Best of both worlds: how to blend long and short-term investing
Have you ever checked to see if your investment portfolio is too dependent on success from higher risk assets such as shares in the tech, mining, oil or drug sectors?
While these types of investments can often be very exciting and rewarding, having too much exposure can be problematic if these sectors go out of favour or the stocks do not live up to their hype.
A neat trick to retain the excitement of investing in this market AND provide some ballast to your portfolio is to split your assets into two camps.
First, make sure you have a diversified selection of solid assets (lower-risk, longer-term investments) to form the core of your portfolio. Then you can stick the fun stuff (short-term, higher-risk investments) on top as satellite holdings.
Read on and we’ll tell you how to rejig your portfolio, or build one from scratch, in this manner.
One of the most common questions we’re asked by readers is how to build a proper, robust investment portfolio.
Many individuals are eager to start investing by backing young, exciting growth stocks as they get lured by a rapid upwards share price chart. This is certainly one way to experience the world of investing, yet it perhaps isn’t the best place to focus if you want to develop a serious, long-term investing habit.
Stock markets in many parts of the world have been in a general rising trend for approximately eight years, being the period since the global financial crisis.
Over that time it has arguably been quite easy to make money from the stock market as so many stocks have gone up in value. The real test for an investor is being able to survive a more volatile market, particularly periods of distress.
A lot of people whose only experience with investing has been since 2009 won’t have had much experience with more volatile market conditions including large corrections, so not much thought may have been given to ensuring portfolios are sufficiently robust.
Having a core of long-term, solid ideas should provide a robust backbone to your portfolio and provide important diversification. Theoretically this should reduce the risks of serious wealth destruction if some of the assets in your portfolio fall in value.
Adding shorter-term satellite holdings with an element of higher risk can help to enhance returns and also provide a fun element to your investing strategy.
The strategy to help you avoid panicking
Ensuring the satellite component only accounts for a small part of your overall portfolio may also ensure you remain calm if markets start to turn. Many investors chasing the ‘next big thing’ on the stock market often panic if the share price is falling, causing irrational behaviour and widespread selling of assets.
Knowing the bulk of your money is tied up in investments that have the potential to produce steadier returns could ultimately help you to stay focused and not panic.
In this situation, a drop in some of your higher-risk satellite holdings may not be too devastating to the value of your whole portfolio, meaning you should still feel confident to keep making adventurous calls and not be soured by a dent in the value of your assets.
We aren’t saying the core part of your portfolio is guaranteed to be safe. Investing always carries an element of risk. We’re simply saying that picking lower-risk investments as the backbone of your portfolio, together with having lots of diversification, should help you keep a level head.
How to weight a core/satellite portfolio
Many investment experts believe a good strategy is to split your portfolio 80% in favour of the core component and 20% for the satellite component.
We’ve heard some suggestions of putting the core investments in a SIPP (self-invested personal pension) and the satellite ones in an ISA. Although that will provide a clear distinction between the two different strategies, there are downsides to consider.
Many people don’t want to touch their pension in the early stages of retirement, preferring to draw upon assets from an ISA where all withdrawals will be tax-free. In comparison, only 25% of your pension can be withdrawn without paying tax.
Anyone fortunate enough to be able to invest more than £20,000 a year will find themselves restrained by how much they can add to their ISA annually due to the £20,000 subscription limit.
What’s suitable for the core element of your portfolio?
In general, we would suggest low-cost exchange traded funds with broad exposure to some of the biggest stock markets in the world, property and corporate/government bonds.
If you like the idea of a fund manager actively looking for the best ideas, you should consider funds or investment trusts which have some or all of the following: a global focus, a capital preservation strategy, a focus on higher quality firms or ones which enjoy slow but steady profit growth and which pay a regular and rising dividend.
What’s suitable for the satellite element of your portfolio?
This is where you’d park any investments in individual company stocks such as a disruptive tech firm; a miner with a highly prospective project; or even a firm whom you think could see their share price recover following recent bad news.
We’d also use the satellite component to house investments in specific themes, sectors or niche areas of the market such as private equity funds or investment trusts which invest in infrastructure assets.
How should you allocate your money?
There is no one-size-fits-all asset allocation model for investors as it depends on a variety of factors. ‘The right asset allocation for an individual will depend on their circumstances, financial objectives and attitude to risk,’ says Patrick Connolly, a certified financial planner at independent financial adviser Chase de Vere.
‘Younger investors are usually focused on capital growth, whereas older investors may still want capital growth but are likely to need some degree of capital protection and possibly income.
‘A combination of equities, fixed interest and commercial property (with separate cash holdings) can work well for a “balanced” investor with perhaps 50% in shares, 35% in fixed interest and 15% in property,’ comments Connolly.
Ryan Hughes, head of fund selection at stockbroker AJ Bell, suggests for someone building a core portfolio a 50:50 split between shares which he classifies as the higher risk component, and the rest in lower risk assets such as fixed interest and cash. ‘This balanced approach should be able to smooth out the returns in volatile times,’ he adds.
In the past you might have heard of the 60:40 portfolios concept which refers to the split between equities (shares) and bonds, respectively. The weighting towards equities decreases as you get older.
Longer life spans mean people in retirement may need to hold more equities for a longer period to ensure they don’t outlive their savings or see their returns damaged by inflation.
Having a more dynamic approach to asset allocation may be more beneficial, perhaps allocating a greater percentage of equities if you’re younger as you would have a longer investing time horizon and can tolerate market volatility.
