Author: James Roberts
Covestor models: Fortune’s Most Admired, StockDiagnostics, Best Ideas
I wrote recently about reducing correlation with the S&P 500 (SPX). One of the strategies mentioned was the inclusion of Master Limited Partnerships. It became clear to me that stocks with high predictability, low volatility, and relatively high dividends have become more expensive versus stocks with opposite characteristics.
Consequently, it seems to me that I am paying too much for security by owning Enterprise Production Partners (EPD), a MLP. I sold EPD recently and purchased Tesoro Petroleum (TSO) for the Best Ideas portfolio because it exhibits considerably more volatility than EPD. The early July sale of Sunoco’s East coast refinery to a private equity firm indicates that refineries have a somewhat brighter future.
Another way to reduce correlation with the S&P is to include some stocks in your portfolio which have demonstrated a history of lower volatility than the index. I believe that Berkshire Hathaway Class B (BRK-B) has compiled a track record of terrific returns to shareholders as well as lower volatility. On a value basis, BRKB is not expensive and I purchased the stock on June 19th.
One stock that I believe is undervalued (and that I bought) is Microsoft (MSFT), which has exhibited considerable stability for the last several years while the index fluctuated more substantially.
Yet another strategy to reduce correlation with the S&P index is to include precious metals stocks or the precious metal itself. I have not utilized this strategy recently. Furthermore, I sold AGCO Corp. (AGCO), a fertilizer stock, because its fortunes are tied to the vagaries of the natural gas market as well as the weather (extremely hot weather is good in this case as it reduces the corn crop).
Predicting commodity prices is not something that I want to pursue. Tesoro benefits from the “crack spread” which might become more or less favorable because of a move in the price of crude in either direction. Owning refiners does not necessarily require a conviction on the direction of the price of crude.
The current favorite way to reduce correlation with the index is owning U.S. government bonds. Treasuries have been the biggest winner over the last several years. In fact, Treasuries have done so well that I believe they are more risky (subject to volatility) than many investors realize.
I haven’t been putting unused investment proceeds to work in money market funds or ETFs that are proxies for the bond market. It is convenient not to be required to sell an ETF in order to purchase a stock when it appears attractive.
