Rules of the Game: Cull Portfolio Duplications

 | Dec 26, 2012 | 5:00 PM EST
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Year-end is always a good time to do a portfolio review. Of course, it's good to see which positions could be sold at a loss for tax purposes, and where capital gains should be taken. In addition, it's a great time to do a "sweep" of your holdings to see where you might have too much sector or geographic exposure, and take some steps to balance things out.

Earlier this month, I did a portfolio review with a client who happened to be holding two ETFs for water: the Guggenheim S&P Global Water Index (CGW) and the PowerShares Water Resources Portfolio (PHO). Although these ETFs are pegged to different water indices, it's still too much exposure to one area.

Another client was very particular about wanting health care exposure. He was already holding a position in the SPDR S&P 500 (SPY), and wanted to add the SPDR Health Care ETF (XLV). Rather than give him too much exposure to health care, we opted to pare back the SPY position to make room for the health care.

Keep in mind that I don't use the terms "portfolio cleanup" and "panic selling" synonymously. With this week's market pullback, amid looming worries about politicians' seemingly limitless ability to damage the economy, it would be easy to panic and pull the plug on anything that is showing a sizable percentage decline.

But that's not what I'm talking about. Don't forget: The media need the fiscal cliff drama to keep readers and viewers hooked. Has there ever been a time when there wasn't the fear du jour? Do you even recall -- without Googling -- what the fear du jour was a year ago?

So, portfolio balancing is not about being scared; rather, it's about understanding the levels of exposure to certain investments relative to other portfolio holdings.

For example, DJIA components General Electric (GE) and United Technologies (UTX) are both getting support above key moving averages. GE's dividend yield is larger, but United is the better price performer.

The stocks behave somewhat differently, but at this juncture, there is no good justification for owning two DJIA-component industrial conglomerates. If I had to choose between the two, United would win, simply because of its superior price performance. The 2013 earnings growth outlooks are similar, so that is not a significant factor. United also has two years of growth in free cash flow per share, whereas GE is only showing one year.

The point of today's article is not to give you a recommendation of United Technologies over GE. Frankly, I'm not terribly excited about either, nor do we hold either in our equity overlay portfolio that many of our clients are in. I'm just emphasizing the need to cull your own portfolios of any possible duplication or overweighting.

In some cases, you may want to add some alpha by taking a position in a stock that is a major component of an ETF you own. That's not a bad strategy, as long as it's one you are pursuing deliberately, not accidentally.

So rather than panicking about fiscal cliff scenarios and bailing out of anything trading lower this week, get a good sense of the sector and geographic weightings within your portfolio. Take some time first to cull, and make decisions about new positions after that.

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