The past year, moreover the past decade, has been a
wonderful period for investors. It has been less kind to those of a speculative
nature (as is, perhaps, the case for all decades!). The total return of the
S&P 500 in 2019 was a whopping 31.5%; even the lower quality FTSE 100
achieved a total return of 17.2% for the year. Over the past 10 years the
annualised figures are 13.5% and 7.4% for the S&P 500 and the FTSE 100,
respectively (measured in local currencies).
And what of the portfolio. Well, 2019 was a year to forget…
to put it mildly. Essentially the question of whether putting capital into what
I can now admit were highly speculative enterprises was an investment or a
speculation has been rather abruptly answered. They were a speculation. Unfortunately,
the early gains had the perhaps predictable effect of making them appear lower
risk than any rational person could easily have appraised them to be. The
opportunity to exit them with significant gains locked in was taken to an
almost complete extent during 2018 then, sadly, undone during 2019. Very sadly,
the significant gains within the largest holding were all but reversed in 2019
to leave nothing but coal in the place of the 2017 carbuncle stones.
Whilst this speculative episode can have nothing but
deleterious effects on any hopes of creating a strong investment track record,
in terms of attracting institutional funds, the entire track record was – to
some extent – spoiled by the initial foray away from solid investment assets
and into the realms of the highly speculative early-stage biotechnology
nano-cap universe. With the benefit of hindsight, any straying from sound
investment principles was an invitation to the risk of a permanent loss of capital.
But the allure of easy gains proved a temptation hard to resist at the time.
Perhaps the reasons were partly related to working in a somewhat speculative
environment. Perhaps with external capital and the promise of sticking to sound
investment principles the initial investments would never have happened. But
they did, and the results show the dangers of straying from a sound investment
approach.
So, 2019 in portfolio-land was a poor -6.5%
return. By way of mitigation, this was after larger losses
part-way through the year with August YTD losses of -17% followed by a gain of +12% since the end of August (when the strategy was finally return to one of
high-FCF yield investments in unloved enterprises with a long history and some
degree of predictability to future cashflows). In a slightly stronger form of
mitigation, results for the decade were an annualised gain of 23.6% and a total
return of 732%.
Clearly 2019 would have been a lot more profitable and a lot
less stressful had I simply followed the sound advice to hold index trackers.
The noted cash holdings were a drag on returns (vs the broad indices) at first,
and then far worse when transferred into speculative holdings. But what of the
decade ahead?
The S&P 500 began the 2010s at a price of 1115 and ended
it at 3231; the FTSE 100 began the decade at a price of 5412 and ended it at
7542. Whilst it is impossible to say what the next decade will hold, a repeat
of the multiple expansion seen over the past 10 years in the world’s most
followed (and possibly most important) index is highly improbable. In the
absence of multiple expansion, with a dividend yield of 1.8%, to match the past
decade’s returns the index would require earnings growth of over 11% and an
absence of multiple contraction to counter-act these positive sources of
returns.
11% annualised earnings growth may be possible, but this is partly
due to the fact that some potential future market participants such as Uber ($60bn market cap; $6bn
in losses over the last 12 months) and Tesla ($87bn market cap; $800m in losses
over the last 12 months) will either grow earnings significantly over the next
decade or not join the index. Large market constituents such as Apple and
Microsoft (with a combined $2.6tn price tag, or 9% of the index’s $30tn total
capitalisation) appear to be growing per-share earnings at double-digit rates,
but the outlook for these behemoths will need to be at least as good by the end
of 2029 as it is today for their earnings multiples (22x and 28x, respectively)
to remain in tact.
Perhaps passive index tracking is, indeed, the best solution;
it certainly appears to be for the vast bulk of investors. Much of the
portfolio’s returns during the 2010s was from a sweet spot in the first half of
the decade where earnings grew strongly, and multiples expanded markedly –
especially for smaller companies. With multiples now at elevated levels for
quality businesses and with the economy towards the tail-end of an expansionary
phase, growth in asset prices will be harder to come by. But the fun of trying,
and the challenge of doing so, means it is likely I’ll keep plugging away. Compounding
capital at over 20% annually for a decade may be a tough challenge, but
challenges are there to be met and it is heartening to know that the portfolio
managing this elusive goal over the past decade, albeit with some significant
fluctuations along the way!
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