In Archived

Forty-two percent [1].  This is the percentage of large cap fund managers that beat the S&P 500 return of 1% over the past five years.  Assembling a portfolio of assets to succeed in a challenging environment has proven difficult.  With many more challenges on the horizon – European debt, fiscal deficits, political gridlock, a potential housing bubble in China and the prospect for war in Iran, Korea, etc. – piecing together a portfolio that offers positive absolute returns, and limited downside, is tough.  While there are several risks ahead, we have been busy putting together a roster of asset classes and securities that should offer a balance of solid long term returns and downside protection.
Twenty-one percent [2].  If you are a general manager in the National Football League (NFL), this is the chance that a player you draft will be starting for your team five years from now.  There are 214 players drafted into the NFL every year, and the majority of those players will not have a positive impact on their team.  So how does an NFL general manager draft well, and succeed, in what is a low return (21% success rate) environment?  Some answers can be found in the drafting of Tom Brady by the Patriots in 2000 NFL Draft.

Brady was the seventh quarterback (199th pick overall) drafted.  He was selected after Chad Pennington, Giovanni Carmazzi, Chris Redman, Tee Martin, Marc Bulger and Spergon Wynn, yet Brady has started in more NFL games than all of those quarterbacks combined.  He has also passed for 40,000 yards and led his team to five Super Bowls during his ten seasons as a starter.  To say Tom Brady has been a positive contributor to his team would be a dramatic understatement.

Bill Belichick, the head coach of the Patriots, drafted Tom Brady.  Belichick’s track record in the draft is remarkable, and it has allowed him to compile a winning percentage of over 72% during his twelve seasons with the Patriots.  His philosophy has been outlined in books and by peers, and consists of the following: draft based on value, find players still growing their football skills, be aware of the cost of highly drafted players (players taken early in the draft are expensive), be analytical, be a great listener and anticipate rather than react.

At Crestwood, we believe investment managers can appreciate similar tenets.   Selecting investments based on valuation today and future growth opportunities is a cornerstone that we use to purchase attractively valued securities and asset classes.  A good example of this is our recent purchase of the Doubleline Total Return Fund (DLTNX).  We believe the housing market in the United States is in the midst of a modest recovery, and that Mortgage Backed Securities (MBS) offer great value.  As we write this, DLTNX provides an attractive 7%+ annualized yield, is purchasing MBS at an average of 91 cents on the dollar and is run by one of the most experienced and successful portfolio managers in the business.  We feel the addition of DLTNX offers great value to our clients’ portfolios, and that the MBS asset class offers attractive long-term returns with some downside protection.

We have also been taking proceeds in investments where we believe it makes sense to do so.  This is how we are trying to stay aware of the risk of expensive (i.e. “highly drafted”) securities.  For example, we have trimmed Apple (AAPL) and our biotech exposure (i.e. XBI) recently in an effort to manage risk and the size of these positions within the portfolio.  While we continue to hold positions in AAPL and XBI for most clients, these securities have become more expensive due to their price appreciation.  At their current valuation levels, we do not believe they should represent an outsized portion of the overall portfolio and we are therefore taking proceeds to manage the risks.

We recently decided to reduce our position size in Gold (i.e. GLD).  While we believe the housing and economic recovery for the Unites States will be slow and uneven, we do believe that a modest recovery is underway, causing interest rates to eventually increase which may negatively impact GLD as a result.   This asset class has performed well, and we continue to hold a substantial position in gold as a hedge to currency devaluation and other risks that remain globally.  However, we believe the economic data is demonstrating to us that a modest recovery is at hand and a relatively smaller position in gold is warranted.

We do our best to avoid useless crystal ball gazing; however, we can try to anticipate risks by monitoring those securities that are fairly valued as well as opportunities in securities that are more attractively valued.  At current levels, the broader stock market as measured by the S&P 500 appears fairly valued and, by at least some measures, even expensive relative to history.  We have been using the recent strength in the market to take proceeds in assets that we feel are fairly valued and, while these sales have generally led to temporarily elevated cash levels, we are confident that we will get an opportunity to deploy the excess cash into attractively valued securities in the months ahead.

As we recently wrote about more fully, the current investment landscape is fraught with economic and political risks and, in such a climate, finding securities that offer attractive return potential while providing downside protection is no easy task.  For example, as of early May, the five year treasury rate is at 0.82%, the ten year is at 1.95% and the 30 year is at 3.12%.  These types of investments do not offer investors the return necessary to outpace future inflation, much less the return necessary to meet savings goals such as retirement and college funding.  Despite this backdrop, we are optimistic about the long-term prospects for our current holdings.  We also remain opportunistic with regard to deploying cash into attractive securities and asset classes.  Low returns litter the landscape, but we are working hard to uncover opportunities that will offer solid long-term returns and downside protection.

Our goal is to build a portfolio of as many “Tom Bradys” as we can for clients.  We attempt this by “drafting” based on value, staying aware of the cost of overvalued securities, and maintaining our analytical abilities by anticipating risks and opportunities.  This approach has proven to be effective in the low return world of the NFL draft, and is a useful metaphor for our efforts in managing portfolios through the risks and potential low return investment world that still lies ahead.

[1] Crestwood research on large cap mutual fund managers

[2] All football stats in this article were compiled from

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