Why this investing strategy thrives in winter

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Backing seasonal shares that have a strong track record of outperforming in the winter months is an investment strategy that’s tended to deliver the goods more often than not. Lee Wild, head of equity strategy at ii, joins Kyle to explore the reasons behind the trend and name the shares in his two hypothetical Winter Portfolios.

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to On The Money, the weekly podcast that covers investments and pension topics in a practical manner. 

In this episode, we’re going to focus on an investment strategy that’s tended to deliver the goods more often than not, which is to target shares that have a strong track record of outperforming in the winter months. 

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To explain all, and also, towards the end of the podcast, discuss some other stock market approaches, I’m joined by Lee Wild, who is head of equity strategy at interactive investor. 

So, Lee, it was 12 years ago when you first put together these two hypothetical Winter Portfolios. To kick off, could you explain the premise of the strategy and how you decide which shares make the course?

Lee Wild, head of equity strategy at interactive investor: Yeah, sure. Thanks Kyle. Our objective is to create two portfolios that best exploit stock market seasonality.

So, some stocks do better in the winter months from November to April. So, the portfolios are data driven, and we don’t make any sort of stock-specific decisions ourselves. We run the data, and that gives you the five constituents for each of the two portfolios, there’s no manual intervention. So, it’s a really simple process, and we only screen stocks from the FTSE 350. That’s just for a greater level of liquidity.

So, there are two portfolios. We’ve got the Wild Consistent Winter Portfolio. That’s the five most reliable winter performers over the past 10 years.

We run the data over 10 years. We see year by year which stocks returned profits and are generating positive returns. So, for the Consistent Portfolio, constituent companies must have generated profits in nine of the past 10 winters. So, those with the best average return make the cut. So, average return between November and April over the past decade, excluding dividends, for this year’s constituents in the Consistent Portfolio is 13.9%. So, if you had owned them for the FTSE 350 benchmark index, it’s 5.1%.

For the Aggressive Winter Portfolio, that’s made up of slightly higher-risk, higher-return stocks. They may still have risen in eight of the past 10 winter periods. So, we relax the entry requirements, and it gives us a bigger pool of potential companies to choose from. To get in that pool, logically, some would have generated better returns than those stocks in the consistent portfolio.

So, we look at those high-return stocks that have still risen in eight of the past 10 winters, and the average return for them in the current portfolio is 20.1%.

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Kyle Caldwell: And over the 12 years you’ve been running these hypothetical portfolios, they’ve outperformed the market nine times out of 12. Could you run through the figures? What for you are the key drivers behind performance? Why does the winter portfolio strategy tend to work? 

Lee Wild: Things were brilliant up until Covid. So, Covid threw a spanner in the works of a lot of these stock market anomalies. So, up until then, the portfolios had risen every year since 2014. Since then, we’ve had a few volatile years, but we’re back on a winning track. Last year, the portfolios did well. I think we’re going to talk about them in a minute.

But the data is provided by Stephen Eckett. He’s a mathematician and co-founder of [publisher] Harriman House. Statistics produced by him show that £100 invested in the FTSE All-Share index in 1994, if you’d held them for the past 32 years, you’d have got £352 now, excluding dividends, so it’s a good return.

If they’d only invested in the market between 1 November and 30 April every year, that £100 would be worth £486. So, significantly better. Just for clarity, if you’d only invested in the summer months over that period, your £100 would have shrunk to £66.

This seasonality, not everybody believes in it, but the numbers don’t lie. As I say, the portfolio had risen every year until the pandemic. Still up nine out of 12 winters. 

So, yeah, recovery since puts the aggressive portfolio in a very strong position versus the benchmark. If you’d have bought the aggressive portfolio in 2014, reinvested profits into the 2015 portfolio and so on, you’d have generated a return of a 115.6% so far. So, it’s 13 percentage points more than the FTSE 350.

The consistent portfolio is less, it’s a 67% total return, but still respectable.

You ask why it works, but there isn’t really a neat explanation. Research by Stephen Eckett has gone back many decades and, rummaging through the history books, you can really trace some of these trends in seasonality back hundreds of years. And it’s not just the UK where it works, it works in other markets too. 

There’s lots of theories why that is, and these are the three most probable, I think.

First, it’s the greater flows into the market after the summer break. So, a lot of the big decision-makers at the financial institutions in the City, on Wall Street and elsewhere, obviously take the summer breaks. Decisions are parked until those decision-makers return from the holiday, then those decisions take time to implement in the market, and that’s when the repercussions of those decisions start to feed through, through the winter months.

In the old days, the City would shut down for Henley and the cricket and all that. All those sporting events over the summer. People would go away and nothing would happen in the markets. It’s not like that anymore. It’s 24/7 global markets. Communication’s much quicker and easier these days. So, it’s a liquidity and a sentiment thing, I think, from this perspective. 

