The UKVI Investment Strategy
Too many investors jump into the stock market with little idea of what they’re really doing. Investing may not be rocket science, but it does require goals, a well thought out plan, and the willingness to stick to that plan for many years.
Investing really comes down to having two things:
An investment strategy or system – The rules that you follow when buying and selling stocks, and the rules that you follow for organsing a portfolio of those stocks.
Defensive value investing
The strategy upon which the various UKVI resources are based is defensive value investing. As the name suggests, this strategy can be used to build a portfolio of high quality companies with attractive valuations and yields. Each step in the investment process is meticulously laid out so that it is clear, repeatable and improvable.
What are the strategy’s goals?
No guesswork - By giving the investor a systematic plan for all investing activities.
Easy and quick to use - Requiring no more than a few hours a month.
High income and growth with low risk - By investing in a diverse group of outstanding companies with attractive valuations and yields.
What sort of companies will it invest in?
Large – Investments are only chosen from the FTSE 350, which means that in most cases the market-cap is well over a billion pounds.
Income generating – With most yielding more than the FTSE 100. It’s also important that each company has at least 10 years of unbroken dividend payments.
Growing – Each company will be bigger today than it was a decade ago, as measured by a combination of sales, profits and dividend payments. The more consistent and reliable the growth, the better.
Financially strong – Debt is one of the biggest corporate killers so manageable debt levels is a key requirement of any new investment. Pension deficits and other obligations are also reviewed.
Available at an attractive price – Paying too much for an investment is one of the biggest mistakes an investor can make. Each potential investment is valued using long-term stable measures like 10-year earnings averages and 10-year dividend averages. High earnings and dividend yields are a feature of most of the portfolio’s investments.
These high quality companies with high yield shares are found by using the Stock Screen.
What does the strategy have to say about portfolio wide issues?
Active investing is not just about choosing which shares to buy; there are many other decisions to be made which relate to the management of the overall portfolio. The main policies for managing a portfolio are:
Asset allocation – the strategy aims to be as near to 100% invested in UK listed equities as possible. Most holdings would be in the FTSE 350, and any cash is incidental. However, asset allocation is a personal issue and many investors like to hold more cash to reduce volatility in their portfolios.
Wide diversification – Research shows that holding shares in 20 different companies will provide almost all of the diversification that it is possible to get in the stock market. However, there is more to diversification than simply holding 20 or 30 companies – if they were all banks then such a portfolio would have suffered horrendous losses during the credit crisis. For diversification to really work it is important to be diversified in terms of industry and geography as well as in number, so the strategy has a policy of only holding one or two very similar businesses at the same time. There is also has a goal of having more than 50% of a portfolio’s revenues generated from outside the UK.
How does the strategy improve on buy-and-hold?
Some people like to buy a group of shares and hold them forever. Unfortunately these buy-and-hold portfolios can sometimes drift away from the original plan. For example a high yield buy-and-hold portfolio may gradually lose the high yield as share prices rise.
Many investors are familiar with the process of rebalancing a portfolio. This is done so that a portfolio always stays within its original remit, and doesn’t drift off course. A common example is that of rebalancing a 50/50 stocks/bonds portfolio once a year. If the stock market goes up the balance may become say 70/30, exposing the portfolio to more risk than was intended. By annually rebalancing the portfolio it maintains its original purpose.
In the same way it may be better to “rebalance” a portfolio of individual shares in the same way, rather than buying them and holding them forever.
By rebalancing a portfolio towards high yield, high growth, high quality businesses, a portfolio may have a better chance of maintaining its high income and growth goals than if it were left to drift along unguided.
In terms of the house building analogy, buy-and-hold is like building a house and then never maintaining it. It would not take long for the house to drift into disrepair.
The Investment Plan’s rebalancing strategy is designed to ensure that a portfolio is always heavily weighted towards quality companies that are attractively priced. It does they by using a:
Fixed buying and selling schedule - The strategy includes a plan to buy or sell just one investment each month. This allows a portfolio to be managed in a calm, methodical and proactive way, rather than reacting to whatever news happens to be coming out on any given day.
This buying and selling pattern means that six companies are replaced each year, which is 20% of the total (assuming 30 stocks are held). This is a relatively low amount compared to most professionally managed funds, and it helps to keep trading costs down. It also means that each investment will be held for around five years, which give each company time to grow, and keeps this strategy firmly in the realm of investing rather than speculative trading.
Robust valuation criteria – At any given time a company’s shares can be over or under-valued, and having an informed opinion of the level of over or under-valuation is a key part of being an active investor. To take advantage of the market’s volatility, each holding is revalued each month. Every other month, the least attractively valued investment is sold (typically because the share price has risen more than the intrinsic value of the business) and replaced the following month by the most attractively valued shares in the market. This process of constantly improving a portfolio is a key difference to passive investment strategies such as index tracking.