Paul Kaplan: Share ownership – even more conservative than Buffett

This Podcast is brought to you by ABSA, member of Barclays and Paul Kaplan is a Director of Morningstar in Canada. He’s in our studio in Johannesburg. Have you visited South Africa before, Paul?

No, this is my first time in South Africa.

What brings you here?

There’s an investment conference and I’m going to be one of the speakers.

So is this part of your international exposure? Do you get much around the world?

I typically bet more around Europe. In fact, before I came to South Africa, I just spent two weeks in Europe.

But you’re based in Canada?

Based in Canada.

You’re speciality, being Morningstar – clearly, you do a lot of research. You’re the Research Director in the Canadian office. What is the area that you focus on?

I focus on a few things. One is on asset allocation – how one ought to divide one’s portfolio among stocks, bonds, etcetera, and another area is in some of the portfolio construction and particular, in some equity strategies. I work very closely with our index group and, yes, things like different types of indexes, for value investing or momentum investing, and so on.

Let’s get back to the first one, portfolio strategy, or allocation of the assets right now.

Yes.

It’s tricky. Not too many people are sure how to be allocating their assets. I guess if you’re a long-term investor, it’s where you’re start, and maybe we can start there.

Okay.

What period, if you’re in equities, what period of time should be investing for?

Well, I would say if you’re an equity investor, you probably are talking about having an investment horizon of ten or more years, because equities are very risky. The reward can be quite substantial, at times, but you really have to be in the market for a long period of time, in order to pick that up.

Do you read: Warren Buffett’s Berkshire Hathaway’s letter to shareholders?

No, I don’t.

Oh, it’s a pity because in his latest one he said something similar. He said to shareholders, “If you buy Berkshire shares and you hold them for five years,” he said.

Yes.

“Then I can pretty much guarantee that you will make money but if you sell them in anything under five years, I could almost guarantee you the opposite,” which is Buffett’s beat for ‘don’t be a trader in the shares’. You reckon ten years is a more viable time horizon.

Yes, for equities, generally, because in a five-year period any portfolio stocks could stumble, in a five-year period.

And right now, how are you seeing the way that investors should be allocating their funds, in a global portfolio?

Well because my focus is on long-term investing, so I’m not going to get into kind of what the current environment is very much but generally I, in principle, all investors should really be global investors. They really should find a way to hold equities really across the world. Now, do equity investors generally do that? Generally, no – generally we have what we call the ‘home country bias’, so you will find, for example, Canadian investors holding a disproportionate amount of their portfolio in Canadian securities, relative to the global portfolio.

What is an ideal split?

Well, I don’t really have an ideal split because I think the split should be customised, based upon the investor’s risk tolerance, their risk capacity, their goals, and so on. That’s, in a sense, which I think asset allocation can be a fairly complex decision because you have to take all these factors into account but for some reason, the discussion of that asset allocation always seems to focus around 60/40. People talk about 60/40 – 60 percent equities and 40 percent bonds or fixed income, or other assets, beyond stocks and bonds, and that’s kind of a starting point for a lot of people. If you have a greater capacity to take risks, so for example, let’s suppose you’re young and you’re just starting your career and you are, for the very first time, being invited to start participating in ‘retirement savings program’. Someone like that can be very heavily in equities.

One hundred percent?

They could be it doesn’t have to be. They may want to cushion that a bit but the thing is that even if then the stock market crashes the next day, they still have their entire career ahead of them. Whereas, someone I suppose, who is getting near or winding up their career, and they’re thinking about retirement. What they really need is a nice nest egg.

Paul, do you ever take into account the level of markets before making an investment? You’ve mentioned, “If the stock market crashes the next day.” If we go back to the 1969 or the 1987/98 situation – there the markets were very high before they did pull back significantly. Do you take that into account?

Well, when I think about asset allocation, no, I’m thinking about it just being a long-term investor but there are times when that could certainly be attractive, so yes, after a major market correction, equities might be very attractive at that point, and maybe that’s a good time to just, if you haven’t already. Maybe that’s a good time to start buying because the prices are depressed.

You said earlier, “Spread your assets around the world,” through that diversification.

Yes.

What percentages would you typically have in the United States, Canada (home country bias), Europe, and Asia?

Well, if they went strictly on the basis of the relative sizes of the market, the United States is the dominant market – probably something like half – then you would put a large percentage in Europe and Japan. Ideally, the small countries like South Africa, Canada, and Australia probably should just have small bits.

Such as?

I don’t know maybe, again if you’re in the market, you know, of course you are going to be biased towards it.

But no more than five percent, say in the small countries?

Yes, because you also want to have some room to put a bit into emerging markets as well because you really want to be diversified around the world and you want to have some representation of these emerging markets in your portfolio.

How do you work that out? How do you sit down with a piece of paper and say ‘good’ – Paul Kaplan says, “50% in the American market.” How do you structure that?

Well, there are a number of different approaches to structuring it. I’m sure people don’t use or take a mathematical approach to it. They probably just have some preferences and ideas to put to it. Other people might want something of a more rigorous approach.

What do you do? How’s your portfolio structured?

Well, I keep things pretty basic, so I do keep a good percentage in the U.S. a little bit in Canada, and then also some international.

A good percentage being what?

Oh, I don’t know, off-hand, what the exact percentage is but certainly the majority of my equities are in the US

Are in the US?

Yes.

And then the cash. Again, Warren Buffett describes cash as the same way as oxygen for human beings.

Yes.

You don’t notice it until you need it and then that’s all you notice.

Yes.

What percentage of cash should one have available to you or in your portfolio?

That kind of depends on what your needs are. One purpose of cash is to have a cushion against unforeseen consequences, so even that young/new person starting a new job, we were talking about before. They may put almost all – you know, their retirement portfolio they might put it nearly in all equities, but they should still have some cash outside of that because, after all they might lose their jobs.

But from an investor’s perspective and this is where Buffett did so well in the 2008 disaster, where he was able to take $16.5bn and allocate it to various companies, in a three-week period.

Yes.

And (of course) made massive returns on it, because they needed cash at that point in time.

Yes.

So, as an investor, would you have ten, 20, or even 30 percent cash on the side, waiting for that kind of correction?

It’s not so much about waiting for a correction. I think the first and foremost, it’s about taking care of and that you have enough cash on hand. I think the number, should something happen, like you lose your job or you become disabled or something like that. It is more a kind of the personal issues.

So you wouldn’t put money aside, in a portfolio, in cash, ready for an opportunity that could come.

That’s not the approach that I take.

Dr Paul Kaplan is the Director of Research at Morningstar in Canada, and this special Podcast was brought to you by Standard Bank Webtrader.

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