Conducting a portfolio performance review on a regular basis is a key step in the investment process. If you aim at nothing, you’re likely to get it, as the saying goes. So, self-directed investors need a goal, and they need to review their progress towards it at suitable intervals.
I have chosen quarterly reviews because I think a month is too short a period to have anything interesting to say, and a six-month or annual review is a little too passive for my liking.
Know your goals
You should have a set of goals or outcomes that reflect your own personal situation. For the UKVI model portfolio, the goals are simply to have higher income and growth than a passive alternative, with less risk. Specifically, I want the following:
- A higher yield than the FTSE All-Share at all times
- Greater long-term income and capital growth than the FTSE All-Share
- Lower capital volatility (risk) than the FTSE All-Share
Choose your tactics
To achieve the goals set out above, I use several tactics, including:
- Invest in successful companies with good track records
- Buy them when their valuations and yields are attractive
- Hold them for years rather than months so that they have time to grow and pay dividends
- Sell them if their valuations and yields become unattractive
- Be more quantitative than qualitative (approximately an 80/20 split)
- Be systematic and follow (and improve) a pre-meditated plan
- Focus on the long-term rather than the short-term (again, perhaps an 80/20 split)
Measure your results
The portfolio has been running since early 2011, and you can see the total returns to date below. Note that the portfolio is compared (including all trading costs) against a FTSE All-Share tracker trust as well as two estimates of the returns to typical self-directed investors. The “average” investor underperforms by 3% a year (a number quoted by Barclays Wealth in a recent report), and the “bad” investor underperforms by 6% a year (taken from the book “Monkey with a pin” by Pete Comley).
In a bit more detail:
- 1-year return is 22.2% compared to 17% for the index
- Return from inception is 33.1% compared to 24.8% for the index
- Annualised return is 11.7% compared to 8.9% for the index
- Total value is £66,537 compared to £62,377 for the index
- The dividend yield is 4% compared to 3.1% for the index
- 1-year beta is 0.6 (index beta is 1)
So the portfolio has met each of its core goals of providing a higher yield, with higher growth, for less risk than the market index. However, I’m well aware that this is a short time period, and I’m more interested in how things will look in a few more years, but so far, so good.
If you don’t currently track annualised rates of return or beta, then here’s a link on how to calculate annualised rates of return using MS Excel and another on how to calculate beta.
Don’t forget income
One part of the investment goal is to grow income faster than the index, which doesn’t really show up very well in the chart above. So here’s another way of looking at the portfolio’s performance, which focuses on dividends paid rather than capital values:
Here you can see the growth of income in both the index tracker and the UKVI model portfolio. These incomes are reinvested, so they are growing faster than if they had been drawn down.
It’s easier to see the growth in the index’s income because there are only two payments a year. In fact, it has grown very well as we’ve gradually come out of the great recession. The model portfolio’s income has grown too, and the results so far in each year are as follows:
- 2011 – £825 for the model portfolio compared to £1,531 for the index (because the model portfolio was built up gradually through 2011, and so held large amounts of cash for much of the year)
- 2012 – £2,659 for the portfolio compared to £1,742 for the index
- 2013 – £2,164 for the portfolio year to date, compared to £1,937 for the index (with three months still to go)
Dividend growth for the portfolio is a little hard to measure over such a short time period, but the index has done well, growing by 13.8% from 2011 to 2012 and 11.2% from 2012 to 2013.
Analyse what drove those returns
Now that the results have been reviewed, it’s a good idea to review what drove those results.
There are three “actors” at play here:
- The companies that you’re invested in, their management and competitors
- Mr. Market, the excitable and somewhat frantic entity that decides what price each share will have.
- You. Specifically, the buy and sell decisions you make.
I don’t really have the space here to go into all the various things that have happened to the 30 or so companies in the model portfolio in the last three months. In most (but not all) cases, the companies continue onwards and upwards, continuing to succeed today as they have in the past.
As for Mr. Market, I would say that recently he has been relatively calm. The FTSE 100 currently has a CAPE (Cyclically Adjusted PE) of 13, which is slightly below average and nowhere near “frothy”. Mr Market is certainly not irrationally exuberant at the moment.
As for my own actions, I buy or sell one company each month, and the last three months have seen the following decisions:
- July – Sold Interserve for a total return of 117%, which gave an annualised return of 45%
- August – Bought a FTSE 250 company with a dividend yield of 4% and a growth rate of 12%
- September – Bought a FTSE 100 company with a dividend yield of 4% and a growth rate of 11%
As you can see with Interserve, I will occasionally take profits from companies where the share price has bounced up. I expect that this will help to drive the portfolio forward, in addition to reinvested dividends and growth from the underlying companies.
Make sure your investments are headed in the right direction
It really is important to do this sort of review at least once a year. If you don’t, then you won’t have a good idea of how your investment efforts are working. If you’re up 10% for the year, then that may be great, but if the market is up 20%, then perhaps you’re not doing so well.
They’re also a way to break up the long investment journey. They’re like mile-stones in the road. You can take a rest to see where you’ve been, then make sure you’re still on the right path, and finally, think about where you’re going and how you’re going to get there.
