New Sunday Times Feature - Diary of a Private Investor

[Colm Fagan]

I love reading your posts Colm.

Thank you, DeeKie. I enjoy writing them, even the painful ones.

I’m curious as to whether you got to ask the questions that you wanted answered at the Reinshaw AGM?

Yes, I did attend the AGM and I did ask my question. To be honest, it was more a statement than a question. I wrote down what I planned to say in advance, and here it is:
"Sir David. I’ve been an admirer of Renishaw ever since I bought my first shares in the company 20 years ago for the princely sum of £4.05 a share. The annual dividend yield on the original investment is now almost 15%. That has helped fuel my admiration!

I have particularly admired the Board’s and management’s determination to do what’s right for the business in the long-term, and not getting too concerned about the short-term impact on the Profit & Loss account or the share price. This year’s Annual Report makes me wonder however if you’re paying too much attention to short-term results and showing far too much respect to what Warren Buffett disparagingly calls “Mr Market”.

For example, the opening paragraph of your chairman’s statement refers glowingly to the Total Shareholder Return of 48% in the year. Total Shareholder Return is calculated by taking the change in the share price over the year, adding dividends, and expressing the result as a percentage of the share price at the start of the year. The same calculation for the period from 30 June last to 15 October shows a Total Shareholder Return of minus 23%[1] for the period, and that includes the dividend of 46p a share coming into our bank accounts next week. I’m sure you’ll agree that neither the plus 48% for 2018 nor the minus 23% for the first three-and-a-half months of 2019 has any relevance to the real long-term value of the business or your stewardship of it. Yet, the very fact that you give the figure such prominence in your chairman’s statement makes me fear that even you are being seduced by short-termism.

On the same lines, but more worrying in some ways, is the sharp cut in R&D expenditure in the healthcare division in FY 2018. As people in this room know, some analysts have criticised Renishaw over the years for the continuing losses in its healthcare Division. Long-standing shareholders didn’t agree with the criticisms. We were prepared to be patient: we recognised that healthcare requires considerable up-front investment in developing new products. We also recognised that there are long lead times in getting regulatory approvals in various jurisdictions, etc. Patience is required. It is reasonable to expect losses for a number of years before investments start to pay off.

When I looked at this year’s accounts, I was pleased initially to see that the healthcare division had turned the corner and had made a profit, albeit a small one, in 2018. Then I looked again and saw that R&D Expenditure in the Division had been cut by more than 20% (and that’s after excluding the restructuring costs from last year’s figure. The cut was closer to 30% based on the figures in the accounts.) If R&D expenditure hadn’t been cut, healthcare would have produced a loss in 2018 also.

I was left wondering if R&D expenditure had been cut specially to appease “the market” and to show a profit for the year. I asked the question at the results presentation in July. Will assured me that I was wrong, that it was more a case of focusing R&D in areas of healthcare where you believe that Renishaw can succeed in the long-term. I believe him, and I agree that it would be wrong to continue investing in areas that are unlikely to generate a long-term return. At this time of transition, however, with Will taking over as Managing Director, I would ask the Board and management to keep its focus firmly on the long-term and not be seduced by short-term considerations.

Finally, I presume there will be no reference to Total Shareholder Return in next year’s Chairman’s statement!"

I don't recall the chairman's exact reply, but I know he shares my views. I suspect that it was an over-eager junior accountant who put the bit about Total Shareholder Return into the Chairman's Statement. I am confident that it won't appear in next year's Chairman's statement, irrespective of what the price does between now and year end. In answer to my question on healthcare, the MD (Will Lee) reiterated what he told me at the time of the results announcement. He amplified it by saying that, at later stages of the product development cycle, the focus of "development" cost moves more to distribution, which doesn't count as R&D (At least, I think that that's what he said; I'm not familiar with that type of business, so the reply was over my head to some extent).

In answer to your final question as to whether they impressed me in person, the quick answer is yes. I've got to know quite a number of the senior team at this stage and they're 100% committed to doing the right thing for the long-term prosperity of the business. I want to keep it that way!!


