Why Strategy Matters
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over the past week and a half I’ve been taking the opportunity to add some global exposure to my paper trading portfolio called the “No Drip, No Mess” Portfolio. Given the stormy seas of Grexits and Spanics that investors have been navigating, along with a rumored slowdown in China and a fiscal cliff here in the US makes any investment decision feels risky. Yet, we are looking out over this precipice and using the volatility instead of fearing it because we are guided by a strategy that reduces risk.
Now in week three, I’ve recommend eight trades that have the potential to invest up to 30% of the portfolio’s $100,000 in virtual cash. Yet, only about 11% of that cash has been invested with the balance being set aside for potential put obligations. Through a combination of options strategies, we’ve generated just over 1.25% of cash for the “No Mess” side of the portfolio. In reviewing the three most recent trades, I want investors to see how these three holdings, while all involved in global trade, are not as concentrated as they might appear at first glance.
The underlying business of containership owner Seaspan (NYSE: SSW) would seem to be driven by every wave of volatility that hits the global economy. Yet, despite what the price volatility the shares would seem to indicate, the underlying business is very stable thanks to their long-term, fixed rate charters. Their fleet of 72 containerships has an average remaining charter length of seven years with four maturities this years, two next year and none in 2014. As investors we are taking advantage of the disconnect between the business and the perceptions generated by the global economy by writing puts to profit from the volatility. For the portfolio I was able to pick up $137.44 in put premium which represents a 4.6% yield on the cash set aside for the trade. We have the potential to have shares shipped to us for nearly a 15% discount to its current price.
Global mining giant BHP Billiton (NYSE: BHP) is a much more economically sensitive investment, especially where China is concerned. They must make investment decisions now for the future they see over the next decade. What makes them different from a company like portfolio holding Linn Energy (NASDAQ: LINE) is that they don’t hedge their commodity exposure. Instead, their strategy of having a, “diversified, low cost, tier one asset base enhances the resilience of our cash flow by reducing our exposure to any one commodity or currency and provides for more predictable and robust financial performance. It allows us to invest in and grow our business throughout economic cycles thereby delivering superior long-term value to our shareholders.” Linn Energy on the other hand will hedge 100% of their commodity exposure out up to five years to ensure the stability of their cash flows. Both strategies have their pitfalls and pluses but in the context of a portfolio you can reduce your risk by knowing how each company manages their risk profiles. We further reduced our risk by writing puts for a net yield on our cash of 2.7% but more importantly we’d be picking up shares for 18% cheaper than current prices.
The final addition to the portfolio over the past week was Brookfield Infrastructure (NYSE: BIP). Like Seaspan a vast majority of their cash flow is locked in for the long term no matter what happens to the economy. In Brookfield’s case, about 80% of their revenue is regulated or contracted. Their growth will come from the ability to capture inflationary price increase and a combination of accretive expansion projects and incremental revenues from any new investments. What’s interesting is that future growth coming from assets like Brookfield Rail or their Dalrymple Bay Coal Terminal is in part thanks to the growth of companies like BHP Billiton. They are managed by Brookfield Asset Management (NYSE: BAM) who’ve not only seeded them with great assets but have given them access to transactions that they wouldn’t have been able to be involved in otherwise. While shares are more fairly valued than I’d like, we did pick up a 2% allocation at $33.68 a share. If the shares get caught up in a global sell-off, we’ll be there to scoop up shares at lower prices and fill out our allocation.
As we continue to build the portfolio, or any portfolio for that matter, it’s important that each piece fits together as an integrated whole. We need regulated, contracted and hedged assets to give us peace of mind to hold those companies with a more risky profile. The headlines might be worrisome but proper risk management combined with smart asset allocation will enable any investor to navigate the stormy seas of market volatility.
latimerburned owns shares of Brookfield Asset Management, Linn Energy, LLC, ssw (covered call), and BHP Billiton Limited (ADR). The Motley Fool owns shares of Brookfield Infrastructure Partners and Seaspan. Motley Fool newsletter services recommend Brookfield Asset Management and Brookfield Infrastructure Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.