Diary of a Private Investor

Investment Strategy

Portfolio Objective
To generate an absolute return in excess of 10% per annum and to consistently beatĀ  external (FTSE All Share Total Return Index and the Stockopedia NAPS/SNAPS portfolios) and internal (Fidelity Global Equity and the Investment Trust Index) benchmarks.

Portfolio Mindset
I treat my portfolio as a large cash machine, its purpose being to provide an inflation proofed retirement income for my wife and I until the end of our days. Individual holdings within the portfolio either add cash to the machine over time or they are a drag on it. The ongoing challenge is to ensure that I have the right mix of portfolio components to balance risk and reward, relevant to the prevailing market conditions. Below, I have outlined my portfolio rules/guidelines which are subject to ongoing refinement as lessons are learned.

My primary mechanism for risk mitigation is to run a well diversified portfolio. At the time of writing, this amounts to 40-50 holdings, each holding designed to bring something different to the portfolio. I update portfolio holdings/weightings regularly (approximately quarterly) here and in between times, I post weekly on Twitter regarding any trading activity.

I had a massive aha moment in the middle of 2017 regarding the power of compounding. My article at the time is worthy of a permanent reference. In short, compounding is at the heart of my portfolio’s growth strategy. At a high level, that means that I have to take out each year, less than my investment return so that the portfolio grows over time and hopefully, at a faster pace than inflation. Within the portfolio, each share has the potential to contribute to compounding returns from bottom up compounding (dividends reinvested), top down compounding (top slicing winners) and internal compounding (companies with strong balance sheets that are able to grow organically through reinvestment of profits).

Core Strategies
Each holding in the portfolio is bought and retained with a perspective as to what it brings to the portfolio party. I use two core strategies; compound growth and diversified income and each holding fits into one or the other. Within these core strategies, I have a variety of sub-strategies:

Compound Growth
Quality at a Reasonable Price (QARP)
– these are shares that have the high quality characteristics necessary to deliver internally compounded returns over the long haul. Typically, I screen for high operating margins (an indicator of a strong “moat”), high ROCE (return on capital employed) over time and strong cash flow (with low to no debt). I often find that these companies also have the very best dividend track records (dividend well covered, rising consistently) but invariably, they are too expensive to buy as a pure income play.

Growth at a Reasonable Price (GARP) – these are shares that are delivering decent growth (top line and bottom line) and in my assessment, likely to continue doing so. Typically, they pay a small dividend too, although I am more interested that the growth story remains on track.

Value and Recovery – shares are usually cheap for a reason such as cyclicality, recovery/turnaround situations or in the case of some of my holdings, political risk. I try to have some exposure to value shares in the portfolio but often I struggle with the business quality and risk/reward.

Diversified Income
Large Cap, High Yield – these shares are boring but reliable dividend payers. I generally look to hold these companies as long as the dividend looks secure. These companies tend to bring low volatility to the portfolio and provide liquidity in times of market stress.

Investment Trusts – I hold a basket of investment trusts that provide a high yield, low volatility and diversification into areas that I don’t have the capacity to address directly.

Small/Mid Cap, High Yield – occasionally, I encounter small or mid cap shares that don’t offer particularly compelling growth characteristics but nonetheless, offer a reliable dividend. I am happy to have a small number of these in the portfolio but accept that they can be higher risk.

Risk Profiles
Stockopedia (which is my main investment tool for share screening/assessment and portfolio management) provides a risk profile for each share based on its volatility over a three year period. An important part of running a balanced portfolio is to have a mix of volatility in order to provide upside returns and reduce downside risk. My aim is for the portfolio overall to have low volatility and above average returns by having a mix of risk profiles:

Conservative = low volatility; generally large caps with high yield (in my portfolio) or collective funds such as investment trusts.

Balanced = medium-low volatility; a mix of large/mid caps with either high yield or strong quality characteristics.

Adventurous = medium volatility; generally small/mid caps in the QARP/GARP sub-strategies.

Speculative = medium-high volatility; mainly small caps GARP/Value. Super growth stocks with high momentum can also fall into this risk profile.

Highly Speculative = high volatility; limited exposure to the occasional small cap, low liquidity holding

StockRank Styles
In addition to the QVM (quality, value and momentum) rankings, Stockopedia ehanced their tool to also categorise shares into 4 winning styles (on average), 4 losing styles (on average) and a neutral style. I try to avoid the losing styles while having a mix of the four wining styles and neutrality. This ensures I have exposure to quality, momentum and value factors while avoiding many of the common traps (of course, it is about probabilities rather than certainties). For more info on StockRank Styles, I wrote about my interpretation of themĀ here, shortly after Stockopedia originally introduced them.

Other Diversification Factors
Other factors that I try to incorporate into my portfolio diversification include market capitalisation, sector/industry, geographic and currency exposure. While diversified, I do not try to cover the whole market but rather, I choose to apply some selectivity based on my assessment of the market – for example, being in cyclical businesses at the right stage of the cycle.

Weightings and Momentum
It could be argued that optimum diversification for most private investor portfolios is in the range of 20-30 holdings whereas I choose to run with 40-50 holdings. I believe that an opportunity to outperform with limited risk is to rebalance the portfolio periodically – top slicing the main winners for that period, adding in dividends received and topping up existing holdings (perhaps those that have been out of favour but preferably, those that are showing signs of increasing momentum). There is an element of trying to “time the market” with this approach but I see it more as letting the “trend be my friend” based on what my portfolio screens are telling me.

Averaging Up v Averaging Down
As a rule of thumb, I am much more likely to “average up” on a holding that is rising (before top slicing at a rebalancing point) than I am to “average down” on a holding that is falling. There are exceptions. The main one is that by averaging down on income shares (if I am confident the investment thesis remains intact) can be a way to increase the “natural yield” in the portfolio. For growth shares, I would prefer to wait for positive momentum to return before adding rather than trying to catch the bottom.

When to Sell
The main reason for selling is if the investment thesis no longer remains intact. That is, if a growth share stops growing or an income share stops paying a dividend. Usually, such bad news (or the precursor of potential bad news) comes via regulatory newsflow from the company (RNS). In particular, I have an (almost unbreakable) rule to sell a holding whenever there is a “profit warning”. Beyond this, I use a stop-loss-decide based on the volatility of the share, as follows:

Conservative = 10% trailing stop loss
Balanced = 15% trailing stop loss
Adventurous = 20% trailing stop loss
Speculative = 25% trailing stop loss
Highly Speculative = 30% trailing stop loss

I do not use automatic stops. When a stop-loss is breached (or often, when it looks like it is about to be), I force myself to make a decision – buy more, hold, reduce or exit? Usually, it is a decision to either reduce or exit.

Reality Check
I am a non-qualified amateur playing a professional game which employs some of the smartest, most educated people in our society. This site is about me learning out loud in pursuit of my own investment goals and financial independence. First and foremost, I write for my own benefit and my own learning BUT if my ramblings and transparency can help you with your own investment journey, that’s great and I’m delighted to have you along for the ride. Feel free to connect with me on Twitter (@BrilliantLeader).

Markets go up and markets go down, some shares rise and others fall, often for no discernible reason. Where there is risk, there is opportunity and I am simply trying to weigh the odds in my favour, over the long haul, based on my own financial situation and tolerance for risk. No financial advice is ever intended in my writings.


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