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Shaping up your Sipp for trying times

How asset allocation rules of thumb hold up as markets fluctuate
Shaping up your Sipp for trying times
  • How do market rotations affect the best rules of thumb for shaping your Sipp?
  • We outline good practice, and some key portfolio vulnerabilities

Prosaic as it sounds, taking a common sense approach to asset allocation has helped many a self-invested personal pension (Sipp) stay on track through the ups and downs of markets. Broad rules of thumb can help keep your Sipp in shape, whether your goal is to maximise capital growth, eke out an income or protect your portfolio against volatility.

The bad news is that constructing a portfolio appears to have grown more complicated lately. High levels of inflation have pervaded our lives and central banks are seeking to put the genie back into the bottle by raising interest rates – something that has upended markets and hit the winning stocks of the last decade especially hard, while also playing havoc with one particular portfolio diversifier. It has served as a stark reminder that market conditions can change quickly and significantly.

It must be said that the dominant trends and investments of the last decade have often proved much more resilient than we might assume. But the economic shifts now under way may require a change of tack.


Investing for growth

Investors with a long time horizon who seek to maximise portfolio growth can allocate most or all of their portfolio to equities. As we noted in last year’s Sipp special, some would argue that a growth investor with 15 years or longer to stay invested can often simply put everything in equities. Similarly, those who are retired but can rely on other assets may want to embrace risk and maximise Sipp growth ahead of passing it on to family, given that it sits outside of an estate for inheritance tax purposes. A useful approach is to run down your savings in Isas and elsewhere before turning to a Sipp, and as we discussed last year that can involve taking a more balanced approach in the former and taking on greater risk in the latter.

Individual attitudes and circumstances always influence what you do, and broad rules have variations. Rory McPherson, head of investment strategy at Psigma Investment Management, notes: “There isn’t a one-size-fits-all approach to discerning asset allocation, but a decent rule of thumb would be that subtracting an investor’s age from 100 would be a good starting point for establishing the target weight to equities. For example, if the investor is 20 years old then having 80 per cent in equities (100 less 20) would be a decent starting point.”

Diversification is essential whatever your equity weighting, meaning your investments should encompass different geographies, sectors and investment styles. The latter point has become especially apparent recently: the quality growth style that has dominated for so long is faltering for now. Value investments, which typically include exposure to economically sensitive sectors such as energy and financials, might be expected to keep faring better if we see a continuation of high inflation and rising interest rates – although that could all turn if the economy tips into a painful recession. As before, what is arguably more important is keeping a mixture of exposure to different factors.

Investors may wish to consider 'real', physical assets if they are looking for inflation hedges – think infrastructure, property and commodities, for example. Dedicated real asset funds exist, as do numerous property investment trusts (from generalists such as BMO Commercial Property Trust (BCPT) to specialists focused on logistics assets, care homes and social housing among other things). Think resources-focused funds from BlackRock World Mining Trust (BRWM) to commodity and gold exchange traded funds. We discuss infrastructure options later on.

Recession caveats notwithstanding, such assets are likely to remain important. As Sophie Burke-Murphy, investment director at Featherstone, observes: “The last 10 to 15 years of low interest rates and plentiful quantitative easing have supported financial markets – virtually all asset classes have appreciated. It has been a goldilocks period for anyone who has owned financial assets and a passive approach to investing has done very well.

“We are now transitioning into a new investment environment of rising interest rates and inflation and quantitative easing is going into reverse. Our view is that the investment landscape has changed, and a forward-looking active approach is going to be key in this environment.”

On the asset allocation front, Burke-Murphy points to the strength of oil, metals and agriculture in recent times as a hedge against inflation, noting that she has backed funds such as the WisdomTree Industrial Metals ETC (AIGI) and the WisdomTree Enhanced Commodity UCITS ETF (WCOM). She stresses, however, just how volatile commodities can be, and the need to monitor and manage the size of your allocation here. It's also worth noting that investors have piled into such areas, suggesting a risk of a pullback in the future.

Much as last year’s claims that inflation will simply be 'transitory' seem well and truly defeated, an era of persistently higher rates and inflation is certainly not guaranteed. While investors may wish to lean into certain regions, sectors or styles on which they have strong views, it makes sense to ensure that the portfolio is diversified across these as a means of preparing for whatever transpires.

It's also worth noting some other useful disciplines. Investors can rebalance their portfolio at a regular frequency – perhaps quarterly, every half year or year – to effectively reset to their original allocations and not become too heavily weighted to recent winners. You should resist the urge to sell out in a hurry if volatility emerges, unless the investment case for a holding has genuinely deteriorated. If recent market rotations have exposed your portfolio as being too reliant on the likes of growth stocks, it makes sense to shift the balance by deploying new money to other investments rather than selling growth holdings and banking recent losses.