That’s what these new strategies would do. When the people return from the summer holidays, you get a big boost in liquidity and sentiment. So, that’s the first reason. 

The Santa rally is the next one. Again, why that happens is up for discussion as well. So, this really refers to when equity markets historically have done well in the run-up to Christmas. You could attribute it to seasonal optimism more broadly, but there is also some calendar year-end window dressing of portfolios by the funds and investment houses.

So, where they might sell losers, buy stocks that have done better over the year, might flatter the portfolios or the numbers that determine the City bonuses. So, that’s another theory. 

And finally, you’ve got ISA season, which is a really strong period for shares. It’s at the end of our financial winter. So, investors are really taking advantage of tax-efficient products in the run-up to tax year end. So, investing in companies and parking them in tax wrappers. 

As I say, it’s referred to as ISA season and we know that that’s a busy period for stock markets. On its own, it’s not going to be a huge driver, but as part of that, it likely will have some influence.

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Kyle Caldwell: As you pointed out, some people will believe in the seasonality, others won’t. But I do think it’s very fascinating at the very least, and we’ll come back to the Santa rally towards the end of the podcast.

You’ve just mentioned the long-term performance, and you pointed out that last year was a successful period. Could you run through the shares that stood out last year?

Lee Wild: Yeah, of course. Last year, there’s always a number of - and it’s normally geopolitical events - that will move markets through the six months. Last year, we had obviously the Iran war crash and subsequent recovery. So, at the end of the strategy last year, the consistent portfolio had returned 6.3% or 6.6% including dividend income. 

The aggressive portfolio was up 6.7% or 7.7% with dividends. The FTSE 350 with 6.2% and 7.5%. In terms of the companies, well, the consistent portfolio, we had the IT services firm and now FTSE 100 constituent Computacenter (LSE:CCC). There were profit upgrades there. Shares were up 30% over the winter, a great contributor.

Safety products conglomerate Halma (LSE:HLMA), that did brilliantly too. That was up around 24%. And in the aggressive portfolio, we had real stellar returns from Keller Group (LSE:KLR), the engineering contractor, that was up 41%, and Games Workshop Group (LSE:GAW), fantasy war games, that was up 22%. 

BAE Systems (LSE:BA.) was in the news because of global conflicts and pressure from the States for European governments to spend more GDP on defence. That was great for BAE, a big boost from that extra military spend and expectation that that spend will continue over many years. Shares were up over 9% last winter.

Kyle Caldwell: Let’s now move on to this year’s line-up. For people watching the podcast on either YouTube or Spotify, we’re going to show both hypothetical portfolios and tables of the constituents. But could you give us a brief run through, Lee, of what’s made the line-up this year?

Lee Wild: Yep. We’ve got three stocks keeping their place in the consistent portfolio. So, Computacenter after last year’s rally, which I just mentioned, was never going to miss out. It’s had a great summer too, though. News flow has been good. We’re going to find out more. There’s a capital markets day on 24 November, and there’s a full-year trading update at the end of January. So, we’ll find out more about Computacenter. 

But the fact that it had a great summer, it may or may not be a problem. It just could be a long period of positive momentum, which is fine, but it’d be nice if it had tailed off, slowed down over the summer to take a breather. But Computacenter still looks like a great company, so we’ll see how that does. 

Halma is in again. Shares were down over 20% after a great winter. Shares were down at 20% over the summer, doing really what we would like constituent stocks to do: do well over the winter, not so well over the summer. Come back the next winter and do well, that sort of thing. So, yeah, over the summer, most of it was downgrading full-year growth forecast, but hopefully a platform for recovery this winter. 

Admiral Group (LSE:ADM) was in again, risen nine of the past 10 winters, so, fingers crossed for another one this year. Games Workshop, that’s one of two new constituents. As I say, it was in the aggressive last year, now it’s in both. Shares were back where they were this time last year after a big tumble over the summer, so hopefully, again, a platform for winter growth.

And Standard Chartered (LSE:STAN) that’s the other new face. Not been in either portfolio since inception. It does have a strong record of winter returns. So, all eyes on the banks there.

In the aggressive portfolio, we’ve got Games Workshop, Keller, BAE. They keep their place. Computacenter is, like Games Workshop, in both portfolios this year, and it’s joined by Antofagasta (LSE:ANTO), the big Chilean copper miner. Shares fell 8% over the summer. Disappointing production targets for ‘27 and a warning about higher diesel prices and their impact on cost. But Antofagasta has bounced at the start of this year’s portfolio, so it had a couple of great sessions until the midterms. But one, hopefully, to watch this winter.

