Private Investor Diary: My 10-stock experiment

Government bonds stabilised after a sharp sell-off in late June/early July, with the US 10-year Treasury yield at 2.3 per cent and the UK 10-year yield falling a tad, to 1.23 per cent. Much to the market’s surprise oil rallied, with Brent Crude up 7.5 per cent and finishing the month back above $50 per barrel. Gold also had a better month, up 2.6 per cent to $1,273 an ounce.

JIC Portfolio Performance

A good month for the JIC Portfolio and it is pleasing to see it finish the month at an all-time high and achieve the milestone of a 150 per cent gain since inception in January 2012. During July, the portfolio was up 3.7 per cent, nicely ahead of the 1.2 per cent rise of the FTSE All-Share. Since 1 January it is up 18.1 per cent, well ahead of the All-Share’s 6.7 per cent and since inception in January 2012 it has gained 150.8 per cent (an annualised return of +17.9 per cent) versus 72.7 per cent (+10.3 per cent annualised) for the index.

While my performance in 2016 was hurt by a lack of FTSE 100 exposure, this year I have benefited from the better performance of mid- and small-cap companies. However, since 1 January the portfolio’s performance stands up well against the FTSE 250 return of +11.2 per cent, the FTSE Small Cap return of +10.8 per cent and the Aim All-Share’s +16.5 per cent return.

Performance was achieved through a few strong winners, which happened to be among the largest positions in the portfolio and, luckily, the absence of disasters. Conviviality (CVR), the drinks distribution company, now my largest position, was up 24.9 per cent, following excellent results mid-month which included a 33 per cent increase in the dividend. AdEPT Telecom (ADT) was up 10.2 per cent, helped again by strong results and a 19.2 per cent dividend hike. The market responded well to a trading update from Avation (AVAP), the aircraft leasing company, which included an 85 per cent increase in the dividend. There seems to be a lot of scepticism about this company but it is delivering strong growth and it's pleasing to see my faith in it being rewarded at last. It was up 9.8 per cent during the month, making 22.5 per cent this year. Statpro (SOG), unfortunately my smallest holding given its performance, was up 15.6 per cent on further consideration of its acquisition of UBS Delta in April.

As I said, no real disasters, with Accrol (ACRL) the worst performer. It gave up 9.9 per cent following results in early July. The results from this Lancashire-based manufacturer of own-label tissue products were good. This year, however, it needs to force through price increases to make up for the currency-related cost hikes it is incurring. Those conversations with the big supermarkets are never easy. In its favour, it is growing market share, especially with the discounters such as Lidl, and should also benefit from trading down as the squeeze on consumer spending bites. The shares of this well-managed company look cheap; on consensus forecasts for the current year ending April 2018, the shares are valued at 11.1 times for 27 per cent forecast earnings growth and a prospective dividend yield of 5.3 per cent. Once the market gains confidence that it has managed to push through price increases and current forecasts are safe, the shares should start to perform again. I’m sticking with it.

Number of holdings

In June, I attended a presentation by a hugely successful private investor, an Isa millionaire, (several times over). The presenter, clearly a believer in the Warren Buffett approach of holding a few eggs in your basket and watching it very closely, had well over 25 per cent of the portfolio in his largest position; a position that has grown through fantastic performance and his averaging up on four or five occasions. That presentation got me thinking. Do I have too many holdings and am I holding my performance back with a lack of focus on my highest conviction ideas? You only need to search the internet for articles on what the ideal number of stocks is in a portfolio, to see a huge range of opinions. Only two weeks ago, Todd Wenning explored this very subject in this publication. Some believe that once one holds more than 10 stocks, the additional diversification benefits are minimal. At the other end of the spectrum, others point to academic studies that show, even with 100 stocks in a portfolio, performance can still deviate significantly from the benchmark.

It is informative to look at the approach of a few well-known UK investors. At 30 June, Neil Woodford’s UK Equity Income Fund contained no less than 135 holdings. The largest 10 positions however, added up to 42 per cent. Stock number 28 was less than 1.0 per cent of the portfolio and the 29 smallest positions comprised just 1.0 per cent of the portfolio in total. Clearly, Mr Woodford has found this approach successful; presumably, the larger, safer holdings provide steady growth and income while the smaller holdings have the potential to boost overall portfolio growth. While there will be some failures in the bottom 60 or so stocks there will be some multi-baggers to which, no doubt, he adds.

