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The year ahead

John Baron reports on 2016, reminds readers of the portfolios’ investment principles, and reviews strategy for 2017
January 13, 2017

Whilst both the Growth and Income portfolios made positive returns over 2016, both were behind their benchmarks – the second year since their inception in 2009. The Growth portfolio was up 9.0 per cent compared to its WMA Growth benchmark return of 19.3 per cent, whilst the Income portfolio was up 9.6 per cent compared to its WMA Income benchmark return of 15.0 per cent. Meanwhile, the FTSE All-Share index was up 16.8 per cent. All figures being total return and rounded to one decimal place.

Regular readers will know that, whenever reporting short term performance, the portfolios have highlighted the importance of maintaining a longer term perspective. Share prices can take time to reflect potential but then more than make up for lost time when they do.

Despite 2016, both portfolios continue to outperform their benchmarks on a three and five year basis. Indeed, since inception in 2009, the Growth portfolio has returned 206.8 per cent compared to benchmark returns of 123.3 per cent, whilst the Income portfolio has returned 161.2 per cent compared to 96.9 per cent for its benchmark. By comparison, the FTSE All-Share returned 132.7 per cent over the same period.

 

 

Investment principles

As with the start of any new year, there is no shortage of predictions by major financial organisations as to what 2017 has in store. Readers would do well to remember what the renowned economist J.K. Galbraith once said: “Pundits forecast not because they know, but because they are asked.” History suggests these forecasts are rarely right – the recent and very public back-peddling by the Bank of England and others as to their predictions of doom and gloom should the UK exit the EU is a case in point.

Investment is best kept simple to succeed. Complexity adds cost, risks confusion and usually hinders performance. A degree of humility is also required. Regular readers will know the portfolios remain invested and seek to add value over time – wiser investors succeed in timing the market. Such an approach also allows the full harvesting of dividends which become an increasingly important contributor to total return. In helping to protect past gains, the portfolios also acknowledge the importance of rebalancing and diversification.

When deciding portfolio strategy, little attention is paid to short term market ‘noise’ – from wherever it originates. The most important determinant is the ability of companies to create wealth and add value. The focus remains on the longer term when assessing sentiment and fundamentals, and volatility is therefore seen as an opportunity. Furthermore, portfolio changes should not be seen in isolation. A ‘holistic’ view is taken of the portfolios. Changes need to be seen as part of the whole, rather than simply a list of individual trades.

Key strategies

As requested by readers, it may be helpful to highlight certain strategies from which the portfolios, by their disposition, are hoping to profit – whilst humbly accepting some may not prove profitable in 2017, and whilst acknowledging there are few substitutes to good stockpicking.

2016 saw the portfolios implement two key strategy shifts – the substantial reduction in bond weightings during August and September, and the increased exposure to the US equity market following Donald Trump’s election victory. Previous columns have explained the reasoning.

A further development was the subtle but still important increase in exposure to other less-correlated asset classes including commodities, commercial property and renewable energy. In addition to their individual merits, these asset classes will more than compensate for the loss of bond income whilst allowing dividend increases over time – the portfolios offering yields well in excess of their benchmarks

Such strategies will continue into 2017. It will certainly remain important to ensure adequate diversification at a time policymakers are struggling to generate faster economic growth. The exceptions to such policy failure could be the US and the UK, whose equity markets may benefit from Trump’s proposed economic plans and the fall in Sterling courtesy of Brexit - as highlighted in last month’s column: The ‘Tyranny of the masses’ fills the policy void (9 December 2016).

Geographically, outside the US and UK, the portfolios favour Japan whilst maintaining a watching brief on Europe, the Far East and emerging markets. Japan’s domestic reforms and low price-to-book values offer the prospect of enticing gains – almost regardless of currency swings. On the other hand, the EU remains stuck in the global economic slow lane with shamefully high youth unemployment rates to match – forthcoming elections in key countries could further fracture the shaky foundations of this inefficient structure.

Meanwhile, the emerging markets may struggle should the US dollar strengthen further – stronger US growth, tighter monetary policy and a boost to oil and gas production, are strong tailwinds for the currency. Some also face socio-economic and geopolitical challenges not yet factored into prices. The markets in the Far East will certainly be influenced by the extent to which Trump’s rhetoric regarding China is translated into action – negotiating ploy or not, the ramifications of a hard line policy could be profound.

Within the equity exposure, the portfolios will pay more attention to ‘value’ stocks in general. The portfolios have benefited from ‘growth’ shares having done well over the past decade. But the comparative valuations have reached extreme levels. Faster growing economies, at least in the US and UK, should allow ‘value’ shares to catch up somewhat.

However, the portfolios will continue to support the key ‘growth’ themes of biotechnology, technology and private equity. Previous columns have highlighted their various attractions: Biotechnology is close to relative lows compared to pharma despite its vastly superior earnings outlook; technology is one of the few sectors forging a greater share of the global economy, regardless of the economic cycle, which the market is undervaluing; private equity conceals untold riches, including excellent managers, and performs well when economies and markets struggle. Add in good performing investment trusts on mid-teen plus discounts, and the outlook for all three themes looks favourable.

 

 

 

 

 

 

Portfolio changes

Activity during December saw the Growth portfolio top-slice its holdings in European Assets Trust (EAT) and Henderson Smaller Companies (HSL) in order to introduce Monks Investment Trust (MNKS). The website www.johnbaronportfolios.co.uk highlights the merits of MNKS. It also highlights the reasons for introducing North American Income Trust (NAIT) to both portfolios in early November - given my promise in last month’s column to explain NAIT’s merits in this column, should space allow!

Meanwhile, the Income portfolio added to its holding of F&C Private Equity (FPEO) which will help the portfolio maintain a healthy yield. There is also a pending corporate action regarding Acorn Income Fund (AIF) where the Income portfolio is taking no action – again the website has further details.

This just leaves me to wish all readers a healthy, happy and prosperous New Year.