Tips of the Year Review 2016

It seems only fair to point out that comments about the potential for a recovery in the resources sector cannot truly be described as prescient on my part; had they been we would not have decided to avoid this part of the market when picking our eight plays for 2016. That said, we were at least right to give resources stocks a wide berth in the first month and a half of 2016 as this part of the market went through a final ghastly sell-off before beginning what has turned out to be a tremendous bounce back.

The IC companies team can also take some solace from the fact that we stayed true to our pledge at the time of making our 2016 Tips of the Year, to try to help readers prosper from the emergence of a resources recovery by providing tip ideas in our weekly tips section (tips that have a less prescriptive time horizon). Indeed, our resources picks played a major role in the outperformance of our 170 weekly 'buy' tips in 2016, which were on average almost 2 per cent ahead of ‘the market’ (9.5 per cent versus 7.6 per cent) based on an average tip period of about six months.

However, the tips of the year enjoyed none of the benefit of the substantial recovery in the resources space, which has made it particularly hard for them to outperform the principal index that we compare them with: the FTSE All-Share.

The bar graph opposite shows the distribution of returns from FTSE All-Share ex-investment trusts constituents from the Tips of the Year publication date to the year-end. The distribution illustrates how hard it was to pick stocks that beat the index’s 19.9 per cent total return. Indeed, only 30.5 per cent of shares outperformed the index and the median (mid-ranking) return stood at just 6.0 per cent – a massive 13.9 per cent below the index return. The ‘fat tail’ of stocks producing returns of over 100 per cent is of particular note.

FTSE All-Share distribution of returns

The FTSE All-Share’s performance is based on the performance of its constituents weighted to reflect their market size. So the fact that the UK market contains several very large resources companies means they had an outsized influence on overall performance. This compounded the difficulty our equal-weighted Tips of the Year portfolio had outperforming.

The weighting issue can be seen by comparing the performance of the commonly quoted weighted FTSE 100 index with the equally weighted version (see table). FTSE Russell does not currently produce an equal-weighted version of the All-Share. But it is also important to note that over both three and five years, ignoring weightings has been a big advantage and something that will have flattered the comparison of our Tips of the Year with the index over these periods.

The FTSE 100 weighting game

Source: FTSE Russell

So, looking at the median performance and the equal-weighted index performance, perhaps it would be wrong to be too disparaging about the disappointing performance of our Tips of the Year in 2016 (see table). The 15.2 per cent total return was not too shamefully far off the index return, but clearly we would have liked to have done much better.

2016 Tips of the Year

Tips of the Year 2016

This is also the first time the Tips of the Year have underperformed the market since 2010 and the time before that was 2005. So, on a longer-term basis, performance still looks strong, with a cumulative total return of 39.9 per cent over three years compared with 19.7 per cent from the FTSE All-Share and 131 per cent over five years compared with 60.5 per cent. Factoring in a 1 per cent annual charge, those cumulative returns drop to 35.7 per cent and 119 per cent (see table).

Long-term returns

Tips of the Year 3-year return

Tips of the Year 5-year return

Our choice of shares for 2016 also suffered due to the vote for Brexit (note the big mid-year drop in the one-year performance chart above) as a number of picks were focused on the UK economy. That said, while the total returns from these stocks may not have impressed, many of these companies have delivered on our expectations. Indeed, the worst performer from last year, Lloyds Banking (LLOY), was re-tipped by us over the festive break based on the progress it has made with rebuilding a strong capital base that should support future dividend payments. The company has also used its capital base to acquire credit card business MBNA, which we think looks like a smart strategic move. Property company NewRiver Retail (NRR) and housebuilder MJ Gleeson (GLE) have also performed well operationally, but have fought against negative sentiment towards their sectors.

J Sainsbury (SBRY) was another company hit by Brexit fears during the year, although with this tip we did pick up on a promising sector theme – the recovery in the supermarket sector. Unfortunately, we chose the wrong horse to back. The year got off to an unexpected start, with Sainsbury announcing in January that it wanted to buy Argos owner Home Retail. The deal was somewhat grudgingly accepted by the market, but is yet to prove a source of major investor enthusiasm. The other issue with Sainsbury is that because it had done a relatively good job navigating the problems that beset its subsector, it has been seen as having less recovery potential. Shares in its more troubled peer Tesco (TSCO) have actually done far better as investors have looked for supermarket recovery plays. The recovery narrative in the sector was less well established when we picked Sainsbury as a Tip of the Year, and to an extent we paid a price for hedging our bets. Nevertheless, while there has been a rebound in the sector, supermarkets look set to continue to suffer a number of headwinds.

Like Sainsbury, our Takeover Tip of the Year 2016, Penna Consulting (PNA), also experienced some ‘timing’ issues associated with our fixed publication date. Part of our reason for tipping the specialist recruiter was that we saw the possibility of ongoing earnings upgrades based on strong trading. Unfortunately, the shares jumped the day before our tip was published when the group told the market to expect higher profits than analysts were pencilling in. Still, the shares should have done well for any readers that followed the recommendation as Penna, like a number of its industry peers, received an offer from staffing giant Adecco in March.

The two big surprise events of the year – Brexit and the election of Donald Trump – did provide a spur to two of our tips. Disney's (US:DIS) strong performance was primarily a reflection of the dollar’s strength against sterling due to the two vote results. The shares themselves suffered due to fears about the company’s sport network ESPN losing share to online streaming services. More recently, suggestions that ESPN could be spun off have provided a fillip. Defence company BAE Systems (BA.) is a big dollar earner, so also benefited from currency movements. Its sector was also given a boost by the Trump win and its high debt and large pension deficit (known as financial gearing in City-speak) helped amplify the impact of these positives. Our Old Reliable tip, plastics packaging group RPC (RPC), delivered impressively on a mega acquisition it announced in late 2015. We’re hoping for a similar dynamic from our Growth Tip of the Year this year.

All in all, the performance of the Tips of the Year does not look that bad to us considering the challenge posed by the sharp recovery in the resources sector. And while it is painful to have had the Tips of the Year miss out on the upside from the resources sector, the savage sell-off at the start of 2016 offers some vindication for our view that it was foolhardy to make such a big call at that time. Nevertheless, it is a shame to have broken a five-year record of beating the All-Share. So fingers crossed for a stronger showing from our batch of eight buy tips for 2017.