Private Investor's Diary: A high-quality addition to my portfolio

October was a miserable month for financial markets. Government bonds and equities both fell. It started with continued weakness in US Treasury bonds. Having ended September at 4.6 per cent, the US 10-year Treasury bond yield continued to rise into October. The horrifying events in Israel caused a brief rush to safety before the relentless march up in yields continued. On the morning of 23 October, the yield on the 10-year Treasury touched 5 per cent for the first time since 2007. That spurred Bill Ackman of Pershing Square into action. He tweeted that the company had closed its short position. He was joined by Bill Gross, who said he was buying Treasuries as he foresaw a looming US recession. Whether that was the catalyst or not, yields quickly retreated. Following the 1 November decision by the Federal Reserve to keep interest rates on hold, the 10-year Treasury yield had dropped back to 4.7 per cent. The pattern was similar in the UK and continental Europe: yields peaked mid-month before falling away.

It proved another difficult month for equity investors on both sides of the Atlantic. Major indices were under pressure before rallying in the last few days. The Nasdaq Composite was down 2.8 per cent, and the S&P 500 was down 2.1 per cent. Cracks started to appear in the ‘magnificent seven’ – Apple (US:AAPL), Microsoft (US:MSFT), Alphabet (US:G00GL), Amazon (US:AMZN), Nvidia (US:NVDA), Meta (US:META) and Tesla (US:TSLA). The S&P 500 fell 2.1 per cent over the month and was 10 per cent off its July high at one stage. This year, it is still up 10 per cent, but would be broadly flat without the seven tech stocks.

The UK was the worst performing of the major markets, with the continued outflow from equity funds exerting its toll. The FTSE All-Share Total Return (TR) Index was down 4.1 per cent. Worst still were the returns from mid and small caps. This is where the outflow of money, poor liquidity, and even an air of people giving up, hurt most. According to Calastone, investors withdrew another £1.2bn from equity funds in October, including £740mn from UK equity funds. This was the sixth successive month of net outflows from funds. The FTSE 250 was down 6.3 per cent, the Aim All-Share down 6.2 per cent and the FTSE Small Cap fell 6 per cent. On the continent, the CAC 40 was down 3.5 per cent and the Dax lost 3.7 per cent, although Italy's MIB was only down 1.4 per cent. In Asia, the Nikkei 225 was down 3.1 per cent, and the Hang Seng fell 3.9 per cent.

Talk of recession started to take hold with commodity prices falling. Zinc fell 8.2 per cent, aluminium 4.4 per cent, nickel 4 per cent and copper 1.9 per cent. On the back of the terrorist attacks in Israel, Brent oil rallied to $95 per barrel before falling back to $85. The market is taking an optimistic view about the risk of the conflict escalating outside Israel and Gaza’s borders.

Gold rose 6.8 per cent to $1,996 per ounce (oz), and Bitcoin leapt 28.8 per cent to $34,665, showing themselves to be havens.

Performance

My two portfolios are having a challenging time. The JIC Portfolio was down 5.4 per cent in October. It was the twelfth worst monthly return out of 142 months since inception in January 2012. Unfortunately, three of those 12 occurred this year, so the year-to-date return is minus 13.6 per cent. The FTSE All-Share is up 0.3 per cent this year. Since its inception in January 2012, the JIC Portfolio has gained 271.1 per cent, equivalent to an annualised growth of 11.7 per cent. In contrast, the FTSE All-Share (TR) Index is up 111.9 per cent, with an annualised gain of 6.6 per cent. Over one year, the JIC Portfolio is down 7.2 per cent versus a 5.9 per cent gain for the index, and over five years, JIC is up 45.5 per cent versus a 21.1 per cent rise.

The Funds Portfolio was down 5.1 per cent compared with a 2.4 per cent drop in the FTSE All-World (GBP, TR) Index over the month. Apart from VT Argonaut Absolute Return Fund (GB00B7FT1K78), up 7.4 per cent, BH Macro (BHMG), up 2.3 per cent, the other 12 positions were down. They succumbed to the drop in mid- and small-cap and commodities. Since this portfolio's inception in June 2020, it is up 17.6 per cent versus 30.1 per cent for the All-World.

