New Year Share Tips – Are They Worth Following?

It’s that time of year when financial magazines and newsletters analyse their past share tip performance and give their New Year tips. Are the tips worth picking up or even reviewing?

One approach you might think would be effective would be to simply back those publications who had the best historic performance. One review I picked up on Twitter (I am not sure of the original source) gives the Investors Chronicle (IC) as the winner in 2019 with a 37% return with The Independent bottom of the table. However, the performance varies from year to year – for example the IC had a negative year in both 2017 and 2018, while the Guardian had negative returns in all three of the previous years. Perhaps not many investors read the Guardian but that may be to the good.

One problem of course is that the tip writers may vary even within a publication from year to year and few put their names to the articles. In essence backing the share tips based on the “form” of the publications or the writers is not going to work. Even if the writers stay the same, and their “styles” of investment such as a focus on growth or value, what works one year might not work in another.

Another failing is that some writers rely on advice from well known fund managers who tend to “talk their own book”. So the Questor column in the Daily Telegraph, written by Richard Evans, tipped Bioventix (BVXP) as “AIM stock of the year” on Friday (10/1/2020). That was after talking to Keith Ashworth-Lord of Sanford DeLand Asset Management who has a big holding in the company. The share price rose 9% on the day this tip was published which as a holder of the stock I am quite pleased with, but I would not previously have rated it as other than a “hold” personally.

Many share tips in the national media and reputable investment newsletters will rise in price on the day the tip is issued – indeed even before you have got up for breakfast. Investors then pile in further over the next few days and if you follow that herd you are going to lose money. After a few weeks, when the company’s performance does not instantly shoot up or there is little news, the speculators lose interest and the share price falls back again.

It’s worth pointing out that it does of course depend on whether you are a long-term investor or a short-term speculator. Such share price movements may be great for speculators , most of whom I suspect lose money, but for long-term holders like me share tips can be positively dangerous. My approach is therefore as follows:

I use share tips as ideas for research. Only one in ten is worth more analysis and if I consider it worthy after that I would buy a few shares and see how the company and its share price develops. Most companies fail on the “due diligence” phase. I am not a “plunger” who bets a lot on any new holding. I am looking to find companies that I can hold for the long term and in which I wish to take an opening position. Apart from anything else, moving a lot of cash out of existing holdings to invest in new ones is often a mistake, I have learned from past experience. It’s the syndrome of looking for the pot of gold at the end of the rainbow, i.e. picking new investments you don’t know much about but which someone else thinks are a great proposition, and abandoning ones that you do know.

What are the kinds of tips that I avoid?

Firstly I hate the “recovery story” kind. These are where a company with a pretty dismal historic performance has improved analyst forecasts (which is what most tipsters focus on). For example, Investors Chronicle has Burberry (BRBY) as one of their 2020 tips. The supporting article has lots of positive comments about the changes taking place in the company and its “transformation”, but a quick look at the financials gives me doubts. Revenue in the last 3 years, which is a key metric for any retailer, was static or falling and the forecasts for the next two years are only slightly higher. Earnings per share follow a similar pattern. Even under new management, is this a growth business or a just another rather mature company in a crowded sector (revenue about £3bn) flogging expensive clothes to suckers? Is there any real innovation or growth above inflation taking place is the key question?

Another example of a recovery story is Momentum Investor tipping Marks & Spencer (MKS) based on their move into on-line groceries via the joint venture with Ocado. But the wisdom of this tip was soon disproved after the company issued a trading statement on the 9th of January with dismal figures for clothing sales. The share price is down 12% since then. Too many “skinny” fit men’s trousers was one problem as the company tried to be more fashionable so that’s just another management failure partly arising from the sclerotic supply chain at the company. Tipping shares can be a quick lesson in humility of course which is one reason why this writer does not do it. Let those who get paid for their alleged wisdom continue to do so though so we can have the occasional laugh at their folly.

Window supplier Safestyle (SFE) was tipped as a recovery story by ShareWatch but is likely to still make a small loss in 2019. Are profits really going to come back in 2020 and will investors regain confidence in the business and its management? I do not know the answer to those questions so I am unlikely to invest in it.

