Well I’m glad to see the back of 2020, a year in which the world truly went to shit. Given the catastrophic hit to GDP, it’s surprising that 2020 turned out to be a very decent year for investors who managed to keep a level head. My overall return for 2020 came in at 34.1%, exceeding my long term average. All in all I’m happy with this result, but I was a bit lucky to be honest.
The events of this year have thrown up a few broader points for investors that I think are worth highlighting. One is the precedent set by the use of such interventionist government policies. Much of the world’s population have faced restrictions on working, socialising and in some cases even leaving their homes for the better part of a year. Before we went into this crisis there was a widely-held consensus that such policies were the preserve of authoritarian regimes like China and would not be accepted in western societies. This consensus has been shattered as lockdowns have turned out to be surprisingly popular. I expect the consequences of this paradigm shift to be wider than responses to health emergencies.
The pandemic has also cast a spotlight on the information war that has been developing in recent years. Opposing views on the correct response to the pandemic are supported by differences in understanding of the empirical evidence out there. However, these differences are not being resolved effectively by public debate. Instead there seems to be an increasing desire for there to be a single controlled narrative and for opposing views to be marginalised or censored on the basis that is is ‘harmful’ for citizens to encounter information that challenges the moral consensus. While the stock market has generally been pretty effective at dispassionately aggregating different views and information, I think there is good chance of this being diminished. There may be some interesting opportunities for more contrarian investors in the years to come.
Many governments have spent and borrowed huge amounts in order to mitigate the economic harms that lockdowns have caused. So far this seems to have been successful in keeping economies intact and the consensus seems to be that it has been worth it. But looking forward I’m not sure we are out of the woods yet. It may be that the sharp increases in government debt are already a ticking time bomb for many countries, set to explode when interest rates rise and financial markets lose confidence in the ability for this debt to be serviced. Even if the timer for this bomb has not yet been set, it seems likely to me that it will be at some point. The lesson some seem to be drawing from this is that interventions that cost double-digit percentages of GDP are not a big problem for the economy as government can just spend its way through them given interest rates are low. Hmm… I’m no expert but this seems likely to get us into trouble in the future.
These are all very broad points that probably don’t have much immediate significance for investing but are things to bear in mind for the future. More immediately the stock market has been doing very well. I believe that we may be in the early stages of a bubble, though one that is currently limited to a rather narrow set of specific stocks, as I described in my last post. My view is still that it is premature to talk about a wider bubble bursting, though the signs that this will happen within the next few years are building. In the short term it feels that we may be due some sort of correction given the strong performance in recent months, though there is a possibility of a ‘melt up’ first. I don’t think any drastic action is warranted but I’m slowly getting more bearish over time and am keeping a close eye on my exposure to more speculative highly valued investments.
The performance of my portfolio (QSS) is shown against its benchmarks in the table below. My main benchmarks have been the FTSE 100 (total return), the S&P 500 (total return) and a portfolio of the top decile of UK shares according to their Stockranks. I’ve also continued to benchmark my portfolio against a handful of professional fund managers I rate highly. I’ve updated my calculations this time to include dividends for the FTSE100 and S&P500 benchmarks (something I should have been doing before to be honest). Unfortunately, I’m not sure how to do this for the Stockranks portfolio. Dividends compound over time, so these figures materially understate its actual performance. I estimate it could add up to something like 25 additional percentage points of performance over 5 years (based on a dividend of 3% a year).
The last three months have been OK, though my portfolio has lagged a little against the FTSE 100 and S&P 500 indices as there has been a bit of a rotation away from growth to value. The Stockranks benchmark appears to have particularly benefited from this. For the year as a whole I’ve beaten all my benchmarks fairly convincingly, though there was quite a bit of luck involved. I happened to sell more than a third of my portfolio before the March crash to finance the deposit for a house purchase. My more deliberate attempt at market timing was pretty terrible – I made the cardinal investing sin of selling a sizeable chunk (about a quarter) of my remaining portfolio during the March crash, not all that far from the bottom. I then slowly reinvested these funds through the summer as I realised my mistake and it became clearer my house purchase was not going ahead.
