Barstart - I've taken some time to consider your perspective and think about our discussions on the Board as we considered that decision.
You are correct that diversification is, in general, a valid and valuable strategy to minimize risk and maximize potential returns for the average investor. You are also correct that, as fiduciaries of a 501(c)(3) public trust, each Board Member and each Office have a responsibility to protect the assets of the trust on behalf of the contributors and the public. We also, however have a responsibility to carry out the objectives set when those assets were contributed to the trust.
Diversification in and of itself is not an appropriate single strategy for any investor, nor is it a proper end objective for an investor. What diversification accomplishes is spreading the eggs around, ensuring that a portfolio will have a number of losers and a number of winners. That means that a given portfolio employing that strategy will, by definition, never get the highest return of a given risk pool, nor will it expose itself to the highest risk profile. It will also, by definition, never get the lowest return of a given risk pool, nor will it expose itself to the lowest risk profile.
To reach the healthiest mix between risk mitigation and return maximization diversification needs to be considered and it was in this case. Other factors, however, most often override the risk mitigation benefits to be had from a diversification strategy. For example, I had a client who was an entity associated with the Seventh Day Adventist Church. They managed and operated from the returns on an endowment fund with a net worth of about $35 million. While diversification was one consideration in their investments in stocks and bonds, their religious principles prevented them from investing in entities involved with tobacco, alcohol, caffeine and meat production, among other products.
Despite the restrictions imposed by their philosophy, which ruled out investment in more than 50% of the stocks on the New York Exchange, they and their investment advisors crafted some very successful and high return strategies, even though they were not very diversified. Their portfolio was subject to a much higher risk profile than if it were fully diversified, and probably experienced a higher volatility in short and medium term value changes. They understood and accepted this. Frankly, when you looked at their chart of long term (fifteen to twenty years) the overall trend was a slightly better performance profile than the market as a whole.
Another example where diversification and risk mitigation are not necessarily the best advice is in the case of an individual who owns his own business. Most of my clients and most of my employers are pretty successful sole proprietors or participants in small corporations, partnerships or limited liability companies. Most of them have had no diversification, most or all of their money is invested in their single small business. They know that business intimately, they work very hard every day all day to make it successful and most of them continue to grow and succeed. They have the highest risk profile, but most of them experience the highest long term returns on their investments, too. If I were an absolute diversification purist, I would have to advise them to divest much of their funds from their own businesses and invest somewhere else. That result would dilute their focus on their own business and also their rewards if their business succeeds. Even though it is counter to a diversification strategy, that advice just wouldn't make sense.
When we on the Board considered what to do with this $200,000.00 of funds which had no near or mid term use, we considered diversification, investment in one or several mutual funds and other strategies. We had to look, however at the source of the funds and the objectives of our organization, as well. We are the Antique Caterpillar Machinery Owners Club. There is a singular common thread which unites every Member and every person who has contributed to this Club from its start in 1991 until now. That thread is the Caterpillar corporation.
Some of these Members are those contractors who have a single brand fleet, wouldn't own anything but a Caterpillar, believe Caterpillar has never made a bad machine and never will and wouldn't consider anything that wasn't Highway Yellow. Some own every different brand in their operations, and in their collection, but have an interest in Caterpillar, its history and its future. Some just joined because of this silly discussion board, or because of the models, and don't really give a hoot about the corporation directly. Even those, however, need Caterpillar to continue and succeed because the models and the bulletin board survive partially because of the name and trade dress licenses which the Club has from Caterpillar.
If you remove the emotion from the picture, Caterpillar is a very strong, stable and long lived corporation. An investment in its stock would be assessed among the lowest in risk profile by any metric. Caterpillar has an over 70 year history of issuing quarterly dividends meeting or exceeding 3.2%. Its stock value is prone to fluctuations along with the rest of the market and Caterpillar is probably slightly more exposed to world economic and political instability than the average publicly traded company. They have a unique, long history, however, of surviving those fluctuations and maximizing returns will doing so.
Finally, our organization is unique because it exists solely because of that unique common thread among our Members. If the Caterpillar corporation failed, our organization might continue. There are Studebaker clubs, Rumley clubs, Cletrac clubs and Letourneau clubs. We would not continue with the strength we have now, nor in the form we have now. If Caterpillar failed, we'd no longer have the license to use the name in our corporation, on our website or in our publications, so the change would be dramatic and touch just about every aspect of our operations. There is a good chance the Club would not survive if the corporation failed.
The Board considered all the above factors when considering what to do with that $200,000. We also considered that we were not investing that $200,000 for the purpose of maximizing growth. We had two primary objectives, maximize investment returns (dividends in this case) while minimizing the long term risk of erosion of value. Our fortunes, both emotionally and financially, are very closely connected to the Caterpillar corporation. None of our Members would be very happy if we invested one third of that money in Caterpillar, one third in Komatsu and one third in John Deere. Nor would they be really happy if we invested in General Electric, who also compete with Caterpillar in several arenas.
Overall, we as a Board felt that the pros of investing in Caterpillar stock, betting on the one corporation upon which every Member agrees, getting a very strong likelihood of short term and long term investment income, and maximizing the likelihood of long term value preservation, far outweighed the dictates of a diversification.
Pete.
I agree with you that we need to be keenly aware of our fiduciary duties. I would contend that we carefully and completely carried them out with this investment decision. Diversification in this case would have been irresponsible and contrary to those duties.