Secondly, I ignore sudden enthusiasm for boring companies. Another of IC’s tips was Johnson Service (JSG) which provides textile rental and cleaning services – hardly a new business and one that I doubt has barriers to entry. The company is growing, but on a forward p/e of 19 and relatively high debt, I cannot get enthusiastic.

Apart from drain-pipe trousers, something else I used to favour in the 1960s that is back in fashion is ten pin bowling. Two companies that were tipped by Momentum Investor and mentioned in Investors Chronicle – Ten Entertainment (TEG) and Hollywood Bowl (BOWL) may be worth looking at. TEG (which I hold) was also tipped by ShareWatch. These companies are changing from not just being bowling alleys but indoor family entertainment centres with other games available and good food/drink offerings. Some also stay open long after the pubs have shut. You can see why they are experiencing a revival in demand with more centres opening. The key with share tips is to follow the new trends, not the old ones.

Thirdly I ignore tips that back racy stocks already on high valuations. For example Shares Magazine tipped Hotel Chocolat (HOTC). This is a chocolate retailer that seems to have a good marketing operation and decent revenue and profits growth but on a prospective p/e of 45 it seems too expensive to me. The slightest hiccup would likely cause a sharp drop in the share price so there looks to be as much downside risk as upside possibility to me.

Lastly, I ignore tips in sectors I don’t like or businesses I do not understand – the former includes oil/gas and mine exploration, airlines and banks. Shares magazine tipped Wizz Air (WIZZ) and Lloyds Banking (LLOY) for example but they are not for me. Businesses I do not understand might include some high tech companies with good stories of future potential but no current profits.

To reiterate, share tips are useful for providing ideas for research but blindly following them is not the way to achieve superior investment performance.

Preferably share tips should confirm your views on shares you already hold – such as Bioventix, Ten Entertainment and several others I hold which have been tipped in the last couple of weeks. That may be a reason to buy more, but not in any rush.

As regards other tips like the best countries, or the best sectors, or whether to invest at all based on economic forecasts or Brexit prognostications here’s a good quotation from John Redwood in the FT this week: “The safest thing to forecast at the beginning of the 2020s is more of the same”. An economist with real wisdom for a change.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Year End Review and Future Forecasts

Following folks on Twitter suggests that there was an enormously wide variation in the overall portfolio performance of private investors in the last year. But without people saying what they invest in and how big and diversified their portfolio is, I am not sure the information provided helps much. I also worry about how they calculate their performance figures and whether it includes dividends reinvested because I never find it a simple thing to do as none of the software products I use give me a correct figure so I still have to do the calculations manually.

One feels wary of publishing such data because when you have a good year you appear to be a clever dick with an inflated ego, while in a bad year you look a fool. Consistency is not applauded on social media. But here’s a summary of my portfolio performance.  Total return for the year (including dividends) was almost exactly 30% return on my capital invested at the start of the year. As my target is simply to consistently beat the FTSE-AllShare which was up in capital terms by 14.3% last year and dividends would have added another 4%, I am happy with that outcome.

My portfolio is very varied with a slight emphasis on UK small and mid-cap shares but it does include a very few FTSE-100 shares and several large investment trusts and funds including some overseas focused ones. One of the reasons for outperformance was probably betting on a successful resolution of the Brexit impasse before the General Election, which has clearly had a very positive impact on markets, particularly in UK small cap stocks.

It was partly a good year because I had few bad failures – Patisserie was the worst, but when you have a large number of holdings, as I do, then there are always one or two disappointments. Others I managed to get out of without much damage but Patisserie had trading suspended at the initial announcement of possible fraud and never returned.

Well at least I beat Warren Buffett’s Berkshire Hathaway last year. He only managed an 11% gain last year while the US market gained 31.5% last year, including dividends. No doubt some clever sod will suggest that I could have saved a lot of effort and just invested in an S&P 500 tracker but that would have been a risky strategy because the US markets can be very volatile. Incidentally Berkshire now has cash of $128 billion. Buffett is clearly finding it difficult to invest the money. Perhaps he is slowing down at aged 89 and if he has another bad year like the last one folks might be encouraging him and his partner to retire. But few investors achieve outperformance every year – one needs to consider performance over 5 or more years.

