Working out 'why'

Naturally enough, however, my hope is that the distribution will continue to grow because the purpose of an income fund is to do what it says on the can – to provide an income. Maybe it won't be the sole income on which its beneficiaries will live, but it should provide a useful supplement.

From that perspective, the Bearbull fund, which was launched in September 1998, offers clear glimpse of what a working lifetime’s sensible investment can produce; though – I feel obliged to add – only for those of us fortunate enough to live in fully-functioning nation states. Assume the fund has a 30-year build-up period after which it will be drawn down over, say, 25 years. In that case, the build-up would have another 14 years to run. How much income might the fund be producing by the time capital drawn-down starts? Assume 3 per cent-a-year growth and the payout at year 30 would be £20,800; 4 per cent brings £23,800 and 5 per cent £27,200.

Of course – and warming to this theme – those who build a pot for retirement are unlikely to draw an income during the build up. In which case, dividends will be re-invested. If the Bearbull fund had re-invested the £132,000 it has distributed, then – assuming a modest return on the income retained – its capital value would be, say, £450,000. What might that be worth in 14 years? In today’s money values, and assuming real growth of 2 per cent a year, the sum would be knocking on £600,000; 2.7 per cent (the real rate at which the Bearbull fund’s value has compounded so far) would bring £650,000.

The foregoing is another way of saying that, despite 2014’s poor showing, I should not beat myself up too much. The income fund’s long-term performance is still good. Besides which, on the theory that there is a strong random element to all investment returns, a poor year was due. The fund’s total return (changes in capital value plus income received) had beaten the total return on the FTSE All-Share index four years running, 2010 to 2013 (see ‘Long-term performance’ table).

Perhaps what’s most disappointing is that the fund started the year especially well. Its value rose 5.8 per cent in February, helped by a 4.7 per cent gain from the All-Share. So its fall from the year’s peak was almost 11 per cent during a 10-month phase when the All-Share only fell 3 per cent. The question is: how much of that underperformance was avoidable; put bluntly, how much was down to my own failings (laziness, stupidity, whatever) and how much to the cupidity of fate?

To answer that, we need to study the ‘performance bridge’ table, which shows how the fund’s start-year value of £294,225 was reduced to £277,869 by the end (or, to be precise to 22 December, when I am writing to this). We can ignore all the income that flowed through the fund during the year since all dividends and income received are distributed.

By far the biggest loser was the holding in bookmaker Ladbrokes (LAD), about which I wrote most recently on 14 November 2014. Naturally, it would have been lovely if I had sold the fund’s holding in Ladbrokes when its share price dropped below the stop-loss trigger at 182p late in 2013. That alone would have added 3 per cent to the fund’s end 2014 value. But I didn’t. I reckoned there was more upside than downside in the share price and I have reached the same conclusion several times subsequently.

Each time I’ve been proved wrong and the situation does leave me wondering if I am missing bearish factors staring me in the face. It’s true Ladbrokes’ bosses made a complete Horlicks of installing a decent ‘digital’ (ie, online) betting platform. But it looks like they got there in the end.

Meanwhile, I’ve crunched the numbers again and find that, even if the best Ladbrokes can do long term is to equal 2013’s free cash flow of 10.8p per share, that would justify a value of about 127p (against a current share price of 109p). If the average free cash of the past five years – 15.4p – was do-able long term, that would generate value of about 180p. In addition, Ladbrokes does some capital spending in excess of depreciation – 2.2p a year on average. Depending on assumptions, that could add between 30p and 60p per share of value. In other words, it’s tough to come up with a per-share value much below 160p and feasible to reach around 240p.

Naturally, doubts remain – if Ladbrokes shares are so cheap, why am I the only one to notice? Yet it’s not as if the company operates in a declining industry. For reliability of income, few occupations beat bookmaking. So I think I’m managing the Ladbrokes holding sensibly. Ditto the loss-making holdings in aircraft broker Air Partner (AIP) and currencies manager Record (REC), both of which are new and need more time.

However, I should give the other two loss makers more attention. I questioned the ability of pharma giant GlaxoSmithKline (GSK) to grow its dividend – perhaps even to maintain it – last autumn (Bearbull, 19 September 2014). That prompted me to lighten the fund’s holding in Glaxo and influenced my decision to sell the holding in BP (BP.). I may yet dump the rest of Glaxo, though not before I have crunched its data through my valuation spreadsheets. That must be a high priority for 2015.

Ditto shares in support services provider Mitie (MTO), whose falling price implies the company’s acquisition-driven business model has gone as far as it can – after all, Mitie is now a £2bn-a-year turnover business that has been relying on the same model for over 20 years.

A more welcome task will be monitoring the share price of electronic equipment maker Zytronic (ZYT), the fund’s best performer in 2014. That performance means I have shifted upwards the stop-loss levels on Zytronic twice since I bought the stock in October 2013. I have also narrowed the stop-loss parameters as I attempt to maximise profits. That’ll tricky because Zytronic’s price is volatile in a rather illiquid market. Still, it may be worth the effort to monitor the share price closely because, at 298p, it may be close to fair value.

That’s another task to check out soon as I go into 2015 feeling that – despite the fund’s poor performance last year – it has a better balance between big and small companies than 12 months ago. Meanwhile, the aim remains the same: find high-yielding shares in good companies selling at attractive prices and, occasionally, shares in distressed companies selling at knockdown prices.