While I’m happy with my return for the year, I’m not so happy with my mistake. I estimate it cost me significantly north of 20% return, which would have made this my best ever yearly performance. This is going to be etched into my investing psyche for some time. Hopefully this is a useful lesson I will learn from!
Longer term, I’m pleased with a compound growth rate of 30.6% since I started properly recording my performance in 2015. This far surpasses the expectations I had when I started. The table below shows my performance by year against the FTSE100 and S&P 500 benchmarks (including dividends).
2020 was yet another excellent year for quality investing. This type of approach has been knocking it out of the park since well before I started investing in 2011, so it seems natural to expect it to go through a period of underperformance at some point soon. I don’t think it is a good idea to make any dramatic changes to the overall strategy in anticipation of this, but it is important to think through how I intend to respond to different circumstances so I have a plan and don’t respond rashly. I’ve thought of the following scenarios:
Scenario 1: the status quo continues. This is the baseline case where nothing overly dramatic happens. High quality shares continue to rise slowly or go through a period of consolidation (the latter probably being preferable in the longer term). In this case I pretty much stick to my strategy though pay increasingly more attention to valuations as they continue to rise.
Scenario 2: melt-up. I think there is a reasonable chance that the bubble-like behaviour we are seeing now continues to develop. This is a tricky scenario to respond to. If valuations continue to rise dramatically from here I think my two main responses should be to incrementally shift to more cheaply rated stocks and ultimately start to raise cash. To give myself more flexibility for this while sticking to my overall strategy, I think it makes sense for me to include a few more lower-rated shares in my watchlist (but compromising on quality as little as possible). I have been starting to gather ideas but have not yet made any changes. I intend to write a further post on this. I’d only start to raise cash once valuations have risen fairly substantially from here. I’m adverse to the idea of market timing given my experience this year, but raising cash during a bubble seems like an altogether more sensible proposition than speculating that a crash has further to go.
Scenario 3: the market corrects. If the market corrects from here, or not far off here, I don’t think this is major cause for concern in itself. My plan would be to just stick to my strategy and remain fully invested, rotating to better opportunities as they arise. Similarly, if there is a rotation away from quality towards value I will stick to my strategy, allowing my periodic rotations to incrementally shift me towards better performing stocks.
Scenario 4: inflation and interest rate expectations change. This is the one macroeconomic fundamental that I think has the potential to cause a major shift away from growth stocks and precipitate the next major crash. I don’t think this is likely in the near future while the economy is still reeling from the effects of the lockdown. We were in a deflationary environment even before the pandemic hit. However, I think the extensive government stimulus we’ve seen this year does make this scenario seem more likely once economies have recovered. I don’t have a good sense of how long it may take to transpire but the stakes are high so I think it makes sense to be prepared. I think the key will be to act quickly so if I do find myself in a position to see this coming or react quickly I will take drastic steps – most likely selling off a large proportion of my portfolio before then pausing to consider what the next steps should be.
The other part of my strategy that I think needs a check-up is my approach to trading. I intend to reconsider the frequency of my trading and refine my approach to deciding what to buy and sell. There is a lot of substance to cover here so I’m going to save it up for a later post.
Below is an update on the progress my current investments. The main aims are to keep tabs on momentum, valuation and news flow and to consolidate my thinking about which positions to add to and which to consider replacing.
Games Workshop (9.2%): Games Workshop’s roll continues with another cracking update in December. The near term prospects look excellent to me. There is some real momentum building with the underlying business that doesn’t seem to be reflected in the share price. Another short term catalyst may be that Games Workshop has reached a size where it is more likely to be picked up on the radar of US or other international funds looking to take advantage of cheaper UK assets benefiting from resolution of Brexit uncertainty. I’ve been adding to this quite a bit over the last month but am now nearing my 10% limit.
