Keystone portfolio shaken up under James Goldstone – Keystone has published results for the year ended 30 September 2017. It lagged its benchmark, the All-Share index, over the period, returning 7.8% in NAV terms against 11.9% for the index. The discount widened from 8.4% to 12.6% and so the return to shareholders was 3.2%. The total dividend for the year was 59.7p. This included a special dividend of 4.7p. The underlying dividends rose from 53p to 55p.
The chairman says that a number of stock specific factors had a significant negative impact, such as Provident Financial, Acacia Mining and BT Group. In addition, not holding HSBC and being underweight in commodity stocks. All the underperformance this year was recorded in the period when Mark Barnett was in charge of the portfolio. The chairman says that returns have matched the benchmark over the short time that James Goldstone has been running the fund. He also says that James made substantial changes to the portfolio.
James says that he hasn’t yet finished the process of changing the portfolio. “I was appointed portfolio manager by the Board on 1 April 2017; portfolio activity from this date reflects the gradual transition to my preferred investment strategy. By the company’s year-end this process was largely completed, but given my focus on valuation to enhance return and mitigate risk, I have delayed adding or selling certain holdings in anticipation of a better opportunity to do so. I have tilted the portfolio towards domestic cyclicals and financials by investing in businesses, often at depressed valuations, where I believe there is considerable potential upside to earnings.”
Major influences on returns
Looking at the factors that influenced returns, James says “Relative performance was negatively impacted by the portfolio’s underweight positioning in mining (which returned +32.7% over the year) and the oil and gas sectors which also performed strongly. Not holding HSBC (+35.2%) also detracted from relative performance.
The holdings in the tobacco sector were among the top contributors to performance, benefiting from the sector’s overseas earnings, but also from continued consolidation. British American Tobacco completed its merger with Reynolds American in July; the deal has created a combined entity which is well-positioned to exploit next generation products, particularly in the key US market. However, share prices were negatively affected across the sector in August as the stock market focused on plans announced by the US Food & Drug Administration to launch a consultation on lowering nicotine levels in cigarettes. We expect any new regulation emerging from the consultation will take significant time to come to fruition and the tobacco industry has grown well-accustomed to dealing with such headwinds. Elsewhere in the portfolio, the holding in BAE Systems (+24.9%) contributed positively to performance against a backdrop of rising geopolitical instability. The company, which derives a significant proportion of revenues overseas, benefited from sterling weakness and expectations of a sharp increase in defence spending following the US election. BAE confirmed a series of major contracts through the 12-month period, including a multi-billion pound deal for support work on new generation F-35 stealth fighters and a GBP3.7 billion contract with the Ministry of Defence to build a new fleet of warships.
Next (which rose 45% from its low point in July) contributed positively through what has been a fairly torrid year for UK retailers. After a tough Christmas trading period, the company’s recent interim results prompted a sharp rise in the shares as management modestly upgraded full-year sales and profit guidance on a “somewhat less challenging” outlook. This is a business with a track record of consistently delivering within the guidance range set at the start of each year and an exceptional understanding of shareholder value. Notwithstanding the ongoing structural challenges from online retail, Next’s online directory and logistics infrastructure equip the business to navigate the shift to online better than its competitors.
In the financial sector, Legal & General (L&G) (+25.0%) contributed positively. L&G continued to capitalise on opportunities in the bulk annuity market, where it has a global market-leading position. Provident Financial (-71.4%) was the single largest driver of underperformance for the period. The sub-prime lender has delivered strong performance in the portfolio over many years, but the business was hit by major operational disruption in August following a strategic shift in its home credit operating model. The company issued a profit warning, downgrading Q3 earnings forecasts for its Consumer Credit Division and announcing that subsidiary Vanquis Bank is co-operating with an FCA investigation into its Repayment Option Plan ancillary product. The previously announced interim dividend was withdrawn and the CEO resigned. This prompted a 70% intra-day decline in the company’s share price. Subsequent to this initial decline, the share price showed some recovery, albeit from a low base, and I sold the holding.
Acacia Mining (which fell 56% over the second half of the year) also negatively impacted performance. The gold miner presented a compelling investment opportunity, offering free cash flow yield at the then prevailing gold price along with the downside protection of gold in an uncertain market environment. Acacia conducts the bulk of its exploration and extraction in Tanzania, which has traditionally been a business-friendly environment. Unfortunately, the company has found itself mired in a dispute with the Tanzanian government, who have alleged historic underdeclaration of exports and therefore tax payments and have, as a result, suspended Acacia’s concentrate exports.
BT Group (-23%) also detracted as the market continued to focus on ongoing developments around the legal separation of its Openreach high-speed broadband network. In January an update on accounting irregularities in the group’s Italian division prompted a sharp share price fall, which worsened after a profit warning from the company highlighted a more challenged outlook for domestic public services contracts. The valuation remains depressed, but the company is starting to see some improvement following its acquisition of EE.”
KIT : Keystone portfolio shaken up under James Goldstone