by Mark Dampier
Another good recent example came in September/October 2014 when the markets sold off quite sharply and I was able to add to two of my favourite holdings – both of them, for the reasons I have given, income funds. One was my old favourite, Neil Woodford’s Equity Income fund, and the second our own HL Income and Growth Fund (which invests in many of our research team’s favourite funds). A few years ago, in the same circumstances, I might not have put so much into income funds, and split the money somewhat differently. Another fund I bought, one which invests in more volatile emerging markets, was experiencing a particularly bad run at the time, but the manager was doing nothing different – it was just market sentiment at work, so I was happy to buy some more.15
The point is that as a long-term investor, confident about which funds I want to own, I can afford to take a more relaxed attitude to short-term market moves, knowing that the ups and downs of sentiment-driven market cycles will even out over time. Many first-time investors find it difficult to sit through market squalls. If everyone else seems to be selling, you have to be quite determined to want to do the opposite. Yet that is what you have to steel yourself to do. At the end of the day, investments are like everything else. The cheaper they are, the more value you will get from them. Yet bizarrely investors often seem to think that only the expensive stuff is worth buying! To remind myself of the need to stay calm during market declines, I have a sign on my desk at work which reads: “Don’t just do something, sit there!”
With specialist funds, my thinking has changed somewhat over the years. I was one of those who enjoyed the gains from the BlackRock Gold & General fund as its value went shooting up during the commodity boom in the first decade of this century. But I have to admit that I also then hung on for far too long after the price started to decline. What I think now is that if you can spot a developing trend in a specialist area, there is nothing wrong in joining the bandwagon – just so long as you keep a sense of reality and perspective about you. If you reach a point where a fund is up by 100% in one year, or by 200% or more over three to five years, my advice is that you should already be thinking about reducing your exposure or selling out completely.
Unlike mainstream or broad market funds, where it is sensible advice to stick with your winners, you can have too much of a good thing with specialist funds. Don’t worry about leaving money on the table. Bank the gain and move on to something else. I would certainly say that failing to sell specialist funds when I have already made a lot of money from them is at the top of the list of my worst mistakes as an investor. Unless you are confident you have the self-discipline to sell somewhere near the peak, you might do better to avoid the specialist sectors altogether.
The funds I own
In order, the top holdings in my SIPP and ISA (at 30 June 2015) were as follows:16
Main SIPP holdings
HL Growth and Income
Darwin Leisure
Woodford Equity Income
Marlborough Micro-Cap and Nano-Cap
Royal London Sterling Extra Yield
Artemis Strategic Assets
RIT Capital Partners
Lindsell Train Global Equity
My aim is never to have more than 10% in any one fund. A few years ago my SIPP was 100% invested, but more recently I have been gradually increasing the holdings of cash. This is partly the result of reviewing my pension plans in the light of recent legislative changes, which have changed the rules of the game for someone in my position.
These funds together make up somewhat over half of the overall value of my SIPP, with cash or equivalents around 30%. The two Marlborough funds are both managed by Giles Hargreave and his team at Hargreave Hale. While they have different objectives, I mentally count them together as my largest exposure to the smaller company universe. As I have said, the cash holding, at 30%, is very high by my historical standards.
Here are my brief thoughts on each of the funds. It is important to say that while I rarely make big changes in my personal portfolio, there is no guarantee that I will still own these funds by the time you read this book. These funds suit me, but I am not recommending that they will necessarily be the best ones for you. What I am trying to do is explain the thinking behind my owning what I do.
HL Multi-Manager Growth and Income
As my working days revolve around analysing funds, you may be wondering why there aren’t more of the funds we recommend to clients in my portfolio. Well, actually, there are. The multi-manager team, led by my colleague Lee Gardhouse, is responsible for bundling the best of the funds we like into well-diversified multi-manager funds. They are aimed at clients who for whatever reason decide that they don’t want the hassle of doing all the necessary fund research themselves. We now have seven different multi-manager funds, having added UK growth, European, Asia and emerging markets offerings to the range in the last year.
The Growth and Income fund, now the largest holding in my SIPP, was one of the first multi-manager funds we launched back in 2002 and it remains the largest and most popular today. I have been a regular investor since the start. What does it do? Well, by now, given my longstanding bias towards equity income funds, you won’t be surprised to hear that it invests in the best equity income funds we can find. One or two of the funds in the portfolio, like the Woodford Equity income fund, are ones I also own directly. But many of the others I do not. The fund has 11 holdings in all and includes equity income offerings from Artemis, Threadneedle, Jupiter, Liontrust and First State. The historic yield is about 3.75%, while the capital value of the accumulation units has risen by around 80% over five years.
