How Many Stocks?

There was an interesting article in this week’s Investors Chronicle by John Rosier which discussed the number of holdings he had in his portfolio. He had attended a presentation by a well-known private investor who had 25% of his portfolio in one stock. John questioned whether he held too many stocks in his own portfolio (32 according to his portfolio list). He mused that Neil Woodford held 135 stocks in his UK Equity Income Fund but the largest 10 positions made up 42% by value. Mark Slater who runs the MFM Slater Growth Fund also had 42% in his top 10 but Nick Train in his Finsbury Growth & Income Trust has 75% in his top 10.

Now this caused me to examine my own portfolio. I actually have 95 equity holdings, and at this point in time, no bonds or other fixed interest stocks. The figures for my portfolio are:

37% in the top 10.

60% in the top 20.

85% in the top 50.

So it’s moderately concentrated and only slightly less concentrated than those mentioned above apart from Nick Train’s. As John Rosier said in his article, the concentration of the portfolio in the largest holdings is more important than the total number of holdings.

One interesting aspect is that this concentration is not just from design. It has arisen because I tend to buy more of the winners and sell the losers. Indeed, it would have become even more concentrated but I have a rule that I do not like to have any holding go over 5% of the total. That limit is even lower for smaller cap stocks because they are obviously more risky and my innate conservatism leads me to prefer to avoid large shocks to my overall wealth.

If I was younger, and not solely depending on my investments to finance my living standard then I might be able to take a more aggressive stance. Indeed, at my age (71), most financial advisors would say I should have well over 50% in fixed interest but I have taken a different view as to what is safe and what is not. More diversification, particularly across many small cap stocks with many on good dividend yields backed up by cash (ignored in the above calculations), gives me some protection. In addition with some smaller AIM stocks, it can be very difficult to buy or sell large blocks of shares so getting out when you want to can be very difficult if you have a big stake. So investors who hold AIM shares are probably sensible to have more shares in their portfolios than those who concentrate on FTSE shares alone.

Perhaps the issue with my portfolio is that there are 45 stocks I hold that make up only 15% of the overall portfolio value. Why bother with them? Some of these are ones where I am building up a holding from an initial low level, and some are simply small cap speculations where I am still learning about them. A few are VCTs that I bought years ago and find it difficult to dispose of without incurring capital gains tax. Others are holdings not in my ISA and SIPP accounts where disposing of them altogether would crystalise a capital gains tax liability when I am already over the annual allowance. There are a few “duds” where the holding shrank to a very small size as I gradually sold it down as a result of following the share price trend.

The key to managing the 95 holdings is to use some automated software tools to track one’s portfolio and the individual holdings to ensure you don’t miss any share price break-outs (up or down) or any news – I use several such products and services.

Having pondered this question of “how many stocks”, I am not uncomfortable with the current structure of my portfolio but it’s probably worth doing this exercise regularly and clearing out some of the smaller holdings once per year.

Another aspect to consider is of course how diverse the holdings are in terms of them operating in different market segments – to avoid the problem of them all moving together. It is very obvious from studying the reader portfolios regularly published by Investors Chronicle that many private investors have too many holdings – typically multiple funds that are likely to move in step.

I hope this article has prompted readers to look at their own portfolios and the concentration they have in them.

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

Disclaimer: Read the About page before relying on any information in this post.

ETFs and Index Trackers – More Dangerous Than You Think

Lots of financial pundits have encouraged investors to be “passive” investors rather than try to pick stocks, or invest in funds that do that latter (“active” funds). Even the FCA has recently criticised active funds for being more expensive and the additional management fees end up impacting negatively on overall returns over time. So persuasive writers such as John Bogle have convinced many to take the “no brainer” route of buying Exchange Traded Funds (ETFs) or other index tracking funds.

But there are surely dangers creeping up on all of us from this approach evidenced by several interesting articles in the Financial Times and Investors Chronicle in the last week.

