S&P 500 2,345.96 -2.49
Gold$1,224.80 $5.30
Nasdaq 5,817.69 -3.95
Crude Oil $60,490.00      $-1570.00
Allocation, Selection, and Caution
James Balanced: Golden Rainbow Fund
Interview with: Barry R. James

Author: Ticker Magazine
Last Update: Mar 15, 10:48 AM ET
Long-term investors are unlikely to forget how much one makes is important, but what one keeps matters more. Barry R. James, portfolio manager of the James Balanced: Golden Rainbow Fund, utilizes proprietary research while allocating capital between stocks and bonds in search of securities with the potential to generate returns with the least amount of risk.

“We started with a basic theory that stocks do not move randomly; there are paths of inefficiency, and losing money is a very bad thing. Our approach is to take the least amount of risk that does not prevent us from making money.”
Another point of consideration with stocks is relative strength. If we find a stock that is declining in the short term but has a long-term upward trend, that is the best time to buy. It’s like baseball, when a great hitter is temporarily not hitting well, that is the time to have confidence, because he is going to get back to normal eventually. The bond side is more about risk; we know we are going to make most of the money in stocks and not in bonds. However from 2000 to 2010, the stock market was basically flat but our fund gained over 100% because we did not have big losses and we made money in bonds.

Q: Does a company’s ability to pay dividends factor into your selection process?

A: At times it does. What we look for is a mispricing on dividends. For instance, utilities are paying high dividends today, but our perception is they are expensive on a historic basis, and that indicates to us that they are higher risk. So we would have a lower position in utilities. Obviously over the long term dividends have been a huge part of the overall return in stocks, but unfortunately yields are low today, though I think they are going to be rising. So we do not take dividend yield itself into account directly, but it may be an overlay we would add to the portfolio.

On the bond side, our approach is if we are not going to be in stocks, we do not want to lose money. So we only buy investment grade. We want to be diversified across sectors and the key risk profile we try to address is duration. Every week we do an analysis of the risk levels in the bond market, which are historically interest-rate sensitive. It is a combination of two things: the structure, whether you are more barbell, bullet or ladder type of portfolio, and the duration. We generally go from a duration of about two years to seven years. We are trying not to take excessive risk; we view bonds very much as the safety component, the shock absorber when things happen with stocks, though obviously we will try to make money and have longer durations in a falling interest rate environment. We are in a changed scenario right now where we are at a bottoming in rates; we think they will be heading up and we do not believe there may be great returns in bonds over the next 5 to 10 years. So we are taking a slightly different approach. But it is still a protector of the portfolio.

We do not give up much overall return but we do give up a lot of downside by having bonds in the portfolio. Most balanced funds have a flat 60/40 allocation but we make that adjustment over time based on where we see risk and opportunity. In 2008, which is an extreme example, we were about 30% in stocks and 70% bonds.

Q: Can you give examples of your research process?

A: In 2015 we saw oil prices dropping, which was really good for refiners and airlines, and stocks like Valero Energy Corporation and Alaska Air Group Inc. met all our criteria and helped the Fund. They were relatively cheap and had good earnings, prices were rising, and the macro environment was helping them.

The good news was they went up; the bad news was they became a larger part of the portfolio. Then in 2016, when prices started to reverse in the oil sector, it left them a bit high and dry. While they still made sense from the valuation standpoint, they had a huge headwind going against them, so we trimmed back. The airlines have come charging back since then but the refiners not quite as much. But having too large a position in them was just too much risk.

Last year, on the fixed income side, our indicators on bonds changed from being more positive to less positive. So we made specific decisions to reduce some of our holdings in longer-term Treasuries and made the portfolio a little more defensive in nature. We bought Treasury Inflation-Protected Securities (TIPS) and floating-rate securities and shorter term Treasuries, so we lowered the overall duration but at the same time made the mix itself a little more defensive.

On TIPS, we looked back historically to determine an average breakeven level. If what TIPS are offering us as an inflation adjustment is below that break-even level, that is a good time for us to buy them. The environment is starting to fade a little but they have been outperforming this year. So that is one small area where our research has been helpful.

Q: How do you construct the portfolio? What are your benchmarks or diversification approaches?

A: Our portfolio management team has eight portfolio managers and nine people on the investment committee averaging over 20 years with our company. The team meets a couple of times a week to review the securities we have on our buy list. For instance, if we want something in the energy sector the team will look at the top-rated stocks according to our internal proprietary ratings system and narrow the list down on more of a qualitative basis. Then the team will bring it to the entire investment committee, where every member, from the most junior to the most senior, votes. If the committee votes that it is appropriate and needed for the portfolio, we buy it.

We use as a benchmark probably about half stocks and half bonds, maybe a little cash. The actual stated benchmark is weighted 25% in S&P 500 Index, 25% in Russell 2000 Index, and 50% in Barclays Capital U.S. Intermediate Government/Credit Bond Index.

The most important decision for a stock is when to sell it. Several triggers bring up a stock for review: its strength might no longer be above the market average, and that might be an early warning of a long-term downtrend. Or a significant move in the price of the stock, or a significant outside event like a merger, acquisition, or lawsuit, might trigger a sell decision. Portfolio turnover is in the 40% range.

After about six months we review the stock and look at our proprietary rating. You want to fish where the big fish are; we know that the top-rated securities are the best performing over the long haul. But if the rating starts to slip, that would trigger a review; if the performance does not match up to our expectations we would try to find something else that might perform better. We’ll bring it to the committee for a review. We might sell it, or say it is now on our sell list and then sell it at an opportune time to get the best price for it.

We do not buy or keep a stock because we are in love with the company or the CEO. We might love the way they run the business, but we let the numbers do the talking for them.

Q: What is your definition of risk and how do you manage it? Which types of risk do you primarily focus on?

A: Our definition of risk is losing money. Lowering our overall risk is embedded in everything we do; in our asset allocation, our sector diversification, our stock selection, our bond duration. It works most of the time, but it does not work all the time. Our risk management is about trying to figure out, when what we have is not working, whether it is something systemic to us or just a normal pattern within the market. That is always the hardest part of investing.

At the same time there is always a risk that maybe we are on the wrong track, that maybe our processes which have usually worked just are not working any more. So over every two-year period we go back to every component of our risk analysis and of our ratings for stocks, and revalidate every single one. Just to give an example, back in the early 1980s when we first started using computers to help us, quarterly surprise had months and months of carryover; it would predict rising prices for a stock for three to six months. Today, it may be one or two days. So it does not have much value and we do not use it very much. Now we have found alternatives, such as stock buybacks.

We do not jump from one extreme to another—we use exponential smoothing. We look at what has worked over the past two years, and if it continues to work over the next two-year period we give it greater and greater weight. We continually try to prevent hubris, from thinking ours is the only way and it is always right.

We believe in continuing to adapt. The techniques may change, but the basic philosophy that drives us is rock solid.

  1  2

  More: Mutual Funds Archive

Sources: Data collected by 123jump.com and Ticker.com from company press releases, filings and corporate websites. Market data: BATS Exchange. Inc