2022 goes down as my worst performance investing so far, with the portfolio down just shy of 20%. It’s small consolation that this was a similar return to the S&P 500 and that many growth-focused funds were down a lot more. While most of the underperformance is down to my focus on quality growth stocks there are some lessons that could help me avoid more of the damage next time.
As mentioned in my last post, a new year’s resolution for me is to spend less time worrying about the overall macroeconomic picture. While it is plain to see that macroeconomics has been the major driver of share prices over the last few years, it doesn’t seem to be worth my while trying to anticipate where the roller-coaster will go next. I’ve acknowledged that worrying about macro is useless several times before but need to goad myself from time-to-time to redouble my efforts not to get distracted. As part of this I think I should get into the habit of writing up less of my macro-related pontifications and focus more on the businesses I am investing in.
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.
Portfolio performance over the last quarter has felt a lot better but relative to my benchmarks it has actually been pretty mediocre and below that of the FTSE 100 and S&P 500 indices. The last quarter has been particularly good for the UK, where UK-focused smaller caps have recovered to some extent after the Trussonomics debacle.
It is a similar story if I look back across the last year. Note that this is not quite consistent with the calendar year as I am measuring partway through January. This makes quite a difference as the beginning of this year has been a hell of a lot better than the beginning of 2022. My performance for calendar 2022 was -19.5%. I underperformed most of my benchmarks for 2022, with the exception of the buy-and-hold portfolio which holds all the shares in my portfolio and watchlist and does not trade. This tells a pretty clear story that what cost me was my overall focus on growth-oriented investments. Holding a bit of cash and leaning towards the more defensive investments on my watchlist mitigated the underperformance but only to a limited extent. I could have saved more had I done this more decisively.
Over the last five years it is remarkable how similar my performance is to that of several benchmarks, including the S&P 500, the highest Stockranks and Fundsmith, with all clocking in total returns of 50-60%. It is a bit dispiriting to think that I could have got the same return by simply investing in an S&P index fund, but it could definitely be worse. I outperformed my benchmarks very materially prior to the last five years but overall I don’t think I can say I’ve convincingly demonstrated my strategy works rather than that I was lucky in capitalising on a temporary growth stock boom.
Qualitatively speaking, I can break out the following three drivers of my performance: A) the focus on quality growth stocks; B) the timing and execution of individual trades; and C) macro-related market timing decisions to raise cash. Over the last five years I have little doubt that A), the focus on quality growth stocks, has been beneficial even if it was the main thing that cost me last year. I don’t think it is something I should change. However, on B) and C) there is clearly lots of room to improve. The fact that I’ve fairly consistently failed to outperform my buy and hold benchmark suggests that I need to improve the execution of my trades. It is also clear that some of my big market-timing decisions (in particular raising cash near the lows in 2020) hurt my performance very materially.
There has been quite a bit of speculation recently about whether the ‘regime change’ from growth to value is likely to persist. It is possible to draw worrying parallels to previous periods during which value outperformed growth for sustained periods: in the wake of the Dot.com bubble value stocks outperformed growth stocks for a number of years; in the high inflation 1970s value outperformed growth for about a decade while the stock market went nowhere. By analogy to these situations, it certainly seems possible that growth could be in for sustained period of underperformance but it is unclear how long or indeed whether we have already experienced most of it. The current situation doesn’t seem as bad as either of the parallels drawn above: inflation is unlikely to be as bad as the 1970s and is hopefully being dealt with more effectively; while growth has done very well over the past decade we didn’t see a bubble like Dot.com.
Across the market cycle I still believe the best hunting ground for outperformance is in quality growth stocks. It is clear that some aspects of quality, such as pricing power and ability to maintain profitability are very important in an inflationary environment. I don’t have much confidence in my ability to predict the timing of the value vs growth cycle or indeed in my ability to successfully execute a value investing strategy. This means that the decision for me to continue to focus on quality is straightforward. However, when selecting quality investments I am trying to put more emphasis on defensiveness, profitability and pricing power and less on long term growth potential.
The most important thing to get right about my strategy is the execution of individual trades. It is also the most difficult. After struggling for years to meaningfully outperform my buy-and-hold benchmark, I am coming round to the view that I should be following a more systematic, mechanical approach with greater adherence to the ranking implied by the watchlist ranking spreadsheet (which puts most weight on momentum and quality factors). This would help provide the discipline needed on years like 2022 where the underperformance can get frustrating and create the temptation to make mistakes.
