Aer Lingus Group, Aminex, Connemara Mining Company, Fastnet Oil & Gas, Irish shares, Irish Stock Exchange, Irish value investing, ISEQ, Kenmare Resources, NTR plc, portfolio performance, TGISVP, The Great Irish Share Valuation Project, Zamano
Continued from here.
My commentary & analysis of last year’s TGISVP losers & winners may have been meat & veg for some, but let’s kill the suspense & move on to dessert… How did 2014 performance stack up for the TGISVP Portfolios, vs. our ISEQ benchmark? Let’s take a look at the Beta Portfolios first:
[NB: Here’s a reminder of how they were constructed:
TGISVP – Beta Portfolio: Assume an investor goes equally long all 27 stocks with positive Upside Potential (e.g. invests EUR 1 in each stock, for a total of EUR 27). The other 54 stocks, identified as neutral (2) or over-valued (52), are ignored. The portfolio return contribution from each stock is simply its Gain/(Loss)%/27.
TGISVP – Smart Beta Portfolio: Stocks are chosen on the same basis as the Beta Portfolio, with one twist: All 27 stocks are divided into quartiles – assume EUR 4 is invested in each top quartile stock, 3 EUR in the next quartile stocks, down to EUR 1 in the bottom quartile stocks (for a total of EUR 70). This preserves diversification, but focuses the portfolio on stocks with the most Upside Potential.]
[NB: Again, see my last post – the appropriate benchmark return here is 4.7%, reflecting the ISEQ’s performance from March-30th ’til year-end. For reference, calendar year ISEQ performance was 15.1%].
Er, this isn’t looking too good… [And perhaps not so promising for my Wexboy Portfolio 2014 performance either..?] It’s also the first time (in 3 years) the Beta Portfolios have under-performed – here’s my 2012 & 2013 TGISVP performance. But looking back, I tagged a mere third of TGISVP stocks as under-valued, so perhaps I just wasn’t bullish enough starting the year? Except only about a third of all stocks actually recorded a positive return in 2014! Um, which might suggest my market stance was correct, but my individual stock picking was lousy… Except if we dig a little deeper, we home in on the real culprit:
Yep…it’s resource stocks!
As I’m always forced to remind my muppet critics, I’m not simply bearish by default on (junior) resource stocks. In fact, my valuation perspective was right in line with the rest of the TGISVP stock universe – i.e. I was also bullish on a third of all resource-related stocks for 2014. Which proved to be my downfall…
In the Beta Portfolio, a 6.3% gain from Aminex (AEX:LN) was a huge & unexpected tailwind (and the largest individual stock gain across all TGISVP Portfolios), but it was still swamped by other resource stock losses. In aggregate, resource stocks contributed a net loss of just over 3%. Otherwise, Aer Lingus Group (AERL:ID), NTR plc & Zamano (ZMNO:ID) were the main winners on the long side (across all Portfolios), but overall the non-resource stocks in the portfolio were mostly noise… The Smart Beta Portfolio did worse, which actually came from under-weights in the portfolio (rather than over-weights, as you might expect): Since I was only barely bullish on AEX, it was a far smaller holding in relative terms & contributed a much reduced 2.4% gain – accounting for most of the additional portfolio under-performance.
More generally, this highlights some relevant/important issues:
– TGISVP’s always been more of a valuation exercise, rather than a stock picking exercise. [Recently, I’ve been highlighting why these are two v distinct exercises in my whole Art vs. Science discussion (and yes, I have another post coming!)] Valuation’s an entirely quantitative exercise, while stock picking is obviously far more qualitative. And right from the outset (of TGISVP), I chose to rely on a purely valuation-based approach. Now I think about it, I’d hoped to offer readers a more rigorous & unique Irish stock portfolio exercise and reference resource, rather than simply an Irish portfolio that was filtered & quite possibly distorted by my own specific stock picking biases. [Well, comments?!]
Of course, it goes without saying…I wouldn’t actually dream of buying some of the stocks which I objectively consider to be under-valued! [But I have said it! Quite regularly, in fact – I’ve been careful to stress this important proviso to readers, particularly in relation to resource stocks]. Yes, it’s true, valuation’s always an essential hurdle – but ultimately, it’s only one piece of the puzzle when it actually comes to picking & buying stocks.
– At this point – call it (personal) capitulation**, if you like – I’ve been forced to conclude a value investing perspective is basically irrelevant (& maybe even dangerous) when it comes to investing in junior resource stocks. [**Unfortunately, despite the carnage, I suspect we may still be trading well shy of total market capitulation in resource stocks…]. A genuinely undervalued resource stock, in terms of net cash and/or actual reserves & resources, doesn’t necessarily make a good investment – like other value traps, its market value may never converge towards its (perceived) fair value. [More often, fair value will converge to market value!] And it often lacks the funding/resources that are required to actually extract the value from its underlying assets.
Granted, such a company may enjoy a (somewhat) better chance of attracting an acquirer – but in reality, the odds of being acquired are actually pretty low, as exploration licences are always going begging somewhere & larger resource companies usually prefer to acquire operational projects (since they invariably offer a superior risk/reward).
Positive cash flow is also tempting, but: i) I don’t mean positive operating cash flow, I mean positive free cash flow – this may seem extreme, but in most instances I think it’s prudent to treat all exploration spending as basically worthless, ’til its value is actually confirmed (if ever) via a proving up of reserves/resources, or an actual sale, ii) how often do you come across junior resource stocks with positive free cash flow anyway?!, and iii) overall, I don’t think positive cash flow’s enough to ensure (let alone guarantee) an increasing market value…though obviously it can significantly relieve the selling pressure resource stocks usually tend to suffer from regular equity fundraising & a lack of tangible news/progress/profits.
