I’m getting defensive: Here’s why and how – J. Ballard

Author: John Ballard
Covestor model: Mid-Cap Fundamentals

* See important disclosures

In February I liquidated several small positions that I considered, overall, somewhat speculative. They were my least favorite ideas and therefore were the first to go as I began positioning the portfolio more defensively.

I want to beat the market return but not at the expense of attaining absolute annual returns. I know I won’t earn a positive return every single year, but that’s what I aim to do, which means from time to time I will increase my cash position if I see potential for a significant correction in the near term. After the huge, and I think unsustainable, run the market has had recently, I suddenly started feeling more and more uncomfortable being fully invested. It made sense to be fully invested in 2009 and 2010 because, for the most part, stocks were very attractive on a valuation basis. Now, I’m not so sure. It’s getting more difficult to find attractively valued mid cap stocks. I think the most attractive mid cap is Activision Blizzard (ATVI), the second largest position in the portfolio. (It’s technically a large cap according to some definitions.)

I have maintained positions in my favorite ideas for long term growth: Markel (MKL), Apple (AAPL), Activision (ATVI), Netflix (NFLX), and Amazon (AMZN) to name a few. I sold some of my smaller, more speculative, high growth ideas to increase the cash level above 20%, which gives the model ample dry powder to add to existing ideas and possibly pick up a few more bargains if we do see a major correction in the short term. This cash in itself serves as a nice hedge against a potential market dip.

I added a few new positions to the portfolio that I consider defensive, but with short term upside potential whether the broader market falls or not.

One of these new positions is Retail Opportunity Investment Corp. (ROIC). Management is currently snapping up real estate properties and institutional investors are starting to take notice. According to its website (http://www.roireit.net/), ROIC “targets properties strategically situated in densely populated, middle and upper income markets in the eastern and western regions of the United States.” The company owns 25 shopping centers of around 2.8 million square feet. The CEO Stuart A. Tanz is a value conscious acquirer. According to a Forbes profile, he was CEO of Pan Pacific Retail Properties from from 1997 to 2006, and during that period the company’s total market cap increased 795% from $447 million to over $4 billion.

Another new position is Alleghany (Y), a property and casualty insurer with a steady track record of profitably growing premiums and book value per share. The growth of book value is the key to building competitive advantage and growing intrinsic value for an insurance business. I purchased Alleghany on March 1 at $341 per share, which should approximate book value by the time first quarter earnings are reported. Alleghany owns $530 million of Exxon Mobil (XOM) and around $100 million of ConocoPhillips (COP) according to the most recent 13-F filing with the SEC. Since the end of 2010, Exxon and Conoco have increased significantly in value due to the recent breakout in the price of crude oil. The 7.5 million shares Alleghany owns of XOM alone should have added around $10 per share to book value since January 1, 2011. Overall, it’s reasonable to expect that I paid roughly book value for the stock – a great price to pay for a profitable insurer.

I also purchased a full sized position in Seabridge Gold (SA), which is a great defensive position and gives us good short term upside potential if the price of gold continues to trend upward, which I expect it to over the course of 2011. With the investment in SA combined with the existing position in Sprott Physical Gold Trust (PHYS), the model has a 6% exposure to gold.


“Stuart A. Tanz Profile” Forbes.com, 3/3/2011. http://people.forbes.com/profile/stuart-a-tanz/136288

“Form 13F” Alleghany Corporation, 12/31/2010. http://sec.gov/Archives/edgar/data/775368/000095012311011439/y89623ae13fvhr.txt