Portfolio Update Q3, 2021

With the third quarter of 2021 done and dusted, it’s about time I get stuck into another Portfolio update.

Like Q2, the ASX 200 and S&P 500 were both higher over the quarter, although only slightly thanks to September’s sell-off. Prior to September, The ASX 200 capped off 11 straight months of gains during Q3. The last time that happened? 1943!

Portfolio Strategy 

For new readers, I should note that my portfolio is based on a ‘Core and Satellite’ approach. Ideally, the core consists of broad-based index-tracking ETFs, while the satellite portion of the portfolio is made up of high-conviction investments. For the purposes of this article, and my previous portfolio updates I’m strictly writing about the shares and cryptocurrency I hold outside of super. 

If you’re keen to learn more, I’d highly recommend heading over to my Q4 2020 Portfolio Review to get a stronger grasp on my approach. 

Ideally, the core part of my portfolio should consume a larger weighting in my portfolio (targeting 70%) to mitigate any concentration risk, while also providing ballast to my overall portfolio should a satellite holding be troublesome. 

Compared to Q2, the core portion of my portfolio has increased from 33.7% to 38.7%. As I continue to dollar cost average into Index Tracking ETFs, the core portfolio will eventually hit my 70% target weighting. One factor that might delay that target is outperformance from my satellite portfolio. Admittedly, that would be a nice problem to have. 

As you can see, my cash position is still quite high, although it is down slightly from the previous quarter as anticipated. This is due to my satellite investment into Magellan Financial Group and my monthly core investments into broad-based index-tracking ETFs.

20% Cash? What’s With That?

I’m planning to reduce my cash position to between 5-10% over time. This will happen as I continue to regularly invest and add the odd satellite position. The March 2020’ Covid-19 crash taught me the value of having some dry powder available to take advantage of any market pullbacks, which is why I’m planning to always have some handy.

For clarity, the cash I’m referring to is strictly available for wealth creation purposes through shares. I hold cash for other purposes (travel, emergency etc) in other accounts that I have no intention of deploying into the market.

Core Portfolio

Under normal circumstances, my core portfolio shouldn’t change much over time because it’s designed to hold passive investments in broad-based index-tracking ETFs that I add to every month. That being said, I did need to make a change to my monthly dollar-cost averaging structure due to risk with ASX: VAE I felt was too big to ignore. 

The China Risk

The trigger for the change mainly revolves around the looming intervention risk the Chinese Government poses to the growth of Chinese Companies. An example of this risk materialising occurred when Chinese regulators barred tutoring companies from making profits, which sent their share prices plummeting. It’s anyone’s guess who the next target might be for the CCP. 

This article from Ray Dalio un-packs the state of play in China from his lens. It also demonstrates how the interests of the Chinese Government differ from the interests of Western Governments.  

To curb the China risk, I’ve decided to gradually reduce my exposure to VAE by decreasing how often I add to that position. Previously I’d add to VAE four times a year. My new and Improved cycle below requires me to add to that position once per a year as per the cycle below. 

Month 1Month 2Month 3Month 4
Month 5Month 6Month 7Month 8
Month 9Month 10Month 11Month 12
Table #1 – Jesses Core Dollar Cost Averaging Cycle

In other news, I’ve added VISM into the core portfolio. VISM provides exposure to over 4,000 small-cap companies listed in major developed countries. My investment in VISM is designed to partially offset my investment in VGS, which provides exposure to large companies listed in major developed countries.

I’m also planning to add A200 to my core portfolio,  which tracks the ASX 200 index. Previously I’d avoided holding Australian ETFs because our local market is so small in comparison to the global marketplace (approximately 2%). That being said, the ASX 200 has performed very well historically so I believe it deserves to make up a small part of my internationally diversified core portfolio. I’m also a patriotic guy, so why not own a basket of our largest companies? 

You can read my review of A200 here to see why I prefer it over alternatives like VAS and IOZ. 

Satellite Portfolio

My satellite portfolio is designed to house my highest conviction stock picks that I believe will outperform the ASX 200 Large Cap Index over the long term. 

I’m well aware that history says I’m playing a losing game by trying to pick winners. The reason I do it is because I enjoy the process of researching individual businesses through my ‘inch wide, mile deep’ analysis. Boring, I know. 

Know What Your Edge Is

When dabbling in individual stocks, I believe you need to know what your edge is over the next person. As a retail investor, one of my edges is having a long term time horizon. Another is my in-depth research process.  

My biggest edge of all is that I know what I don’t know, which means I won’t hesitate to put investment Ideas in the ‘too hard basket’. For example, I don’t have much insight or interest in the mining industry, therefore I won’t invest there. 

These edges have held me in good stead so far this year, and hopefully, they continue to do so into the future. 

What’s Changed This Quarter

My satellite portfolio remained unchanged over the quarter apart from one minor investment, and one sale.

You may have noticed the ‘others’ category below. This comprised a few US companies I hold through Stake like Visa and Ferrari.

Satellite Portfolio: What I’ve Bought

Bought: Magellan Financial Group (ASX:MFG)

One of Australia’s ‘Supercompounders, (a company that has produced extraordinary returns for shareholders) Magellan Financial Group (ASX:MFG) has been in the wars lately.

Magellan’s woes commenced after they reported their net profit after tax was down 33% to $265.2 million compared to the prior year as a result of fewer performance fees triggered by lagging returns from their funds, one-off fund restructuring costs and one-off losses that “reflect the start-up costs” from their Magellan Capital Partners segment. This triggered an 11% sell-off on the day their report was released. 

