The macro environment continued to worsen during Q3. The UK economy is now in recession with inflation reaching 10% and forecast to go higher still. A relief rally in July and early August gave some respite from the losses incurred in the portfolio but inevitably gave way to the downward momentum of the current bear market.
The change in sentiment between the first and second halves of the quarter measured by the MIA Sentiment Index is shown in the charts below. Sentiment has now fallen in six of the last seven weeks and the index ended the quarter back in the ‘Fear’ range where it has spent most of the year. So far though, the index has still not dropped into the ‘Extreme Fear’ range that would signal market capitulation.
Portfolio Holdings
At the end of Q3 the portfolio comprised of 6 holdings with almost half of the portfolio value held in cash:
This is an experimental virtual portfolio with a trading strategy based on the MIA Ratings and the MIA Sentiment Index. All trades in the model portfolio are automated according to the rules outlined in this post.
Frontier Developments (FDEV), the largest position in the portfolio at the end of Q2 was exited following the release of its full year results. Operating profit was hit significantly after the decision to fully amortise the capitalised development costs of the poorly received Elite Dangerous: Odyssey - previously described by the company as “a huge investment in the future of Elite Dangerous”.
A new position was opened in Auto Trader (AUTO). This is very much the Rightmove (RMV) of the automotive sector - a cash generative, high ROCE business with a dominant market position and high levels of recurring revenue. Will it prove to be resilient in a recession?
Performance
The portfolio ended Q3 close to where it began, falling by -1.9%. This figure hides some much larger movements in the period. A brief rally saw the portfolio rise by 11.3% at the start of the quarter before giving up all of those gains and ending the quarter at a YTD low of -19.4%.
The chart below shows the YTD portfolio performance compared to the SPDR FTSE UK All Share Accumulation ETF (FTAL) as a proxy for the FTSE All Share Total Return index. The benchmark fell by -3.6% in the quarter closing at YTD lows of -7.8%. For comparison the FTSE 250 ended the quarter down by ~28%.
Auto Trader was acquired late in the quarter but proved to be a falling knife and was the biggest detractor from performance. The biggest contributor was Alpha FX (AFX) which continues grow rapidly, particularly with its Alternative Banking Solutions.
The return contributions from each of the holdings during the quarter are shown below:
Summary
For now, the wider macro environment continues to be the dominant force driving the share prices of the portfolio. Fundamental analysis can feel like a futile exercise in an environment where almost all shares are being dragged lower, but the market will eventually turn.
The current market conditions may have led many investors to reassess their strategies. I’m becoming increasingly persuaded by barbell style strategies - those with a large proportion of the portfolio in extremely safe assets and a small proportion of the portfolio in highly speculative assets. Limited downside, while retaining the potential for large upside.
This portfolio takes a more variable approach. The risk assets are not highly speculative, but hopefully have potential for high returns over time. The ratio of risk assets to extremely safe assets (cash in this portfolio) is based on current market sentiment - an attempt to maximise upside when the perceived downside risk is reduced. As evidenced above, this strategy can leave the portfolio exposed when sentiment is low. Share prices can keep falling.
At the end of Q3 almost half of the portfolio remained in cash and sentiment was again trending downwards. Opportunities for further deployment of cash into risk assets should present themselves as the market sell off continues.
This article is intended for informational purposes only. It is not a recommendation to buy or sell shares or other investments. Always do your own research before buying or selling any investment or seek professional financial advice.