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The Art of Execution – Essential Reading For Investors

I am an avid reader of newsletters and the national press on investment matters and noticed a couple of writers recently mentioned very positively the book “The Art of Execution” by Lee Freeman-Shor. I have now read it myself and it’s definitely a book every stock market investor should read. Here’s why:

There are thousands of books available on investment, aimed at both neophyte and experienced investors. They tend to fall into two main groups: those teaching you how to pick out good investments and those explaining how successful past investors have operated. Incidentally reading the latter ones simply tells you that there are many different styles that can be successfully used. But the main problem with the former approach alone, as the author points out, is that even with the most expert fund managers (and the most highly paid), only 49% of their “best ideas” made money when he analysed their performance.

Mr Freeman-Shor managed investors in his role as a fund manager at Old Mutual Global Investors and studied all the deals they did over seven years. Some investors made money for him overall but others did not, and the main differentiator was how they reacted to various circumstances, not their skills in initial stock selection.

Every investor faces decisions. When your favourite stock, where you have a big holding, drops 20% do you cut your losses and sell, or buy more? When another stock rises by 20%, 30% or more do you sell it to realise profits in fear of it falling back? Or do you buy more? Or perhaps you sell some and keep the rest (“top slicing” as it is called)? Do you worry when your portfolio ends up with 40% or 50% in one or two holdings?

Many investment gurus tell you to use a “stop-loss” to avoid big mistakes, but Freeman-Shor explains that many successful managers actually bought more if they believed in the fundamentals of a company. Clearly there is more to this subject of successful execution than the simple rules advocated by many. What really differentiated the successful investors is not how good they were at picking out winners, but how they managed their holdings later. He identifies a few distinct styles which differentiate the winners from the losers.

One of the handicaps of professional investors the author identifies is their unwillingness to take risks in case they get fired for short term underperformance. So they tend to over-diversify and take profits too early. These are bad habits that private investors can avoid.

There is much in this book that I have learned myself from 30 years of investing. But the author identifies the key habits and investment styles than can be successful. Essential reading for any new investor and highly recommended. And also interesting for those already experienced.

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

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KIDS – Who Is Kidding Who?

There was an interesting article published by Citywire yesterday on the subject of Hargreaves Lansdown removing 96 investment trusts from its trading platform. Such trusts as Dunedin Enterprise, Blue Planet and Oryx International Growth have been suspended. The reason is because they have not yet made available a “KID” (Key Investment Document) which is required by the new PRIIPS regulation and mandated by the FCA/EU from the start of this year (see https://www.fca.org.uk/firms/priips-disclosure-key-information-documents for more information).

At present investment trusts are mainly affected. Unit trusts and OEICs that are UCITS have another two years to comply.

The Citywire article quoted Annabel Brodie-Smith and Ian Sayers of the AIC (trade body for investment companies) as saying it was only a transitional problem but that the mandatory performance figures in the KID “will in some cases, be suggesting too favourable a view of likely future performance” and the “single-figure risk indicator will potentially be understating the risks”. Mr Sayers has also criticised the fact that open-ended funds will not need to disclose underlying transaction costs when investment companies will need to do so, thus making comparisons difficult.

Investment Trusts are of course a peculiarly British investment platform whereas most of Europe use open-ended funds, and hence the legislation was focused more on the needs of the rest of Eurupe rather than the UK. The UK already had quite extensive disclosure of fund information, particularly for investment trusts which was published in such documents as a “Monthly Factsheet” with performance date readily available from the AIC web site, Trustnet and other sources.

I posted a comment on the Citywire article which said: “The regulations impacting investment trusts are a typical example of EU laws written by folks who do not understand the UK market environment, and are also generally ignorant of the financial world. The sooner we depart the better. Expensive and incompetent bureaucracy in more ways than one.”

That immediately prompted the usual abusive comments from EU lovers – anonymously of course. A vigorous debate then followed. So what is the truth? Are KIDs going to be useful? Were some trusts deficient in being up to speed on making KIDs available? Is the additional expense of producing a KID worthwhile?

Now it is undoubtedly the case that some investment trusts might have been tardy in meeting the regulations (although I believe Dunedin Enterprise Trust is winding down so they might have not put a high priority on it). But as it will prevent purchases but not sales, this needs to be rectified as soon as possible otherwise prices might be distorted.

