Intelligent Investor Equity Growth - June 2017

Despite political instability around the world, markets have taken it in their stride – but the resulting high prices have created their own problems.

It’s been said that markets climb against a wall of fear and it’s rarely been more true than in the 2017 financial year.

Crucial elections were held around the world, in Italy, the Netherlands, the US, the UK and France. Results were mixed, but the US and UK produced major shocks. There were of course no elections in North Korea, but the rogue state served up its own brand of instability.

Markets took it all in their stride, though – even managing to turn Donald Trump’s election as US president into a positive, which must be the purest form of seeing a glass as half-full. The high prices that have ensued have caused their own problems, with good opportunities thin on the ground.

In the face of such difficulties, the best response for long-term investors – as ever – is to seek the sanctuary of a bunch of decent-quality and undervalued stocks. That’s largely what our Growth Portfolio has done over the past year (much like the year before in fact) and by and large it’s turned out OK.

Table 1: Performance - Intelligent Investor Growth Income (to 30 Jun 2017)
  1 Mth 3 Mths 6 Mths 1 Yr 2 Yrs S.I. (p.a.)
Intelligent Investor Growth Portfolio (before fees) 0.99% 3.28% 3.54% 13.88% 13.48% 13.46%
Intelligent Investor Growth Portfolio (after fees) 0.92% 3.08% 3.10% 12.94% 12.49% 12.47%
S&P/ASX 200 Accumulation Index 0.17% -1.58% 3.16% 14.09% 7.11% 7.10%
Excess to Benchmark 0.75% 4.66% -0.06% -1.15% 5.38% 5.37%
* Inception date is 1 Jul 2015.

A run down the list of holdings shows (with only a few exceptions) a collection of cash-generative companies, with competitive advantages in important areas. While the market might fret about the near-term prospects for stocks like ASX, Ansell, Computershare, Seek and Sydney Airport, we’re happy to back their ability to deliver a growing stream of cash over the long term.

Of course such businesses don’t grow on trees, and it’s even harder to find them at bargain prices. So once we’ve bought them we tend to hold onto them – at least until we find something demonstrably better. This was the case recently, for example, with the shift of some of our holdings in Computershare into a new position in Navitas.

Too much tinkering, though, will hurt your returns. Most obviously there’s a cost in terms of brokerage and taxes; more insidiously, though, it can suck you into the market’s short-term thinking and thereby negate the biggest advantage you can give yourself.

During the year, we’ve sold and reinvested a bit less than 20% of the portfolio. That’s in line with the previous year and implies an average holding period of about five years, which is about what we’d expect in the future.

Although the portfolio has a bias towards quality (the long-term merits of which are often undervalued), markets are dynamic and offer different types of opportunity at different times. We therefore try to be flexible in our approach and will buy any kind of stock so long as we think it’s sufficiently undervalued.

Fleetwood is an example of a lesser quality stock bought at a very cheap price, and it has served us well so far, returning 41% on average since our two purchases in 2014 and 2015 (including 25% over the past year).

We’ll also invest in more speculative situations, within tight portfolio limits. As you’d expect, the experience here has been mixed, with Nanosonics up more than threefold since it was added to the (then model) portfolio at 78.5 cents in 2014 (and up 16% over the past year) and iCar Asia down 73% since it was added at 96.5 cents in 2015 (and down 67% over the past year).

We’ve also had some situations that have turned out to be more speculative and/or lower quality than expected – to put it politely – a category that would include GBST Holdings and OFX Group. In both cases we overestimated the quality and overpaid, but in GBST’s case we think the basic investment case is still on track and have held on, while with OFX we’ve taken what’s left of our money and run.

In GBST’s case we’ve now made a loss of 36% (29% over the past year), while with OFX we got out with a loss of 30% (incorporating a loss of 37% in the past year).

Overall, though, such mistakes have been relatively few in number. Out of 31 stocks held over the past two years (since it’s been accepting real money), the portfolio has lost money on seven (and the losses on three of those are in single digits). The one double-digit loss not already mentioned was in Origin Energy which lost 14% before being sold in June.

These losses have been more than offset by gains on stocks like Trade Me (up 35%), South32 (up 23%), ASX (up 23%) and Sydney Airport (up 21%), which have combined healthy gains with larger weightings to deliver the greatest dollar gains.

Of course these performances have been helped by a buoyant sharemarket, with the S&P/ASX 200 Accumulation Index returning 14.1% over the past year and 7.1% per year over the past two. Although our Growth Portfolio slightly lagged that benchmark in the 2017 financial year, with a return of 12.9%, it is comfortably ahead over two years, with a return of 12.5% per year (after costs).

Since it began as a model in July 2001 it has returned 9.5% a year, after assumed costs of 0.97% a year (matching the real costs since 2015), compared to 7.9% a year for the index.