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My portfolio: you win some you lose some

Last time I blogged I talked about my top down approach to asset allocation and how I used the Salty Dog data www.saltydoginvestor.com.  What should your investment horizon be? The Salty approach seems to promote churning. Buy when performing, sell when not, then reinvest. I would like to emphasise that I don’t “actively trade”, I am a long-term investor. My approach is aimed at being low cost and low maintenance: I don’t churn my portfolio a lot, that increases costs and I don’t want to be active on even a monthly basis, I’m too busy and unless there is a major world event, my view isn’t going to change that quickly. That makes me a longer horizon investor. Some assets I own I bought in 2012 and 2013.

My approach is to take a top down view:

  1. What asset classes and currencies do I believe will perform best? Think at least 12 months to 2 years, I can’t follow too actively, I’m too busy
  2. Start looking at some good performers from Salty dog. Buy a bit
  3. If they go well buy more
  4. If they don’t do what I expect (i.e. they go down) stop being wrong. Sell them
  5. Don’t buy individual stocks – find good managers with momentum and let them do the work
  6. Use a benchmark portfolio like one of the Salty portfolios to measure my portfolio risk. Have a risk target and stick to it until my market view changes a lot

Broadly my portfolio has looked like this:

2001-2006 – pretty much all equities – it doubled in value.

2006 – I went into cash having lost about 10% off the top. I have a habit of predicting the end of the world – this time I was right. My glass half empty view makes it a challenge for me to own equities, particularly if you like reading newspapers as I do: every week you will read that stocks are expensive on some measure or other. Not selling can be very challenging.

2006/07 – I took the view that this was a once in a lifetime opportunity to buy BBB rated bonds and make double digit returns in a low interest rate environment. I owned a lot of Personal Assets Trust (full of gold and Singapore Government bonds. Very much a “tinned food and gun” type investment). I also figured that if the Euro fell apart, good quality corporate bonds and gold would be very valuable whereas equities would collapse.

2008/09 – I held on in bonds and as things progressed I realised that the banks weren’t going to go bust and so increased my weighting in funds like Invesco Perpetuals, then a top-performer with lots of long dated bank tier 1 & tier 2 capital bonds in. Great returns. I was, I gradually realised, kidding myself about what I was buying: any “corporate” bond fund is going to be around 50% bank/insurance company bonds. A corporate bond fund is really a non-Government bond fund. Financials are just too prolific in their issuance to be ignored. So, I was betting on banks anyway, not against them. I thought I might as well go all in: banks were being bailed out. As 2009/10 went on I realised that the world wasn’t going to end.

To put 2007-2010 in perspective – I was happy with the returns I’d had and the downside protection of bonds. If I’d been in equities I’d have made literally double the return! I just wasn’t prepared to take that risk at that time. I had seriously thought there was more than a 50%+ chance of the Euro collapsing. If the Euro had got into real trouble the downside for equities would have been awful.

In 2010 I started taking more risk – I figured that bond prices couldn’t keep going up and that the yields were now poor (I was, it turned out, at least 3 years too early in that assessment). I thought equities would outperform and that there was nothing to stop equities from doing well. I was wrong about bonds – yields kept going down and prices up! but equity returns were better. I’ve been in equities ever since.

What equities did I do? Well I dabbled with some mining stock but lost money both sides – bad timing: I owned Xstrata and Glencore when Glencore took it over. I thought I was clever – I bought Glencore when it was 30% below its IPO price and Xstrata. I lost money on both positions in a takeover! Clearly the market was telling me not to break my rule about buying individual stocks. I also was in emerging markets for quite a while but got out as the $ started strengthening. My timing was good! I got out before a period of lacklustre performance. I did some very conventional things: as bond yields fell, investors turned to equity income funds looking for yield. I did too, I believe in dividends – 2/3 of equity market returns come from dividends reinvested. I picked some good funds that missed the worst of the problems in oils (BP etc. are big dividend payers). I also invested in mid-caps. My view was that Sterling would stay strong. The Euro was overvalued so my money should stay at home. I like midcaps because small companies grow faster than large companies.

As a small investor, I am not trapped in large caps like big fund managers are. You must not underestimate what a challenge size is for large fund managers. The need for liquidity and their large asset allocations effectively forces them into large caps, even though they grow more slowly. Similarly, an allocation to bonds for most big investors is compulsory: there are too few alternatives of any scale. BlackRock for example controls in the region of $1Tn, there are in the region of only $70Bn of UK small and mid-caps. There are simply not enough small businesses for the firm to buy and for it to make a difference.

As oil prices fell over 2014 & 15, the FTSE which is dominated by oils and minerals fell for 1½ years consecutively. Not very appealing? Banks are also a very large component too. I know a lot of people are excited by banks at the moment – Lloyds has turned the corner etc. but Terry Smith’s view is banks are too complex for him to understand. Terry is one of the investors in the world who I respect most highly, he was for a number of years the City’s most highly respected bank analyst in the 80s/90s. His Fundsmith Fund is a top performer. Terry is a talented and focused stock picker. Deutsche Bank is a perfect example of the ills of the banking sector: it has endured five years of fines, legal settlements and cash calls to remedy its past failings. I have no confidence in anyone’s ability to predict the end of these problems. Neil Woodford, perhaps Britain’s highest profile and best performing fund manager, is of the same view. There are no banks in his funds.

Another reason for my FTSE aversion is that I dislike very large corporates because they just get too big to be nimble and create value. It’s rare to find ones like Microsoft that have a monopoly and can just grind out growth. The Unilevers and the like can also do this, but they get inefficient too, hence Kraft Heinz’s bid. Kraft and Heinz are now in the hands of Brazilian private equity managers backed by Warren Buffet. Why? To manage these assets better and more aggressively. Part of my aversion is emotional, but there isn’t time here to talk about all the reasons that small and mid-caps have potential (not all the time) to outperform. The bottom line is that in bull market, cyclicals and small caps should outperform. I also have some absolute return funds – you have to momentum trade these ruthlessly. I haven’t, so have had great and poor performance from them.

Today:

Here we are in 2017 and my risk profile has just got more concentrated. Each time there is a geopolitical event I am nervous: my portfolio was leveraged pre-Brexit vote, i.e. I’d borrowed money to buy stocks. I’d had a pretty lack-lustre year. I got rid of the leverage but had assumed that the Brexiteers would lose the vote and sterling would rise again. If I had been purely in US stocks I would have made a fortune, but that is the flip-side of diversification. Sterling went from 1:70 to 1:25 over 9-15 months. The good news is that when the Brexit vote was lost I already had a big allocation to Fundsmith going back 2-3 years. This has a big US weighting. I also owned CF Odey’s absolute return fund. He was the only UK manager of note who bet on Brexit, so we didn’t actually lose money in £ terms through the vote! We did miss a big profit opportunity though. My $ allocation has increased, the logic for more $s was more weakness in £ and the Euro and stronger growth in the US, with a possible Brexit related dip in the UK and loss of confidence. I didn’t love American stocks, they were just the least worst option: more geopolitical risk, investors go “risk-off” and that means fewer emerging markets etc. I also have bought Japanese equities because of their low valuations and good fundamentals. I have some fundamental value-based investments in emerging markets like Vietnam, Russia and Brazil.

As usual I was wrong – well not completely. The UK economy did well post vote, but the US economy and market did even better. Having worried about Trump and not sold enough stock, I have been on a winner ever since! Thanks President Trump. So, my least worst bet – i.e. the US, has been a great choice.

I have also now begun to invest in some small cap stocks. But that is a story for another day...

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