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Buying Japan and gold

Market volatility creates opportunities, so our regular columnist increases his exposure to Japanese equities and gold
October 10, 2011

Regular readers will know that many months can pass without any changes being made to either portfolio. This is how it should be. If one is investing in well-performing trusts for the longer term, then there should be no need for high turnover. Dealing costs eat into portfolio performance. However, I do monitor whether trusts have become expensive, and it was this consideration that prompted a number of changes to both portfolios during September.

As suggested in my previous column, I have again tried to take advantage of market volatility to increase the portfolios' overall exposure to equities - this time in unloved Japan. For volatility can often throw up wonderful opportunities.

Portfolio performance summary

JAN 2009 TO SEP 2011GrowthIncome
Portfolio Total Return [%]50.644.9
APCIMS Total Return [%]24.223.5
Relative Performance [%]26.421.4

Equity changes

One of the attractions of investment trusts is the ability to pick up a portfolio of stocks at a discount to their worth - when the share price is less than the net asset value. The extent of the discount depends on a number of factors including the long term performance record, yield, gearing, sector and market outlook. Generally, the better the news, the tighter the discount. Trusts which stand on small discounts or even premiums, particularly if they offer little yield, should be closely monitored. Narrow discounts can make for awkward falls when sentiment turns negative.

Artemis Alpha Trust (ATS) and Scottish Oriental Smaller Companies Trust (SST) have been superb performers for both the Growth and Income portfolios. However, after strong runs, their discounts at times last month became almost non-existent and so I took the opportunity to top-slice both holdings.

The proceeds and available cash were used to increase both portfolios' exposure to Japanese equities via the Baillie Gifford Japan investment trust (BGFD). Negative sentiment and improving fundamentals make for a good investment opportunity.

Both portfolios already have Japanese exposure, particularly through Witan Pacific Trust (WPC) and Ruffer Investment Company (RICA) - at 30 per cent and 25 per cent of portfolios respectively. But BGFD now significantly adds to this. BGFD has an excellent track record relative to its peers and was bought when on an 11 per cent discount - its recent historical average. It is also nearly 20 per cent geared, which will be a positive if the market rises.

The gold switch

Readers will know I have been positive on gold for some time now. The race to devalue currencies by printing money, fear of inflation and economic uncertainty are favourable tailwinds. Meanwhile, very low interest rates for years to come mean the holding costs are minimal. And this is before one takes into account increased demand for jewellery, particularly from the emerging markets. No wonder central banks have turned net buyers for the first time for decades - the World Gold Council believes no central bank sold gold in 2010 for the first time since records began in the late 1980s. This will further boost gold's credibility.

To date, both portfolios have held gold directly through the physical gold ETC (PHAU). This has worked well. But towards the end of September, there was a sharp downward leg in the price of the yellow metal. I believe this is nothing more than a retracement in what is fundamentally a bull market. With less than 1 per cent of global financial assets held in gold, compared to over 3 per cent when it last peaked in 1980, we are still well off bubble territory.

Accordingly, I took advantage of the setback to increase both portfolios' exposure. I did this by selling PHAU and buying ETFS Leveraged Gold (LBUL). This fund provides 200 per cent of the daily change in the gold price, before fees and expenses. Looking at the charts it has a good track record of delivering what it promises. The management fee is 1 per cent and it has UK reporting status. Only 60 per cent of the proceeds of the PHAU sale were invested in both portfolios, as this is a geared investment. But the net effect is increased exposure to gold with reduced capital outlay.

Bond purchases

Market volatility has not just been restricted to equities or gold. Fear of government default has haunted the corporate bond markets, and bonds have retreated as a result. Spreads on sterling investment-grade corporate bonds - the amount their yields exceed those of gilts - have been at their widest level for more than two years.

The remaining proceeds from the gold switch have therefore been added to existing holdings of New City High Yield trust (NCYF) in the Growth portfolio, and to the Corporate Bond ex Financials ETF (ISXF) and City Merchants High Yield trust (CHY) in the Income portfolio. Read why I prefer decent yielding corporate bonds over gilts here.

GROWTH PORTFOLIO

Asset class/assetAllocation
Fixed interest
New City High Yield IT7.5%
UK Income/Growth
Temple Bar IT6%
BlackRock Smaller Cos IT5.5%
Standard Life UK Small Cos IT5%
Artemis Alpha IT4%
Global Growth
Scottish Mortgage IT7.5%
Templeton Emerging Markets IT6.5%
Jupiter European Opportunities IT6%
Witan Pacific IT6%
British Empire Secs IT5%
Scottish Oriental Smaller Cos IT5%
Baillie Gifford Japan  IT3.5
Themes
City Natural Resources IT6%
Herald IT5.5%
Worldwide Healthcare IT5.5%
ETFS Leveraged Gold 4%
Sarasin Agrisar OEIC 3.5%
Absolute Return
Ruffer Investment Company IT7.5%
Cash0.5%
Total100%

INCOME PORTFOLIO

Asset/asset classAllocation
Fixed interest
    New City High Yield IT9%
    Ishares Corp Bond Fund ex-Fin[£] ETF8.5%
    M&G Optimal Income Bond Fund UT7%
    City Merchants High Yield IT5.5%
UK Income/Growth
    Temple Bar IT5.5%
    Standard Life UK Small Cos IT4.5%
    BlackRock Smaller Cos IT4%
    Artemis Alpha IT3%
Global Growth
    Scottish Mortgage IT7%
    Templeton Emerging Markets IT6.5%
    Witan Pacific IT4.5%
    Scottish Oriental Smaller Cos IT4%
    Jupiter European Opportunities IT3.5%
    Baillie Gifford Japan  IT2%
Themes
    City Natural Resources IT5.5%
    Worldwide Healthcare IT4.5%
    Herald IT4%
    ETFS Leveraged Gold 3.5%
Absolute Return
    Ruffer Investment Company IT7%
Cash1%
Total100%

Holdings are rounded to the nearest 0.5%. Relative to benchmarks (Apcims growth and income), the portfolios are underweight bonds, with a bias towards corporates and index-linked, and overweight overseas equities witha bias towards emerging markets. Both portfolios are overweight gold, commodities, healthcare, technology and smaller companies.