[1] Price 29/6 £52.80; Price 15/10 £40.06, Div. £0.46. TSR: 23.25%. FY 2018: (52.80 + 0.60)/36.20 = 47.51%

 

[Colm Fagan]

I'm just wondering to what extent ethical considerations inform your investment considerations. Personally, in view of climate change challenges and especially given your very concentrated portfolio, I would not be comfortable shorting Tesla or holding Ryanair.

You raise an interesting question. I'll deal first with the specifics of Ryanair and Tesla.

As far as Ryanair is concerned, I recall saying in the article that I didn't particularly like investing in them, no more than I like flying with them, but at times they offer such compelling value that it's hard to ignore them. (Given the recent trajectory of the Ryanair share price, you know what to think of that opinion). My dislike of Ryanair stems more from their attitude to their workers rather than for being environmentally unfriendly. I don't think they're significantly worse than other airlines in terms of their environmental record, but I could be wrong.

My decision to short Tesla was similarly not based on a dislike of their cars. I just thought they were massively overvalued. I also have major doubts about Elon Musk's ability to lead a major company. He loses top executives by the new time.

I do try to have an ethical approach to investing. For example, I would find it hard to invest in Paddy Power Betfair. I don't like the thought of profiting from compulsive gamblers (although some might claim that I'm a compulsive gambler on the stock market!). Neither do I have any drink or tobacco stocks in my portfolio. Having said that, I can't say that I would never invest in them. My decision on whether or not to invest in such companies is not going to change the world.

 

[Sarenco]

I must say I continue to admire Colm's fortitude. A 26% drawdown over a three-month period would be tough for the most stoic of investors.

I appreciate that index investing is anathema to Colm but I think it's worth noting that, in Euro terms, the MSCI World index was only down around 3.5% over the same three-month period and produced an annualised total return of around 10% over the last five years.

 

[joe sod]

Hi Colm,

I was very struck by David Attenborough's speech in Poland yesterday. I'm just wondering to what extent ethical considerations inform your investment considerations. Personally, in view of climate change challenges and especially given your very concentrated portfolio, I would not be comfortable shorting Tesla or holding Ryanair.

I dont think "ethical investing" will make one jot of difference, because if you dont invest in ryanair someone else will and its not really investors that are driving ryanair, its demand by consumers and whether they worry about global warming or not they are still going to fly on budget airlines. In actual fact I think "ethical investing" is really about reducing your guilt and trying to gain the high moral ground without making any massive changes in your lifestyle. You can sort of wear it like a badge of honour well I can still fly to spain on my holidays because I have some ethical investments and have paid for a few trees to be planted somewhere to allow me to continue with my current lifestyle.

 

[WhiteCoat]

Thanks Colm and Joe,

I understand much of what you are saying. I will try to respond properly when time permits.

 

[Colm Fagan]

I think it's worth noting that, in Euro terms, the MSCI World index was only down around 3.5% over the same three-month period and produced an annualised total return of around 10% over the last five years

Hi Sarenco. I'll come back to you in due course on the performance of my portfolio versus the MSCI World Index, but it's important not to lose sight of the wood for the trees. The most important point by far is that I'm now "retired" for eight years and I am 100% (plus, but forget about the plus!) invested in equities. A significant proportion (the vast majority?) of financial advisers would regard that as anathema for someone my age. They would have me invested primarily or exclusively in bonds and cash for the entire period since my retirement (and probably for a number of years previously, through so-called "lifesyling"), either directly or through an annuity (which is invested completely in bonds). If I had followed their advice, I would be lucky to have earned 2% a year - before charges - on my money. The difference between 2% and 10% a year for the last 8 years equates to 97% of my starting capital. In other words, I have almost twice as much money now (ignoring what I've drawn down in the meantime) as I would have if I had followed standard financial advice for people in my position.

And that's only the start of it. They would also have me in bonds/cash for the rest of my days, however long I may last. I hope to be around for the next decade, possibly two. That's a hell of a lot of money down the drain. OK, I know that I (and stock markets generally) have done well over the last number of years, despite the recent glitch, and we're unlikely to do as well in future, but it's almost certain that, over a ten or twenty year investment horizon, which is what I'm still looking at, equities will outperform bonds by an average of 3% to 5% a year.

