Ranking by risk and reward

US equity indices were off around -2.0 per cent, as was the German DAX.  

The Nikkei 225 gave up -3.8 per cent and Russia -4.9 per cent, not helped by a fall in the oil price; Brent crude was off -7.9 per cent to $57.47 per barrel. In Hong Kong, against the background of ongoing protests, the Hang Seng fell -7.4 per cent but China was relatively unscathed. The China A All Share was down just -1.0 per cent and at +22.6 per cent, is the best-performing major equity market this year. Another bright spot was nickel, up 23.8 per cent on the month and 67 per cent this year.

In the UK, with 31 October rapidly approaching and a new government in place, markets fretted about what a “no-deal” Brexit would mean for the economy. The FTSE All-Share (Total Return) Index was off -3.6 per cent but within that, the FTSE 100 was down -5.0 per cent. The FTSE Aim All-Share was down -6.4 per cent, not helped by the more than halving of its largest company, Burford Capital (BUR) after the publication of a report by short-seller Muddy Waters.

Performance

After July’s fireworks, it was perhaps inevitable that the JIC Portfolio would pause for breath, especially given the market background. The JIC Portfolio’s fall of -2.2 per cent left it up 23.0 per cent this year, compared with +11.1 per cent for the All-Share. Since inception in January 2012, the JIC Portfolio is up 202.7 per cent (+15.5 per cent annualised) comparing favourably with +84.1 per cent (+8.3 per cent annualised) for the FTSE All-Share.

First the positives. Anglo Asian Mining (AAZ) was up 27.3 per cent, helped by both a rising gold price and the news that the Azerbaijani government had engaged consultants to advise it on acquiring the company. The Azerbaijani government presumably believes that it is a good time to be increasing its exposure to gold. Not only does the outlook for the gold price look bright, but Anglo Asian has significant reserves and the potential to increase production. I’m holding tight in the hope that management can realise a fair price for the assets. Avast (AVST), the FTSE 250 provider of anti-virus software and other cybersecurity products, was up 13.0 per cent following the publication of strong half-year results. Earnings forecasts for the full year edged up by around 3.0 per cent, leaving the shares on a price/earnings ratio of 15.2 times for calendar 2019. That looks attractive to me for 15.9 per cent growth, especially as it is such a highly cash-generative business model. It is valued at just 12 times free cash flow. The third holding worth a mention is the L&G Gold Mining ETF (AUCO), which benefited from the robust gold price, gaining 9.3 per cent on the month. All three holdings mentioned above were added to the Portfolio during May and June and, as I write, are up 58 per cent, 16 per cent and 14 per cent, respectively.

Now to the stocks that were a drag on performance. Tremor International’s (TRMR) share price continued its rollercoaster-like performance; after gaining 60 per cent in July it fell 19.5 per cent in August. There was no news from the company; that is coming later this month when it publishes its half-year results. If they show the company is performing well, it could, given the current cheap valuation, be due a strong run. It is currently valued at just 4.3 times 2019 earnings forecasts and 6.7 times free cash flow. Syncona (SYNC) fell 9.1 per cent, with its holding in Nasdaq listing Autolus (US:AUTL) proving a drag. Hopefully Autolus’s weak share price will prove temporary and the stock will recover once the overhang from Neil Woodford’s holding is resolved. Finally, Rockrose (RRE) gave up some of July’s stellar gains, falling -9.0 per cent. Given that it is my largest position, it would have contributed getting on for half of the -2.2 per cent fall in the Portfolio. I think it looks very attractive given it is trading pretty much at the value of cash on its balance sheet; a cash pile that is growing by the day.