But are KIDs useful? You can see one for JPMorgan Euro Smaller Companies Trust (a trust I hold) here: https://documents.financialexpress.net/Literature/83197092.pdf ). The risk rating is simplistic and the “performance scenarios” are likewise. It shows that over 5 years a holding in this trust might generate a negative return of 18.62% per annum, but in a “favourable scenario” you might make 36% per year. Does that help you? Not a lot.

That is particularly so as those figures are forecasts, not the real historic data. In comparison the information on the AIC web site or the company’s web site, including in the company “Factsheet” is much more comprehensive and more helpful. For example, it tells you about the historic price performance versus the net asset value performance (and over several time periods), the discount levels, the performance against a benchmark and lots more data.

The KID does have some useful information on costs, as it includes transaction costs. As a result it gives the “Impact on Return” due to costs of 2.81% per year whereas the AIC reports an “On-going” charge of 1.13% for this company because they don’t include transaction costs. This is a company that does not have a performance fee though which would complicate reporting on other trusts.

The objective of the KID to standardise the reporting of basic information on investment funds, and provide consistent and accurate “all-in” cost data was laudatory. But the implementation is a dog’s breakfast with the result that investors are hardly likely to spend a long time looking at these documents even if they are forced to do so.

On the latter point, the Share Centre now require you to tick a box to say you have read the KID before buying the shares, but other platforms such as AJ Bell YouInvest don’t seem to require that. I suspect folks will soon learn to tick the box regardless simply because most investors will have done some research on the fund, or already hold it (perhaps on another platform).

In summary, KIDs are designed to meet the needs of unsophisticated pan-European investors where little information might have been available to them previously. Whereas in the UK we are awash with information on trusts and open-ended funds to the point that a lot of investors are suffering from information overload. The KID just adds to it.

The information provided in the KID can be grossly misleading about the risks and returns that investors might expect. The document is the end result of the complex bureaucratic processes in the EU for devising new financial regulations, where those developing them seem to have little understanding of financial markets or investment and the end result is often a compromise between different national interests. The process is also heavily influenced by the large financial institutions such as banks that dominate the retail investment scene in much of Europe.

Financial regulation in the UK is not perfect of course, and we have the same difficulties that they are often written not for the benefit of investors but for market operators and intermediaries. We might just be able to do better. But we also need to push for improvements to the content of KIDs because we may still need to produce them to enable trading of investment trusts and funds across Europe.

It is though unfortunate that the cost of producing a KID will be significant and will be passed on to investors. Likewise the MIFID regulations brought in on the same date have resulted in major costs for stockbrokers. More regulation costs money and investors do not always benefit from it. One particularly disadvantage is that it deters new entrants into the investment world, i.e. protects the interests of the big boys from more competition. Financial regulations when devised need to be simple and low cost to implement and enforce. That is a long way from being the case at present. The PRIIPS regulations are a good example of how not to do it.

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

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Year End Review, the Future, RBS Requisition and New Year’s Honours

This time of the year is when all private investors who invest directly in the market should be reviewing their investment performance over the past year. If you can’t do better than the professionals (after costs) then you might as well let them manage your portfolio. So when it comes to the year end I work out the data and look at where I made and lost money (as a learning exercise).

Let me first explain that I have a very diversified portfolio and I simply aim to beat the FTSE-AllShare as a benchmark. It is diversified both in size of company and market sectors. This was the breakdown of my holdings recently:

AIM Shares: 37%
FTSE-100: 5%
FTSE-250: 24%
FTSE Small Cap: 4%
Funds/Trusts: 15%
Property Trusts: 6%
Unlisted shares: 1%
VCTs: 8%
Bonds 0%

 

The result was a Total Return of 22% for 2017, which compares with the FTSE-100 increase of about 7%, FTSE-250 of 14%, FTSE-AllShare of 9% and FTSE-AIM of 33%. Clearly I would have done even better to have invested solely in AIM shares but that would have meant an overall portfolio very concentrated on smaller companies (particularly bearing in mind that some of the Funds/Trusts and all the VCTs invest in smaller companies).

The overall portfolio dividend yield was 3.9%. The reason why this is so high is partly because the Venture Capital Trusts (VCTs) paid out large dividends, but these actually showed capital losses during the year – apart from a couple of AIM VCTs. That just shows how the market drove up AIM shares last year, because AIM VCTs are often tricky investments because of their propensity to take up IPOs. Other VCTs showed a preference to turn capital into tax free dividend income because of the rules they have to adhere to that stops them retaining cash and a desire to “recycle” capital so investors get more tax reliefs.

