New Sunday Times Feature - Diary of a Private Investor

[Colm Fagan]

The MSCI World index is currently reflecting a yield of 2.24% - a long way short of 4%. In any event, it's total (net) return that ultimately matters.

Hi Sarenco
The dividend yield on the FTSE 100 at close of business on Friday last was 4.13%. That is the main benchmark I've been using (expressed in euros). Your suggested figure is probably more appropriate.

 

[Daddy Ireland]

Hello Colm,

Catching up on this entire thread from the outset.

When you get a chance I am interested to know if you still hold or have been buying into FTSE blue chips in the last 18 months with sterling averaging approx .88 to the euro over that time as you stated back in 2015 that the majority of your holdings were in UK companies. There are a large number of top FTSE household named companies offering dividend yields of between 5% to 7%. I would think most of these blue chips should be able to maintain the dividend. My thinking is that with Brexit sterling should not get any worse than .95 to the euro over next number of months and that there may even be a chance of Sterling strengthening against the euro and even it weakened to .95 no doubt over time it will come back again to its current position. In your actuarial opinion would you see my idea of availing of current dips of buying 10 or so well diversified high dividend yielding UK blue chips as a very risky idea or has it a reasonable chance of success? I can live with dips in the market but am fed up of getting zero return on my money in the bank and top UK companies offer attractive dividend yields. Thanks.

 

[galway_blow_in]

the problem with holding the ftse 100 or any other index is they are completely and utterly in thrall to what happens in the u.s market

no european market ever goes anywhere ( at any time ) unless the u.s market is also moving to the upside and the u.s market is far more diversified than the ftse 100 , the uk stock market is heavily dependent on energy , finance and natural resources companies

you might as well just own the s + p as it always always does the best over any duration anyway

 

[joe sod]

I mulled over Renishaw when you mentioned it and I regret not purchasing some, opting instead for such safe havens as UK utilities and energy companies, that has proven to be poor judgement on my part but hey its only money and I am learning all the while.

Sometimes sectors like UK utilities are out of favour for very long time, I think jeremy Corbyn is holding the "sword of damacles" over the UK utility sector which explains why the shares have done so bad over the last year and more. The US technology sector was out of favour for a very long time even as recently as 5 years ago, stocks like Microsoft and Intel could be bought at a fraction of their current value. I think the prevailing wisdom then was that these tech companies were old hat and would be wiped out by the new tech companies, it didn't happen in fact some of the new tech companies actually did not have any deep technology or intellectual property at the back of it all. With regard to UK utilities, these now regarded also as old energy, the future is renewables etc etc until a week like last week comes along and suddenly the UK is short of gas and power.

 

[Colm Fagan]

Here's a link to the academic paper referenced in the above Irish Times article.

It's pretty dense but I think it helps to explain why concentrated equity portfolios commonly lag market returns.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447

Hi Sarenco

Thanks for the link.

I had a quick look at the paper. I think the reason for the disconnect between the results in the paper and my scepticism about them, from observing and investing in the stock market over many years, is that the paper simply looks at numbers of stocks and gives no weighting whatsoever to market capitalisations. A 400 lb gorilla is given the same weighting as an ant.

One observation near the start of the paper is that the single most frequent outcome for the results is a loss of 100%, i.e. the companies went bust. As we all know, companies have a high chance of going bust in the early years. On this topic, I can't help recounting my experience on the first anniversary of setting up my own business. I threw a party to mark the occasion, and told the assembled guests that the reason why I had thrown the party was that I had heard that 90% of businesses failed in the first year; the fact that I had survived justified the party. One of the guests - who amazingly is still a good friend - responded by asking if I had heard that 95% have gone bust by the end of the second year!

That little anecdote helps to explain the Professor's results and also why I am so sceptical of them. I would reckon that a significant number of his sample were small, young companies, that just didn't survive to maturity. I am loath to invest in publicly quoted companies that haven't demonstrated their long-term viability.

At this point, I could make a general point about academic research, that the aim is to get publicity by coming up with something unexpected, even though you have to go through contortions to arrive at the result. This to me is one of those examples.

 

[Sarenco]

I think the reason for the disconnect between the results in the paper and my scepticism about them, from observing and investing in the stock market over many years, is that the paper simply looks at numbers of stocks and gives no weighting whatsoever to market capitalisations.

That's certainly true Colm. Still, it's a striking statistic that 96% of publicly traded stocks in the US since 1926 collectively generated lifetime dollar gains that matched gains on one-month T-Bills – the entire net excess return came from only 4% of stocks.

