SUNDAY, JUNE 25, 2017
NEW ADDITION TO PORTFOLIO LINE-UP
(and an Important Revision to the Relative Value Portfolio)
Some subscribers have expressed frustration over the last six months or more because the performance of our two model portfolios (Deep Value and Relative Value) were not the overachievers they have been in the past. We share that frustration with you. After all, we also invest our funds in undervalued companies, many of which we present on the pages of IntelligentValue. Part of the problem lies in the overall underperformance of the entire category of value stocks since the election last November, which we discussed in our May 29 Value Alert editorial. Large-cap growth has surged since then, particularly technology stocks, while value stocks have struggled.
Nevertheless, investors want to see their money produce good returns no matter what the year or market environment, and while our long-time subscribers are still quite satisfied on the whole with the portfolios, newer customers wonder what all the IntelligentValue fuss is about and how we achieved those exceptional returns in the past. Our portfolios based on 'relative value' are intended to find good undervalued stocks even if the market environment is expensive. Therefore, we have modified our Relative Value portfolio with the objective of improving returns in the current richly priced conditions. We have also added a new portfolio! We'll explain those changes in this Value Alert.
BEHIND THE SCENES: NOSE TO THE GRINDSTONE
While our model portfolios still show excellent annual returns since launch, what matters to investors paying for our service today is the performance they get today. We are not satisfied to rest on our laurels and brag about returns from "back in the day." IntelligentValue's objective with our model portfolios is to produce consistently excellent results that are superior to the market's performance and superior to an investor's other online advisory alternatives. Therefore, we have made some significant changes to improve the prospect of achieving this goal.
Lots of midnight oil has been burned by the IntelligentValue staff in the last few months to address our portfolio's performance issues. Specifically, we 1) are moving our high-return, large-cap Blue Chip Value portfolio from the IntelligentValue Pro section to the section for individual investors (this one) today; have 2) made an improvement to our existing Relative Value Portfolio to boost returns in this pricey market environment, and 3) are adding an ETF-based portfolio soon. We think these changes will provide our subscribers with excellent portfolio performance going forward!
This page documents the changes to the IntelligentValue portfolio roster, effective June 25, 2017.
'BLUE CHIP VALUE' PORTFOLIO - ADDED JUNE 25, 2017
We recently completed the process to move an excellent-performing portfolio from our IntelligentValue Pro service for professionals (hedge fund managers, mutual fund managers, and other institutional investors) to the portion of our website dedicated to individual investors (this section). The portfolio produces exceptionally smooth, high-return performance with very low drawdowns.
One of the advantages of this portfolio is that since it is based on the S&P 500 universe, dilution and liquidity are not issues about which to be concerned, so any amount of money can be invested in the selections. With a universe that consists only of large-cap S&P 500 companies, the stocks selected also offer more consistent returns. The reason for this is that the businesses in the S&P 500 are not prone to dramatic overnight selloffs, which can frequently occur in small-cap stocks on the slightest unexpected news.
This portfolio is made available for individual investors starting on Sunday, June 25, at no additional cost. Now that we also have updated the RV Portfolio's Buy Rules and Ranking System, members have two great mid-and large-cap portfolios with almost no limit on how much can be invested in the stocks in each.
Chart 1 below shows the historical Equity Curve chart for our "Blue Chip Value" Portfolio in the top window, with the portfolio's Drawdown chart shown in the lower window. In both windows, the portfolio is represented in red, while the S&P 500 EW index is shown in blue.
Chart 1: Our new 'Blue Chip Value' Portfolio provides steady returns in the current, richly priced market environment with minimal drawdowns.
It's easy to see that this is a portfolio with excellent historical returns (red line, top window), but one which will also allow investors to sleep soundly at night. Notice how small the drawdown is for the portfolio (red line, lower window) compared to the S&P 500 EW index (blue line, lower window) during the financial crisis.
Our"Blue Chip Value" portfolio has delivered a totaIt isl return from September 1, 2004-to-present of 13,692% for our professional and institutional investor clients in the IntelligentValue Pro service. This calculates to an annualized return of 46.58%, a maximum drawdown of only -16.23% (compared to -60% for the S&P 500 EW index), and 69% overall winners.
