Asset allocation

Given the rapid technological advancements and globalisation of financial markets over the years, investing has become increasingly more complex and complicated – not to mention opaque.

This lack of transparency was laid bare just over 18 months ago when one of the UK’s best known ‘star’ Fund Managers, Neil Woodford, told investors that they couldn’t sell their holdings, because many of his holdings were illiquid as they were in unquoted companies or small quoted companies, which amazingly, he didn’t realise couldn’t be sold at short notice!  Compounding the problem, many of his holdings were in biotechnology companies which require a high level of specialised expertise to fully understand – and as a result, many were found to be worth a lot less than Neil Woodford paid for them.

However, this level of risk wasn’t at all clear to retail investors – in fact most investors had no idea what was driving Neil Woodford’s performance or what risks he was taking with their investments.

Unfortunately, many investment documents contain an array of complicated strategies and definitions, such as ‘delta hedging’, ‘short gamma’, or ‘rho trading’ – and while these strategies sound very grand and important, they say absolutely nothing about the potential investment risks, just like mortgage-backed securities were seen as a secure investment, until the global financial crisis in 2008/9 exposed how low quality the underlying loans were.

At my wealth we like to keep things not only transparent, but simple, by investing in three asset classes; cash, bonds and equities – as we believe that these are the foundations of every successful investment strategy.

Additionally, we believe that risk management is just as important as investment performance and returns.  This means that while we will never shoot the lights out with our investment performance, our portfolios should hopefully allow you to have a good night’s sleep!

Our aim is to achieve a real return (i.e. above inflation) over the long-term, by investing in a diversified number of companies and investment funds from across global markets.

We have a dedicated, qualified and experienced Investment Management Team (rather than a maverick ‘star’ fund manager like Neil Woodford) who actively monitor and manage client portfolios by researching, selecting and blending equities and investment funds.  As our Investment Managers have extensive access to these investment funds, it allows them to look at how each investment fund is positioned in terms of their actual and relative compositions. This means that they analyse the best way to blend these funds together to ensure that our client portfolios are fully diversified as it is pointless diversifying clients’ money by investing in a selection of different funds, if all those funds are all positioned in exactly the same underlying stocks and sectors.

For example, as a number of companies have reduced or cut their dividends over the past 12 months due to the coronavirus outbreak, many equity income funds (i.e. those funds that focus on investing in companies that pay dividends), are now starting to chase the same remaining dividend paying companies – and as a result, these funds have become similarly positioned, which obviously reduces the underlying diversification.

In order to diversify our clients’ portfolios, the Investment Team splits down the international section geographically (i.e. US, Europe, Japan, Asia and Emerging Markets) and the UK section, where we hold direct equities. These are then split down on a sector basis (for example, mining, pharmaceuticals, banks, etc.).  This strategy allows the team to exploit the characteristics of each asset class, geography or sector, as one of each will always perform better than another due to different economic conditions.

The selections made by the Investment Team will differ in order to match different investor risk profiles – from a cautious strategy for low-risk investors to an adventurous strategy for investors willing to take more risk.

These risked portfolios have a benchmark allocation which we refer to as our ‘neutral position’. In order to make full use of our asset allocation, we have the ability to invest +/-5% either side of these neutral points if our Investment Managers believe this is where value could be added. This is referred to as our ‘actual position’.

my wealth’s ‘neutral’ and current ‘actual’ positions for the Cautious, Balanced and Adventurous portfolios are:

Graph 1 - Neutral and Actual

As you can see, we currently favour (i.e. we are overweight) equities over Fixed Interest and Cash (as these are underweight versus the neutral position).

While the key aims of our Fixed Interest and Cash holdings are to offer diversification from equities and to dampen volatility; given historically low interest rates, returns from bonds are likely to be subdued in the medium term, while cash returns are almost non-existent – hence our underweight position.  However, within the Fixed Interest section we have holdings such as TwentyFour Asset Management, which has lower volatility than many of its peers, and Royal London Corporate Bond Fund, which provides strong diversification, as the fund manager concentrates in areas of the market, such as securitised bonds, that are less prevalent in other funds.

We have only recently moved overweight the UK market.  Having been hurt by the coronavirus induced recession and market sell-off, the FTSE-100 should benefit from the global economic recovery, as the index is heavy in economically sensitive companies such as commodity and banking stocks.