In the JIC Portfolio, only three of my 20 positions were up. PayPoint (PAY), added to the portfolio on 11 October at 515p, gained 2.1 per cent. IG Design (IGR), courtesy of a 38 per cent rally in the last few days, was up 1.4 per cent, and Renew Holdings (RNWH) gained 0.6 per cent. IG Design rallied in response to a half-year update. It confirmed that it had achieved “significant growth in profit and margins for the six months ended 30 September”. It added that “net debt was significantly lower than a year ago, reflecting strong cash flow”. “Both measures were notably ahead of management’s expectations for the period.” Canaccord Genuity issued a note that valued the company at 12.4 times earnings the current year ending March 2024. More importantly, it expects it to recommence paying a dividend in the following year to March 2025. Even after the rally in the share price, that leaves the stock at 150.5p, on a March 2025 price/earnings (PE) ratio of 5.9 times and a dividend yield of 6.4 per cent. Management is doing an excellent job of restoring the business to profitability. The jump in the share price suggests expectations were at rock bottom. I don’t think it is the only stock in my portfolio where some good news will spark a sharp recovery in the share price.

At the bottom of the performance table were some of my mining companies. Ecora Resources (ECOR) was down 19.9 per cent, and BlackRock World Mining (BRWM) fell 8.6 per cent. Sylvania Platinum (SLP) was off 8.9 per cent, although most of the fall was due to it going ex-dividend on 26 October. If government bond yields have peaked for this cycle, there will likely be better times ahead for commodity stocks. Valuations are attractive, and the underlying demand growth from the transition towards a net zero world remains. Just this month, Danish wind company Ørsted (DK:ORSTED) saw its share price fall 20 per cent (down 80 per cent from its 2021 high) as higher costs are making its projects unprofitable. Either governments give up on the move to net zero or increase subsidies for renewable projects. Consumers will pay for it somehow, but most probably through their bills. In any case, the demand for raw materials such as steel and copper will increase – as will all the energy required to mine the stuff.

Me Group International (MEGP) was down 11.2 per cent. I’m unsure why, except perhaps profit-taking after an excellent three-year performance. I expect an update from the company in the next week or so. Polar Capital (POLR) was down 10.3 per cent. I guess the market background wasn’t favourable for asset managers. Assets under management on 30 September were down slightly since 31 March, and performance fees ran lower than a year ago. Results were due to be published on 20 November. I expect it to maintain the half-year dividend of 14.0p. If forecasts are met for the full-year dividend to March 2024, the shares, at 424p, are on a prospective yield of 10.8 per cent. It won’t need much of a change in sentiment and fund flows to see a good move in the share price.

NextEnergy Solar Fund (NESF) was down 9.9 per cent. It has been hit, along with other renewable funds, by the increase in interest rates. This increases the cost of capital for new projects, and with 10-year gilt yields above 4 per cent, investors chasing yield have another choice for their money. It plans to pay four 2.09p quarterly dividends, making a total of 8.35p, up 11 per cent on last year. That it confirmed its second quarterly dividend for the year of 2.09p, ex on 16 November, gives me confidence.

I look forward to hearing more about the half-year results on 22 November. In the meantime, at 78.8p, it is on a prospective yield of 10.6 per cent.

Activity

I added PayPoint to the portfolio on 11 October after the close of trading. I only had enough cash to buy a 0.7 per cent position, but I will add to it when possible. PayPoint appeared on my 'screen' for high-quality companies (return on capital employed, consistent growth in free cash flow and a high cash return on invested capital) trading at a cheap valuation (based on price to free cash flow, a low PE ratio and high yield.) PayPoint achieves a return on capital in the high twenties and a return on equity in the mid-30s. It is on a prospective PE ratio of 8.5 times and a yield of 7.7 per cent. Not only that, but forecasts have been upgraded several times since July. That month, earnings were forecast at 55.6p for the year ending March 2024. Predictions are now 8.5 per cent higher at 60.3p. It is not quite what renowned private investor Lord Lee calls a double seven (a PE ratio of less than seven times and yield above 7 per cent), but it's close. Interim results are due on 23 November.

On 18 October, I reduced Sylvania Platinum to my target weight of 5 per cent at 86p. The shares had run up nicely since the lows of August. It was an opportunistic sale of the shares I added in July and August at 70p and 73.5p, respectively. With the proceeds, I added to Bioventix (BVXP) at 3,500p, taking it up to my target weight of 7.5 per cent, to Polar Capital at 401.6p (up to 5 per cent) and to NextEnergy Solar Fund at 77.8p, also to 5 per cent.

