2022 Investment Review

2022 proved a painful year from an investment perspective. My ISA which mostly holds direct equities fell -13.19%. In nominal terms the portfolio fell more than my day job's net earnings for the year, a sobering thought. I don't have good data prior to 2011 but this has to be the worst year I've had since the credit crisis (2007/2008) both in nominal and relative terms. The FTSE Allshare Total return which has been my benchmark did a much better job at preserving capital, putting in a positive return of +0.34%. Its high weighting in natural resource companies helped the index to stay in positive territory.

The US S&P 500 index wasn't so good losing -18.11%. Warren Buffett's Berkshire Hathaway finished up c. +3.17% for the year. The Nasdaq index delivered a woeful     -32.54%. Terry Smith's Fundsmith Equity fund fell -13.8%.

Last year I commented that irrational optimism seemed to be gripping the market, mentioning speculation in high beta stocks as well as cryptocurrencies and SPACs etc as signs that things were getting rather frothy. These areas have certainly all come down with a bump during 2022 in the face of inflation, war in Europe & rising interest rates, neatly demonstrated via a graph of Cathie Wood's popular ARK Innovation ETF plotted against Berkshire Hathaway. Rationality has returned, the tortoise vanquishes the hare.    

Last year's portfolio metrics were - weighted average EV/Ebit= 22.7x. The weighted average Free Cash Flow Yield = 4.2% and weighted average forecast EPS growth = 26.82%. weighted average ROCE = 20.08%. Weighted average forecast dividend yield = 1.82%.

Current portfolio metrics are - weighted average EV/Ebit= 17.5x. The weighted average Free Cash Flow Yield = 5.6% and weighted average forecast EPS growth = 8.4%. weighted average ROCE = 21.72%. Weighted average forecast dividend yield = 2.23%. These figures exclude Rightmove and Berkshire as they significantly skew the ROCE and EPS growth figures upwards.

Notably the portfolio looks cheaper from a valuation perspective than last year, but growth expectations have significantly reduced.  

Current holdings/weightings are:

 

 

Holding	%
Berkshire Hathaway Inc	8.70
Fidelity China Special Situations	6.00
Alphabet	4.54
IG Group	4.51
Starbucks Corp	4.34
British American Tobacco	4.03
Imperial Brands	3.96
Diageo	3.49
Pepsico	3.33
Apple	3.13
Microsoft Corp	2.90
Unilever	2.85
Philip Morris Inc	2.80
Legal & General	2.76
Meta Platforms	2.67
Amazon	2.58
Walt Disney Co	2.45
Domino's Pizza Inc	2.40
Costco	2.35
Netflix	2.12
Adobe	1.99
Games Workshop	1.98
Activision Blizzard	1.83
Tencent	1.74
Altria Group	1.57
Warner Brothers Discovery	1.53
Visa Inc	1.33
Intercontinental Hotel Group	1.33
Astrazeneca	1.21
Rightmove	1.06
Alibaba	1.04
Money Supermarket	1.03
Electronic Arts	1.00
Autotrader	1.00
Intel Corp	1.00
Paypal Holdings Inc	0.97
Restaurant Group	0.96
Flutter	0.91
IG Design Group	0.87
Take-Two Interactive	0.80
Future	0.80
Car Gurus	0.77
Intuit	0.50
Estee Lauder	0.38
Cash	0.32
Boohoo	0.13
JD.com	0.03

Long term performance - 

 

Year	Portfolio Return	Allshare TR	Outperformance
2011	0.50%	-3.50%	4.00%
2012	16.00%	12.30%	3.70%
2013	27.30%	20.80%	6.50%
2014	4.90%	1.20%	3.70%
2015	5.30%	1.00%	4.30%
2016	12.00%	16.00%	-4.00%
2017	15.80%	12.60%	3.20%
2018	-8.44%	-9.47%	1.03%
2019	19.93%	19.17%	0.76%
2020	9.73%	-9.82%	19.55%
2021	13.21%	18.32%	-5.11%
2022	-13.19%	0.34%	-13.53%
12yr Total Return	151.77%	101.87%	49.90%
12 year average p.a.	8.00%	6.00%	2.00%

The consumer staple holdings and Berkshire held up well during the year but most other areas suffered.

