This is just a quick update on recent events in the UK Value Investor model portfolio, including buys, sells and performance relative to a FTSE All-Share tracker.
Before I get into the nitty-gritty, here’s a recap of the model portfolio’s goals:
- High Growth: Generate higher capital gains than a FTSE All-Share tracker
- High Yield: Have a higher dividend yield than a FTSE All-Share tracker
- Low Risk: Have lower volatility and smaller peak-to-trough declines than a FTSE All-Share tracker
- Consistent long-term results: Grow from £50,000 to £1,000,000 in less than 30 years
I’m currently competing against a virtual portfolio which is fully invested in a FTSE All-Share tracker from Vanguard. Vanguard’s funds are some of the cheapest available and should therefore be the best performing and hardest to beat.
Here’s a snapshot of the results of these two portfolios so far:
Higher capital gains? Yes
I know that weekly, monthly and even yearly ups and downs are not important, so I measure capital gains over periods of five years or longer:
|Results to 01/07/17||Model portfolio (A)||FTSE All-Share (B)||Difference (A – B)|
|Value at inception (01/03/11)||£50,000||£50,000||£0|
|5-Yr total return||88.3%||64.8%||+ 23.5%|
|5-Yr annualised return||13.5%||10.5%||+ 3.0%|
|Total return from inception (01/03/11)||88.8%||64.6%||+ 24.2%|
|Annualised return from inception||10.6%||8.2%||+ 2.4%|
As long as the portfolio beats the FTSE All-Share then I’m happy, but what I really want is to get at least 10% per year (on average) which will keep the portfolio on target to hit £1 million within 30 years.
If you’re interested in short-term returns (which you shouldn’t be) then both the model portfolio and the All-Share are up by around 7% so far this year, which is well above average for a six-month period.
However, those gains could easily be wiped out by a minor market “correction”, which is precisely why I don’t like to think about short-term returns.
Higher dividend yield? Yes
The model portfolio has always had a higher dividend yield than the FTSE All-Share and that continues to be the case:
- Model portfolio yield: 4.1%
- FTSE All-Share tracker yield: 3.15%
If (like me) you’d like to live off your portfolio’s dividend income one day, then the yield is obviously very important.
For example, to get a £20,000 dividend income from a portfolio yielding 4.1% (like the model portfolio) you’d need almost £490,000 invested.
But if your portfolio only yields 3.15% (like the All-Share tracker) you’d need almost £635,000 invested.
So you would need to save up another £145,000 just to make up for that 1% shortfall in yield.
As they say at Tesco, every little does indeed help.
Lower risk? Yes
The chart above shows peak-to-trough declines for the model portfolio and its All-Share tracker benchmark portfolio.
Hopefully, it’s clear that both portfolios are about 2% below their all-time highs today, and also that the model portfolio has seen significantly smaller declines than the FTSE All-Share since 2011:
|Peak-to-trough declines to 01/07/17||Model portfolio (A)||FTSE All-Share (B)||Difference (A – B)|
|Maximum decline over 5 years||– 3.9%||– 11.4%||+ 7.5%|
|Maximum decline from inception||– 8.1%||– 13.5%||+ 5.5%|
Keeping volatility and declines to an acceptable level is something that many investors ignore.
They chase high returns from high-risk stocks, which is fine when the market’s going up. But when a bull market turns into a bear market, many of these investors find out that their tolerance for losing money is much lower than they thought.
Many of them end up panic-selling at the bottom of a bear market, locking in losses which would otherwise only be temporary.
So although focusing on controlling risk isn’t exactly “sexy”, I think it’s hugely important. And when in doubt, you should probably underestimate your risk tolerance, just to be on the safe side.
Growing to £1m within 30 years? Perhaps
I wrote recently about my new goal to grow the model portfolio from £50,000 to £1,000,000 pounds before its 30th anniversary in 2041.
For this to happen, the portfolio will need to double in value four and a quarter times in 30 years, which means doubling in value every seven years or thereabouts.
This will require a long-term average growth rate of at least 10% per year.
