Saturday 5 January 2013

Portfolio Up One Third in 2012

2012 has been an unusually prosperous year for the DIY Income Investor portfolio with a total return on the stock market securities of one third.  This is a cracking performance - but how unusual is it and how much of this is down to luck?

To recap, this is a real portfolio, described in detail on the 'Portfolio' page of this blog, with key changes reported as they happen. For the stock market investments (as opposed to the purely cash savings accounts, which are not included in this result) I track the total returns each month (i.e. changes due to the price of the security plus any income received), and deduct any new investment.

The result for 2012 is almost exactly 33%. In case you are wondering , although actually not the highest 12-month return I've seen - but it is much higher than the typical returns from the last few years.

However, I have to face a serious question: is this great result (well, great for me at least) because:
  • I have found a perfect formula for making money on the stock market, or
  • I am a Lucky Fool
And by Lucky Fool, I am referring to Black Swan author Nassim Nicholas Taleb’s definition: "Lucky fools do not bear the slightest suspicion that they may be lucky fools - by definition, they do not know that they belong to such a category. They will act as if they deserve the money. The lucky fool [is] defined as a person who benefited from a disproportionate share of luck but attributes his success to some other, generally very precise, reason." (Fooled by Randomness)
So, that’s me told, then. But maybe it is useful to try to unpick what has happened and what choices have led to this (possibly temporary) happy state of returns.
First, how have the benchmarks done? My portfolio is made up of:
  • 50% high-yield UK dividend shares, drawn from the FTSE 250, including a few ‘legacy’ shares (that is a flattering term for ‘poor investments’) left over from the 2008 crash;
  • 50% high-yield fixed-income securities, quoted on the London Stock Exchange and almost exclusively from the UK finance and insurance sector and consisting of corporate bonds, preference shares and PIBs (I sold my UK gilts during the year).
So, the appropriate benchmarks might be those related to:
Some surprises there, to me at least, particularly on corporate bonds, which I had assumed were in a bigger bubble than that! Still, apart from the good showing of the FTSE 250, there is still not a good explanation of the portfolio’s performance.
Taking again the key features of the portfolio and recent asset allocation decisions, there might be some other explanatory factors:
1. The portfolio is almost exclusively UK-based, and the UK has at least avoided the Euro currency storm and the US election and ‘fiscal cliff’
2. I made a conscious decision during last year to increase the share of fixed-income to 50% of my portfolio
3. The portfolio is overweight in the financial and insurance sectors - both of which were heavily hit by the global financial crash but have recovered strongly during the year
4. I have bought ‘distressed’ high-yield fixed-income securities significantly below par - and these have benefitted from a change in market sentiment
5. My ‘legacy shares’ - notably LLOY, RBS and BARC have recovered significantly during the year (although remaining far below their purchase prices)
So this good result must be due to the specific choice of asset classes and individual securities - in that sense it must be a quite unusual result. No doubt some other Lucky Fools have done better - but not many, I'd guess!
And what does this Lucky Fool take from this review? Well, I am sensible enough to realise that this performance is not sustainable - the continuing difficult economic times in the UK may mean an slide in my portfolio’s value in the coming years. And it is increasingly clear that my portfolio is not really as diversified geographically and sector-wise as it perhaps should be.
Perhaps time to work on my New Year’s Resolutions: I have already started taking profits.
(A version of this post appeared previously on Citiwire Money)

I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.


  1. Great result well done.

    What was the breakdown of return between the fixed income and stocks component of your portfolio?

    Re lucky fool - investing is always partly luck! Your approach is interesting and so far successfull - the concepts and implementation seem sound to me. (not that I know anything really!)
    I am particularly impressed with your ability to change your approach to deal with changes in the environment. Distressed securities was a great idea.
    Taking profits is a wise move IMO.

    Good luck with the year ahead.

    Just think if you were a hedge fund manager with this result you would be asking for a £100 million bonus!

    1. Thanks Anon

      The gains are strongly in the fixed-income end of the portfolio, although bank shares have also done very well.

      I'll have to ask the shareholders about the bonus...

      More 'sells' likely!

  2. Good result Moneyman, not many people would have thought the top riser in the FTSE 100 would turn out to be Lloyds.

    I’d echo your concerns about risky assets at present. There’s a few warning signs for me:

    The VIX is below 15.

    The spread on corporate bonds over govt bonds is below its 10 year average (142bps v 157bps – Barclays Global Corporate Index).

    The challenge for me is finding ways to reduce risk within a portfolio without buying seemingly overpriced gilts or leaving too much in cash.

  3. Yes this is very interesting,I've had 23% in corporate bonds,and the rest in Dividend payers.
    I need to reduce my cash,but the higher quality bonds look overpriced
    and gilts have to be avoided.
    So where to go now?

    1. Moneyman

      Well done. I suggest don't dump all the banking bonds:- the yield is still hard to beat, and the rising institutional strength reduces the risk on these as well. I agree about rebalancing away from GBP (which seems likely, more than likely to tank a bit).

      A couple of suggestions: first a short Gilt fund ETF XUGS (cost is around 0.25% plus cost of carry)

      Second, as a hedge against inflation consider the Principality 2020 7%. It trades below par so yield is upwards of 8%, and come 2020 it will either be called or rate reset to 3% + 5 year gilt rate: you can't get a better inflationary hedge than that.

      Good luck with the triage process and look forward to 2013 being almost if not quite as good.

    2. Thanks Tulipcraze

      I already have a slug of Principality 7% and was thinking about buying more - their latest report & accounts looks OK. Plus all the benefits you mention.

      I don't short (yet) but in relation to gilts I am waiting for CN4 to reach 4.5% again.

  4. Moneyman, I have never ever shorted a single thing, ever.

    But I think I will shortly make an exception. My rationale:

    A) The UK AAA rating is IMHO very likely to be taken away this year (as was for France last year). Reasons for this boil down to the current negative synergy of low UK growth plus increasing UK debt. This will reduce the price of current gilts.

    B) My bond funds have done well. But as current bonds mature the replacements being bought have lower yield reflecting the current yield curve, and so the return on these funds will reduce further.

    C)QE must eventually end. QE is keeping down gilt yields. So if I understand it effectively, when gilt yields rise those who short current gilts will benefit. The underlying mechanism here is not intuitively obvious and would be worthy of a whole article from you, hint hint.....