Since then Magellan’s share price has fallen further after the fund manager reported net-outflows of 1.5 billion during September as clients re-balanced their portfolios. For context, MFG managed 117.9 billion at the end of August. This triggered further price falls to a 52W low of $31.34, down over 50% from their 52W high of $63.48 per share. The good news is that Magellan didn’t lose any clients during the period. 

Things Could Turn Quickly for MFG

Managements track-record leads me to believe it’s likely they’ll turn recent under-performance around and potentially propel Magellans core funds management business into its next phase of growth through the attraction of new FUM through products like Future Pay among others.

Magellan’s fund’s management business is mature, but still has room for growth when you consider its total addressable market. Magellan Capital Partners business also really excites me. Although it will take a while for this side of the business to start driving its earnings growth.

Could Magellan Become Australias Berkshire Hathaway?

Similarly to  Berkshire’s Hathaway insurance business, Magellan’s fund’s management business is oozing free cash flow that they’re using to re-deploy excess capital into investments in other businesses through their Magellan Capital Partners division. In fact, they recently bought a stake in my favourite takeout chain, Guzman Y Gomez. 

Assuming Magellan can continue generating modest inflows into their funds over the longer term, I’m confident their investing prowess will hold them in good stead to continue making prudent investments with their free cash flow to compound shareholders capital for decades to come. 

Lots of Water To Go Under The Bridge

I’m aware that there’s a lot of water to go under the bridge with Magellan, but Magellan has proven their ability to outperform over the long term, so I’m backing them to turn their performance around and continue to re-invest their shareholder capital into profitable private equity-type ventures. For that reason, I believe it’s plausible Magellan will be a much larger, more diversified business in 10 years time.

With this in mind, I added to my very small position in MFG, bringing my average entry price to $37. At that price, Magellan’s price to book value (per share) multiple was 7.2 (based on FY21 reported shareholder equity figures). That’s a 40% discount from October 2019 (based on FY19 reported shareholder equity figures).

At $37, I was also getting a healthy dividend yield of roughly 6% for a business that can grow faster than the overall market.

I believe I’ve made a good decision here, but only time will tell.

Risks With Magellan

As with any investment, there are risks. Here are the key risks I considered before adding to my MFG position.

  • Magellan’s fund performance does not improve, this could result in material FUM outflows.
  • Key personnel leave Magellan, this could result in reputational damage.
  • Magellans Capital Partners investments do not materialise into profitable ventures, this could continue to drag down earnings over the medium term.

Satellite Portfolio: What I’ve Sold

Sold: Kogan.com (ASX:KGN)

In Q2 I took a small position in Kogan.com after their share price tumbled following a string of bad news, and missed expectations. These included a backlog of excess inventory, slowing growth rates and some one-off demurrage fees.

While Kogan’s performance was dissapointing in the short term, I thought nothing has changed regarding its long term growth prospects, and to an extent, I still believe that to be true. Unfortunately, Kogan’s annual report released in August 2021 revealed some wrinkles listed below I really wasn’t comfortable with.

The Wrinkles I Found With Kogan

  • Unexplained addition of 78M of long term debt added to the balance sheet, reducing the net cash position to roughly 13M. This makes a capital raising and associated dilution of existing shareholders possible should Kogan continue pursuing acquisitions.
  • I believe Kogans discretionary retail business model will suffer as consumers spend on travel in FY2022 and beyond. This will squeeze margins and increase marketing costs over the medium term.
  • Massive operating cash flow loss. Cashflows may not improve due to reasons explained in point 2.
  • Inventory of $227.4 million at the end of July 2021. This comprises $177.9 million in warehouse and $37.5 million in transit. As a comparison, the company ended FY 2020 with inventory of $112.9 million, comprising $32.5 million in transit and $80.4 million in warehouse. There’s still more than double the inventory in its warehouses since this time last year. For this reason, I don’t think the marketing spend is decreasing as quickly as I originally assumed.
  • No dividend paid to raise cash. While I feel this was a prudent decision from management, an Inconsistent dividend demonstrates Kogan’s earnings fragility.

While I still believe Kogan has structural headwinds playing in their favour, the wrinkles I’ve outlined above were enough for me to call it a day on the e-commerce juggernaut. I exited my position in Kogan in August at a marginal gain. 

Goal Check-In

During my Q4, 2020 update I set some portfolio goals for 2021. Let’s check-in to see how I’ve been tracking.

1. Continue dollar-cost averaging into my core ETF portfolio. 

Yep, still going strong. I’m grateful to have that privilege every day. 

2. Keep an eye out for any exciting opportunities for the satellite portfolio. 

During Q3 I made a reasonable investment in Magellan Financial Group on a risk-adjusted basis. I also considered other opportunities that I’ve passed on. For now..

3. Consolidate overlapping holdings, namely IHVV (S&P 500) and VGE (Emerging Markets). I’d like to roll all or part of those holdings into VGS and VAE given there’s a huge overlap with the underlying investments. 

Another tick on this one. During Q3 I decided not to consolidate VGE into VAE. Although their underlying holdings are currently similar, they have quite different strategies so I am happy owning both separately.

4. Achieve a 15% compounded rate of return (Excluding dividends) 

Watch this space. I’ll let y’all know in January. 

5. Increase my monthly investment amount by about 10%. 

Completed in May 2021.

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About The Author – Jesse
Hi, I’m Jesse, but you can call me Jes for short. My passion is simple, I’m on a mission to make the world of investing easily understood by removing the ‘too hard basket’ stigma that surrounds it.

P.S. I’d love to meet you on Twitter or Insta or both.

Disclaimer: This website (the “The Money Pal”) is published and provided for informational and entertainment purposes only.  The information in the Blog constitutes the Content Creator’s own opinions and it should not be regarded as financial advice.

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