The AIC published research this week showing that discounts on investment trusts are at a 40-year low, following a bull market that has seen appetite for risk return.
This means that good stockpicking is even more essential, which is why we at FE Trustnet are putting together our own dummy portfolio of investment trusts, using the recommendations and commentary of the experts.
Our unconstrained portfolio is aimed at maximising growth through using narrowing discounts and overlooked opportunities, and should hopefully help readers come up with some ideas for their own portfolios.
We are using an asset allocation model of 10 per cent in bonds and 90 per cent in equities, split between UK, global and specialist sectors. The model comes from the AFI Aggressive index, which is derived from the average asset allocation of a panel of the country’s leading IFAs.
Fund selection is based on our own judgment, but guided by the recommendations and warnings of expert commentators.
Judging by the AFI Aggressive index, the average aggressive portfolio has roughly 10 per cent in bonds of some kind, with a small weighting to alternatives such as property and absolute return.
It is hard to get bond exposure through trusts, so we have included some defensive funds with a weighting to fixed interest instruments within them to provide some ballast, and a 5 per cent position in the open-ended Jupiter Strategic Bond fund to make up the difference.
We would love to hear your comments on the trusts we have chosen and any that you think would do better. We will revisit this portfolio regularly over the year to see how it is getting on and make any tweaks necessary.
Here is the full list of funds and weightings.
FE Analytics allows us to run a number of health checks on our portfolio to highlight some strengths and weaknesses.
Although we are going for growth, we have managed to take the edge off the volatility of investing in equities, at least judging by past performance.
Our three-year volatility is 11.39 per cent, compared with 14.87 per cent for the FTSE All Share.
The downside risk figure – which looks at volatility in down markets – suggests we are also more defensive, coming in at 11.97 per cent to 15.89 per cent.
However, the maximum drawdown – the most investors could have lost if they had bought and sold at the worst possible moments – is higher, at 16.69 per cent compared with the 15.94 per cent of the portfolio.
This is not particularly surprising given that investment trusts are known to fall more in down markets thanks to the action of discounts – the share price can fall further than that of the underlying investment.
Simon Elliott, investment trust analyst at Winterflood, says that we need to be wary of down-markets, but should do well if markets continue to rise.
“This portfolio contains many high-quality investment trusts, with strong track records and well regarded management teams,” he said. “It is a very growth-orientated portfolio that should perform well in positive market conditions, although it may struggle in more volatile circumstances.”
“The portfolio contains a number of value opportunities such as Edinburgh Dragon and F&C Private Equity that could benefit from discount tightening.”
Clearly we are going to be keeping an eye on markets and looking to reduce some risk if the current economic optimism proves unfounded, but we are setting a portfolio up for long-term growth so are prepared to take on some risk.
As well as our defensive holdings in Ruffer and Capital Gearing, we are also holding an equity income trust – FE Alpha Manager Mark Barnett’s Perpetual Income and Growth – which should add some extra protection, while the Asian Total Return portfolio has a very low volatility thanks to its use of derivatives to hedge market-specific risk.
The latter has also slipped onto a small discount recently, which has piqued our interest.
However, there is no question that we are set up for growth and a market correction could require us to make some changes.
FE Analytics data shows that our portfolio has been performing well in the prevailing economic conditions.
Over the last six months we would have been up 13.2 per cent to the All Share’s 5.42 per cent.
Performance of portfolio vs benchmark over 6months
Source: FE Analytics
The R-squared figure of a portfolio shows the strength of the correlation between its returns and its benchmark's.
Our R-squared of 0.74 over the past three years suggests that 74 per cent of the movements in the portfolio can be attributed to the movements in the All Share, which for a portfolio of investment trusts is not too bad.
It suggests we have produced a reasonable amount of diversification from the FTSE, even though the below graphic shows we are significantly overweight the UK. Of course, all figures are derived from past performance, and the same patterns cannot be guaranteed to continue.
Geographic weighting of portfolio
Source: FE Analytics
While we have gone for the larger, more liquid trusts as a rule, there are a couple of lesser-known portfolios we thought worth including.
Herald Investment Trust invests in technology, but has a broader remit than other tech funds, which gives it more freedom and should limit its exposure to the tech sector per se.
For example, it holds advertising company M&C Saatchi and publisher Euromoney in its top-10, alongside chipmaker Imagination.
It is also sitting on a hefty discount of 13.1 per cent, much wider than the other technology funds out there.
Capital Gearing is another smaller portfolio to be included, although the manager Peter Spiller is well known to aficionados.
He has run the trust since 1982, and has an excellent record of protecting capital. Just over 41 per cent of his portfolio is in bonds, with another 20 per cent in preference shares and convertible debt, which adds to our bond exposure through Jupiter Strategic Bond.
The portfolio has just come in from a large premium following a period in which risk assets have become more popular and defensive funds slipped off the radar.
It is still on a small premium of 3 per cent, and there is a risk of that coming in further, but on the other hand its stellar track record should mean that investors pile in if markets go south: this is what we want from the protective part of our portfolio.
The £89m Strategic Equity Capital trust is another of our less well-known picks, although it is highly regarded by the various analysts in the market and is held by a number of them.
The managers Stuart Widdowson and Adam Steiner use private equity valuation techniques to plan their entry and exit from investments, and fish largely in the small cap and AIM markets; this gives a balance to the more mid cap-heavy funds in our selection.
We would be interested in getting your opinion on our picks below. We will be checking up on the progress of the portfolio regularly through the year and rebalancing as appropriate.
