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Heatmap shows up volatility (and hard workers)

John Rosier identifies areas of volatility in the portfolio but notes that reducing these holdings would impact returns
October 3, 2019

All in all, a pretty good month for financial markets, with equities making further gains. It was the best first three quarters of a year for the S&P 500 in over 20 years. One has to go back to 1997 when the dotcom bubble was in its infancy to see a better first nine months. Markets became a little more optimistic about the outlook for global economic growth. It seems that central banks will do whatever it takes to boost growth. The European Central Bank (ECB), Japanese Central Bank and the Federal Reserve reduced interest rates. (The UK remains one of a handful of countries where the last interest rate move was a hike.)

In the US, the US 10-year Treasury fell, leading to its yield rising from 1.5 per cent to 1.69 per cent over the month. Whether this is a temporary respite in a downward trend remains to be seen. This renewed optimism saw industrial metals such as copper and zinc make gains, but gold – a traditional haven in uncertain times – had a weak month. It fell by -3.7 per cent to $1,473 an ounce. It is, however, still up 15 per cent this year.

 

Performance

Following the JIC portfolio's return of +8.6 per cent in July, the JIC Portfolio has endured two miserable months. The value of the JIC portfolio fell -2.2 per cent in August and a further -0.4 per cent in September. That leaves it up 22.4 per cent in 2019 compared with +14.4 per cent for the FTSE All-Share. Since inception in January 2012, it is up 201.4 per cent (+15.3 per cent annualised) comparing favourably with the +89.6 per cent return from the FTSE All-Share (+8.6 per cent annualised).

My two North Sea oil and gas holdings, Serica Energy (SQZ) and Rockrose Energy (RRE) were the two standout performers. Since coming back from suspension in July, Rockrose has seen steady selling from two of its original backers. Cavendish Asset Management held a 14.5 per cent stake and Macquarrie held 5.9 per cent. Given the more than doubling of the share price on return from suspension, those holdings probably became too large. For Cavendish especially, reducing the position was prudent. During August, there was a growing appreciation of the cheap valuation, robust cash flow and prospects of further value-enhancing deals. Half-year results showed that it had unrestricted cash (cash not required to meet future decommissioning liabilities) of £225m, or 90 per cent of the current market capitalisation. It also announced a half-year dividend of 60p and a proposed final dividend of 25p, making 85p for the year, giving a 4.5 per cent dividend yield. The cost of paying that dividend is only £11m and, given its financial strength, it could have afforded a much higher payment. That it didn't increased speculation that it was keeping its powder dry for another North Sea deal. Rockrose was up +12.4 per cent during September. Serica Energy's +18.8 per cent gain bettered that. No dividend from Serica yet, but its results on the same day as Rockrose showed what a well-managed business it is. Serica increased production in the first half to 31,000 barrels oil equivalent per day, (boepd) compared with 26,000 boepd in the previous year.

What's more, it reduced field operating costs per boe, (barrel of oil equivalent) by 30 per cent, reflecting both higher production and a lower cost base. At mid-year, it had more than doubled cash deposits to £88.2m and had no debt. It generates loads of cash, with my calculations suggesting that if it maintains production at 31,000 boepd in the second half and an operating margin of £16.80, that is £520,000 per day or £94m for the half year. As with Rockrose, another North Sea deal is highly likely. I eagerly await news from both companies.

Within equities, Japan gained +5.1 per cent. Continental European markets responded to the apparent determination of the ECB to support growth; the Dax was up +4.1 per cent and the CAC 40, +3.6 per cent. In the US, the trade war with China continues, with little outward signs of progress on trade talks. The impeachment of President Trump is looking increasingly likely. Neither of these events had much impact, with the S&P 500 up +1.7 per cent. Politics again hogged the headlines in the UK. A growing belief that Parliament will not allow the UK to leave the European Union without a deal on 31 October might have been behind sterling's strength against the US dollar (+0.9 per cent) and euro (+2.3 per cent). The FTSE All-Share (Total Return) Index was up +3.0 per cent, but FTSE Small Cap and FTSE Aim All-Share were up only +1.7 per cent and +0.2 per cent, respectively. If a no-deal Brexit was less likely, one might expect UK sensitive small-cap stocks to have done a little better.

