August proved to be a month of two halves for both the Growth and Income portfolios. In last month's column, I explained why, during the first, I rebalanced somewhat both portfolios - after good performances year to date - by increasing exposure to commercial property and corporate bonds. Taking profits is seldom the road to ruin.
This column will cover why, during the second half of August, I took advantage of market weakness on 'Black Monday' (24 August) to increase exposure to China and the Far East in general. In times of uncertainty, one must focus on the fundamentals - volatility can then be embraced as the investor's friend.
In every crisis, there is opportunity
There can be little doubt that the path China has chosen will not be smooth. It is in the process of rebalancing its enormous economy away from investment and export-led growth towards domestic consumption. Urbanisation on a massive scale compounds the challenge. This will produce volatility and a slowing economy, but the resulting growth will be of a far higher quality.
We should perhaps remember that markets essentially made little progress for years despite much stronger economic growth, in essence because the quality of that growth - dependent as it largely was on state investment in infrastructure - was poor.
Meanwhile, the significance of some of the Communist Party's other reforms are not being recognised. Plans to encourage the more efficient allocation of resources, to raise productivity and living standards, by limiting the heavy hand of the state and allowing private enterprise a bigger role should be applauded.
Allowing the renminbi to modestly devalue is part and parcel of these reforms - even if the policy was pushed by the People's Bank of China to help keep the Party leadership on the reform track. And yet, despite being welcomed by the IMF, the move has been condemned by markets. The Party's attempt to tackle shadow banking should be seen in a similar light.
Many commentators have been critical of the Party's 'incompetence'. The mishandling of the Shanghai stock market correction did not inspire confidence. But we should remember that this enormous country has long beat to a different rhythm. China has come a long way and these occasional blips should be seen in the round. The Party's market reforms have been quietly in train for some time. The 13th Plenum simply added to their momentum.
The Party fully appreciates the importance of meeting the expectations of its increasingly aspirant middle classes, while walking the tightrope of political control. Partly because of this, China's leadership is also making a renewed effort to combat corruption and poor corporate governance.
Markets do not like either. When the Party last tackled these evils in the years before the financial crash, China's CAPE multiple rose significantly, but then fell away when the impetus faded. This time one senses a real determination - for a variety of reasons - to follow through with reform. Again, this can only add to the quality of the earnings growth - which markets will come to reward.
Now all this would be somewhat academic to investors if the market was expensive - but it is not. When I last looked, China remained one of the cheapest markets around relative to the growth on offer. Meanwhile, its stock market is worth a fraction of its GDP, compared with around 100 per cent in most countries.
Add in very healthy foreign currency reserves, signs that the property cycle is turning up and evidence that the slowdown will not turn into a slump, and this 'crisis' should be seen for what it is - an opportunity.
Hence my addition to the Growth portfolio's holding of Fidelity China Special Situations (FCSS) when on a near-20 per cent discount, funded by selling Hansa Trust (HAN). At least for now, the timing proved fortuitous, but volatility will return.
China casts a large shadow over the region. Asian markets in general also suffered during this market shake-out. Various studies had already shown that the region contains a disproportionate number of cheap stocks - as defined by PE multiples of less than 10.
Yet Asia's long-term prospects remain bright. An increasing number of quality companies, many offering decent yields, together with its work ethic, favourable demographics and high savings ratio are just some of the positives. Volatility should again be seen as an opportunity.
Accordingly, on the same day when adding to FCSS, I added to both portfolios' existing holdings in Henderson Far East Income (HFEL) when on a small discount and offering a safe 8 per cent yield - opportunities such as these do not come along every day! Its exposure to China and many of the region's unfashionable sectors simply add to the attraction.
F&C UK Real Estate Investment
Regular readers will know that I turned positive on the commercial property sector at the end of 2011. I remain optimistic about prospects for reasons given in last month's column ('Rebalancing pays dividends', 4 September 2015). Given my optimism, I introduced F&C UK Real Estate Investment (FCRE) into the Income portfolio during the second half of August.
Ian McBryde, the manager of FCRE, likes to run a balanced fund, with assets broadly divided equally between industrial, warehouse, office and retail. Overall, around 50 per cent of exposure is to London and the south-east but the intention is to look more outside the region as the recovery gradually gains momentum.
This complements the portfolio's existing holding in Standard Life Property Income (SLI) with its exposure to industrial assets outside the south-east.
The strategy is opportunity-led rather than sector driven, with the emphasis on new properties, strong covenants backed by household names, average tenancies of seven to eight years and low void rates. Given the outlook for the sector, I am comfortable with the gearing of 30 per cent. Meanwhile, the 5 per cent yield is attractive, with the 5p dividend looking to benefit from a possible refinancing of the debt.
A well-respected manager, one of the lowest premiums in the sector at around 2 per cent, an emphasis on quality and a positive outlook for the sector all bode well for FCRE. The purchase was funded by the sale of TR Property (TRY) after a strong run and when standing close to par.
September's portfolio changes
As visitors to my website will know, during September I top-sliced both portfolios' holdings in International Biotechnology Trust (IBT), sold the Income portfolio's holding of BlackRock Commodities Income (BRCI), and added to the Growth's holding of Ecofin Water & Power Opportunities (ECWO).
I also continued to increase both portfolios' exposure to a broad range of commodities, both hard and soft, and to precious metals via City Natural Resources (CYN). I will explain why in next month's column.
