Simple But Not Well Diversified

Barron's had a short article on the proliferation of 2X single stock ETFs and the extent to which they represent an intersection of where market participation becomes gambling. At the far opposite end of the spectrum was a comment from a Barron's regular on another article who said that after 40 years, his dividend on Coca Cola (KO) exceeds his cost basis. 

This metric is called yield on cost and it certainly is a fun idea but not a real metric to evaluate a portfolio. KO has been a great long term hold, outperforming at times, lagging at times that has often yielded close to 3%. It got me to thinking about a permanent, individual stock portfolio. Instead of 25% each into an equity index, long bonds, gold and cash, what about 25% each into individual stocks that seem to combine staying power as well as some sort of easily identified demand story that bodes well, not necessarily for outperformance although that would be nice, but to benefit from survivorship bias.

In choosing those names, I am a big believer in having defense industry exposure, the demand is never ending. I chose LMT instead of the one I own for clients. JNJ is a long time client holding. Some might think of Pfizer in this context too, I've never been a fan of Pfizer I wrote an article for the Motley Fool in 2004 bagging on Pfizer and I don't view the name any differently. JNJ has evolved over the years by necessity so I am optimistic it can continue to do that when needed. 

Looking backwards, people have not been able to get enough soda (I realize there are a lot of other products) but to own it going forward is to believe they can figure out what to do if carbonated sugar water becomes less popular. This is a similar idea as very long term client holding Philip Morris. Smoking is less popular so they bought Swedish Match to get nicotine pouches. 

Microsoft also has shown it can evolve but it has gone painfully long periods of underperforming. Twenty five years ago, someone doing this exercise might have picked Intel. Intel owned the world at one point but this century is has compounded at 1.65% despite having a strong run from 2014 to mid-2021. If I had to guess, to repeat this exercise going forward, I might sub Google in for MSFT but I don't think MSFT is going to disappear in the next 75 years. 

Twenty or 25% in one stock is way more than I would ever consider, this is just a thought experiment trying to explore simplicity. Holding four ubiquitous stocks that avoid crazy CEO risk and benefit from some sort of underlying demand story that could continue many years into the future is simple but not very well diversified. 

And a quick pivot to a comment on a WSJ article about do-it-yourselfers trying to sort out whether there is an AI bubble. The commenter indicated that he is older and that he has 60% in a covered call ETF tied to the NASDAQ and 40% in "diversified high yield." That seems pretty nutty so the result was very surprising.

One of the two is the total return 60% Neos NASDAQ 100 High Income (QQQI)/40% HYG and the other one is VBAIX which is a generic proxy for a 60/40 portfolio. The price only compounding of the QQQI/HYG blend is 4.1% so it "yields" about 12%. The 4.1% is about 130 basis above the rate of inflation over the period of the backtest. 

The above is worth adding to the discussion. The same Portfolios 1 and 2, it is important to understand that high yield bonds take on some equity beta and a derivative income fund tracking QQQ is likely to fall more than a derivative income fund tracking the S&P 500 if there is some sort of AI meltdown. WTPI sells puts on the S&P 500. Portfolio 3 with WTPI and cat bonds is less volatile, goes down less and goes up less but the "yield" is still close to 12%. The real return though would be negative if all of the "yield" was taken out of the account, 1.79% price only return versus 2.82% inflation rate. 

A week or two ago I mentioned Christine Benz writing about a "good enough" portfolio. If 60% in a NASDAQ 100 derivative income fund with 40% in high yield is good enough for the original commenter then who are we to question what he should do? I wouldn't suggest anyone do this but hopefully it continues to be good enough for him.

If there is an AI bubble that pops then a portfolio holding 60% in QQQI or some other covered call ETF tied to the NASDAQ will get pummeled unless the original commenter has some sort of trigger point to sell which could spare him the pummeling or turn out to be a mistake if his trigger point turns out to be the low in an immediately forgotten about dip. If the NASDAQ cuts in half, the large distributions from QQQI could spare this guy a couple of hundred basis points but that wouldn't mean much in a down 50% world. This person has painted himself into something of a corner but his idea is interesting. 

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