My father is an excellent gardener and an astute investor. In the aftermath of the coronavirus, I was sitting outside quietly admiring my withering roses when he yelled at me and said, Everything is going too well. ” It was a strange complaint, but the disappointing performance that followed that strong year unfortunately shows he had a point.
I think about this every year when the Chelsea Flower Show starts. In my father’s opinion, a portfolio should be like a garden, not a show garden, but a real garden. If they all bloom at the same time, your flower bed can look pretty bleak for the rest of the year.
Similarly, if all stocks are rising at the same time, you can see that your portfolio is at risk of quickly becoming a mish-mash of yesterday’s stories. We need tomorrow’s winners there. It corresponds to a plant that is dormant and ready to bloom when other flowers die.
There are good reasons for this. It is very difficult for fund managers to tolerate poor performance over long periods of time. Advisors and clients think you’ve lost the plan and are considering moving your funds elsewhere, but it’s probably just bad timing. We all did it and watched in despair as the funds we abandoned suddenly found themselves at the top of the performance table.
From an investor’s perspective, you never know when you might suddenly need to tap into your investments. So a portfolio without volatility is probably one that is risk-free and won’t go anywhere, but for many of us, too much volatility can be damaging.
Anyone with a portfolio focused on a handful of giant U.S. companies that have driven global stock indexes higher over the past 18 months would do well to keep this in mind. I think over time, breadth and variety will become important again. Is it time to save some of your profits to free up space in your portfolio for next season, just as you might hard prune a shrub to plant a new one?
What will you plant tomorrow? My expertise is British equities, so in some ways I’m talking about my own book, but I think there’s real potential emerging in Britain’s battered small and medium-sized enterprise sector. I’m not the only one there. The big question is when things will get better.
In one important sense, gardeners have an advantage over portfolio managers. Spring follows winter. Bull markets follow bear markets, but the timing of their arrival is less predictable. The average duration of a bear market is considered to be nine months. However, the UK market has been relatively weak by global standards since the 2007 global financial crisis, and that weakness has been exacerbated by Brexit.
I am often asked what triggered my recovery. Catalysts are easy to identify after the event, but are often difficult to recognize at the time. But it seems to me that there are strong signals coming through that things are changing.
The UK is emerging from recession and the FTSE recently hit a record high. But it still looks relatively cheap. Company leaders have shown their anxiety at low valuations and have been buying up their own shares at levels I can’t remember in my working life, spending more than £50bn on share buybacks last year.
UK stocks are expected to yield 4% next year (mid-cap stocks are expected to yield closer to 3.4%). On average, they expect to return another half or so to shareholders through share buybacks.
This reduces the number of shares and means a larger portion of the profits for remaining investors. At some point, that becomes clear and the stock price corrects. More recently, he has seen banks such as Barclays and NatWest – both big buyers of their own shares – rise by nearly 50% in just three months.
On the other hand, I didn’t know that many of the stocks I own are acquisition targets, often at a significant premium to the pre-offering stock price.
This certainly helped the underperforming trust mentioned at the beginning, the Henderson Opportunity Trust. After a tough period when its exposure to promising small and medium-sized companies did not align with market preferences, it has risen more than 25% in six months (almost double the performance of the FTSE All Share).
Green sprouts? perhaps. i hope so! Some might say it’s still too early to add to the types of stocks the company owns. However, as any gardener knows, it is much cheaper to buy young plants before they mature and bloom.
One thing that could drive a correction in UK SME stock prices is lower interest rates. This could create a virtuous cycle as profitable companies push forward with capital investment in projects that have been put on hold, and cash investors who have prioritized interest payments over equity may be encouraged to switch.
Industry in particular could benefit from lower interest rates. Despite all the talk about British manufacturing being on the decline, there are certainly some very good industrial businesses in the UK.
Surface Transforms have potential. The company has just raised an extra £6m to build a new facility to increase production of ceramic brake discs, which are far more effective than traditional brakes at slowing down luxury electric cars with heavy batteries. is. The company has suffered a series of accidents and its stock price has plummeted over the past year. The hope is that we have turned a corner. If you can manage to scale it up, it will be a great product. The stock is priced at just over 1p and could accelerate rapidly from here.
Renold has had its share of problems, but it now appears to have costs under control. The company, which makes precision chains used in everything from power plants to chocolate manufacturing, has just secured a £10.6 million order from the Royal Canadian Navy. The company’s stock price has risen 83% over the past year, but in my view, the valuation still doesn’t reflect the current state of the company and its strong order history.
Finally, battery developer Invinity also looks interesting. Shifting power generation to renewables requires more battery storage to power the grid when the wind isn’t blowing and the sun is behind clouds. If you have an older smartphone, you know that one of the big problems with most batteries is that they become much less efficient. Invinity’s technology (a lithium replacement) appears to have overcome this problem. Unlike many younger competitors, Invinity has manufactured and delivered over 1,200 large-scale batteries around the world.
We own all three of these companies in a diversified portfolio. In other words, you can use “mixed boundaries” if you prefer. That means if they disappoint, they hope their other holdings will prosper and make up for it.
Industrial recycling companies often have relatively fixed costs, and many companies have recently succeeded in reducing these costs by promoting efficiency. Since costs don’t have to rise as orders increase, the revenue goes directly to revenue, significantly increasing profits. Valuations are low because analysts are too fixated on recent difficulties and have not factored in this possibility. The market likes positive surprises. It may not take long for this type of stock to break out.
Remember all this as you make your way through the crowds to catch a glimpse of the show gardens at this year’s Chelsea Flower Show. Imagine if these gardens were still there six months later. What will they look like then? Plan and invest for the future, not just the present.
James Henderson is co-manager of the Henderson Opportunity Trust, Roland Investment Company, and Legal Bonds.