Another successful investor, Mark Slater, holds up to 50 stocks in the MFM Slater Growth Fund (GB00B7T0G907), with the top 10 stocks again comprising 42 per cent of the portfolio. At a presentation I attended in March 2015, Mr Slater said that if he was managing a private portfolio, “personally there was a strong argument for having only 5-10 holdings”. I took that as meaning private investors have the advantage of being able to sell out of a stock quickly if they need to. It’s not so easy with a large fund, especially when dealing in small- and mid-cap companies. Terry Smith’s Fundsmith Equity Fund holds only 29 stocks in total with the top 10 comprising around 46 per cent and, last of all, Nick Train of Finsbury Growth and Income Trust (FGT) holds just 25 stocks, with a huge 74.8 per cent in his top 10.

Unsurprisingly, it seems that the concentration of the portfolio in the largest holdings is more important than the total number of holdings.  After all, these are the real drivers of performance. Apart from Nick Train, with his 74.8 per cent, the other three have a similar concentration in their largest 10 holdings.

I tend to hold between 20 and 30 stocks, believing it gives me a reasonable balance between the risk of focusing on too few stocks, (very high volatility), and having so many that any individual stock has little impact on the whole portfolio.  As of 31 July, the JIC Portfolio has 30 holdings, seven of which are investment trusts. I have concluded that I could live with the risk of concentrating more of my resources on my best ideas. Consequently, in the last month or so I have added to Conviviality, Bioventix (BVXP), Avation and XLMedia (XLM), increasing the proportion in the largest 10 positions to 55.7 per cent. I anticipate increasing this to 60 per cent or more. I prefer not to hold many 'sleepers'; stocks that I think will come good at some stage in the future. Ideally, all holdings would be contributing to performance. I often start a position with a weighting of around 1-2 per cent. If the stock starts to perform as I hoped, and as I get to know it better, I add. Current Top 10 holdings, Conviviality, Bioventix, AdEPT Telecom, Avation and XLMedia all started as 1.0 per cent to 2.5 per cent holdings.

Naturally, my largest positions will comprise those stocks where I have a high conviction that the upside I am expecting will be realised. Coupled with this, I try to assess what the downside might be if I’m wrong.  Currently, four of my largest 10 holdings are investment trusts, where my main risk is getting the theme wrong rather than individual stock risk. Sure, if continental European small- and mid-cap companies start to fall, TR European Growth (TRG) is unlikely to emerge unscathed; equally, it is highly unlikely that I will come in one morning and find it down 30 per cent due to a profit warning. The same goes for Fidelity Asian Values (FAS), Baillie Gifford Shin Nippon (BGS), Biotech Growth Trust (BIOG) and my other investment trust holdings.

To conclude, I don’t think there is a right or wrong answer to the number of positions one holds. It’s all about judgement, what one is aiming to achieve and ultimately, what one feels comfortable with.

Nearly three years ago, as an experiment I started a 10 stock portfolio, the JIC Top 10. It’s still early days and the results have been mixed but it was encouraging to see it up 5.7 per cent in July and 19.3 per cent since the start of the year.

Activity

A busy month with two stocks sold completely and three new stocks added. I cut Serco (SRP) for a small loss and Imperial Brands (IMB) for a small profit (including dividends). The new holdings were Iomart (IOM), Bloomsbury Publishing (BMY) and Central Asia Metals (CAML). All three stocks have issued upbeat trading updates, generate oodles of free cash and are on attractive valuations. As mentioned earlier, I averaged up some of my larger positions, Conviviality, XLMedia, Bioventix and Avation and added to my holdings in Lloyds Banking (LLOY), Elegant Hotels (EHG) and Card Factory (CARD).

Looking Ahead

For much of this year I have expressed some caution about markets which thus far has proved unfounded. Luckily, I limited my cash position to a maximum of around 10 per cent before last month’s spending spree. If I had been fully invested, I estimate my overall return this year would be around 1.0 per cent higher in 2017, so not too damaging.

In the last month, US equity indices have powered on to new highs which should be a bullish sign; after all that is what equities are meant to do. It’s why we hold them. I am happy enough with my 18 per cent return this year, but I’m sure I could have done better. I have been reluctant to chase some of the popular, higher-growth stocks. Admittedly, on the back of strong trading, they have moved, in my opinion, to very stretched valuations. That’s fine but in the event of a correction, which will come, I think the falls could be quite painful. What starts as a little profit taking, turns into something more sinister as selling gathers pace and buyers stand on the sidelines waiting for valuations to fall to more tempting levels. My stocks would not be immune but with attractive valuations and, in the main, strong cash flow, I hope the damage will be limited. As Warren Buffett said: “Only when the tide goes out do you discover who has been swimming naked”. Without a meaningful correction for well over a year, I think it’s best to make sure I have my trunks on.