Portfolio update

We continue almost fully invested in stocks (~99%).

Our new sector allocation for stocks look like this (please click the picture to enlarge):

The main theme is "technology and related services" as nearly 50% of the portfolio is now allocated to companies providing high tech products and/or services (software and/or hardware) or supplying components to such companies (e.g. semiconductor manufacturers).

In terms of place of incorporation, more than 60% are based our home country (Finland, Europe) and the rest are based in USA. Majority of the corporations operate and sell globally.

Sold Berkshire Hathaway and trimmed down Nokia

I have made many changes in our portfolio.

Selling all shares in Berkshire Hathaway (NYSE: BRK.B) is the most significant move this year. The position grew to be our largest position from entry at $126,75 in January 2016 to exit at $200,34.

Majority of the proceeds were converted to euro and deployed to grow our existing positions at Nasdaq Helsinki. The remaining dollars were used to open positions in Dell Technologies (NYSE: DELL) and CVS Health Corporation (NYSE: CVS).

Our position in Nokia Corporation (Nasdaq Helsinki: NOKIA) has been trimmed down significantly (over 50% sold). Our average entry cost - before trimming - was 3,13 euros with majority of the shares now sold having been acquired below that. Thus, a significant profit taken also from there. The proceeds were re-deployed to our other positions at Nasdaq Helsinki.

The main rationale behind the actions is to balance the portfolio and move money to the positions that seem to be much more promising over long term (5-10 year) than those that were sold.

We have now 25 stocks in portfolio and out of those 17 from Nasdaq Helsinki. Top 3 positions are dominated now by U.S names:

1. Western Digital
2. Apple
3. Micron

Cost control

The expense ratio of an Exchange Traded Fund (ETF) measures how much of the assets are used for administrative and other operating expenses. Expense ratios have come down significantly over the years as the funds have grown and have thus become more efficient (same fees etc. divided by larger amount of assets under management).

ETF expense ratios vary typically between 0,1-0,8% and the lowest ratios are to be found among very popular passive index funds such as SPDR S&P 500 ETF Trust (NYSEARCA: SPY).

Compared to actively managed mutual funds ETFs have very low yearly fees. However, it's easy to fall into trap of thinking that expense ratios below 1% are small enough not to matter that much.

To illustrate why even expense ratios in the ballpark of 0,2-0,6% are significant over the very long term, I calculated two examples for investment of 10.000 euros over 40 years.

In the first scenario (above) I assumed that yearly gain is 5%. The difference between no yearly cost (expense ratio 0%) and 0,6% year cost is 14.422 EUR.

To get a more drama, I calculated a second scenario (below) where yearly gain is 10%. There the difference between no yearly cost (expense ratio 0%) and 0,6% year cost is staggering 88.935 EUR.

Naturally, the markets do not produce steady returns and there are ups and downs over the years. Thus, the calculations above are completely theoretical and made to illustrate the effect of yearly cost in simple scenarios.

Takeaway for buy and hold investors:

In the long run, it's not the profits alone that matter - also cost of holding matters a great deal!

The good news is that the investor can fully control his/her yearly fees by selecting ETFs smartly or investing directly into stocks.

Winner take all - until..

Some of the Internet giants - also known as the "FAANG" companies based on their initials - start to be so big due to the winner-take-all effects that they may face antitrust lawsuit.

From what I understand two of the companies in particular are nearing this stage: Amazon and Google. Both are very dominant and vertically integrated (i.e. they develop most of their infrastructure by themselves). Apple is also vertically integrated, but in my view, they don't have the same kind of dominance in their respective markets than Google and Amazon do.

