Master portfolios: Low risk

But this bias towards caution shouldn't blind investors to the very real need for growth – very few investors will probably have saved enough by their mid fifties to last them for potentially another 30 to 40 years (much of it in retirement). They'll still need some growth in their capital but only at acceptable levels of risk – and that requirement implies diversification. A balanced portfolio that has some equities to produce substantial long term returns will need other assets to provide capital preservation. That conservative allocation is probably best served for most investors by a holding of fixed income securities or bonds and gilts.

The key to long term success is to mix and match different assets producing different returns for different levels of risk. By and large bonds produce lower returns than equities over the very long term (except for the last decade, when they've been the big winner) but there's much less risk of a big loss in capital value. Equities by contrast have tended to produce higher compound returns but have also been much riskier.

In this portfolio we have avoided the riskier end of the equity spectrum – we've focused on developed world equities, involving indices such as the MSCI World. The beauty of huge, global composite index like this is that it captures the vast majority of the total developed world large cap companies including those in the US and Japan.

We've avoided emerging markets. Some experts may argue that emerging markets do have some small place even in low risk portfolios (maybe 2 to 5 per cent) to spruce up potential returns but recent evidence suggests that the risk of really big drawdowns is just too great.

Overall, though, we have weighted this portfolio very heavily towards more cautious bonds and in particular government bonds, although many experts would challenge our very heavy bias against corporate bonds. At the moment many analysts believe that corporate bonds are a great investment but they are much more vulnerable when equity markets are distressed – in fact the main reason that corporate bonds may be such good value is because they've fallen so much in recent months as equities have sold off. The correlation between corporate bonds and equities is just too high for cautious investors. If you want to secure a higher income then you could increase your corporate bond holding from 5 per cent to maybe15 per cent but only at investment grade level.

Within government bonds or gilts we've weighted our holding towards conventional rather than index linked gilts. This small bias towards conventional gilts begs a much bigger question – if you believe that bonds are overbought and that within two or three years inflation will shoot back up because of all the monetary easing, you should consider buying more inflation linked gilts. Also if you think that inflation over the very long term of more than 2 to 3 per cent per annum is a real likelihood, again consider buying more index linked gilts.

Last but by no means least there is a small weighting towards alternative assets – this ranges from forex and hedge funds through to commodities. We have included some commodity exposure – probably best bought via a commodity index tracker – partly because over the long term commodities are fairly uncorrelated with equities and bonds and partly because commodities are usually a good store of value in inflationary times.

Broker view

"Low risk does not mean 'no risk'. Investors who are prepared to accept some risk in their portfolios can expect longer-term returns to be better than cash. This portfolio reflects the trade-off between accepting sufficient risk to deliver desired returns but not so much that low risk investors will have trouble sleeping at night. When thinking about this sort of strategy, our approach should be one of planning for the longer-term, riding out short-term volatility and perhaps drip-feeding funds into the market to take advantage of pound cost averaging.

This low risk portfolio has been built to achieve relatively safe, dependable returns and that leads to a bias towards capital protection. Here it hits the nail firmly on the head by being overweight in fixed interest. And when selecting equities, it does so from the more reliable sectors such as the defensive utilities and dependable infrastructure. This sector, in particular, offers relatively safe and consistent returns from both capital and income over the longer-term. This being said, the portfolio is careful to select assets which avoid the volatility associated with currency risk."

Stephen Barber is head of research at stockbrokers Selftrade