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The Conviction Five: 2006-20

General discussions about growth strategies which focus primarily on investing for capital growth
Luniversal
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The Conviction Five: 2006-20

#378074

Postby Luniversal » January 17th, 2021, 3:27 pm

In Dec. 2012, at The Motley Fool, I proposed a portfolio called the Conviction Five. It was designed, to quote one of its members' professed aims, to preserve wealth and to grow it 'in that order'. Not losing much even in crashes was paramount.

The C5 is for investors who would rather see their pile remain stable than risk it in pursuit of gorgeous gains. To quote the introductory post 'Wealth Preservers- Through Thick and Thin':

A tracker only spares you from doing worse than your fellows, on average; a 'conviction' investment trust, as they have come to be known, purposes to limit losses when others are losing. It can also take advantage of occasional bouts of optimism to lift that capital to a new plateau, but safety first.


The conviction brigade is distinguished by free and easy means as well as an unwavering end. It is loosely pledged, or not at all, to maintain a conventional long-only equity stance or an orthodox asset allocation; it roves from type to type as the spirit moves it. Unconcerned about looking like Growth sector trusts, Conviction follows no benchmark but strives to keep capital safe come what may. That may prompt either full investment in shares, and a passing resemblance to trusts which liquidate their portfolios little and seldom, or it may entail buying bonds (conventional or index-linked), cash, gold bullion, derivatives, stakes in trading businesses... whatever serves the cause of Never (well, hardly ever) Losing Money.

To continue the 2012 introduction:

I have confined myself to five freewheelers whose portfolios are not too artery-hardened by large long-term holdings in unquoted companies or dynastic shibboleths. They can turn on a sixpence. That is when they are not sitting tight looking down their noses at the lemmings rushing for the entrance or exit in a craze or panic; 'masterly inactivity' is an important facet of the Conviction style, going against the crowd almost axiomatic in running such a fund. Not by coincidence, those who do run them are middle aged or older and have seen nearly all of it before, more than once...

...The five in the spotlight are Capital Gearing (CGT), Independent (IIT), Lindsell Train (LTI), Personal Assets (PNL) and Ruffer (RICA), which last is not a British authorised trust but a Guernsey 'investment company' listed in London (1). All are midsized, dedicated to not losing money and tended by opinionated maestri relaxed about being out of step with conventional wisdom.



The C5 has been calculated back to Jan. 13, 2006, like my paper High Yield Portfolio, HYP06, and other investment trust collections, the Growth Ten (G10) and the Baskets of Seven (B7) and Eight (B8). All these assume £75,000 is invested before 1% initial costs, with equal apportionment to their constituents and no ploughing-back of income. Deflated figures use the Retail Prices Index.

The models' objectives differ starkly. But to see how widely they diverged in combined return, and how it splits between bird-in-hand dividends and capital gains, tells us something about the right horse for one's course, as well as reveaing volatility along the 15-year line of march. The period took in a brief spell of calm, a dire, compacted slump in equities and a very long but slow and fitful recovery, halted by a weird, fierce but brief panic. Such conditions provided a strenous circuit for a wealth preservationist.


CAPITAL

The Conviction Five's year-end market values; nominal and real percentage changes/performance in percentage points versus the FT All-Share Index:

2006: £84,060, +12.1, +7.7/0.8
2007: £76,957, -8.4, -12.4/-10.5
2008: £70,932, -7.8, -5.7/25.0
2009: £88,518, +24.8, +22.4/-0.2
2010: £104,493, +18.0, +17.2/7.1
2011: £104,743, 0.2, -4.6/6.9
2012: £116,310, +11.0, +7.9/2.8
2013: £124,875, +7.4, +4.7/-8.3
2014: £131,970, +5.7, +4.1/7.8
2015: £159,806, +21.1, +19.9/23.6
2016: £208,661, +30.6, +28.1/13.1
2017: £219,673, +5.3, +1.2/-3.7
2018: £243,389, +10.8, +8.1/23.7
2019: £259,609, +6.7, +4.5/-7.5
2020: £294,612, +13.5, +12.6/25.9


The quintet increased its deflated value in twelve of 15 years, including all since 2008. It beat the index in ten of 15 years. Its compound annual growth rate (CAGR) was 9.6% pa or 6.7% after inflation.

Nominal-value CAGRs per trust were: CGT, 5.6%; IIT, 5.3%; LTI, 17.7%; PNL, 4.0%; RICA, 5.0%.

Resilience was creditable in the early days. The global financial crisis poleaxed share prices from 2007. The portfolio would have fallen by about 8% then and again in 2008, but regained one-quarter in 2009: in real terms, it recaptured all lost ground since the end of 2006. A further advance of 18% followed in 2010.

For a decade until spring 2020, the C5 would have ridden the gentler upswing which became Quantitative Easing's silver age for asset prices, their longest modern bull run. The portfolio stood higher in nominal worth at each of eight New Year's Eves from 2012 to 2018, and by at least 5% every time.

