Last Updated February 11, 2016
My defensive value model portfolio is ahead of the market by just under 14% so far this year. The reasons are 1) a sensible strategy and 2) some luck.
To be honest, the FTSE 100 and FTSE All-Share are not providing much in the way of competition at the moment because both of them have fallen in value this year.
However, I can’t be blamed for that; all I can do is focus on the model portfolio’s goals which are:
- High yield – A higher dividend yield than the FTSE All-Share at all times
- High growth – Higher total return that the FTSE All-Share over any 5-year period
- Low risk – Lower risk than the FTSE All-Share over any 5-year period
Both the model portfolio and the All-Share tracker are virtual portfolios which started with £50,000 in March 2011. They both reinvest all dividends and take account of broker fees and bid/ask spreads.
I have basically all of my family’s long-term savings invested in the same stocks as the model portfolio.
Ahead on a total return basis
Clearly, the All-Share portfolio has not done well lately. At the start of October it was down 3.7% relative to its value in January. In contrast, the model portfolio gained 10% in the same period, producing a relative outperformance of 13.7% year to date.
The gap between the two portfolios is now £13,370, which is 27% of their original value.
In annualised terms the All-Share portfolio has generated a return of 5.9% per year (including dividends) while the model portfolio has returned 10.3%.
One of my goals for the model portfolio is to beat the market’s total return by 3% per year, and that goal is still firmly on track.
Ahead on dividend yield and (probably) dividend growth
Another of the model portfolio’s goals is to have a high dividend yield at all times. This goal has always been met since 2011 and the portfolio’s current yield is 4.2%, which compares well with the All-Share tracker’s yield of 3.7%.
Dividend growth has also been relatively good too.
The All-Share tracker has paid out the full 2015 dividend already (of £2,384), while the model portfolio’s cumulative dividend is ahead so far (at £2,650) and still has three months of dividends to go.
I fully expect its total dividend to far surpass the All-Share’s by the end of 2015.
Success with Cranswick ends a bad run
In terms of individual investments, 2015 has been a bit of an up and down year.
Although I realise a sensible investor must expect some individual investments to perform badly, I was somewhat peeved after a string of underperforming holdings during the first half of the year.
As you may know I sell one holding every other month and replace it the following month. The idea is to repeatedly replace the “weakest” holding in the portfolio with a stock that has a better combination of defensiveness and/or value.
Following that approach I sold ICAP in February for an annualised return of 15% which, while not spectacular, was more than satisfactory. But after that things took a turn for the worse.
In April I sold Balfour Beatty – after three years of profit warnings – for an annualised return of 2.6%, which is obviously below par.
After that came the sale of Serco in June, which was my worst investment to date and returned a loss of 50%.
Next up was August and the sale of RSA, which returned a just-about-acceptable 6% per year. Even that result was largely down to luck and a well-timed exit during a brief share price peak, thanks to the now withdrawn Zurich takeover bid.
However, such doom and gloom ended with October’s sale of Cranswick, which you may have read about last week. It produced a record result for the model portfolio, returning 135% in just under three years, for an annual return of 35.3%.
And so it continues to be true that some you win, and some you lose. The lesson here is that it is a portfolio’s overall result that matters and not the performance of any one investment.
A couple of winners drive performance
In addition to Cranswick, there have been a couple of really stand-out holdings this year whose performance has been, quite frankly, bordering on the ridiculous.
The first outstanding performer is JD Sport, which is up by about 90% from the start of the year. The second is Telecom Plus (trading as The Utility Warehouse), which is up by about 50% from where I bought it in May.
After these impressive results the share prices of both companies have reached levels that I would no longer consider attractive. In fact, I am more likely to trim their positions back a bit if their share prices keep going up as they have done recently.
Wide diversification helps reduce risk
The model portfolio is a defensive value portfolio, so risk reduction is as important to me as performance. My main weapon in the war on risk is diversification, diversification and yet more diversification.
I mention diversification three times not just for effect (although it’s partly that) but also because there are three dimensions to the portfolio’s diversification strategy:
- Company diversification – The portfolio holds 30 companies, with no more than 6% in any one holding. This protects it from problems in any one company.
- Industry diversification – The portfolio holds no more than three companies in any one FTSE Sector. This protects it from problems in any one industry.
- Geographic diversification – The portfolio generates no more than 50% of its revenues from the UK. This helps to protect it against problems in the UK economy.
One additional line of defence against risk is the portfolio’s focus on defensive sectors. My rule of thumb (which it currently meets) is that the portfolio should always be at least 50% invested in defensive sectors.
This focus on defensive sectors helps me to reduce the impact of economic and industry cycles on the portfolio’s capital value and dividend output.
Expectations for the future
Currently the FTSE 100 (and therefore the FTSE All-Share) is attractively valued, relative to both its own historic norms and the current valuations of international indices such as the S&P 500.
The fact that the FTSE 100 has recently had a dividend yield of over 4% is a clear indication of this, although the CAPE ratio is my preferred measure of value.
With these low valuations I think above average returns are likely from here on out, which means more than 7% a year or thereabouts. Of course that expectation is a long-term expectation, measured over the next five or ten years rather than the next five or ten months.
The model portfolio’s goal over that period will be the same as it always is: To beat whatever income and growth the market produces, with less risk.