The defensive value investing model portfolio and its investment strategy did what they were supposed to do in 2013 by producing a high and growing dividend income with high capital growth and little volatility.
A market-beating year (more income, more growth, less risk)
At the end of 2013, the portfolio stood some 25.8% higher than it did at the start of the year. In comparison, the benchmark FTSE All Share tracker trust gained 19.5%. These figures should be compared to the average annual gains that you should expect from the stock market, which is closer to 7 or 8% (or 5% after inflation).
The defensive value strategy and model portfolio have therefore outperformed the market by some 6.3% in 2013, which is a better annual out-performance than I would expect in most years.
Total gains for the portfolio have been 41% since its inception in March 2011. That’s a 9.6% out-performance of the All-Share tracker trust. In cash terms, the portfolio is ahead by £4,764 in less than three years, with a starting value of £50,000.
Put another way, the annualised returns have been 12.9% for the model portfolio and 10.1% for the benchmark, which is a 2.8% annualised performance gain or 28% higher returns in relative terms. You can see the results to date below:
Note that the ‘average’ investor underperforms the market by 3% a year (an estimate from various studies on investor performance), and the ‘bad’ investor underperforms by 6% a year (an estimate from the book ‘Monkey with a pin’). Outperformance relative to the ‘bad’ investor is around £15,000.
Beating the market is one thing, but this is a defensive and income-focused strategy, so a high dividend yield and low risk are also required:
- High yield – Throughout the year, the portfolio’s yield averaged 4.2% while the All-Share’s averaged 3%. The portfolio’s forward yield (the income produced during the year relative to its capital value at the start of the year) was 4.8%.
- Low risk – The defensive value portfolio has also been less volatile during 2013 than the All-Share tracker trust, with Beta (a measure of volatility) hovering around 0.6, which means the portfolio has been just 60% as volatile as the wider market.
1% more from dividend yield, 1% more from growth and 1% more from effective buying and selling
A 2.8% annualised improvement over passive investing is close to what I’d expect from a good defensive value strategy. I believe it’s possible to get an extra 1% each year from a high dividend yield, 1% from owning fast-growing companies, and 1% from repeatedly buying low and selling high.
Of course, these are estimates, but I think they are realistic, and a 3% absolute improvement is actually a 60% relative improvement compared to the 5% real return the UK stock market has historically provided.
So what did 2013 actually look like in terms of actively managing a portfolio of shares? How much effort was required, and how much stress did it involve?
The answer is, surprisingly little of either. The portfolio is managed using a steady, plodding approach to buying and selling. Each month just one company is bought or sold, and in 2013 8 companies were bought, and four were sold.
The first sale came in January with N Brown, the catalogue and multi-channel retailer, leaving the portfolio. The holding period was just eight months, but in that time, returns were almost 60%, primarily from a dramatically increasing share price.
This wasn’t anything that I had seen coming; the portfolio was just in the right place at the right time, although it helps to have a robust means of discerning a low price from a high price.
The proceeds were recycled into two companies that offered a better combination of value, quality and defensiveness.
The second sale was Reckitt Benckiser, the monotonously successful consumer goods company, sold in April. RB is exactly the sort of defensive, high-quality company that I would expect to see in the model portfolio, but only at the right price.
As with N Brown, gains of more than 50% over a 2-year period meant there was perhaps better value to be found elsewhere, despite the company’s intrinsic qualities. The profits were again recycled back into two more attractively valued companies.
I would not be surprised to find RB back in the portfolio once again if the shares can be bought at an acceptably low level.
The third company to leave the portfolio was Interserve, sold in July and producing gains of more than 110% over two years.
Interserve showed the value of patience; after a virtually flat first year, the shares shot up by around 70% in their second year. At that point, they began to look expensive relative to the rest of the portfolio, so profits were taken in order to be recycled into some better value-for-money shares.
The last sale of the year came in October and was of Go-Ahead Group, the leading UK public transport company (over Christmas, I travelled on HS1 – which they operate – and very impressive it was too).
Despite being in an apparently ‘dull’ and defensive industry, Go-Ahead’s shares produced total returns of more than 30% in just over a year and a half. Again, a rapidly increasing share price was the main driver, although the starting yield of 6% gave a real boost.
Profits from Go-Ahead have been recycled into yet another two value-for-money, high-quality companies.
Slow and steady wins the race
All in all, it has been a steady year, with this slow, methodical, plodding approach to buying and selling proving itself worthwhile. I think it’s a good pace to work at, which allows the portfolio to be improved and profits to be taken, but without having to rush around keeping an eye on the market at all hours of the day.
For 2014 I expect to sell 5 or 6 companies and to maintain the number of holdings at around 30 with the addition of 5 or 6 new holdings.
I also expect the combination of high-quality, relatively defensive companies – mixed with high-yield shares and prudent profit-taking – to continue to provide above-average income and growth at below-average risk.
John
I don’t think the benchmark you chosen is relevant for your portfolio. Something like FTSE 350 high yield or Dimensional Value fund should be chosen.
Also, you can’t in my opinion compare the annual performance with the annual ‘average’ performance. There will be years with negative performance.
I understand that you want to sell your services, and it is laudable. However I recommend that a bit of humility will help. I will tell you why. There will be years when your strategy won’t work, like when a growth strategy works or when the stock markets will raise in a demential way as it happened in 1999.
My way to deal with outperformance as well with underperformance is by using humility. Humility in investing always pay. The way I play it with my clients is by telling them that the performance of the portfolio is mainly due to the markets performance (which is absolutely true). If there is some outperformance I will say that this is mainly due to the strategies we employ (value, growth, small cap, high yield, low volatility etc), investing only in developed markets, selling the fixed income funds etc.
In the last year, for example when I analysed our model portfolios performance attribution I realised that the majority of the outperformance is due to getting out of bonds at the start of May’13. Second but far, there was the outperformance attribution due to having higher allocation to US Mid and Small cap and third by having some allocation to Japan when others had none.
Hi Eugen,
The benchmark is the FTSE All-Share because the model portfolio is supposed to represent what an active investor, using the tools and strategies available to UKVI members, might come up with as an alternative to passively tracking the All-Share index.
Of course if someone is an active investor then they will probably want to improve upon a passive approach (otherwise why bother?), and so the model portfolio has the goal of producing a higher yield, with higher growth, at lower risk than the passive alternative.
If the goal was a higher yield alone then the FTSE 350 High Yield index might more appropriate, but since the goals are both higher returns and lower risk I think the All-Share is appropriate.
Hi Eugen
I’m a new ‘amateur’ investor at UKVI and my primary reason for joining was that I ‘understand’ the strategy. You too, appear to have services to sell to clients, and the outline of your last para certainly looks impressive – but only proves that there are different strategies for different people. By the sounds of it, your proposition is not for someone like me. As WB said, ” Never invest in something you don’t understand”. I’m not a professional like you, therefore I am happy with that mantra. We all have a choice of strategy that suits their own particular needs and requirements, and this one suits me. p.s. I had a quiet giggle at the irony of your comment ‘humility will help’ followed two words later by the phrase “I will tell you why’.