Holding up in difficult conditions - Income Growth Portfolio

The last few months have been a difficult time for investors as sentiment has become increasingly bleak.

Concerns about the lack of global growth have grown due to China's slowdown, commodity prices have continued to fall and Europe has edged further towards a recession. The emerging markets have also been looking increasingly fragile. Our hypothetical income growth portfolio has held its ground over the last quarter despite a nasty fall in one of its holdings.

Reflecting on recent progress, Tony Yarrow, chairman at Wise Investments, says: "Sentiment has been deteriorating steadily since the beginning of the year, when people were feeling relatively positive. Over the past three months the UK stockmarket has gone nowhere, but has been very volatile in the process.

To view the income growth portfolio's holdings and trading chronology, click here.

Portfolio changes

"On the whole equities are still the cheapest asset - but it is difficult because some stocks are cheap but are still going down, while others seem expensive but are still going up."

The steep fall in the stockmarket that occurred in September and continued into mid-October has prompted Yarrow to make some changes to his portfolio.

He started off by selling his holding in War Loan. He explains his rationale for the changes. "War Loan had done its job. It had provided stability and a 4% yield. But it does not offer any prospect of capital growth.

"It is something to hold if you think the market is going to go down, and between September and October it worked brilliantly. But once the market has gone down, you should sell the things that have not fallen and buy those which have so that you get into them at the bottom of the market. You need to rotate into things with more potential, and on the whole we prefer to be in risk assets."

Yarrow used the £5,400 proceeds of the sale, split equally, to boost three existing holdings in the portfolio - BlackRock World Mining, Investec Emerging Markets Debt and Middlefield Canadian Income.

Perhaps the most surprising of them was BlackRock World Mining. It has been the portfolio's poorest performer over the past quarter. Its share price is down 30% over the period.

The trust suffered a heavy price fall in October after it announced that it was writing-off one of its largest holdings, the London Mining Marampa royalty contract. The Marampa mine in Sierra Leone was an early-stage project which was hit by a financing crisis after the collapse of the iron ore price and the arrival of Ebola.

Mistake

Yarrow explains why he has decided to invest more in the trust. "What happened with London Mining was a big ball for BlackRock's managers to have dropped, but everyone makes mistakes.

"I look at the trust's other top holdings - Rio Tinto, Glencore and BHP Billiton, three companies that hold the world's best mining assets, which are trading on rock bottom prices, and which you are getting at an 11% discount now that the trust's share price has fallen. You can't buy these holdings this cheap when everyone likes them."

He maintains that the commodity cycle is close to the bottom. "China is not the only country that builds infrastructure; the US does, and so do we," he says.

"As commodities get cheaper, the more likely it is that other countries will start building more infrastructure. That's the way markets work. Admittedly I may be a bit early, but this trust is still paying a good yield so we are being paid to wait."

Similarly, Yarrow believes emerging market debt, which had been fashionable and then became deeply unfashionable, resulting in rising yields, is also nearing the bottom of its cycle.

In fact the value of his existing holding rose by nearly 2% over the quarter. As a result he decided to top up the holding in the Investec Emerging Markets Debt fund.

The share price of Middlefield Canadian Income, on the other hand, fell nearly 3% over the quarter. Yarrow gives several reasons for his decision to increase his investment in this trust.

Stable economy

Above all he feels it is very well managed, but he also points out that the Canadian economy is stable and its stockmarket has a good number of higher-yielding stocks.

The trust is exposed to real estate investment trusts, natural gas, industrial and financial stocks. Yarrow explains: "I think of this trust as a good diversifier and it also has a 5% yield, which is very good. Although the Canadian dollar has recently weakened against the pound, I think we may be near the bottom of that trend too."

Elsewhere in the portfolio, the two best holdings over the quarter were F&C UK Real Estate Investments (FCRE) and Princess Private Equity Holdings which both rose 7% in value. The F&C trust continues to benefit from the strong demand for property investment this year.

Princess Private Equity recently reported a strong increase in its net asset value as a result of the revaluation of its direct holdings.

Direct investments have been driving its performance recently, and now represent over half (54%) of the portfolio as it continues to change itself from a fund of funds to a portfolio of direct investments. However, it is still trading on a large discount of over 20%.

Despite recent problems and concerns, Yarrow remains generally optimistic. He says: "There are still lots of things to worry about - the Ukraine, ISIS, Ebola - but we have to think of the best things to do with investors' money and we believe there is a lot of selective value in UK companies, much more so than a year ago.

"I continue to be wary of Europe, but I believe we may be further through China's problems than everyone thinks. I am reasonably confident about next year from an investment point of view."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.