Part 1 – The Benefits of Not Buying a Ferrari
I’m still here, I’m still investing, and I didn’t buy a Ferrari. This years take-away lesson for me was that sticking with the plan and not spending your savings are both Good Things To Do.
It’s easy to talk about valuations, rebalancing, asset allocation, analyst projections and all the other stuff that private and professional investors love to bang on about. But for me the most important thing is to just stay in the game and not get blown off track by the things that life throws at you.
Since selling my house in 2004 and ‘lucking’ into a sizeable chunk of capital, there have been an enormous number of things in the outside world that have wanted a slice of that money. The two big chunks that escaped out of the ISA before I got serious about investing went into a Jaguar XK8 (which I had for two years and it lost about 20% a year – not a good investment even including the fun factor) and a franchise business for my wife (which has returned about 30% a year so far in a tough recession, so a somewhat better investment than the Jag).
Other than that I’ve fought off countless urges to spend the money on various enjoyable but ultimately goal-defeating items. That is my main achievement for the year and hopefully that’ll be a pattern that lasts into the distant future.
Part 2 – Cut the Crap, How Did The Portfolio Do?
Things were going okay until December which was crazy. It produced a 12% gain which took the results for the year to over 22%, which is 10% clear of the iShares FTSE 100 ETF total return benchmark. 2010 is safely in the bag with results that were well worth the effort.
Relative to other small cap funds the results are not quite so impressive. For example the Standard Life UK Smaller Companies fund managed 47% and on http://www.trustnet.com the smaller companies sector was up 30%. In blog-land Mr Beddard over at Interactive Investor was up 27% and the amazing Running Capital managed 58%, although with a much higher work rate than my good lazy self. Overall it seems to have been good times galore in the small cap camp.
Part 3 – 2011
2011 starts off with my recently changed strategy, although I hope the changes are evolutionary and not revolutionary as they like to say in F1.
There was a problem in mid to late 2010 where I think my fund under performed relative to some of my peers. This was likely due to a feature of my old investing style where those companies that performed well (reached a price/book ratio of 1) were sold, while those that did poorly were kept on. Eventually this led to a portfolio with an increasing proportion of weak businesses who were perhaps really not worth book value (their average ROE10 was 5.7%). A portfolio to deservedly cheap companies is not a good place to be.
To fix that I have changed my approach somewhat as detailed in recent posts. A further tweak to those changes is that I will force myself at gunpoint to make one trade per month. Each month I’ll sell the least undervalued company (or use existing cash) and buy the most undervalued company in the market, by my measures. If I hold twenty companies this should give an average holding period of twenty months, which is slap bang in the middle of the range where value shares outperform the wider market (citations needed but I don’t have them to hand now – just take it as given that value shares don’t out perform over 3 months and they don’t outperform over 10 years, the sweet spot is somewere in between).
Following on from the last post where I quickly covered the sale of the old guard and their mighty balance sheets and weak earnings, below are the new entries that will carry me forward into 2011, along with the main metrics I currently use to generate a ‘reasonable’ valuation:
Company ROE10 ROE5 ROE3 Avg p/b
Barratt 14.3 7.3 1.8 7.8 0.25
AGA 9.2 7.8 5.4 7.5 0.42
Vislink 9.5 13.5 12.0 11.7 0.61
Airea 6.7 2.6 0.7 3.3 0.33
Belgravium 20.9 10.1 8.1 13.0 0.34
Tribal 7.3 7.5 7.8 7.5 0.25
Interserve 21.5 26.3 27.0 24.9 1.22
Flying Brands 25.7 22.2 21.5 23.1 1.33
Creston 7.5 11.2 11.2 10.0 0.55
As I’d expect, the companies that have produced the highest returns on equity generally have the highest market price for that equity, but the price/book ratios are still low and the combination of low price/book and relatively high ROE figures are where I hope to make my gains in 2011.
Part 4 – The Blog
I’d like to say thanks to all readers who comment in such measured and thoughtful ways, the blogging game would be a boring one without your input. And to those that just read, I doff my cap in your general direction repeatedly each day.
I hope 2011 serves you well.
Hi there. Just a quick question – how are you calculating your returns? Are you using a time-weighted return? Or do you not have external cash flows to take into account?Kind regards,-Joe
Hi Joe. There are no cash in or out flows to this fund so I don't need to use time-weighted returns or the unit valuation system. New money that I save into my 'pension' is fed into a separate fund that I blog about occasionally (my tactical asset allocation fund if you want to search for it on this site), where I just invest in index tracking ETFs and rebalance once a year.
Well done UKVI. Wow! I'm shocked, though, by your determination to sell you worst performer every month. It seems to me the most undervalued company could be the same one as the worst performer. After all falling prices is usually what makes value investments cheap. If value is your criteria for buying, surely it should be your criteria for selling? Otherwise it's a bit like buying an XK8 because you want a big, glamorous car that can go like a rocket and then selling it because it isn't economical, and cute like a Mini.
Hi Richard. Good point about the XK8, I should have thought about fuel economy before buying it!As for selling, I'm selling the LEAST undervalued company, i.e. the most 'expensive' company, and replacing it with something cheaper from the market. So if a holding shoots up in value it might become the least undervalued, at which point I'd sell it any buy something Mr Market hates.Don't panic, I'm not into selling my losers just yet!
The 2010 returns quoted above are very attractive- 22%, 47%, 27%. But they're dubious if there's a high probability of the respective portfolios falling by 30%+ in any single year in the next 10-15 yrs (as many did in 2008).Who did better- the guy who made 19% return whilst averaging 60% held in cash in 2010 (this anonymous poster), or the guy who achieved a 30% return via being fully invested in leveraged companies?"Look after the risks and the returns will look after themselves"! If you don't beat the index by 5% points in a boom year, it could be because you're in a position to trounce it by 20% points the next [crash] year.
Hi Karl. Excellent point. These one year figures are cited just because this is an annual review, not because I think annual figures are important. You're totally correct to say that the 10-15 year picture is the important one. And on top of that the kind of drawdowns that the fund inflicts on its owners. Losses of about 50% on my part via 'natural resources' investing in 2006-2008 were a key driver in my change to value investing where I hope I understand what I'm doing much better than before.Unfortunately since I have only been value investing since 2008 and it's been all up since then I don't have much info on my current downside risks. But the next time we have a big sell off you can be sure I'll point the finger at myself if I'm not holding enough cash.
Sorry, UKVI, can't have been concentrating this morning. Well that makes more sense! Although I've gone the other way. I used to consider selling at 50% profit, but now I just review each holding once a year (when it publishes its annual report). If it goes through the roof in between I don't care. It was getting too complicated tracking the prices of 30 companies and then reviewing them at certain price points. Life's too short :-)Also I agree with Karl, and your reply. To be fair I don't put any store by one year's returns. I always say it will be five years before the record means anything meaningful.
"To an extent, run your winners".That's my modified version of the age old investing wisdom!As for the business franchise… a profitable wife is a beautiful asset. Well done! 😉
Richard – I know what you mean about time, that's why I try to invest mechanically, otherwise you could spend your life looking at companies.Monevator – Thanks, I think!
Hi UKVI, I noticed that you hold Barratts, which piqued my interest, because I sold BWY (Bellway), a housebuilder, last month. My reasoning, and a fuller writeup, is here: http://bit.ly/gEGkJX