We live in interesting times. Equity and bond markets have had a good year to date and portfolios have benefited. This may continue for some time. But it is prudent to remember the importance of diversification, particularly as an investment journey progresses. Accordingly August saw profits taken on a number of mainstream equity and bond holdings. The equity proceeds were invested largely in commodities, including precious metals, and renewable energy. The bond changes reflect a slight 'nuancing' of policy as well as modest reduction in exposure.
Regular readers will be aware of my long-held views regarding the economic and interest rate outlook. Given the amount of debt in the system, the difficulty in generating growth and the extent to which many countries or economic blocs are unwilling to make the necessary structural changes, interest rates were always going to remain low for longer than consensus forecasts.
The IMF's overly optimistic GDP growth forecasts have been about as useful as central bankers' forward 'guidance' - never before has so much resource been wasted by the financial community in analysing its own briefings. Central bankers were always going to struggle. In the increasingly desperate search for growth, policies once considered radical - persistently low interest rates, quantitative easing (QE), negative interest rates - have now become the norm. Yet still low growth and the prospect of deflation haunt the corridors of power, at a time when protectionism is on the rise.
If central bankers continue to struggle then governments may decide to take more direct action. Why not a globally-co-ordinated 'debt armistice'? If that is too radical, why not stop issuing bonds and simply print the money to fund pet projects - be they infrastructure or otherwise? One policy option doing the rounds in Japan would see money given to parents for every child born - thus also addressing the issue of the country's ageing population.
Whether such 'helicopter money' becomes a reality or not, the point is that these are indeed uncharted waters. Existing central policy initiatives are blunt and may yet have unforeseen consequences on a global financial system that is not yet back up to full health. Yet such policies are set to continue as growth proves illusive - will the financial markets blink first, or not blink at all? This is one reason among many why 'Brexit' was never anything more than a dog barking from the sidelines as the elephants walked by.
We may muddle through as we have done so often before, but we also need to be cognisant of the risks. While a general withdrawal of liquidity would affect the price of most assets, the message is that investors should ensure they are adequately diversified relative to their risk profile and investment time horizons. History suggests trying to time markets has been a mug's game, but that adequate diversification has stood the test of time.
Investors will appreciate that this is a key theme of the portfolios. With this in mind, two new holdings were introduced into the portfolios in August - one focusing on solar power, the other on gold and silver mining companies.
Bluefield Solar Income Fund
During August, Bluefield Solar Income Fund (BSIF) was introduced to the Income portfolio. Renewable energy investment trusts were only launched a few years ago and are not well-known despite their high yields and inflation-linked income. As such, they typically trade at lower premiums than infrastructure trusts despite yielding more. Opportunities exist for the patient investor.
Like infrastructure funds, they receive a decent income stream from government-backed green subsidies, directly linked to RPI inflation, which aim to encourage renewable energy production - where the government has a good record. The key difference is that PFI infrastructure funds have the security of government-backed cash flow and do not have to contend with volatile power prices. So there is a modest differential in risk between the two types of trust, but the market is penalising renewable energy when assessing the extent.
BSIF focuses entirely on solar power in the UK. The attraction with solar is that the variability in the energy source is typically 5-7 per cent compared with 15-20 per cent for wind. The technology is very advanced yet simple - there are few moving parts. This makes for stable earnings and a good income stream. BSIF offers a near-7 per cent yield, while having tucked 0.5p into revenue reserves this year.
The management has experience and a good track record. Over the past two years, they have managed a near-40 per cent reduction in power prices without the help of any cheap leverage. The model has proved robust, with a well-priced portfolio. Of course, prices could continue to fall, but the harsh pricing environment is factoring in a lot of bad news.
From April 2017 the solar subsidy regime changes and this may result in a scarcity factor regarding existing capacity. Well-positioned portfolios could benefit. It could also mean there will be less fundraising by the renewable funds, and this may help share prices over time.
All in all, BSIF looks attractive. The trust has a strong and committed independent board with large shareholdings. Furthermore, the overall fee structure is low and yet has a modest element of it linked to dividend outperformance, which is paid in shares - this element being waived if outperformance is not achieved. Interests are well aligned.
Other portfolio changes
The BSIF purchase was funded by the sale of iShares Corporate Bond ETF (SLXX) - with remaining monies funding the topping up of New City High Yield (NCYF) and the portfolio's cash position. This resulted in a reduction in the portfolio's bond exposure, while increasing the focus within the remaining balance towards higher-yielding bonds and other fixed-interest assets. Lack of space here suggests an explanation in next month's column.
Meanwhile, during August, Golden Prospect Precious Metals (GPM) was introduced to the Growth portfolio. GPM specialises in gold and silver mining companies - again, the reasoning will be covered in next month's column. City Natural Resources (CYN) was also added to when standing on a near-20 per cent discount. This was funded by top-slicing Fidelity China Special Situations (FCSS), Finsbury Growth & Income Trust (FGT) and International Biotechnology Trust (IBT) after strong performances year-to-date.
Finally, the Growth portfolio holds Ecofin Water & Power Opportunities (ECWO), which is undergoing a reconstruction. As ever, the devil is in the detail, but choosing the right options will enhance returns - please refer to my website, johnbaronportfolios.co.uk, for a full explanation. Some brokers have been confused about the terms on offer.
ABOUT THE AUTHOR:
John Baron waives his fee for this column in lieu of donations by Investors Chronicle to charities of his choice. As these are live portfolios, he has interests in all of the investments mentioned. For more portfolios and commentary please visit John's website at: johnbaronportfolios.co.uk
