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The key to optimizing gains and minimizing losses in an equity portfolio is to hold a relatively small number of stocks, and balance those with good bond investments, says advisor Jeanie Wyatt. She discusses how she achieves that balance, and discusses three of her favorite widely held stocks.

Kate Stalter: Today on the Daily Guru we are talking with Jeanie Wyatt. She is the founder of South Texas Money Management.

Jeanie, your investment philosophy, as I understand it, centers around using diversification to help your clients navigate market cycles. Can you say something about your approach, and if you have made any adjustments in all the recent volatility?

Jeanie Wyatt: Certainly. We follow a strategy of strategic diversification, is what I call it.

I find that a lot of investors today are actually overdiversified, which doesn’t sound like that would be possible. But it is happening so much, where individual investors might own a number of mutual funds, and they could, at the end of the day, literally have thousands of stocks.

We, of course, manage stocks and bonds. We manage portfolios. But what I am talking about now is our stock approach, our equity strategy. We believe that you can be appropriately diversified or strategically diversified with technically about 60 stocks. And that is our goal, again to have the strategic diversification where the stocks that you are buying, the sectors that you own, all of that provides diversification, and if one of those names does well it is going to have a positive impact.

Of course, if you own thousands of stocks and one of those stocks doubles, it is not going to have any impact on your returns. So we want to have a list of strategic diversification.

We want to have exposure to about 60 companies, but we also want to have general sector diversification. In other words, we want exposure to all sectors. We want to have a balance between growth stocks and value stocks, because those two styles are very consistently good hedges to one another.

The cycles can be very short, it can be a week cycle or a month cycle, when value might be doing very well and growth isn’t, and vice versa. So we always want to keep that balance between growth and value.

We want large-cap, mid-cap, small-cap, and even international. That sounds like a lot of diversification, but we can accomplish that in our portfolios with only about 60 stocks. So, we obviously monitor those stocks very, very closely, but if one of those stocks does well—also of course, if it does poorly—it will have meaning, if you will, in the portfolio.

Kate Stalter: One thing that I was wondering about as you were speaking, Jeanie: Have you made any kind of adjustments in the overall asset allocation ever since the market peaked earlier this year?

Jeanie Wyatt: Yes. Of course, in a very short timeframe, relatively short timeframe, the areas of the stock market that did very poorly were those areas that clearly had economic sensitivity.

I think what you saw in that market correction—and I think we can still define that as a market correction—those areas like energy, like materials, like industrial stocks, consumer stocks, and small-cap stocks, those areas where a recession would have a bigger impact, that is where you saw the biggest downshift.

So I think that market correction was saying, there was real concern about the US economy going into a recession because of what was happening in Europe, and just kind of a globally pervasive loss of confidence.

Fortunately, it was those same areas that snapped back the fastest in October, because we saw very good US GDP numbers for the third quarter, surprisingly good, and actually economists were raising their GDP forecast for this fourth quarter. I think the confidence was built that the US is not in a recession and is not rolling into a recession, so those areas were oversold.

Having said that, and to answer your question, we did an extra scrub on all of our companies to make sure that their leverage ratios, their balance sheets, could support perhaps a downshift in economic growth. That was one thing—really want to make sure that these balance sheets, if we had a 1% to 2% fourth-quarter GDP, which is not our forecast, but if it was disappointing economic growth, those balance sheets would be fine.

We did pare small-cap exposure somewhat. Again, we always want small-cap exposure, but we did pare it somewhat. And probably most meaningful, we really like the dividend yields you can get on a number of stocks now. When we are going through our analysis on stocks to buy, it is not what we make our sole decision on, but if it has a good current dividend yield, that is attractive to us in this slow growth environment.

Kate Stalter: That leads right into something that I wanted to ask you about: Which are the investments that you are putting clients into these days?

Jeanie Wyatt: Well, one company that we have been buying is Intel (INTC). It has a very good balance sheet, very good dividend yield, and we have liked the technology sector.

We always want to have technology exposure, but this year we have felt like there was very good value in the technology sector. So that is one example of a name with a good yield.

I mentioned that we always have international exposure. Of course, that has been a real challenge for any investment manager this year. The third quarter and even year-to-date international has been a real challenge.

A European company that we like very much is Unilever (UL). That is a consumer-staples company. It has a very attractive yield, close to 4%, and a good balance sheet, but we feel confident that they have a good growth strategy in their business model.

Unlike a company like Procter & Gamble (PG), Unilever is really developing a lot of new markets and emerging markets by producing and marketing goods for those specific market areas. They have leadership teams, for example, in India—or even smaller sections of India—where they are providing consumers what they need and want, not trying to give them a product that might really be more recognized in another part of the world.

We also felt really good about a number of consumer-discretionary names and took advantage of that when the market fell off in the third quarter.

A name that we like is Macy’s (M). It’s a very good company; they really have done a good job of improving their margins and marketing the company. We feel confident in that name and have a good exposure to consumer-discretionary names in general. So those are three names that we like.

Kate Stalter: Do you prefer to normally use individual stocks, or do you also put your clients into funds? How do you approach that question?

Jeanie Wyatt: We prefer to own individual stocks. Again, our record and our study doing back testing has shown that you can, with as few as 60 names, maybe 70 names, you can get all of that strategic diversification. We know it means you have to really stay on top of those individual names, which is what our research team does every day.

The only time we might use an ETF is if we want to get exposure to an area of the market—utilities might be an example—where we want to have exposure to all sectors. A utility ETF can give us that exposure. Pretty much those names tend to perform in line with the sector.

Kate Stalter: The last question I have for you today: You started out by mentioning that oftentimes individual investors may be overdiversified. Any other advice that you might have for people listening to this today?

Jeanie Wyatt: Well I think the most important decision any investor makes, whether they are individuals, endowments, or pension-plan managers, the most important decision is going to be the asset allocation—how much you put in stocks to begin with.

Of course, the best hedge to stocks is high-quality bonds. So getting that decision right is the only thing that is going to make you satisfied with your long-term performance. Because if you are overly conservative or overly aggressive, that is No. 1 to the specific strategy on the stock side. So we do a lot of work with our clients on the asset-allocation decision.

Kate Stalter: Is that something that is determined, say, by a person’s age or other factors?

Jeanie Wyatt: A number of factors, because if you have someone that is in their 80s or 90s, but they have more than sufficient assets to last their lifetime, they wouldn’t necessarily look like another 80- or 90-year-old in a different situation.

So I don’t think the pure age-based models are necessarily the best way to go. We think doing a full-blown financial plan where you gather as much data as you can on the investor is the best way to refine that asset-allocation decision.

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