I've no doubt that the results would be considerably less dramatic if you screened out stocks on the basis of their size, profitability, etc.

However, the fact remains that stock market returns are driven by a small minority of "overachievers", which is one of the principal challenges of any concentrated, stock picking strategy.

 

[cremeegg]

"Diversification is a false God"

Great headline, even if it did not reflect the article.

An investor could decide to buy only the share with the best prospects, after all why buy the second best share.

There are two objections to this.

First that the investor may have miss-identified the best share. This always strikes me as a trivial objection, if you do not trust yourself to identify an opportunity stay away. If you do trust yourself, invest and accept the results of your efforts.

The second objection is that the share with the highest expected value, to borrow a phrase from gambling, still has the possibility of a bad outcome. The lotto sometimes has a positive expected value. You have a 1 in a million chance of turning a €1 stake into €2m. That does not mean you should remortgage your house to buy lotto tickets.

Diversifying is to reduce your own exposure to such negative results.

 

[Duke of Marmalade]

Just catching up on this thread; I've been busy defending common sense against an onslaught from bitcoin barbarians, whilst you guys have been enjoying yourselves

I remember the original article and was tempted to exchange some of my Prize Bonds for Renishaw. Alas my risk aversion is of the chronic variety, but I do sleep nights.

I think I go along with the argument that Colm was "lucky" to beat the market with a concentrated portfolio. I also think Warren Buffet was lucky.

This discussion would have had a very different colour in 2010. Though I am persuaded by one of Colm's favourite themes - the Bernanke Put Option, one that he highlighted again in his thought provoking presentation to the Society of Actuaries on DC pensions.

Here's the way the argument goes. I think if the markets had been left to run their course during the crisis we would possibly have had a meltdown which would have knocked us back to the Stone Age. The financial models do allow for the possibility of such a meltdown. But what happened is that the powers that be (I'm with TheBigShort on this) pulled out all the stops to save the situation. Most notable and enduring of all is QE. There can be little doubt that QE is behind the strong recovery in stock markets in recent years. I'm not saying that is a bad thing but it does seem that the stock holding classes (which includes workers' pension funds) have a sort of buyer of last resort in the central management of our economies. So whilst I myself will remain mostly in "safe" assets, I think over the medium term there are systemic reasons for believing equities will out perform.

What little part of my portfolio (an ARF) is invested in equities I chose one of those funds which purported to invest in, I think, only 20 stocks. I sort of felt that I should take a slight "punt" if I was putting my toe in the water. I didn't track it very closely but I don't think it significantly outperformed a fully diversified approach, at least certainly not to the extent of Colm's portfolio.

I did actually once try picking my own 10 stocks as per Brendan's advice. The volatility kept me awake and glued to Bloomberg and within a matter of weeks I threw in the towel.

I think the following quote from fella needs a clarification.

...if you only hold a small number of stocks i’d expect you to beat the market that’s kinda obvious but your been rewarded for taken extra risk ...

Modern Portfolio Theory argues the opposite. You get rewarded for overall stockmarket risk but you do not get rewarded for concentration risk. The reason being that the latter can be avoided whilst the former cannot. But I think he meant that Colm was lucky which, as I said, I think I agree with.

 

[Martyn]

At this point, I could make a general point about academic research, that the aim is to get publicity by coming up with something unexpected, even though you have to go through contortions to arrive at the result...

Can you cite any academic research to back up that claim, Colm?

 

[zephyro]

The dividend yield on the FTSE 100 at close of business on Friday last was 4.13%. That is the main benchmark I've been using (expressed in euros).

Are you hedged against EUR/GBP Colm, otherwise presumably this has had a significant effect on your returns in euro terms?

I can live with dips in the market but am fed up of getting zero return on my money in the bank and top UK companies offer attractive dividend yields.

Why not invest in top eurozone companies then and avoid the FX risk, or do you actually want to bet on EUR/GBP too?

 

[galway_blow_in]

Are you hedged against EUR/GBP Colm, otherwise presumably this has had a significant effect on your returns in euro terms?



Why not invest in top eurozone companies then and avoid the FX risk, or do you actually want to bet on EUR/GBP too?

hedging is unimportant when most of the companies on that index draw profits from overseas

investing in the eurozone is a waste of time , the u.s market determines which way the eurozone ( and uk ) stock market goes ,, it also outperforms the eurozone stock market almost all of the time and all of the time over a significant period , its quite extraordinary really but as sure as night follow day if the s + p or dow close in the red at 9 pm irish time , the european stock markets will be down the following morning

 

[Colm Fagan]

Can you cite any academic research to back up that claim, Colm?

