BALANCING GROWTH AND INCOME; A CLIENT-FOCUSED PORTFOLIO STRATEGY FOR LONG-TERM INVESTORS

Note that I cannot give personalized advice over a general blog post such as this. The following portfolio is one I would be comfortable with, but my situation might be quite different from yours. The information here is illustrative and you should consult with a financial advisor before making any decisions. Please also see disclosures at the end of this post.
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While I’m generally an advocate for focusing an equity portfolio on the most compelling investment ideas, within reasonable bounds, I can empathize with clients who prefer a more diversified approach. This post considers how I might design such a portfolio.

Legendary investors such as Warren Buffett have long advocated for a concentrated equity portfolio. In 2008 Buffett said “It’s crazy to put money in your twentieth choice rather than your first choice.” His business partner Charlie Munger has the majority of his money in only 3 stocks.

For me, the sweet spot is approximately 20 position, which can offer the majority of the diversification benefits of an index, assuming that holdings are not overly concentrated within a single sector, industry, or theme, while being focused enough to “move the needle” if a few of the positions perform well over time. You can find my investor letters discussing my “concentrated” portfolio here.

Nonetheless, the fact remains that a large number of investors find it challenging to cope with the volatility inherent in such a focused portfolio. While I personally feel at ease with volatility due to my thorough research and comprehension of its holdings, I can empathize with clients who prefer a more diversified approach. When asked how I would design such a portfolio, my response is as follows.

Below, you will discover a well-diversified portfolio comprised of five distinct funds, with each (excluding gold) containing a substantial number of underlying stocks. As an investor who meticulously investigates companies and performs in-depth fundamental analysis, I believe I possess the aptitude to assess other funds and comprehend their strategies beyond merely examining their returns.

In general, I perceive such a portfolio as being divided into "growth" and "income" components.

The growth components include the following:

Akre Capital is an exceptional fund that has consistently outperformed the S&P 500 since its inception in 2012. The fund's strategy is grounded in a "three-legged stool" approach, which involves investing in companies with strong management, high returns on invested capital, and a long-term focus. This method has enabled the fund to deliver impressive performance, as it embodies true value investing with a highly refined process. The portfolio is relatively concentrated, with the majority of the fund's assets allocated to just 16 holdings. The fund managers remain unafraid to maintain positions almost indefinitely, as long as their original thesis holds true.

Oakmark is another well-regarded fund with an appealing long-term performance record. With approximately 30 holdings, the fund is not hesitant to alter its investments more frequently, offering a slightly different style yet still maintaining a history of success.

Gotham's fund, managed by Joel Greenblatt, is intriguing. Mr. Greenblatt earned recognition in investment circles after generating remarkable returns over a 10-year period, compounding capital at around 50% annually, with an ultra-concentrated portfolio that endured extreme volatility. Mr. Greenblatt now oversees a range of more diversified funds. The Gotham Index Plus fund closely tracks the S&P 500, investing long in top-performing stocks and shorting underperforming stocks based on a proprietary formula, which considers valuation and ROI. The fund has successfully achieved its objective of delivering returns close to the S&P 500 while significantly reducing volatility.

Gold serves as a general hedge against monetary debasement, having been valued as a store of wealth for millennia. Given the growing prevalence of financial manipulation in today's economy, I like a modest allocation to gold. Its 8% annual appreciation against the dollar over the past 20 years makes it an attractive hedge, providing a real return to investors.

The income components include the following:

The WisdomTree Large Cap Dividend ETF is an affordable, passive fund invested in companies boasting a long-standing history of consecutively increasing dividends. Although its initial yield of 3% may appear modest, years of compounding can generate a growing cash flow that keeps pace with inflation. Historically, a collection of dividend stocks has outperformed inflation over extended periods, and I expect this trend will persist. While share prices may vary, dividend streams tend to exhibit less volatility, as companies are often hesitant to reduce dividends once established. This results in a stable and expanding cash flow stream.

