Friday 26 October 2012

Investors Chronicle Comments

As stated in my last post, I thought the comments received from the guys at the Investors Chronicle were largely positive, and I'm very grateful for their input. They did pose a few interesting questions concerning my strategy, and I hope I can answer them sensibly here.

Firstly I'll list the points Chris Dillow makes, and try to answer them in turn.

Q. Why are you so attracted to defensives? There's a bad reason and a good one. The bad one is that defensives are 'safe'. But they are not. Take BAT, your biggest holding, and one of the most defensive stocks on the market..... (he goes on to talk about volatility and says if you want real safety you should be in cash).

A. I disagree with his statement that Defensives are not 'safe'. They are volatile of course, but as Warren Buffet says 'In the short run, the market is a voting machine. In the long run, it's a weighing machine.' The share price of BAT (his case in point) may fluctuate wildly with the rest of the market in the short run, this is in part because the prevalence of index trackers means that the market moves in lock step as the computer controlled funds are forced to sell across the board when people pull their money out forcing all shares down regardless of underlying value.
However, the underlying business in BAT's case is rock solid; they generate massive amounts of cash and are selling a product with a very inelastic demand curve which means they are well placed to pass on any inflationary effects incurred to the consumers of their product. They are also expanding into emerging markets which is more than offsetting the decline in smoking in the West. Their long term share price graph says it all really.

Furthermore I disagree with the notion that being in cash would be any safer. In an environment where inflation is running higher than the average return in a cash ISA I think cash would be a very destructive place to hold your money, especially for a young(ish) investor like me who has plenty of time to ride out any short/mid term dips in equities.

The good reason he talked about was that defensive shares are - 'very often under priced. Investors' pursuit of exciting shares means they ignore dull ones, giving these above-average returns to those smart enough to buy them.'

This is a good point that I totally agree with. While studying for my degree in Economics we covered the subject of the 'favourite-long shot bias', which is where bettors /investors tend to overvalue long shots (tech firms, knee deep in debt and making no money) and undervalue favourites (tobacco firms etc). The topic we were studying at the time was horse racing odds but I think this theory equally applies to the equity markets and many other similar situations where human psychology is involved in betting on outcomes.

Q. There are two things that worry me about your approach. One is that you say you'll trim your tobacco holdings if they rise more....... the old advice to 'run your winners is good'.  My second concern is your preference for good dividends (goes on to say some dividends are high for good reasons etc)

A. I do agree with both these points. As a rule I do let my winners run. However if one company or sector grows so much that it is dominating your portfolio, the portfolio is then subjected to more company/sector specific risk. So it's a balancing act really, and as a loose rule I don't want any one company or sector to represent more than 25%-30% of my portfolio. This gives the tobacco firms some way to run before I would start to sell.
The second point is also a good one, you have to be sceptical about why a company's yield is high. When I look for defensive companies to invest in I like to see a good history of steadily growing dividends and also good dividend cover ( the ratio of company's net income over the dividend paid to shareholders ). This generally sorts the good from the chaff.

Helel Miah says that now I have matched the liability on my mortgage I should aim to preserve my capital and structure my portfolio so that it doesn't suffer too much should market conditions turn sour.... 'The best option may be to pay off the mortgage.'

This is sound advice and would certainly achieve my initial objective, however as a relatively young investor with a long mortgage term, I think the best option is to remain invested in equities. I have considered however paying my mortgage down a bit so that I have 40% equity in the property and can benefit from better mortgage deals. If I were to do this the ROCE (return on capital employed) would be about 6% which I think is very attractive in the current environment.

A few people have asked me what performance I've achieved over the last 7 years. I've invested approximately 60k so have effectively almost doubled my money over the timeframe. This includes dividends being re-invested. It is hard to calculate an annualised gain as I've been drip feeding money in randomly, as and when I could afford to. But I think I've easily averaged over 10% a year which is quite pleasing in a market which has barely moved over the period.



Thursday 25 October 2012

Investors Chronicle Article

Was chuffed to bits last week to have an article about my portfolio published in the Investors Chronicle, a publication over 150 years old that I would recommend to anyone with more than a passing interest in investing.
The comments were positive in the main I thought, although a few questions were asked concerning my strategy, which I will answer/explain in my next blog post.

