Winning Value Portfolio Outperforms

 | Dec 27, 2012 | 1:00 PM EST  | Comments
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ibm

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Last January, I unveiled the Winning Value Portfolio for Real Money subscribers. The idea was simple: I selected 10 securities I deemed attractive investments and created an equal-weighted portfolio among the 10 candidates. The objective was even simpler: Hold this portfolio until year's end with making any changes.

To many, such an approach was unconventional. A 10-security portfolio was too concentrated and not being able to sell out any losers seemed to defy what many are taught to do as investors. I believe the approach, however, holds its own advantages. Excessive diversification rarely, if ever, reduces risk but can often diversify away returns. A 20-stock portfolio would have been satisfactory, but I would have been adding filler stocks to come up with 20 good bets. I also believe that the rapid selling and replacement of stocks in a portfolio guarantees higher frictional costs without any guarantee of better returns. A one-year holding is a relatively short period for any business: If you have carefully selected your investments, unless that business has run afoul of the law or you realize you have missed a very important variable or the stock price has quickly moved up, then such a business should be held for at least one the three years.

While this portfolio approach is simple in construct, implementation is much more difficult. The investment landscape today is full of temptation to move money around at lightning speed. The purpose behind this portfolio exercise was the exact opposite: Find 10 companies with quality prospects selling at attractive valuations and then let time do the work for you. The table below shows the results for 2012.

*As of market close Dec. 26, 2012

The Winning Value Portfolio has outperformed the S&P 500 by more than five percentage points in 2012. Famed investor John Bogle, founder of the Vanguard funds, once cited a study that revealed that approximately 80% to 85% of active money managers fail to beat the S&P 500 by three percentage points on an annual basis. Since our Winning Value Portfolio was constructed and held without any changes, frictional costs from trading fees were essentially nonexistent -- the 16.4% is real. I like to be conservative and measure returns against the S&P 500 inclusive of the reinvestment of dividends. Even by that metric, the portfolio was ahead by well over three percentage points.

Again, the simple part was putting the portfolio together. The hard part was sitting still and allowing time to be an ally and not an enemy. Next week, I will unveil the 2013 Winning Value Portfolio.

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