In our most recent series written by Jamie Cornehlsen, Denver CFA and founder of Capstone, FLOW examines how we seek out investments and make selections based on current market trends and future forecasts. Part four of our series uncovers the various reasons why investors select particular investments when creating a portfolio, as well as the importance of each component.

In building a portfolio, I always ask: what is the purpose of this particular portfolio? It seems like a simple concept to be purposeful with what to invest, but often times this imperative thought escapes the process.

This question may seem like common knowledge to some, but it is of vital importance for an investor to ask.

What Are You Investing For?

Investing comes with many trade-offs. Generally speaking, higher yields often imply lower capital appreciation, and vice versa. 10% yields are eight percentage points above the S&P 500. Companies that are on a fast growth trajectory tend to retain the cash they have for further growth.

Investors do not have the same goals, needs or investment objectives. Some investors want outright appreciation in order to beat the stock market. Others are concerned with protecting the downside. And then there are the investors that want the highest income possible. Consequently, I believe investors should ask what purpose is this investment for?

For the FLOW portfolio, the investment objective is maximum cash flow with the current yield. For high-yield, investors should expect a lower rate of capital appreciation in order to achieve their goal. If you are looking for maximum capital appreciation or total return, you will not find it in a high-yielding portfolio such as this one.

Portfolio Characteristics

  • 20 Investment Positions
  • 10 Investment Categories
  • Categories: Convertible/Preferred, Covered Calls, Emerging Markets, Foreign Governments, Go Anywhere (manager discretion), High-Yield (junk bonds), REIT, Mortgage Debt, Infrastructure, and Individual stocks.

The main objective of the FLOW portfolio relies on the investment’s ability to create cash flow, which will either produce a capital appreciation over time, or will distribute a cash flow directly to the investor.

Consequently, the volatility in the value of this portfolio should not matter. It is only important that the investments continue to sustain the 10% or more cash flow distribution.

Future total returns will also be functionally related to the level of valuation that a company can be purchased at. Lower valuations can lead to higher future returns generated by price-to-earnings ratio (P/E) expansion as a result of a reversion to the mean. Consequently, if valuations are low enough, which could also be the source of an above-average current yield, this can result in high or above-average future returns that can be accomplished even through investing in lower growth entities.