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 3 year anniversary in March) 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 the current 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 two main equity strategies once the risk of market wide losses is reduced to an acceptable level.
As shown in the section below, the Long Term Value portfolio had outstanding performance over its first 3 years through March 17th. In the 2nd quarter of 2008 its performance was amazing as our energy theme generated fantastic returns. In contrast, the Special Situations portfolio produced disappointing results between July 2007 and March 2008. Prior to that, the Special Situations portfolio had a record even better than the Long Term Value portfolio. We expect this strategy to sometimes brings us short term losses if we invest in a declining sector before it hits bottom. The extent of disruptions in credit markets surprised us and this portfolio took a beating – especially in March as more than half of the portfolio was devoted to financial stocks. These risks are precisely why I recommend only a small portion of client money be invested in this strategy. Currently my average recommendation is no more than 12% of a client's assets be allocated to this strategy so as to give room to allocate more in response to lower prices and thereby reduce our cost basis. Since March things have rebounded and the following data shows that we have still performed well overall despite the short term setbacks in this portion of the portfolio.
For the 3 years ended June 30, 2008 a representative client following my most common allocation recommendations earned an overall cumulative return of 33% compared to just 8.9% for the S&P 500.
The chart above plots the cumulative returns for the Long Term Value Portfolio and the overall blended portfolio recommendation (for a representative client) over the 3 years ended June 30, 2008 as compared to the S&P 500 index. (This particular client was selected because he was the only one who held the complete recommended portfolio blend over the entire 3 year period).
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.
The Long-term Value portfolio returned 49.2% over this three years and so was an even better investment than our blended allocation recommendation. See the more detailed review of this portfolio in the section below.
Given inflation of about 3.4% over the last three years, our annual return goal was 13.4%. Although, we achieved a 14.3% annual return in Long Term Value, we fell a bit short on a combined overall basis – earning a 10% annual return. The severe disruption in the credit market is responsible for this under performance and I expect to reach our target returns over longer periods. Of course there can be no assurance that any particular return can be achieved and there is always some risk of losses.
As can be seen in the graph, we were meeting our return goals until October 2007 when the market peaked. In January 2008 we became defensive to preserve capital but were still hit hard by turmoil in financial holdings in March. The value of our financial holdings hit such a low level in March that our exposure to this risk factor was relatively minor as of June 2008.
Long Term Value Portfolio Results
Berkeley Investment Advisors began managing money for clients in its Long Run Value Portfolio strategy on March 17, 2005. As the name implies, the strategies employed in the portfolio are meant to outperform the market when given enough time. The graph below charts the performance of the Long Term Value portfolio since its inception on March 17th 2005 using client account data for the three years.
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Over the three years ended March 17, 2008 the Long Term Value Portfolio had a cumulative return of 40.3% after fees. This equates to an annual compounded rate of 11.9%. The Standard & Poors 500 (S&P) index had a cumulative return over this period of 13.5%: an annualized return of 4.3%. Thus the Long Term Value Portfolio outperformed the S&P by a total of 26.8% over the three years, an annualized advantage of 7.6%. Looking at the graph on the prior page, you can see that this portfolio is more volatile than the market. This is so because the portfolio is concentrated in relatively few stocks (about 30) and is focused on certain sectors - energy and foreign stocks most heavily.
The following table breaks down returns by calendar year.
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Period
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2005
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2006
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2007
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2008
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3 year total
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S&P 500
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6.4%
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15.8%
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5.5%
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-12.6%
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13.5%
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LT Value
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23.8%
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7.0%
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7.5%
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-1.5
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40.3%
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Difference
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17.4%
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-8.8%
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2.0%
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11.1%
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26.8%
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 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. The result is that our energy positions were priced as if oil had already fallen.
In 2008, energy prices are in fact rising, not falling – this in spite of a U.S. recession which probably began in January. As a result, the portfolio lost very little value up to its anniversary date of March 17th while the S&P lost more than 12%. These results are consistent with the assertion that the portfolio's value investing focus reduces the risk of large declines in value over longer time frames. Given the portfolio's 5.4% dividend yield, this portfolio can generate positive returns in 2008 even if stock prices don't move; this should lead to much better results than the S&P 500 in a bear market environment.
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Ray Meadows, the investment manager and president of Berkeley Investment Advisors, has managed his personal portfolio for over 9 years. From 1999 to the end of 2007 his cumulative return was 398% compared to just 35% for the S&P 500 index. If he didn't make another dime and the market kept providing the same return as the last 9 years, it would take another 40 years for the market to catch up. As you can see, superior returns really can make an important difference over long time periods.