Ray Meadows, the investment manager and president of Berkeley Investment Advisors, has managed his personal portfolio for over 10 years. From 1999 to the end of 2008 his cumulative return was 209% compared to minus 15% for the S&P 500 index. (Click here for year by year details). As you can see, superior returns really can make an important difference over long time periods.
Looking at the long run is important because it is the erratic results in the short run that can lead to emotional decisions that wreck your chances for superior long run returns. Ray's conviction in his analytical abilities and investment skill allow him to stay the course and reap the rewards of his focus on business and economic fundamentals. After all, in the long run cash flows over-rule emotions in the investment world. Our strategies are designed to outperform over periods of longer than 3 years since it may take this long for fundamental factors to outweigh the short term emotional factors that drive the market up and down like a seesaw on a playground.
Client Portfolio Returns
At Berkeley Investment Advisors, we implement our investment strategies in a number of different risk portfolios which we allocate client money to according to their risk tolerance. Our primary equity portfolios are called Long Term Value (which hit its 5 year anniversary in March 2010) and the Special Situations portfolio which came just a bit later. In January 2008 we initiated what we call the Hedge portfolio which we use to reduce the risks of the first two strategies under adverse market conditions. At that time we also moved a portion of client funds into some income oriented portfolios so that this money would be available to reinvest in the Long Term Value portfolio once the risk of market wide losses is reduced to an acceptable level.
As shown in the section below, client portfolios had outstanding performance from inception in March 2005 up to October 31, 2007 when cumulative returns peaked at 56%. In January 2008 we put on hedges against further expected market declines. Consequently we did not lose money for the first 6 months of 2008. After that, the rapid drop in oil prices and very high volatility rendered our hedging instruments less effective than expected. Still, we were able to break even in October 2008 when the market was crashing and our portfolio was also close to break even in the early 2009 market drop. After accounting rules were weakened so banks could hide their losses and pass the stress tests, the market began its recovery but with a great deal of hidden risk out of view. We remained defensive since we were more concerned with protecting against principal losses than speculating on a favorable market response to a “less bad” economy. Our defensive nature after March 2009 caused us to lag the overall market significantly but our clients still earned very good returns and without taking undue risks. With such large risks it not a time to be greedy. There will be plenty of opportunities for more smart risk taking in the future - so long as we preserve our clients' capital.
For the 5 years ended March, 2010 the first four clients to set up accounts, on average, earned an overall cumulative return of 20.9% compared to 4.1% for the S&P 500 over the same period.
The chart above plots the cumulative returns for the overall blended portfolio recommendation (for the average of the first 4 clients) over the 5 years ended March 17, 2010 as compared to the S&P 500 index.
Client returns data includes reinvestment of dividends after netting out fees and expenses. Note that our client portfolios are much less diversified than the S&P 500 index and therefore exhibit higher short run volatility. As explained in the section on The Relationship of Risk to Investment Time Horizon, our view is that short run volatility is not an appropriate measure of risk of loss for long term investors. Still, we did use hedging to reduce volatility over the last 2 years so as to avoid large unrealized losses which might cause clients to sell at the worst time.
In summary, our clients have managed to outperform the market over the last 5 years while taking less risk. Although cumulative returns to date are somewhat unimpressive on an absolute basis, by sticking with our strategy we are well positioned to withstand further declines and produce outstanding returns as uncertainty is resolved and the balance of returns and risks become more favorable.
The following table breaks down returns by calendar year.
| Period | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 5 Year Total |
|---|---|---|---|---|---|---|---|
| S&P 500 | 6.2% | 15.2% | 5.1% | -39.0% | 26.3% | 5.1% | 4.1% |
| Avg. of 1st 4 Clients | 21.8% | 16.1% | -2.4% | -24.6% | 14.2% | 1.8% | 20.9% |
| Difference | 15.6% | 0.9% | -7.5% | 14.4% | -12.1% | -3.3% | 16.8% |
The big gain in 2005 was driven by a correct prediction of rising energy prices and some good real estate picks. In 2006 the portfolio lagged the overall market significantly – energy prices stalled out for the year. A surprise Canadian tax increase on energy trusts also took a chunk out of returns that year. By contrast, 2007 saw further big gains in energy prices which helped the portfolio post strong returns but the impending recession induced by the credit market problems pulled our portfolio down along with the rest of the market in November and December. In 2008 and early 2009 we outperformed by reducing risks but since March 2009 our reduced risks have caused us to lag the market - though we still earned good returns while we waited for risks to abate.
As of our 5 year anniversary we remain defensive due to two factors: 1) there are still potentially large hidden losses embedded in bank balance sheets and we are waiting for more data on the size of these losses to come out, and 2) overall market valuation multiples are very high relative to the weakened state of the economy and thus there seems to be more downside risk than upside potential. We expect this situation to resolve itself over the next few months.