My portfolio also includes some Venture Capital Trusts (VCTs) which would have generated a less good overall return because they tend to be vehicles for turning capital into tax free dividends. As usual they mainly showed small capital losses although two VCTs focused on AIM stocks did relatively well for a change.

What of the future and where should we be investing? I am still keen on technology stocks and here’s a useful quotation from Alan Turing who is soon to appear on new £50 notes: “This is only a foretaste of what is to come and only the shadow of what is going to be”. He wrote that in 1949 about the future use of computers, but it still applies as many new and innovative businesses based on software and the internet are still being founded. However, I think the valuations of early-stage unprofitable companies are getting overblown (e.g. in fintech and biotech) so I suggest one needs to be careful.

One slight negative in my portfolio performance last year was that total dividends received fell slightly. That’s probably because I sold a few high yield shares – with a buoyant economy it hardly seemed the best place to be. I hold no builders, no banks or other financial institutions and no oil companies at present and generally do not as I am prejudiced against them.

The slight cloud on the horizon is that Boris Johnson has to conclude a free trade deal with the EU in the coming year, or face a difficult decision. That might cause some business uncertainty in the meantime. But I doubt if it will affect those companies with quality businesses. As I have been saying for the last 6 months, it is business perspective investing that enables you to generate good returns, and that is very much the basis of my good performance last year. Plus avoiding too many investment disasters as I said in a previous blog post.

If you were hoping for details of my holdings, or share tips for the future, you will by now be disappointed. What made money for me last year, may not do so this year, and giving tips for the coming year is a very risky proposition. Such tips tend to encourage churning of portfolios and increase the readership of publications giving them but it is not necessarily a productive exercise. I prefer a strategy of buying good companies and holding them for as long as it makes sense to do so.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Should Companies, their Investors and Bankers Adopt Some New Year Resolutions?

Environmental concerns are all the rage at present. Indeed it’s become a new religion verging on paranoia. Some people believe that the world is going to become impossible to live in after a few more years, or that seas will rise enough to submerge many major cities. They ascribe the cause to global warming caused by rising CO2 emissions from the activities of mankind. Even if we are not all wiped out, the impact on the economy could be devastating due to mass migration and the costs imposed by decarbonising all energy production, food production and transport.

This article is not going to attempt to analyse whether global warming is a major threat, or what its causes might be, but simply what the reaction of companies, their investors and their bankers should be. Should company directors adopt a New Year’s resolution to divest themselves of all activities that might result in CO2 generation? Should investors who hold shares in such companies sell them and invest in something else, and should bankers stop lending money for projects such as creating new oil production facilities.

Even outgoing Bank of England Governor Mark Carney gave some dire warnings in a BBC interview a couple of days ago.  He suggested that the world will face irreversible heating unless firms shift their priorities soon and that although the financial sector had begun to curb investment in fossil fuels the pace was far too slow.

What do oil companies or coal miners do if faced with such rhetoric?  There is clearly a demand for their products and if one company closes down its activities then other companies will simply move in to take advantage of the gap. There will be a large profit incentive to meet the demand as prices will likely rise if some producers exit the market.

Companies also have the problem that they cannot close down existing facilities, or move into new markets such as wind or tidal energy in the short term without incurring major costs.

Famous investor Warren Buffett does not think they should do much at all. He has suggested that even if Berkshire’s management did know what was right for the world, it would be wrong to invest on that basis because they were just the agents for the company’s shareholders. He said “this is the shareholders money” (see FT article on 30/12/2019).

So long as the law of the land says it is OK to exploit natural resources even if they generate CO2, and the shareholders support a company’s activities then company directors should not be holding back he suggests.

But I suggest shareholders have other things to consider whether they believe in global warming or not. Investors clearly face a risk that even if they are happy to invest in coal mines, the Government might legislate directly or indirectly to put them out of business. As a result of Government policies in the UK, the amount of coal produced and consumed in the country, particularly for power generation has been going down. It’s now only about 5% of electricity generation, largely replaced by natural gas usage (with lower CO2 emissions) and renewables such as wind-power and hydroelectricity. Forget trying to get planning permission for any new coal-fired power stations even if very cheap coal can be imported.