Of course the question that immediately drops out of this is whether my systematic approach is looking at the right factors. This probably warrants a more detailed exploration in a further post but for now my main thought is that I should keep things simple and focus on what I am most confident should work, which in my view supports relying primarily on momentum.
My portfolio turnover has been higher than ideal. While I aim to restrict the number of trades I make and only trade when there is clear case to, I am not too concerned about erring on the side of trading more frequently than ideal. While it results in higher trading costs, at least it means I take advantage of new opportunities and deal with issues with my existing holdings quickly and decisively. Provided I am disciplined in following a systematic approach that makes decisions consistently, rather than changes its mind, and is not oversensitive to short-term volatility (a danger when following momentum), I don’t think trading as frequently as I have been is such a big problem.
Finally, I have been thinking again about how (and how not) to approach market timing. I think it is worth having a bit of flexibility to not always be fully invested at times of heightened risk of an overall market crash. However, it’s also critical to both minimise the risk of making big mistakes, like selling at the bottom, and to avoid the mental load of constantly and fruitlessly worrying about macroeconomics. What I need is a very simple system that clarifies when I should be fully invested and when I should raise some cash (and how much cash). Again, this is probably best covered in a later post but I have a rough idea of what it might look like.
Below is a quick review 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.
Bioventix (8.7%): there hasn’t been any news since my October review but there has been a good share price recovery. Bioventix should benefit from several tailwinds at the moment given the strength of the dollar, recovery of diagnostic medial services post pandemic and secular growth in demand for tests using its antibodies. However, I am conscious that exchange rate benefit is likely to reverse. For now I am optimistic that momentum should continue. The valuation doesn’t seem too demanding. I’m happy with the size of my current holding and am neithe looking to add not sell for now.
FICO (7.0%): a good trading update back in November sent the share price up by a third in one day. I was surprised by the size of this jump, though it has brought the valuation closer to where I think it should be. The valuation no longer seems so appealing but I still wouldn’t say this was especially highly valued given the quality. More broadly I am very happy with this as a particularly resilient and high quality long term investment that should do well in these uncertain times. I would be happy to add more, especially if the price breaks out from current range
Xpel (6.3%): the November trading update was steady as she goes. The share price continues to be very volatile but I’m in good profit overall. Long term, I see this as an excellent and exciting opportunity. It currently seems to be very reasonably valued, though there is some risk from exposure to cyclical auto market. I’m happy with size of current holding for now.
Judges Scientific (5.4%): Judges reported a decent trading update this week. Earnings are expected to be modestly ahead of expectations but order intake slowed down in the second half before picking up again following relaxation of China’s Covid restrictions. This doesn’t seem too concerning. The share price has done pretty well over the past quarter and has been bouncing around near the highs. I have high conviction in the long term quality of the business but this isn’t an immediate priority for further funds as the valuation is fairly high and there are some question marks about whether trading might slow down.
MasterCard (5.0%): MasterCard reported decent results back in October and share price has recovered a lot since then. MasterCard should benefit from cross-border trade picking up again and should be resilient to inflation but is not especially defensive. Long term I think this is an extremely high quality investment and valuation right now doesn’t seem too high. I’m looking to add further to my position.
Calnex (4.4%): Calnex has had a very strong run since low at end of October. I’ve been surprised by the strength of the share price because results in November, while good, were only in line with expectations. The illiquidity of the shares seems likely to have played a role. Calnex is a relatively new business and, without a very good sense of how much growth is left in tank and how consistent it will be, the valuation seems quite high. I’m tempted to take some profits here.
Copart (4.2%): the results back in November were OK but a little disappointing, partly due to the (temporary) impact of Hurricane Ian on costs. The share price has done OK over past quarter but the recovery since the October low has been more modest than many other stocks. I have strong conviction in the long term quality of business and the valuation seems reasonable. This is a candidate for topping up but not an immediate priority,
Fonix Mobile (4.1%): there is little news to update on apart from an AGM statement in November that everything is on track. Momentum has been very strong over last quarter with share price breaking out in November and steadily making new highs. The more I look at Fonix the more I like it. It is extremely profitable, should have fairly stable demand and has some growth potential through international expansion. The valuation seems reasonable. I have been adding as the share price has risen and I am tempted to go further.