On the 7th August John Plender in FTfm showed how index tracking funds break prudent portfolio rules. He warned about the concentration of holdings in Nasdaq stocks where the top five holdings (Apple, Google (Alphabet), Microsoft, Amazon and Facebook) represent 41 per cent of the index. He said “Concentration risk that is forbidden to an active manager is considered reasonable if it happens to be an index. This is dangerous nonsense”.

The Editor of Investors Chronicle published an editorial that warned that one of his worries was the huge inflows to passive funds and said “But I am concerned at the presentation of ETFs as an investment panacea because it has created the impression that investing is easy and riskless”. That is surely very true as private investors have simply bought more and more lately in a steadily rising market in recent years, driven by “momentum” trading styles. They don’t look at the valuations of what they are buying (hey – the index must be the best valuation is it not), they just buy and sell regardless based on trends. As the IC editor also said “What happens when the US bull market comes to an end?”. A good question indeed to which there is an obvious answer – a market crash as investors who have never been through a bear market capitulate.

Just today we have a front page article in the FT headlined “surging flows into exchange traded funds drive US stocks bubble anxiety”. It covers the record breaking in-flows into ETFs this year so far. It includes a good quote from Howard Marks of Oaktree Capital: “When the management of assets is on autopilot, as it is with ETFs, then investment trends can go to great excess”.

I certainly agree that investors need to examine very carefully the costs of the funds they invest in, if they do not wish to invest directly in shares. There may even be a place for index trackers in a portfolio – not that I hold any. But the real worry is that ETFs are now distorting the market and protecting yourself against that distortion, or from the likely collapse when everyone realises the emperor has no clothes, is not easy. It has led to a general rise in asset prices, in particular share prices, while simply staying out of the market while this is going on does not make much sense either.

The situation is surely analogous one of the causes of the great Wall Street crash of 1929 where “trusts” dominated the market and were sold to investors on the basis that they only went up. That was not helped by trusts investing in other trusts in a kind of pyramid scheme, and by low cost finance to purchase shares on margin – and we surely cannot get much lower interest rates than we have now. Restrictions on credit was one immediate cause of the 1929 crash, causing margin calls to be invoked and a spiral down.

There is no simple solution to protect oneself against the hysteria of momentum investing and index tracking, but the most vulnerable shares are undoubtedly those that form a large part of any index. Those are the ones where valuations may become unrealistic and where active traders may not feel it wise to try to sail against the wind. So the message is surely to look askance at unreasonably high valuations in relation to earning or cash flows in companies. Simply “buying the index” when everyone else is doing so is not a sound approach.

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

Disclaimer: Read the About page before relying on any information in this post.

The Internet of Things – Telit and Tern

Most investors in AIM will have noted the unfolding news at Telit Communications (TCM) last week. It has culminated today with an announcement from the company that CEO Oozi Cats (a.k.a. Uzi Katz) has resigned after an independent review did indeed find that he was the subject of a US indictment 25 years ago which had not been disclosed to the board. However, they denied that other allegations about the operations and finance of the company were true. Specifically, they said “there is no substance to the speculative and accusatory articles that have been published and that it stands behind the Group’s audited accounts to 31 December 2016 and the most recently published interim statement”. Will the publisher receive yet another threat of legal action as a result? We will see, although companies are reluctant to spend time and money on such cases and it is more difficult for them (as opposed to individuals) following recent changes in libel law.

Is this yet another example of how AIM regulation is defective? The simple answer is no. Both I and ShareSoc have campaigned for improvements in that area, and the LSE have recently published a paper entitled “AIM Rules Review” which has some helpful suggestions.

But the alleged legal problems of the CEO and his wife were 20 years before the company even listed on AIM in 2015 so no amount of due diligence was likely to have discovered that issue. The more recent allegations – which are about possible fraud at the company – are not an issue of AIM regulation. Possibly more an auditing issue if any such problem exists, which the company clearly denies. However, one has to question the willingness of AIM to list companies based in foreign countries some years back. Why did they list on AIM rather than in Israel or the USA for example? Possibly because they thought there would be less scrutiny. There does appear to be more examination of new listings of late and it’s covered in the paper mentioned above also.

