strongly earlier).
If I now have a new entry, I could just use the proceeds from the earlier sale, but that would lead to the new position being underweighted (overweighted) from the start.
Alternatively, I could sell some shares of my strongest performers to top-up the new entry, but cutting my best stocks might not be a great idea if they still have good momentum.
Lastly, I could rebalance the entire portfolio, but that involves a lot of trades, trading cost and cutting some of my stronger stocks.
As you can see, he raises a good point, and it is something we all must deal with when buying and selling.
Portfolio rebalancing is the adjusting the weights of different investments as values change over time. The weights of investments are also known as position sizes.
Understanding Position Sizing in Portfolio Rebalancing
Position sizing is crucial as it decides the weight of each investment in your portfolio, affecting both risk and potential returns.
If an investment's value changes significantly, its part in your portfolio will also change, which may not align with your strategy.
The newsletter recommends fixed 2% buy positions which gives you a very diversified portfolio where the strategy, not the individual positions, is the most important factor.
You can of course decide on your own weights however we recommend that you keep them under 5% to give you the benefit of diversification.
Challenges in Rebalancing
As the question mentions, when you sell an investment, the proceeds may not match the intended size for a new purchase, leading to an imbalance. This could result in the new investment being too large or too small, potentially disrupting your portfolio's balance from the outset.
Strategies for Effective Rebalancing
You can choose to rebalance your entire portfolio to realign every investment with your original size, but this may not make sense as it increases transaction costs.
A better idea is adjusting only the most misaligned positions. This reduces costs and keeps your portfolio in line with your goals.
For example, if you sold an investment for a loss, leaving you with a smaller position to reinvest you could add cash to your portfolio or sell some of your largest gain to make up for the difference and give you a full position size again.
Yes, this option does reduce the investment of the company with the best momentum (biggest gain) but remember you want the investment strategy to drive your gains not the largest position.
Also, it is not that large positions get sold all the time, only now and then when you need a bit of cash to top up an investment sold at a loss.
If you sold a position with a large gain your next investments will be a bit larger as your portfolio has grown. If there is still cash left over hold it in a money market fund until it can be used with a next investment.
Conclusion
Regularly review your portfolio to check for imbalances that may need rebalancing is essential maintenance for your portfolio to make sure it still is diversified.
Also, as with anything in investing, there is no “right” answer there is only “what works for you”.
Reading Recommendations
Lyn Alden’s April newsletter Balanced Portfolio Construction is a good read, as always.
Main Points
She challenges the effectiveness of the traditional 60/40 (60% Stocks 40% Bonds) portfolio in the current economic climate, highlighting its reliance on declining interest rates and a strong U.S. stock market.
Also mentioning the risks associated with the 60/40 portfolio during periods of high inflation, noting its lack of exposure to commodities and hard money assets which typically safeguard against inflation.
She suggests diversified portfolio alternatives like Harry Browne's Permanent Portfolio and the Ivy Portfolio by Meb Faber to better withstand the effects of inflation.
She introduced Lyn Alden's "three pillar portfolio" approach, recommending a mix of:
- Profitable equities,
- Commodity assets, and
- Cash equivalents
to navigate different economic cycles effectively.
Summary and Conclusion
"The 60/40 portfolio might not serve the best interest during times of economic uncertainty and high inflation. Considering alternatives that include a variety of asset classes, such as commodities and hard money alongside traditional stocks and bonds, could potentially offer better protection and growth opportunities. The proposed 'three pillar portfolio' aims to adapt to various economic conditions by dynamically balancing asset types."
Most Important Point
Diversifying beyond the conventional 60/40 stock/bond portfolio is crucial, especially in a changing economic environment characterized by the end of a long-term period of declining interest rates and potential for high inflation.
Morningstar - Can Japan Continue Its Strong Run?
Jeff Atherton from Morningstar wrote an interesting article on Japanese stocks called Can Japan Continue Its Strong Run?
Key Points:
- Japan is overcoming deflation, boosting the potential for equities and property.
- A corporate governance revolution is enhancing shareholder value through initiatives like higher dividends and share buybacks.
- Japan's equity market is increasingly attractive compared to the U.S., especially with a weakening yen and reasonable valuations.
Summary and Conclusion
"Despite historical scepticism, Japan's stock market holds strong potential for growth due to significant economic reforms, a governance revolution, and attractive valuations compared to the U.S. It’s a promising time for investors to consider Japanese equities, as the nation experiences economic changes that could sustain a longer bullish phase."
Most Important Point
With its proactive steps against deflation and aggressive enhancements in corporate governance, Japan's market offers a compelling, undervalued opportunity compared to the U.S., making it a good time for investors to look east.
Your analyst wishing you profitable investing