LVMH (4.0%): the luxury sector has been performing very strongly recently and LVMH is no exception. The last results back in October were very strong, benefiting from recovery in international travel and continued strength in domestic demand. The business should be fairly resilient to both inflation and recession. The removal of Chinese Covid restrictions should be a significant further boost. Reflecting this, the share price has been on quite a tear recently for large cap. The valuation is not looking like such a great deal now but still seems reasonable. I have been adding to my position but probably shouldn’t go much further as some of the current tailwinds are likely to be temporary.
Fope (3.7%): Fope is another business in the luxury sector that is also doing very well. It issued a trading update this week that was ahead of expectations. Fope has strong tailwinds, a lot growth potential and a modest valuation so it could go a lot further and seems like a very promising opportunity. However, there are plenty of risks – the long term success of Fope’s brand is not certain and in the short term the share price is very illiquid and volatile. It has been a bit of a rollercoaster so far with my holding very rapidly up around 40% before giving most of it back. I’m definitely tempted to add more but I don’t want to let my position get too large.
London Stock Exchange (3.5%): there haven’t been any trading updates since my October review at which point trading and the integration of the Refinitiv acquisition seemed to be going well. However, in December LSE announced a strategic partnership with Microsoft to build/improve its customer data platform using LSE data and Microsoft cloud and other technology services. This deal also resulted in Microsoft taking a 4% stake in LSE. This seems fairly exciting and is supposed to lead to revenue growth for LSE but I have little sense of exactly how significant it is. The share price has been fairly directionless and has traded in a fairly narrow range for some time. I am confident in the long term quality and the valuation seems good so I’m happy to hold on for now.
Cerillion (3.3%): the last results in November were very good with management still bullish about further growth. The share price continued to make steady progress over the past quarter but has come off a bit over the past week. The valuation now seems quite high but it still looks like there may be plenty of growth in the tank. I could be tempted to add more but it is not at the top of the list.
AB Dynamics (3.3%): there is not much news to update on other than a short recent AGM update that trading is in line with expectations. The share price has done well over the past quarter and the valuation is not looking quite as appealing. I’m optimistic about the prospects here but want to see more good trading updates before adding more.
SDI (3.1%): the interim results in December were decent though a little underwhelming. I have a lot of conviction in long term prospects and the valuation seems quite cheap. However, the share price momentum has been weak and the risk of a temporary slowdown in growth seems high given some of SDI’s businesses have benefited from short term pandemic-related tailwinds. I didn’t feel this merited the top spot in my portfolio any longer so I decided to take profits on about half my shares. I’m not looking to add for now.
Games Workshop (2.9%): the share price has rebounded very convincingly off the October lows and the news of the Amazon deal spurred it on further. The Amazon deal certainly sounds exciting and could be very lucrative if it does well but there is a high chance it does not. In any event, any positive outcomes from it will take some time to come through. The results in January were a bit disappointing with fairly lacklustre sales growth and pressure on margins. However, management seem optimistic about prospects. Share price momentum is strong and the valuation seems reasonable but not obviously a bargain. I’m happy to hold for now but not looking to add immediately.
Alpha International (2.8%): the trading update this week was ahead of expectations but the share price continues to lack direction. I am a bit frustrated that it hasn’t gone anywhere since I bought despite strong trading, but I suppose holding its ground over a very difficult year in spite of high valuation is not too bad a result. I am still pretty confident in Alpha’s prospects but feel like I might be missing something. I decided to trim my position a bit.
PepsiCo (2.7%): there is nothing new to update on since October and the share price has drifted a bit. The valuation is quite expensive given the rather pedestrian growth rate but to a large extent seems justified by resilience and pricing power of the business, which are highly valuable in an inflationary environment. This holding provides some useful defensive ballast, reducing volatility for the portfolio. I’m not looking to add right now but happy to hold for this reason.
Diageo (2.5%): As for Pepsi there is nothing new to update on since October and the share price has treaded water. This is performing a defensive role and happy to hold on to it for now.
The rest of my portfolio is made up of smaller positions in Lululemon, Keywords Studies, Celsius, 4Imprint, Medpace, Monster Beverage and O’Reilly Automotive.