Hi Martyn
It's quite prevalent. I saw it most recently in behavioural psychology. See https://retractionwatch.com/2017/02...d-studies-nobel-prize-winner-admits-mistakes/
I've also seen it many times in other areas of science. I can't recall the details: I'm not an academic researcher!
PS: Needless to say, I'm not saying that it's true for ALL academic research. It's a completely understandable phenomenon. If I do a study and conclude that roast beef doesn't cause cancer, no-one will notice, but if I can find some way to adjust the statistics or the statistical significance test I'm using, to conclude that it DOES cause cancer, then I'm onto a winner in terms of publicity.

 

[Sarenco]

the u.s market determines which way the eurozone ( and uk ) stock market goes ,, its also outperforms the eurozone stock market almost all of the time and all of the time over a significant period , its quite extraordinary really but as sure as night follow day if the s + p or dow close in the red at 9 pm irish time , the european stock markets will be down the following morning

As previously pointed out to you on other threads, this statement is simply untrue.

European stocks have outperformed US stocks over significant time periods - including the decade to the end of 2010. You are also conveniently ignoring currency effects.

In any event, the past is not prologue. European stocks are less richly valued than US stocks by almost every reasonable measure, which implies an expectation of higher future returns.

 

[Colm Fagan]

Are you hedged against EUR/GBP Colm, otherwise presumably this has had a significant effect on your returns in euro terms?

hedging is unimportant when most of the companies on that index draw profits from overseas

I agree with both of you!

If you go back to my update from Saturday last, #79 in this thread, I said that I had hedged my exposure to Phoenix in two ways: (1) by borrowing in sterling to pay for a portion of the investment and (2) by taking out a sterling hedge for the balance of my investment in that company. I hedged my Phoenix exposure because practically all its revenues and costs are denominated in sterling.

I didn't hedge my foreign currency exposure for either Renishaw or Apple. In Renishaw's case, even though it's a sterling denominated stock, the vast bulk of its profits are earned outside the UK. Thus, if sterling weakens, its revenues increase in sterling terms. A high proportion of its distribution costs will also be in the currencies of the countries where the sales are made, but the major proportion of its R&D costs will be in sterling (at least I think they are). Thus, we have the perverse situation that a fall in the value of sterling will, all other things being equal, cause its value in sterling terms to increase by more than sterling has depreciated. Sounds complicated when I say it like that, but it is actually quite straightforward.

 

[Daddy Ireland]

And so Colm if I am reading you correctly and coming back to my earlier post buying UK blue chips with big international exposure even with a weakened sterling is not a bad idea.

 

[Colm Fagan]

I think I go along with the argument that Colm was "lucky" to beat the market with a concentrated portfolio. I also think Warren Buffet was lucky

Hi Duke

I'm happy to be put into the same "lucky" bucket as Warren Buffett!

I agree with you to some extent, but not completely. One of my core beliefs is that we are buffeted by good luck and bad luck throughout our lives, in investment as well as in more important aspects of our lives. The trick is to minimise the harm caused to us by bad luck and to surf the wave as best we can when good luck comes our way. I try to reflect that belief in my approach to investment. My general approach is to dip my toe in the water initially and get to know the company and its industry as best I can. Sometimes I conclude after the initial courtship period that I’ve bought a dog and do my best to limit the damage. Other times, I conclude that I've unearthed a real winner. In those cases, I pile in. That is broadly what has happened with Renishaw over the years and also with the other companies where I have big holdings. It also helps to explain the highly concentrated nature of my portfolio.

 

[Colm Fagan]

And so Colm if I am reading you correctly and coming back to my earlier post buying UK blue chips with big international exposure even with a weakened sterling is not a bad idea.

First of all, sorry for not coming back to you earlier.

I confess that I have no views whatsoever on particular market sectors - be they UK blue chips, US technology, European small caps, whatever. I am an unashamed stock picker. I invest in particular companies because I think they have good prospects at the prevailing price, not because I like that particular sector. You could be right in your views on FTSE blue chips, but you would need to ask someone who has the big picture perspective, which I don't have unfortunately.

 

[Brendan Burgess]

I have posted all of Colm's original articles here

Colm Fagan's Diary of A Private Investor

 

[Gordon Gekko]

I think that Daddy Ireland is speaking to the point that it doesn’t matter what currency a truly international company is listed in; its share price will adjust accordingly to take account of currency. If all of UK plc’s earning are in the US and Sterling collapses in value, UK plc’s share price should soar commensurately.

 

[Daddy Ireland]

Thanks Colm.