It is also worth bearing in mind that adding equities or bonds to your satellite portfolio will change your overall percentage asset allocation; so don’t simply do your sums based on the core component of your portfolio.
SUGGESTED PRODUCTS FOR A CORE PORTFOLIO
PASSIVE FUNDS (i.e. ones which track indices)
Hughes says AJ Bell’s ‘Passive Funds’ range has been designed exactly for the purpose of being a core portfolio component. There are five different versions of the fund based on risk appetite, stretching from ‘Cautious’ to ‘Adventurous’.
Each fund invests in a range of low-cost exchange-traded funds. For example, VT AJ Bell Passive Moderately Adventurous Fund (GB00BYW8VL77) is split 52% equities, 33.2% bonds, 10.4% property and 4.4% cash.
You’ll get exposure to areas including large cap stocks listed in the UK, Europe and the US, various corporate and government bonds, real estate companies and some emerging markets stocks.
A similar proposition is Vanguard’s LifeStrategy fund range which contains different ratios of stocks to bonds, although it has a much greater exposure to US stocks than the equivalent AJ Bell product.
ACTIVE FUNDS (i.e. ones run by a fund manager who makes ongoing decisions about investments)
Fundsmith Equity (GB00B41YBW71) has been a big hit with investors and is one of the top picks for a core portfolio by Peter Banks, wealth and investments expert at financial advice provider Drewberry.
The fund has delivered 19.9% annualised return since it launched just over seven years ago. It invests in equities on a global basis with a strategy to have a portfolio of between 20 and 30 stocks.
Top holdings include payments giant Paypal and beverages group Dr Pepper Snapple. The fund says its portfolio features ‘high quality, resilient, global growth companies that are good value and which we intend to hold for a long time’.
Rathbone Global Opportunities Fund (GB00B7FQLN12) is worthy of a place in a core portfolio, says Patrick Connolly at Chase de Vere. It achieved a 17.1% annualised return over the past five years and is heavily weighted towards equities with more than half in US stocks. Top holdings include medical devices firm Align Technology and video games specialist Activision Blizzard.
Morningstar analyst Peter Brunt is also bullish on the Rathbone product, saying: ‘We continue to consider this fund a great option for investors seeking global equity funds with a high-growth, all-cap profile.
‘(Fund manager James) Thomson seeks companies that benefit from endogenous growth, avoiding those whose future revenue streams are dependent on external factors. As a result, the fund has exhibited long-standing under-weight positions in materials, energy, telecoms and utilities, giving it a markedly different sector profile to the FTSE World reference benchmark.
‘The search for superior earnings growth also tends to result in biases to companies with high growth profiles and those found in the middle of the cap scale.’
For the fixed income element of the portfolio, Paul Derrien, investment director at Canaccord Genuity Wealth Management, suggests GAM Star Credit Opportunities (IE00B510J173). This fund has achieved 11.5% annualised returns over the past five years and invests in a range of bonds including ones issued by governments and major banks such as Lloyds (LLOY) and HSBC (HSBA).
An alternative to consider is the Ian Spreadbury-managed Fidelity Strategic Bond Fund (GB00BCRWZS59), says AJ Bell’s Ryan Hughes. It has delivered just below 4% annualised returns over the past five years.
Commenting on the Fidelity product, research group Square Mile says: ‘Spreadbury is an extremely experienced manager who has built up a strong reputation for successfully managing fixed income funds over a number of market cycles, generating good long-term returns for his investors.
‘He has established a prudent and well-considered investment approach that looks to ensure the fund is well diversified and should meet its income objective in a broad range of economic scenarios.’
If you’re looking for a multi-asset fund which contains a wide range of different holdings, Connolly at Chase de Vere recommends CF Miton Cautious Multi Asset Fund (GB00B0W1V856). It is currently split 47% in equities, 39% in corporate bonds, 9% in cash, 4% in government bonds and 0.4% in property. The fund has generated 6.3% annualised return over the past five years, according to Morningstar.
SUGGESTED PRODUCTS FOR A SATELLITE PORTFOLIO
Satellite holdings are a good way to encapsulate shorter term and potentially higher risk opportunities to complement the core portfolio.
‘Having a strong core to a portfolio enables some additional risk to be taken with the satellite approach that can be a useful way of potentially adding value and diversification to a portfolio,’ says Hughes at AJ Bell.
‘Often, thematic ideas such as commodities, technology, health care are used as satellite holdings while country specific exposure such as China or India can also be used here.’ Relevant ideas to consider, according to Hughes, include First State Global Resources Fund (GB0033737767), Polar Capital Global Technology Fund (IE00B42W4J83) or Worldwide Healthcare Trust (WWH).
Where to find more ideas
With regards to individual stocks, we suggest you read Shares every week as we present lots of investment ideas and company analysis.
A good starting point is our Great Ideas section which each week features two solid ‘buy’ suggestions on UK-listed stocks.
Finally, we would point out that having a satellite component of your portfolio isn’t suitable for everyone as many investors are happy to build a core selection and leave them to hopefully accumulate wealth while they go and enjoy life.
‘For many investors there might not be the need for satellite holdings at all,’ says Connolly at Chase de Vere. ‘If they are looking for diversified exposure to asset classes, consistent performance and to manage risks effectively, this can be achieved through a range of core investment holdings.’ (DC)
DISCLAIMER: The author has a personal investment in Fundsmith Equity referenced in this article