I think it’s fair to say that it’s been a difficult first quarter for most investors, but especially those who invest in growth stocks or small caps. A rout in growth stocks driven by inflation and the anticipation of tightening monetary conditions was compounded by the war in Ukraine. There has been a significant rebound since then but my portfolio is still down by around 10% YTD, having been more than 20% down at one point.

Performance

The performance of my portfolio (QSS) is shown against its benchmarks in the table below. My main benchmarks have been the FTSE 100, the S&P 500 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.

The first quarter in 2022 saw an acceleration of the trends from the end of 2021. Small cap growth massively underperformed as fears about inflation reached a crescendo. It’s not surprising then that my portfolio underperformed most of its benchmarks. This was not unforeseeable, so in hindsight I regret not having taken a more defensive posture, raising more cash or diversifying into commodities at an earlier point.

On the bright side, I did materially outperform my buy-and-hold benchmark, suggesting that my stock selection and the trading I have done hasn’t been too bad. Quite a few of my more defensive larger positions have held up well and I was successful in reinvesting a lot of my cash balance at lower prices than where I sold. However, outperforming the buy-and-hold benchmark is rather small comfort as it did perform fairly atrociously compared to the wider market.

Over five years, I’m still ahead of my benchmarks but they have caught up a lot as the excellent years of 2016 and 2017 recede into the distance.

So overall, the first quarter was a bit of a mixed bag. While I did finally manage to get some market timing decisions right, it feels like a case of ‘too little, too late’.

Strategy

My overall strategy of investing in high quality growth continues to be out of favour. I still think it is likely to outperform over the longer term and am keen to persist with it, though my recent experience has made me realise that I could benefit from being more flexible in how I apply it. The risk posed by rising inflation on the high valuations of growth stocks has been apparent on the horizon for some time. However, I lacked the flexibility and discipline to take an appropriately defensive position in anticipation. Hopefully this is something I can learn from.

As mentioned in my last review, I have been aiming to hold 10-15% cash to give the option to buy on any fear-induced crashes. After being caught flatfooted by the falls in growth stocks over the past year, the flexibility from holding some cash is attractive and helps keep me psychologically on the front foot compared to staying fully invested. Previously I lacked the patience to hold cash for very long, but my experience over the past couple of years has bolstered my resolve to try harder. I was able to take advantage of the market falling on news of the Ukraine invasion before rebounding and have now raised some cash again since the macro outlook remains uncertain. The optionality from having sufficient cash on hand to invest in a crash currently seems very valuable. For the time being I’m likely to see further rebounds as an opportunity to raise more (and crashes as an opportunity to reinvest).

The macroeconomic outlook looks very gloomy at the moment, with rampant inflation and a possible recession on the horizon. It does feel like a major crash could be on the cards but this is far from certain. Sentiment seems to be very negative at the moment and I think there is a good chance that things don’t turn out as bad as feared. A recession might actually help growth stocks if it reduces inflationary pressures and causes interest rates not to rise as much as feared. At some point the Ukrainian war will be resolved. Over the longer term it generally pays to be optimistic so I’m not quite convinced that selling everything would be a good idea. As long as I am invested in good businesses, ultimately they should recover.

I’m still of the view that lower-rated quality defensives are likely to be the investing sweet spot over the medium term, but I’ve also become more bullish on some more growth-oriented stocks as valuations have come down.

Individual shares

Below is a quick review of my holdings to identify candidates where my current conviction is highest to reinvest my cash balance when the time comes, as well as weaker positions to swap should other opportunities arise.

Microsoft (7.3%): to a large extent it is steady as she goes for Microsoft. There still seem to be a long growth runway in the various different markets Microsoft operates in, despite its huge scale. Trading should be robust in the face of concerns about inflation and recession. The main news from the last quarter was Microsoft’s intended acquisition of Activision. I think it is touch and go whether this gets through the regulators, but if it does it could be quite a smart move to better take advantage of the opportunities presented by cloud gaming. The price for Activision seems reasonable, though it’s a major acquisition of a business experiencing difficulties – quite often these don’t go well. Microsoft’s share price has held up fairly well through the recent market gyrations, though the valuation is quite high and it would not be immune to a wider crash. Overall, I’m happy to have this as my largest investment and have full confidence in its long term prospects but I’m not looking to add here for now.

Beeks Financial (5.1%): Beeks has clearly reached an inflection point in its growth with take-up of its new Proximity Cloud product starting to take off. It is currently investing heavily in the necessary infrastructure to take advantage of this opportunity. This seems sensible and I’m glad to see it recently raised money to sure up the balance sheet. The share price took quite a tumble following the Ukraine news and I took this opportunity to add more. This seems to have worked out well so far. While the prospects look good and the valuation reasonable, this is a risky investment, not least because the shares are so thinly traded and difficult to sell. Beeks would probably get hit hard in a wider market crash and I’d want to be buying rather than selling, so I don’t want to let this holding get too much larger.

Calnex (5.0%): Calnex has been the star performer of the last quarter. It upgraded expectations at the beginning of March and should be relatively immune to macroeconomic concerns. The share price has convincingly broken out to new highs after a long period of consolidation. Long term it is not super high conviction for me, as trading looks to have the potential to be lumpy. I’m happy to let my current holding run but not looking to add more for the time being.

Games Workshop (4.8%): trading seems to be going OK but the share price has taken quite a dive over the last quarter. I had been building up my holding to take advantage but was wrong-footed by the extent of the weakness in the share price and decided to cut back again. Games Workshop is facing some pressures on its costs but these seem fairly minor. It is somewhat exposed to falling consumer confidence and I assume fears about this are behind the recent performance. However, I am still confident in the long term resilience of the business and the valuation now seems pretty cheap all things considered. I’m happy to keep holding here but not quite confident enough in near term prospects to add more at this point.

