FFJ Portfolio – September 2017 Dividend Income Report

Hi Chuck,

I wanted to respond to your question, “How has your portfolio performed for you lately?” The simple answer would be very good and felt a need to provide a rather long and not entirely explanatory answer but I suspect it may generate if nothing else some discussion..

I think one of the dangers all independent investors face is to assume that they have found “a system” of investing that works based on some formula or precedent. I know you put a very impressive effort into your research of specific companies and you are obviously comfortable doing so and have been investing successfully.

Still, a couple of comments for you to consider, given my view that we are living in an age of unprecedented technological change and in unique financial circumstances after the financial crises.

I liked your analysis of MSFT, since like most people, it reinforced my own investment in the company. As a natural contrarian, I might have appreciated an opposing view point. We all have a tendency to look only at opinions that match and reinforce our own which can be dangerous.

Given my own investments, I was struck by your statement that MSFT is only your second investment in a technology company, the other one being Cisco.

Firstly, I take issue with you that you only have two tech companies in your holdings, since many others would be in that category. More importantly, there is not a company in the world today that does not rely to varying degrees on technology and/or is not susceptible to disruption, ie look at the effect of Amazon has had on bricks and mortar retailers, or its impact on what seemed like a stable sector, grocery chains.

One might think of Nike, another one of your holdings, as a shoe and clothing retailer with a pretty simple easy to understand operation. However, the actual cost of making their shoes, as a percentage of the selling price is tiny, and the rest goes into market research, design and marketing. As such, Nike is really a tech company dressed largely in a famous logo and subject to intense competition and a need for constant innovation. This view was reinforced for me by the following comment :

a decade ago the company started focusing on sport-specific products. Now it will focus not just on the sport, but taking it down even further by focusing on the particular metropolitan area in which the company’s products are sold. This level of granularity is a massive move, but is made possible by ‘big data’ analytics, which will help the company move forward

I noticed that you own both Visa and Mastercard, both with great histories of investment success. Still, are they not subject to fintech disruption as other digital financial payment systems are being developed and becoming widely used starting in Africa, and soon in India and Europe etc?

Similarly, there is an article in yesterday’s Globe and Mail “A New Lease on Manulife” that has a new incoming CEO, who is quoted as saying that insurance and wealth-management companies are “stuck in the stone ages” and that technology is the way forward.

My own view when it comes to investing is that we are in a period of rapid globalization and technological change, and that change is accelerating and every investment decision must be considered in that light. What worked a few years ago, a decade ago or even yesterday, is subject to disruption, and our assumptions need to be reviewed very frequently.

It also behooves us to try to understand technology and to participate directly in the disruptors. The FANG and similar stocks have created immense wealth in a very short period of time and have established dominant positions that they are likely to retain, for some time to come. Tech companies of today are not unlike the railways, oil companies, car manufacturers, steel makers of the early years of the previous century.

We must also be mindful of where we are in the post financial crisis period, a near decade of continues declines of interest rates and QE. With zero or very cheap borrowing costs, it has created a bubble in bond prices, equities, in almost every asset class from real estate to stock values, increased debt to unprecedented levels by governments, corporations and households. I am of the view that we are at or near the bottom of this cycle, and we are facing QT, quantitative tightening, higher interest rates which will affect every sector of the economy, and especially those seemingly stable companies with attractive dividend yields, manufactured through cost cutting, borrowings, share buybacks etc. They will behave like bonds, and also face the risk of being left behind by more technologically savvy competitors. They will benefit banks, as the rates rise and the yield curve steepens.

As for my personal investments, with a background in real estate, I did very well buying REITs and real estate equities as rates declined and selling them as their values become too high. I still hold a few with unique attributes.

Over the last several years I have taken large positions in Facebook, starting at the end of 2013 at an average price of $50 in my margin account, and at $70 a year later in my registered account. I also own a number of other tech names, including Chinese, believing that they serve large and rapidly growing markets.

I also own FDN an ETF in the sector and TXF.TO, hedged to the Canadian $ that writes covered calls on about a third of its holdings, generating a “dividend” from option premiums of about 5.5%.

In addition to anticipating broad “themes” I also use options to enhance the returns from my holdings. I know options are deemed speculative, and that it is a topic very few people can get their heads around. Still, I would feel remiss, if I did not use at least one example to illustrate how one can make significant returns, with zero money with known risks. I do this by establishing a synthetic long position in companies I am highly confident will increase in value slowly over time. Using options I buy long dated calls and sold naked puts, both at the same price. A synthetic long has the exactly the same consequences as owning the equity, without buying the stock for cash or on margin.

As illustrated below, I did this starting in December 2016 with MSFT, believing that with its legacy business generating a steady stream of cash, and with new management the company will be successful in the cloud by marketing to its huge client base.

(I had intended to reproduce my purchases of MSFT over the 9 last months, but the formatting got all messed up as I tried to copy it here)

By way of explanation, I started by buying 5 calls and selling 5 puts, at $62.50, with an exercise date of January 2018 in December 2016. The calls cost 3,141.24 and the puts gave me a credit of -3,008.69 for a net cash investment of $132.55. As of today, my gain is $ 2,913.76 for the calls plus $2,783.69 for the puts for a total of $5697.45, on just these two positions.

As the statement shows, as the price of MSFT moved up, I bought more at $67.50, $70.00 and $72.50 and extended the date to 2019..

Hope you find these comments of some interest.

andrew