SIF folio Q3 review: navigating a tricky period

Market volatility has surged recently, for reasons you’ll have read about elsewhere. By the time this article is published, the picture may have changed again, so I won’t make any attempt to guess at what happens next.

The underlying story seems to be that the UK (and global?) economy is probably slowing into a recession. However, the forward-looking nature of stock markets means that downside is often priced in well before the real-world economy starts to recover.

My rules-based SIF portfolio has become somewhat depleted over the last quarter. But with valuations down, I’m hopeful that my screen will present more buying opportunities over the coming months.

Here’s a summary of the portfolio’s performance and stock trades over the last three months.

SIF folio performance

SIF’s performance during the third quarter left my model portfolio marginally ahead of the FTSE All-Share index, which I use as a benchmark.

The decline over the last quarter meant that SIF fell by around 12% during the first nine months of 2022, leaving it marginally behind the FTSE All-Share on a YTD view:

I’m not too concerned about this. SIF has broadly followed the wider market and such reversals are a normal part of investing life.

On a longer-term view, SIF has held on to most of its outperformance versus the FTSE All-Share index. The SIF portfolio is up by 57% since its launch in April 2016. That’s equivalent to a 7.2% annualised return, excluding dividends. In contrast, the All-Share is only around 10% higher than it was in April 2016.

Cash weighting: A shortage of new buying opportunities has left SIF with a stubbornly high cash weighting this year. Recent sales and a dearth of new buys have not improved this situation, despite my decision to increase the standard position size:

However, the portfolio’s large cash weighting has probably benefited its performance so far this year. In a falling market, cash outperforms!

SIF’s big (virtual) cash pile also means that I will be able to add stocks to the portfolio without being constrained by liquidity, when my screen starts to provide a greater number of new buying opportunities.

SIF trades in Q3

I sold six shares from SIF during the third quarter and added three new companies. This left the portfolio holding a total of 14 stocks at the end of September.

Here’s a brief review of each of these changes.

New stocks: As a quick reminder, I select stocks for the SIF folio from the results of my buying screen.

The three shares I added to the portfolio in Q3 were:

Drax (LON:DRX) – this coal-to-wood electricity generator is enjoying bumper profits at the moment thanks to high energy prices. I’ve owned Drax in SIF before and sold the previous holding in June for an 80% return.

My screen then flagged up Drax again in August, after the company upgraded its profit guidance in July.

Unfortunately, like many sequels, this repeat investment seems likely to be a flop. Drax’s share price has slumped on reports that the government may impose a revenue cap on renewable generators.

SIF’s holding is currently deep underwater and almost certain to be culled this month, due to my stop-loss rules.

I added Drax to SIF on 8 August 2022 at 760p per share.

Tclarke (LON:CTO) – this popular building services contractor qualified for my SIF buying screen in August, when the market was considerably more optimistic than it is now. Although I rate TClarke quite highly as a business, I suspect SIF has overpaid for this stock, given the deteriorating macro outlook.

In fairness, TClarke’s half-year results included details of record revenue, stable margins and upgraded full-year guidance. Broker forecasts have not (yet) been cut, either.

If the economy avoids a deep dive, TClarke shares could offer value, in my view. However, I’m unlikely to stick around to find out – like Drax, TClarke is almost certain to be stopped out of SIF shortly.

I added TClarke to SIF on 15 August 2022 at 162.5p per share.

Natwest (LON:NWG) - I suspect that FTSE 100 bank NatWest was the best of SIF’s Q3 buys. While recession risks are a concern, rising rates mean that net interest income should be surging at the big banks. In turn, this should boost banks’ return on equity.

NatWest’s half-year results suggested that the bank’s return on tangible equity could rise to 14%-16% in 2023. I expect to see a strong Q3 update next week.

The main risks now seem to me to be political. If bailed-out big banks start reporting bumper profits while many Brits are struggling with soaring mortgage payments, the government might be tempted to apply a windfall tax.

I added NatWest to SIF on 22 August 2022 at 262p per share.

Sold stocks: The default holding period for SIF stocks is nine months. After this, stocks are tested against my selling screen to see if they qualify for an extended stay in the portfolio.

I also have to sell stocks if they issue profit warnings or breach my ‘soft’ stop-loss limit of 25%.

I sold the following stocks from SIF during the second quarter:

Coats (LON:COA) - a falling share price meant that this venerable thread-making firm no longer satisfied some of my momentum rules when I reviewed the stock in July. The recent performance of the business still seems positive, although I think that regular acquisitions and the giant pension fund may merit further scrutiny.

Bought: September 2021 @ 79.5p

Sold: July 2022 @ 63p

Total return: -19%

Finsbury Food (LON:FIF) - weak momentum and a slowing outlook for earnings growth meant that baked goods producer Finsbury failed my stock review in July. The shares have since recovered somewhat and the FY22 results looked okay to me. However, profit margins slipped last year, and I’d guess this business will be facing price pressure from supermarket buyers and cost pressures from inflation. A modest valuation seems appropriate to me.

Bought: October 2021 @ 92.5p

Sold: July 2022 @ 72p

Total return: -19%

Airtel Africa (LON:AAF) - African mobile operator Airtel has continued to perform well at an operational and financial level, as far as I can see. The shares don’t look expensive to me, either.

However, I sold the shares in August when the company’s share price fell below its 50-day and 200-day moving averages, breaching two of my rules.

Bought: June 2021 @ 77.8p

Sold: August 2022 @ 134.7p

Total return: +80%

Burberry (LON:BRBY) - I remain a fan of this luxury fashion group, but once again, a falling share price meant that the stock triggered a sale decision after nine months in SIF. Looking ahead, I think the main area of uncertainty relates to the level and pace of recovery in the Chinese market.

Bought: November 2021 @ 1,917p

Sold: August 2022 @ 1,745p

Total return: -7%

Morgan Advanced Materials (LON:MGAM) – this industrial group triggered a stop-loss sale when its share price plunged through August into September.

MGAM’s recent half-year results looked positive to me and this is an example of when I would not have chosen to sell, in a discretionary portfolio. Time will tell whether my stop-loss strategy has paid off this time round.

Bought: January 2022 @ 351p

Sold: August 2022 @ 244.5p

Total return: -28%

Watkin Jones (LON:WJG) - this is one example of when my stop-loss rule appears to have protected SIF from a much bigger loss. This build-to-rent and student property developer issued a profit warning on 4 October due to higher borrowing costs and delayed sales.

Graham covered this news in more depth in the SCVR, but the impact on the shares has been brutal:

I’ve admired this company’s progress in the past, but I’m not sure whether its historic profitability will be sustainable in an era of higher interest rates.

Bought: January 2022 @ 258p

Sold: August 2022 @ 178.6p

Total return: -28%

SIF portfolio update – heading into Q3

To wrap up this review, here’s a snapshot of the SIF portfolio as it was on 17 October 2022 (I’m writing this review slightly late as I’ve been away).

As we head into the final quarter of 2022, I’ll continue to look for buying opportunities and sale triggers. I believe the current market should provide some attractive buying opportunities, but at this stage it’s hard to be sure how near the bottom of this market we might be.

As I commented in July, SIF has never operated against a backdrop of high inflation and rising interest rates. I’ll be interested to see what impact (if any) this has on performance and stock selection.

Disclosure: At the time of publication, Roland owned all the stocks listed in the SIF portfolio. He also owns shares in Burberry.

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