Private Investor's Diary: I'm getting my portfolio ready for the next stage

Financial markets falter

With rising bond yields, equity markets faltered. The US fared best with a decent rally in the last week, paring back much of the earlier losses. The S&P 500 and Nasdaq were down only 1.6 and 2.2 per cent, respectively. The Nikkei was down 1.7 per cent but is still up 25.0 per cent this year. In continental Europe, the CAC was off 2.4 per cent (16.2 per cent in 2023), the MIB 2.9 per cent (22.0 per cent) and the DAX -3 per cent (14.5 per cent in 2023). UK indices fell somewhere in between, with the FTSE All-Share down 2.5 per cent, the FTSE 250 down 2.4 per cent, the FTSE Small Cap down 2.8 per cent and the FTSE Aim down by 2.9 per cent.

Looking at the year-to-date numbers shows how far the UK has fallen behind: the FTSE All-Share gained just 2.6 per cent, the FTSE 250 1 per cent, FTSE Small Cap was down 0.2 per cent and FTSE Aim down 9.8 per cent.

The US 10-year Treasury yield ended the month at 4.1 per cent, and in the UK the 10-year gilt yield ended the month at 4.3 per cent, having touched 4.7 per cent. That was the highest since September 2008. Given the ballooning cost of interest payments on government debt, the Treasury hopes the 21 August high of 4.7 per cent proves the peak for this cycle. The government is currently spending the same amount servicing the national debt as it does on education and defence combined. 

Sterling fell against the US dollar to $1.27. Gold was down 1.4 per cent to $1,942 an oz, and bitcoin gave up 11.3 per cent to $25,930. Up 56 per cent in 2023, it continues to be a highly volatile speculative instrument.

Performance

“The thing about bear markets is that they’re very boring – the boredom is punctuated by moments of pain as a stock, or the market periodically lurches down.” James Henderson, former colleague and co-manager of Henderson Opportunities Trust (HOT) and Lowland Investment Company (LWI), declared in the Financial Times last month. August proved another one of those downward lurches. The JIC Portfolio was down 2.2 per cent in August, which means that it is down 9.2 per cent year-to-date. The FTSE All-Share is up 2.7 per cent this year. Since its inception in January 2012, the JIC Portfolio has gained 290.2 per cent, equivalent to annualised growth of 12.5 per cent. By contrast, the FTSE All-Share (Total Return) Index is up 117.0 per cent, with an annualised gain of 6.9 per cent. Over one year, the JIC Portfolio is down 8.5 per cent versus 6.3 per cent for the index, and over five years, JIC is up 43.3 per cent versus 18.1 per cent.

Crumbs of comfort are that the JIC Portfolio did better than the FTSE All-Share (-2.5 per cent) in August, and, over the past three months, the JIC Portfolio is up 2.9 per cent versus 1 per cent for the All-Share. Fingers crossed that the bottom is in for my portfolio.

The Funds Portfolio was down 2.5 per cent, slightly worse than the 1.2 per cent fall in the FTSE All-World (TR GBP) Index over the month. It has been a torrid year for the Funds Portfolio, principally due to its lack of exposure to US large-cap tech. So far in 2023, it is down 4 per cent versus a gain of 9.2 per cent for the FTSE All-World (TR, GBP). Since this portfolio's inception in June 2020, it is up 23.1 per cent versus 36.3 per cent for the All-World.

The main positive contributors to performance were IG Design (IGR), up 9.0 per cent, and Serica Energy (SQZ) (my most significant position), up 4.3 per cent.

IG Design bounced back following a 10.85 per cent fall in July. There was no news from the company. Serica Energy responded to an increase in both the oil and gas price. The threat of industrial action at an Australian LNG plant caused a spike in European gas prices. It demonstrated the fragility of the global gas market. As I write, seeing Serica Energy at a six-month high is welcome.

The leading detractors were Glencore (GLEN), down 11.0 per cent (but it did go ex a 5.0 per cent dividend), Hargreaves Lansdown (HL.) down 10.6 per cent, Brooks Macdonald (BRK) down 7.6 per cent, Sylvania Platinum (SLP) down 6.5 per cent, BlackRock World Mining (BRWM) down 6.4 per cent, Harbour Energy (HBR) down 6.2 per cent and Next Energy Solar Fund (NESF) down 5.1 per cent.

Fears about muted global growth were predominantly behind the falls in BlackRock World Mining, Glencore and Sylvania Platinum. Harbour Energy responded poorly to half-year results. The market's main concerns were that production was slightly lower than expected and was not quickly replacing its reserves. The summer malaise hanging over equity markets impacted the share prices of Brooks Macdonald and Hargreaves Lansdown. Half of the fall in Next Energy Solar Fund was due to it going ex a quarterly dividend of 2.08p on 17 August. The share price is down 16 per cent on my average purchase price, but my total return is only down 3.0 per cent due to dividends received. At some stage, the market will appreciate the near-10 per cent dividend yield, and I might get some capital appreciation. The recent let-up in the rise in the 10-year gilt yield should help, especially if it continues. It reduces its cost of capital and makes Next Energy's high yield relatively more attractive to those prepared to take the risk. Positive news on the planned sale of some of its solar assets would be helpful.

The Funds Portfolio

The falls in BlackRock World Mining and Next Energy Solar Fund also depressed the performance of the Funds Portfolio. Global X Copper Miners ETF (COPX) was down 8.6 per cent, and Nippon Active Value Fund (NAVF) fell 7.5 per cent. The best performance came from VT Argonaut Absolute Return Fund (GB00B7FT1K78), up 4.3 per cent. The Funds Portfolio was not immune to the discounts to net asset value (NAV) of investment trust widening during August. The discounts widened by a few per cent for some of my recent purchases, including Nippon Active Value, Strategic Equity Capital (SEC) and Fidelity Asian Values (FAS).

