How to get on the UK equities ladder?

Trading Portfolio; Momentum

Update Q1 2021

Some thoughts on how to get started playing with equities in the UK and an update on the latest Q2 performance of the momentum portfolio experiment versus the S&P 500 index.

For some people based in the UK when they want to start investing it can be quite a confusing puzzle. Should they sign up with one of the CFD or spread betting providers?

You do not trade on the exchange there, but play against your broker.

It is usually not buy and hold, but more speculating on fast moving highly volatile assets.

With the CFD and spread betting providers usually over 70% of the customers lose money against the broker.

So while some people may be able to make money this way for most this is a losing game to play. It is a negative sum game. The house/broker sets the rules, spreads and commissions and therefore the CFD and/or spread betting broker wins on average and the customer loses most of the time.

A much better way could be starting a stock ISA.

At least that is a positive sum game.

On the 6th of April 2021 the new UK tax year started again and in a stock ISA UK taxpayers can put £20000 a year on a use it or lose it allowance. Once your money is in a UK stock ISA it is not taxed on capital gains or on dividends.

That still leaves the problem of which stock ISA broker to select. Some ISA brokers charge fees as a % of the portfolio value while others charge a flat fee. If you intend your stock ISA to grow into big stock market portfolio and the broker charges a reasonable flat fee Holland Park Capital London’s preference is clearly a flat fee broker. Especially if you invest in mutual funds the charges of % of the portfolio value can be steep for some reason. Also some brokers are more global than other ISA brokers. Some ISA brokers only allow you to invest in UK listed products. Some ISA brokers allow you to invest globally. For the global ISA brokers the currency rate charges when investing in stocks listed in other currencies than £ can vary greatly as well. Clearly charges per stock trade can vary widely as well and different clients have different stock ISA needs. The fees to open the ISA account vary as well.

You the client have a choice which broker to entrust with your money. Use it wisely and if in doubt get help/some authorized professional advice. Those yearly fees add up over a lifetime of investing in a stock ISA.

Here is a little table to illustrate the difference of the yearly fees you need to pay for your stock ISA portfolio just to the broker for the privilege of having the account. Yearly fees for investment trusts, mutual funds and ETFs are still on top of that and have not been taken into account.

Both the flat fee ISA broker used in the above table (Interactive Investor ii.co.uk) and the % fee ISA broker (Hargreaves Lansdown hl.co.uk) are market leaders in the UK.

As one can see in terms of the yearly fees one has more downside than upside with the % fee broker compared to the flat fee broker as per April 2021. Of course people have to take a number of factors into account when selecting the right ISA broker and the yearly fees is just one of the considerations. For example there is no point going for the cheapest flat fee UK only ISA broker when you are planning on making investments on the US stock exchanges.

Examples of flat fee ISA brokers are Interactive Investor (full disclosure; used by Holland Park Capital London), iWEb, X-O, Freetrade, Idealing, Eqi, IG and Halifax.

So let’s assume you have opened a flat fee ISA account and put in £20000 and plan to add another £20000 for the next couple of tax years.

Now what?

Ideally you need to write yourself a one pager word document with an investment plan now. Simply putting a plan on paper creates discipline and means an investor is more likely to stick to investing in good and bad times. It is even the main reason Holland Park Capital London writes these blogs. Putting words on paper creates discipline, a process and consistency. Ideally of course you would like to read these blogs as well as a bonus! The investment plan needs to include at a minimum when to buy and sell and what £ value an investment should be when one buys it.

How many holdings should an investor aim for?

This is a subject where everyone has a different opinion. As not everyone can be Warren Buffett for investors it is best to remember the only free lunch is to diversify, diversify and diversify some more. As Paul Volcker once said the only financial innovation lately that improved people’s wellbeing was the ATM. Being too smart only hurts one in investing as smart people are over confident, can be arrogant, use too much leverage, are too highly concentrated with their investments etc. All the Greek letters in investing can be thrown in the garbage bin. Alpha is only useful for giving portfolio managers a benchmark in order to be able to judge if they did a good job or not. Beta exposure to equities and a long time horizon is what one needs to make money in stocks. Nobody knows what the right stock market benchmark is anyway. Is it the MSCI World index? Or is it maybe the S&P 500 index? Or is it maybe the FTSE world index? Or is it perhaps the FTSE 100 index? For different people that live in different countries there is likely a very different answer as to what the stock market is anyway....

Let’s go back to another useful financial innovation from the book The Origins of Value – the financial innovations that created modern capital markets by W. M. Goetzmann and K.G. Rouwenhorst;

“The truly revolutionary event in Holland in the seventeenth century was the widespread adoption of diversified investment portfolios by ordinary investors as well as wealthy ones. Using annuities, perpetuities, life rents and even corporate shares, investors could create a portfolio of relatively stable assets that would sustain them into old age and protect those who might not be able to earn an income through labor. The financial revolution in Holland allowed individuals to master their own, independent economic destiny. Investment portfolios, if they were sufficiently large and diversified, might substitute for a family firm.”

Somehow modern day investors have lost track of this idea. You want to be financially independent? Start as early as you can by building up a sufficiently large and diversified stock ISA, if you are a UK tax resident. There are plenty of people that make good money in the City of London in finance for a couple of years who can do this. In a lot of cases however the good money is spend during the good times. That is not great when the good times are gone and the City folks have lost their seat at the table.

