A balancing act
As an investment manager I often get asked “what is the best way to invest?” My answer is always a boring, “there is no ‘best’ way to invest”. Investing isn’t like maths. There is no correct answer. Mathematics deals with the absolute – one plus one will always equal two, three threes are always nine, and anything to do with a circle always involves pi.
But investing is all about relatives. Nothing is static. Sometimes bonds are better than equities, sometimes not. Sometimes energy companies are better than technology companies. Sometimes the yen is better than the dollar.
Even investors with the same general aims can end up with very different portfolios. There’s lots of room for interpretation, and lots of devil in the details.
The statements above aren’t absolute though. Investments can be both good and bad at the same time, depending on who’s holding them, and what their aims are. A UK government bond might be a brilliant investment for me, but a terrible one for you, depending on what you want from your pot of money.
And in fact, even investors with the same general aims can end up with very different portfolios. There’s lots of room for interpretation, and lots of devil in the details. We’ve looked at six of the most popular Balanced portfolios in the UK, and picked out some of the differences in the way they allocate their investments – bearing in mind that there is no right answer.
First, watch out for differences in the total allocation to equities. Some portfolios have less than 50%, others have upwards of 60%. This difference alone is worth looking out for – is your Balanced fund as defensive as it seems?
You also have to take note of which equities are being held. Global equity markets look nothing like the global economy, as equity indices are based on market size, not country size. This means that broad global benchmarks such as the MSCI All-Countries World Index (ACWI) will have large weights in countries where equity markets have been around for a long time, regardless of how important that country is.
For example, the US is 24% of the global economy, but is 60% of the global equity benchmark. Perhaps more bizarrely, the global benchmark invests more in UK stocks than in Chinese stocks – a reflection of the past, not the future.
At 7IM, our strategic asset allocation considers more than just the size of equity markets. We take into account lots of other factors too as part of the quantitative optimisation process. This means our allocations look different to many peers, but end up more balanced when it comes to risk.
Every Balanced portfolio includes a chunky allocation to bonds. But there are so many different types of bond that, again, it’s worth digging deeper.
There’s the geography to consider – the global government bond benchmark allocates to those countries with the largest bond markets, which tends to be those with most debt. So Italy is the third largest part of the global ‘safe-haven’ benchmark!
As well as the regional differences, bonds have lots of other characteristics to keep track of too. Maturity can vary widely, from cash-like bonds all the way up to 50-year maturity or more. This can dramatically alter the behaviour of that portion of the portfolio as interest rates shift.
Or if the bond portion involves corporate bonds, there is likely to be an increase in risk, depending on whether the companies are investment grade – Microsoft, GlaxoSmithKline or Barclays – or junk-rated – Netflix, Ford, or Matalan.
The 7IM portfolios blend all of these types of bond together, looking at the combined impact on the portfolio, and once again trying to balance the risks appropriately – to complement the other parts of the portfolio, as well as diversify.
Exposure to the emerging markets is another area where there is more than meets the eye. When we think of emerging markets, we think of South America, Africa, Eastern Europe and of course, Asia. But 80% of the equity benchmark is entirely invested in Asia – Brazil is the largest non-Asian nation with a 5% allocation. Direct exposure to large chunks of the world aren’t possible in most broad equity indices.
Instead, it’s important to remember that investors often gain exposures to these parts of the world through investing in developed markets. Some Japanese companies’ fortunes are linked to China, Germans to Eastern Europe and Americans to Mexico. Last year, the strongest growth area of the London-listed, British-Dutch Unilever was in emerging markets.
We don’t just look for exposure through equities. The emerging market bond universe is far more evenly spread – with under one third of bonds issued by Asian nations. So our portfolios get emerging market exposure from both the bond and the equity assets available in the developing world.
The classification of assets as “other” can leave a lot of room for interpretation. Completely different assets get lumped together: hedge funds, commodities, physical property, aircraft leases, private equity and so on.
There are pros and cons to all of these assets. Each of them may well be a good investment as part of a portfolio. But the fundamental reasons for inclusion need to be clear, and performance needs to be monitored; not just for return, but for risk too.
Our “other” basket is very simple. It is composed of global real estate investment trusts (REITs) and alternative strategies. The REITs offer diversification, liquidity and growth through exposure to the global property cycle. The alternative strategies allocation is something we construct ourselves, to offer defensive characteristics to portfolios, whilst still returning above inflation. We know exactly what’s in our “other” section, and how it is likely to interact with the other parts of the portfolio.
A balancing act
At 7IM we construct portfolios which take into account the aims of our clients, and attempt to deliver them in as robust and sensible a way as possible. This means looking at more than just the headline allocations, and getting to grips with what exactly it is that an asset class is doing as part of the wider portfolio. And it means monitoring all of the constituent parts, individually and together.
We don’t worry about building the “best” portfolio in the world. We focus on building portfolios which are best suited to our clients’ expectations and needs.
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