Not that this has always been enough to match the All-Share Index: the C5 lagged in 2013, 2017 and 2019. But last year it was 26 points ahead of the benchmark, its best yet. That is relative: as a partly growth-focused enterprise, the C5 is more aptly stood against the Growth Ten, whose worldwide coverage ought to reflect the capitalist world's vivacity more than British-based businesses alone.

Since inception, though as likely to grow in value each twelvemonth, the G10's actual value exceeded the convicts' only in 2007, finishing £8,000 ahead. After the V-shaped crash and rapid rally, at end-2009 the C5 was £16,000 ahead and has held the lead ever since.

It topped £100K at end-2010, whereas the G10 did not hit six figures until end-2013. At that point the C5 was only £5,000 in front-- such is the penalty of wealth conservation when prices are exuberant-- but by end-2015, after bullishness had cooled, it led the G10 by £23,000. Now the lead is £34,500 or 13%.


CONTRIBUTORS

The C5 has evolved as a kind of barbell strategy. At one end, Lindsell Train and Independent have been highly volatile, though tending to grow fastest; at the other, Ruffer, Capital Gearing and especially Personal Assets have been safety-first shock absorbers at the expense of growth.

Let us consider the year-end percentage weights at five moments of the portfolio's life: 2007, when the market was beginning to crumble; 2009, after the speedy recovery; 2013, following a lesser fit of nerves; 2016, when the charge into LTI began; and 2020, apres bounce and after LTI blew off somewhat, before forging ahead anew:

CGT: 19.1/21.4/18.4/13.0/11.5
IIT: 17.8/12.6/13.5/11.6/11.1
LTI: 24.3/23.2/32.7/50.7/57.6
PNL: 19.7/18.8/15.3/11.2/9.2
RICA: 19.1/24.0/20.2/13.5/10.6


Constituents have not altered their mandates or methods since a year ago, when detailed examination of each appeared here:

viewtopic.php?f=96&t=21531&p=280716#p280716

Lindsell Train always dominated the selection, though never as much as now.


METRICS

The aggregate of financial results for the composite year to Jun., which best fits different accounting dates, discloses these measures of the C5's robustness: percentage change in deflated net asset value per share; year-end (discount)or premium/expenses as percentage of year-end net asset value:

2006: 8.2, 4.9/1.01
2007: 7.9, 8.0/0.95
2008: -5.3, 2.7/1.01
2009: -5.1, (0.5)/1.11
2010: 23.5, 7.0/1.05
2011: 4.2, 2.4/1.03
2012: 3.8, 3.9/0.95
2013: 9.7, 3.7/1.06
2014: -0.6, 4.2/0.97
2015: 13.3, 3.1/1.03
2016: 6.0, 15.6/0.92
2017: 10.2, 22.2/1.02
2018: 11.1, 24.4/0.94
2019: 11.4, 43.2/0.89
2020: 4.1, 7.7/0.75


Same metrics by trust, average 2006-20:

CGT: 2.7, 4.8/1.13
IIT: 7.0, (7.8)/0.34
LTI: 13.8, 16.2/1.09
PNL: 1.1, 0.9/0.32
RICA: 2.7, 1.2/1.29
------------------------
C5: 7.0, 9.7/0.98

Real NAV per share has risen by an average 7.0% pa and in twelve of 15 years, while share prices are up 7.9%. The last serious setback was 2009. There has been a continual purchase premium except in that year, when optimism temporarily left safety shots in the locker; but discount control contained said premium below 10% until Lindsell Trainmania set in four years ago.

Expenses average 0.98% of NAV; they too peaked in 2009, but have been pruned, although the elephantiasis at LTI aided a dip to a lowest-yet 0.75% last year. Presently at least, the C5's running costs are in the same area as the Growth Ten's.

Some people nurse an inhibition about buying trusts on a premium. The C5's has been nearly 10% during its life. In 2020 LTI's blowoff reduced it from a barmy 43% to under 8%. A more practical complaint is that the prices of LTI, PNL and CGT are very heavy, rendering smaller investments less easy.


VOLATILITY

As mentioned, the portfolio's market value compounded at 6.7% real in financial years 2006-20. Standard deviations of price changes across these years averaged 10.5. The FE Trustnet Risk Score (measuring volatility in prices over the last three years but weighted towards the present), was 115 at Jan. 7 where cash is 0 and the FTSE 100 index 100.

For constituents, CAGRs of share prices (% pa), standard deviations and Risk Scores at Jan. 9 are:

CGT: 5.6/8.2/38
IIT: 4.5/31.8/166
LTI: 15.7/19.0/161
PNL: 3.8/7.3/45
RICA: 6.1/8.5/51


Inverse relationships between Risk Score or SDs and growth rates in value are manifest, except that Independent's performance is subpar against its price gyrations: LTI has not only grown far faster but with fewer upsets. The other three members are of a piece. They accomplished minimal real growth, 1-3% pa, but with volatility half or less that of the Footsie.


INCOME

Dividends, even less of a consideration than in the Growth Ten, are best regarded as a sweetener.