Boohoo (9%): Boohoo is another high conviction position that has been consistently smashing it out the park for a few years yet looks very undervalued. It has courted a lot of controversy this year, with the scandal about conditions at its suppliers’ factories raising concerns about its governance. This has held back the share price this year despite excellent performance for the underlying business. My view is that these concerns are overblown. The issues are well-recognised and seem straightforward to resolve. I’m hoping for some more excellent results in 2021 and a big re-rating.
Best of the Best (6.3%): my holding in BOTB grew to almost 20% of the portfolio earlier in the year as a result of its outstanding results and speculation about a possible takeover. I offloaded most of my shares a few months ago to fund my new house purchase as it seemed a takeover bid was unlikely to be forthcoming, dampening short term prospects. The share price did fall but has since rebounded some of the way back to the highs. BOTB has confirmed trading is still strong and the shares seem likely to be materially undervalued. However, I’m unlikely to add more unless the next results are really outstanding. My holding is large enough already given my long term conviction in the business is relatively low compared to most of my other investments.
Bioventix (6%): this is a long term favourite but recently it has been a bit of a damp squib with the share price flatlining for most of the year, barring a short-lived dip in March. The last results were decent but the near term prospects are fairly mixed. Bioventix has suggested that its next results may be affected by pandemic disruption to diagnostic pathways involving the tests it supplies antibodies for. It will also stop receiving royalties for one of its main drugs this summer. More positively its Troponin antibody sales are starting to ramp up and I think it continues to guide overly cautiously for its main product – Vitamin D testing antibodies. Overall, while I’m still a fan of the business long term, I’m feeling fairly cautious about near term prospects and have plenty of other candidates to add to, so may look to trim here.
Gamma Communications (5.6%): both the underlying business and share price have quietly been making steady progress through the pandemic. There is little new to report here and I think my position is already large enough so I am probably best served by just sitting on my hands for this one.
Atoss Software (5.4%): Atoss continues to perform very strongly. It’s a great business but I’ve thought the shares look relatively expensive for a little while now and trimmed a bit to fund my house purchase. I think I’m best off just holding on to the remainder until something changes.
DotDigital (5.1%): DotDigital’s last results in November showed it continued to perform very strongly through the pandemic, also upgrading its expectations for next year. I really like this business and have been adding quite a bit to my position. I could well add more depending on what the next results look like, though a big increase in the share price over the last few months has left it looking more expensive.
Keywords Studios (5%): barring some minor short term disruption, Keywords is a pandemic beneficiary. It reported it was ahead of expectations in November and the share price has responded appropriately, making it one of my portfolio’s stronger performers. I have no intention of selling any for now, but I’m also not sure about adding as the valuation is not obviously very attractive. Another one where sitting on my hands seems the best course of action.
IG Group (4.5%): IG has benefited from exceptionally strong trading volumes this year, as a result of the high stock market volatility. Volumes continue to be strong and IG’s last trading update in mid-December was very positive. However, the share price has only responded modestly and the valuation looks cheap. It seems to me that the market may be materially underestimating how sustained this effect on IG’s business may be. IG also has the attractive property of being a ‘volatility hedge’ that should perform well if the rest of my portfolio performs badly. I also think the long term quality of IG’s business is underestimated. This is a candidate for me to add more to.
SDI (4.1%): earlier in the year I thought SDI’s share price had been rather disproportionately affected by pandemic-related fears. Over the summer it reassured that its business had not actually been that badly affected and its interim results in December were actually very strong, surpassing my expectations. The share price has really rocketed up over the last few months, I think justifiably. It’s tempting to take some profits after such a sharp rise, especially given the shares are quite illiquid. However, the valuation still seems reasonable to me so I think I’m probably better served by sitting on my hands for now.
Somero (3.6%): there’s little new to report on since I bought Somero. It looks very cheap for a high quality, albeit cyclical, business that hasn’t been as badly affected by the pandemic as feared. It updated that trading was ahead of expectations in November. Share price momentum over the last few months has been positive after being in the doldrums for a while since the trading disappointments of last year. Somero also provides some useful diversification towards value in the rest of my portfolio which is more heavily oriented to growth. It is not without risk but I’ve been adding to my position and think there is still room to continue.