Now I have never invested in Telit, although I have looked at it more than once in the past. There were several aspects about this company (other than the country of residence) that put me off. The nature of the product was one – albeit it’s operating in a hot sector but was there good protectable IP? Others were the lumpy nature of hardware orders, the directors and their pay, the issue of director share sales, the failure to turn profits into cash, the repeated fund raisings…..I could go on.

In summary, this is the kind of company I do not want to own.

It’s probably just another example of a persuasive CEO encouraging investors, often unsophisticated private investors, to punt on a concept of rapid growth in a hot technology sector.

Interestingly another company focused on the “Internet of Things” sector is investment company Tern (TERN) who raised some funds via platform Primary Bid over the weekend via a placing and open offer. The latter closed early due to the demand. Indeed, the COO of Primary Bid said: “We are delighted to have facilitated the fundraise for Tern plc. It was good to see such strong demand for this Offer, demonstrating how popular Technology related companies can be with tech savvy PrimaryBid Investors. More than 50% of all investors subscribing for this offer did so via a mobile device”. Note particularly the last sentence.

I had a quick look at Tern, but had great difficulty in valuing the company because it’s largest investment by a long way is a holding in a company named Device Authority Ltd. Is there any information provided on the revenue or profits of that company in the announcements about the fund raising or in recent past company announcements, or are there any recently published accounts filed at Companies House for this UK registered company? Apparently not, so any “due diligence” is difficult. But Tern does not look expensive at face value because of their revaluation of the investment in Device Authority last year by the company in the same way as any other private equity investment is valued.

Is this another case of over-enthusiasm by private investors to get into this high tech world? We shall no doubt see in due course.

There is another thing which Telit and Tern have in common. They have both been harassed by the same “journalist”. Indeed, director Angus Forrest of Tern even went so far as to report him to the police for harassment in 2015 although the matter was not pursued (harassment can be both a criminal law and civil law case).

Investors are recommended to take a cold shower whenever anyone talks about hot technology sectors. A lot of businesses in them never turn a profit, or give a decent return on investment. You just have to look at the early history of Apple – now the largest company in the world by market cap – to see how tortuous and extended can be the path to success. And most of their early competitors simply disappeared.

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

Disclaimer: Read the About page before relying on any information in this post.

Departures – AA and Blur

Yesterday was the start of many people’s holidays. But two company chief executives are going to be taking longer holidays than they expected.

The Executive Chairman of the AA Plc (AA.) Bob Mackenzie has gone. The announcement from the company said he “has been removed by the board….for gross misconduct, with immediate effect”. According to press reports, this arose from a fracas in a bar, although there is also a suggestion that he may be suffering from a mental illness. Some newspapers just suggested it was a “Jeremy Clarkson moment”.

The share price of the AA dropped 14% on the day, which probably reflects the problems that can arise when you have an Executive Chairman dominating a business. It’s not recommended corporate governance practice and personally I tend to avoid companies who have them.

The AA is an interesting organisation which provides breakdown cover and other services for many motorists. Back in 1905, it was formed to warn drivers about speed traps. It later transmogrified into a commercial organisation when the members sold out. Now it is one of the largest operators of driver education programmes such as speed awareness courses. That has become a booming industry and more than a million drivers are now attending speed awareness courses each year. This has resulted in the funding not just of commercial organisations such as the AA but more than £40 million per year goes to the police and local authorities. For the first time in English law, it is now allegedly legal to pay the police to drop prosecutions – all you have to do is promise to attend such a course. There is no evidence that it has any benefit in road safety. More information on this dubious practice is present here: http://www.speed-awareness.org (a campaign run by the ABD against it).

The other departure yesterday was of founder and CEO of Blur Group (BLUR) Philip Letts. This was a company that listed on AIM more than 5 years ago and in 2014 traded at a price as high as 665p. It’s now 3p.

This was a company that was a typical “concept” stock. It was going to revolutionise the commissioning by SMEs of services which is still very much an informal market by introducing an internet market. Mr Letts must be a very persuasive person to keep the business alive this long by repeated fund raisings. But it’s a typical example of how unproven business models are very risky investments. Most companies would have changed the business focus and the CEO long ago, or simply wound up, but Mr Letts persisted.

