BlastInvest
Blast Investor Real-time Plus           by Henry Lu

2006 BIRTP Portfolio Annual Review

12/31/2006

Goal of BIRTP Newsletter and its Model Portfolio

The whole purpose of Blast Investor Real-time Plus (BIRTP) newsletter is to help BIRTP subscribers to make above average return using value investing strategy. Our main goal is to achieve high total return on BIRTP portfolio as well as to publish our investment thesis and timing for every model portfolio transaction in real-time. If subscribers follow BIRTP model portfolio passively, the model portfolio return would be the rough return number that subscribers can get. The publishing operation side has been pretty smooth over the past 3 years so that the focus of this review is on the performance of the model portfolio.

Specifically our investment return goal is to deliver 20% per year average return for BIRTP model portfolio.

For the past 1 year, we are not quite satisfied with our performance result. BIRTP model portfolio was down 2.65% for the year while S&P500 index was up 13.62%. Part of that under-performance was due to our investment mistakes, and part of that was due to normal volatility of focused value investment style.

But before I start the detailed review of portfolio, I want to address the correct investment attitudes first.

Correct Attitude for Winning in the Long Run

Besides all the mistakes I had in the past,  I would not want to regret anything. Regret is not healthy attitude for winning in the long run. There is no "What if", "Should if" questions, we don't ask that questions. In that sense, I only want to look at current and future pictures of fundamentals and valuations, and I would not want my past mistakes to hamper my judgment.

What we need is to learn from the past in a rational way, not with regrets or emotions. We admitted our mistakes and corrected the portfolio problems in the portfolio rebalancing efforts since summer of 2006. This self-learning and self-correcting is long term process that we will do regularly. We won't go into detail on this issue, please refer to our newsletter homepage for more information.

Attitude on 06 Under-performance

I am not satisfied with BIRTP 2006 performance, I am not happy with it. However,  I would not go on crazy about it. Mistake was mistake in the past, success was success in the past, I will move on.  Regrets or emotions won't do investors anything good.

Further more, Warren Buffett once said in his hedge fund annual letter that he hoped that his fund investors would judge his performance in 3 year period. Buffett argument was that 1 year was too short, but 3 years time frame should be long enough to judge a fund manager's investment skill. Many value picks require 2 to 3 years time frame minimum to realize the profit potential so that volatility of value stocks could easily make 1 year underperformance. This is particularly true for a focused portfolio such as BIRTP model portfolio.  We hope that our subscribers can judge the BIRTP portfolio in longer time frame in 3 year period as well.

Over the last 3 years, BIRTP portfolio averaged 26.5% return, above our goal of 20% return and far above S&P500 index's 8.4% average return. Therefore, although we are not satisfied with our last year performance, we are content on our 3 year average return.

Performance Comparison

From the past records of value investors, and from past behavior of BIRTP performance, you can find that BIRTP performance does not correlate with market index closely. When S&P500 index had low single digit return in 2004 and 2005,  BIRTP performance was  making 30% to 60% return. But this year, the market was red hot for double digit return of S&P500, BIRTP return was negative 2% return.  This non-correlation is expected because BIRTP model portfolio does not track sector weightings of S&P500 as many funds would do. Furthermore, the focused style of BIRTP would make model portfolio more volatile than index in general.

From now on, we not only will compare our performance to S&P500 index, we will also compare our performance to popular value-style mutual funds.

Oakmark Select Fund (OAKLX) is $6 billion size mutual fund that is also based on focused style of value investing strategy.  Oakmark fund manager Bill Nygren is a famous fund manager so that we picked his fund for comparison.

Table 1 performance comparison
performance
 04
 05
 06
 3 year average
Oakmark Select Fund I
 9.73%
 4.84%
 12.86%
 9.79%
BIRTP Model Portfolio
 59.53%
 30.42%
 -2.65%
 26.52%


From table 1 we can tell that BIRTP performance does not correlate with that of Oakmark Select Fund. 2006 was best year for OAKLX for last 3 years while 2006 performance was worst for BIRTP in last 3 years. 04 and 05 performance for the Oakmark Select Fund were poor while BIRTP performance was extremely high in those 2 years.  This noncorrelation is understandable because both portfolios are focused style with difference stock picks. Focused style also tend to generate high volatility on portfolio as well. BIRTP under-performed OAKLX in 2006, but for the last 3 years, BIRTP beat OAKLX significantly.