Darwin Leisure
People are always surprised to find this virtually unknown fund near the top of my list of holdings. They are even more surprised when they find out what it does, which is invest in a portfolio of caravan parks. What could be less glamorous or mainstream than that? To be honest, even I never expected this fund to do so well when I first bought it over a decade ago. But it has done me proud ever since then.
The fund is effectively a kind of family unit trust. What the fund does – and what makes them different – is buy, manage and then improve their caravan parks. Most caravan parks don’t do improvements. The owners take the income but rarely invest in making them more attractive places to stay. I have one down the road from me and I have seen the difference that their investment makes. Their sites are closer to chalets than what most of us remember caravan parks being like. That in turn attracts a more upmarket kind of visitor – more Center Parcs than Carry On Camping, if you like.
It has become a fantastic business, which is what this fund really is. The fund yields about 6.5% and now they have gone through their big reinvestment programme more of the cash flow will be coming through to investors. I wouldn’t say that they are immune to the economic cycle, but they are pretty close to it. In 2008 they didn’t see any fall in business. In fact, they got more because even if people’s incomes were hit and they couldn’t afford to go abroad, they still wanted somewhere pleasant to stay. The fund has returned about 10% per annum compounded since I bought it the first time, and I have been regularly adding to my holding for the last decade at least.
You should be aware that this fund, unlike all the others I own, is an unregulated fund, meaning there is less protection for you as an investor should anything go badly wrong. Because of its specialist nature, the fund has been closed to new investors for some time. You won’t find it listed on any of the leading platforms for individual investors, and I therefore suggest that you don’t waste time trying to find it.
Royal London Sterling Extra Yield
The last few years have been exceptional ones in the bond markets. Yields fell quite sharply after the financial crisis, but since then, despite most pundits expecting yields to start rising as economies started to recover (which normally happens after crises), they have instead carried on falling. They are now at t
he lowest levels that anyone still working can remember. You can lend money to the government for ten years and get a return of just 2% – historically a very poor reward for lending money to such profligate spenders!
There are several reason why bond yields have remained so low. One is that inflation has been falling; the Consumer Price Index is down from 5% a few years ago to less than 1% today. Another is that governments and central banks have deliberately been taking steps to keep interest rates as low as possible. With its quantitative easing policy, the Bank of England injected £375 billion of new money into the banking system in an effort to keep the economy moving. To do that it bought billions of pounds worth of government bonds. The Americans and Japanese have been doing the same thing.
On the plus side, low bond yields and unprecedented buying by central banks means that the price of government bonds has continued to rise. (Bond prices fall when yields decline, and vice versa.) That in turn has helped lift the price of all other kinds of fixed-interest investments, which traditionally are priced by reference to government bonds. That includes corporate bonds, which are effectively debt that has been issued by companies.
The Royal London fund is the main way that I have been gaining my exposure to the bond market. I have been fairly relaxed about the outlook for bonds for a few years now. Although valuations look very stretched on historic measures, my view has been that interest rates are going nowhere fast for some time. This is not a normal interest-rate cycle. With so much debt still overhanging the economy, the authorities are going to do everything they can to keep the cost of borrowing as low as possible for as long as they can. That reduces the risk of owning bonds, even at these fancy prices.
I will admit that I have still been surprised by quite how far bond prices have risen. The Royal London fund is very much at the riskier end of the bond spectrum, since it primarily invests in high-yield corporate bonds, and not just the ones with the best credit ratings. The fund suffered hugely during the financial crisis, when it lost at least 40% of its value, and that was when I started to put some money into it. The yield on the fund had reached more than 10% at one point, but since then it has made a good deal of money out of its high-yield bonds (an industry euphemism for what were once called junk bonds, but an often underrated asset class). The fund’s capital value has risen by more than 150% over five years with income reinvested – not the kind of performance that you normally expect from a bond fund. If you take the income, it pays a tax-free yield of around 6%, with some handsome capital gains on top until the last couple of years.
Although many pundits have been worrying about what a period of soaring interest rates could do to the value of bonds, I don’t believe that rates are going to rise by much (if at all) for quite some time. Financial crises take a long time to work their way through the system and we may be only halfway through the process of recovery after the big banking bust of 2008. As long as the risk of a large bond market sell-off remains remote, I will continue to keep some money in bonds for protection, even though the returns are unlikely to match those of the past two decades, and if there is a big sell-off at some point I would be looking to buy back in if prices fall too far.
Marlborough small-cap funds
Giles Hargreave has been one of the most successful UK small-cap fund managers for nearly 20 years. In recent years, with our help in some cases, he has expanded the range of funds he offers so that they now include funds covering every part of the market capitalisation range. One of the surprising things to first-time investors is how big some so-called small-cap companies can be. An established company like Majestic Wine, a popular choice for many investors, is valued in the stock market at more than £250 million. At the other end of the spectrum there are some genuine minnows, companies that are valued in the stock market at less than £5m. Yet both qualify as small-cap investments.
