UKVI Portfolio review for 2015 Q2

How time flies. Another quarter of a year has passed and so it’s time for me to review the UKVI Portfolio once again. That makes me happy because portfolio construction is one of my favourite topics (sad, I know).

Note that while this is a virtual portfolio it effectively contains my “best ideas” and so I have basically all of my net worth invested in the same stocks.

Goals

I’m a big believer in having clear goals, so here they are for the UKVI Portfolio:

• High growth: Generate higher capital gains and dividend growth than the FTSE All-Share (over 5 years or more)
• High yield: Have a higher dividend yield than the FTSE All-Share (at all times)
• Low risk: Be less volatile than the FTSE All-Share and have smaller drawdowns
• Low effort: Take just a few hours each month to maintain

Strategy

The strategy I’m using to achieve those goals is defensive value investing. The basic strategy is value investing, but the companies I buy are restricted to relatively defensive companies with long track records of profitable dividend growth.

Tactics

Here are some of the main tactics I’m using to implement that strategy:

• Reduce company-specific risk: Hold around 30 companies, approximately equally weighted (each new position starts off at around 3% to 4% of the portfolio, depending on available cash)
• Reduce country-specific risk: Have at least 50% of the portfolio’s revenue coming from outside the UK
• Reduce sector-specific risk: Have no more than 3 holdings in any one sector
• Be defensive: Have at least 50% of the portfolio invested in defensive sector companies
• Buy market-leading companies: Invest primarily in the FTSE 350, but be willing to buy “large” small-caps
• Buy reliable companies: Only invest in companies that have a 10-year unbroken record of dividend payments
• Rebalance occasionally: Sell half of a position if it grows to more than 6% of the portfolio in order to reduce exposure to any one company
• Reduce trading costs: Only make one buy or sell decision each month (which gives an average holding period of 5 years for a portfolio with 30 holdings)

Performance

The UKVI Portfolio started life in March 2011 with a value of £50,000 and is benchmarked against another £50,000 portfolio which only holds a FTSE All-Share tracking investment trust (the Aberdeen UK Tracker Trust).

Their performance to date looks like this:

Note that the chart includes an “average” and “bad” investor, who underperform the market by 3% and 6% a year respectively, primarily because they buy what has gone up, sell what has gone down and buy and sell too often. This is based on figures quoted by Barclays Wealth and Pete Comley’s book “Monkey with a Pin”.

Here is the portfolio’s performance in numbers:

• Total return from inception: 55.3% (39.0% for the All-Share tracker)
• Annualised return from inception: 10.7% (7.9% for the All-Share tracker)
• Current cash value: £77,635 (£69,504 for the All-Share tracker)
• Dividend yield: 3.7% (3.2% for the All-Share tracker)
• Maximum decline: 8% (13.5% for the All-Share tracker)

And here’s another graph, this time comparing annual dividends reinvested to date:

So far the UKVI Portfolio has met all of its performance goals of having a high yield, high total return and low risk.

At the outset I thought it should be possible to beat the market by about 3% a year, with less volatility, and so far the portfolio’s annualised performance has been at about that level.

With the portfolio now more than £8,000 ahead of the All-Share tracker (not to mention £16,000 ahead of the “average” investor and £23,000 ahead of the “bad” investor), I think it’s safe to say the effort has been worthwhile so far.

Assuming it takes about 100 hours per year to manage this portfolio (a couple of hours per week, with a couple of weeks off per year) then over the four and a quarter years of the portfolio’s life it has taken approximately 425 hours to run.

Dividing the £8,131 outperformance by 425 hours gives a rate of £19.13 per hour, which seems fairly worthwhile to me. Of course that hourly rate will grow exponentially as the portfolio grows over the long-term, assuming its annualised outperformance remains approximately the same.

One caveat to all this is that gains over 5 years or less are highly susceptible to good and bad luck, so generally I think investors should ignore such short-term results.

However, until the UKVI Portfolio is more than 5 years old I have little choice but to look at these short-term results, taking them with the appropriate pinch of salt due to their short duration.

Recent trades

In line with my one-trade-per-month rule, I made three “full” trades during the last quarter, initiating a new position or exiting an old position in full:

• April: Sold Balfour Beatty for a 9% return in 3 years and 8 months
• May: Bought a utility company with a dividend yield of almost 5% to replace Balfour
• June: Sold Serco for a 50% loss in 1 year and 1 month

I also made one “rebalancing” trade, which was to sell about half of the position in JD Sport (for a second time) as it had once again increased in value to more than 6% of the portfolio (the original purchase price was 228p whereas the price today is 712p).

Obviously in terms of the performance of the two companies I’d sold in full, this wasn’t a good quarter. In fact Balfour and Serco have been by far the two worst performing investments to leave the UKVI Portfolio so far.

But as the rebalancing of JD Sport shows:

Investing is a game of averages, with winners and losers. As long as the winners significantly outnumber and outperform the losers the overall portfolio should do fine.

As for Balfour and Serco, they have both contributed enormously to the improvement of my investment strategy, resulting in new rules on investing in defensive sectors, being more cautious about borrowings, more cautious about pension liabilities and asking questions to avoid value traps.

Diversification

As I’ve mentioned, I have a few rules covering diversification, e.g. how many stocks to hold, from what sectors and so on.

To give you an idea of how those diversification rules play out in the real world, here are a few of the portfolio’s diversification-related features:

• Number of holdings: 30, up from 29 after a new purchase at the start of July
• Aggregate revenue from the UK: 50% and therefore 50% coming from abroad
• Defensive sector allocation: 47%, slightly below my target minimum of 50% (which means I will probably try to acquire defensive companies in my next couple of purchases)
• FTSE 100 allocation: 43%
• FTSE 250 allocation: 44%
• Small-cap allocation: 13%

And finally, these are the sectors the portfolio is spread across, including the number of companies in and the percentage allocated to each sector:

• Aerospace & Defense (defensive): 2 companies, 5.6%
• Banks (cyclical): 1 company, 2.8%
• Electricity (defensive): 1 company, 3.6%
• Financial Services (cyclical): 2 companies, 7.5%
• Fixed Line Telecommunications (defensive): 1 company, 5.1%
• Food & Drug Retailers (defensive): 2 companies, 3.1%
• Food Producers (defensive): 1 company, 4.9%
• Gas, Water & Multiutilities (defensive): 1 company, 1.9%
• General Retailers (cyclical): 2 companies, 8.1%
• Household Goods & Home Construction (cyclical): 1 company, 3.5%
• Industrial Engineering (cyclical): 1 company, 4.4%
• Industrial Transportation (cyclical): 1 company, 3.0%
• Media (cyclical): 1 company, 3.5%
• Mining (cyclical): 2 companies, 4.1%
• Mobile Telecommunications (defensive): 1 company, 2.4%
• Nonlife Insurance (defensive): 3 companies, 7.2%
• Oil & Gas Producers (cyclical): 1 company, 2.7%
• Oil Equipment, Services & Distribution (cyclical): 1 company, 2.1%
• Pharmaceuticals & Biotechnology (defensive): 2 companies, 7.4%
• Support Services (cyclical): 2 companies, 9.1%
• Tobacco (defensive): 1 company, 3.1%

Hopefully by the end of all that you have a pretty good idea of how I like to structure the UKVI Portfolio, as well as the reasons why.

I’ll be back with another portfolio review at the end of Q3.