Tristel (3.6%): little has changed here. Tristel should be a long term beneficiary of the pandemic. However, it has not done as well as I hoped this year because of disruption to medical procedures. Hopefully, this will start feeding through into its results this year. This seems like a possible candidate to add more to when funds become available, though probably not at the top of the list.
Servicenow (3.4%): Servicenow has continued to make steady progress since my last review, with its last results in October being characteristically solid. I still feel it looks like it might be a bit expensive so not looking to add more but happy to continue let it run for the time being.
Pinterest (3.2%): Pinterest is a relatively new holding, bought near the beginning of September. Its last results were excellent though the share price has done even better. The price has doubled since I bought, though has fallen off a little in the last couple of weeks. It seems to have been caught up in the bubble-like behaviour we’ve been seeing in some of the more speculative end of the US tech sector. This leaves me ambivalent about what to do from here. The temptation for me to bank the gains and switch to something a bit less racy is high but I also wonder whether it might be good to maintain exposure to the bubble for now, as it could well continue for some time yet. At the moment this is pencilled in for my first sale of 2021, conditional on me finding a suitably better replacement, though I may well change my mind.
Monster Beverage (2.9%): Monster’s last results provide further confirmation that it has been largely unaffected by the pandemic and the share price has continued to make steady progress. I’m attracted to its defensive characteristics in these more uncertain times and am looking to add to my position when funds become available.
Liontrust Asset Management (2.8%): Liontrust’s share price has been consolidating for the better part of a year now, despite its results continuing to be positive in line with the recent strong performance of equities overall. The valuation looks cheap so I’m looking to add to my position here.
Adobe (2.7%): Adobe is another of my more boring investments. The share price has been consolidating near its highs since my last review and it has not been caught up in the large rise affecting the more speculative end of the enterprise software sector. It’s clearly very high quality with relatively assured long term prospects and the valuation I think is justified by this. I’d be looking to add more if the share price does break out to new highs.
Etsy (2.7%): Etsy has performed well since I bought it in September but the share price has not risen to the same extent as Pinterest. The last results were excellent but a slowdown is expected next year following the spectacular growth driven by the pandemic. I’m still very bullish on the long term prospects as I think most of the benefits derived from the pandemic-induced switch to e-commerce and Etsy’s increased scale are likely to be permanent. However, the valuation is fairly demanding so I’m in two minds about adding immediately.
Fortinet (2.6%): it feels very satisfying to have caught Fortinet pretty much exactly at the bottom of a short term dip in its share price, though this is may be largely due to luck rather than good judgment. I bought Fortinet very recently in November and there is no news to update on since then, but with the share price consolidating near its highs and the valuation still looking reasonable, this looks like another decent candidate to add to.
Pharmagest (2.5%): after suffering some negative impact from the pandemic earlier in the year, Pharmagest has recovered strongly since my last review. The last results were very strong and the share price has done correspondingly well. I’m not minded to sell any but the valuation is relatively high so not looking to buy more either.
Fabasoft (2.1%): Fabasoft has been performing strongly this year and has been little affected by the pandemic so far. The share price has been motoring away. However, Fabasoft has been quite cautious in its outlook statements, warning about the possibility of more limited growth from new customers if they become wary about making new capital investments. I’m less worried about this possibility than I was at the beginning of the pandemic, though some risk remains. While I think the valuation is justified, it doesn’t seem especially attractive so I’m not looking to add right now.
Tracsis (2.1%): Tracsis is a fairly recent purchase bought principally because of its cheap valuation despite fairly limited impact from the pandemic. There’s been a small rebound since my purchase. I will wait for the next results before deciding whether to add more to this position.
CMC Markets (1.7%): CMC is my latest purchase. I’m yet to write it up properly so won’t comment on it here other than to say my thinking is similar as for IG Group.
Broadridge (1.8%): Broadridge has progressed slowly and steadily since I bought in September. Slowly enough that most of my gains have been offset by a falling exchange rate. The last results were good and it’s fairly cheap so I’d be happy to buy more.