The market will always present opportunities and risks which can often be exaggerated by the fluctuation of investment trust discounts. But the regular maintenance of portfolios is just as important for investors - especially if performance has deviated from benchmarks by some measure or markets have moved significantly. Such exercises can also be a good time to re-examine investment strategy.
Regular rebalancing
Earlier in the year I felt that a lot of bad news was priced into equities. Accordingly, during May I started to reduce defensive positions and this has helped both portfolios turn in decent returns. For the year to 1 December, the Growth and Income portfolios were up 17.43 per cent and 16.11 per cent, respectively, compared with their Apcims Growth and Income benchmarks of 9.19 per cent and 7.39 per cent - all figures being total return.
I remain positive about equities. However, one should never be complacent about the market - for it can often surprise. And almost regardless of market outlook, history suggests investors should regularly rebalance their portfolios. Rebalancing is one of the first principles of investing, and yet it is often overlooked. The concept is simple. If a 60/40 bond/equity split is adopted and equities then have a very good run relative to bonds, one could end the period with a 70/30 split. Evidence suggests that it pays to rebalance this portfolio provided one’s risk profile and investment objectives remain unchanged.
Rebalancing worked well in this recent downturn. In the period 2007-09, a portfolio starting with a 60/40 split would have lost 37 per cent if unbalanced, compared to 30 per cent if balanced annually. However, this time frame is too short to prove the principle worthwhile.
Longer-term case histories are more revealing. Forbes has shown that £10,000 invested by way of a 60/40 split in the US in 1985, and rebalanced annually, would have been worth £97,000 in 2010. An unbalanced portfolio would have been worth £89,000. What is noteworthy is that the rebalanced portfolio particularly protected investors better when markets fell significantly - which is logical. Investors with higher-risk investments take note!
Confirming strategy
Such a rebalancing exercise should also be used to revisit investment strategy. Readers will be aware of my long held mantra of 'Go high, go deep, go east'. Both portfolios, relative to respective benchmarks, reflect this strategy: they are overweight high yielding equities and corporate bonds, overweight smaller companies and overweight the Far East. But could this now be wrong? Has the time come to change any or all of these calls after a good run by both portfolios?
I think not.
Interest rates are set to remain low for some time to come. The slowdown in the West is unusual: this is a deleveraging recession and not a destocking one. Traditionally, a good dose of Keynesian stimulus - using borrowed money if necessary - would have corrected the situation. This option is not available today. The hallmark of this recession is excessive debt - both governments and consumers have lived beyond their means. The cupboard is now bare.
The long-term solution is economic growth. But governments are not grasping this nettle. Where are the much-needed supply side reforms within the eurozone? Where are the measures to encourage greater competitiveness and reduce taxation? Instead, political leaders are simply moving the debt around the system, between governments and banks.
In perhaps recognising their failure, governments have set upon the course of 'financial repression'. The objective is to create a little more inflation in order to help erode the debt over time - a policy pursued after the second world war. This is being achieved by keeping interest rates artificially low at both ends of the yield curve.
This is easy at the short end because of the compliance of government-appointed central bankers. It is achievable at the longer end by forcing the big players, the pension funds and banks, to be buyers of government bonds through regulations such as asset/liability matching and capital adequacy ratios - and yields reflect this artificial demand.
This is a dark art. Quantitative easing is also part of the script. But whether successful or not, interest rates will remain low for years - there is too much debt in the system, and governments want to avoid default. In such an environment, high yielding equities and corporate bonds will remain in demand - particularly those equities which can increase payouts. Meanwhile, overseas income will play a more prominent role in portfolios.
As for the 'go deep' part of the strategy, I remain of the view that smaller companies will continue to do well relative to the wider markets - for reasons first espoused in my column 'Big dividends from small caps' (3 September, 2010). Better managements and greater access to international markets courtesy in part to technology and globalisation, together with the sector generally remaining under researched, makes for a powerful combination for good fund managers.
Furthermore, sentiment towards the sector may improve as the low growth environment ushers in less extreme economic swings and therefore sector volatility. The 15-20 per cent discounts on good performing smaller company trusts provide a wonderful investment opportunity.
Meanwhile, I am more convinced than ever investors should 'go east' for superior returns. In my column 'A tale of two hemispheres' (9 July, 2010), I cited young populations, high savings ratios, greater infrastructure spend, a low entitlements culture and a work ethic. Nothing has changed. Faster economic growth rates make it easier for good fund managers to find good companies. The region is full of promise - investors should view volatility as an opportunity and not a risk.
Portfolio changes
With these factors in mind, I have made a few changes to both portfolios. In the Growth portfolio, I have sold Murray Income trust (MUT) at a premium to net asset value (NAV) and Templeton Emerging Markets trust (TEM). With some of the proceeds, I have introduced New City High Yield trust (NCYF) which invests in high-yielding fixed-interest securities, and presently yields around 6.5 per cent. NCYF is already held in the Income portfolio.
With the remaining proceeds I have also introduced Aberdeen Asian Income trust (AAIF) on a 3.3 per cent yield and JPMorgan Emerging Markets Income trust (JEMI) on a 4.2 per cent yield. AAIF has a truly excellent track record while JEMI, although relatively new, has made a good start. Speaking with the respective managers, Hugh Young and Richard Titherington, both continue to see great opportunities ahead - with the usual proviso that the road to success is seldom smooth.
Finally, within the Income portfolio, I have reduced Murray Income Trust (MUT) and added to existing holdings of Murray International trust (MYI).
