This quarter shows the value of patience and diversity
The first quarter of FY-16 has seen a poor start to the financial year with the Australian market down 7.2%, or 5.8% including dividends. This quarter combined with the -6.2% decline in Q4 2015 makes for the worst six monthly market return (-11.7%) in the past four years, since around the time of the European debt crisis.
To put the decline in perspective the current market decline whilst significant, is less than both the 15.5% decline in the six months to September 2011 and September to March 2009 (which marked the end of the GFC) pullback of 29.7%.
What should First Samuel clients make of such markets?
As we have noted and presented to you for the past three years we have had a cautious approach to the overall market. This involved ignoring the highly loved (and priced) larger caps (think banks, Telstra etc) as prices rose. And moving towards more defensive sectors and unloved sectors (thus lowly priced), and, in the absence of either opportunities, cash.
This has made our clients' portfolios far less susceptible to extreme market declines. As a result our (relative) performance has been very good. In fact, the month of August marked the best single relative performance month in First Samuel's (16 year) history.
Against a market that is down -5.8% this quarter, the average equity portfolio at First Samuel is +0.5%.
It is true that you 'cannot eat relative returns' but you will certainly be a lot less hungry!
There are two key reasons for this significant relative difference. The first, and most important, is sensible diversification. Whilst clients’ portfolios certainly look very different from the market's portfolio this has more to do with the market than First Samuel. As we have noted for many years now, the Australian market is highly concentrated (particularly around financial stocks) which means that most investors (except First Samuel clients) have a much higher risk portfolio than they realise. Our portfolio is much more balanced in that its financial weights are in keeping with other sectors, and we are not significant owners of resource stocks.
The second reason is patience. Not only have we pursued a much more balanced approach to investing, we have done it with a more sensible view of time. This has meant that we have invested in a number of companies that at the time of investment have looked poorly, which are still good companies, and will be able to recover substantially in coming years. We have always done this, as by looking out beyond the less-than-a-year approach of the market we have been able to find strong future investments.
It is pleasing that over the past 12 months our best investment (less one – Energy Developments which is under take-over and was previously a similarly unloved company) was Pacific Brands (up +46% in the past 12 months, against a market which has returned -0.2%). The only way to experience these great performers is through patience, and First Samuel clients have benefited significantly, especially compared to others.
So in our opinion First Samuel clients should be feeling quietly confident and reasonably relaxed about their portfolios and what the future holds. We are not anxious.
But what about the future?
The economic outlook is cloudy, and we expect it to be for some time yet.
We see many short-term potential hazards, but likewise many potential ways to alleviate them as well. It is important to realise that all economic conditions are but a moment in time; what we are trying to do is improve our situation in several years from now (or to paraphrase the great Wayne Gretzky “we are trying to skate to where the puck will be, not where the puck is right now”).
As a result we are best served by just focusing on what we are doing. And making sure that we only invest in things that make sense (not just in what our neighbours are doing, or the smart banker down the road, or the sovereign wealth fund from Turkmenistan, etc).. This is a hugely different but imminently sensible approach particularly when compared to those conflicted folk in the rest of the funds management and broking community.
Clients' portfolios today are the most defensive they have been since the creation of First Samuel (before the turn of the last century - 1999). Absent any other changes we expect dividends (which are currently yielding 5%) to grow at greater than 15% pa for the next three years, and with a Price to Earnings (i.e. P/E) of 9 (which is less than that of the GFC trough – 9.5) we are well protected from the significant downside that others may face should conditions worsen. This positioning and the strength and diversity of the things we own give us comfort that we will be able to deliver good absolute returns over the coming years.
If you currently own a standard market portfolio you may be right to not feel quite so confident.
Clients' equity portfolios hold about 21% cash (including the Energy Developments take-over position, which will be cash in October), 49% defensive positions (dividend paying and growing – economy regardless), 17% companies which are unloved (but extremely undervalued) and in the process of turning themselves around, and 13% in cyclical companies (that pay good dividends, are cheap and will provide strong capital returns through the cycle, which they will survive – think BHP).
Given this positioning and the work that has proceeded this period over the past few years, we are currently able to spend our time looking for new investments that will provide returns in coming years. This contrasts with others, who are currently more worried about the present.
Our position is a strong one that allows for confidence and clarity. And means that we can sleep well through the current market.