It's worth mentioning that the portfolio has meaningful reliance on advertising income. For Alphabet, Meta Platforms & Future it forms the core of their revenue. For Amazon and the media businesses (Disney, Warner Bros. Discovery & Netflix) it forms a reasonable part of income.    
Most of these businesses' share prices have been hit hard facing the prospect of recession and subsequent trimming of marketing budgets. Alphabet (Google) is down -39.15% over the year. Meta Platforms (Facebook/Instagram/WhatsApp) is down -64.45%, Future plc is down -65.59% during the year. Amazon -50.7%, Disney -44.58%, Warner Bros. Discovery -62.82% & Netflix -50.64%. With the power of hindsight, I should have trimmed some of these positions whilst I top sliced Apple last year (NB I didn't own Netflix or Warner Bros at the time - these are new positions bought during the year). Valuations were looking very stretched and the pullback that we have experienced was possibly inevitable. That said I had no idea that interest rates were going to rise as fast or as high as they did, and valuations did make some sense in the near zero interest rate environment that we faced at the time. Inflation and the war in Ukraine have thrown a spanner in the works. I now believe that all the aforementioned businesses look decent value and are probably worth topping up. Furthermore, the portfolio's low margin businesses (e.g. Amazon, Boohoo & International Greetings) have seen their profits largely vaporised in the face of inflation and rapidly rising costs. Terry Smith's letter to shareholders at the beginning of 2022 citing the importance of high margins as protection against inflation was prescient. On the plus side, last year my cash level was sitting at 4.86% due to a dearth of investment opportunities on account of relatively expensive valuations at the time. Now that we seem to be in a "risk off" environment I have had a chance to deploy that cash as valuations appear a lot more sensible. During the course of the year, I have instigated new positions in Netflix, Warner Brothers Discovery, Estee Lauder, Intuit, Adobe & Microsoft and have topped up several existing holdings and finish the year more or less fully invested. I exited Domino's Pizza Eurasia quite early in the year as the Russia/Ukraine war started to look more likely. I have also exited Murray International Trust as I saw better opportunities elsewhere and the Fundsmith Emerging Equities Trust (FEET) was liquidated which is probably a blessing as performance has not been good. Notably when FEET listed, its holdings were very highly rated which should have been a warning sign that returns could be lacklustre. They also seemed to be repeatedly affected by adverse macroeconomic events which demonstrates some of the issues surrounding emerging market investments.

There currently appears to be a lot of negativity surrounding media businesses that are engaged in DTC streaming. Streaming seems to be viewed as an inferior business model to the pre-existing set up wherein content creators would mostly produce content for third parties that would be aired on cable channels and satellite tv etc. It is certainly true that increased content spend has put a serious near-term dent in the profitability of these businesses, but it is my view that streaming will prove to be a boon in the long run. I imagine that in 10 years' time advertising will be as prominent on the streaming services as it was on cable & satellite and the content spend will moderate relative to subscription income. Subscription prices will rise faster than inflation and there will be a clampdown on account sharing, all of which should juice profitability. Piracy is one potential risk with the growing use of "chipped" devices that negate the need to pay for such services.

My Chinese investments look increasingly precarious given president Xi's slide towards dictatorship and his government's backwards stance on COVID and increasing aggression towards Taiwan. A Chinese invasion of Taiwan is a significant risk for global markets. I am currently considering selling my holdings in Fidelity China, Alibaba & Tencent but will wait to see how things progress.

It will be interesting to see how higher rates affect the residential property market in the UK this year. Most people with mortgages are currently on either 2 or 5 year fixed rate deals and when their current mortgage product ends they will be faced will significantly higher mortgage repayments which will reduce their disposable incomes. It's hard to see house prices rising in this environment despite the ongoing supply shortage.

As a side note my funds-based pension is down -12.04%. I hold a UK tracker within it that helped buoy performance a little. Also because sterling performed poorly during the year the US tracker I hold didn't lose that much value in sterling terms. Lindsell Train Global put in an okay performance only losing -4.4%. Some of the smaller cap funds I hold did quite poorly and dragged down the average.

Looking forward to 2023 I think inflation and interest rates will prove pivotal to market performance. I am dubious of the merit of further rate rises and hope they may have peaked. Inflation does currently seem to be falling from its highs in the US at least. Once the market thinks that rates have peaked, we could see a resurgence in stock and bond prices. If I am wrong and rates continue to rise because of stubborn inflation, then we could well be faced with another difficult year.

All the best for 2023, if anyone has any queries, please contact me via twitter @mattbird55 or via the comments section of the blog or at mattbird55@hotmail.com