As a consequence, within the UK, we currently favour the mining companies (BHP Group, Rio Tinto and Glencore).  Mining companies will not only benefit from a revival in industrial activity, China’s infrastructure spending and a weaker US dollar (as commodities are priced in dollars), but also the green energy revolution.  As more wind, solar and geothermal power, as well as energy storage are deployed, millions of tonnes of metals will be needed.  In fact, both BHP and Glencore have recently provided us with optimistic trading outlooks, and in a sign of confidence, Glencore reinstated its dividend and BHP increased its dividend pay-out to a record high.

Likewise, we also like the oil companies (BP and Royal Dutch Shell).  While this may appear strange given the accelerating decarbonisation trends, the oil price is currently benefitting from a number of factors.  The obvious ones include the anticipated demand boost when economies fully reopen and OPEC supply cuts.  However, we believe that Joe Biden’s Presidential election victory is a big positive for the oil market.  Although Joe Biden has made it obvious that he wants to tackle climate change by unveiling a set of executive orders to cancel the Keystone XL pipeline and initiating a moratorium on shale oil drilling, he is inadvertently supporting the oil industry.  Then, add in the fact that Joe Biden doesn’t appear in any rush to lift sanctions on Iran (a big oil producer) and the current (albeit temporary) very cold US weather; it all helps to reduce the oil inventories built up during the coronavirus lockdowns – which means that the path of least resistance is for permanently firmer oil prices.

We have also added to our domestic holdings, such as SEGRO (formerly Slough Estates Group), the owner of commercial and industrial properties, as we believe it is well placed to benefit from the structural tailwinds and fundamental shifts evident in consumer behaviour and the increasing trend towards online shopping, coupled with the persistent reduction in urban land zoned for industrial use at a time when demand for ‘urban’ and ‘big box’ warehouses is accelerating.

If we now look at the ‘Rest of the World’ section, you can see that we are overweight to US, Europe, Asia and Emerging Markets and underweight to Japan.

Graph 2 - Neutral and Actual_rest of world

Investing globally provides clients with a wider exposure to different, and more importantly, faster growing industries and companies. For example, we have a 1% overweight to the US (which means a typical Balanced portfolio will have around 12.61% direct exposure to the US), which provides exposure to technology companies or new industries such as Alphabet (the owner of Google), Amazon, Apple, Microsoft, Netflix and Tesla – many of which have been beneficiaries of the coronavirus lockdowns.  We have gained exposure to these names via funds such as the UBS US Growth Fund.

We are also 1% overweight European equities due to attractive valuations, coupled with the fact that the European Central Bank recently increased its stimulus package to €1.85tr, to soften the impact of the coronavirus lockdowns.  Additionally, financials and industrial stocks account for a large percentage of the Eurozone economy – and while these have suffered during the past year thanks to the coronavirus outbreak, they will be a big beneficiary of the global economic recovery.  Within the sector, we particularly like the Premier Miton European Opportunities Fund as this also provides exposure to companies that have a unique and difficult to replicate business models, such as the sports car manufacturer, Ferrari, which performs robustly in most economic environments.

Our favoured regions within the ‘Rest of the World’ are both Asia and Emerging Markets (with a focus on more easterly nations, rather than Latin America or Emerging Europe).  With countries such as China beginning to return to some form of normality following the coronavirus outbreak, coupled with the demographic of countries such as India keeping the mortality rate from coronavirus low, these markets look particularly attractive – especially given the prospect of a turnaround in global trade as coronavirus vaccines are rolled-out, along with the implementation of a new Asia-Pacific trade agreement and the prospect of better relations with the new US administration.  In order to gain access to both the economic recovery and the longer term domestic growth story, we hold positions such as the VT Halo Global Asian Consumer Fund, which gains exposure to companies such as the online retailer Alibaba.

While we are underweight the Japanese equity market by 1.25% due to ongoing demographic issues and policy uncertainties, there are still some attractive investment prospects.  For example, Japanese smaller companies tend to be under-researched, which provide lots of opportunities to specialist fund managers.  Consequently, our portfolios have exposure to this area of the market via funds such as the Baillie Gifford Japanese Smaller Companies Fund which invests in companies such as GMO Payment Gateway – a company that provides credit card transaction services for ecommerce firms; which is also an area that is benefitting from today’s increasingly online world.