The boys of ’66

For readers of Investors Chronicle, however, there is an alternative anniversary dating from 1966 to celebrate – the publication of Investors Chronicle’s 50-year portfolio. According to the original article back in March 1966, this selection “will, if left alone, provide outstanding growth stocks in the years ahead”. Was that simply bravado that would never be tested, or was it a sober assessment? Let’s see.

It is widely suggested that Sir Alf Ramsey stumbled upon the formation of ‘wingless wonders’ that captured the World Cup for England. That might be a little unkind, though serendipity did play a hand. Much the same could be said of 1966’s 50-year portfolio. True, it was put together at a time when modern portfolio theory was still in the corridors of academia. Even so, the basic merits of diversification had been known for decades, yet the ’66 portfolio largely ignores these.

Maybe that was deliberate, but, if so, it was brave or reckless, depending on your point of view. What’s fairly clear is that a portfolio of just 10 securities isn’t enough to bring the benefits of planned diversification – the optimal outcome between risk and returns.

The portfolio’s creator may have rejected diversification on the grounds that the ‘Noah’s Ark’ approach to investing – two of everything – is really just a case of lacking the courage of one’s convictions. And we can’t accuse the portfolio’s author of that. Having selected just 10 securities, our IC writer proceeded to spread those between just five broad sectors – natural resources (three stocks), retailers, closed-end funds and finance (two each) and beverages (one stock).

Brave or reckless, the portfolio selection has worked out, as Table 1 shows. Assuming an equal weighting in each stock when the portfolio was assembled – as was recommended – then the capital return, adjusting for changes in exchange rates, was 4,492 per cent over the 50 years. In contrast, the FTSE All-Share index, London’s broad equity index, gained 3,127 per cent over the same period.

Let’s not get too carried away, however. A better comparator might be the MSCI World Index for large-cap equities from developed markets, though data for this only goes back to the end of 1969. But from that start point through to end February 2016 – and calculated in sterling – the MSCI index gained 7,140 per cent. Almost certainly that makes its performance far superior to the 50-year portfolio.

Nor is it likely that extra diversification would have produced better performance. Quite likely the really fat returns from Royal Bank of Canada (TSX:RY), BHP Billiton (BLT) and Legal & General (LGEN) would have been diluted. Still, anyone who followed the IC’s lead in 1966 should be well satisfied today, even if a bit old to enjoy the rewards (and, we must ask, is there actually one such out there?).

Satisfaction would be enhanced if the dividends received from the holdings were brought into consideration. Calculating the portfolio’s total return would be a huge task, so let’s content ourselves with two broad-brush observations.

First, our 1996 write-up of the portfolio’s progress says that it came with a 4 per cent dividend yield up front. If we assume that pay-outs then proceeded to rise at 5 per cent a year, that would have generated almost £84,000 of income. Second – and this is where it really starts to get good – if all the dividend income was re-invested at 5 per cent, then the stream of income from all those re-invested dividends would total £936,000. In other words, the grand total from investing £10,000 back in March 1966 would be almost £1.48m.

True, there is the little matter of taxation. The portfolio was set up long before PEPs let alone Isas (individual savings accounts) came along and, for a while, would have had to endure the so-called ‘investment income surcharge’ – remember that? – where marginal investment income could be taxed at 98 per cent. Combine that with the difficulties of receiving dividends from foreign companies and the possibility of double taxation and we can assume that, in the real world, the net return would be much less than the gross. Even so, the portfolio demonstrates the virtue of patience, the power of compounding and the blessing of living in a stable democracy with strong property rights.

Despite these attractive returns, there is still a pertinent question: what’s the point of constructing a 50-year portfolio? That’s fair to ask since 50 years is more than the investment span of most adults. True, Warren Buffett celebrates 50 years as a money manager this year, and look where time – plus a little ability – got him. For most mortals, however, to enjoy the fruits of a 50-year portfolio would mean starting out aged around 15.

So it might make a good project for a GCSE economics student. But, actually, that observation comes close to the best justification – the portfolio functions as an inter-generational transfer. It’s the sort of thing wealthy parents build for their children, or – more likely – their grandchildren. The alternative – and weaker – justification is that you build the 50-year fund knowing that, really, the investment horizon is, say, 30 years. But the longer time span makes it less likely that you will tamper with it.

Which brings us to the best bit, building the portfolio for 2066. We pursued three aims:

■ Make the portfolio future proof. That means two things. First, don’t try to spot the future trends because you can’t – it’s just not possible. Back in 1966, who could have guessed the technological changes that would soon be up and running let alone which companies would have benefited from them? As we observed in our 1996 update of the ’66 portfolio, it was impossible to have invested in Microsoft (US:MSFT) back then because Bill Gates was barely out of kindergarten.

Second, just as football is recognisably the same game today as Alf Ramsey’s boys played – it’s still 11-a-side, the goal is the same size – so people will do the same things in 2066 as they do today – eating, drinking, getting sick, getting well and so on. So it should be possible to build a portfolio of companies whose core functions won’t be blitzed by technology. Among the 15 stocks, none is in activities that might have disappeared by 2066 with the possible exception of Facebook (US:FB), but more of that in a moment.

■ Make the portfolio well diversified. Ten stocks – as per the 1966 portfolio – was probably too few. True, research shows that portfolio risk is halved as the number of a portfolio’s components rises from one to 10. It continues to fall thereafter, though no worthwhile risk reduction is gained as a portfolio size rises beyond 20. So 15 holdings seems a happy mid point – and it’s a number that’s feasible to monitor. We have made no attempt to select on the basis of the negative covariance in price changes between each pair of securities in the 15. In that sense, our diversification is ‘naive’, but given the big market capitalisation of 14 of the 15 holdings, it would be a major surprise if the portfolio’s returns ran counter to global equity returns even over a short period.