Hi John
Impressive. One thing that always concerns me is whether the whole general market falls. If this portfolio had started in 2007 then it may have fallen less than the market but cash would have done much better. I suppose in theory at exuberant market peaks sensible candidates in these methods would be thin on the ground and the portfolio would be usefully diluted with cash. The falls of 2008/2009 seem to me to be often blind panic leading to excellent value for the courageous as I doubt whether there was much logic in the market action.
A question that I often cogitate is whether it is the share or the market that is most important.
Do you think that your method would steer you away from experiencing these nasty falls of 08/09 ?
Regards
Ken Brennan
Hi Ken, the equity weighting of a portfolio is a really interesting question. The model portfolio that I wrote about above is a 100% equity portfolio so even if it were 2007 or 1999 it would be 100% equities, so in that regard I run it like an investment vehicle with a 100% equity mandate. I would expect significantly smaller losses in a bear market, but you’re right, it would likely move in the same direction, i.e. downward.
If you assume a worst case scenario of 50% declines, then with a beta of 66% I’d expect declines of no more than 33% (approximately of course) even in a really bad bear market. If that were too much then some cash, bonds or other non-correlated asset should be held.
You can see in my newsletter a “guideline” equity weighting when the market is at different CAPE valuations, based on some comments by Ben Graham, who said that the investor might hold at most 75% in equities when the market was cheap, 50% at normal market levels and 25% when the market was expensive. You can download sample issues below:
https://www.ukvalueinvestor.com/membership/sample-archive-2013/
I also developed a more aggressive countercyclical equity weighting system a few years ago where stocks move from zero to 100% depending on CAPE. I did some back-testing and it seemed to work quite well. You can see the results here:
https://www.ukvalueinvestor.com/2010/02/value-based-allocation-strategy.html/
The problem is though that you need to be heavily in cash when the market is expensive, and by definition you will be missing out on the bull market, which is very hard to do, emotionally. And you’d need to do it for a number of years, which is a long time to be “missing out”.
Also, I couldn’t work out a way to improve returns significantly with market timing, it just seemed to reduce risk. So it generates positive “alpha” but not greater absolute returns than the market. That was my experience anyway.
Hope you find some of that interesting!
John
Hi John
I see reading your October sample issue that you have dealt with some of my previous comment. For what it is worth I think that this sort of defensive method would have done quite well in 2000-2003 (battered in 2002) but would have done less well in 07/09. For me these are big questions and the fear of loss colours a lot of my investment. I would not say that I was a particularly good investor but getting better.
I spend a lot of time thinking about these sort of questions , I would be keen to hear what you think.
Regards
Ken Brennan
Ken, there are two basic approaches to reducing risk.
One is to diversify into uncorrelated asset classes (stocks, bonds, cash, real estate, commodities, hedge funds, private equity, etc), while the other is to hold more assets with fixed income and/or capital values. My wife isn’t too keen on risk, so her pension is in a mix of stocks, bonds and cash, and we use the cash purely to reduce volatility to the point where she won’t get too stressed in the next inevitable bear market.
But the exact mix and extent of fixed capital/income investments you hold is up to you and your financial advisor if you have one. My ballpark estimate is to say that the stock market can drop 50% in a given year, so for example if you have the stomach for a 10% capital decline then you would only hold 1/5th of your money in stocks and the rest in cash. Of course the problem is that returns are reduced accordingly, but that’s how the risk/reward trade-off works.
First, as a financial planner I have a comment (not advice) to Ken’s posts. You tend to focus on small periods of time 2007-2009 etc. Value investing is for long term – 20 years + timescale.
The ride will be bumpy, but if you want results you need to stick with it. It may also be an issue regarding your risk profile and/or risk capacity. You don’t need to invest 100% in equity, you could invest less than this based on your risk profile and your risk capacity. Or it may be the case that for your financial plan there is no need to take very high risk, you could get ‘financial independence’ by taking lower risk. One option is to use index linked Gilts especially after their yield will normalise, so you conserve the buying power of your money. In any case, you need to stick with your plan, there is no need to be greedy.
To John, you need to make an allowance for trading cost, stamp duty, and crossing spreads when comparing with a benchmark.
Hi Eugen, thanks for highlighting index linked gilts. Your right, Ken doesn’t have to be 100% equities, and there’s no point being worried about your investments as that’s how people end up making mistakes. I think It’s probably better in most cases to err on the side of caution and have a lower risk portfolio than you think you could handle.
As for trading costs, those are all factored in for both the model portfolio and the benchmark. I run both in ShareScope and use bid/ask prices for trades, and include commission and stamp duty. I chose a starting value of £50,000 as that seemed to be a reasonably conservative estimate of what a typical defensive/income stock picker would have to work with.
Hi John and Eugen
Thanks for your comments. Improving returns by a countercyclic approach is attractive like the Grahamite variation between equities and fixed. As you say being out of the market is no fun too. As I see it so much of the game is perception and other like factors. Its as if the error bars on that measurment are often quite large.
Diversification – In deed I hold a spread of VCTs , safe funds and index linked gilts etc , unspectacular but steady. I dont think that I would bet that ranch on my abilities.
My interest in bear markets – its not that I focus on short term periods but I try to understand these to improve my judgement. I try to not lose capital and buy assets at less that I believe they are on sale for. Bear markets do not help that aim.
Many thanks again
Regards
Ken