As an investor, clearly divestment from coal mining and coal consumption is a worldwide trend in most countries with a few exceptions such as China. So any wise investor might simply look a few years ahead and take into account this trend. Investing in declining industries is always a bad thing to do. However well managed they are, companies operating in such sectors ultimately decline in profitability as revenue falls and competitors do not exit as the management has only expertise in that sector and won’t quit.

Investment is also not about what you believe but about other people believe because other people set the share prices of companies, not you. You might think that global warming is simply not true, but if the majority of investors believe it then they will sell the shares in companies that are involved in CO2 generation and drive down the share price. This is surely already happening to some extent with major oil companies. Shell and BP are on low p/e ratios no doubt because they are seen as having little future growth potential. You can of course become a contrarian investor if they become cheap enough but that is a risky approach because clearly these companies are facing strategic challenges.

Investment managers are divesting themselves of holdings in oil companies so as to please their investors. Both the managers and the investors have been subject to propaganda that has told them for the last few years that oil is bad and consumption needs to be reduced. They are unlikely to take a contrary stance. Once a religion becomes widespread, you have to follow the believers or be branded a heretic, whether the religion has any basis in reality or not.

There are not trivial sums involved. The Daily Telegraph suggests that UK shareholders are some of the most vulnerable in the world with about £95 billion invested in fossil fuel producers. If you consider that CO2 needs to be reduced, and choose your investments accordingly, then you need to exclude not just coal, oil and gas producers but a very large segment of the economy. All miners and metal producers are big energy consumers mainly from fossil fuels, and engineering companies likewise. And then one has to consider the transport sector and the producers of trains, planes and automobiles. Even producers of electric vehicles actually use large amounts of energy to build them although much of that is consumed in other countries such as China. Food production and distribution also consume large amounts of energy, and building does also. For example cement production uses enormous amounts of fossil fuel and actually generates about 8% of global CO2 production for which there is no viable alternative.

There are actually very few things in the modern world that don’t consume energy to produce them. That production can be made more efficient but decarbonising the economy altogether is simply not viable.

For investors, it’s a minefield if they wish to be holier than thou and claim moral superiority. There may be some simple choices to be made – for example why support tobacco companies where their products clearly kill people? But as an ex-smoker, I am more concerned about future Government regulation that will kill off or substantially reduce their business which is why I am not invested in tobacco companies.

Company directors, investors and bankers do not need to make moral choices. New year resolutions are not required. They just need to look to the future and the evolving regulatory environment and the court of public opinion.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Winning The Loser’s Game – It’s Like Tennis

Tennis Player

It’s that time of year when we review our investment performance over the last year and some of us realise that it would have been lot better if it was not for the few disasters in our share holdings. For example, this is what well known investor David Stredder tweeted before Xmas: “End of 2018 and most of this year has been pretty awful investing wise for me…ACSO, CRAW, BUR, SOM, OPM & JLH were all top 15 holdings and lost 50% or more. CRAW actually went bust. First signs of recovery in two of those and thankfully my top three holdings GAW, JDG & INL have all doubled and covered most my losses but shows investing cannot be fab returns every year. Often a roller coaster ride and must prepare yourself…Sell half on first bad news, slice profits, make friends, share bad and good times as happen to all of us. Enjoy the festive break”.

For those like me that cannot remember all the TIDMs of the several thousand listed companies, the failings were in Accesso, Crawshaw, Burford Capital, Somero, 1PM and John Lewis of Hungerford. The positives were Games Workshop, Judges Scientific and Inland Homes. As an aside I do wish investors would put the company name not just the TIDM (EPIC) code when referencing companies in tweets. A lot of the time I have no idea what they are talking about.

As in most years, I have also had failures. Patisserie was a wipe-out. It went bust after a massive fraud. Thankfully not one of my bigger holdings but I ignored two of the rules I gave in my book “Business Perspective Investing” – namely avoid Executive Chairmen, and directors who have too many roles. I lost money on a number of other newish holdings but not much because I did not hold on to the duds for long.

