How to create a portfolio with a return 2-3 p.p. higher than inflation

Andrei Movchan

Aug 21, 2024

We continue to answer investors' questions.

Question to Andrey Movchan

I resonate with your idea that one should invest only if there are competitive advantages over other investors. I was most interested in using the advantage of knowledge about a company that other investors do not possess.

For example, some time ago I bought shares of Howard Hughes Holdings (HHH). The company acquires huge empty land plots and over 40–50 years builds cities like the Moscow suburbs of Odintsovo or Khimki (with populations of 200,000).

The main reason I bought the shares was that the main shareholder of HHH for 14 years has been the Pershing Square fund, managed by Bill Ackman. Currently, the fund owns about 40% of the company.

Bill Ackman was the chairman of the board of directors of HHH for a long time (now another top manager from Pershing has taken over), he personally participates in the appointment of the CEO, and his subordinates (former Blackstone managers) tell Ackman in detail what is happening at HHH. So it can be said that Pershing knows much more about HHH than ordinary investors.

Pershing constantly buys HHH shares: at $90, recently bought at $74. Ackman said they never sold HHH. During the pandemic, when the market fell sharply, Ackman was buying HHH specifically.

I waited until the shares fell below $74 because I wanted to invest on better terms than Ackman and bought shares at $67. Investing in companies chosen by Ackman is a good example of investing with someone who has competitive advantages in knowledge.

Currently, my portfolio is divided approximately in the ratios of 20/40/40: ~ 20% — Movchan’s Group ARGO fund, ~ 40% S&P 500, and ~ 40% in several stocks chosen based on the principle described above. My investment goal is to outpace inflation by 2–3 percentage points. Therefore, the target ratio is approximately 50/30/20 (ARGO, broad market, and own strategy respectively).

How successful can this strategy be at the current moment in anticipation of a key rate cut? At what point does it make sense to increase the share of ARGO in my portfolio?

Answer from Andrey Movchan

Regarding HHH: I would advise determining whether you are buying the company or Pershing's expertise (PSHZF). The fund's investments are well diversified, its share price has grown by 70% over 10 years. The fund's capitalization is about $10 billion, with $17.5 billion under management.

HHH has consistently lost half its value over 10 years, its current capitalization is less than $3.5 billion. Owning 40% of HHH, Pershing allocated only 7% of its assets and about 5% of its portfolio (it's leveraged) to it. It is quite possible to assume that HHH for Pershing is an opportunistic investment or for some reason, the management of Pershing likes this company (perhaps they also receive some benefits from it in parallel, not through its value growth).

Let's assume that Pershing is indeed relying on some advantage when choosing this company for investment. Then why is this advantage used in such a narrow context (randomly choosing 5% of their portfolio), why not just buy Pershing shares or its funds?

By the way, regarding Pershing and Ackman's expertise: the S&P 500 over the same 10 years from 2015 to today has increased by 155%. That is, on average, it grew twice as fast as Pershing. In 2020, Pershing significantly outperformed the S&P 500, and that is the only such year in 10 years. From the end of 2020 to today, Pershing grew by 27%, S&P 500 — by 42%. So the ratio of returns remains. It should be said that our GEIST behaves slightly better than Pershing.

Can it be said that Pershing has a sustainable advantage? I don't know.

Regarding your question — a few considerations:

1. The rate cut (by the way, by how much, when, and how — is unknown) is not the only thing that will happen in the markets. They will also be influenced by political issues, economic slowdown, budget deficit crisis, possible credit crisis (caused by many companies having to refinance at high rates), reduction of money supply, sentiment changes, and simply chaotic movements. When and in what form all this will happen, I do not know. And no one knows.
2. Regarding the overall situation, I can only say banal words: "Stock markets are disproportionately expensive relative to their historical average parameters even for low rates, heavily skewed by sentiment in favor of fashionable ideas, and generally supported by excess money in economies." This is a sign of an imminent correction; but I said the same words in 2019, and since then the US stock markets have grown significantly.
3. In my opinion*, a strategy in which you want to achieve returns 2–3 percentage points above inflation should not require market timing (it doesn't work) and cannot rely on "outright" investments in stock indices in large volumes (especially in individual stocks). Even such remarkable markets as the American one can go negative for many years. If you had entered the US market in 2000 after years of successful growth amid the internet hype (very reminiscent of the recent hype around cryptocurrencies and NFTs and the current one regarding artificial intelligence), your invested funds would have returned to you only in 2013, and accumulated inflation during this time was 47%. No one can assert that such a situation will not repeat now.
4. I do not give individual investment advice, just share my personal experience. In my personal portfolio* to solve the question "how to achieve stable returns above dollar inflation by 3%" I have selected a combination of:

• hedge funds selected by a large number of criteria;
• conservative bets on the macro situation — a portfolio sensitive only to macroeconomic parameters, and derivative overlays on top of it. Risks are minimal, additional returns are there;
• market-neutral strategies (primarily invented by me and Michael Portnoy).

In other words, my portfolio* — is where 40% is in ARGO, 20% in GEIST, 20% in ARQ, 20% in LAIF. In the base scenario, this portfolio should yield somewhere around 6.5–7% per year, in a super-negative scenario of a strong market downturn (once every 20–30 years) — minus 5.5%, in just a negative scenario — returns above or around inflation.

• The provided information is not individual investment advice. The information is not a public offer, proposal, or invitation to invest in the fund, acquire or sell the fund's securities, or make transactions with them. Financial instruments mentioned in the provided materials may not be suitable for you, may not match your investment profile, financial situation, investment experience, knowledge, investment goals, risk and return preferences.