IT growth portfolio has good rationale

TONY'S SIPP AND ISA PORTFOLIO

Source: Investors Chronicle, as at 24 September 2014.

Chris Dillow, Investors Chronicle's economist, says:

There's a lot to like about this portfolio. In particular, I like your preference for investment trusts, which tend to have lower charges than open-ended funds, and your awareness that fluctuations in their discounts can be useful buying or selling signals. I also like your recognition that you can get lots of international exposure by holding general large-cap stocks.

I also applaud the fact that you are not chasing income. Many investors do this unnecessarily, which can be both tax inefficient (if you've got a capital gains tax allowance, use it) and expose one to extra risk, to the extent that some stocks are on a high yield because they are riskier than others.

I also sympathise with your antipathy towards bonds. This might not, however, be much use to you; one of the big failures of my futurology has been that gilt yields haven't (yet?) risen as I've expected.

However, nobody holds gilts for their return. They do so because they are often a good way of diversifying equity risk, because many of the things that are bad for equities - such as increased risk aversion or pessimism about economic growth - are good for gilts.

But perhaps you don't need them because you have a different way of spreading equity risk. The inflows into your portfolio are high, relative to its size. This gives you a way of benefiting from a fall in share prices - because lower prices mean you can buy more of them. In effect, then, high future returns hedge you against negative returns today. You can use time diversification instead of asset diversification.

For this to work, however, it requires that you have the discipline to buy in bad times. To enforce this discipline, I'd advise you to identify a core part of your portfolio - a few investment trusts or (I'd add!) trackers - and invest in them through direct debits. Doing so means you benefit from pound cost averaging; you automatically get more units when prices are low.

However, this only works if share price falls are only temporary; buying on dips makes you money, but buying during a long slump doesn't. This will be the case if shares fall because of an increase in risk aversion (as this implies a rise in expected returns) or because of excessive pessimism about growth prospects. While these account for most share price falls, there is a third possibility - that prices fall because of an entirely reasonable fall in growth expectations. If this happens, prices won't bounce back and so time diversification will fail.

In this context, you need some other means of diversifying. Here, I'd urge you to remember your biggest asset, which is your job. This naturally exposes you to the risk of a downturn in the property market. I'm not sure it would be wise to add to this exposure. This makes commercial property questionable. But it also makes domestic cyclical stocks dangerous, to the extent that falling house prices might be part of a wider economic slowdown (either because a fall in house prices causes a slowdown or vice versa).

This, perhaps, represents a case for investing in overseas equities. I'm not sure it's wise to buy eurozone equities in the hope that QE would have a big effect; it's possible that euro equities would suffer if investors are disappointed by the size or effectiveness of QE. Doing so might, however, be one way of mitigating your exposure to the UK economy.

In this context, I don't think you have gone too far in cutting exposure to UK small caps. For me, these carry two dangers. One, which is specific to you, is that they could underperform in the circumstances in which your property developments do badly - namely, a general UK downturn. The other is that small caps see long phases of outperformance and underperformance, and their good run in 2011-14 might have left them overpriced now. Personally, then, I wouldn't worry about being under-exposed to smaller stocks.

Helal Miah, investment research analyst at The Share Centre, says:

Investment trusts have a lot of attractions for investors. They have all the benefits of a fund, spreading risk across many companies or other funds, but being shares means they are generally easier and cheaper to invest in than open-ended funds such as unit trusts.

They have historically outperformed unit trusts and can also provide opportunities when the value of the assets held is higher than the share price. On the downside, there are fewer of them for investors to choose from compared with unit trusts, and prices can be more volatile as they are driven by market sentiment.

Your portfolio is geared heavily towards growth, with a focus on smaller companies and emerging markets, which suits your objective. The only trusts which are more defensive are RIT Capital Partners and Temple Bar, which tend to invest in solid, blue-chip stocks. As a result the portfolio is generally high risk, although the fact that it contains 19 active funds does help to alleviate that through diversification. From a risk perspective you may wish to consider reducing the Scottish Mortgage holding as it makes up 12 per cent of the portfolio. Having 10 per cent of the portfolio focused on just one country, Japan, is also risky so I would suggest reducing that to around 5 per cent.

As a UK investor we would say that only 35 per cent exposure to the UK is too little and would suggest looking at increasing that. Especially as you are switching away from small caps to large caps, and as you highlighted the large-cap UK equities are actually more internationally exposed.

Although you are aware your portfolio is skewed towards the US, I would say that you are over-exposed to the region. So far this year, this exposure has worked out as US equities continue to slowly make new highs, while UK and European stocks have moved sideways. While we believe that the US economy will lead the rest of the world out of the slump, we have to bear in mind that stocks have been pumped by easy money, which is due to come to an end. We could see a halt to equity rises in the US after this. I therefore believe that you could forego some US equity exposure for UK or Europe where valuations are more attractive. While the US is ending QE soon, the ECB may increase stimulus for the region.

Like you have mentioned, drip feeding in to increase your exposure to Europe is not a bad strategy, especially for small-cap exposure.

You also mentioned you were looking to increase your commodity exposure. Commodities on the whole are still in a trough with the demand supply imbalances slowly fading. However, certain key commodities such as iron ore could see continued price declines as some of the large miners still expect to increase production capacity. You could get a decent exposure to commodities by increasing your weighting to FTSE large cap, which is worth considering.

Overall, you have a well-diversified portfolio using a good number of investment trusts almost exclusively. I wouldn't recommend increasing the number you hold as adding further funds will do little for diversification.