…and a look at what lies ahead in 2018.

One of the advantages of writing an investment blog is that I can look back on decisions I have made, my thought processes at the time and reflect accordingly. Just over a year ago, I wrote this article which gave my thoughts on 2017 and my investment strategy for the forthcoming year. So how good was my crystal ball?

In the preamble of that article, I wrote “2017 is a critical year for me. If I have a really good year (e.g. 60%), then it will be my last year in the corporate world. More realistically, I need three decent years (e.g. average 20% pa) to reach my “retirement number”. I am delighted to report that my actual performance for the year was an overall gain of 59%, just short of my 3 year “retirement number” target. Therefore, my primary aim for the year ahead is to hold the gains. For sure, I also want to beat my benchmarks and deliver an absolute return in excess of 10% but experience tells me that often the hardest year is the one after a great year.

Why was 2017 such a great year?

Firstly, the market was “risk on” for the most part. All the main indices were up with AIM being the best UK index, delivering a 33% gain over the year. The Stockopedia NAPS portfolio was up 45% on the year. Most private investors I interact with on Twitter had a good year. So clearly, there were a number of ways to make money out of the markets in 2017.

At this point, I’d like to offer some words of comfort to those who did not do so well out of the markets in the past year. When I see comments like “if you can’t make money in this market, you should give up”, it really makes me cringe. I can think of several strategies that probably wouldn’t have done well last year, just ask Neil Woodford! The main thing when you underperform is to learn from the experience. Are you diversified enough? Are you paying enough attention to quality, value, income, growth, momentum and volatility? Are you over exposed to too many high risk shares – e.g. jam tomorrow or falling knives? Do you need to broaden your investment universe? Do you need to tweak your strategy? Believe me, I have had my fair share of years when I have “paid for an education” from the markets. It is vital to learn, otherwise you really have lost money.

As far as my own portfolio is concerned, 2017 was quite remarkable. Not because of the overall performance, although that was really pleasing. It was remarkable because, averaging between 30 and 40 holdings throughout the year, I did not have a single profit warning (i.e. holding shares at the time of the profit warning). It was remarkable because I didn’t have a single takeover (ironic given that I had labelled 2017 as the “year of the takeover”). It was remarkable because I didn’t have a single multibagger (i.e. over 200% gain on my overall holding).

I doubt I will ever better this year’s performance but the lessons I have learned will hopefully help me to become a better investor, more able to deliver consistent returns over the long haul.

School Report
Just over a year ago, I wrote about my Six Best Investment Lessons of 2016. So how did I do implementing those lessons?

#1 Diversification is Key – I have really focused on this aspect of portfolio management over the past year, making significant progress diversifying in terms of company size, sector/industry, volatility, stock rank style and strategy. I will cover this in more depth in a forthcoming article. For 2017, I’ll give myself a B+, strong progress.

#2 Weightings are Critical – Portfolio weightings was the main reason for my outperformance in 2017. I went significantly overweight in two holdings, IQE which was a company that was only on my most least watched watchlist going into the year and Hurricane Energy (HUR). It is interesting to note my explanation of how these two situations unfolded in this article. In that article, I talk about having reduced my HUR holding and how I was aggressively averaging up on IQE. In the event, I subsequently bought back HUR only to eventually exit with my biggest single loss of the year (-30%). IQE on the other hand was my biggest winner of 2017 and remains an overweight position, although I have begun top slicing over the past couple of months. In aggregate, the shares in which I was overweight did very well in 2017. Some of that was due to averaging up when holdings had strong momentum and some of it was a combination of luck and market conditions. Overall, I’ll give myself a B- on this one. I’m carrying too much risk in my overweight holdings and I need to rectify that during the early part of 2018.

#3 Over Trading Sucks – I was much more active than I should have been during the year. Some of it paid off, especially the practice of top slicing winners and averaging up on momentum, but much of it could have been avoided. This is a D, must do better.

#4 Timing the Market is Folly – This is an interesting one. In last year’s article, I talked about building up holdings in cash proxies so that I could remain fully invested at all times. I did explore potential cash proxies during the year and concluded that no single holding could be relied upon to fulfill this function. Therefore, I have focused on building a diversified income portfolio and adding more large caps into the mix. Hopefully, this will provide liquidity in times of need. I also plan to increase the weight of these holdings as 2018 unfolds. However, I did not remain fully invested throughout the year. I top sliced a lot of my gains and sold all of my lower conviction holdings at the end of summer. I was concerned that valuations were too expensive and a correction/rotation was imminent. I still have that concern but having some cash on the sidelines enabled me to review my portfolio and conduct further research/analysis before reinvesting. I remain happy with that decision and am now only c1.5% cash, so I’ll give myself a B, good progress.

#5 Let Compounding do its job – Boy oh boy! This was by far my greatest success of the year and also, it was my greatest learning. I wrote about that learning in this article. I’m going to give myself an A for this in 2017. The challenge will be to keep the discipline going in slower markets.

#6 Momentum Matters – I have been fortunate to have had strong momentum in many of my growth holdings during the year. Perhaps that’s not surprising because it has become one of the factors that I screen for and monitor. However, it is not my primary focus for 2018. For sure, I want to make sure there is momentum in my portfolio and I will try to ride that momentum by averaging up on winners but I suspect too much focus on momentum has, in part, contributed to my over trading again in 2017. I’ll give myself a C+, room for improvement.