For another month, there were no trades in the Funds Portfolio.

Other news

Renew Holdings issued a short and sweet update on 2 October, with results coming later in November. Shoe Zone (SHOE) issued a tremendous update for the year ended 30 September, leading to 20 per cent upgrades to earnings forecasts – results are in January. Hargreaves Lansdown (HL) issued an update for its first quarter ending 30 September, which showed revenue up 13 per cent year on year. The market wasn’t happy that the revenue increase was due to higher returns on cash holdings, masking a fall in trading volumes. At some stage, those volumes will pick up. Bloomsbury Publishing's (BMY) first-half results to 31 August were solid, with the consumer division producing 17 per cent revenue growth and 26 per cent profit growth. Nigel Newton, founder and CEO, pointed to a more even seasonal balance to the business. He said it was happy with current forecasts for the entire year. Achieving the current estimates for  turnover of £273mn would require second-half revenue of £135.7m, lower than last year’s £141.2m. I think there is scope for upgrades. On 30 October, Bioventix published results for the year ending 30 June. The final dividend was increased by 20 per cent, taking the year's total to 152p. Last year, it paid 152p, but that included a special dividend. There was a slight disappointment that there was no special this year, but the company likes to keep a cash balance of at least £5mn. Nevertheless, 152p gives a yield of 4.2 per cent at 3,625p. That's not bad for such a high-quality company.

Seasonal investing

October saw the end of another 'summer period' – the six months from 1 May to 31 October. Plenty of evidence shows that most money is made during the six-month winter period ending 30 April. As the table below shows, my experience with the JIC Portfolio backs that up.

The average return of the JIC Portfolio in winter is 8.9 per cent, well ahead of the 3.7 per cent in the summer. The last six months have not helped the cause. In all but two cases, the six months of winter are better than the following six months of summer. Hopefully, given where we are starting, with sentiment and valuations at a low ebb and with interest rates peaking, the next six months will be a reward for the agony of the last two years. I believe the start of a six-month 20 per cent plus return or an annual 30 per cent plus return is close. In the meantime, as the dividend update below shows, I will collect dividends at juicy yields and reinvest the proceeds.

Dividend update

With BlackRock World Mining, Harbour Energy (HBR), Ecora Resources, and IG Group (IGG) paying dividends in October, this year's total received amounts to £27,367. With those announced and due to be paid by 31 December, the count rises to £35,395. That is some 13.8 per cent up on last year. The £35,385 amounts to a yield on the portfolio of 6.3 per cent at its current value.

Outlook

There was no let-up to the long grind downward in October, but there are reasons to be optimistic. Inflation has moderated and should make further downward progress. On this front, the UK has lagged the US and continental Europe, but much of this was self-inflicted due to how the UK managed the increase and subsequent fall in energy prices through the energy price cap. It lagged on the way up and is lagging on the way down. Last week’s publication of October’s inflation data was most welcome; it fell sharply to 4.6 per cent. On top of this, we are starting to see companies cutting staff numbers. For example, among my holdings, IG Group recently announced it is cutting 10 per cent of its workforce or 300 people. Given these factors, the Bank of England likely has raised interest rates for the last time this cycle. The governor is still talking tough, but if there is more evidence of a slowdown in the economy, his tone will quickly change. I reckon it's not a bad bet that the first rate cut will come before the end of March. Another factor that may help UK equities is the chancellor’s drive to boost investment in UK stocks. There is speculation that he will announce measures with the Autumn Statement on 22 November. At the time of writing, we don’t know what is coming – it may prove to be tinkering with the current individual savings accounts (Isa) rules or something more substantial. But it might not need much to change sentiment towards mid-cap and smaller companies.

I understand why many are abandoning equities for the security of holding cash, especially when one can fix at nearly 6 per cent for a year. There is also a strong case for having a cash holding for emergencies. Everyone has their requirements and risk tolerances. I, however, am happy to take the risk of the JIC Portfolio (my self-invested personal pension and Isa) being fully invested. I’m receiving a 6.3 per cent dividend return in my portfolio this year. Next year, I expect the total dividend received to grow faster than inflation, and I expect the capital value to have recovered somewhat. Eventually, net outflows from funds will pivot to net inflows.