One of the keys to successful long-term investing is to simply minimise the number of failures while letting the rest of your investments prosper. It is important to realise that investment is a “loser’s game”. It is not the number of sound investments one makes that is important, but the number of mistakes that one avoids that affects the overall performance of your portfolio.

A good book on this subject which I first read some years ago is “Investment Policy – How to Win the Loser’s Game by Charles D. Ellis”. It covers investment strategy in essence but it also contains some simple lessons that are worth learning. He points out that investing is a loser’s game so far as even professional investors are concerned, let alone private investors. Most active fund managers underperform their benchmarks. A lot of the activity of investors in churning their portfolios actually reduces their performance. The more they change horses with the objective of picking a winning steed, the worse their performance gets as their new bets tend to be riskier than the previous holdings, i.e. newer holdings are just more speculative, not intrinsically better. That is why value investing as followed by many experienced investors can outperform.

But Charles Ellis supplied a very good analogy obtained from Dr. Simon Ramo who studied tennis players. He found that professional tennis players seemed to play a different game to amateurs. Professionals seldom make mistakes. Their games have long rallies until one player forces an error by placing a ball just out of reach. But amateurs tend to lose games by hitting the ball into the net or out of play, i.e. they make a lot of unforced errors. The amateur seldom beats his opponent, but more often beats himself. Professional tennis is a winner’s game while amateur tennis is a loser’s game.

In a recent review of my book by Roy Colbran in the UKSA newsletter he says “the book takes a somewhat unusual line in telling you more about things to avoid than things to look for”. Perhaps that is because I have learned from experience that avoiding failures is more important to achieve good overall returns. That means not just avoiding investing in duds to begin with, but cutting losses quickly when the share price goes the wrong way, and getting out at the first significant profit warning.

However, the contrary to many negative qualities in companies are positive qualities. If they are unexceptional in many regards, they can continue to churn out profits without a hiccup if the basic financial structure and business model are good ones. Compounding of returns does the rest. If they avoid risky new business ventures, unwise acquisitions or foreign adventures, that can be to the good.

The companies most to avoid are those where there might be massive returns but where the risks are high. Such companies as oil/gas exploration businesses or mine developers are often of that nature. Or new technology companies with good “stories” about the golden future.

There were a couple of good articles on this year’s investment failures in the Lex column of the FT on Christmas Eve. This is what Lex said about Aston Martin (AML): “Decrying ambitious ventures is relatively safe. Many flop. We gave Aston Martin the benefit of the doubt, instead”. But Lex concedes that the mistake was to be insufficiently cynical.

Lex also commented on Sirius Minerals (SXX) a favourite of many private investors but where Lex says equity holders are likely to be wiped out. Well at least I avoided those two and also avoided investing in any of the Woodford vehicles last year.

To return to the loser’s game theme, many private investors might do better to invest in an index tracker which will give consistent if not brilliant returns than in speculative stocks. At least they will avoid big losses that way. Otherwise the key is to minimise the risks by research and by having a diverse portfolio with holdings sized to match the riskiness of the company. As a result I only lost 0.7% of my portfolio value on Patisserie which has been well offset by the positive movements on my other holdings last year. It of course does emphasise the fact that if you are going to dabble in AIM stocks then you need to hold more than just a few while trying to avoid “diworsification”.

Not churning your portfolio is another way to avoid playing the loser’s game. And as Warren Buffett said “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” – in other words, he emphasised the importance of not losing rather than simply making wonderful investment decisions.

Those are enough good New Year resolutions for now.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Year End Review and Xmas Greetings

Xmas card

As the final blog post before Xmas, I thought it would be useful to do a quick review of the past year. I have not yet done a detailed review of my investment portfolio performance over the year as I do that after the 31st December, but on a quick look at my net worth, I think it’s been a good year. With the bounce in the stock market after the Conservative General Election victory, most investors should be well ahead this year. The FTSE All-Share is up 13% at the time of writing, with the FTSE-250 up 25%. AIM stocks had a relatively poor year, rising only 8% but ones I hold generally jumped up at the end of the year as UK small cap stocks were suddenly seen to be relatively cheap.

