Defensive value portfolio review: 2016 Q3

In this review of the UKVI portfolio, I’m going to look at three things: Setting appropriate performance goals, tracking performance and lowering risk.

But first, a few general points:

  • The portfolio holds 30 stocks, split about 50/50 between the FTSE 100 and FTSE 250, with one or two incidental small-cap companies
  • I use the Aberdeen UK Tracker Trust (a FTSE All-Share tracker) as a benchmark
  • Although the UKVI portfolio is a virtual portfolio it does take account of all real-world costs such as broker fees
  • More than 90% of my personal savings are invested in the same shares as the UKVI portfolio

Setting performance goals: High income, high growth, low risk, low cost

Obviously, I can’t tell you what goals your portfolio should have, but if I show you the UKVI portfolio’s goals and how I measure them then hopefully it might give you a few ideas to chew over. The goals are:

  • High income today: Always have a higher dividend yield than the FTSE All-Share
  • High income tomorrow: Generate more income over five years than the FTSE All-Share
  • High growth: Beat the FTSE All-Share’s total return over five years by at least 3% per year (after fees)
  • Low risk: Have a smaller maximum peak-to-trough decline than the FTSE All-Share over five years
  • Low cost: Reduce expenses by only making one buy or sell decision each month

So those are the goals and their related metrics; let’s have a look at whether the portfolio has achieved them or not.

Tracking performance: Beating the market, but not by as much as I’d like

Here’s the usual chart and table of results which shows how the last few years have panned out:

Defensive value portfolio chart 2016 10
Past performance is no guide to future performance
defensive value model portfolio dividend chart 2016 10
Dividend growth is at least as important as capital growth
defensive value model portfolio table 2016 10
Both portfolios have produced above-average returns

And here’s how the portfolio performed against its five main goals:

  • High income today: The portfolio’s dividend yield is currently 3.7%, which is higher than the All-Share’s 3.4%. This has been the case throughout the last five years
  • High income tomorrow: For each £100 of capital value five years ago, the UKVI portfolio and All-Share tracker have produced total incomes of £30.60 and £23.70 respectively
  • High growth: The portfolio’s five-year annualised return is 13.3% per year compared to the All-Share’s 10.8% per year, an annual outperformance of 2.5% which is slightly below the 3% target (I’ll outline my response to this below)
  • Low risk: The portfolio’s maximum decline over the last five years was 8% compared to 11.4% for the All-Share
  • Low cost: I added one new holding in July, sold one in August and added another in September, so as usual I’m sticking to the plan of making just one trade per month

The portfolio is entirely on track other than that it failed to beat the market by 3% a year or more over the last five years, but I don’t think that’s a major problem. Here are a few thoughts:

Bull markets are harder to beat: As many investors found out during the 1990s, bull markets are hard to beat, and since 2011 the All-Share has, for the most part, been in a bull market.

The All-Share’s five-year annualised return is now almost 11%, which is well above its long-run average of about 7% (5% real return plus 2% inflation – see the Monevator website for a review of historical UK asset class returns).

The UKVI portfolio has beaten the market by 2.5% a year, and within the context of a bull market, I’m quite happy with that.

Missing this goal may be a blip: This is the first quarterly review in which the five-year total return goal hasn’t been reached. For example, at the last review in July the portfolio had beaten the market by 5.1% a year and in the April review the margin was 5.2% a year.

By the next review in January, the portfolio’s outperformance could well be back above 3% again.

But, it might not be a blip: If the portfolio continually fails to beat the market by 3% a year over the next few quarters then I will pick apart previous and current investments to understand what’s holding the portfolio back (which, to be honest, I do through post-sale reviews already).

If changes can be made to the investment strategy that I think will improve performance then I will make them.

Overall though, and despite only beating the market by 2.5% rather than 3% a year, I’m generally pleased with the portfolio’s returns and especially its low risk.

Note: I was going to take a brief detour into how I track performance using a spreadsheet, but in the end, the detour wasn’t very brief. I’ll do the topic justice with a separate article in the near future.

Lowing risk: Across companies, countries, sectors and cycles

As a defensive value investor, low risk is just as important to me as high returns, and on that front, my weapon of choice is broad diversification; or more specifically, multi-factor diversification.

In simple terms, multi-factor diversification means being invested in a wide variety of companies that make profits in different countries and that operate in different sectors with different business cycles.

Some companies, countries, sectors and cycles will be on the way up while others are on the way down. By investing in a wide range of these risk factors the ups of some will negate the downs of others, which reduces overall risk.

