Welcome to the annual UK Value Investor portfolio review, in which I either a) bask in the glory of my investing genius or b) role out a long list of excuses as to why I underperformed the market again.
In this review I’ll briefly touch on a range of topics including performance (of course), what went wrong, what went right, what I bought or sold and what returns I expect from the market over the next few years.
But first I want to provide some context, so here’s a quick review of my investment goals and overall strategy.
Investment goals and strategy
Here are the primary goals for my model portfolio (yes it’s a virtual portfolio, but my real-world portfolio is virtually identical in terms of holdings):
- High yield: Dividend yield should be higher than the FTSE All-Share’s yield
- High growth: Total returns (dividend yield plus capital gains) should beat the FTSE All-Share over five years or more, preferably exceeding 10% annualised
- Low risk: The portfolio should be less volatile than the FTSE All-Share and suffer smaller drawdowns over five years or more
- Low effort: Managing the portfolio should typically require only one buy or sell decision each month
- Buy above average companies at below average prices and hold them as long as both conditions remain true
The portfolio holds about 30 companies, split fairly evenly across the FTSE 100, FTSE 250 and Small-Cap indices, and I don’t buy anything that isn’t in the FTSE All-Share.
Okay, that’s enough about the strategy. Let’s take a look at how this portfolio did in 2019.
Good returns in 2019, acceptable returns over the longer-term
First of all I should point out that investment performance over a single year is almost certainly irrelevant, unless your portfolio either lost 90% or gained 300% or something equally unlikely.
That’s because performance over a single year will always be dominated by the market’s “random walk“.
You need to look at performance over at least five years – and preferably ten years – before you can say anything robust about whether you’re a halfway decent investor or not.
However, almost everybody likes to look at one-year performance, so for the sake of convention here’s a table showing the portfolio’s annual and annualised results from inception:
The headline result for 2019 is a 20.9% return, which is far above the 10% annualised return I’m hoping for over the long-term.
Over five years and from inception (2011), annualised returns are 9.0% and 9.2% respectively, which is ahead of the FTSE All-Share but slightly behind my 10% target.
Overall I’m reasonably happy with the portfolio’s progress so far, although of course I’ll be trying hard to exceed that 10% annualised target in the years ahead.
The chart below shows the same results and gives you an idea of the level of price volatility as well.
Ideally I’d like the portfolio to reach £1 million before its 30th birthday in March 2041, which requires an annualised total return of about 10.5%. Here’s a comparison of that target rate of return versus reality:
As you can see, the portfolio is close to but slightly behind target. If it were perfectly on target it would have a value of £123,000, so it’s about £15,000 behind that. The logarithmic chart below shows the same data in a more useful but less impressive way:
So that’s my very long-term plan for the portfolio, but what about 2019?
2019 was a year of two halves, split by the general election
The first “half” of 2019 ran from January to October, where the portfolio underperformed the All-Share by as much as 7%.
This was largely down to the portfolio’s greater exposure to UK cyclical stocks and retailers in particular.
UK cyclicals have been out of favour and have seemed cheap for a long time, very probably because of Brexit uncertainty, and as 2019 wore on that uncertainly only seemed to increase.
I’m a value investor and I invest where I see value, and to be honest the portfolio has become overexposed to companies from the General Retailers sector. It holds six General Retailers, with a combined weighting of 21.9%.
This breaks one of my rules, which is:
- Don’t put more than 10% of the portfolio into any one sector
The portfolio holds 30 companies, so I try not to have more than three holdings from a given sector. I’ve definitely broken that rule with retailers, so I will probably look to offload some of the less obviously cheap retailers during 2020.
As for the second “half” of 2019, it started in October, shortly after a snap general election was announced for December. Very soon afterwards, the portfolio started to outperform as the potential for some clarity around Brexit increased, driving up expectations for UK cyclicals and the portfolio’s retailers.
Somewhat surprisingly, the portfolio gained 13% from the start of October to the end of the year, compared to a gain of 3% for the All-Share over the same period.
