Letter from the President
Having said last week we would not bail out of our long positions in energy, for the short-term model portfolio only, I’m doing a U turn: we’re bailing out. This portfolio holds ETF that holds a broad basket of commodities futures. We’re selling it on Monday and reassigning that small position (5% of the total) to U.S. large cap equity. This will double our U.S. equity holdings in this portfolio from 5% (now allocated to the low volatility large cap segment) to 10%. We changed our minds because of the continued unexpectedly precipitous fall in energy prices and the low-volatility mandate of this portfolio—its investment horizon is 6–24 months. The blood is gushing faster than we expected it would; it has become urgent to stop the bleeding.
We hold to our energy and other commodity exposures in our medium- and long-term portfolios. These are equity dominated and have investment horizons of at least two years. Hence they can hold up under the volatility energy holdings are subjecting them to better than can the short-term portfolio, dominated by poorer performing bonds and having a short investment horizon.
In an attempt to recoup some losses, we’re going to gamble a bit with the money released by the commodity futures ETF: we’ll put it into large cap U.S. equity. To prevent the stocks from introducing too much volatility, we’ll make two additional changes:
- Extend bond duration a bit, pulling some money out of U.S. short-term investment grade corporate bonds to invest it in medium-term (5–10-year) investment grade corporate bonds.
- Close out our relatively new position in a U.S. 5–10 year investment grade bond fund that holds both government and corporate bonds in order to switch back into 7–10 year U.S. Treasuries.
These two changes will extend slightly the average duration of the bond portion of this fund and assign a bit more weight to U.S. Treasuries (versus corporates). Given our expectation that rates will move up next year, this might sound like folly. However, in combination with increasing our equity exposure, it is likely to be stabilizing. If U.S. growth turns out slower than expected next year, the additional equity could fall; we’d hope that the medium-term investment grade bonds would jump high enough to offset the equity losses. On the other hand, if U.S. growth proves strong, equity could grow by leaps and bounds, hopefully faster than any drop in medium-term bond prices.
In the worst case scenario we’ll have what we have called “the bad kind of volatility”, in which everything except U.S. dollar cash falls in price. We would expect the whole portfolio (and the medium- and long-term ones as well) to briefly crash in this case, but to rebound in at most six months.
It is this risk that explains why we urge clients to hold enough cash in the currency they operate in to cover at least six months of operations.
Previous Letters from the President
 Read descriptions of these portfolios here. Clients receive details on their composition in addition to individualized strategies and portfolio management services. To request more information, please write to firstname.lastname@example.org.