American Telephone & Telegraph Company (AT&T) is an interesting precedent because it was vertical integration - not it's domination in itself - that motivated Federal Communications Commission to sue AT&T. They suspected that the AT&T was using monopoly profits from its Western Electric subsidiary to subsidize the costs of its network, which was contrary to U.S. antitrust law. The case was filed by the United States Department of Justice in 1974. [source]

Vintage Telephone Equipment at Museum of Communications 

by Marcin Wichary [CC BY 2.0]

Initially, The plaintiff in the court complaint asked the court to order AT&T to divest ownership of Western Electric. AT&T didn't want to do this. Instead, they proposed to give up ownership of the local operating companies, which was what eventually took place in 1984. [source]

Over ten years later - in 1996 - AT&T divested also the equipment arm as Lucent. The end result is that no operator today has significant own development in the telecommunications equipment. There has been significant consolidation in both operator and equipment provider space (e.g. in latter space what used to be separate Alcatel, Lucent and Siemens Communications are now part of Nokia Corporation.

The same kind of development may have to take place in the Internet economy to prevent some corporations become too dominant for the market to function efficiently. Separating technology development from the "operator" function is one way. I'm not too deep into FAANG family so will not speculate on details. What is clear though is that monopoly (and near monopoly) is a bad thing in free market economy and authorities will step in when some company becomes too dominant. Winner really can't literally take all.

Disclosure: Long Nokia and Apple.

Thoughts on Technology stocks

Over third of our portfolio is invested into technology stocks. But what is considered a "Technology company" ?

It seems "Technology" in this context has come to mean computer, computer networking and electronics related technology and services:

• Digital electronics (includes computers and components thereof)
• Software
• Services making use of computers and networking (e.g. on-demand video over Internet, e-commerce etc.)

Intel core i7-970 pin side

Image: Rainer Knäpper, Free Art License

"Tech" companies are often spending a lot on research and development (R&D) activity and many of them end up having sizable patent portfolio over time that protects their core innovations. 

I know R&D very well having spent more than 20 years in the front lines of technology development. It can be described as endless running competition. Even if you would have the advantage of being first in some space, you need to continue as others - perhaps companies 10 times your size - will be looking to enter the competition.

Netscape was first to release modern browser and it was at the time superior to anything before it. They were undisputed market leader in the mid 1990s with over 90% market share. Yet, by 2006 they had just 1% market share as Microsoft and many others invested heavily in their own browsers.

People typically see only the winners and forget the losers. For every "tech" that have made it big time there are tens of losers. And even those that make it "big" may not last for a very long time. This makes investing in "tech" very tricky. 

I have seen many first releases of a product and can say that in many that release will need considerable patching later on. Perhaps even second major release to really get it solid. The thing with R&D activity is that the more you have released the more you have to maintain. The maintenance part may - depending on the nature of the business - tie significant amount of R&D engineers. In the worst case, you need to also customize the releases for a given customer increasing the parallel software branches still.

Over time it is also easy to get locked in to a particular platform. Nokia's former mobile phone business is a famous example of this. They were so heavily locked to Symbian that they just could not pivot fast enough and were overrun by iOS from Apple and Android from Google. Apple didn't invent smart phone. They observed the market and available technology and eventually came up with far better design with iPhone that anyone before them - by a wide margin. They also came up with "Apps" and made the ecosystem fly.

Especially big tech companies have this kind of option that Microsoft used with browsers and Apple with smart phone. They can observe and learn from existing players while making their first release. If you are big (and skilled) enough, you can catch up pretty fast.

Therefore, small technology companies have to grow big fast or they risk being overrun. Many times the big will buy the promising small companies before they make it big. There are, of course, famous exceptions to this rule. The problem is that they are so visible and so good stories that people forget the "tech graveyard". The ones that didn't made it.

As an investor I tend to favor fairly valued established technology companies with long history, excellent brand and products, big enough footprint in their core markets, sizable patent portfolio and large R&D and sales departments. These are all things that are not easily replicated. For semiconductor stocks, you can add extremely expensive production lines requiring tens of years of know-how to build and operate.

It is hard to find "ten baggers" with this profile. However, it is possible to find companies that will see their market value grow many fold over time. That's good enough for me combined as it often comes with limited downside risk compared to whatever is currently "hot" in tech sector.