2012 Performance review

I’m sure you’ve heard it said many times before that investment returns don’t correlate to our cycle around the sun, but a yearly review is still a good idea. 

In fact, reviewing a portfolio’s performance on an annual basis, rather than monthly or quarterly, is likely to improve returns by reducing the number of bad decisions caused by reacting to noise in the market and the media.

On that basis, here’s a review of how the UK Value Investor model portfolio has done these past 12 months.

First, some background

This portfolio began life with £50,000 of virtual money on March 1^st 2011.  Although the portfolio is virtual, my own retirement funds hold exactly the same investments.

At the start of 2012, the portfolio was valued at £46,535 and had 18 holdings and 15% cash.  The initial goal for the number of holdings was 20, but during the year, I increased that to 30 to reduce risk – risk as measured by price volatility and the risk of making bad decisions caused by over-exposure to any one company (i.e. the larger your position in any one company, the harder it is to ignore the urge to sell if the share price drops).

By the end of the year, the portfolio had increased in value (with dividends re-invested) to £56,043, an increase of more than 20%.  Cash is now just 3.4% of that value, and the portfolio holds 25 companies, mostly from the FTSE 100 and FTSE 250.

Luck or skill?

You should always be very wary of the investor who attributes all their returns to skill.  Investing in equities is very much a game of both luck and skill, and the trick is to use skill to make luck work in your favour.

I think some of the best indicators of skill over luck are dividend income and realised capital gains.  Both these measures have, at least in the longer term, much more to do with an investor’s skill (or application of a sound approach) than they do with the vagaries of a largely random market.

Dividends

Dividend income for the year was £2,659.  Based on the value of the portfolio at the start of 2012 (£46,535), that’s a return from income of just over 5.7%.

By comparison, the FTSE 100 index tracker which I use as a benchmark, produced an income of 3.6% during the year.

Realised capital gains

I sold three holdings in 2012 as part of a process of continually improving the portfolio’s income, growth and value characteristics.  The three companies were:

Robert Wiseman Dairies – Supplies around 30% of the fresh milk in Britain.  This company was taken over by Muller Dairies shortly after the start of the year.  The realised gains from this sale were £508 (about 21%).  Read the case study.

UTV Media – Runs the ITV franchise in Northern Ireland, as well as the talkSPORT radio station (among other things).  This sale netted capital gains of £1,015 (about 40%).  Read the case study.

UK Mail – The largest parcels, mail and logistics services company in the UK.  This sale netted capital gains of £571 (about 23%).  Read the case study.

The total realised capital gains in 2012 were £2,094.  If these realised gains were taken as income, they would have boosted dividend income by an additional 4.5%, taking the total cash generated by the portfolio to £4,753, or 10.2% based on the starting value.

So approximately half of the 20.4% returns were down to (a) selecting high-yield companies that sustained their dividends and (b) occasionally selling them to capture capital gains.  The other half of the total returns are mostly down to the random movements of the market, which is, of course, luck rather than skill.

New holdings

There were ten new investments made during the year, four from the FTSE 250 and six from the FTSE 100.  As with the existing holdings, they are all companies with long histories of profitability, dividend payments, relatively consistent growth and sound finances.

The expected holding period is around five years, but this can vary widely depending on how Mr Market chooses to value each company in any given month.

Expectations for 2013

I expect the dividend income in 2013 to be higher than in 2012, but how much higher, I do not know.

In terms of capital growth, I expect to sell at least four holdings this year.  I’ve already published the sell alert for the first of these, which has returned over 50% in just eight months.

Even though the original buy alert was only sent out in the May 2012 issue of the UK Value Investor newsletter, the shares have indeed shot up 50%, while the intrinsic value of the business has changed barely at all.

That’s why sensible investors should be thankful for Mr Market and his manic mood swings.  If I buy shares at one price, and then eight months later, Mr. Market wants to buy them back from me at a 50% premium, who am I to argue?

So regarding capital growth, I expect to make a profit on each of the four sales scheduled for this year.  Beyond that, it’s difficult to say anything because markets are random in the short term.

However, another year of 20% gains would be very welcome indeed.