The argument is trotted out that it's different for investors in drawdown, who have to withdraw money regularly. The argument is that they are less able to ride out a downturn. Yes it is different when you're in drawdown, and I have suffered by having to make withdrawals over the last few months, but they were not significant in the overall scheme of things. I hope to enjoy a reasonably comfortable lifestyle by drawing down 6% to 8% of my savings each year - 1.5% to 2% a quarter. Even if we hit a bad quarter, such as the one I've just gone through, it's not the end of the world to have to cash out when I'm down 20% (say) on that 1.5% to 2%.

I do realise however that the vast majority of people are not prepared to take the psychological pain of the occasional market setback such as the one I've just experienced. As I said in my latest update, such setbacks are an integral part of an equity-based investment strategy, despite what people flogging absolute return funds may try to tell us. The good news is that I have a solution to the problem, which I submitted to the Department of Employment Affairs and Social Protection a few weeks ago under its consultation process for the national auto-enrolment pension scheme. I'm pleased to attach a copy of my submission. I will be more than happy to take comments and questions on the submission. I really do believe that what I've proposed will allow people who don't have any knowledge of financial markets to earn the sort of extra returns that I have earned in the past and hope to continue to earn in future.

 

[opexlong]

There is a massive recency bias in this paper. A snapshot of the period 1986-2017 cannot stand as representative of historical stock market data and it is a mistake to even use the phrase "longer term" in this context.

Not every 32-year period is going to encompass equivalents to the bull markets of the '80s and '90s followed by the quantitative easing of the last two decades.

From a historical perspective, the 1966 through 1982 Secular Bear Market was the third one we have had since 1900 and was not overwhelming in terms of loss, it simply meandered sideways virtually going nowhere for 16.5 years.

The Dow Jones Industrial Average lost 1.18% per year over the course of this secular bear market

You mention back-testing the last 118 years for the UK stock market and over the last 92 years for US stock market, but where is that data? How would a person 100% invested in equities who retired on the eve of a lengthy bear market in 1929 or 1966 have fared using your approach?

 

[opexlong]

The bolt from the blue was the unexpected profit, not the price hike.

Ah. Fair enough.

 

[Colm Fagan]

There is a massive recency bias in this paper

I quote from paragraph 8 of the submission:
"1986 is the earliest year for which monthly figures were available. Approximate calculations for earlier years (based on yearly changes in market values and adjusting the smoothing formula for yearly rather than monthly data) indicate that smoothed returns would have been positive in every year bar one since 1900, a period that covered two world wars and the great depression of the 1930’s. In 1974, the sole exception to the record of positive returns, the yearly smoothed return would have been only marginally negative."

I also refer you to the concluding paragraph:
"Approximate back-testing results against the returns from 1870 for a diversified portfolio, including real estate, as published in the paper “The Rate of Return on Everything 1970-2015”[1] support this conclusion."

How much further back than 1870 do you want me to go?

If anyone can provide me with monthly results going back this far, I'll be more than happy to test the approach against them.

I don't disagree though that a prolonged bear market - or one that does very little over a long period - would cause problems. For a previous paper, presented in February last, I concluded that a repeat of Japan's experience between 1990 and 2010 would have caused major problems for my proposed approach. I overcame that problem by noting the peculiarities of the Japanese market both before and during that period, and asserted that the world has learned lessons since then. I also said that the fund would not be over-reliant on a single market, asset type, etc. A final note is that the February paper looked specifically at Group ARF's, i.e. people only joined the fund at retirement. The AE model is more robust. Preliminary calculations indicate that the proposed approach to AE would survive a repeat of the Japanese experience of 1990 - 2010 (The conclusion is complicated by the fact that much depends on other assumptions, particularly contributor behaviour). I plan to explore that issue in more detail and will publish my conclusions in due course.



[1] “The Rate of Return on Everything, 1870 -2015”, Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick and Alam M. Taylor. National Bureau of Economic Research, Cambridge MA, December 2017

 

[opexlong]

I see. Very interesting. Thanks for responding to my questions.

 

[Colm Fagan]

Thanks for responding to my questions.

No problem, and thank you for being so gracious.

