Bargain shares flying

To recap, the idea behind Bargain shares is very simple. It's to invest in companies where the true worth of the assets is not reflected in the share price, usually for some temporary reason, but where we can reasonably expect that it will be in due course. That’s not to say that investing this way is a one-way bet as this strategy underperformed in both 2008 and 2011.

However, over the long-term this investment approach has worked a treat. Moreover, the returns we have made have been quite eye-catching since the start of last year. In fact, following on from last year’s bumper 31.9 per cent return on my 2012 portfolio, my 2013 motley crew of 10 Bargain shares has raced ahead by 28.2 per cent on an offer-to-bid basis since early February.

To put this performance into some perspective, the total return on the FTSE All-Share index has only been 9 per cent in the same eight-month period. The FTSE Aim index has fared even worse, posting a 6.6 per cent total return. The best performer, the FTSE Small Cap index, is up 18.2 per cent including dividends, so still lags my portfolio by almost 10 percentage points.

How Simon Thompson's 2013 Bargain Shares Portfolio has performed

Clearly, the bumper returns we have been enjoying by riding the upside in the current bull market will not last forever, especially when market conditions are far less benign. And it is only fair to acknowledge that the UK government’s decision to allow the inclusion of Aim-traded shares in individual savings accounts (Isas) has buoyed the performance of my portfolio. That’s because no fewer than seven of the 10 shares I selected in February are traded on Aim. Still, these companies have been reporting a constant stream of good news, so the fundamental case for investing has been sound. It has also been underpinning the increased demand we have seen for Aim-traded equities from Isa investors.

Furthermore, having updated the investment case on the top performers in my portfolio last week, Inland Homes (INL: 45p) and Terrace Hill (THG: 26.25p), there has been further news flow from other companies in the portfolio which warrant updates.

Smart acquisitions for Randall & Quilter

Shares in specialist non-life insurance investor Randall & Quilter (RQIH: 154p) are riding a 12-month high and with good reason. True, the annual 8.4p a share is attractive, and we are due another 3.4p payout next month, but the chunky 5.5 per cent dividend yield aside, operationally the company has been making strong progress.

Founded in 1992 by executive chairman and chief executive Ken Randall and finance director Alan Quilter, Randall & Quilter is a specialist in managing the run-off of insurance companies and Lloyd's of London syndicates that have stopped underwriting new contracts, but have already settled liabilities arising from policies written.

This is a huge market estimated to be worth around £30bn in the UK alone - accounting for 15 per cent of the non-life insurance market - and in excess of $500bn (£316bn) globally. Managing the run-off of insurance companies and Lloyd's of London syndicates is also hugely profitable, which explains why Randall & Quilter's board has been able to pay out over 23p a share of dividends in the past three years. It's a sizeable operation, too, employing 400 professionals based in the UK, US, Bermuda and continental Europe, offering a wide service capability in both the 'live' and 'run-off' insurance markets.

R&Q currently has a portfolio of 12 companies in run-off with net assets of £96.4m, owns a Lloyd's authorised managing agency and manages Lloyd's syndicates 102 and 3330, which are both in run-off. It has been growing through acquisitions, too, having raised £25m at 120p a share in March through an institutional placing. The money is being spent wisely.

For instance, last week’s acquisition of Flagstone Alliance, a Cyprus domiciled insurer and reinsurer, from the Validus Group, looks a smart deal and is also the company's largest run-off transaction since 2006. The consideration payable by Randall & Quilter in cash from existing resources is $24.1m (£15m), a 14 per cent discount to the estimated adjusted net asset value of $28.1m. Flagstone Alliance commenced underwriting in 2000 and went into run-off in 2010. The business comprises primarily international reinsurance business with net reserves of $16.4m equivalent.

The purchase fits in very well with the company’s commitment to shareholders to seek out legacy portfolios which meet its strict capital return and pay-back criteria. Moreover, expect further deals in time as "in addition to further captive related acquisition opportunities, the company is seeing some larger sized legacy opportunities."

