Welcome to my 2018 portfolio review.

While gathering my thoughts for this article, I read back through my narrative of the year. It is funny how the memory distorts and I am glad I have this journal to keep me on the straight and narrow. I shall reference that narrative as I reflect on the year that has gone, before outlining my plan for the year ahead.

Headline Performance
My total investment return for 2018 (as at 28 December) was 20.36% which is comfortably ahead of all benchmarks (FTSE All Share Total Return -9.65%, Fundsmith Equity +2.81%, Investment Trust Basket -15.13%), resulting in a CAGR of 36.55% since inception of my Portfolio For All Seasons (PFAS).

Clearly, I am delighted with this return given how tough markets have been in the second half of the year. Moreover, this was my first year as a full-time investor and I am thankful that while the bull has given way to the bear, I have been able to preserve capital and manage the transition. It is a process that is still ongoing but so far, so good.

In short, 2018 was a year when a plan came together. There was some luck involved for sure and there were some mistakes made along the way but overall, I had an agile plan and executed it reasonably well. Here is how it unfolded…

First Quarter
At the start of the year, I had two overweight positions in IQE and AAZ (13% and 7%, respectively) within a portfolio of over 30 holdings. Both were high conviction holdings and my rationale was that these gave me the opportunity to outperform while the diversified and quality-oriented underbelly would provide market matching returns, at least.

Then, we had a bit of a market shock in February – volatility returned to equity markets. This was a key moment of the year for me and I learnt a lot about my portfolio’s reaction in a volatile market environment. I wrote about that in early March, here. In that article, I re-rationalised my overweight positions in IQE (still 13%) and AAZ (now 14%). I also added some new focus on reducing portfolio volatility and increasing the natural yield.

If you read the section on IQE from the article above, it is clear that is the point I should have at least reduced my position. The short interest had surfaced, the share price was volatile and I was planning to reduce my position “after full year results”. And yet, I maintained an overweight position despite my misgivings.

PFAS performance at the end of the first quarter was a small loss of 0.77%.

Second Quarter
I began the second quarter by writing in more depth about my plans to reduce volatility and increase the portfolio yield. In that article, I also ran my analysis with and without IQE which continued to cause me concern. It is clear that I should have sold out of IQE entirely at this point. And yet, I maintained an overweight position.

To round out the quarter, I reviewed my whole portfolio with a critical eye on what changes I might need to make in the third quarter as we went through interim results season – in pursuit of reducing volatility and increasing portfolio yield. This included a continued overweight position in IQE – sigh!

PFAS performance for the second quarter was a gain of 9.27%, despite a loss making June.

Third Quarter
Having spent much of August away from the markets, I returned full of fear at the start of September when I wrote that I perceived market risks to be too high and that I was top slicing holdings in order to increase cash weighting. Oh yes, and just three days after this article was written I was still buying IQE – unbelievable!

A month later on 30th September, I was in fine prophetic form with this article when I wrote, “I have no idea what the fourth quarter has in store for us. I have written recently about my unease with the macro environment and the possibility of a market sell-off, especially in the US. As for the UK, it’s not a frothy market but nonetheless, it is riddled with both Brexit and currency risk. Indeed, cash is now my third largest position”. At the time of writing, I was around 7% cash and it would take a further month to reach “peak cash” of 17%, including a complete exit from IQE – hurrah!

PFAS gained 11.25% during the third quarter thanks mainly to a 50% gain in largest holding, AAZ.

Fourth Quarter
As the markets sold off in October and November I was well positioned. Firstly, AAZ continued its re-rating and moved counter to the market which saw some brutal drawdowns. Secondly, I had reduced the portfolio volatility, selling out of many speculative holdings and reducing position size in adventurous core holdings. Therefore, I had a cash pile which meant I could buy as the markets were selling off.

PFAS gained a nominal 0.51% during the final quarter for a year-end total return of 20.36%.