 

[Colm Fagan]

I appreciate that index investing is anathema to Colm but I think it's worth noting that, in Euro terms, the MSCI World index was only down around 3.5% over the same three-month period and produced an annualised total return of around 10% over the last five years.

Hi Sarenco. As I said earlier, how I get my equity exposure is secondary to the main issue of getting such exposure (or exposure to other real assets), but we've already discussed that in #428 above.

The exact figure for my "over 10%" is 11.1%. That's the average return on my portfolio, starting with its market value on 1 January 2013 and ending with its market value on 30 November 2018, allowing for monthly cash flows in the intervening period.

I should also emphasise that the 11.1% return is net of all provider charges (for administering the ARF and AMRF), custody charges, commission on purchases and sales, stamp duty on purchases, bid/offer spreads on the underlying securities, currency conversion costs, bank charges. It is also net of withholding taxes for dividends on non-UK or Irish stocks (for example, there's a non-recoverable withholding tax of 15% on US dividends). There is also a withholding tax on a UK REIT that I can't recover. Of course it doesn't allow for tax I have to pay in Ireland on dividends and capital gains on monies held outside the ARF/AMRF, nor for the PAYE tax on withdrawals from the ARF.

The conclusion from that is that I have done significantly better over the period than if I'd invested in the MSCI World Index. As I think I've stated a number of times however, that does not mean I'm a brilliant investor. I've just been lucky that Renishaw, my largest holding, has done extremely well over the period, despite the recent glitch. I may not be that lucky in future.

 

[Duke of Marmalade]

Ethical investors are deluding themselves. If I buy shares in BadCo my money does not go to BadCo. On the other hand if I buy shares in GoodCo for all I know the person at the other end of the trade is a very bad hombre indeed who will use the funds supplied by me for very wicked ends. A truly ethical investor should never transact on an anonymous market

 

[Colm Fagan]

Duke. I normally agree with you, but not this time. If I buy shares in a company, I want it to succeed. I don't want BadCo to succeed, so I don't buy shares in it. At an individual level, you can say that my decision doesn't matter a whit, but at a macro level, it does. If there are enough people like me, BadCo will trade at a discount to its "fair" value, as determined by reference to P/E, etc. Its cost of capital will be higher, and thus it will (hopefully) be less successful in the long-term. I know there are a lot of links in this particular chain, but I believe that my decision to shun such companies does have an impact, albeit very small.

 

[Duke of Marmalade]

Colm, I was being a bit tongue in cheek but you rightly pulled me up on it.

 

[WhiteCoat]

Duke. I normally agree with you, but not this time. If I buy shares in a company, I want it to succeed. I don't want BadCo to succeed, so I don't buy shares in it. At an individual level, you can say that my decision doesn't matter a whit, but at a macro level, it does....

Colm,

That's really well said - thank you.

I understand and share your reluctance of investing in alcohol, tobacco and betting companies. My moniker here signals my profession and I have seen at first hand the destruction these products have caused.

In terms of having one's aspirations aligned with one's investments, I am concerned with climate change. Personally, I believe that mankind will not make the required adjustments in time. In my opinion, there is simply not sufficient urgency, action or cohesion in relation to this danger in spite of all the irrefutable evidence. We see what's happening right now in the city of the last big climate accord. Of course, I hope that I am wrong. At a personal level, I believe we can make a very small impact and hope that this somehow develops and over time becomes part of the zeitgeist - in time.

If disaster is to be avoided then clean technology will have to be at the forefront. For this reason (and the reason I posed my question in the first place), I hope that the pioneering technology that Tesla is part of succeeds and would not wish to financially gain from its decline (which incidentally could very well happen as I believe the CEO is behaving very, very strangely and I am unable to dispute any of your financial analysis.) Similarly, regular air traffic is a significant polluter and air traffic is already expected to grow significantly in the coming years. So I don't wish to add fuel to the climate change fire by hoping that Ryanair becomes even more successful that it already is and anticipated to become and that is why I wouldn't personally invest in them. It's not even anything to do with its CEO!

