Small Cap Value Report (Fri 17 Nov 2017) - Portfolio Management, CTO, REC, CLLN | Graham Neary

16th Nov '17 by Graham Neary

41 comments 16614 reads

Good morning and Happy Friday!

This is the usual placeholder article, published the night before, to enable early comments and suggestions from readers.

Best,

Graham

Good morning!

It's quiet in RNS-land, with only a few announcements of interest today.

So I thought I'd spend a few moments explaining what I've been doing with my personal portfolio this year - and please remember that these articles don't count as advice, merely discussion!

One of the practical reasons an article like this can never offer an advisory service is because each of us has our own individual situations, with our own individual investment goals, time horizon, risk tolerance, liquidity requirements and tax situation.

Because of this, even if we all had exactly the same opinion on particular stocks, and by some miracle it was the correct opinion, it wouldn't follow that we would all want to invest the same way. We would still have to tailor our portfolios to each of our individual needs.

With that out of the way: this is what I've been doing in 2017.

In the first half of this year, I added IG Group (LON:IGG) and Next (LON:NXT) to my portfolio (currently 5% and 4% of my portfolio, respectively).

In the second half, so far, I have mostly been selling. This was due to my personal situation where I was bidding on a property and needed to be ready to buy it. So I sold up my lowest-conviction shares and moved 40% into cash.

However, bids on that property eventually moved to a level which I thought represented poor value, so I let it go.

Since then, I've been trying to figure out what is an appropriate level of risk exposure for someone who wants to make a property purchase within the short-term (e.g. within two to three years). As always, greed and fear need to be balanced. There is not going to be an exact or a perfectly scientific answer.

One thing that plays on my mind is the belief that with the FTSE at c. 7400 and the Dow at 23,500, there is the pronounced risk of a broad market sell-off.

In normal circumstances, I would welcome such a sell-off for the buying opportunities it would present, but in my specific circumstances,…

Unlock with Email

Unlock with Google

Already have an account?
Login here

Ramridge

17th Nov '17

Re. T Clarke (LON:CTO)
Actually the scheme is closed to new members. Here is an extract from the last full year report.

" The Group has proposed an increase in employee contributions from 8% to 10% of pensionable salary and is consulting with employees on this proposal. The scheme is closed to new members and the Group continues to meet its ongoing obligations to the scheme."

And fair play, they are trying to get existing members to contribute more from their pockets..

Aislabie

I am in the fortunate position of having owned one house or another for the last several decades. They have gone up and down (twice with mortgages pushing me into negative equity) an at the moment I can show that a house so far has been an excellent investment.
But...
It isn't an investment, it is a home, and despite now being mortgage free and sitting on a much higher value I can no more eat it than I could at half the value. I like being here and, while it may make a difference to my inheritors, it will still feel the same if it falls in value. There are those who view a home as just an investment and hop from one to the next as they attempt to maximise their gains (and Robert Kiyosaki has got wealthy advising people to think of it as purely as an investment).
Each to his own, but maximising its pleasure as a home may help you get over whether or not it stacks up against a "jam tomorrow" biotech!
Good luck!

Ted Striker

So then Graham, when do we get your fantasy fund to compare with Paul's?

Effortless Cool

cic - further to T Clarke (LON:CTO),

I allow for pension deficits in my valuations the same way I allow for debt. I add back the contributions to fund the deficit (net of tax) to income before applying a valuation multiple and I deduct the deficit (net of deferred tax credit) from cash in making my cash/debt valuation adjustment.

PS I am actuarially qualified, although I have never worked in pensions (thank God).

WDWombat

It is rather tricky - no, impossible -on my computer to see the dates below that very interesting opening chart - US net debt/cashflow versus junk bond yields. The latter are generally issued by companies with low ratings due to already poor balance sheets or companies trading unprofitsably. So it is a total picture of the (I assume) listed corporate sector versus a pretty specific group of listed strugglers. I wonder is there is any correlation between these and the US stock market, say the Fortune 50?
Anyway, the real concern for me is that the p/e, imprecise as it is, is so high at a time when corporate America has reportedly been increasing debt to buy back shares, which should theoretically reduce the p/e. I know this trend reversed in the data released for the most recent quarter - that is net buying by corporate America reversed - and the p/e has anyway been very high for ages now. But I still can't see anywhere else to put money safely except the bank in devaluing sterling. And if the US sneezes we still all catch a cold.

AnonymousUser252054

Looking at ten year charts the FTSE100 is only up about 15%, the FTSE all share is up a third and AIM100 is only just back to where it was (early-mid 2007). In the grand scheme of things that doesn't seem unreasonable, if fall and recovery are just parts of the historic trend upwards. That reassures me a bit but having said that, as Graham says, when America sneezes.