This is yet another example of why it’s such a bad idea to sell after a period of pronounced but short-term underperformance.
If I’d thrown in the towel after a disappointing 2018 (where the portfolio fell 13% compared to the All-Share’s decline of 9%) then I would have missed out on a 21% return through 2019. And if I’d sold in October after underperforming the market by 7% then I would have missed out on the subsequent 13% rebound.
My point is that investing is a long-term game and investors should focus on the long-term. That means measuring performance over the last five or ten years and setting goals for the next five or ten years, rather than worrying about what’s happened over the last few months.
The portfolio’s dividend yield remains slightly higher than the All-Share’s
As well as total returns, I keep an eye on dividend yield because I like the idea of living off a portfolio’s natural yield, i.e. dividends alone, without the need to sell shares to support day-to-day living expenses.
The portfolio’s current dividend yield is 4.1% compared to the FTSE All-Share’s 3.9%, so the yield is higher although only just.
This is quite a change from several years ago when the portfolio had a yield more than 1% higher than the All-Share’s.
The yield gap has declined over the last few years primarily as a result of my drift towards what I hope are higher quality companies. The downside is that these companies usually come at a higher price and with a lower dividend yield.
That shouldn’t be a problem as long as the portfolio’s overall yield stays ahead of the All-Share’s yield, so that’s definitely something I’ll be keeping an eye on in 2020.
If the portfolio’s yield drops below the All-Share’s then I’ll definitely focus on investing in some higher yield shares to balance things out.
What went wrong in 2019?
The short answer is, a lot.
I recently called Xaar my worst investment ever and it was basically a mistake. The company had seen one of its inkjet printheads explode in popularity in the Chinese ceramic tile market around 2013, but that success turned out to be a one-off that would not be easily repeated. I should have excluded those windfall profits from my analysis, but I didn’t. It’s a mistake I shall try not to repeat.
As for Ted Baker, it’s an interesting story as the company had what appeared to be an almost perfect record of fast and steady growth over a very long time.
I did my initial review of Ted Baker in August last year and invested soon after. By December I was beginning to poke holes in my own analysis as I started to pay more attention to the company’s consistently weak free cash flow.
However, I eventually backed away from analysing free cash flows directly and so Ted Baker remained in my portfolio.
After the company’s recent collapse I revisited the investment case yet again, and this time I have followed through and integrated a couple of relevant changes into my investment checklist and spreadsheet.
I’ll publish a full review of the Ted Baker situation sometime in January along with a detailed explanation of what those changes were (and yes, it does relate to the company’s weak free cash flows).
Despite the value of these two investments falling by more than 80%, the impact on the portfolio was limited. That’s because I always hold around 30 companies, with no investment making up more than 6% of the overall portfolio.
This does of course limit gains when one investment does particularly well, but I’m more interested in avoiding financially and psychologically damaging losses if one of my investments goes to zero.
What went right in 2019?
If I measured success by short-term share price gains then I would say that my best performing holding of the year was Dunelm, which saw its share price increase by more than 100% in 2019.
But I don’t, because short-term share price movements in individual companies are not particularly relevant to long-term investment success.
What is important is to:
- have a sensible investment process,
- stick to that process and
- improve your knowledge and your investment process as you make numerous good and bad investment decisions over the long-term.
So with that in mind, what did go right in 2019?
I stuck fairly rigidly to my investment process and didn’t panic or get distracted either by the poor year-end performance in 2018 or the portfolio’s poor returns relative to the market through most of 2019:
I made several substantial but not fundamental changes to my investment process, which will hopefully improve the portfolio’s performance in the years ahead:
- Learn from my mistakes and avoid these three value traps
- The ultimate value investing checklist
- The hidden debt of lease obligations
And finally, the portfolio continued to outperform the market over five-years and longer:
- 9% annualised total return over five years versus 7% for the All-Share
- Dividend growth of 16% in 2019 (with dividends reinvested) which is nice, but behind the All-Share’s very impressive 23% dividend growth for the year.
