Recent Frequently Asked Questions by FIM Group Clients

by Barry Hyman

Posted February 10, 2010

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February Edition

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by Suzanne Stepan

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Q: "Now that my portfolio has recovered much of 2008’s declines, should I sell, move some money to cash or move to a different FIM Group portfolio risk tolerance category?"

A: Those are portfolio management decisions FIM Group considers on our clients’ behalf continuously, not just during periods of volatility. The short answer is that we are already doing this to some extent. When the market reached its bottom in March of 2008, there were so many bargain-priced investments that our challenge was to separate the "super bargains" from "regular bargains" and invest accordingly. The performance of our accounts in 2009 achieved our objectives of doing better than that of the broad market indexes. With the strong performance of many investments during the first leg of the recovery, some had reached the prices we expected and no longer presented a favorable risk-adjusted potential as they once did. As valueoriented, disciplined managers, "price to intrinsic value" is one cue to exit such investments. Notwithstanding those that have reached our target prices, there is still tremendous value in the securities we continue to own and those we are buying, many of which are concentrated in pockets of the market.

On a macro level, we feel broad markets have recovered to the point at which values of entire indexes are also no longer priced at favorable risk-adjusted bargain levels. The investment landscape has gone from a "kid in a candy store" environment to one in which security selection has become even more critical than normal. If you monitor your portfolio closely, you will have noticed the selling of select securities recently, specifically in the equity-oriented FIM Group "Growth" and "Balanced" portfolios. We have been "ringing the cash register," selling some of the positions we own as well as "cleaning house" by reducing others that are no longer compelling. We are redeploying the cash into more defensive positions and increasing the concentration in positions that we believe still offer sufficient riskadjusted, long-term return potential.

Q: "What goes into FIM Group’s decisionmaking process when determining what to sell and when? Sometimes it seems like you sell too early, while other times it seems you wait too long. Still other times it seems like you just give up while there are some positions in my portfolio that have sat there for years doing very little."

A: There is a complex array of reasons that factor into our decision to sell an investment. The simplest one is when a security approaches our "sell target," but even that is not a static condition. Whenever we make an investment we establish a price that we feel is a "fair value" for the security based on our fundamental analysis. We consider many other factors – such as a company’s products and services, competitive forces, debt and financial condition, cash flow, and the ratios between its price and the current and estimated cash flow, income, revenues, etc. – but all of those things can change over time.

Another common reason to sell an investment is to replace it with better opportunities as they become available. For example, in FIM Group growth accounts we look to purchase equities that provide additional returns from dividends and potential currency gains. In some cases, we will sell a perceived "good" investment to replace it with one we feel has superior return potential. In other cases, we may sell an investment in a growth account but continue to hold it in our income-oriented account if the price has gotten closer to our sell target, but the dividend income still meets our objective.

It is important to understand that our process is not static. If we buy something and it rises to our sell target quickly, we will likely sell some or all of it. But a quick appreciation to our sell target is the exception. More often, before an investment meets our initial sell target, the fundamentals may improve, in which case our sell target will rise, or deteriorate, and our estimate of fair value declines. A major mistake investors can make is to stay fixated on original assumptions or price targets. To be successful you must be able to reevaluate each investment continually, especially as new information becomes available, with no attachment to prior decisions or assumptions. Remember, flexibility reduces risks. Sometimes it is the case that assumptions made about a specific company still hold, but the macro environment, competition, government regulations, etc. for that company or industry has changed.

It is also paramount to be able to ascertain whether the market is misreading or overreacting to endogenous or exogenous factors. The fact that the market price of an investment has declined does not necessarily mean that it is worth less. Rather, it may simply be the result of the market being "inefficient" or emotional, presenting an opportunity to increase the size of an investment. Rather than selling along with the masses, it can pay to be contrary.

A description of the rationale behind some recent positions we have sold or are in the process of selling in various client accounts may help shed light on some of the complex reasons we decide to sell an investment. Please keep in mind that not all of these investments were appropriate in every client account, so it may not have been held in your account based upon your personal strategy. We also might not be selling the securities in each account they are held.

KPJ Healthcare – Health care is one of our most favored sectors, and KPJ Healthcare is a holding in many of our growth and balanced accounts. KPJ operates medical centers and provides health care services. We especially favor medical tourism and emerging economy hospitals, and KPJ is one of our favorite companies in this space, so selling it is like saying goodbye to an old friend. The price of the stock has run up to historic high valuation levels and has simply become too rich for our blood.

STO – Statoil ASA is a Norwegian oil and natural gas company. This sell was for reasons quite opposite those of KPJ. We originally began purchasing STO in September 2008, at the beginning of the financial crisis. We continued to like this company and purchased it throughout 2009. It paid us an annual dividend ranging from 3.75% to over 4% and we like energy companies and favor foreign currency-denominated securities. We liked STO’s price-to-value relationship and its dividend, but the company recently made a few decisions, some of which were questionable in our mind and others that we feel were detrimental to the company’s financial health. We felt its implied risk has increased, and therefore it no longer qualified as a position we feel worth holding.

ELNK – Earthlink is an Internet Service Provider that offers services across the Internet delivery spectrum. Because Internet access has become a basic necessity in today’s world, their business is somewhat defensive to economic cycles. The company generates around $0.25 quarterly in cash flow for each dollar of stock and sells for less than its book value. Those are some of the qualities we look for in an investment. We liked this company at its current price and even higher prices as recently as last year. But we have become concerned about the competitive environment specific to Earthlink and the fact that the company has not deployed its cash to diversify or raised its dividend to send shareholders more of its profits. There are other investments we believe offer more benefits to our portfolios.

Most sell decisions are far too complex to briefly explain in a newsletter. They are made based on a complex matrix of the company’s specific financials and market-related factors, paramount of which is preference for other investments we would rather own. In short, we sell for three broad reasons: 1) When a security reaches its fair price, 2) when we find something we like better, or 3) when its price-to-value or fundamentals erode.

We are always available to discuss your portfolio, so please don’t hesitate to contact us with any questions.