Yesterday the temporary suspension on AIM was lifted as they finally published some accounts. The results were slightly improved in that losses were reduced, but it still looks an unviable business unless the new management can make substantial changes. Mr Letts was removed from the board effective on the same day.

Incidentally I do hold a few Blur shares – market value now £6 so I hope that has not prejudiced my comments. If you get enthused by the hype surrounding some early stage companies, and the persuasiveness of the management, there is one simple thing to do. That is to only invest a very small amount until the company proves its business model and actually shows that the business is likely to be profitable. Revenue alone is not enough, because anyone can generate revenue by spending lots of your money.

The other protection is when the company fails to achieve its stated business plan, to simply sell and move on. Ignore the tendency to “loss aversion” where you hold the dogs in case of recovery. Or if you fear missing out on a big recovery, simply reduce your holding to a nominal level as I did on Blur and saved myself even more money.

So I invested a very small amount initially and then reduced it later to a miniscule level.

Just one point to note is that the company actually spells its name “blur” rather than “Blur” as I have used above, thus ignoring the rules of English grammar. Such affectations in companies to be “different” are always a bad sign in my experience.

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

Disclaimer: Read the About page before relying on any information in this post.

Utilitywise Profit Warning

A trading update from Utilitywise (UTW) caused the share price to fall another 18%. It’s already down from over 350p in May 2014 to 48p the last time I checked. A pretty disastrous investment for many. This was one of those go-go small cap stocks that lots of share tipsters were promoting back in 2013/14. Revenues and profits were apparently on a strong upward trajectory from their sales of utility services to commercial users.

I even bought a few shares myself. But I sold when I came to realise that their revenue recognition practices were in my view somewhat aggressive. So far as I understood it, they were recognising profits on contracts when the customer signed up for an annual or longer contract. From today’s announcement that even included recognising profits on signature rather than contract commencement. But the real problem to my mind is that instead of most businesses where profits are taken on amounts invoiced, which is shortly before cash is paid on them, in this case the cash was received very much later. So I got cold feet and bailed out. I simply don’t like imprudent accounting and aggressive revenue recognition (Quindell was a similar example).

That is basically what is so damaging in today’s trading statement where they cover a change in accounting policy to IFRS 15 which has tougher rules on revenue recognition from contracts. Who were the auditors of Utilitywise? BDO LLP.

Respected investor Leon Boros has already tweeted that with the adjustments to their accounts required, all the historic profits of the company will disappear. As he says “always follow the cash”.

I did write a report on a Mello event for ShareSoc where Utilitywise was one of the companies presenting back in 2013, but it was not a particularly complimentary one – it mentioned possibly regulatory problems, aggressive sales practices and director share sales for example. The revenue recognition issues only became apparent at a later date.

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

Disclaimer: Read the About page before relying on any information in this post.

AIM Rules Review

The London Stock Exchange have published a document entitled “AIM Rules Review”. ShareSoc, including me personally, have criticised the LSE in the past for poor regulation of the AIM market. Many investors view it as a casino because of the numerous problems of fraud, poor disclosures, many delistings or simple bankruptcies in AIM companies. See the ShareSoc campaign page here for more information: https://www.sharesoc.org/campaigns/campaign-improve-aim-market/

As you can see we made a number of recommendations on how to improve the AIM market, and had meetings with AIM management where we put these proposals forward. The LSE regulates the AIM market but their responsibility lies primarily in ensuring the AIM Rulebook is adhered to and that Nomads meet their responsibilities. Other aspects of the market such as market abuse or false accounting are covered by other regulatory bodies, which many private investors do not understand.

So have any of the ShareSoc proposals been covered in the latest document? In summary, yes they have been. Here’s a quick review:

The AIM Rules Review does emphasise the improved recent performance of the AIM market and the fact that the average size of companies listed on it is growing. That has helped to improve the quality of the market.

