Keep it simple and cheap

In a previous life as a charity and private client fund manager, there was always industry talk of the latest "black box" idea which would somehow produce great returns relative to risk. Even sitting later on the other side of the fence, helping charities and individuals monitor their fund managers, the talk continues although the products have changed.

To illustrate the virtues of simplicity, towards the end of 2008 I created two portfolios of pooled funds whose performances are monitored against the APCIMS Growth and Income indices, standard benchmarks that can help clients monitor performance. As you can see from the breakdown, each consists mostly of investment trusts, with some unit trusts and exchange-traded funds. The fund managers at the coal face are doing the hard work. I aim to add value through choice of funds, asset allocation decisions and themes, and, in sharing with you the successes and failures, hope this portfolio and subsequent updates will help you shape and manage your own portfolios.

A few pointers: the two portfolios will generally remain fully invested, as attempting to second guess short-term market moves can be a mug's game. It can also be a dangerous game, for missing a few days of good performance can be very costly. £1,000 invested over a fifteen-year period between June 1992 and June 2007 (with dividends re-invested) would have produced a total return of £4,612. Yet had you missed the 10 best trading days, your return would have fallen a whopping 34 per cent to £3,041. Evidence suggests the longer the timeframe, the harsher the punishment for missing the best days.

So the message is clear: stay invested, as this is more important, and more profitable, than trying to time the market. This is particularly true at times like these when sentiment has been negative.

Investment trusts form the backbone of both portfolios. The reason I prefer these instruments is that they have the useful capacity to borrow and so gear up if they think the market is attractive. Their 'close-ended' structure also allows fund managers to take a longer term view of investments, as they are not forced to sell holdings when investors look to redeem shares, as happens with unit trusts.

And crucially, their fees are low relative to unit trusts. A golden rule of investing is that small fee differentials can make a big difference to revenues over the longer term. Motley Fool recently analysed the returns from investing £100 a month for 30 years, assuming a 5 per cent a year return, and applying fees of 0.75 per cent, 1.5 per cent and 2.5 per cent. Not a big differential in fees, but after 30 years, the first portfolio returned £71,800, the second £63,100 and the third £53,500.

It can be worth paying up for superior fund manager performance, but fee levels are far more important. You can't predict what a fund manager's performance will be like in five or ten years. But fees are there in black and white at the start. Research from Lipper has found that the average investment trust's total expense ratio (TER) is 1.4 per cent, and a third have TERs under 1 per cent. Unit trust TERs average over 1.5 per cent. This all helps to explain why investment trusts have outperformed unit trusts over the longer term, as recent research from Money Observer has confirmed.

As for asset allocation, as measured against the two benchmarks, you will see that common themes abound. Both portfolios are underweight bonds but within this weighting there is a bias towards corporate over government. Meanwhile, both portfolios are overweight equities with a particular bias towards overseas and emerging markets, and both are overweight certain themes such as technology, commodities and the environment.

Portfolio performance, year-to-date

Such asset allocation has served us well so far. Over the first three quarters to the end of September, the growth portfolio has outperformed its benchmark by 11.2 per cent and the income portfolio by 7.2 per cent, rising 26.4 per cent and 19.0 per cent respectively.

Next time I'll explore the asset allocation, themes and choice of funds in a little more detail. One of the big questions for investors going into 2010 is where the next bubbles will be created. Given the extent of monetary easing by central banks around the world, the investor needs to be both on guard against inflated asset prices, and aware of the many opportunities that will exist.

Growth portfolio asset allocation

Income portfolio asset allocation