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Investing Specialists

Wide Moats Holding Strong in Market Turbulence

The StockInvestor portfolios get a performance checkup.

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In managing the Tortoise and Hare portfolios that are the centerpiece of our flagship StockInvestor newsletter, I have a fairly simple strategy that can be boiled down to two steps:

1. Focus on companies with wide economic moats.

2. Buy only stocks with a margin of safety (i.e., appropriate discount to our fair value estimate).

Given the makeup of the portfolios--both have an emphasis on very high-quality companies that are excellent core holdings--I expect the portfolios' relative performance to depend on the market environment. Namely, my expectations are that in years where the S&P 500 flies, the Tortoise and Hare portfolios will have positive absolute returns, but they will mildly underperform the index. Take 2003, when the S&P 500 had a 28.7% total return, but the Tortoise and Hare on a combined basis was up "just" 26.2%. We are simply not going to keep pace in times like these, being owners of stalwarts like  Coca-Cola (KO) and  Johnson & Johnson (JNJ).

But in years like 2002 and 2008 where the S&P 500 flounders, I expect these are the times we will capture the greatest degree of relative outperformance. The companies I own may not excite speculators and/or sport 40% growth rates during an economic expansion, but they are generally very well positioned to ride out economic rough patches. (How many wars, recessions, corrections, and bear markets has Coca-Cola lived through?) So with all the market uncertainty caused by this real estate meltdown/credit bubble burst/quasi-recession/whatever you want to call it that we are currently experiencing, are my expectations coming true?

In a word, yes; I'm glad to report my strategy of focusing on companies with the strongest competitive positions is yielding significant downside protection in this difficult time for investors.

 Tortoise and Hare Portfolio Performance

Tortoise & Hare
Combined (%)

S&P 500
+/- S&P 500
2008 Year to Date-9.3-20.010.7
Since Inception (Cumulative)60.58.452.1
Since Inception (Annualized)

* Data as of Sept. 17, 2008. All returns include dividends and interest. 2001 returns start at inception date of 06-18-01. Tortoise and Hare Combined returns are time-weighted, assuming equal investments in each portfolio at inception.

It's not surprising that the Tortoise is beating the Hare in 2008 (negative 6.5% versus negative 12.5%, respectively). Beyond hitting the jackpot twice with the buyouts of  Wrigley (WWY) and  Anheuser-Busch (BUD), the Tortoise simply tends to own larger, lower-risk companies, as exemplified by current top holding  Berkshire Hathaway (BRK.B). Meanwhile, the Hare tends to own smaller and more volatile fare, such as  MasterCard (MA). As the portfolio names imply, I expect the Tortoise companies to safely trudge along, while the Hare stocks will have much greater volatility.

To sum, you might say my expectations are that the Tortoise and Hare will lose far less in a downturn, and they will merely keep pace with the market during an upswing. Over longer periods of time, if my expectations continue to come true, the portfolios will continue to achieve positive absolute returns, while beating the market. All the while, I'm holding companies that generally allow me to sleep well at night. Although it is obviously difficult to get too excited about near-term results when the portfolios have declined in market value, years like 2008 are when the seeds of long-term outperformance are sown.

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Paul Larson has a position in the following securities mentioned above: BRK.B, JNJ, MA. Find out about Morningstar’s editorial policies.