Kyle Caldwell: What are your thoughts on the prospects for the portfolios this year during the winter months? As ever, there’s no shortage of headwinds, but there does seem to be, at the time of this recording at least, a lot more pessimism at the moment. A lot of volatility among tech-related, AI-related companies with increasing question marks over whether the enormous sums of money that are being spent on artificial intelligence, infrastructure, and advancements, will lead to the future earnings growth and profits that the market expects. What are your thoughts for the portfolios against that backdrop?

Lee Wild: As we speak, the past two trading sessions have seen massive losses for the stocks that you’re referring to, the AI trade. So, yeah, it’s a warning that markets can be volatile. As you say, they’ve spent hundreds of billions of dollars on computer chips and data-centre infrastructure. Investors are going to want to see a return on that money. 

The midterms, they knocked BAE Systems amid concerns about defence spending. BAE makes a hell of a lot of money in the States, and any suggestion that defence spending there may be curtailed to whatever degree is making investors nervous around those defence stocks, be it the US-exposed stocks.

In the articles that I write to introduce the Winter Portfolios, every year I run through a big list of risks and most years, it’s the same. Last year, we had the AI trade. Last year, I was talking about the Budget and wars, whether it be the Ukraine conflict or tensions in the Middle East, it’s very similar risks every year, and they’ve done pretty well up to now. 

The Budget that we’ve just had, the launch of this year’s Winter Portfolios was sandwiched by the UK Budget and the midterms. The UK Budget was kind of neutral for the portfolio anyway. And the midterms, we’d have expected some volatility anyway. Whether or not there was any sort of direct impact on the AI trade, you’d have expected a little bit of volatility as people analysed the repercussions and what the election result meant. But the biggest impact, really, has been the Middle East and the decision in February to attack Iran, and we’re still feeling the repercussions of that through inflation and higher interest rates.

So, yeah, we’ve been confident in previous years. We’ve had worse in previous years. We had the pandemic and bounced back from that. So one would imagine we can bounce back from some of these other high-profile geopolitical events.

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Kyle Caldwell: As you’ve outlined, there’s always risks and headwinds. If there weren’t many risks that people were thinking about, then that’d be a risk in itself. That’d be a sign that maybe the market’s become way too over-confident and valuations are potentially racing ahead of reality.

Now, while our customers cannot buy the portfolios in their entirety, the constituents within them can provide plenty of food for thought. Although, there should be lots of other things that investors should be thinking about when researching stocks, thinking about a lot of fundamental factors, and, of course, investors should be trying to ensure that they have a resilient and well-rounded portfolio.

Lee Wild: Yeah. I mean, the portfolios are never intended to form the nucleus of any investment strategy. It is an anomaly. It’s got a good history of success, but the portfolios are very concentrated. There’s only five in each one. So, you would never pin all your hopes on Winter Portfolios. They should really make up probably just a small part of an investor’s broader portfolio.

Kyle Caldwell: And while the historical data does show that stock markets do perform better over the winter months versus the summer months, that doesn’t mean that you should ‘sell in May and go away’ like the old maxim says.

For me, that’s a saying that is old hat. I think you referred earlier to the reasons [behind] it. It used to be that investors would go away for the summer and come back on St Leger’s Day. They didn’t have mobile phones. Well, as you mentioned, now, it’s trading 24/7 in some instances, and everyone’s got a mobile phone, and they can use apps to buy and sell stocks very easily.

Lee Wild: Yeah. Well, look, the Winter Portfolios and selling, they are related strategies. But you’re right. The idea that you should sell all your portfolio ahead of the holiday period and then come back and buy it all back, obviously, it doesn’t make any sense. The concept is dated. 

But as I’ve mentioned, the summer can be a tricky period with fewer people trading, and volumes down. It affects liquidity and can cause greater volatility. So, there are reasons to just be a little cautious over the summer, but, yeah, ‘sell in May’ doesn’t really work.

Kyle Caldwell: I’m going to end by just very briefly going through a couple of other strategies. One that comes to mind for me is the ‘Dogs of the FTSE’ strategy. 

Under the strategy, you build a portfolio of the 10 highest-yielding FTSE 100 stocks and you hold them for a year, and you then look for the next 10 highest-yielding stocks. You typically do it at the start of a year. 

The rationale is that some of these companies are potential value opportunities. They’ve been out of favour because the share price has fallen, and the yield has therefore risen. 

However, I think with any high dividend yield, you should really treat it with a healthy dose of skepticism because, as share prices and yields have that inverse relationship, the high yield can mean the stock’s out of favour, and the market is potentially expecting a dividend cut down the line.