■ Select the right sort of companies. Basically, that means three things. First – as just alluded to – buy holdings in big companies. That’s chiefly because they are much less likely to disappear than smaller ones in the coming 50 years. True, come 2066 some of those 15 will be inside different corporate wrappers. But there is every chance that any new company will be able to trace its provenance back to one of the original 15, meaning that mergers or takeovers will have been done with a share swap and investors will be able to maintain an interest in the new company.

Second, be confident that the companies are special, though quite what constitutes ‘special’ is tough to define. We have pinned it down to four inter-linked characteristics: longevity, size, family control and corporate ethos.

With the exception of Facebook, all 15 have been around for decades at least, which indicates they are doing something right. Size points in the same direction. There is usually a correlation between size and success. True, there are exceptions, but for the most part companies become giants because they provide what customers want and keep on doing that. And there are some very big companies in our list, including three of the top seven by market capitalisation in the US – Berkshire Hathaway (US:BRK.B), Facebook and Johnson & Johnson (US:JNJ).

Table 1: Here’s how the boys of ’66 performed

Family control and/or the influence of founders runs through much of the portfolio. That’s why London-listed Associated British Foods (ABF) is in there, a hugely successful foods conglomerate that has been controlled by four generations of the Anglo-Canadian Weston family. Similarly, it’s why we chose Hong Kong-listed Swire Properties (SEHK:1972) as the portfolio’s exposure to property. The company is a subsidiary of Swire Group, which has been owned by the Swire family since the mid 19th century. It gives exposure not just to land – which is worth having on the strength of the Mark Twain dictum alone (“Buy land, they don’t make it any more”) – but to real estate in Hong Kong, where the supply is especially limited, and on mainland China.

Ditto the choice of Caledonia Investments (CLDN) as the portfolio’s closed-end fund; the 1966 portfolio had two such funds and we thought it sensible to continue that stance since fund vehicles can bring a flexibility that most companies lack. Caledonia is basically where the Cayzer family keeps much of its capital and has done since 1951. That helps give the investment trust a long-term perspective, a focus on value investing and an idiosyncratic portfolio of both quoted and unquoted investments. This has worked to the extent that – all being well – this year Caledonia will have raised its dividend for each of the past 50 years.

The influence of founders is clear at both Facebook and Berkshire Hathaway. True, Facebook’s core service is by no means future proof. However, a company with 1.65bn active users – more than the population of China – has a resource from which it may be able to derive revenues in ways at which we can only guess. In that sense, it’s likely to stick around. But we chose Facebook largely because of the Mark Zuckerberg factor and in preference to the obvious tech alternative, Alphabet (US:GOOG), formerly Google. That was simply based on the intuition that Mr Zuckerberg is more likely to exert a long-term influence on Facebook than the joint founders of Google, Larry Page and Sergey Brin, whose attention is starting to drift in other directions. Indeed, it’s quite possible that 32-year-old Mr Zuckerberg may still be running Facebook when the 2016 portfolio is due for its final assessment. After all, by then he will still be three years younger than the chief of Berkshire Hathaway, Warren Buffett, is today.

Much debate is devoted to whether Berkshire Hathaway will long survive the demise of Mr Buffett, aged 85, and the company’s vice-chairman, Charles Munger (aged 92). Mr Buffett believes it will, saying that Berkshire’s strong corporate ethos, based on giving employees responsibility and trusting them, will endure. Trust, says the great man, is very efficient and self-reinforcing. True, but whether Berkshire’s virtuous circle will be strong enough to last another 50 years, only time will tell. Yet that’s partly why we have included Berkshire’s ‘B’ shares in the portfolio – just to test the Buffett hypothesis. Meanwhile, Berkshire seems to have a future-proof core. Mostly it’s a mix of insurance operations and utilities (electricity generation and supply plus railways). So it provides services for which there will almost certainly be demand in 2066.

A clear corporate ethos runs through other companies on the list – notably aerospace group Boeing (US:BA), whose bosses have been willing to bet the company on achieving game-changing goals, 3M (US:MMM), an industrial conglomerate that makes a virtue out of trying lots of things and cultivating what works, and Walt Disney (US:DIS), whose employees are encouraged to treat their work as a little piece of show business. Yet Johnson & Johnson and Danish insulin supplier Novo Nordisk are also noted for their distinctive corporate culture.

And the third aspect of selecting shares in the right companies is to have a bias towards US companies. Maybe it’s because no people in the world revere the corporation as do Americans. In the hands of Americans, the company has been elevated close to a religious status, which may be why so many of the outstanding US companies have been so successful for so long. As a result, six of our 15 are US companies. Yet the number might easily have been higher; why, for example, the absence of Procter & Gamble (US:PG), General Electric (US:GE) or American Express (US:AXP)?

One word of caution – apart from the likely resilience of their business activities, the 15 have been selected largely on the basis of their corporate reputation. The factor that did not figure in their selection is whether their shares currently look cheap. When you’re taking a 50-year view, we reckon that does not matter.

So, for posterity, here it is – the 2016 Investors Chronicle 50-year Portfolio. If we could, we’d put it in a time capsule and post it to the year 2066. Though maybe we’ll review its progress once in a while before then. Perhaps our younger readers might remind future generations of IC writers to attend the task. Oh, and let’s hope England have won the World Cup again before then, though, of course, a tournament is due that year.