A lot of money has flowed into UK equities, of course, but apparently that has started to reverse. Funds are still growing but putting money elsewhere now.

As Paul sometimes suggests, the bigger macro picture is important and if May is pushed out and the Brexit 'negotiations' stop, stocks, good as well as bad, could suffer a harsh slide.

I started investing (again) after the post-referendum crash (I was far too slow to take advantage), and I'm curious what was it like for PI's over those weeks. What happened on a day to day basis? Was everyone being stopped out and at prices well below their stops? Were spreads ridiculous discouraging buying back in? And when did people start buying back their shares and at what kind of price difference? I suppose I'm wondering what is the best strategy should something similar happen again?

Wol

Thank you Graham for your interesting question (at the start of this SCVR).
Yes, we all have different investing objectives. In my case my investments pay my rent and expenses as well as (hopefully) growing in value enough to give me a comfortable pension pot for my retirement. Given where I stand now I expect to continue as an active investor for quite a few years to come.
I have never in the past been any good at timing the market. So I am doing my best to watch carefully. What strikes me most is:
1. this bull market has had a good long run. All good bull markets come to a close sooner or later (even if the central banks keep pumping up the lilo with fresh supplies of ultra cheap money
2. volatility seems to be increasing in the high growth shares that have done so well over the last few years (BOO, BVXP, ACSO, KWS, FEVR...)
3. We have no idea how Brexit will turn out. Will it be a brave new future (as some say)? Or will there be lorries queued up at Calais and Dover unable to complete the paperwork necessary to allow them process our exports and imports? And if so how will those businesses that depend on imports and exports survive?
In response I am now 30% cash and gradually working through my portfolio selling off or reducing my lower conviction or more risky holdings. And I am trying to apply stricter criteria to my new purchases. Of course I might miss out on some of the next leg of the bull market. But then again I will find it easier to sleep at night.
And if all of that sounds confident and composed.... well actually I really just wish I knew what was going on but, given that I don't, this seems like my best balanced guess as to a decent way forward. My fingers and toes are very firmly crossed.

cic

EC - I do the same, actually, so that is reassuring, but as I am usually a long term investor what I really want is a handle on the effect of the pension long term on the company. Usually, in a DB scheme the pension contributions in the short term are fixed as a result of a negotiation between the company management and pension scheme administrators. The current contributions could be too low, in which case I am investing in a company with a nasty shock in store next year, or the year after. Or they could be too high, resulting in a shareholder benefit when they are reduced. I have no way of estimating which applies. What I really want is info to enable me to make an evaluation of future pension effects on profitability. The effect of normal debt does not vary in the same way - there is not the possibility of regular debt evaporating as there is with pension deficits, so using this model is only useful forecasting one or two years out. That is what I am trying to get my head around. I hope this makes sense.

seadoc

18th Nov '17

Graham,

Interesting musings, I would like to be 40% cash. 22nd will be very interesting, sticking plasters or major surgery? I think sticking plaster but then again what if I were an ambitious politician in No 11? Two observations:

This is SCVR. Rightly or wrongly I am hugely over represented in AIM shares, risk decision over the last 10 yrs on my part and despite nearly 30% fail rate I have done well, but that may just be luck. But some positions are 10 or in one case 17 times over NMS so the only time I can sell is while the sp is going up. I used to think that the advantage of being a PI was being able to go "all-in" and "all-out" but beginning to see the reasons the big boys ignore small AIM shares. For ten years I have sold to maximum of CGT allowance and as far as possible moved favoured shares to ISAs. I have still got about £100k in shares I would like to sell from AIM outside ISA and I have already gone well over my annual CGT allowance. Do I sell more and get taxed at 40% (if I sold all it would be at marginal rate of 45%) or assume the coming correction will be less than 40%?

When Gordon introduced the SIPP it seemed like a good deal to me, so having maxed into ISA each year over my last five years at work, I also put nearly all my 40% tax earnings band into SIPP, albeit by cashing in NS&I bonds. The gap between my work pension and higher rate tax is about 5 times my remaining SIPP (and I have deferred state pension getting 10.6% pa return). I could take less from pension and reduce CGT on shares. I guess I have to take a view on how long I will live and more importantly my risk of dropping dead without the chance of reviewing the option on the state pension.

5 (4 in NZ) days to go.

Regards,

Seadoc

Edit: Days to go is to the Budget, and hopefully not to my demise!

rpannell

Do I sell more and get taxed at 40% (if I sold all it would be at marginal rate of 45%) or assume the coming correction will be less than 40%?

CGT is currently at a very generous rate of 10/20% (except for residential property gains). This is the lowest for many years so I would take advantage of this low rate - unless you intend to die in the next few years where CGT is zero on death.

