ATHENS, Greece–The SRI Portfolio continues to outperform.

New readers, please note that this is a long-only portfolio. I imposed this restriction in order to fairly compare performance against benchmarks, and all major market indexes are also long-only.

Though quarterly results aren’t my main concern, the end of the period offers an opportunity to assess performance since inception. I also publish yearly returns at the appropriate time.

Since its inception 15 February 2006 through the end of the second quarter of 2007, the Portfolio is up 45.3 percent, while our benchmark–the Morgan Stanley Capital International All Country World Index Total Return (MSCI World Index), which includes gross dividends—is up 28.7 percent. The S&P 500 is up 19.3 percent, including dividends, during the same time frame.

Please note that this performance refers to the Long-Term Holdings portfolio.



Source: Bloomberg, SRI

Two of the three permanent hedges–US Treasury bonds via the iShares Lehman 7-10 Year Treasury Fund, recommended in early March 2006, and gold bullion, recommended later that same month, also made respectable contributions. The former was up 4.7 percent, while the latter was up 12.6 percent.

I initiated the bond hedge at a time when many pundits were busily justifying their views as to why the 10-year US Treasury yield was about to rise to 6 percent and beyond in 2006, a target first revealed at the beginning of that year.

But bonds didn’t collapse, a fact that should have come as no surprise to SRI readers. Furthermore, bonds proved a good hedge instrument, holding their own during uncertainty this past year. That said, the long-term downtrend in the 10-year yield was recently broken to the upside; see the chart below.

But the view here remains that the move isn’t a convincing one yet, and consequently I expect US Treasurys will remain a good hedge to long-only portfolios.



Source: Bloomberg

Given my long-held bullish view on gold, a word on the metal is warranted.

It’s becoming increasingly obvious that the majority of investors remain uncertain as to what will be the final outcome of the Federal Reserve’s moves and the slowdown of the US economy this year. The debate between deflationists and inflationists remains animated.

I anticipate an eventual deflationary outcome (i.e., a deleveraging of the consumer). Yet the only hedge able to cover both is gold.

Gold has been the object of ardor and the target of scorn throughout the centuries but has never been refused as means of payment. The reason is that gold has no substitutes.

And given the demand for gold we’ve seen during the past three years (from central bank buying to new gold exchanges and liberalization of trade around the world), gold has become the world’s fourth currency. In today’s world of massive deficit spending and financial imbalances, expect demand for gold to continue to increase.

I first recommended gold as a hedge three years ago (while overseeing a portfolio for another advisory), and the metal remains the ultimate bulwark. The metal is in a secular bull market that commenced in 1999 and should be expected to rise much higher, easily surpassing previous highs by the end of the decade. I strongly recommend gold as a hedge position for long-only portfolios.

The third permanent hedge position, shorting Consumer Discretionary SPDR, was recommended toward the end of 2006 and to date hasn’t made a visible contribution as global markets have been performing well. This is a leveraged hedging short to a long-only Asia overweight portfolio and should be viewed as such.

Pay attention to the hedges and see them as what they are: protection for the rough patches. Protecting your portfolio is always a good idea.

Markets

A little more than a month ago (see SRI, 30 May 2007, Tactical Considerations) I suggested that a potential selloff in the domestic China market could lead to a broader market selloff in Asia. And although the Chinese market is off 10 percent since then, the rest of Asia has moved in the opposite direction.

It’s very encouraging that the rest of Asia has been able to hold its own during a China market correction. Of course it’s still early, and investors need to remember that a market correction coupled with economic weakness or negative sentiment among Chinese investors will have a much different impact on the rest of the world.

That said, I expect markets to move higher by the end of the year, although I can’t rule out a deep correction in the meantime. You should remain diversified and trim excess profits. I’ll try to inform you when I think a serious selloff is on the way, but as I’ve often noted, there’s no guarantee my timing will always be perfect.