Also, it is not a question of Ryanair's relative environmental record - no more than if we were having this conversation in the past and someone had written "I wasn't aware of Philip Morris producing cigarettes that are more cancerous that other manufacturers". Ryanair is part of an industry which as a collective, under current technology, is a disproportionate polluter in terms of what individuals, at a personal level, have some control over.

 

[Colm Fagan]

@WhiteCoat Well said yourself. The question for this forum though is whether we as investors can affect outcomes by deciding not to buy the shares of BadCo's. @Duke of Marmalade was too quick to accept my argument that we can help make the world a better place by not buying the shares of such companies. It occurred to me - in the middle of the night! - that the opposite is true for Ryanair. We actually help to INCREASE its earnings per share by shunning it. This paradoxical result stems from the fact that Ryanair is a cash machine. Instead of giving the cash back to shareholders as dividends, it repurchases shares in the market and extinguishes them. Thus, the lower the share price, the more shares it can buy back and extinguish with a given amount of money, and so the higher the earnings per share for continuing shareholders. It seems therefore that the best way to affect outcomes (as an investor) is to buy the shares and attend the AGM to argue our case.

 

[WhiteCoat]

Hi Colm,

I feel like an undergrad again....pls bear with me! I'm not trying to be obstinate just a little better informed. Thanks for your engagement in all this.

Firstly, I don't understand the relevance of the earnings per share metric. For example, if a company did a share split (2 to 1), an investor's earnings per share is immediately halved. What's the problem with this? Has the overall return prospects of an investor in such a company been damaged by such an action and if so why would a company engage in such activity?

By extension, do similar points not apply (in a kind of reversal) to share buy backs? Otherwise, wouldn't all companies be at it? Surely, ir can't be some sort of secret returns weapon that only some companies have worked out?

Secondly, if you believe your conclusions, shouldn't you actually invest in tobacco, gambling and other bad boys (especially those with similar buy back practices?)

Thirdly, again based on your conclusions, why would ethical / socially responsible funds exist at all?

This world of ours is somewhat complex!

 

[joe sod]

Similarly, regular air traffic is a significant polluter and air traffic is already expected to grow significantly in the coming years. So I don't wish to add fuel to the climate change fire by hoping that Ryanair becomes even more successful that it already is and anticipated to become and that is why I wouldn't personally invest in them.

is this not the crucial issue, air traffic is going to increase despite all the talk about climate change, and is "ethical investing" really just a cover to allow people to continue with the lifestyle that they dont want to give up. Its easy to beat up on the big bad "ryanairs" of this world, but people are selfish and only care about their own personal circumstances so they will continue to fly unless it is heavily taxed. Flying is also crucial to the global economy, with many people flying to the other side of the planet as part of their job, so paradoxically are you in favour of renationalisation of the global economy with the centre shifting back to the nation state and more products produced locally, like the much derided de Valera vision of ireland .
As regards tobacco stocks, the only reason why smoking and the consumption of cigarettes has fallen off a cliff is because of peoples concerns about their own personal health. If it was simply the case that smoking cigarettes was very bad for the environment but had no health issues then smoking would be higher today than ever just like flying.

 

[cremeegg]

All this talk of ethical investing has a touch of the sanctimonious about it, or virtue signalling, as I believe the modern phrase has it.

I understand and share your reluctance of investing in alcohol, tobacco and betting companies. My moniker here signals my profession and I have seen at first hand the destruction these products have caused.

Smokers, drinkers and gamblers are adults and wether you invest in Best Dry Gin or not has nothing to do with their lives. You are not responsible, in either sense. If it's legal to sell, it's legal to invest.

Personally I believe that all forms of recreational drug taking should be legalised and taxed. Not for the benefit of drug users but to suppress the organised crime that has destroyed so much of Latin America, and has made murder a regular event in Dublin.

I wouldn't personally like to invest in tobacco, but if people want to smoke then there should be somebody to sell tobacco. Of course misleading advertising should be banned and the adverse effects of tobacco should be highlighted as public health information.

EDIT: If a person wishes to reduce their carbon footprint, they are free to stop flying, or to campaign for taxes on aviation fuels, but equating Ryanair with "Badco" is not a grown up response to the issue.

Perhaps the Mods should split this talk of ethical investing into a separate thread as it is hardly central the the main discussion.