The historic yield averaged c. 1.5%, against c. 2% for the G10, 3.5% for the All-Share Index and 4% for the universe of 24 income trusts whence my 'baskets' were drawn. Nor has any C5 trust pursued a 'dividend hero' path of ever-rising income. They do not promise to struggle against cuts or freezes. Such policies would compromise the overriding necessity to skirt loss of value: it would imply truffling among higher-yielding shares which might well be prone to markdowns.

However trusts by law must shell out 85% of their revenue. Outcomes tell a rather different tale from theory. Here are nominal and real percentage changes between calendar years and purchasing power/indexed to 2006:

2006: £921/100
2007: £1,113, +20.9, +16.9/117
2008: £1,232, +10.7, +9.8/128
2009: £1,564, +26.9, +24.5/160
2010: £1,726,+10.3, +5.5/169
2011: £1,516, -12.2, -17.0/140
2012: £1,517, +0.1, -3.0/136
2013: £1,966, +29.6, +26.9/172
2014: £1,973, +0.4, -1.2/170
2015: £2,115, +7.2, +6.0/180
2016: £2,687, +27.0, +24.5/225
2017: £2,785, +3.6, -0.5/224
2018: £3,750, +34.7, +32.0/295
2019: £4,885, +30.3, +28.1/378
2020: £6,756, +38.3, +37.4/519


Total £36,505 v. £35,647 for G10. The Conviction Five's receipts grew at 15.3% pa, considerably brisker than its 9.3% for capital and twice as fast as G10 income's CAGR. Revenue has swelled more lustily than receipts from the baskets or my HYP-othetical. Real falls occurred in four of 14 years, but purchasing power was always at least one-third higher than in Year 1.

Income per trust: total, percentage share of total, CAGRs (%):

CGT: £2,318, 6.3, 8.4
IIT: £6,605, 18.1, 7.9
LTI: £18,666, 51.1, 25.9
PNL: £4,713, 12.9, 2.6
RICA: £4,204, 11.5, 4.7
------------------------------------------------
C5 total/average: £36,505, 100.0, 15.3


More than half of these dividends were provided by Lindsell Train. The surge since 2017 is due to the stake in its fund management earnings. Given the scale of that business, if its LTBH bias is endorsed by customers those earnings may be more reliable than dividends from the portfolio... unless fans take against Messrs Lindsell and Train as they eventually did against Barnett and Woodford, or unless the founders or their heirs change LT's house style drastically and detrimentally.


COPING WITH COVID

Between Jan. 3 and Apr. 3 last year the All-Share fell by 29.2%, including six week-on-week declines on the trot in Feb. and Mar. Equities were weakening in the New Year before the virus scare moved up the news schedules. Since early spring London has shown willingness to retrace lost ground, while Wall Street finished last year at a record high.

It is debatable whether Q1 2020 amounted to a very brief and baleful bear market or a correction in an extraordinarily long bull run since Mar. 2009. Either way, the first 14 weeks of 2020 gave the C5 a stiff if short test of its intended resilience.

Here are the overall price and FTAS changes for this spell, numbers of weekly falls out of 14, largest weekly falls and the standard deviations of prices' and index's changes:

CGT: -5.0, 3, -9.8/19.2
IIT: -37.8, 7, -31.5/1.0
LTI: -14.3, 5, -9.6/102.9
PNL: -4.1, 3, -6.6/13.0
RICA: -2.5, 7, -3.6/0.0
--------------------------------
C5*: -12.7, 6, -6.5/6.3
FTAS: -29.2, 10, -16.8/5.6

*unweighted


The portfolio lost less than half as much as the index, yet its volatility was about the same overall (SD ~6). It dropped six times between Fridays to the index's ten. No constituent except Lindsell Train fell by more than one-tenth in any week, whereas the index did so twice.

The barbell effect is seen in Independent's and LTI's behaviour: jagged where the other three were quite sedate in the storm. Ruffer managed not to deviate from its average price. Personal Assets and Independent-- one calm, the other's ups and downs netting out-- added stability.

Turbulence came mainly from Lindsell Train, which is obliged to hug its holdings and not be stampeded, and from Capital Gearing, whose pronounced fear of inflation (hoarding gold and US index-linked Treasuries) looked irrelevant in the first days of the crash. But CGT only declined in three weeks, while Ruffer fell in seven. So did Independent, but Ruffer flickered and Independent swung hard, making some tactical missteps which the manager confessed in Friday's annual report.


CONCLUSION

As IIT showed, the Conviction Five can suffer perils as a concentrated portfolio. Managers may run amok or be replaced by less able ones. Fashion shifts may leave them behind. Too much may ride on one runaway winner like LTI. However, the blend would so far have done what it was commissioned to do, not least in the WuFlu moment.

How much, though, rests on which five trusts one picks? I will address that doubt in a separate post.
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(1) The pool from which these were fished included AVI Global Trust (AGT), formerly British Empire; Caledonia Investments (CLDN); Hansa Investment (HAN), formerly Hansa Trust; Manchester & London (MNL); and RIT Capital Partners (RCP).

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