Allocation of Capital is one of my core focuses for my portfolio and any portfolio I advise on. For all the credit that Warren Buffett and Charlie Munger receive for their investing success you will rarely hear credit given for their most important skill and accomplishment. In order to achieve success an investor needs to do a lot of things well. I would argue that the most important task is how you allocate capital in your portfolio.
Before you even invest your first $100 I believe it pays dividends to take a few hours reading everything Buffett has said on allocation of capital and its importance. By doing this you will gain a better understanding of how to focus on the long-term, the need to allocate effectively, efficiently and when to deploy those resources. The bottom line is that an investor needs to understand the true cost of capital and this forces you to make better decisions with your money.
When it comes to portfolio turnover I am an investor who attempts to keep turnover at a minimum. Turnover can trigger favourable or unfavourable tax implications in a taxable account. An example of this would be my practice yearly between October and December examining my portfolio for any tax-loss selling to balance out gains I may have been forced to take. Turnover can also diminish your ability to stay focused, on target and disciplined. Many investors have a hard time sitting on their hands in a volatile market because they feel compelled to do something or chase something.
So What’s Your Point Brad?…
My point is that all successful investors will tell you what they did, but it doesn’t help you if you don’t understand why and how they did it.
In more of my future posts I am going to try and talk through my decisions in a basic format so you can better understand what motivated my decisions. If I’m targeting a total return of 8-10% per year for an investment then I need to be confident the dividend (X%) plus the growth of the business (Y%) will equal 8-10% and therefore can justify allocating the specific portion of capital to it. I don’t need to achieve that return each and every year, but over the length of time I own the investment I expect it, at a minimum, to achieve that target.
In late 2015 I started the process of my yearly portfolio review and made a decision that some turnover was necessary in certain holdings due to the following reasons:
- Underperformance
- Changes in Profitability
- Poor Shareholder Value
- Desire for Improved Efficiency
Underperformance would be an example of selling completely my long-term position in Cominar REIT (CUF.UN). This was a company I had held since 2007, had paid a nice monthly distribution, but management had disappointed me in unlocking value I perceived to be present and I sold at basically the same price I had bought. Changes in profitability and poor shareholder value were the reasons I sold out of Husky Energy (HSE). The steep decline in oil prices and decisions on their dividend policy were red flags right from the beginning.
The desire for improved efficiency along with selling out of Cominar led me to make a decision on all my REIT holdings which also included Smart (SRU.UN) & RioCan (REI.UN). I took some time to calculate the relative value of Canadian real estate in all my holdings to see how that compared to my REIT weighting in my asset allocation target. I decided that I only needed a 3.25% allocation outside of my other holdings. I came to the conclusion that although Smart & RioCan had outperformed their index over the period of time I’ve owned them I would be better served for efficiency to buy the BMO Equal Weight REIT Index ETF (ZRE) for the interim.
New Position Added: ZRE – BMO Equal Weight REIT Index ETF (3.5%)
Along with some other decisions I had targeted 5-7 positions I wanted to fill across various sectors in the portfolio.
The first was a new utility. I have held Emera (EMA) and Fortis (FTS) off and on over the years, but with both making large acquisitions and their debt rising significantly I decided to jump into the IPO for Hydro One (H). I did enough research to be confident, but really this was about feeling assured I could make a 20-30% return in a 12 month period before needing to make a decision about going back to either EMA or FTS. I already held Capital Power (CPX) and Atco (ACO.X) in a higher weighting so I bought during the IPO and will reassess each quarter from here.
New Position Added: H – Hydro One (3.25%)
Second was my interest in Cara Operations (CAO). Cara had been a stock I owned before it went private in 2004 and in April of 2015 it came public again with an IPO. After 10 years with no transparency it was impossible to assess if the capabilities of Cara was still intact. From a qualitative perspective the restaurants had continued to do well, but I needed time (a few quarters) to assess the quantitative numbers. In February the stock dipped below $25 (IPO at $23) and I filled out a full position. They have continued to report decent results each quarter including the acquisition of Groupe St-Hubert Inc., Québec’s leading full-service restaurant operator as well as fully integrated food manufacturer, for $537 million in March. I had a position open for a consumer stock in my sector allocation and I’ve filled it with Cara likely for the long-term. I do want to see sales growth improve as it’s been on a downward trend the past few quarters, but given some of the challenges facing consumers in Canada I’m willing to be patient for now.
New Position Added: CAO – Cara Operations (3.5%)
Third was a desire for increased exposure to professional services. I didn’t have a specific sector, model or stock in mind when I started this search, but I knew I wanted a few names that were unique, different and distinct in the portfolio. I originally started my research with SNC-Lavalin (SNC), but quickly during my Situational Analysis I removed it from consideration given the political and legal exposures it had over the years. In my opinion that is an environment created by management and because I put so much stock in the quality of management running a company (and I didn’t like the valuation) that it was excluded.
Two stocks that did come up in my search were CGI Group (GIB.A) and WSP Global (WSP).
CGI Group provides a host of services to business and government providing business transformation, IT strategic planning, business process engineering and systems architecture. It doesn’t pay a dividend, but I have held non-dividend paying stocks in my portfolio from time to time if I determine there is appropriate value and the allocation of capital is warranted. When reading through a series of annual reports (I advise all investors do this for any new stock you add) I liked the business model, that management has a good pulse of the business and the backlog of work due is high enough to attract good clients, but not large enough to deter CGI’s bids for future services. This was a stock I had selected with a $52-$54 entry and the fall out of the Brexit vote offered me the opportunity to buy in at a full position. If all things go well I see this as a company with long-term enduring value in a space not easy accessed for retail investors. Their more global footprint also fits with my long-term goals for the portfolio.
WSP Global is a professional services firm that also works with business and government providing engineering services in various sectors. At half the size of SNC it was a stock I had researched for a client back in 2013 (and liked), had placed on my watchlist, but until earlier this year didn’t really have the room for it in my portfolio. Again I liked the business model, management and backlog of contracts, but I’m not yet sold on its dividend growth. For the moment I’m content with my 3.5% dividend, but want to see them grow it at a sustainable rate with the growth of the business.
New Position Added: GIB.A – CGI Group (3.25%) & WSP – WSP Global (3.25%)
Fourth was a company again had on my watchlist for quite some time Brookfield Infrastructure Partners (BIP.UN). Brookfield acquires, manages and operates global infrastructure assets such as utilities, communications, transport and energy. The growth of their distribution was what really kept coming up in my screens over and over again and I’ve liked how management continues to seek opportunities that benefit shareholder value. Having the ability to grow their distribution at 11-13% annually is a nice fit for the cashflow growth I’m targeting for the allocation of this portion of the portfolio.
New Position Added: BIP.UN – Brookfield Infrastructure Partners (3.25%)
Finally I completed a lengthy analysis of Alaris Royalty (AD) for one of my clients. Alaris provides financing to private companies, typically in the form of “preferred limited partnership interests, preferred interest in limited liability corporations in North America, or long-term license and royalty arrangements.” At first glance I wasn’t sold on the business model, but after researching each of the businesses they hold a stake into I really started to open up to the idea of this structure. With over 15 active partnerships management has done a good job of finding companies with relatively stable operations in established markets, but have suffered from some non-repayments that have stung. This is a more volatile stock than I would like for my portfolio, but at roughly a 3% allocation I can afford a little more risk for the corresponding cashflow I’m receiving.
New Position Added: AD – Alaris Royalty (3.25%)
Thanks for reading. Any questions please feel free to leave a comment!