If one starts investing in stocks early enough and long enough one can be lucky enough to be able to take the initial investment out of the stock market and use it to enjoy one’s live when still healthy enough to make the most of that. At the same time one would still have a “free” diversified portfolio that hopefully is enough to sustain one into old age. Risk is not volatility for the long term investor. Risk for the long term investor is not having enough money to sustain one’s lifestyle into old age.

Dylan Grice during his time as SG Securities’ quantitative strategist had some interesting ideas about how to go about creating a “portfolio of relatively stable assets”. Grice called it the “cockroach” portfolio. Grice’s cockroach is a portfolio divided in four equal parts; stocks, bonds, cash (defined as deposits or Treasury bills) and gold bullion. The reason Grice called it the “cockroach” portfolio was that cockroaches are not clever of inventive, but are very good at surviving (cockroaches can survive a nuclear blast). A portfolio with lower drawdowns makes one sleep better. The worst drawdown was about 20%. Grice calculated that over 50 years his cockroach portfolio made average investment returns, in excess of inflation, of about 5% a year. That compared to 5.5% for stocks over the same period.

These days one could probably expand on this idea. Holland Park Capital London hates bonds. Bonds could be replaced by high quality boring dividend aristocrats stocks for example. The 25% cash part can be split in a 15% cash part and a 10% in global REIT stocks part. The 25% gold bullion part could be split in a 15% gold bullion part and a 10% bitcoin part. The bitcoin price will either go to zero or be worth something as an alternative to gold. Let’s call it the “termite” portfolio. The termite portfolio invests when started 25% in global stocks, 25% in global high quality boring dividend aristocrat stocks, 15% in gold bullion, 15% in cash, 10% in bitcoin exposure and 10% in global REIT stocks. Keep in mind that Dylan Grice probably rebalanced his portfolio every year. Holland Park Capital London doesn’t rebalance the termite portfolio as that is simply too much work for not enough return.

While we are talking about rebalancing; Holland Park Capital London just rebalanced the Trading Momentum portfolio this week. Let’s have a look at how that momentum portfolio has been doing versus the S&P 500 index so far. Hopefully the three rebalances were not a complete waste of time versus just investing in an S&P 500 ETF.

Q1 2021 was a difficult time for momentum as most investors define it (12month return-last1month return). The toxic waste rally that started in November 2020 continued. Basically everything in the stock market that performed badly in 2020 is having a great performance in 2021 and vice versa. Looking on the Seeking Alpha website the U.S. Equity Factor MTUM is up 6.15% year to date (YTD). Seeking Alpha is having the S&P 500 as up 10.27% YTD now. So the momentum factor is lagging by about 4% this year. Luckily the trading momentum portfolio is using a different definition of momentum. Also the trading momentum portfolio is constructed in as much an equal weight way as possible without using odd lots. The Equal Weight factor RSP is having a great 2021 so far and is up 14.76% YTD.

The Vanguard S&P500 ETF VOO portfolio is worth $66,858 according to the Stockrover tracking website. The Sigfig portfolio tracking website has the Vanguard S&P 500 ETF VOO portfolio now at a value of $67,081. The Trading Momentum portfolio is worth $67,521 now (excluding dividends/dividends are taken out) according to the broker Charles Schwab website. So the conclusion is that the Holland Park Capital London portfolio has escaped being destroyed by the toxic waste rally so far. Still performance is very similar to the ETF VOO and the S&P 500 index. $440 difference is neither here nor there. All this rebalancing could still end up being a waste of time, but the experiment has only been live with the real money portfolio for 3 quarters now so it is way too early to tell. In another 4 years or so the time horizon will start to be long enough to be able to filter out the luck factor with more certainty. The top 10 holdings for the Trading Momentum portfolio for Q2 2021 are 1 share of CMG, 1 share of AZO, 1 share of MTD, 3 shares of SHW, 1 share of BLK, 2 shares of DE, 1 share of BIO, 1 share of ALGN, 1 share of LRCX and 1 share of SIVB.

Thanks for reading if you got this far. Holland Park Capital London hopes you enjoyed the information. Holland Park Capital London Ltd is not receiving any compensation from anyone to write this blog. Holland Park Capital London is long some stocks in the article as mentioned. Holland Park Capital London is a customer of Interactive Investors and Charles Schwab. Holland Park Capital London has no business relationship with any company whose stock is mentioned in this blog. Holland Park Capital London expressed its own opinions. This is not advice. Make your own decisions please. Do your own research. Please go and see an authorized financial advisor before making any investment decisions. What works for Holland Park Capital London may well not work for you and your personal situation is unknown to Holland Park Capital London. Stocks go up as well as down and you may get back less than you invest. Any information in this blog should be considered general information and not relied on as a formal investment recommendation. This blog is for information purposes only and helps Holland Park Capital London with its own keeping score and discipline in the investment process. Holland Park Capital London is not liable for any mistakes in this blog. This blog cannot be a substitute for comprehensive investment analysis. Any analysis presented in this blog is illustrative in nature, limited in scope, based on an incomplete set of information and has limitations to its accuracy. The information upon which this blog is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore the accuracy cannot be guaranteed. Any opinions are as of the date of publication and are subject to change without notice.