There is clearly a huge difference between investing in these two kinds of company. A very small company may be dynamic and entrepreneurial and well on its way towards becoming a household name of the future, like Majestic. Or it may be a start-up company that is struggling to survive and will in time fade away altogether. You need a lot of specialist expertise and experience to distinguish between the two and between the good and the bad in both spaces. That is what Giles and other successful small-cap fund managers, such as Dan Nickols at Old Mutual and Harry Nimmo of Standard Life, have consistently shown they are able to do.
It is true that small-cap shares have had an exceptionally golden patch since the turn of the century. Academic studies tell us that smaller company shares should outperform over time, precisely because they are riskier and less liquid than their bigger counterparts. The scale of that outperformance since 2000 has been striking, making me very glad that I have maintained my exposure to this sector.
A particular feature of the small-cap sector is that there are a surprising number of smaller companies that pay a healthy and rising dividend out of their cash flow. That has been a particularly rewarding area in which to invest and one that Giles has managed to exploit very successfully. All his funds are very broadly diversified, with more than a hundred holdings, and he has shown himself to be highly skilled at selling or cutting his winners at the right time (a skill I envy). He rarely has more than 3% of his funds in any one company, to avoid the risk of being derailed by a single investment blowing up in his face.
Artemis Strategic Assets
The Artemis Strategic Assets fund employs a ‘go anywhere’ approach, with the flexibility to invest in equities, bonds, cash, commodities and currencies. It can also use derivatives to take short positions in certain types of assets, which can magnify returns but also increases risk. That makes it different from most of the other funds I own. The fund is managed by William Littlewood, who made his name in the 1990s when he ran the Jupiter Income Fund with great success.
The fund has a twin objective – to achieve returns greater than the FTSE All-Share Index and cash deposits over three year periods. While the fund sits in the IMA Flexible sector, I prefer to think of it as a total return fund – one that is designed to do well in all kinds of market conditions. Since its launch in May 2009, the fund has performed better than cash, but lagged the FTSE All-Share Index. The main drag on performance to date has been Littlewood’s bond investments, where he has taken a big bet on bond yields rising sharply.
The fund is positioned to benefit from the falling prices of Japanese, French, UK, Italian and, to a lesser extent, US government bonds. As I noted earlier, these bonds have generally performed well in recent years and this has therefore cost the fund quite dearly. If it wasn’t for the short bond positions, the fund would have performed broadly in line with the FTSE All-Share since launch. Littlewood has not changed his view that government bond prices, particularly in Japan, have been driven artificially higher, partly thanks to the effects of quantitative easing.
While he can’t predict with certainty the exact timing, he continues to believe prices will fall and is happy to maintain the positions. The view that quantitative easing has distorted financial markets and that the amount of global debt is unsustainable is also reflected elsewhere in the portfolio. Currency exposure is currently biased towards Asian nations which do not have the same issues with excessive debt as we do in the West. In contrast, Littlewood believes the euro, Japanese yen and sterling are set to weaken and has positioned the fund to benefit from devaluation in these currencies.
Finally, about a tenth of the fund is invested in commodities, predominantly precious metals. Gold is the most significant investment, accounting for over 7%. As the price has fallen from the high of almost $1,900 reached in September 2011, the fund has been increasing its exposure. Gold is considered a store of value that cannot be debased by printing or creating more. It is held partly to diversify the portfolio against risk associated with excessive global debt and equity market volatility.
I have been somewhat dis
appointed with the fund’s performance, but am happy to stick with it, given how different it is to the other things I hold. The advantage of a diversified, multi-asset fund such as this is that different areas of the portfolio will perform well at different times. Since launch the fund has tended to hold its value pretty well when stock markets have fallen, but lag behind when markets have risen strongly. That makes it a potential capital shelter in tough markets and therefore suitable either for a more defensive portfolio, or – as in my case – as ballast in an otherwise fairly aggressively positioned pension fund. It is doing something different to the other funds, and my thinking is that it rarely makes sense to have all your holdings positioned in the same direction.
Woodford Equity Income
In my opinion Neil Woodford is the best fund manager currently working in the UK. He has been investing in out-of-favour companies, with robust earnings and strong cash flow, for over 25 years. What makes him stand out from the average run-of-the-mill fund manager is that he is prepared to stick his neck out and make high-conviction bets on the companies and sectors he believes in, while areas he doesn’t like – which in recent years have included banks and big oil companies – he avoids completely.
I have been investing in Neil’s funds for nearly 20 years and have never regretted it. It was big news when he left Invesco Perpetual, where he had worked for 25 years, in 2014, with the intention of starting his own fund management business. His first fund, the Woodford Equity Income fund, was launched in June 2014 and his second, an investment trust to invest in a range of quoted and unquoted start-up businesses, mainly specialising in science and technology, in 2015.