SDI (4.7%): SDI has been busy, landing a couple of decent-looking acquisitions since the last review: Scientific Vacuum Systems and Safelab Systems. Growth is due to slow down over the next year after the boom in Covid-related orders at some of SDI’s subsidiaries, which likely explains some of the recent weakness in the share price. Long term I’m very bullish about SDI’s prospects as it looks set to continue successfully executing its buy and build strategy. I’m keen to take any opportunities to add to my position here.

Fortinet (4.2%): this has been a very successful investment so far and I’ve taken quite a bit of profits along the way. Fortinet has held up remarkably well through the recent volatility. The last results were very strong. The cybersecurity sector is booming and demand further boosted by the current conflict, though Fortinet’s Russian operations are currently closed. Demand should be fairly defensive and Fortinet seems fairly inflation and recession-proof. The valuation is on the high side but it seems to be setting up to possibly break out again so I might be tempted to buy more.

Somero (4.1%): trading is going well at Somero but the share price has fallen by almost a third over the past quarter. This is a bit surprising. After last year’s excellent performance Somero expects modest growth this year, supported by strong demand for more warehousing driven by ecommerce. The valuation looks very cheap now but there is a significant risk that a recession would hit Somero particularly hard. Likely this explains the recent poor performance. Somero is well capitalised with plenty of cash on the balance sheet to weather a downturn and I think the reward to risk looks attractive here. However, given the illiquidity of the shares, this seemed too risky to have as my largest position so I took advantage of the recent bounce in March to take profits on over half my holding. I’m happy now to hold the rest.

Lululemon (4.1%): Lululemon’s recent results were excellent, causing a big rebound in the share price and tempting me to add to my position. I’m now a bit less confident that this was a great idea as the valuation is pretty high and you would expect Lululemon to be at least somewhat exposed to falling consumer confidence. That said, I think this is an excellent business that is currently trading very strongly so I’m happy to hold on for now.

Keystone Law (3.7%): trading appears to be going well at Keystone. It upgraded expectations back in January and seemed very bullish on future prospects. However, the share price subsequently sold off with other growth stocks and this was compounded by read across from another listed legal business, Knights Group, issuing a profit warning about a month ago. Knights Group said it had been negatively affected by Covid-related disruption and from slowing demand for corporate legal services. This read across seemed likely to be misplaced as Keystone’s business model is quite different, being focused on home working and more London-centric rather than regional. So I took the opportunity to add significantly to my holding. I’ve reduced a bit again now after the rebound and await the next results at the end of April with bated breath. While I am a fan of Keystone’s business model and think the long term prospects look good, my investment feels quite risky at the moment given the Knights Group profit warning and how illiquid the shares are.

Shopify (3.6%): Shopify is a recent purchase as described in my last post. I was lucky enough to make my first purchase at the recent low and was patting myself on the back, added on the way up as the price rapidly rebounded some 50-odd percent. However, this was short-lived and the most of the gains have since been given up. I think it’s quite likely that this volatility will continue for a while yet. My intention is to wait patiently and take advantage of any major price falls to add to my holding. I think the long term prospects look excellent.

MasterCard (3.5%): MasterCard has held up relatively well over the past quarter. The last results were decent as cross-border transactions (on which MasterCard takes a much higher cut) continue to recover after the Covid-induced slump. MasterCard has a very solid long term position and seems ideally suited to prosper in a more inflationary environment. I have been adding to my holding and am keen to bring it back to being one of my larger investments.

iShares gold producers ETF (3.5%): this investment is quite a big departure from my normal focus on quality growth stocks. I think the times call for better diversification and I’ve decided to be a little more flexible in this regard when the situation warrants. The idea is that this should as a source of diversification that hedges against inflation and recession and my expectation is that it should perform well. I’m not confident that this is a great idea and it’s not an asset I would want to be invested in long term, so I’ve kept my holding fairly small.

Copart (3.4%): Copart is a recent purchase aimed at taking advantage of the broader dip in growth stocks. Not a great deal has happened since I bought it – the price dipped a bit further and then bounced. I think it’s a great business with solid long term prospects but I’m feeling more ambivalent about its medium term prospects since I bought. Since the Russian invasion of Ukraine oil prices have shot up and it has started to feel more likely that a recession is around the corner, both of which create some risk for Copart. One to monitor more closely.

Bioventix (3.3%): Bioventix is an old favourite that started to rebuild a position in over the last few months. We are starting to see over the hump caused by Covid-related disruption to medical testing and one of Bioventix’s major royalty streams expiring. Demand for its Troponin test seems to be growing well and I expect demand for its other tests should resume their rapid growth soon too. I am hopeful that it could start beating forecasts soon. The valuation looks cheap and tge price has started to recover from its slump. I’m keen to add to my position.

Alpha FX (3.2%): Alpha FX is trading very strongly at the moment. Its end of year results were excellent, causing the share price to rebound strongly from dip it had suffered in common with other small cap growth stocks. In hindsight I could have taken better advantage of the opportunity to quickly add to my holding. Alpha should be fairly inflation and recession-proof, though it does face some credit risk if customers become insolvent. I am reasonably confident in Alpha’s long term prospects but it is not an especially high conviction investment, so not looking to add.

Broadridge (3.2%): Broadridge was trading in line with expectations at its last results. The valuation is not especially punchy and the share price has held up fairly well through the recent turbulence.

Cerillion (3.0%): there has not been much news at Cerillion since I bought. The share price has fallen a bit and the valuation seems cheap given the current momentum in trading. I look forward to the next update.

The remainder of my portfolio consists of smaller positions i Adobe, Fresnillo, Diploma, Autotrader, London Stock Exchange, Intuit, Adyen and Amazon.