Recent activity

After a very quiet July with no trades, I was a little more active in August with eight trades in total; I sold three positions completely, reduced two and added to three. On 13 August, I sold my positions in Central Asia Metals (CAML) (190.5p) and Diversified Gas & Oil (DGOC), (96.4p). In both cases, I had set stop-loss levels which were hit. I felt comfortable reducing my exposure to natural resources in the face of mounting evidence of a global slowdown. They both looked attractive from a dividend yield perspective, but that did not seem to be providing support. On 15 August, I sold my smallish position in India Capital Growth Fund (IGC), (75.13p). I held it for nearly three years and unfortunately it had not added any value to my portfolio. I simply thought I could deploy the money better elsewhere. I added to the L&G Gold Mining ETF on 13 August at 2,464p, taking the position to 5.0 per cent. Two days later, following Avast’s half-year results, I increased the position to 4.0 per cent at 343p and on 22 August, following Anglo Pacific’s (APF) half-year results, I increased the position back up to 4.0 per cent (194.5p). Anglo Pacific recorded a strong first half, with revenue up 60 per cent year on year and adjusted earnings up 42 per cent. Cash generated increased by 78 per cent to £26.6m so that it repaid its borrowings and had a net cash position of £14.5m at 30 June. It said that, subject to market conditions, it expected to pay a minimum dividend of 9.0p for 2019. That compared with market forecasts of 8.0p and left the stock on a prospective yield of 4.9 per cent. On 28 August I reduced two positions, Tremor International (157.5) and Altitude (ALT) (100p) to 2.5 per cent each. More on the rationale for those sales later.

Excellent investing

After reading 100 Baggers by Christopher Mayer during July, in August I turned to Excellent Investing: How to Build a Winning Portfolio by Mark Simpson. I think it is a well-written investment book with plenty of sensible advice on picking stocks and building a portfolio. I particularly enjoyed the section on portfolio construction. I think intuitively we all tend to look at the risk/reward we expect from a stock, but he proposes a more disciplined way of matching one’s exposure to an individual stock to the expected risk/reward. He ranks stocks on risk, defined as potential downside, as low, medium or high and on reward (potential gain), also as high, medium or low.  The most attractive investments would clearly be low risk/high reward into which he would invest a whole 'unit'. Medium risk/high reward and low risk/medium reward would have target weightings of two-thirds of a 'unit'. Finally, high risk/high reward would have a target weighting of one-third of a 'unit' as would medium risk/medium reward. If the expected reward was low, one simply wouldn’t hold it at all, whatever the risk. The size of a 'unit' is left to the individual investor to determine, based on their risk tolerance.

I analysed the JIC Portfolio using these measures and in the portfolio table below there are two new columns ranking each stock on risk and reward. I also decided that I was happy with a unit size of 7.5 per cent of the Portfolio. This leads to three target weightings of 7.5 per cent, 5.0 per cent or 2.5 per cent. There is a degree of subjectivity involved as although for instance, I have ranked Games Workshop (GAW) as low risk due to its strong balance sheet and cash flow, some might argue it should be medium risk. I ranked Games Workshop medium reward because I think the current valuation does not leave enough upside over the next year to merit it being ranked high reward. I know some will disagree with that. One of the benefits of this approach is that it provides a good point of discussion. Rockrose Energy is the only stock I currently judge as low risk/high reward. With it trading at less than cash on the balance sheet, I think low risk is appropriate and with strong cash flow, (a dividend is likely) and further value-enhancing deals to come, I am happy to give it a high reward ranking.

Back to those sales of Tremor International and Altitude. I judged both stocks as high risk/high return and therefore reduced both positions to move them in line with target weightings of 2.5 per cent. Tremor International looks cheap, hence the high reward. If it proves that the problems of the last year are behind it, then I will have no hesitation in moving the risk from high to medium, thus increasing the target weighting to 5.0 per cent. Altitude also looks potentially cheap but before I can lower the risk rating from high to medium, it needs to demonstrate unequivocally that its business model is working. Last week’s 45 per cent fall in the share price vindicates that reduction, although of course, it would have been better if I hadn’t held any at all.

Each time I review a stock, I plan to refer to my risk/reward rating and consider whether it is still appropriate. If I make a change, I will justify why. Hopefully, it will result in a more disciplined approach and ultimately higher returns for the portfolio as a whole.

Looking forward

It definitely feels like a time to tread more cautiously. True, UK equities look good value, and, in the US, it is not often that the S&P 500 yields more than the US Treasury 10 Year bond but slowing growth and negative bond yields are concerning. I have maintained my overseas exposure in case sterling takes another dive on Brexit and what looks like an imminent general election. At 31 August, my exposure to gold was over 10.0 per cent, through Anglo Asian Mining and the L&G Gold Mining ETF. I have this month, increased that further through the ETFS Physical Gold ETF (PHGP).