Fresh Money Buys

If you’d like to add to your positions in Portfolio recommendations or allocate new funds, focus on the following markets, in order (for both countries and sectors): South Korea (banking), Hong Kong (real estate, publishing, infrastructure), India (pharmaceutical, banking), Malaysia (ETF), Russia (telecommunications, energy), Taiwan (technology, telecommunications), Singapore (telecommunications, banking, industrial), Europe (oil, pharmaceuticals, industrials, communications equipment, media), Japan (industrials, banking), China (consumer, coal, power, oil, water) and Macau.

How SRI Works

I often include some notes regarding how I view the investment process. Long-term readers who have a grasp on how we do things can take a break, but those who are unclear on such issues should read on.

The SRI Portfolio has been constructed around the view that domestic economic demand and investment are driving Asia’s economic ascent. The areas I’m looking at for investment ideas continue to be mainly property, infrastructure, financials, retail, telecom, energy and utilities.

I’ve noted repeatedly that the Portfolio should be viewed as a whole rather than an assortment of stocks. It’s my hard-earned assumption that investors seldom follow such advice, so I also offer some direction in an effort to assist with the decision-making process, under the Fresh Money Buys section. In this section readers can find a guide as to how I rank countries and sectors at any point in time. The ranking changes often, so pay attention.

The ranking starts with the countries I prefer and then lists specific sectors you should look into. When I mention a sector, it’s assumed that the first pick will be from the Long-Term Holdings and then, if more exposure is warranted, from the Alternative Holdings part of the portfolio. Of course if a country isn’t represented in the Long-Term Holdings, refer to the Alternative Holdings for a selection (as is the case for Macau).

Portfolio recommendations should be taken at face value, in the sense that if a stock is recommended as a buy and trades below the price indicated in the Portfolio tables, then the recommendation stands for new readers as well as longer-term ones.

Occasionally I recommend–as I did in the beginning of 2007–that long-term readers take profits off the table:

I also advise long-term readers to take profits from ICICI Bank and Dr. Reddy’s Laboratories–without selling the stocks outright. Take any gains you have and leave the initial capital invested.

I’d like to make a couple clarifications. Regarding the mechanics of the above advice, I expect investors to look at their profits (i.e., how much money they’ve made above the initial investment) and then calculate how many shares they need to sell in order to take these profits off the table.

Second, if you’re not a “long-term reader,” chances are you probably don’t have profits to take from the specific stock; you’re unaffected by the recommendation. The fact that I haven’t advised selling the stock outright indicates that it remains a good, long-term holding.

As mentioned above, SRI has one main portfolio, the Long-Term Holdings, and an alternative, the Alternative Holdings-Permanent Hedges. Investors should look first to the Long-Term Holdings for asset allocation in the markets covered here.

In the Alternative Holdings-Permanent Hedges Portfolio, readers can track permanent hedges and shorter-term recommendations. It also includes companies I’ve recommended for longer-term or more fundamental reasons, and they represent additional exposure to favored investment themes. For example, Lukoil provides extra exposure to a favored theme–Russia and energy.

On the left-hand side of the Web site’s main page, under Portfolio Performance, you can get a snapshot of the Portfolio’s return compared to other major indexes.

On the Portfolio page, you can click on the asterisk next to each holding to review the original commentary and recommendation. I plan to enhance the Portfolio table with extra features and welcome comments and suggestions.

Many new readers have also asked, “What do we do when the market drops substantially?”

Since SRI’s inception, I’ve been skillful and lucky enough to have booked profits before the fall, in which case I recommend sitting still, or to issue a Flash Alert to sell if a substantial selloff is indicated, as was the case a year ago. (See SRI, 15 May 2006, Silk Road Investor-Flash).

Because SRI is a weekly publication, readers need to be reminded of certain investment themes or analysis presented here before. The way to do this is either through a link or by reproducing a couple of the crucial paragraphs.

If you’re interested in taking full advantage of the service, read some of the older issues to gain an understanding of the investment philosophy of the publication.

In the alternative, ignore the above and try to find the next big hitter the Portfolio will produce. Although it can happen, be aware that SRI isn’t in this game; “fast guns” are wasting their time with this publication, as well as Asia and the rest of the international markets as an asset class.