A balance to strike

Many investors will ease off the risk as they get closer to retirement. McPherson’s '100 minus your age' notion is one useful point of reference here for equity exposures, although individuals may well be tempted to both run higher equity weightings and to hold off on derisking until fairly late, for the sake of squeezing out maximum portfolio growth. As noted last year, some individuals may wish to hold off from derisking until as little as five years before entering drawdown. Once you move into retirement, a residual equity allocation, often of between 40 and 60 per cent depending on an investor's attitude and circumstances, should be useful for maintaining some growth.

A big conundrum for investors is where exactly to put the rest of the money. Government bonds have long looked expensive and have come under huge pressure in the face of tightening monetary policy. This year the 10-year UK gilt has seen its yield, which moves inversely to price, shoot up from less than 1 per cent to 1.8 per cent, the highest level since 2015. Bond interest payments lose value in the face of rising interest rates and inflation and the asset class could have much more pain to come.

A few professional investors have tip toed back into certain bonds on the back of higher yields, but many remain wary. Burke-Murphy warns that the “traditional toolkit” of stocks and bonds in a balanced portfolio needs to change, with a big emphasis on inflation-proofing. She points again to real assets, as do other investors such as Tyndall Investment Management’s Edward Allen.

“We are not in the fixed interest camp,” Allen says. “While we do have some bond exposure it tends to be very inflation-linked or short duration [having low sensitivity to interest rate changes]. We like alternative assets such as infrastructure – it’s real asset exposure with a government-guaranteed inflation uplift.” He switches in and out of funds, but likes vehicles such as International Public Partnerships (INPP), Greencoat UK Wind (UKW) and the Bluefield Solar Income Fund (BSIF). Allen also backs some property names such as LXI Reit (LXI) and Urban Logistics Reit (SHED).

Backing alternative assets usually leads you towards investment trusts, given they are well structured to hold illiquid investments which take some time to trade. Investors should never forget the associated drawbacks, however. Shares in popular trusts can trade on a large premium to the value of underlying assets, as tends to be the case with infrastructure funds and certain niche property trusts, and these have a long way to fall if sentiment turns.

Similarly, trust shares are vulnerable to market sentiment and can fall substantially if investors panic, as they did (briefly) in February and March 2020. Some solutions here relate to position sizing and, again, diversification. Because alternative assets usually have their own idiosyncratic risks, it can be prudent to have a spread of different exposures.

If conventional fixed income looks troubled, it’s worth noting some specialists still like more esoteric forms of exposure. Allen likes TwentyFour Income (TFIF) trust, which uses more obscure forms of debt and diversifies across different bond sub-sectors, while McPherson is a fan of the Allianz Strategic Bond (GB00B06T9362) fund, a portfolio that uses all manner of tools including options and currency exposures to offset equity market volatility.

Some pockets of the equity market could also prove defensive. Equity income funds, for one, have held up fairly well during the market's recent travails, from those exposed to cyclical industries to quality-minded offerings such as Guinness Global Equity Income Fund (IE00BVYPNY24), which focuses on total returns rather than chasing yield.


The income approach

Income remains a tricky subject, because generating it involves risk but those seeking payouts are often less able to withstand losses. Equities, for example, remain a leading source of yield, but also the greatest source of risk.

Investors may again wish to adopt a balanced approach, taking a mixture of different equity exposures while using alternative income assets alongside. On the equity front, the UK has tended to offer the juiciest yields – even at times when the market is not underperforming its global peers – but this tends to come with a reliance on cyclical sectors such as commodities. Markets such as the US, Japan and Europe tend to produce lower yields in sum. By contrast, we noted in March that Asia continued to stand out on the dividend front, although the region has recently been marred by its own difficulties relating to China's struggling economy.

McPherson notes: "We’d acknowledge that equities tend to be biased towards the UK and certain sectors, so would suggest blending this with slightly lower yields in areas of the market such as Asia but also by using select alternatives."

Infrastructure and property stand out here. Some flexible bond funds such as those run by TwentyFour can also generate equity-like yields, with the caveat that now looks an uncomfortable time for bonds.

Importantly, investors should remember that chasing yield is not the only option. They can instead run a balanced portfolio for growth and take capital gains as a source of income. Some funds, such as JPMorgan's 'growth and income' equity investment trusts, use this approach. While not without its drawbacks, it lessens the risk that you back a shaky sector or company that trades on a high dividend yield purely as a result of its operational struggles.