With an excellent return and minimal drawdown , the portfolio has an outstanding risk-adjusted return (Sharpe Ratio) over the last 13 years of 2.37. To put these excellent ratios in perspective, the S&P 500 ETF (SPY) has a Sharpe ratio of 0.91, Berkshire Hathaway has a Sharpe ratio of 0.76, and the NASDAQ index has a Sharpe ratio of 0.17.
This system also does not rapidly churn stocks, which is something we often see in portfolios as a shortcut to to achieving higher performance numbers. With an average hold time of 1.57 months, the Blue Chip Value Portfolio is not a buy-and-hold-forever system, but the steady, unhurried pace of trading and low drawdowns minimize investor's stress.
The equity curve chart above shows a smooth progression with minimal drawdowns. Note that the portfolio moved to cash during the July 2016–Feb. 2017 period of market turbulence. Example holdings include such well-known names as Goodyear Tire & Rubber Co, Western Digital Corp, Progressive Insurance, Best Buy, The Gap, Allstate Corp, NRG Energy, Tesoro Corp, Southwest Airlines, Xerox Corp, and many other easily recognizable companies with abundant American corporate histories.
The 'Blue Chip Value' Portfolio also demonstrates an even stronger performance when we review the same dates used for fine tuning the Relative Value Portfolio's recent performance; i.e., the bull rally from February 8, 2016 to present (updated on August 2), as shown by this chart:
The 'Blue Chip Value' Portfolio performs even better when backtested in the most recent period, from February 8, 2016 to present.
Note: Chart updated on August 2, 2017.
The chart above shows that during this recent time period - which reflects the current market environment and comprises about 1.5 years, the portfolio achieves a total return of 115.63%, an Annual Return of 68.16%, a Maximum Drawdown of -8.04%, 66% overall winners, and a risk-adjusted return (Sharpe Ratio) of 2.37.
While we knew from analyzing rolling, 1-year historical returns that the portfolio was very consistent regardless of the market environment, we were pleasantly surprised to see that it is performing in the last 1.5 years more than 20% better on an annual return basis that it did closer to the time when it was created. Typically, there is a slow deterioration of a portfolio's performance advantage over time as other investors discover the anomoly it exploits and chip away at whatever inefficiency was in the market that originally generated the excellentreturns.
The charts below show Risk Measurements for the trailing three years and since inception (September 1, 2004):
We are quite proud of this portfolio and believe it will make an excellent addition to the IntelligentValue portfolio lineup for individual investors. With a 46% return through all market environments, bull, bear, and sideways, the portfolio should continue to produce great results going forward.
Please log-in to see the Blue Chip Value Portfolio page for all the historical transaction details and this week's stock selections.
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'RELATIVE VALUE' PORTFOLIO - REVISED JUNE 25, 2017
Let's face it – conditions have dramatically changed since the RV portfolio was launched in March 2009. While there are still undervalued stocks in the market, the overall valuation level of companies has increased significantly. We have spent much of the last several months working on refinements to our Relative Value Portfolio's stock-selection system to better match today's rich asset environment. We made improvements in two phases: The first phase modified Buy Rules and was implemented several weeks ago. The second phase modified our TurboValue Ranking System factors and formulas (creating the "TurboValue 2.0" ranking system) and will be implemented today with new stock picks.
BUY RULES: To accommodate this costly market environment (i.e., the S&P 500 CAPE Ratio is at its second-highest level in history), we revised our Relative Value Portfolio by relaxing one of the tight valuation requirements for a company to be considered for purchase. The key Buy Rule that turned out to be causing the performance problem was requiring a company's Enterprise Value-to-Operating Income (before Depreciation) ratio to be less than 8.0.
We discovered that when the portfolio was launched in 2009 there were many hundreds of stocks that met that requirement, but today, out of 1300 stocks in the base universe, there are only 95 that have an Enterprise Value-to-Operating Income ratio less than 8.0. The number of stocks that meet the other requirements to be in the portfolio, which aren't nearly as rigid, bring the possibilities down to about 21 companies – and those aren't very good companies.