Will attach the link to their site below and also copy the text underneath as i'm not sure how long that page will stay live.

Playing it too safe?

By Chris Dillow , 12 October 2012

Reader portfolio

  • Name Matthew Bird
  • Age 32 , Risk-averse share portfolio
  • Objectives Pay off mortgage
Is our 32-year-old reader wrong to be attracted to defensive stocks?
Matthew Bird is 32 and has been investing seriously since 2005. He initially started investing to pay off an interest-only mortgage of £105,000. After seven years he has achieved this goal but will continue to invest as long as he sees value in the market.
"Usually, I like to buy safe, well-known, large-cap companies with good dividends and the possibility of moderate growth. However, some of the portfolio is quite speculative - ie, banking, insurance and builders. I am still positive about all of my holdings. I think in years to come Lloyds Banking may prove to be the most lucrative investment but am wary of over-exposing myself to one company.
"The yields from insurers are very attractive, so maybe a top-up of Aviva or possibly Admiral could be next. I'm a bit disappointed with the performance of my Tesco and AstraZeneca shares, but both look great value so I might increase those, too. The tobacco sector has done very well lately - if it goes up much further I may trim my holdings a little so I'm not over-exposed there."

Matthew Bird's portfolio
Name of shareTickerNumber of shares heldPriceValue
BAE SystemsBA.1,683334p£5,621
Barratt DevelopmentsBDEV2,894175p£5,064
British American TobaccoBATS4093,248.16p£13,285
Imperial TobaccoIMT3092,313p£7,147
Lloyds BankingLLOY32,76139.01p£12,780
Polo ResourcesPOL55,2172.95p£1,629
Telford HomesTEF1,953133p£2,597
Taylor WimpeyTW.5,04354.65p£2,756
Source: Investors Chronicle. Price and value as at 03 October 2012.

Last three trades: Lloyds - Buy at 28p Lloyds - Buy at 22.5p Polo Resources - Buy at 2.8p 

Chris Dillow, Investors Chronicle's economist, says:

This is a well-diversified portfolio. Sixty per cent of it is in defensives - telecoms are like utilities these days - with most of the rest in high-beta stocks such as builders and Lloyds. Your one genuinely speculative holding, Polo Resources, is too small a proportion of your portfolio to matter much.
This poses the question: why are you so attracted to defensives? There's a bad reason and a good one.
The bad one is that defensives are 'safe'. But they are not. Take BAT, your biggest holding, and one of the most defensive stocks on the market. Its volatility since January 2000 is such that there is almost a one-in-five chance of it falling 10 per cent over a 12-month period, even if you think (optimistically) that its average returns will be 10 per cent a year. And its correlation with the All-Share index implies that, if the market falls, BAT will probably fall, too. It is a defensive stock not because it is safe, but because it is less likely to lose a lot of money than other stocks, and more likely to fall less if the market falls. But losing money slowly is not a virtue.
If it's a safe asset you want, you must hold cash, not defensives. Risk aversion is no case for holding defensives.
Instead, the case for them is that they are very often underpriced. Investors' pursuit of exciting shares means they ignore dull ones, giving these above-average returns to those smart enough to buy them. The reason for holding defensives is that you think this process is still happening.
One sign of how well-diversified you are is that you only have the one bank. For me, this is good. Banking stocks tend to be highly correlated with each other, all falling or all rising together - although, of course, to (slightly) different degrees. In this sense, holding more than one bank stock would be pretty redundant. Yes, stock-specific risk matters in banks. But sector-specific risk matters more. If fears of another financial crisis fade, banks will do well, and Lloyds will very probably gain.
There are, though, two things that worry me about your investing approach. One is that you say you'll trim your tobacco holdings if they rise more. For the tobacco sector, this is no bad thing, because there tends not to be momentum in large defensives. However, as a general approach to investing, it is a problem. Trimming your winners risks denying yourself the profits that can be made from momentum. The old advice to 'run your winners' is good.
My second concern is your preference for good dividends. On this point, economic theory and common sense agree - you don't get owt for nowt. A good yield is, in theory, only compensation for poor growth prospects (such as tobacco and utilities) or especial risk. And recent history vindicates theory. High-yield stocks were clobbered by the 2008 crisis - remember, Northern Rock and Bradford & Bingley were high yielders - and have recovered only a little since then. This warns us that the old idea that a high yield is a sign that a share is cheap can be dangerously mistaken. Lots of things are cheap for good reasons.
By all means, regard a high yield as a clue that a share might be underpriced. But a clue is not the same as proof.