Today the model portfolio has a virtual value of £94,213, almost £12,000 ahead of its FTSE All-Share tracker benchmark portfolio, which sits at £82,318.
So the first of those four and a quarter doublings is almost complete, and it has taken just over six years from inception in 2011 to (almost) get there.
And that means the portfolio is still on schedule to achieve its 30-year one million pound goal:
Recent purchases, sales and the benefits of Stoic equanimity
If you’ve been reading this blog for more than a few months, you’ll know that I have a long-established policy of buying or selling exactly one company each month.
This steady approach allows me to take profits on winners, weed out losers and replace both with even better companies at even lower prices (hopefully).
Here are the three trades I’ve made since the last portfolio review in April:
- May: Sold BAE Systems for a 142% gain over six years
- June: Bought a FTSE 250-listed UK-focused company operating in the Support Services sector
- July: Sold Morrisons for a 2% loss over four years
As you can see, some investments perform well while others don’t.
It’s important to remember that if an investment goes badly (like Morrisons) it does not mean you’re a bad investor, or that your strategy is bad. Investing is not as black and white as that.
Instead, investing is more like a game of chance. For example:
- Imagine you have a single dice (or “die”, if you’re pedantic) with four green sides and two red sides
- Now roll the dice
- If the dice lands green side up, you win £1,000; red side up, you lose £1,000
- Repeat 60 times
On average, you should expect to get green twice as often as you get red, so after 60 rolls you should expect to get green 40 times and red 20 times. That’s £40,000 won and £20,000 lost, giving an expected profit from this game of £20,000.
So despite this being a good game from your point of view, because you’re very likely to make an easy few thousand pounds, you can expect to lose money about a third of the time.
The stock market is exactly the same. Even if you’re playing by a set of rules which you know will lead to a positive outcome in the long term, you can still expect to lose money on a regular basis.
Of course, you have to have more winners than losers, but you also have to be able to accept the fact that you will lose money on some investments.
Some investors are psychologically crushed whenever they lose money, and I think that’s a serious mistake.
A better approach is to accept that you’ve lost money with stoic equanimity and that occasionally losing money is an inescapable part of the investment game.
When you lose money you should review the original purchase decision and your decision-making process. Work out what went wrong and decide if it was something that was avoidable or if it really was just bad luck.
If it was avoidable then make the necessary changes to your investment process. If it was just bad luck, take the loss on the chin and keep rolling the dice.
Leaning towards mid-cap cyclical UK-focused companies
As the level of uncertainty around the UK economy has increased, the valuations of many UK-focused companies have declined.
However, as a value investor, I am drawn towards lower valuations, so over the past three months the portfolio had nudged its way towards smaller, more cyclical, less international companies.
And I’m not alone in thinking that UK-focused cyclical companies are attractively priced, as Neil Woodford’s blog has said much the same thing.
In concrete terms, here’s how the model portfolio has changed:
- More smaller companies: FTSE 250 stocks now make up 46% of the portfolio, compared to 42% in April
- More cyclical companies: Cyclical sector stocks now make up 57% of the portfolio, compared to 50% in April
- More UK-focused companies: 46% of the portfolio’s total revenues now come from the UK, compared to 41% in April
I don’t want to go overboard with this idea though, so I have rules which limit how cyclical and how UK-centric the portfolio can be:
- Don’t have more than 66% of the portfolio invested in cyclical sector stocks
- Don’t have more than 50% of the portfolio’s total revenues coming from the UK
If I’m wrong about the attractiveness of UK cyclical stocks then these rules will help to protect the portfolio from my erroneous judgement.
To one million pounds, and beyond
So that’s one more quarter down in the portfolio’s long journey to a million pounds.
I’m reasonably satisfied as the portfolio has continued to hit all its performance targets, with more income, more growth and less risk than the FTSE All-Share.
It’s also on track to reach the million-pound mark before 2040, and perhaps even before I reach 65 in 2037.
Hopefully, we’ll all still be around at that point to see how things panned out.