National Grid also used the “consolidation” trick to turn capital into dividends following a major disposal which affected the numbers slightly, but otherwise also lost value no doubt because of investors’ worries about the threat of nationalisation or more Government interference if Corbyn gets into power.

Lots of my big winners during the year were the most popular AIM shares – technology and internet stocks – I won’t name them for fear you’ll all be piling into them even more as seemed to happen in the last few days of 2017, and at risk of talking about my own “book” which will lead to recriminations when one or more come unstuck. But there were a few larger winners – Persimmon and Greggs for example – which were both big losers in the previous year. I sold Berkeley Homes at the start of the year which was a mistake although that was partly offset by investing in Telford Homes (an AIM stock of course). Apart from McColls (a convenience store chain), retail shares were out of favour so Dunelm was a big loser. Property companies did surprisingly well so my holdings in Segro, Tritax and TR Property Trust did better than everyone was forecasting for the year. I did invest in some investment trusts with large international exposure which helped the portfolio performance because of the fall in the pound.

Needless to say, it may be wrong to change one’s investment approach simply based on the results of one year, particularly when the market seems to be so buoyant in certain sectors. Is the market going to crash in the near future as some have predicted? Who knows – not me. Should I pile into more AIM shares that have been driven up by momentum traders? You can do that but I won’t because the chance of getting out at a decent price if a crash did occur in small cap shares is small. I still look at the fundamentals of companies and I have been limiting my exposure to some of the AIM shares in my portfolio because revenue growth can only be worth so much. Cash flow and profits are also important. I only try to hold AIM shares where the business has quality and a longer-term future. That way you can ignore short term fluctuations in the share price, and avoid big tax bills unless you trade only within an ISA or SIPP.

Some shares and sectors certainly look overvalued at the moment, but that is always the case. US stock markets are probably of more concern in terms of valuations than UK ones, but if the US crashed then so would the UK and other markets soon after – they are now globally synchronised. So I am holding a moderate amount of cash at present which probably reduced my portfolio performance last year to some extent. I’m just waiting for those buying opportunities, but they may not come any time soon. It’s a “bottom up” strategy rather than “top down” so if shares at attractive valuations appear, I’ll buy them.

One of the biggest news items in the last few days was the submission of a requisition for the appointment of a Shareholder Committee by ShareSoc and UKSA at the Royal Bank of Scotland (RBS) – a photo of ShareSoc director Cliff Weight outside the RBS offices is shown below.

RBS - Cliff Weight

This is of course the second year that such a resolution has been submitted for the RBS AGM. Last year it was rejected by them on what I consider spurious grounds. Let us hope they accept it this year because the ability to add resolutions to meetings (or requisition General Meetings as per the recent event at the London Stock Exchange, the LSE) is a fundamental element of shareholder democracy in public companies. If that part of the Companies Act is ignored it means directors can do what they want. The LSE had the good sense to accept the demand for a vote on the Chairman, let us hope that RBS do likewise.

Incidentally, the LSE directors and Mr Rolet, who they accused of being other than a team player, would do well to read a book I reread over Xmas – “How to Win Friends and Influence People” by Dale Carnegie. I read it first many years ago but had forgotten what it says (when my wife noticed I was reading it she said I should have read it 30 years ago and I had to admit I had done so). The first lesson in there is “Don’t criticise, condemn or complain”. But it’s a good read anyway, both amusing and well written, particularly if you are looking for some self-improvement.

To get back to the events at RBS, if Cliff manages to persuade RBS to accept the resolution, and can then persuade the Government to support the resolution (they have enough votes to swing the outcome) this will be a major achievement. It takes a lot of effort to pursue such campaigns as I know myself. I would suggest we should nominate him for an “Honour” if he achieves his goals – just go here for how to do it: https://www.gov.uk/honours

That thought came to mind when I was reading the New Years Honours List in the FT (not that I am in the habit of perusing the list but there was not much else to read over the Xmas holiday). One surprise was the award of an OBE to Suranga Chandratillake, for “services to engineering and technology”. He was a former director and founder of controversial company Blinkx (since renamed RhythmOne) – or as the FT said – a company whose market value has been volatile since its IPO in 2007. Mr Chandratillake remains on the board as a non-executive director having stepped down from being CEO some time before the furore over possible misleading stats reported by internet advertising companies blew up. Still public Honours may not be awards for success – just consider the award to Nick Clegg. I had better not say anymore otherwise I will be unlearning the lessons from the above book.

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

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