The following charts show how the UKVI portfolio is diversified across a range of risk factors as well as the rules I use to manage those factors:

defensive value model portfolio company 2016 10
Rule: The portfolio should hold around 30 companies with no more than 6% invested in any one company
defensive value model portfolio sector 2016 10
Rule: There should be no more than three holdings (about 10% of the portfolio) from any one sector
Defensive value model portfolio geography 2016 10
Rule: No more than 50% of the portfolio’s overall revenues should come from the UK
defensive value model portfolio business cycle 2016 10
Rule: No more than 50% of the portfolio should be invested in cyclical stocks

Of those risk factors, only the cyclical/defensive split is currently outside of my preferred range (slightly more than 50% of the portfolio is invested in cyclical stocks).

That’s because attractively valued defensive sector stocks are hard to find at the moment. In fact, the Telegraph’s Andrew Oxlade compared defensive stocks to the Nifty Fifty, the US bubble stocks of the 1960s.

I’m not sure defensives are in a bubble, but most of them are definitely a long way from cheap.

However, although the risk to the portfolio from cyclical stocks is higher than I would like, by simply monitoring this risk I am at least aware of it. Using that awareness I can then decide how far above 50% I’m willing to allow the portfolio’s cyclical stocks to go.

More importantly, I can decide at what point to I want invest in a defensive stock (even at a slightly higher price than I’d normally prefer) in order to keep the portfolio’s cyclical risk under control.

The key point here is that it’s just as important to be aware of your portfolio’s current risk factors as it is to understand its past performance.

So there we are, another quarterly review is in the bag and I’ve looked at my portfolio’s goals, past performance and current exposure to a range of risk factors. I suggest you do the same.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

6 thoughts on “Defensive value portfolio review: 2016 Q3”

  1. Always interesting thanks.

    I would be very interested in learning how you track performance. It’s something I try to do but as I’m constantly drip feeding money in, it can get complicated.

    1. Hi Doug, hopefully if I can clean up my spreadsheet a bit and publish it online you might find it useful. And if my spreadsheet isn’t up to the job I’ll list a few portfolio-tracking options, free and not free.

      Suggestions on the back of a postcard…

  2. “”More than 90% of my personal savings are invested in the same shares as the UKVI portfolio””

    That’s what I like to see, a man with conviction and skin in the game.

    ” Beating the market by not as much as I’d like”

    If you can beat it at all I think that’s more than admirable — too modest John. In time with good companies you should beat it by more, especially as there are so many bad companies in the “market”.

    The dividend thingy — It’s nice to have a target above the number thrown up by the index, but it doesn’t really matter does it if the company retains the money and puts it to better use than you, especially after you’ve been asked by HMRC to pay tax on it?

    On defensives v cyclicals — I’ve always found this a point to ponder on, since some of the companies that are supposedly defensive can turn out to be really high risk and end up looking incredibly cyclical.
    I guess that brings me back to companies like BAE and RR — OK I don’t mean because they are defense companies that they automatically should be classed as defensives, but I view them differently.
    Their order patterns are often dependent on big deals that are either government funded or some prince in Saudi Arabia getting his cheque book out of the sand before quarter end. That looks highly cyclical to moi.

    On balance I get the principle but there are huge grey areas.

    I helped your Victrex investment, as I’ve been buying on the way up and I like the fact that they could start to throw back special divis (their stated policy) now that they have finished all the factory spending. Oh you hypocrite I here in the background, you are not supposed to be concerned about the divi 🙂

    Great summary though and interesting to see the broad sector mix.


    1. Hi LR,

      On defensives v cyclicals: You’re right of course. Just because a company is in a “defensive” industry doesn’t actually mean its going to be 100% defensive, i.e. immune to all shocks and disruptions.

      The aim of having at least 50% defensive sector stocks in the portfolio is more about nudging the portfolio in a defensive direction, i.e. defensive sectors stocks will tend to be more defensive, even if all of them aren’t. By having a minimum percentage of them it should help the portfolio to avoid falling off a cliff when the next major bear market arrives.

      Dividends: I don’t agree with dividend irrelevance theory. I like dividends and I think that the dividend income of from a robust portfolio of shares should be a very reliable and relatively inflation-proofed form of retirement income. It’s a wee bit volatile of course, but having a small cash buffer in the account of a few percent should help iron that volatility out.


  3. On good v bad companies.

    The press deem Sports Direct as a bad company and it’s image is pretty low.

    Do you think it’s really such a bad company?
    It’s debts are relatively low, it’s shops are a tad untidy to say the least, but they have reduced gearing from about 123% 5 years ago to about 58% today.

    They don’t cover themselves with glory, they need someone to manage the image and iron all the clothes in the shop so it doesn’t look like a jumble sale, but is this reflected in the very low price, even despite the growing online competition for sports and outdoor goods?

    Just a thought — off for breakfast now!!

    LR – PS: I’m not invested in Sports Direct

  4. LR – looking only at their shops would not get you a clear picture of the company.

    Retail is a very competitive market and Amazon is taking this area by storm. Having a bad reputation does not help, myself I do not get into their shops anymore.

    I would buy Amazon stock instead. (Actually I own this stock.)

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