No intention of dying, ever! Many thanks will follow this up and sell most, if I can, at cgt of 10% if that is after taking income to top of higher rate band. Got a link, cannot find on HMRC site?

Thanks,

Seadoc

cic,

Yes, a pension deficit involves a high level of potential variability that is very different from a debt. I think that the only way to try and model this accurately would be through stochastic simulation using an economic scenario generator, but this is hardly realistic for most of us.

If you want to impose a "charge" on your valuation to reflect the potential for the deficit to increase, I would suggest basing that on the sensitivity tests in the full results. These sensitivity tests cover the discount rate (+/- 0.5%), inflation rate (+/- 0.5%) and life expectancy (possibly +/- 0.5 years). Take the biggest of these, which is the discount rate for T Clarke (LON:CTO), with a 0.5% decrease increasing the pension liabilities by 12%, which is £6.4m.

You would need to give some thought as to how to calibrate this adjustment, as sensitivity tests are not standard. For example, Macfarlane (LON:MACF) reports on movements of 0.1% and 0.1 years and quantifies the impact on the deficit, rather than the obligations alone. (This makes sense for them as they hold substantial liability driven assets that are intended to hedge against movements in the value of the liabilities).

Anyway, suitably calibrated, this method would provide a sensible adjustment for DB pension risk that would also reflect the riskiness of individual schemes.

It's all too complicated for me, however. At the moment, I just take the view that any discount rate shocks are much more likely to decrease the deficit (higher discount rates than implied by the current yield curve) and that, therefore, future uncertainty on the pension deficit is biased on the favourable side.

Got a link, cannot find on HMRC site?

Try this - http://www.rossmartin.co.uk/private-client-a-estate-planning/capital-gains-tax/110-capital-gains-tax-rates-a-allowances

or the more complicated - https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual

aflash

Real estate is cyclical.

About 20 years elapse between Buyers' and Sellers' markets.

Also we tend to buy and sell for personal reasons so do not think of it that way. Neither are there statistics like Stock market ones. It is an illiquid asset.

From what you have told us your Stock market style tends towards Buffet's 'the ideal holding period is forever.' He held Coca-Cola through the Tech bubble. It subsequently dropped by 50% and he had to admit publicly that it had been an error not to sell some.

Personally I attach great value to the daily price fluctuations in the Stock Market. One can always buy and sell, albeit often at a loss. Not so a house.

So what of Peter Lynch's remark that more money has been lost trying to forecast the next crash than in the downturn itself?
It is true.
However I regard it as Insurance and therefore prefer paying the premiums than looking at a portfolio that has lost 50%

'Markets will fluctuate' Keynes said that.
'Cash is your starting and finishing point' I said that.

The Phoenix

Hi be careful with deferral if you are married as spouse may not get all pension on death could be 50% best case, you could be better taking it and recycling into another pension to build up death benefits if your still working.

rpannell,

Thanks, I would take your advice to sell at 10% except I tend to draw down my SIPP to the limit of higher rate tax band so I would pay 20%. But much better than 40%.

clarea, Thanks, good comment, yes I am married and you are right if I were to drop dead suddenly. But (doc here) at age 67 there is a much bigger chance of some sort of a warning that I am dying and so have the chance to "put my affairs in order" The really interesting calculation is when to start drawing a 10.6% (pa) higher pension against the fewer years that I will have left to draw it. Without any clear health problem I am looking at early 70s. If I found that I had a terminal problem I think I still have the option of taking a standard pension and take the back dated pension as a lump sum. At the moment I probably need to draw down my SIPP as fast as I can while remaining in basic rate tax band. But, hey ho, such thinking beats watching day time tele!

Quantockriser

19th Nov '17

At 79, my take is different ! I moved to a smaller house and trousered the difference. And I am spending it . I bought a 32 ft motor boat and built a garden room to view the plants and the flowers and I am soon off to holiday in Barbados. Kids these days would not thank you for an "inheritance" - if they live in expectation , tough. As for the markets, I just don't care if they fall - i will stop spending, flog the boat and retire to the garden room to eke out a bucolic existence Who needs capital ? You can't take it with you. So sell up and spend !

jonthetourist

Sounds good, quantockriser, but a word of caution. If the markets fall you may struggle to sell a boat at any price. When times are hard who wants to acquire a new cost centre? I suspect you won't care, so fair play to you.

Jon

20th Nov '17

Thank you Jon for your care. But if all else fails, I will sell the house and garden room and live on the boat. I needn't go anywhere. By the way owning T Clarke shares would be my sort of nightmare. I like the Prudential - its large and very boring - that's perfect for an old goat !

Small Cap Value Report (Fri 17 Nov 2017) - Portfolio management, CTO, REC, CLLN

Unlock the rest of this article with a 14 day trial

About the Author

Graham Neary

41 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...