Actually, management might well be the best company-specific indicator of value (or lack of value!?). Look at directors & key management, and trace back their resumes & achievements. Mostly, this is an exercise in elimination – the record of perhaps a majority of junior resource company promoters & personnel is abysmal at best, egregious at worst…compounded by the fact operational success often doesn’t translate into actual financial success.
But failure is soon ancient history & the media shows little interest in digging it up, people prefer to just remember the winners, and deceased company price charts, news & websites conveniently disappear. And you’ll never see a long-term junior resource stock index either – I mean, what broker wants to show you what that looks like?! So yes, it’s a tall order, but thoroughly investigating management is absolutely necessary if you want to know who you should avoid. And even more necessary if you’re hoping to identify the rare nag you should back – plenty of exploration success is simply down to luck, but it’s funny how often the guys who got lucky before…are the same guys who get lucky again!
In reality, no matter how conscientiously you focus on company-specific analysis, in all likelihood it’s a futile exercise… Because ultimately all that really matters is the overall trend & sentiment in the market for (junior) resource stocks. And that’s subject to a particularly toxic brew of commodity price trends, market momentum & risk appetite (or aversion), and plain old fear & greed. Bull or bear markets can last for months, and even years, and 90-95% of stocks are powerless to resist the pull of such a powerful rip current – almost inevitably, junior resource stocks rise & fall as one...
Do you really want to fight the odds by going long in the teeth of what’s obviously a major resource bear market?! The best & only strategy right now is to genuflect & wait…and Christ knows how we’ll recognise when this market finally turns. [I suspect animal spirits will be just as important as fundamentals, so technical analysis may prove a useful tool]. Ironically, once you accept this market predominance, it suggests an obvious yet counter-intuitive stock picking strategy – just identify the crappiest of junior resource stocks! They’re obviously the best shorts in a bear market, while the survivors are sure to soar effortlessly in a bull market! Yes, there’s many a true word spoken in jest… 😉
– Regardless of my thoughts on valuation, it was perhaps inevitable the absolute & relative performance of the TGISVP Portfolios would be dominated each year by resource stocks. They comprise nearly 40% of the TGISVP universe, and their sometimes extraordinary volatility is always likely to disproportionately impact performance & swamp the success/failure rate of most non-resource stock picking.
Now, let’s see how we fared with the Alpha Portfolios:
[Again, a reminder of their construction:
TGISVP – Alpha Portfolio: Same as the Beta Portfolio on the long side. But also assume a short overlay of all 52 over-valued stocks, with EUR (1) invested in each stock short. This essentially adds a second inverse Beta Portfolio.
TGISVP – Smart Alpha Portfolio: Same as the Smart Beta Portfolio on the long side. Again, assume a short overlay of all 52 over-valued stocks. In similar fashion, we divide these stocks into quartiles, and invest from EUR (1) to EUR (4) (for the most over-valued quartile) in each stock short.]
OK, I’m sure you were guessing better performance…but did you guess this?! This out-performance is absolutely unprecedented in the last 3 years of TGISVP! In terms of resource stocks, the Alpha Portfolio suffered the same 3% hit on the long side, but earned a colossal 35% on the short side. [In fact, every single resource short was an actual winner! Congrats & thanks to Fastnet Oil & Gas (FAST:LN), Connemara Mining Company (CON:LN) & Kenmare Resources (KMR:LN) – you were especially crappy!] Non-resource shorts like GameAccount Network (GAME:LN), Allied Irish Banks (ALBK:ID) & Permanent TSB Group Holdings (IPM:ID) also added smaller but still useful gains. The Smart Alpha Portfolio earned an additional 6.0% – this time ’round, as you’d expect, it came from over-weight shorts in some of the biggest losers. You know what…at this point, let’s just sum up:
For 2014, the TGISVP Alpha & Smart Alpha Portfolios out–performed their benchmark return by 32.5% & 38.5%, respectively.
And if anybody wants to kindly tweet some version of that, I’ll just shut up now….’nuff said! 😉 btw For reference, here’s my complete TGISVP FY-2014 Performance file:
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You can’t short AIB. There is no borrow and subject to shorting ban. – hence valuation. Most obvious short ever but shouldn’t be in portfolio.
Well, for every AIB transaction, there’s a buyer…so I’m betting against those idiots! No exceptions for TGISVP, gotta set a fair value and specify a long or short position – yes, of course, AIB is a unique situation, but that also implies a TGISVP short position could just as easily have turned out to be a loser on some crazy price spike…
Niall Hurley said:
I use to work in a fund that specialised in resources. It is a tough area to make money. I was a European generalist. Unless you work in the sector with access to geologists and management on a constant basis I think it is difficult to make money. Focus on simpler businesses that generate cash that are not subject to commodity price moves. My 3 value plays in ireland over the last 5 years have been Datalex, Zamano and Aer Lingus. My main focus now is Zamano. It would be great to discuss Zamano at some point. I’ve done a good bit of work on it. I think if C&C gets down to €3 it is a clear acquisition target. Activists will come in. Management have made too many mistakes >
Most resource stocks are only good for trading sardines, really…
Three great value shares to have owned! Though ZMNO wouldn’t necessarily have delivered a gain yet, depending on your entry point – please send me an email if you have any particular points to highlight, or questions/issues to discuss.
Well, that expectation may be exactly what’s providing support for C&C at this point..! Maybe we will see a sub-3.00 share price – if it does, it could be a good price. But I’ve never been too keen on management & their strategy/deals, so I’m not dying to bet on how quickly an acquirer might take to show up here…