Trading on a modest premium to net asset value of 138p, and offering a solid 5.5 per cent historic dividend yield, I would run the 36 per cent profit we have made on this holding especially as it is only reasonable for the company to deploy its cash by making further value enhancing run-off acquisitions in the coming months.

Hidden value in Oakley Capital

Investors should also expect further good news from Oakley Capital Investments (OCL: 163p), when the closed end Aim-traded investment company issues a pre-close trading update in mid-January. To recap, Oakley makes its money by taking stakes in private equity ventures established by its associated Limited Partnership, Oakley Capital Private Equity, and providing mezzanine debt finance.

As I have noted previously, Oakley has been clearly doing well: the company's book value per share increased by 9 per cent to 195p in the first six months of 2013, up from 181p at the start of the year and 174p at the same stage in 2012. Net asset value (NAV) is made up of cash of 55p a share, the investment in Limited Partnership and loans provided to Limited Partnership and a number of portfolio companies.

So with Oakley's shares currently trading on a bid offer spread of 161p to 164p, the share price discount to NAV is 16 per cent. However, since the end of June there have been some hefty gains in some of the investee companies. For instance, shares in Daisy Group (DAY: 150p), a fast-growing telecoms provider, have hit a five-year high and the price has risen by 13 per cent since Oakley reported its half year numbers. It’s a major holding for Oakley, accounting for over 10 per cent of the company’s net assets of £240m.

Importantly, with analysts at Liberum Capital forecasting Daisy will report current year adjusted free cash flow of £35.3m, underlying pre-tax profit of £45m, adjusted EPS of 12.9p and declare a 4.6p a share dividend, the company’s £400m market value still doesn’t look stretched. And since Daisy paid out a 4p a share dividend earlier this month, the total return Oakley has made on its investment is nearer 16 per cent since the end of June. That alone adds 3.25p a share to Oakley's NAV.

Asset allocation accretive to net asset value

It’s also worth noting that at the end of June Oakley's assets were split between its investments in the Oakley Limited Partnership (52 per cent of assets), cash and cash equivalents (28 per cent), loans provided directly to portfolio companies (12 per cent) and loans provided directly to the limited partnership (8 per cent). These loans generally take the form of mezzanine finance, ensuring that uncalled cash continues to earn a real positive return.

For instance, mezzanine loans carry fixed interest rates of up to 15 per cent and secured senior debt financing to portfolio companies usually carry interest rates of 8.5 per cent. Oakley’s revolving credit facility to the Limited Partnership is charged out at an interest rate of 6.5 per cent per year, which can increase if LIBOR exceeds 2 per cent. In other words, the income Oakley receives on its lending is significant and means that we can expect another decent rise in the company's NAV to well above 200p when it announces a pre-close trading statement in mid-January.

In my opinion, the share price discount to spot net asset value is now at least around 20 per cent. But even that understates the true discount because adjust for net cash worth 55p a share, or £68.2m (including accrued interest) of Oakley's book value of £240m, and underlying investments, worth £172m or 140p a share, are in effect being value at only 108p.

Sound management team

Moreover, it’s not as if the investments Oakley’s management team has been making are duds. In fact, the Limited Partnership has exited four of its portfolio investments, achieving an internal rate of return of 43 per cent on invested capital. Interestingly, realisation proceeds have been 14 per cent above the previous book value of those investments, implying that the valuations in the accounts are conservative.

That’s hardly the performance of a company whose shares should be trading on a deep 20 per cent discount to net asset value. Needless to say, I continue to rate Oakley shares a buy.

Finally, in the past week, I have published six other articles on the following companies or trading strategies:

■ Inland ('Property plays with foundations, 7 October 2013)

■ Terrace Hill ('Property plays with foundations, 7 October 2013)

■ Sanderson ('A smart tech share', 9 October 2013)

■ Pure Wafer ('Time to chip in', 10 October 2013)

■ US debt ceiling deadline looms ('Debt ceiling dilemma', 11 October 2013)

■ Air Partner ('Gaining altitude', 14 October 2013)

■ Polo Resources ('Targeting special situations', 14 October 2013)

■ Greenko ('Targeting special situations', 14 October 2013)