Year End Position
My year-end portfolio can be viewed here. Points of note include:      

  • I end the year fully invested via 28 holdings. It remains to be seen whether I have spent my cash pile prematurely and indeed, if I have bought wisely or not. In the main, I have bought low-to-medium volatility shares with medium-to-high dividends and am in risk-off mode.
  • I end the year with an overweight position (28%) in Anglo Asian Mining (AAZ).
  • I end the year with a natural portfolio yield for 2019 of 5.11% – way ahead of my 4% target. I am absolutely delighted with this, especially as I have maintained a quality-oriented portfolio rather than just chasing high yield shares.
  • I end the year with a weighted volatility of 3.04. While this is higher than the 2.00-2.50 targeted, the figure is skewed by my largest holding which has a volatility rating of 5.00.  
  • I end the year with only 8/28 holdings in profit; AAZ being 132% in profit with a long gap to the next most profitable holding, BVXP (+24%). Of the 20 holdings that are in loss, 10 are losing by more than 10% with BOY (-25%) and XPP (-27%) being the biggest culprits.

Reflections on 2018
It was a tough year for equity investors and a significant one for learning. There were three key moments from my perspective. Firstly, it was the market correction in February which enabled me to observe portfolio constituents in that environment, including how far they fell and how quickly they recovered. Secondly, it was the decision to increase cash weighting at the end of the summer. And most significantly, it was my decision to build and maintain an overweight position in Anglo Asian Mining (AAZ) – a calculated gamble that has paid off, so far.

I made mistakes too. The biggest one was with IQE where it is clear I should have cut and run much earlier (although I did manage to miss the Q4 profit warning by the skin of my teeth). I did get my first profit warning since August 2016 though, courtesy of MPAC which I no longer hold. Arguably, I should have been more aggressive in moving to cash early in September when I felt the writing was on the wall for the markets. It is also debatable whether I should still be sitting on that cash pile, waiting for momentum to return before reinvesting.

As for stop-losses, I abandoned them during the sell-off because I had already reduced position sizes. With hindsight, I remain comfortable with this decision as I believe it was consistent with the “owner mindset”. This said, I was absolutely fascinated to see the way experienced momentum investors were applying stop-losses throughout the year and in particular, during the sell-off. I was also fascinated by the variety of strategies adopted by other investors; from moving into large cash positions much earlier to having highly concentrated, high-conviction portfolios.

I am grateful to all who share not just their results but more importantly, the portfolio and strategy that sits behind those results. I hope my own sharing helps others in a similar way.         

Plan for 2019
Theoretically, my plan for 2019 should be straightforward.

In an ideal world I will be able to gradually normalise my AAZ position size into share price strength (there are a number of news items during H1 that should be value enhancing) and reinvest those funds across the underlying portfolio.

I have decided that my maximum portfolio size is 30 holdings, although that is a limit rather than a target. I will continue buying high quality with decent yield.

I am dispensing with the Investment Trust benchmark and replacing it with an alternative internal benchmark – Vanguard Life Strategy 100% Equity. I will continue to use Fundsmith Equity as an internal benchmark and the FTSE All Share Total Return index as an external benchmark.

Perhaps most significantly, I have decided to dispense with stop-losses. I will still monitor price momentum and potentially act on it. However, I am going to focus primarily on business results, strategy and outlook as my decision making drivers.

To that end, I am looking forward to a flurry of trading updates in January, followed by results February-April. As ever, I will look to be agile and act decisively if business performance/outlook changes the investment thesis for any of my holdings. Beyond that, we can but hope that the macro uncertainty is resolved, a global recession is avoided and optimism returns to the markets. Until then, I anticipate remaining in risk-off mode.

Whatever the market has to throw at us, I wish all private investors a happy, healthy and prosperous 2019.

Happy New Year!

Disclosure – My full portfolio, including weightings, at the time of writing can be viewed here, including many of the companies mentioned in this article.