The focus this year though was certainly on technology stocks – internet and software companies, both small and large which continues the recent trend. Will that continue for the coming year?  I never like to predict market or economic trends, but there was an interesting article by Megan Boxall in the Investors Chronicle this week. It pointed out how the tech sector has outperformed the US market in 2019. Is this another dot.com bubble? She suggests not as companies such as Alphabet, Amazon, Netflix, Adobe, Apple and Microsoft are all highly profitable.

But she does warn that regulators are getting twitchy about the dominance of these companies. For example Google (Alphabet) is now so dominant in web advertising that the competitors are nowhere. They have become the gorilla in the marketplace as companies are bound to want to advertise with search engines that have the most users. Could some of these companies be broken up by US regulators or attacked by the EU as is already happening? Microsoft was of course the subject of an antitrust law suit alleging a monopoly and anti-competitive practices back in 2000, but escaped from any severe penalties or break-up and the case also took years to resolve so I doubt that other tech companies are likely to be badly damaged by any such law suits. But the settlement and some mis-steps by Microsoft did enable newer companies to grow into the size they now are.

Two areas that I am positive about are fintech and biotech, although the latter seems to have had rather a flat year as valuations became too optimistic and concerns grew about drug pricing regulation. Fintech, i.e. the enabling of innovative payment and banking systems, still looks a field where a lot of growth is likely and where there are a myriad of new or early-stage companies bidding to conquer the world. There is though a great danger in following such trends and accepting the hype that is given out by promoters of such companies – a lot of them will prove unsuccessful or never develop a profitable business model, and many of the shares in the good companies are wildly over-priced.

Housebuilding companies and estate agents have jumped up on hopes that the Conservative victory will lead to a recovery in confidence by house buyers. Even ULS Technology (ULS), one of my worse investments during the year and focused on property conveyancing, has risen by 50% since the low at the start of December. Does this mark a revival in the housing market and another golden era for housebuilders? I doubt it. The Government is undoubtedly keen to ensure more houses are built but house prices and the ability of buyers to afford them are driven by many other factors. With interest rates remaining at record lows, if the economy does pick up then interest rates might also rise. Readers need to be reminded that such low real interest rates are an exceptional phenomenon in historical terms. This anomaly surely cannot continue much longer.

Bearing that in mind, I won’t be investing in bonds or gilts in the near future as interest rates can surely only go one way and when rates rise, their prices fall.

Will the Conservative election victory and associated euphoria lead to a resurgence in business confidence, in more investment and hence in the growth in the UK economy? Perhaps, but there is still the potentially tricky issue of negotiating a free trade agreement with the EU over the coming year. That will likely mean the short-term euphoria will fade, as do most Santa Claus market bounces, in the New Year. But as with all market and economic forecasts, I could be wrong. So I will continue just to buy and hold well managed companies in growth sectors. That tends to mean small to mid-cap companies rather than mega-cap companies, although I do hold some investment trusts and funds that cover the latter. The managers of such funds are often closer to the market trends and the views of other investors than any private investor can hope to be.

It just remains for me to wish you a happy Christmas and a prosperous New Year.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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LSE Consultation on Market Structure and Trading Hours

Thanks to ShareSoc for pointing out to me that the London Stock Exchange (LSE) are undertaking a public consultation on such matters as trading hours and auction activity.

On the issue of trading hours, these are basically 08.00 to 16.30 at present although there is an opening auction at 7.50, a closing auction at 16.30 and a midday auction at 12.00 for SETS companies. These are longer hours than most international exchanges but do of course provide some overlap with US and Far East exchanges.

Reducing the hours might however improve liquidity and price discovery as the same number of trades would be concentrated into a shorter period of time.

For private investors, it might encourage more direct investment in shares. At present those who wish to keep up with company news have to get up quite early because RNS announcements are generally issued at 7.00 am so the news has to be digested along with breakfast before the market opens. It might also help stockbrokers and investment managers who have to get in the office early and have a very long day in reality thus restricting the kind of people who can do the job. Or as the consultation puts it: “Help encourage staff diversity” and make a “Positive impact on mental wellbeing of staff”.