Helal Miah, investment research analyst at The Share Centre, says:

You have achieved your goal to match your liability on the interest-only mortgage. You should now aim to preserve your capital and structure your portfolio so that it doesn't suffer too much should market conditions turn sour. Consider when your interest mortgage is due for repayment in full. If it matures within the next 10 years, then we would question whether being invested fully in equities is wise.
Plenty of time is required for equities to ride out cyclical downturns and major market corrections. Let's not forget that the FTSE 100 is still below its highs of nearly 12 years ago, around the peak of the bubble. Maybe more use could be made of safer government bonds; however, in the current climate it is likely that you will pay more in interest charges than you will receive in bond yields. The best option may be to pay off your mortgage.
However, assuming that the mortgage maturity is for a longer period, then equities should be the key focus to generate additional returns.
In terms of the portfolio allocation, the first thing to notice is the large weighting towards the pharmaceutical and tobacco sectors of roughly 20 per cent each. These are defensive sectors that should both provide a degree of safety and also good dividend yields. The tobacco stocks have benefited hugely from emerging markets consumers, while the pharmaceuticals have struggled to generate much capital growth. However, they do partly compensate with dividends, AstraZeneca and GlaxoSmithKline will provide yields of roughly 6 and 5 per cent respectively, while British American Tobacco and Imperial Tobacco will provide dividend yields in the region of 4 per cent. We do like the way you have split up your exposure to the sector by investing in a couple of companies.
We consider the above stocks along with Tesco and Vodafone, which can in some ways be considered utility stocks, as your core holdings, generating high yields with defensive characteristics.
We agree that Lloyds could end up being one of your most lucrative investments, but this goes hand in hand with it being one of your more risky stocks. We are still uncomfortable with banking stocks as the macro environment is still uncertain with plenty of scope for some as yet unknown scandal to pop up again in the sector.
We would consider your 16 per cent exposure to homebuilding companies a little overweight; however, we understand the reasons for your bullishness towards the sector. The sector has been receiving boosts in the form of central banks' attempts to keep interest rates low to get the housing market going and acknowledgment by the government that we are short of roughly 100,000 homes in the UK. The sector will also benefit from infrastructure spending that has been touted to get the economy going. Spreading it out among several names is certainly a good way to play it.
Apart from the exposure to the housebuilders, we would say that the portfolio largely does match your attitude to risk. The majority of the portfolio is weighted towards the large-cap 'core holdings', proving the income and a degree of stability, with smaller holdings in riskier 'satellite' stocks providing stronger growth potential.
The portfolio as a whole has a yield of 3.4 per cent, slightly below that of the FTSE All-Share, and a beta of 0.96, meaning that your portfolio should be slightly less volatile than the market as whole.

Thursday 11 October 2012

BAE Update

Okay, the EADS merger didn't go through so have bought back the sold shares (paid a penny more), and incurred some dealing costs. Bit of a waste of time and money in hindsight. Glad the merger fell apart though, as I believe this company will deliver on it's own, given time.

Tuesday 9 October 2012

BAE Quandary

Yesterday I read an article on the BBC website concerning the proposed merger of EADS and BAE systems.

As i have said in a previous post, I do not think the merger will be a good thing for shareholders. EADS is unattractively priced and it's dividend yield is miniscule in comparison to BAE.

The above article mentioned that Invesco Perpetual (BAE's largest shareholder, owning 13.3% of the company), along with many others are also unhappy with the deal.

If the merger goes ahead I'm sure that the resulting stock will be dumped by many funds and investors, especially those seeking dividend income.  This could be very destructive to the share price.

For me this is no longer an investment, it's a gamble, and for that reason I'm out! I've sold my holdings for a price of 324p netting me a gain of 10% excluding any dividends i've received.

It's a bit of a shame as BAE is a great investment prospect as it stands, if the merger falls through I will probably look at buying back in if the price stays reasonable.