Games Workshop (GAW) gained +7.8 per cent, following a reassuring update and the announcement of a further 35p dividend; its policy is to "distribute truly surplus cash". Baillie Gifford Shin Nippon (BGS) was up +6.2 per cent and Anglo Pacific (APF) up +5.1 per cent.

On the downside, Anglo Asian Mining (AAZ) fell -11.2 per cent. Despite a decent first half and an increase in the half-year dividend, the shares fell with the weaker gold price. Tremor International (TRMR) fell -10.3 per cent after saying that full-year results were expected to be "marginally behind full-year expectations". In August, I reduced the position to 2.5 per cent in line with my high risk/high return rating for the stock. I'm glad I did that and at this stage see no reason to change my judgement of its risk/reward. Cash flow remains robust, and at 30 June it had net cash of $66.5m, up from $54.5m on 31 December. The increase in cash was despite spending $18.9m on share buybacks. The L&G Gold Mining ETF (AUCO) fell -10.3 per cent on the back of the weaker gold price, and Biotech Growth Trust (BIOG) was off -9.8 per cent.

With three quarters of the year completed, Statpro's Revolution system calculates the contributors to the +22.4 per cent portfolio gain. The most substantial positives have been Rockrose Energy +6.7 per cent, Anglo Asian Mining +2.4 per cent and Games Workshop +1.8 per cent. At the other end, U+I (UAI) (no longer held) hit performance to the tune of -0.9 per cent, Syncona (SYNC) -0.5 per cent and Altitude (ALT) -0.5 per cent.

 

I started September with a poorly timed purchase of Wisdomtree Physical Gold ETF (PHAU.L), paying £12.08 a share on 5 September. On 18 September, I added to Games Workshop at 4,731p, buying back the shares I sold in June at 5,105p. On 19 September, I grasped the nettle and sold my remaining position in Altitude for a loss. The trading update on 5 September was disappointing. While I judge it high risk/high reward, the company needs to do more to demonstrate the reward will come. Who knows, I might return to it someday. I reduced my rating on Scottish Mortgage Trust (SMT) to medium risk/medium return, and thus the position to 2.5 per cent on 26 September at 505p. Given the high valuations of growth stocks, a high return over the next 12 months seems less likely.  

 

Recent activity

In what was an opportunistic move, I added Sylvania Platinum (SLP) at 36.5p on 19 September. It had fallen 20 per cent from its August peak to its 50-day moving average. It has a strong balance sheet with steady cash flow and at my purchase price was on an attractive prospective June 2020 dividend yield of 4.5 per cent. I rank it as high risk/high return and therefore bought a 2.5 per cent position. Although the financials are healthy, it is subject to the vagaries of the platinum price, hence the high risk.

 

Risk

With nearly eight years of history for the JIC Portfolio, I have analysed its returns using Statpro's Revolution. It shows the annualised volatility of the JIC Portfolio at 11.3 per cent, which is slightly higher than the 9.8 per cent for the FTSE All-Share over the same period. The annualised return of the JIC Portfolio has of course been much higher, +15.3 per cent versus +8.6 per cent. The Sharpe ratio is a measure of excess performance over and above the risk-free rate, taking volatility into account. A high Sharpe ratio indicates a good return relative to the observed volatility of the portfolio. The higher, the better. Over the near nine years, the JIC Portfolio has a Sharpe ratio of 1.33 compared with 0.75 for the FTSE All-Share. The higher Sharpe shows that despite being slightly more volatile than the FTSE All-Share, the JIC Portfolio has more than made up for it with higher returns. The worst monthly performance for the JIC Portfolio was -8.4 per cent, back in May 2012, compared with the worst month for the FTSE All-Share of -7.2 per cent. The maximum fall of the portfolio from its high point was -11.4 per cent, whereas for the FTSE All-Share it was -12.2 per cent. 70.6 per cent of the months were positive for the JIC Portfolio versus 62 per cent for the FTSE All-Share. Where this leaves me, I don't know, although more of the same would be fine.

