2017 asset allocation portfolios check-up

In truth, neither of the Investors Chronicle portfolios was especially optimistic, with the autumn portfolio holding back 15 per cent in cash. In hindsight, this caution was excessive as risky assets have continued to do well in 2017. In spite of the overweight cash position, the autumn portfolio is up 5.58 per cent overall on a total returns basis, with none of its investments seeing a negative performance. The exchange traded funds (ETFs) which have done best are those giving exposure to European equities (up 9.94 per cent), emerging market equities (13.56 per cent), index-linked gilts (9.77 per cent) and gold (9.89 per cent). These are all potentially volatile investments, however, so it is probably a good thing that the cash holding is large to protect against nominal capital losses when conditions aren't as benign as they have been over the past few months.

The portfolio designed to protect wealth from the impact of populism held less cash, but had a higher allocation towards gold. Over our short timeframe thus far, this has done better than any of the other portfolios published at Christmas. This is partly down to being more concentrated in assets that have done well, including gold and index-linked debt, but other investments - including the global quality and minimum volatility equity ETFs and the UK dividend factor ETF - have also contributed to a healthy 6.57 per cent overall return.

None of our professional investors would have chosen to hold more than 5 per cent in cash. Nutmeg gave suggestions to make our autumn portfolio a bit more optimistic and they took a less concentrated approach to equities than in our original, preferring to track market-cap weighted indices rather than smart beta. They also discussed a more diverse selection of fixed-income ETFs. Nutmeg's suggested investment in sterling-denominated corporate bonds, short-term high-yield debt and US small-cap stocks have yet to come good and the original Investors Chronicle portfolio has benefited, in the short term, from retaining a higher allocation to long duration index-linked bonds.

The Nutmeg team also ditched gold, which has been a good performer in both the IC portfolios. There is always an element of speculation investing in gold, but the reason it is in the IC portfolios is for its low correlation with other assets. In a world in which share and bond prices have been sent in the same direction by quantitative easing (QE), gold acts as a true diversifier. Although, the valid arguments against gold remain that it earns no income and is very volatile in its own right, so the 10 per cent allocation in our populism portfolio was high.

Bestinvest also advised against holding gold when they ran the rule over our autumn portfolio to give it an optimistic character. Had we followed their tactical tilts - a higher allocation to emerging markets would have been rewarded and although the fixed-income investments, Bestinvest, discussed have been solid rather than spectacular, the range of duration and credit risk types is more diverse than in the original IC portfolios.

SCM Capital were one of the asset managers to take a look at our pessimistic populism portfolio and again they disliked gold which they described as a "terrible long-term investment" in December. Instead they counselled adding to the equities allocation and the European mid-cap stocks total return ETF they highlighted - iShares EURO STOXX Mid (DJMC) - is up over 11 per cent. Again, they cautioned against our exposure to long duration index-linked bonds, which are sensitive to interest rates. The SCM suggestions of shorter duration bond ETFs was more diverse than our selection, although they did not include developed market sovereign debt. The bonds of major developed countries have the lowest default risk but are very expensive at the moment, so SCM's preference for quality corporate debt was understandable.

Charles Stanley did not suggest we markedly changed our exposure to index-linked gilts, gold and emerging markets equity. They did, however, look at how we might spread risk in the fixed-income allocation with a shorter duration corporate bond ETF.

The IC populism stress portfolio has done best overall, but a weakness is its concentration in bonds with a longer average duration in the index-linked gilts ETF. Duration is the sensitivity of bond prices to interest rates and is measured in years, to reflect the effective maturity of a bond - i.e. when the investor is paid back at their required rate of return. Holding inflation-linked bonds to maturity offers protection against the real value of the coupon being eroded by inflation. However, if inflation were to really rise then interest rates might go up to the extent that long-dated linkers would have to suffer falls in price of a greater magnitude than their real yield was protected. This would cause painful capital losses for the linker bond fund.

The professionals made an effort to reduce duration risk of bond investments in our portfolio and, while this would have meant missing out on upside as linkers have seen further price gains at the start of 2017, the alternative selections are subject to less interest rate risk. Therefore, although we've done well with our holdings so far this year, we're now going to take some profits on the linker ETF holdings in both the IC portfolios, and reinvest in some shorter duration bonds. For the populism portfolio, we're going to drop the Linkers allocation to 5 per cent and add 5 per cent allocation to both property and 10 per cent to global (G7) government bonds.

What about the other asset classes in the portfolio? Ben Seager-Scott of Tilney-Bestinvest, would now reduce any overweight position towards emerging markets. In his opinion, the value case for EM is less compelling following the strong rebound that the IC portfolios benefited from at the start of the year. Instead, he advocates moving to more of an overweight position in European equities: "There are solid signs of economic recovery in the eurozone and while there are risks, particularly political, markets appear to be discounting these pretty heavily while monetary policy is likely to continue to be very supportive, even if the rhetoric has turned more hawkish of late."

The Nutmeg team on the other hand is more concerned by European political risk and see emerging markets as offering further upside. James McManus, investment manager at Nutmeg, says: "We still favour being underweight European equities as a whole, given the political risk that exists surrounding the French election, and with German elections also on the horizon. While Europe has benefited near-term from an uptick in global trade, we still believe there are better ways to access this 'trade factor' such as emerging markets, where we are now overweight in our managed portfolios."

Rebalancing and updates

For both the IC portfolios there are gains to bank and a third of the way through the year, it seems a prudent time to rebalance the holdings and re-weight or make changes where we think appropriate. As Mr. Seager-Scott says, emerging markets have rallied strongly, and we also think now is a prudent time to take profits and also rebalance to be less at risk of a pullback going forward - especially if President Trump's protectionist policies start to bite or if the dollar strengthens again (making it harder for EM companies to repay debt).

In a year when Europe is still faced with political uncertainty, it seems odd for our populism portfolio to add exposure, but we need to diversify somewhat from the US which is heavily represented in our global factor ETFs. The failure of the Trump administration to repeal Obamacare highlights that there are dangers to expectations of fiscal boosts to corporate earnings, so it makes sense to make a modest 5 per cent addition to European equities and reduce the global factor ETFs somewhat.

Our view on the US is not shared by Nutmeg, who retain an overweight position in their own portfolios, although Mr. McManus says they reduced small-cap exposure early this year due to the magnitude of post-election outperformance versus large-cap. He goes on to explain that they "retain our value bias in US equities, especially as it provides a tilt to some sectors that could be beneficiaries of [President Trump's] reform". We do agree, however, with this assessment of the upside offered by making a value tilt and increase our Global (and therefore US) value factor position in the populist portfolio.

For the populism portfolio, we also get out of index-linked debt and rebalance the bond holdings towards shorter duration funds. We'll also add an investment in commercial property for diversification. For the selection from last autumn, we'll move towards making it more optimistic by dropping the cash element to 10 per cent. This is still high, but represents the truth that many global assets look expensive right now and we'd rather wait until after the critical summer months before going all in. Again, the index-linked debt holding is dropped and the duration profile of our fixed-income holdings is shortened.

On a final note, it is probably something of an anomaly that the populism portfolio has a higher equities allocation than a supposedly optimistic portfolio. It would be more accurate going forward to describe the two portfolios in terms of a general and a populism asset allocation. Both portfolios include risky investments - which is unavoidable to try and make decent returns - but one plans around a specific set of political risks and the other is more generally about managing tactical asset allocations from a broad strategic position.

General Tactical Asset Allocation Portfolio

Source: Investors Chronicle and Bloomberg

Tactically Tilted Populism Portfolio

Source: Investors Chronicle and Bloomberg