Personally I would be quite happy with a 9.00 am opening time and a 4.00 pm close time, and I will be submitting a response accordingly.

Note that some commentators on Twitter suggested RNS announcements should be done after market close time to allow private investors to digest the information before trading in the morning – this might help those who are employed during the day.  The LSE consultation is not about that – RNS announcements can be done at any time and it is only convention, so far as I am aware, that most are done early in the morning. I would not personally be in favour of such a change and I doubt issuers would be either. It might mean more work in the evening when I already spend time reviewing the days trading and significant share price movements ahead of any trading the following day.  The other downside is that it might encourage trading on alternative venues overnight by big investors to the prejudice of private investors – the latter being unable to trade until the next morning.

The LSE is also proposing to reduce the number of auctions for SETSqx stocks (those AIM stocks and small cap stocks). The proposal is to reduce the auctions from 5 to 3 per day which may improve price discovery and trading sizes. I can see no problem with doing so.

There are some other rather technical questions in the consultation which you can read about here: https://tinyurl.com/qntpxlq . You can make a response directly or you can simply advise ShareSoc of your views who will be submitting a response on behalf of private investors. Go here for how to do that: https://tinyurl.com/yx4e6d79

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Mindless Investment Wins Out?

Last week on-line investment news site Citywire published a report headlined “Tracker fund sales smash records as UK investors pile into passives”. I was the first to add a comment which was “Mindless investment wins out. But at least folks are wising up to open-ended property funds and highly dubious ‘absolute return’ funds”. That generated a number of other comments, mainly from people defending tracker funds.

For example, a couple were: 1) Retail investors, with enough sense to be aware of their limited knowledge of macro-economics & its uncertain effect upon investments, stick to more understandable passives; and 2) Sensible folk realise that indexes will always outperform stockpicker funds in the medium to long-term, give thanks for Samuelson and Jack Bogle and ignore sneers from knowalls.

Let’s take some of those claims. It is certainly true that as the market comprises the whole universe of investors, a general stock market index must reflect the gains and losses of all investors. In other words, if all investors were “active” investors then there would be as many winners as losers. So you cannot achieve outperformance just by deciding to be an active rather than passive investor.

The other problem with active investment is that fund management charges are typically higher than for an index tracking fund. Charges are a major influence over long term returns so an active fund manager has to outperform the index substantially just to offset the higher charges. The flip-side of this is that as index tracking funds do have some charges, plus you may be paying a “platform” charge to hold or invest in them, your investment is bound to underperform the index.

But there are some active investors who do appear to consistently outperform their indices. For example Warren Buffett has done so. The latest example I was reminded of in an email that I received yesterday was the CFP SDL UK Buffettology Fund run by Keith Ashworth-Lord. Below is a chart from their Factsheet dated December 2019 showing the performance of the fund since April 2011 versus a UK All Companies Index and the cumulative performance figures. There appears to be clear outperformance shown.

Buffetology Fund 2019-12-01

Keith has been a promoter of “Business Perspective Investing” for a number of years. I recall reading the Analyst magazine with which he was involved and which alas ceased publication many years ago. That publication influenced my own investment approach. Since 2011 he has run the Buffettology Fund which aims to replicate the principles or Warren Buftett and Charlie Munger. In essence he looks at the business first before attempting to value it and is looking for quality businesses with high barriers to entry. Such companies frequently have superior operating margins, superior returns on capital and superior cash generation.

Now readers will not be surprised to hear that I have been following the same principles also and have recently published a book called “Business Perspective Investing” (see https://www.roliscon.com/business-perspective-investing.html ). I thought it would be interesting to see how the performance of my portfolio since 2011 compared to the Buffettology Fund. The chart below gives you the comparison against the All-Share Index:

Lawson Portfolio 2019-12-01

It looks very similar does it not! Both are nearing a 300% return over the period. The only possible difference is that the chart of my portfolio does not include dividends (i.e. it’s capital only, not total return). Both are focused on UK public company shares but I probably have more smaller companies in the portfolio – and I also have more holdings (85 versus 35 in the Buffettology Fund). But that includes some Venture Capital Trusts (VCTs) that provide minimal capital gains but a lot of tax-free dividends which are not included in the data.