Therefore, we relaxed the strict requirement on this factor. As a result of not requiring equities to be so deeply undervalued on an EV/OpInc basis, the projected Annual Return from February 2016-present skyrocketed to 130% annually. This one change opened up a much larger universe of stocks that could be considered and allowed the portfolio's other selection attributes to return performance to its traditionally high levels.
RANKING SYSTEM: Our extensive back testing has uncovered some historically robust factors with proven track records that will significantly increase the RV Portfolio's returns going forward. The modifications we made were intentionally not designed to 'cherry-pick' a few big winners. Instead, we sought broad-based factors that could increase the portfolio's performance across its stock-selection spectrum and not rely on picking a few stocks with exceptionally high returns to improve performance.
Specifically, we supplemented our value-based systems with long-term momentum factors that identify individual stocks that are riding a trend higher, in industries that are also riding a trend higher. We included a Buy Rule that ensures the stocks are not in a mature trend that is already topping out and prone to reversal. Another change we implemented was to reduce the minimum Market Capitalization of the companies from which it could select to $600 million from $800 million. Note: companies are not chosen from the sectors of finance, utilities, or biotechnology, as these are historically difficult to value.
SELL RULES: Lastly, while momentum is a powerful, well-researched factor when combined with value, we did not want to sell our positions based on value AND momentum. We want to sell when 1) a company's value rating has declined relative to its peers, or 2) the investment has become fully valued. Therefore, the new Relative Value revisions utilizes two ranking systems; one for buying stocks that are undervalued and have upward momentum and one for selling stocks based on value alone. On the sell side, the Ranking System reverts back to our base TurboValue ranking, which is focused almost exclusively on value and does not include the new momentum factors.
The results are impressive. We back tested for factors that are working in the present environment; from February 2016 when the most recent leg of the bull rally began - to present. Below we show two charts, the first from the prior version of the Relative Value Portfolio and the second of the new version for this same time period. The 'Old' version produces a total return of just 46% over the last 1.5 years. That calculates to an annualized return of 32.71%, with a maximum drawdown of -17.97%, overall winners of 53.68%, and a Sharpe Ratio of 1.12.
The original version of the Relative Value Portfolio shows more volatility and a significant decline in performance over the past three months.
The Revised version of the Relative Value Portfolio improves on performance significantly and provides a total return increase to 211%. This calculates to an annualized return of 130.84%, a maximum drawdown of only -9.32%, 70% overall winners, and a Sharpe Ratio of 3.06. Turnover is increased a bit, but the stocks are still held a little over two months on average. In looking at the chart, you can see that adding the long-term momentum factors smoothed the equity curve and significantly reduced drawdown.
The Relative Value Portfolio revised version adds momentum factors to the Ranking System and Buy Rules, significantly enhancing performance and reducing drawdowns.
These modifications with new stock picks are implemented starting with the Sunday, June 25 portfolio update and (barring an uneforeseen market meltdown) we expect to see performance improvements in the weeks ahead.
Please log-in to see the Relative Value Portfolio page for all historical transaction details and current stock selections.
Not an IntelligentValue Subscriber?
Celebratory price roll-back to the 1997 subscription level!
For a (very) limited time only. Click here to learn more.
OUR PLAN FOR THIS WEEK
We have provided the stock selections for the Relative Value Portfolio and the new Blue-Chip Value Portfolio on their respective portfolio pages. Please review those pages for details on the equities we will be selling and purchasing at the open on Monday morning.
If you have questions about anything discussed in this publication, please feel free to contact us.
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Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the subjects discussed, market environment, company or ETF SEC filings. Investors may wish to consult a qualified investment advisor. The information in this material was obtained from sources believed to be reliable, but were not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Shareholders, employees, and writers associated with IntelligentValue, Inc. may hold positions in the securities that are discussed. Neither IntelligentValue.com, nor any of its employees or affiliates are responsible for losses you may incur.