Which holdings produced the largest drag on performance?
Here’s a chart showing the capital gain or loss for each holding that was in the portfolio at both the beginning and end of the year:
Here’s another chart, this time showing the contribution to overall returns from each holding (basically starting position size multiplied by capital gain or loss). Note that this excludes dividends, which added about 5% to the portfolio’s starting value:
Perhaps unsurprisingly, Ted Baker was the largest detractor in 2019.
It started the year with a weighting of 3.6% and lost 74% from January to January, contributing -2.7% to the portfolio’s overall return.
Xaar was the second largest detractor, contributing -1.5%.
If I’d managed to sidestep just these two holding then the portfolio would have returned an additional 4.2%, boosting 2019 returns to a very satisfactory 25.1%.
Which holdings contributed the most to performance?
Despite all the doom and gloom around retail, companies from the General Retailers sector were by far and away the biggest contributors to the portfolio’s 2019 performance.
Ignoring Ted Baker, General Retailers made up four out of the portfolio’s top five contributors, adding a combined 8.9% to the portfolio, excluding dividends.
The largest non-retail contributor was Domino’s Pizza (it’s listed in the Travel & Leisure sector although it’s very similar to a general retailer), which contributed (excluding dividends) 1.4% towards the portfolio’s overall 20.9% gain.
What I bought and sold in 2019
I try not to talk about what I buy because that wouldn’t be fair to those who subscribe to my investment newsletter, but I can provide a few details. I bought:
- One FTSE 100 company
- Three FTSE 250 companies and
- Two small caps
These six new holdings were purchased using my somewhat unusual approach of alternating one buy or sell decision each month. So in January I add a new holding, in February I sell an existing holding, and so on, gently churning the portfolio towards better companies at lower prices. Or at least that’s the theory.
The six companies sold (using my four rules for selling shares) were:
- GlaxoSmithKline (27% gain over four years)
- Centrica (37% loss over six and a half years)
- Compass (23% gain in just over a year)
- Vodafone (44% gain over eight years)
- SSE (34% gain over almost eight years)
- Restaurant Group (31% loss over three and a half years)
Other than Compass, which was a good company that saw a rapid share price gain in a short time, the rest of these holdings were so-so performers.
For the most part they were legacy holdings which I’d bought several years ago when I was more focused on value and yield than quality. Removing these legacy holdings from the portfolio was something of a spring cleaning effort, and the portfolio now holds no giant utility companies at all.
What do I expect from the market in 2020 and beyond?
My long-term goal is for the portfolio to return more than 10% per year, on average. Whether or not it produces more than 10% in 2020 depends on two factors which are outside of my control: 1) market valuations and 2) the random walk.
Market valuations tell us how much of a valuation headwind or tailwind the market faces.
If the market’s valuation is high then it will face headwinds because market valuations tend to decline towards their long-term average over the medium-term (within about 10 years, on average).
If market valuations are low then the market will have a valuation tailwind for the same reason, as valuations will tend to expand towards their long-term average.
My preferred market valuation tool is the CAPE ratio, and currently the FTSE 100 and FTSE 250 CAPE ratios are very close to their long-term averages. The implication is that neither index will face particularly strong headwinds or tailwinds from valuation mean reversion.
Ignoring all other factors then, we should expect market returns over the next decade to be about normal, which in the UK is something in the region of 7% annualised.
As for 2020, I have no idea what will happen. Random walk theory says market returns are essentially random in the short term, and history suggests the market could easily be up 20%, down 20% or somewhere in between (or even somewhere outside that range).
We really have no way of knowing, so instead of worrying about what the market will do over the next 12 months, think about where it might be ten or twenty years from now.
And if you like reading year-end review, here are some that might interest you:
- Maynard Paton’s 2019 review
- Richard Beddard reviews his investment process
- Richard Beddard reviews his 2019 investment results
Happy New Year!