The world of investing is also challenging and despite recent equity rallies around the world, we remain in testing times.
Over the last five years, markets have had a bumpy ride and I believe volatility is here to stay. While the S&P 500 Volatility Index (VIX) may be some way off its peak of October 2008, we have been here before and Isa investors would still have experienced previous spikes (for example in May 2010, September 2011, May 2012).
But, while volatility can sometimes feel like a white-knuckle ride it also presents opportunities, and I believe that a portfolio that combines different asset classes is one of the best ways of optimising the potential long-term returns. Rather than ride single price momentum or thematic investing, the best place for Isa money, on a long-term basis is within a portfolio that demonstrates both these qualities. So with that in mind, how should advisers be guiding their clients?
What specifically goes into a portfolio or Isa is all important. A sensible starting point is risk. Once that is established, advisers can start building a portfolio commensurate with the client’s acceptance of downside losses. In five of the last 10 years, the best-selling net retail sector according to the IMA is the Mixed Investment 20 per cent to 60 per cent shares. This typically translates into mandates managed with a “cautious” or “conservative” approach. So let us take that as our primary example. If we think about portfolio construction for conservative mandates we would expect that, over time, 50 per cent of the assets would be invested in equities and 50 per cent in fixed income. Traditionally the equity element for UK investors would comprise almost entirely UK blue-chip stocks: large cap companies listed on the leading index. Similarly, the fixed income element would be biased towards UK gilts.
However, in an ever-complex global marketplace, advisers should consider how to populate those asset allocations (that is, the underlying securities) as they need to reflect the modern investment world. The equity selection should look beyond purely UK blue chips (to international markets) and the fixed income selection beyond purely gilts (to international and corporate debt.)We should also consider using alternative assets.
When you look at our leading domestic index, the FTSE 100, we find that it has a high proportion of companies that generate their income from international markets. This is why, when the index is up more than 6 per cent in January, it does not feel that it is reflecting feelings on the ground in the UK, where we have fears of a triple-dip recession and weak GDP numbers. So when advisers are thinking about the UK equity component, they should consider names that reflect this, names that are listed in the UK, are a leading company by market capitalisation and that benefit from global growth.
As much as many of us living here would like to think it is true we have to accept that the UK is no longer the world’s leading industrial nation, you might consider introducing an element of international equities. For international equities, advisers can think about sector/thematic exposure through direct stock investing or appointing mangers who can add value. For instance, in the US, we would invest in some popular large cap companies because we have the institutional research resources to identify good opportunities. For independent advisers without the time or expertise to devote to individual stock selection, appointing funds from such managers can fulfil the requirement.
Fixed income selection is particularly topical at the present time. There is a lot of noise in the market about the “Great Rotation” (from bonds into equities) but in a diversified multi-asset class portfolio, fixed income certainly warrants inclusion. The Financial Times recently observed that the key argument against the idea of a great rotation into bonds is that net flows in January do not show money moving out of bonds and into equities. In fact, some suggest that there was no rotation in the other direction.The “rotation” of the past few years appears to have actually been a move from cash-like assets into debt, rather than the suggested equity to debt. Argument and counter-argument aside, advisers still have to think about fixed income within a portfolio that is, as aforementioned, more than simply a basket of multi-dated gilts.
The traditional inclusion of fixed income for yield is being challenged in this environment. Many equity yields are higher than those for debt instruments right now. Therefore a disciplined approach would involve investing along the curve and where possible seeking some opportunities that offer an element of capital return.Where can we find that? I like shorter-dated corporate bonds issued by companies that have a strong balance sheet and healthy cashflow. These not only offer a yield pick-up over sovereigns but shorter-dated issues also have lower implied volatilities and this balances the portfolio. For instance, one near-term bank 2014/2015 paper, unfavoured post the credit crisis, is yielding around 2.75 per cent to maturity. Investors would need to go as far as 15 years along the UK gilt yield curve to get the equivalent return, with effectively the same backing given the significant state ownership stake in the bank.
Opportunities can also be found in callable bonds from companies that again have a strong balance sheet and cash flow; the hope is that the issuers will call the debt prior to maturity at a premium for the holders, hereby providing some capital return. Seeking out these individual opportunities however, might be a challenge for an independent adviser. Therefore value-adding fund managers would be an ideal means of access.
There is also a consideration that while corporate bonds can have minimum dealing lots, sovereign issues do not generally restrict bid sizes in this way. Therefore advisers might consider longer-dated gilts such as UK gilt 2042 to diversify along the curve and also Index-linked gilts as a hedge against inflation.
Finally, a multi-asset Isa portfolio would be incomplete without employing an element of alternative asset classes. While the label “alternatives” has come to be associated solely with hedge funds and/or private equity, other alternatives can offer some protection against inflation and currency debasement: real assets such as gold are worth considering. Gold has longer-term purchasing power and can be included directly as pure exposure of the spot price such as ETFS physical gold or indirectly as stocks that benefit from a rising gold price, in particular UK-listed mining stocks, and there are funds available that offer non-direct investing.
It can involve a lot of time and work to identify and populate an Isa portfolio with individual direct or managed investments in addition to determining overall asset allocation and ongoing review and rebalancing. Not only that, direct investments should be monitored constantly to ensure that they still warrant inclusion in the portfolio. My recommendation would be to research those managers that offer a multi-asset class unitised solution commensurate with their client’s risk appetite. Funds available in the market include direct investing, managed investments (fund of funds) or a combination of both. A diversified multi-asset unitised fund should smooth out the long-term ride. Funds focused on a single asset strategy may have the potential for higher returns in the shorter term, but for investors seeking to build on their tax efficient monies year after year, multi-asset funds with their active allocations to a spread of investments offer more potential to achieve this with less volatile returns.
Jon Wingent is investment client director of Close Brothers Asset Management.
Over the last five years, markets have had a bumpy ride and volatility is here to stay.
In an ever-complex global marketplace, advisers should consider how to populate those asset allocations (that is, the underlying securities) as they need to reflect the modern investment world
It can involve a lot of time and work to identify and populate an Isa portfolio with individual direct or managed investments in addition to determining overall asset allocation and ongoing review and rebalancing.
