A balanced portfolio of investment trusts for the cautious investor

Figuring out which assets to own and which investors to listen to is a nightmarish task. Hedge your bets instead and go for a balanced approach that has some exposure to equities alongside more defensive and income-oriented funds. Introducing an eight-fund model portfolio for the cautious investor.

By David Stevenson

There’s a strange disconnect at the moment when it comes to investing and markets. Talk to many investors ranging from well-known US market strategists such as John Hussman to hugely popular UK fund managers such as Sebastian Lyons at Troy or Peter Spillar at Capital Gearing and they sound profoundly worried. They are concerned about valuations. They worry about liquidity. And they are concerned about expectations of long-term returns from risky assets like equities.

But the consensus on Wall Street is relentlessly upbeat, there’s been a Santa rally of sorts, and vast amounts of money are flowing into equity funds in both the UK and the US. The US might even have dodged a recession. Working out who is right – the market sages or the crowd – requires the judgement of Solomon and I’d like to propose an alternative – don’t bother and instead hedge your bets, especially if you are worried by the potential for market selloffs.

To explain this statement lest first go back to basics. My core view is that for most investors with a time window of decades, 100% exposure to equities is probably the most fruitful allocation you can make. That thinking informs my suggested Growth portfolio of investment trusts. Trust in the march of the optimists, ride out market volatility, pick good funds, and forget about your portfolio and come back in a few decades. But for many investors, especially those who are either a bit more risk-averse or who are older and approaching that stage of their life where they are looking to lock in any gains, a more pragmatic approach might be better. To be clear, if you are investing as opposed to saving and you have a time window of say 5 years or more, exposure to equities still makes sense, even in a balanced and pragmatic way. If you have a time window is under five years – say you plan to retire in 5 years and cash up fully – then any equity exposure is probably a bit too risky. The best advice given to me by a learned professor of finance was that over five years, equities have in the past been a winner, under five years its best to stick with cash or bonds or other safer options. So, to be clear, in constructing a balanced portfolio I am still assuming that investors still want a bias towards equity exposure but they also want some diversification away from pure stock market growth. In simple terms they want to hedge their bets, but with the ability to capture the upside from owning risky equities.

The classic answer to a balanced approach is to construct a 60/40 portfolio of 60% equities and 40% bonds. I’m not going to argue with decades worth of accumulated market wisdom and say that’s a bad idea – it isn’t and most of the time it has delivered impressive returns. However, implementing that within an investment trust format is fiendishly difficult. Put simply there aren’t more than a handful of bond funds on the market and the few that exist are very focussed on the riskier end of the corporate bond spectrum. There’s nothing wrong with that, it just doesn’t provide all the diversification you might need. An investor could of course construct a workaround and simply switch to bond ETFs or actively managed bond unit trusts for the bond segment of the 60/40 portfolio.

As an alternative, I have put together a slightly different approach which starts with a number of assumptions:

  1. A 50/50 split between investment trusts focused only on equities and another 50% on trusts with a more differentiated approach that incorporates bonds along with other bond-like proxies.
  2. In the equities portion of the 50/50 split, there is a focus on what’s called equity income. This means funds where the manager is taking a more cautious, defensive approach by relying on sound businesses that also happen to pay out a strong dividend. Share prices can be very volatile but dividends tend to be steady and, in many cases, progressive (they go up over time in a compounding fashion). Bank that dividend cheque and then reinvest it and you have a good chance of building sustainable, compounding long-term returns.
  3. I’ve also favoured a handful of funds that take a cautious, more absolute returns approach to investing. Outfits such as the Ruffer Investment Company move across asset classes and will invest in equities – currently below 20% of the portfolio – but their core focus is on capital preservation. I have also highlighted some funds such as BBGI Global Infrastructure which are in reality bond proxies, that pay out an income, and aim for low share price volatility.

With those principles out of the way, let’s spin through the suggested funds in the eight-fund model portfolio. The two big equity exposures are Murray International (I have also suggested the City of London investment trust as a substitute) which has a great track record and invests in global equities with a defensive, equity income-oriented focus. Next up we have AVI Global which is much more style-driven in its global equity investing approach – in this case, that means a value-oriented approach which involves picking undervalued stocks with lots of upside. Sitting alongside these two main global equities funds are two niche funds: the first is a defensive play on utility stocks globally from Ecofin, and the second is Japanese stocks. I’ll explain each in turn. Utility stocks aren’t exciting, but they are very defensive, and they tend to pay out a decent dividend. The challenge comes with picking the utility stocks that aren’t value traps where dividend growth is unsustainable, which is where Ecofin comes in. It has a long and impressive track record of picking the right utility businesses. Japanese equities are a straight value play and there are very few high-quality Japanese managers I’d trust – CC Japan Income and Growth is one of them alongside the substitutes AVI Japan Opportunity and Nippon Active Value. On the alternatives side of the 50/50 divide the core holding is one of the multi-asset funds with capital preservation as the core investment goal: I have identified the Ruffer Investment Company, but you could also pick Personal Assets and Capital Gearing as substitutes. The latter two have slightly higher equities exposure (the last monthly numbers I have seen show Capital Gearing at 27% equities exposure and Personal Assets at 25%) than Ruffer which is low at 17% of the portfolio but all three are currently heavily exposed to bonds, mainly index-linked bonds. I make no comment on this exposure to inflation-linked government securities except to say that if you think we live in a new world of higher inflation and more volatile markets, then this asset is probably a decent bet. All three managers will opportunistically vary their asset mix but as I’ve said, all three are very capital preservation oriented. On a side note, their equity exposure does mean that on an underlying basis, the overall model portfolio exposure to equities as an asset class is probably closer to 60%. One other point worth noting – Personal Assets has a much higher exposure to gold-related assets at around 11% of the portfolio.

Next up we have a classic bonds fund, in our case the Invesco Bond Plus fund with the CQS New City High Yield fund as a substitute. These funds have a focused approach to corporate debt, with careful management of the risk profile and a generous yield of well over 6% – up to nearly 9% in the case of the CQS fund. I’ve also included two small exposures to the broad infrastructure space, where most of the funds tend to have bond-like characteristics – steady income payouts and lower volatility of share price. I’ve selected the BBGI Global Infrastructure fund (HICL and INPP are very sensible alternatives) because of what it says on the label, it is global, and it has a better long-term NAV return track record. The Renewables Infrastructure Group, TRIG, is a diversified investor in renewable assets such as wind farms and battery projects. It boasts a string NAV track record and respected management but like all renewables funds it’s had a tough 12 to 18 months because of increased interest rates and volatile power prices.

Stepping back from the details, I feel confident in suggesting this mix of eight funds boasts first-rate, respected managers with a very decent track record. There’s a sensible balance of exposures ranging from less volatile, bond-focused funds through to income-oriented, global equity funds, some with explicit dividends focus. This model portfolio will undoubtedly underperform all out growth funds (think Scottish Mortgage or Polar Capital Technology) in a bull market which is full of excitement about the future. It will also underperform straight bonds and cash-only portfolios in a big market sell-off – that equity exposure will hurt in a market panic. But on a balanced basis, this should provide you with something approaching a 60/40 equities/bonds exposure via a cautious approach with substantial income upside.