So, it’s really important to look under the bonnet, and to check whether you think that dividend is sustainable going forward. Look at things like dividend cover, the track record for growing dividends, the debt levels, and whether the management has made any recent comments committing to dividends. Although there have been occasions over the years when management have promised to maintain or increase the dividends, and then they’ve cut them. So, I would also be a bit skeptical about that as well.

For me, if I was looking at the 10 highest-yielding stocks in the FTSE 100, I’d consider them on an individual basis rather than buying all 10.

Lee Wild: You’re right. High yields or super-high yields should be a red flag, but I don’t think you should discount those high yields completely. It’s always worth, as you say, doing some investigation. 

You’d probably only want a little bit of exposure to them anyway. You wouldn’t want to bet the farm on a 10% yield. I mean, it might come good, but it’s less likely and it comes with added risks.

You and I create portfolios at the beginning of the year, portfolios to generate £10,000 of annual income. Within that, you need an element of safety. You can’t be gung-ho when you’re looking to generate that level of income, but you do have some room to add a little bit of spice. 

Things haven’t always gone well. I typically choose maybe one company from the FTSE 100 or the FTSE 350 perhaps, that’s maybe got a slightly higher, more generous yield that comes with extra risk. And I might put a little bit less into that than I do with some of the other constituents. It can supercharge returns in some years. Other years, it doesn’t work, but then you haven’t committed quite so much to that stock.

So, yeah, high yields are a red flag, but do your research and don’t discount them all.

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Kyle Caldwell: Another seasonal strategy we’ve spoken about is the Santa rally. This is based on the fact that December was typically one of the best months of the year for the stock market. 

However, my understanding is from doing a bit of research for the podcast, that there isn’t really a a generally accepted explanation for the reason why December is so strong.

Lee Wild: No. I mentioned earlier a couple of possibilities. You’ve got the broader seasonal optimism. So, everyone’s in a better mood. Maybe.

You’ve got the year-end window dressing of portfolios by investment houses, that sort of thing. So, one eye on City bonuses in a few months’ time, that sort of stuff. Is it the more positive vibe that Christmas generates typically? Possibly. People at Christmas parties and a generally happier time of year for a lot of people.

The Santa rally, everybody talks about it at this time of year. Everybody looks for it. We’ve done some analysis over the years about this. The Santa rally won’t start on 1 December and end over the Christmas period at some point, Christmas Day or Christmas Eve or whenever. 

It depends where you start that Christmas period from [in terms of] what returns you’re going to see. More often than not, you get an uplift at some point during the Christmas period, but it’s not always as clear-cut.

Kyle Caldwell: I wanted to end by focusing on a longer-term trend that tends to be a friend for investors, which is the ‘smaller companies effect’.

There’s been academic research on this and there’s an oft-cited report from the London Business School, which shows that from 1955 there is a notable difference between the performance of smaller companies versus larger companies. 

There’s plenty of logic behind this. Due to their size, smaller companies have greater room to grow versus a larger company. As the late Jim Slater said: elephants don’t gallop. It’s a quote I really like.

And this part of the market is less intensively researched by fund managers and other investors, and that gives stock pickers a greater opportunity to gain an edge.

However, this historical long-term performance has certainly not been playing out over the past five years or so. It’s been a tough time to be a smaller companies’ investor. One of the main reasons is the macro backdrop, the higher interest rates environment we’re in, which has been a headwind for small company stocks.

Lee Wild: Yeah. You’re right to say that it’s easier for investors to research smaller companies these days. I mean, the data going back to the 1950s, back then it was very difficult for you to get a real handle on some of these smaller companies.

Certainly, it would have been the same in the States and the UK. Now, it’s far easier. Have a little look on the internet, and there’s lots of publicly available research. It makes it easier to find information on the company, but it doesn’t make it easier necessarily to find those 10-baggers or those real big winners that people look for among the smaller companies. 

You are also right with higher interest rates. Smaller growth companies rely on borrowed money to fund growth. And if that money becomes more expensive to borrow, then that’s going to impact the business and the growth trajectory as well.

It’s great looking for smaller companies, and there was a good period following the global financial crisis, where you had access to cheap money for a number of years. It’s not quite that straightforward these days.

Kyle Caldwell: Well, Lee, that’s all we’ve got time for today, but you will regularly be updating us on the two hypothetical Winter Portfolios in the coming months. Listeners to the podcast can keep track of them at ii.co.uk.

Lee Wild: Thanks Kyle.

Kyle Caldwell: And that’s it for our latest episode of On The Money. As ever, we love to hear from listeners. If you’ve got an idea of a topic you would like us to cover in a future episode, then please do get in touch by emailing: otm@ii.co.uk. 

As ever, you can find plenty of investment inspiration on the interactive investor website at ii.co.uk. I’ll hopefully see you again next Thursday.