Core-Satellite Investing in the Era of Rising Bond Yields

I recently sat down with Covestor’s Mike Tarsala to discuss my core-satellite approach in the post-QE Infinity era.

Per Tarsala’s article:

A 200-point drop in the Dow Industrials is as good a reminder as any that it’s important to play both offense and defense with your investment strategies, says Charles Sizemore, portfolio manager on the Covestor platform.

One specific way he’s preparing for market volatility as investors react this week to the potential end of loose Fed policies is by taking a Core-Satellite approach to running his Tactical ETF portfolio.

“I’m playing cautiously with the majority of my holdings in Tactical ETF, and dialing up the risk on only a portion of the portfolio that I think offers strong potential reward,” he told me following our latest Google Hangout.

As Sizemore suggests, a Core-Satellite investing approach typically makes a significant allocation to a long-term, lower-risk “Core” strategy, and a lesser allocation to shorter-term “Satellite” holdings. The approach tries to minimize investment costs and volatility while still providing an opportunity to outperform the broader stock market.

The majority of Sizemore’s Tactical ETF portfolio invests in Exchange Traded Funds (ETFs) made up of income-oriented stocks. He is attracted to ETFs with stocks that have long histories of raising their dividends. Sizemore believes that companies that are boosting their distributions to investors will be attractive and may be more resilient to further market downturns.

Meanwhile, Sizemore also is keeping a small portion of his portfolio in the tech sector. In early June, he purchased the Tech Sector SPDR ($XLK) for the Tactical ETF Portfolio.

“If I am right and in the second half we see a sector rotation into higher beta, higher volatility, more cyclical sectors, then tech should do well,” Sizemore says. “Even if I’m wrong, tech right now is priced attractively. And it pays a great dividend yield.”

Tactical ETF also has Master Limited Partnerships in its satellite holdings. So-called MLPs are unique investments that are required to pay out a majority of their earnings as dividends. The underlying investments in most MLPs are energy-related companies.

Sizemore says that the group is attractively priced following a sharp second-quarter selloff amid fears that their distributions would be less attractive in a rising interest rate environment.

“They are one of the few areas of the market where you have excellent fundamentals, and by that I mean a substantial buildup of energy infrastructure projects in this country,” he says. “Yet they also have a nice current yield and potential for rising dividends in the near-term, as well as over time.”

“No matter how you do it, I think it’s important to be tactical in the second half of the year and react to what could be a very different market than what we’ve become accustomed to in the QE Infinity era,” Sizemore says.

Up Close and Personal with Charles Sizemore, Manager of the Dividend Growth Portfolio

Covestor produced the following video featuring Charles Sizemore, the manager of the Dividend Growth Portfolio and three other models at Covestor.

For more information, see the Dividend Growth Portfolio’s profile page, which includes performance and recent portfolio moves.

Netflix and the New Media Revolution

I recently gave my thoughts on Netflix (Nasdaq:$NFLX) and its business model to the E-Commerce Times’ Erika Morphy:

Netflix all but invented the content-over-Internet model, which is quickly reshaping the way consumers view media, said Covestor Model Manager Charles Lewis Sizemore.

“Netflix and its competitors are the biggest shake-up to media since paid cable TV,” he told the E-Commerce Times.

house-of-cards-final-posterHouse of Cards has been a boost to Netflix’s reputation in the same way that original programming vastly changed the way viewers thought about HBO and Showtime, Sizemore continued.

“I don’t know anyone who buys HBO to watch movies; these days they buy it for its original programming — like the popular Game of Thrones. Netflix is trying to follow that model, and they are wise to. Otherwise, the company is a commodity seller of old content with nothing to distinguish it from its competitors.”

Not that it is clear sailing for Netflix going forward. Not that long ago, it was bleeding subscribers.

Competition from Amazon (Nasdaq:$AMZN), Apple (Nasdaq:$AAPL), Walmart’s (NYSE:$WMT) Vudu and other streaming services is a significant concern, Sizemore said. “Netflix needs to keep differentiating itself lest it get lost in this crowd.”

Certainly, these competing companies are not going to give up their own subscribers without a fight, Scherer added. “All of these providers are fighting for the same subscribers, as well as for the same content.”

Content costs remain a concern for Netflix, noted Covestor’s Sizemore.

“They’ve been getting their material from the studios at very attractive prices, but as Netflix grows and comes to threaten the media status quo, the content providers are rethinking this. Higher costs for content, coupled with competition from competing services, mean that margins will likely shrink.”

To read the full article, see Netflix Plays Its Q1 Cards Right

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

After Sandy: Now What?

In the first day of trading after Hurricane Sandy pounded New York, the S&P 500 had its best trading day in seven weeks.

I’m not one to assign a lot of significance to a single day’s trading, but I did find it encouraging.  It suggests that the damage left behind was less severe than the Street feared.  Life is already returning to normal in Manhattan, and power and transport are being restored bit by bit.  The damage tally will not be small, and the disruption will likely take a bite out of 4th quarter GDP.  But the rebuilding efforts should create a nice jolt in economic activity leading into the new year.

Stocks have been stuck in a sideways pattern for the better part of the past two months, as a string of disappointing earnings releases and economic data kept a lid on investor enthusiasm.  But with the bad news now mostly digested—and with the Fed, the ECB and the rest of the world’s major central banks still maintaining the loosest collective monetary policy in history—I expect the animal spirits to return for the last two months of the year.

Sizemore Capital has been pleased with the performance of our Dividend Growth and Sizemore Investment Letter models at Covestor.  Both are beating the S&P 500 for the year without taking significantly more risk.  In a year like 2012, when so much is determined by macro and political risks outside of the control of company managements, an income-focused strategy is the only strategy that makes sense.

Within the Dividend Growth portfolio, we are focusing most heavily on mid-stream oil and gas partnerships and conservative triple-net retail REITS.  In our view, these sectors are attractively priced and throw off healthy amounts of cash.  These are investments we would be happy to hold for the next 1-5 years, come bull or bear market. Given the current pricing of bonds and other mainstream income investments, we expect these investments to outperform by a wide margin with very little risk of principal loss.  In many cases, dividend yields are well in excess of 5%—not a bad income return in a low-yield environment.

The Sizemore Investment Letter portfolio is slightly more speculative and is not limited to a pure income focus (strong dividend growth is one of many investment criteria covered).  In this portfolio, we see the greatest opportunities in European blue chips with substantial operations in emerging markets.  As the European Union slowly congeals into a more “American” style federal system, we see investor risk appetites for European stocks returning.  And in the meantime, we get access to high emerging-market growth rates and a steady stream of dividends.

You can view our Covestor profile here.