Vetting new listings. One proposal we made was that new listings should be vetted by an independent panel because many investors considered some of the new listings in the past to be very dubious businesses. They have not taken this up directly but are proposing to formalise the “early notification process”. In addition, they propose to give more guidance to Nomads (whose role it is to perform due diligence on prospective listings) on what they need to take into account. For example, the “good” character of directors or managers, the corporate structure and business model, risky contractual arrangements and “related party” interests. This looks to be one way to tackle past problems, but one suggestion I would make is to add to that list the “regulatory structure and upholding of the rule of law in the countries where the candidate is listed or operates”. For example, it has proved very difficult to pursue fraud in China, and even Greece creates difficulties in that regard.

Free float. One concern they cover is the issue of low free floats which is a concern of some investors. For example, many of the companies that have turned out to be problem ones are those where there is an executive Chairman who holds a majority of the stock (or their close relations or associates do). This gives that person enormous power to prejudice minority shareholders, ignore the views of other board members and ultimately commit major frauds. The LSE’s response on this issue though is simply that the LSE would like to understand the position on new applications and the Nomad’s consideration of it. That surely is open to abuse, but the LSE does ask whether more specific free float rules should be brought in (the LSE document is a public consultation one so you can submit your own comments).

Minimum Fundraising. They also propose the introduction of a minimum fundraising rule and pose some questions on that. This would help to ensure institutional involvement in a company.

Composition of Boards. They mention this, but give no specific suggestions. That is surely an omission when ShareSoc made some specific suggestions in that regard.

Disclosure and Corporate Governance Codes. The document covers the issue that AIM companies can avoid any adherence to a specific corporate governance code. ShareSoc suggested a specific code should be available and applied by all AIM companies. The LSE asks a question on this at least.

Education and Breaches of the AIM Rulebook. The LSE asks how the market, particularly individual investors, can be further educated as to what the LSE can and cannot do. A good question indeed, which I will ponder.

Breaches of the AIM Rules. But one issue we raised with AIM management was the failure to enforce the existing Rules, or penalise and publicise those who break them. Indeed the document spells out how poor this has been by giving some statistics. There were 93 recorded breaches or where “education” was required, but only 16 warning notices or private censures/fines issued on average over the last three years. There were zero public censures apparently. They do ask a question about possibly imposing automatic fines on breaches of the AIM Rules, and invite suggestions for other changes. I will have some, but the basic problem is “self-regulation” and the resulting unwillingness to take tough action. Both firmer rules on penalties and a cultural change is required.

In summary, this Discussion Paper on the AIM Rules is a useful step in the right direction and does appear to tackle some of the issues about AIM that I and ShareSoc raised. It is though only a discussion paper and hence that does not mean necessarily that action will be taken. In some regards it is still quite weak but regrettably AIM management have an uphill battle to get change adopted when many market participants consider everything in the garden is rosy. However, it is surely necessary to improve the reputation of AIM if the market is to attract more listings and reduce the number of complaints from investors.

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

Disclaimer: Read the About page before relying on any information in this post.

First blog post

This blog is written by Roger W. Lawson and covers topical news and comment on investment (particularly stocks and shares), on corporate governance, on company management, on economics, on transport, on art, on events in London and on local and national politics. It will also cover anything else that I feel may be of general interest to my readers or where I have a burning desire to discuss a topic.

As some readers may know, I have been writing articles and blog posts on stock market investment for many years, more recently mainly for ShareSoc – an organisation for private investors. I will continue to do so as I support the objects of ShareSoc, therefore you may find similar blog posts on their web site as appear here.

This blog may cover a wider remit though in that I won’t shy away from controversial issues as much as a “responsible” national organisation has to do. In this case you are simply getting my personal opinions, but I will of course always try to get the facts straight to support any stance. If that offends some people then so be it. One cannot produce interesting and lively articles while pandering to the sensitivities of everyone in this world.

It will also cover some other areas of interest to me than stock market investment.

I hope you find it a good read.  Review what it says in the “About” section for more background information.

Roger Lawson