This is the third article so far in a series showing the practical steps one can take to re-position a Salad Bar portfolio. You can see the progression of this portfolio – an actual one with actual repercussions if it is badly designed – by reading through the Investment Management Diary articles on the Framework site.

When we started making changes, this portfolio held 86 separate assets, 73 of which were individual stocks. The yield, while a bit better than the market as a whole, was still too low to meet the beneficial owner’s yearly cash needs without withdrawing principal.

Our main goals in this portfolio make-over have been to simplify it – making sure that it is diversified, but still understandable – and to increase the yield.

The Portfolio

As a reminder, here is what our portfolio looked like last week.

 

Figure 1. The large green slice is cash. Gray slices represent funds. All others are individual stocks

My target is to have around 20 stocks that I have some idea of a fair value range and what the key drivers are. In my last diary entry, I gave a short summary of what I know about four of these stocks: AES Corporation, General Electric, Berkshire Hathaway, and Realty Income.

The biggest change since that entry was that I increased the exposure to General Electric by selling puts and liquidated several of the smaller funds.

After those changes, the portfolio looks like this.

Figure 2.

Compared to where we started, we’ve simplified a great deal. We started with 86 total assets, 73 of which were stocks; as of this writing, that numbers is down to 51 assets, 46 of which are stocks. There are still some stocks that I don’t know a lot about within the portfolio, but I’m getting more satisfied that I understand at least the basics of the largest holdings.

The top 20 holdings in the portfolio are as follows:

Each of the rows shaded in blue above are those on which we have a “hybrid” position consisting of both equity and options (AES Corporation is actually exclusively a short put position, but I am counting the notional value of the position were we to own the shares at this price).

We still do not know what yield any of the hybrid positions will generate for us, but the yield-to-best-case is in the low- to mid-teens percentage on an annualized basis.

The average dividend yield (ignoring the option yield) of these positions is 3.1%. My next thought as to how to reform the portfolio is by looking at each of the stocks yielding less than the average and selling them to buy stocks that are yielding above the average. During this process, we might also look for stocks that would be good bond replacement candidates as well.

Portfolio Categories

Looking now at classes of investments rather than individual assets, the portfolio looks like this.

Figure 3. The number before each of the category names shows the average yield from that allocation.

The yield on the equity allocation increased by 50 basis points since my last entry and that asset class now makes up 55% of the portfolio. Zero-yielding cash is 11% of the portfolio and is balanced out by the 11% of the portfolio allocated to bond replacement investments. With the addition of General Electric to the bond replacement allocation, the average yield of that allocation increased 40 basis points since last diary entry. I removed about three percentage points of weight from the allocation to funds and that asset class now represents 23% of the portfolio. Some of the small positions that I sold off had higher yields, so the yield of the fund allocation dropped by 50 basis points.

It’s worth pointing out that the yield on a fund product represents its yield gross of fees. Let’s say that the fee on the funds in this portfolio are 50 basis points; deducting this from the 2.1% yield, our net income from this part of the portfolio is starting to look more like a Certificate of Deposit. It irritates me just to think that some jerk is drinking a nice bottle of wine bought from his mutual fund analyst’s bonus in return for me receiving less than I could by buying a CD.

Goals

Well, now I’m angry thinking about the fees on the funds, I’m half tempted to just sell those funds. That said, I don’t know what else I’d buy with the proceeds, so I guess I’ll just stew for a bit. Next week, my focus will be, as I wrote above, to look at the low-yielding stocks and see if some of the higher-yielding ones’ positions might be boosted while also looking for some more good bond replacement opportunities.