Bill Nygren is great value investor.  I simply want to put table 1 performance comparison in perspective. If I have 6 billion dollar to manage, I do not know whether I can manage better than Bill Nygren or not. But I do know, I had tiny amount of money to manage over past 3 years, and my performance beat OAKLX significantly.

BIRTP underperformed in 2006 due to investment mistakes and volatility of focused investing style. But never the less, I am optimistic on the future prospect of this portfolio.  BIRTP portfolio operation has its internal advantages over many of its competitors, including those popular mutual funds managed by famous fund managers.

Advantages of BIRTP Portfolio

Our goal of 20% average return in the long run is an aggressive goal. We fully understand that over past 50 years, only Warren Buffett was able to make it.  We are not trying to achieve  a goal that is bigger than Warren Buffett.  In early years when Buffett fund size was only several millions to hundred millions, Buffett's average performance was 30% to 50% average return with value investing strategy. 

The dollar amount behind BIRTP newsletter is tiny amount compared to billion dollar size for most Wall Street funds. Therefore, just due to advantage of tiny fund size, we can beat most Wall Street mutual funds in the long run while still achieve less than what Warren Buffett did decades ago. It is wrong to argue that it is impossible to beat market or impossible to make 20% return in the long run regardless of fund size.

The second advantage is that we would stay true with our investment philosophy: a focused style of value investing with around or less than 10 stocks. We believe a 20 stocks portfolio in different industries would make portfolio very diversified, no less diversified than 100 or 200 stocks. But to achieve high return, around 10 and more than 5 is really going to make difference on long term performance.  This focused strategy has been employed by Warren Buffett, Charles Munger, and Joel Greenblatt before, and it will continue for BIRTP.  We would not smooth our performance by over-diworsification of tons of stock picks.

The third advantage is the transparency of operations to insure integrity. For many funds, investors would never know what fund managers would do in between. Mutual funds only report quarterly and many of them gloss over their mistakes by "window dressing" actions. Not only these types of window dressing actions are not ethical, they go against the sound investing principles and would hurt fund performance in the long run. 

At end of day, long term performance would tell all the story.  Think about this, I am a no-name value investor that started value investing by studying Ben Graham books many years ago. I do not have experience in famous Wall Street firms such as Goldman Sachs or Merrill Lynch while many mutual fund managers do. However, if you careful compare BIRTP 3 year's performance to that of many mutual funds, you will find that it is very rare to find a value style mutual fund that had 20% plus annual return in past 3 years.  It is not that fund managers are not smart, they are quite smart. If many fund managers did not do unethical things such as "window dressing" or other short term maneuver, if they stop attracting billions of dollar, if they ignore the short term peer-comparison pressure (at risk of losing their jobs), their performance could be closer or higher than 20% plus average return.

2007 Outlook

Stock market was hot in 2006. S&P500 index was up double digit, and DOW was up16%. Financial magazines and newspapers were full of bullish sentiment recently.

However, I am not buyer of great bull market in the making. The market is due for a big correction.  I continue to believe that the market in the long run is low-return zig-zag performance, and will be a disappointment for most investors.

Fed successfully cooled inflation by raising interest rate. While inflation risk is delayed, economy is also slowed. On the positive side, housing market showed sign of recovering.  In this kind of economy, it is hard to imagine that companies can grow earnings as fast as investors would hope for.

From value investors point of view, most of macro economics are not relevant because the performance mainly rely on stock picking skills. Therefore, although I am not bullish on the stock market overall, the current economy situations are pretty good environment.  In the sense, I am not buyer of imminent big bear market.

I can not predict the near term future of our stock positions. But,  I am comfortable on the prospect of those picks in the long run simply because they have sound business fundamentals and cheap valuations.  In the long run, value works.

Blast Investor Model Portfolio Update

(as of 12/31/2006)

Model Portfolio - Performance

BIRTP
 S&P 500
Portfolio inception date
 12/31/2003
 12/31/2003
Portfolio inception value
 $89,000
 1114.10
Portfolio 12/31/05 value
 $185,166.95
 1248.29
Portfolio 12/31/06 value $180,253.55
 1418.30
2004 Performance 59.53% 8.78%
2005 Performance
 30.42%
 3.00%
2006 Performance
 -2.65%
 13.62%
3 Year Average Return
 26.52%
 8.38%
3 Year Total Return (Since Inception)
 102.5%
 27.3%