OK, that’s enough naval gazing, it’s time to look forward to the main things I’ll be focusing on in 2018…

Portfolio Thinking versus Share Picking
My biggest transition during the past year has been to learn more about managing my portfolio as a whole. It is a big leap of faith but for me, it has been transformational to think about my portfolio as a cash machine with each individual holding as a net contributor or drain on that cash. I thought I did a half decent job of explaining this in my Eighth Wonder of the World article back in August. That is, until I read Nick Ray’s superb article on Stockopedia this week. If there is a better investment article written in 2018, I look forward to reading it!

My own portfolio is still not where I would like it to be but I’m getting there. A huge influence during the year has been the introduction of Stockopedia’s Risk (Volatility) Ratings and StockRank Styles in addition to the already excellent QVM Stock Rank system – Ed Croft and his team really are doing a superb job! I wrote my initial thoughts on these new tools back in May in this article and have referenced them in several articles since.

I am happy with the balance and diversity of holdings in the portfolio, the next step is to address the weightings imbalance that I have created for myself. I am looking for opportunities to reduce my overweight holdings and share the love across the rest of the portfolio.

What type of investor do I want to be?
Another influential article during the year was when Ed Croft took a look at investor styles. In truth, this was less impactful on me than the portfolio management learning but nonetheless, it made me think about my own investment style. Fundamentally, I would like to be an “owner” but I think “farming” is important too (i.e. rebalancing and reviewing portfolio constituents periodically). You’ll note that these two styles are more passive and actually are a much better fit for my personality, my lifestyle goals and my portfolio goals

Stop-Loss Refinement
While I didn’t have any profit warnings during 2017, I did have a few holdings that breached their stop-loss and were subsequently sold. It generally worked out well but the issue I have been wrestling with is setting the right stop-loss level. One school of thought I am interested in is to take a portfolio approach (i.e. setting stop-loss levels based on limiting portfolio risk). However, I have also been experimenting with adjusting the stop-loss level based on anticipated volatility. I am currently refining this based on the Risk Rating (i.e. the expected level of volatility). Here’s where I am at with this experimental approach:

Conservative – 10% trailing stop-loss
Balanced – 15% trailing stop-loss
Adventurous – 20% trailing stop-loss
Speculative – 25% trailing stop-loss
Highly Speculative – 30% trailing stop-loss

My rationale is that for example, if I am buying a Conservative stock, one of the properties it brings to the portfolio is lower volatility. If it starts swinging by more than 10%, it is worthy of review and possibly, needs to be sold or resized. On the other hand, if I have a speculative or highly speculative stock, I am already expecting high volatility (often because of illiquidity) and therefore, I need to give it more room to express itself. For the handful of “speculative” or “highly speculative” holdings in my portfolio, I am more interested in the underlying business performance and growth to come through or value to be outed. This said, profit warnings will nearly always result in me selling out (maybe to revisit when the company recovers).

My overall growth strategy for the portfolio is to compound returns via bottom up cash flow (dividends), top down cash flow (top slicing winners), internal compounding (companies that consistently deliver a high return on capital while generating strong cash flow for further reinvestment or distribution), periodic rebalancing and selling on stop-loss/profit warnings. As I said earlier, the challenge will be maintaining this discipline when the market has less momentum and the rate of compounding slows.

Another article during the year that had a significant impact on my thinking was from Stock Whittler (@dosh100 on Twitter) on the importance of properly benchmarking portfolio performance. Indeed, if there is an investable benchmark that consistently beats my performance, why wouldn’t I just invest in that? Therefore, in addition to the base level FTSE All Share Total Return Index, I have included two further internal benchmarks for 2018. The first is Fundsmith Global Equities which successfully follows the “owner” approach that I aspire to. It also provides me with valuable exposure to global equities (more diversification). The second is an index of 10 Investment Trusts (all of which I own, albeit in non-equal weightings). The main purpose of these holdings is to add diversification, reduce volatility and provide exposure to investment areas where I have neither the time/resources nor ability to master on my own. Nonetheless, I thought it would be interesting to see how my own overall portfolio performs against this (total return) subset run by investment professionals. Additionally, I am keeping a close eye on Ed Croft’s NAPS/SNAPS experiment which returned an outstanding 45% in 2017 (29% annualised return since inception). These are going to be much more challenging benchmarks to try and match/beat in the year ahead.

And Finally…
If you have stayed with me thus far, thank you and I hope my blog continues to add value to your own investment journey. It is primarily a medium for me to “learn out loud” and if that helps others along the way, so much the better. I am extremely grateful to other private investors who blog as I learn a tremendous amount from your efforts as I do from the Twitter community and Stockopedia’s discussion boards.

My next article (or perhaps series of articles) will be a deep dive into my portfolio cash machine – but no promises on timing. In the meantime, I wish all my readers, followers and investment buddies (you know who you are) a healthy, happy and rewarding 2018. We go again folks!

Happy investing
Simon (@BrilliantLeader)


Disclosure – At the time of writing, I own shares in IQE, mentioned in this article.