UKVI Portfolio Review – Q3 2012

The portfolio has been running now for 19 months so it’s beginning to build up a track record long enough to pay attention to.  In general I would say that looking at performance over anything less than 5 years is meaningless, but of course most people just look at the last year and in this case 5 years isn’t possible as the portfolio hasn’t existed that long.

From inception in March 2011 the portfolio is up 8.9% (including reinvested dividends), which is an annualised gain of 5.5%.  This compares to a total gain of 6.6% for a FTSE 100 tracking unit trust, which is 4.1% annualised.  Both portfolios are based on a starting value of £50,000 and trading costs are included.

The portfolio is focused on producing a yield which is higher than the FTSE 100’s and which grows  at a faster rate.  The most recent yield was 4.5% and the index tracker benchmark was at 3.3%.  In the last 12 months the portfolio has produced 40% more income than the index tracker, which is a pay rise I would be happy to have any day of the week.

In terms of activity, over the past three months there have been three changes to the portfolio, which follows the existing plan of having one investment enter or leave each month.  I’ll get straight on and review the first of these changes.

August purchase: A FTSE 100 listed UK energy utility

The portfolio already holds SSE (Scottish & Southern Energy) so this is the second energy utility holding.  The reasons for investing in this company are much the same as they are for any of the portfolio’s holdings.  This company has:

• A long-term growth rate of around 10% a year
• A dividend yield of almost 5%, well above the market average
• A long history of relatively consistent increases in sales, profits and dividends
• A strong balance sheet with low levels of debt
• A market leading position with strong branding and economies of scale

These are the kind of investments that I can own and still sleep well at night.  There are risks of course, there are in all things –but for me this is equity investing at its least stressful.

My expectations for this holding are that not very much happens.  The dividend should hopefully be raised at or above the rate of inflation, and at some point the market may look favourably on this company once again, driving the share price up to a level where it makes sense to sell.

After that I will reinvest in another out of favour, quality company and hopefully repeat the cycle of buying low and selling high once more.

September purchase: A FTSE 100 listed global leader in the mining industry

This investment is completely different to the one above, with a very cyclical rather than defensive business cycle.  The mining industry is taking a bit of a beating at the minute as fears about a Chinese slowdown are everywhere, so this may be an opportunity to buy world class businesses at attractive valuations.  Exactly how the commodity cycle will pan out over the next few years is as yet unknown, although there are hundreds of investment pundits who will tell you that they know the boom is over (or perhaps it’s just beginning).

In my opinion, as long as there are more people living more elaborate lifestyles across the globe, this company should do well in the long run and it’s currently priced attractively, almost regardless of whether we’re still in the expansion phase of the commodity cycle or not.  This company now stands alongside BHP Billiton in the portfolio, which means I’m invested in two of the world’s biggest and best known mining companies.

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The stats for this company look like this:

• Long-term growth rate of more than 20% a year (although this is in the expansion phase of its business cycle)
• Yield of just over 3%, making this investment a bit of an exception as it has a yield lower than the index
• Strong balance sheet and market leading position

As with all new investments in the portfolio, this company was given a 1/30th weighting to start with as the goal is to hold 30 equally weighted positions.

October sale: UK Mail Group sale generates an annualised total return of almost 34%

UK Mail was added to the portfolio back in October 2011.  At the time the yield was 8.6% and to my eyes the dividend looked sustainable.  If that turned out to be the case then it seemed likely that the share price would be bid upwards once the dividend’s safety became more obvious.  And that’s more or less what happened.

As is often the case, most of the return from this high yield investment came not from the dividend, but from the capital gains brought about as other investors piled in to get that yield.

This is an aspect of high yield investing that is often forgotten, which is why dividend investing is often seen as boring.  Personally I don’t care if it’s boring, especially if it produces gains of more than 30% a year, at least occasionally.

You might ask, why am I selling now given that the yield for UK Mail is still almost 7%?

That’s a good questions and it comes down to the fact that I think it’s just as important to have a clear selling strategy as it is to have a clear buying strategy – but unfortunately most investors focus far more on buying than on selling, and that’s a mistake.

With no history of growth, the 8.6% yield was the only thing that made UK Mail attractive.  Now that the yield is down to less than 7% the investment case is less compelling when compared to many other companies which yield almost as much and yet have proven themselves capable of growing over time.  I would rather sell UK Mail, lock in the 34% annualised gains and move the proceeds into something else with a better combination of yield and growth potential.