Statpro also calculates a 'value at risk' for the JIC Portfolio. It measures the likely loss on the portfolio over one day, given normal market conditions. It estimates that 95 per cent of the time, the daily return from the JIC Portfolio should be no worse than -1.09 per cent. There is currently little difference between that and the FTSE All-Share, at -1.13 per cent. A heat-map indicates what each of my holdings is contributing to the value at risk of the JIC Portfolio. The most significant contributors are Tremor International +5.9 per cent, Anglo Asian Mining +4.8 per cent and Serica Energy +4.5 per cent. The smallest contributors are cash at 0 per cent, followed by the ETFS Physical Gold ETF (PHGP) +1.1 per cent and Worldwide Healthcare Trust (WWH) at +1.8 per cent. If I wanted to reduce the volatility of the JIC Portfolio, I should sell Tremor International, Serica Energy and Anglo Asian Mining and add to cash. That should reduce the volatility of the portfolio, but may also impact my returns. Ultimately, it is about achieving a balance with which one is comfortable. The 'heat map' is useful in making sure one is fully aware which stocks are contributing most to the volatility of the overall portfolio.

 

Looking Forward

There are plenty of things to worry about; Brexit, an imminent general election, high debt levels, trade wars and presidential impeachment. The one big positive for equities is the concerted monetary easing around the world. I have become a little more cautious over the summer months, with the introduction of gold to the portfolio, through Anglo Asian Mining, L&G Gold Mining ETF and Wisdomtree ETFS Physical Gold ETF. I have focused on companies that should benefit from further sterling weakness and are not wholly reliant on the UK economy. For the time being, I am happy with that position. I only wish I had joined some of my friends who are in Japan for the Rugby World Cup. Not just for the rugby, but to get away from the current grim politics, which looks like it will only get worse over the next month. 

NameEPICMkt capRisk  low, med, highReward  low, medium, high% of portfolioYield (forecast)
       
Rockrose EnergyRRE261.2LH9.54.4
Anglo Asian MiningAAZ168.2MH5.64.8
Baillie Gifford Shin NipponBGS508.8MH5.4 
Worldwide Healthcare TrustWWH1,401.3LM4.7 
Serica EnergySQZ361.2MH4.6 
AvastAVST3,804.7MH4.62.8
Duke RoyaltyDUKE95.9MH4.56.8
Biotech Growth Trust (The)BIOG319.2MH4.5 
L&G Gold Mining UCITS ETFAUCO MH4.5 
StrixKETL323LM4.44.6
Anglo PacificAPF357.5MH4.34.7
BioventixBVXP192.6LM4.32.0
Games WorkshopGAW1,534.1LM4.23.2
Scientific Digital ImagingSDI51.1MH3.9 
Bloomsbury PublishingBMY180.8MM3.83.5
TR European Growth TrustTRG432.4MH3.82.4
SynconaSYNC1,466.7MH3.4 
Robo-Stox Global Robotics and Automation GO UCITS ETFROBG MM2.8 
Wisdomtree Metal Securities Limited ETFS PHYSICAL GOLDPHAU LM2.8 
AdEPT TechnologyADT83.2MM2.73.0
Sylvania Platinum SLP108.1HH2.64.8
Scottish Mortgage Investment TrustSMT7,475.9MM2.50.6
Cash depositCD LL2.5 
Tremor InternationalTRMR165HH2.1 
Vietnam Enterprise InvestmentsVEIL1,099MM1.7