Lastly, I believe there is scope for incorporating a curated selection of alternative investments, managed by highly competent professionals with notable long-term performance records. For illustrative purposes, I have selected the JLL Property Income Trust, given its more extensive track record on the platform I utilize. In practice, I would not distribute the 25% allocation across several opportunities. This serves as an example of potential returns within the context of our discussion. Alternative investments, encompassing private equity, private debt, and real estate, have sparked much debate regarding their advantages and drawbacks. These investments can offer enhanced income prospects, lower correlation to overall market volatility (we can have a separate lengthy discussion on mark to market issues), and protection against inflation.. Alternative investments can provide these benefits, but also present risks such as illiquidity and elevated fees.

While past performance does not guarantee future returns, the attached portfolio has historically outperformed a passive portfolio allocate 75% to the SPY (S&P 500) ETF and 25% to the BND (Vanguard Total Bond Market) ETF, with reduced volatility.

Chart presented net of assumed taxes, and net of both underlying fund and net of assumed Alphyn Capital fees of 1% of AUM. See disclosures at end of this post. Past performance is not a guarantee of future results.
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The final chart showcases the potential growth of a portfolio, after accounting for taxes and fees, even when the investor withdraws 4% of the total value annually for living expenses. It is crucial to note that while we cannot predict the future, we can strive to make informed assumptions based on historical performance, fully acknowledging that these estimates are not guaranteed.

Chart shows theoretical results, presented net of assumed taxes, and net of presented net of both underlying fund and net of assumed Alphyn Capital fees of 1% of AUM. See disclosures at the end of this post.

While no portfolio is perfect, this one has been designed to offer a blend of expanding cash flows and value, with the aim of building a substantial nest egg for clients. The illustration demonstrates how this objective could potentially be accomplished.

If you would like to explore further, please feel free to reach out to me. I would be more than delighted to discuss the specifics and address any questions you may have.

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DISCLOSURES:
Alphyn Capital Management is a registered investment adviser.  Each investor’s situation is unique so please work with a professional financial adviser, tax accountant or legal representative, as applicable, to develop an individualized plan or address any questions you may have.Investing involves risk including the possibility of loss of one’s investment.  

The Alphyn Master Advantage portfolio presented here is based on theoretical backtested performance. Backtested results are shown over a 6 year period. This period was chosen as this was the longest duration for which performance data was available for all the selected funds. Back tested performance is the application of a strategy to market data from prior periods when the strategy was not actually used during these periods. This information has the benefit of hindsight and do not reflect actual results. These results are shown net of advisory fees, and include the reinvestment of dividends, or other earnings, and assume the portfolio is rebalanced annually. The advisory fee used for this report is 1% and will be based upon the assets under management. Other expenses are not included these may include trading costs, transaction costs or other fees charged by the custodian.
 
The backtest was conducted with www.portfoliovisualizer.com. The interactive analysis tool used are the “Backtest Portfolio” tool. Portfolio model information represents a blended portfolio consisting of the model's underlying positions and assigned weights provided by the user and rebalanced at the specified schedule. The results were constructed using net of fee mutual fund performance. Portfolio Visualizer does not provide preferential treatment to any specific security or investment. The results are based on information from a variety of sources Portfolio Visualizer considers reliable, but we do not represent that the information is accurate or complete. Full details of the methodology used are available here: https://www.portfoliovisualizer.com/faq#methodology
 
The material conditions, objectives and investment strategies used to obtain these results are: the selection of mutual funds that employ a value investing methodology, passive dividend ETFs, and private investment funds available on the Charles Schwab platform. These funds were chosen based on the advisor’s judgement and experience.
 
Benchmarks are used for comparisons based on the similarities of the portfolio holdings and those within the depicted indexes. The portfolio is has a mix of equities to fixed income or alternative income assets in the ratio of 75% equities and 25% income/alternative assets and is presented alongside the comparison of a combination of 75% SPY and 25% BND ETFs. The SPDR S&P 500 ETF Trust (SPY) is an exchange-traded fund that is designed to track the performance of the S&P 500 Index, which is a widely used benchmark for the U.S. stock market. The Vanguard Total Bond Market ETF (BND) is an exchange-traded fund that is designed to track the performance of the Bloomberg Barclays U.S. Aggregate Bond Index, which is a widely used benchmark for the U.S. bond market.This overall comparison was chosen to show how the ACML portfolio might compare to a passive portfolio.  The results for both portfolios are after tax and net of advisory fees, which are 1% of assets under management. ​