Activity

Another relatively quiet month, although I did make the difficult decision to sell one position completely. Following its results, out went long-term favourite SDI Group (SDI) at 117.5p. The simple explanation was that SDI Group's share price might struggle in the short to medium term. There is a long-term case for backing the management, and my initial thought was to reduce the position to 2.5 per cent. However, my answer was 'no' to the hypothetical question: had I sold out at 200p in February, would I now be buying back? The valuation is not attractive enough on a price/earnings (PE) ratio of 15.8 to April 2024 for flat earnings and no dividend. Of course, a decent acquisition could boost profits, but its firepower for acquisitions is less than it used to be. I will be watching, but given what is still a high relative valuation, there are more compelling opportunities in the UK market. The big test will be whether I have the confidence to buy back should the share price drop to a valuation closer to the market average of around 11.0-12.0 times earnings. I logged a decent profit on my position in SDI, equivalent to nearly 6.0 per cent of the current value of the JIC Portfolio, and the fourth most profitable investment in monetary terms since the portfolio's inception in 2012.

The sale of SDI Group raised cash, enabling me to add to several of my existing positions. On 10 August, I bought more Sylvania Platinum at 73.5p, Hargreaves Lansdown at 809.5p, IG Group (IGG) at 706.5p, and Next Energy Solar Fund at 93.1p. On 15 August, I added again to Hargreaves Lansdown at 785p and on 24 August to IG Group at 674p. At 674p, IG Group is on a prospective PE ratio of 6.7 per cent and a yield of 6.9 per cent, and every day it is buying back stock. I could be wrong, but that seems bonkers.

There were no trades in the Funds Portfolio.

Other news: A quiet month for corporate updates

It was a quiet month on the corporate front. Chief executives like to get their results out in July, leaving time for the August holidays. Aside from SDI Group and Harbour Energy, there were updates from Glencore, BlackRock World Mining and Next Energy Solar Fund. Against difficult comparatives in H1 2022, Glencore's results aligned with expectations. The good news was an additional shareholder return of $2.2bn to be paid half via buybacks and half via a top-up dividend of 8¢ per share. It takes total shareholder returns to $9.3bn in 2023, or 15 per cent of the current market capitalisation.

BlackRock World Mining also had to contend with a difficult comparison with the first half of 2022. Although cash flow has held up well, many companies the fund invests in have paid reduced dividends. It confirmed a second interim of 5.5p. The market expects it to pay the same for Q3, but the final is likely to be down on last year. Even so, I think the total dividend for 2023 will be around 32p versus 40p last year. The manager highlighted that stock levels of various commodities are historically low, and that underlying demand should increase to enable the transition to a carbon-free world – "when demand strength returns, the impact on prices from restocking could be dramatic". I'm happy to collect my 5.5 per cent dividend yield while waiting.

Next Energy Solar Fund's quarterly update revealed a drop in the NAV from 114.3p to 109.3p during the three months to 30 June. The decline was principally due to higher long-term interest rates, leading it to increase its discount rate by 0.75 per cent to 8.0 per cent.

Sylvania Platinum entered a joint venture (JV) with Limberg Mining Company. In return for Sylvania's financing, Limberg will provide the feedstock of platinum group metal (PGM) and chrome ores. It should increase Sylvania's PGM production by nearly 10 per cent and add 200,000 tonnes of chromite concentrate attributable to Sylvania. The up-front investment cost to Sylvania is $32mn, and it will also provide the JV with the initial working capital of $5mn. Sylvania estimates a cash payback of three years from commissioning. Liberum estimates that it adds 12p to its net present value, up to 122p. At current spot prices, chrome will represent 78 per cent of the additional revenue to Sylvania Platinum from the JV. That's good news, as the diversification away from PGM improves the quality of the business. I love receiving dividends from Sylvania Platinum and, given the strength of the balance sheet and cash flow, this investment should have little impact on dividend payments in the next year or so. Given the potential returns on this deal, it is a much better use of shareholder money than paying dividends. I'm pleased that management is proactive in looking for value-enhancing deals rather than purely maximising the returns from its existing operations.

Dividend update

By 8 September, I had received a dividend income of £20,691 this year. Another £9,235 has been declared, given a significant boost by Sylvania Platinum announcing on 6 September that it intends to pay a 5.0p final dividend. The £9,235 will be received by 1 December, taking 2023’s total up to £29,922. With undeclared dividends to come from the likes of Hargreaves Lansdown, Brooks Macdonald, Serica Energy and Bioventix, I feel even more confident that 2023's income will exceed 2022's total of £31,104. That's a dividend income of more than 5.0 per cent of the portfolio value. It stays in the portfolio, is reinvested and contributes to the long-term compounding of returns. On a longer view, it is good that the market is lowly valued – it allows me to reinvest the dividends at eye-catching valuations.

Outlook

“Summer days are over; summer work is done. Harvests have been gathered, gayly, one by one.” Hopefully, with everyone returning to work after the summer, we can look forward with greater optimism. Interest rates are the key. We are at or near the peak of the current interest rate cycle and once the market senses the next move in rates is down, equity markets can make progress. Soon, I think, investors will look further out to an improving economic background. Nowhere more than the UK are markets discounting such a dire outcome. Hopefully, my improved performance since the end of May is just a taster of better returns ahead. Returning to James Henderson and bear markets – eventually bear markets fizzle out and a new bull market begins but no one rings the proverbial bell. It just happens because valuations become so attractive and at the margin investors become a little less pessimistic.