Perhaps you think that otherwise I have the same holdings as Ashworth-Lord in my portfolio? That’s only true to a very limited extent. I only hold 3 of his top ten holdings. So the similarity of performance may relate to holding similar types of companies but not to holding the same companies.

The key point is that both I and Keith Ashworth-Lord have done a lot better than we would have done by simply investing in a FTSE index – about 300% gain instead of 30% in capital terms since 2011.

Have we just been lucky, i.e. is the outperformance likely to continue? It’s very difficult to be certain. John Bogle, whose books are well worth reading, claims there is little evidence of persistent out-performance by fund managers. Managers tend to revert to the mean. This may be because successful managers tend to grow their portfolios as new investors pile in, and the bigger the fund the worse it performs. There are only so many good ideas to pursue.

The other reason why performance tends not to persist is that successful investment strategies can be copied by other investors, thus eroding returns. For example, recently technology-based growth stocks have been seen as the way to make money. Will business perspective investing be replicated by others in future and become too crowded a field? Perhaps but it is not a simple strategy to follow and requires both knowledge and experience.

There have been a number of fund managers with a good track record who have not managed to sustain it. The most recent example is probably Neil Woodford but that is an example of a manager changing his investment strategy. Moving from undervalued medium/large businesses to a ragbag of special situations and early stage companies, some of which were not even listed.

Outperformance does require considerable effort though in analysing companies in depth rather than doing a trivial review of their financial numbers. Understanding the strengths and weaknesses of a business is essential, and keeping a close eye on it after investing is essential.

For a private investor if you don’t wish to do the work of researching individual companies the answer is to invest in a fund or investment trust where the manager follows similar principles and has a long-term track record. Avoid “closet” index trackers, i.e. active funds or trusts whose composition is very similar to their benchmark however much they try to convince you they are pure stock-pickers. You also need to avoid funds/trusts with high management and other overhead charges. You then have a chance of outperforming the relevant index.

If you consider that too risky, and active funds can underperform their index over short periods of time, then a tracker fund or ETF may be the answer for you. You will also avoid the real dogs such as the Woodford Equity Income Fund and some “absolute return” funds. But you certainly need to be aware that investors are currently piling into tracker funds at a record-breaking pace and they accounted for two thirds of fund sales in October. To my mind this is potentially dangerous as people are buying units in these funds without any analysis of the holdings therein, i.e. they are just thoughtlessly buying the index. My original comment on the Citywire article (“Mindless Investment Wins Out”) only refers to the success of fund managers in selling the different types of fund, not to their fund performance!

What has been happening in the last few years is that long-term investment has moved to short-term speculation. When John Bogle started promoting index-tracking and founded the very successful Vanguard business, and for many years after, index tracking was a minority interest among investors. Index tracking funds would have little influence on the index. But is that still the case? There is little evidence to suggest this is so but the return on many large cap shares, which dominate the indices, does seem to be falling. You have to bear in mind that index-tracking funds rarely hold all the shares that make up the index. They can replicate the index by just holding a few of the largest components. So there is a strong herd instinct to invest in the large cap stocks, or disinvest in them.

But large cap stocks, for example those in the FTSE-100, are typically very mature business with low growth prospects and often declining returns on capital.

The length of time that investors hold mutual funds and ETFs has now shortened so the average holding period of a stock ETF is now less than 150 days. They have become tools for short-term traders rather than long-term investors. This has magnified the swings in the market to the benefit of the fund managers and other intermediaries who gain from the higher volumes.

Playing in the large fish pools can therefore be tricky while at the other extreme investing in small or micro-cap stocks can be a triumph of hope over experience. For those reasons, business perspective investing probably works best in mid-cap companies that might be less driven by market trends and share price momentum driven by index trackers.

In conclusion, beware of mindless investment strategies and those who promote them. There are no free lunches in the investment world.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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