BMO’s perfect portfolio for a balanced investor

Favouring European and Asian stocks over the US, a healthy weighting to bonds and a sprinkling of alternative assets should give balanced investors the right formula to make money in the long term, according to the BMO Global Asset Management multi-manager team.

So far this year it has been a tough time for all investors. High-risk strategies have nosedived on higher inflation and interest rates, while cautious investors have found little refuge in bonds.

Perhaps the most challenging place has been in the balanced risk zone, where investors want to make reasonable returns while not losing too much on the downside.

Below, BMO fund managers Scott Spencer and Kelly Prior outlined how they would build a balanced portfolio today for the next 10 years using just five funds, blending diversification and risk, as well as taking into account current valuations.

Spencer said: “Overall we decided on two equity funds, two fixed income funds and one alternative fund. We would have more in equities, say 60%, than we would fixed (30%), with a small amount in alternatives (10%).”

Equities

First up, the pair said that their equity bucket would be split between two funds, one in Europe and the other in Asia.

They agreed that a global strategy, or indeed a US one, was chasing the winners of the past decade and that, at current valuations, there were better options elsewhere over the long term.

Spencer split the allocation into two schools of thinking: beta and alpha. The former relies on getting the asset class right, while the latter then focuses on the individual fund pick.

As such, the managers chose a European smaller companies fund to start. “We would expect given where European valuations are relative to US valuations, Europe to at least not get as bad as the US,” he said. His selection was Berenberg European Small Cap.

Total return of fund vs sector and benchmark since launch

Source: FE Analytics

“If we can only have two equity funds we want to go for something that has the potential to grow over a medium-to-long-term time horizon small-caps outperform large-caps.”

Having covered the beta part of the equation, the manager said that the fund has a proven track record in managing micro- and small-cap money and it has a growth bias, which complements their other selection.

Additionally, he said that investors buying smaller companies funds need to consider capacity (assets under management), something that Berenberg has a history of keeping control of.

The other selection in the equities bucket was Prusik Asian Equity Income, a value fund that also has a proven management team and strong track record of running money in Asia.

Total return of fund vs sector and benchmark since launch

Source: FE Analytics

“We are finding that even non-income managers are now starting to look at Asian income as an asset class that has been sold off, so having a dedicated expert in that space is great,” said Spencer.

“When we look at funds we look for the ABCs – alignment of interest, benchmark unconstrained and capacity control. Both these equity funds have both. They blend well: Europe and Asia; value and growth; income and non-income.”

Bonds

Although not a popular asset class at present with rising interest rates likely to lead to falling bond valuations, Prior said there were some managers that could navigate the environment while also dampening the volatility of the overall portfolio.

“Mike Riddell’s Allianz Strategic Bond is one example,” she said, noting that the manager can take “extreme views” and shift the portfolio accordingly.

While there are concerns over fixed income’s effectiveness at protecting capital during times of rising interest rates, Prior added that there were opportunities in the strategic bond space.

“Riddell will move around the space. He has been, and is, underweight on high yield and has just moved his duration along to 9.5 years, which is particularly interesting at this point in time,” she said.

Alongside this, she suggested the Man GLG Sterling Corporate Bond fund, which launched last year.

“It is not a natural choice at this particular point in the market cycle, but manager Jonathan Golan proved his worth when he was at Schroders and brings something unusual as his process is all about credit selection. He doesn’t worry too much about things like duration. He looks for unloved securities.”

He is more concerned with the underwriting of a bond, making sure each holding is providing a reasonable return for the risk involved. This blends well with the macro view of Riddell, she said.

Alternatives

Lastly, with 10% allocated to alternatives, Spencer said he would look to add an absolute return strategy that can continue to add both alpha and beta.

“You need to look for funds in areas where they are more likely to add alpha. Two areas it has naturally been easier to do that are Europe and Asia – which we have that covered. Another area is the UK and we don’t have any exposure here, so fixed that with our alternative selection. We went with Tellworth UK Select,” he said.

The fund is a market neutral strategy that can take both long and short positions in UK companies to generate the best return.

“Individual stock trades are based on the team’s analysis of the fundamental data with overlaid quant data as well,” Spencer said.

The fund was bought from Sanditon and is run by Seb Jory, who is managing money for the first time, having previously been a sell-side analyst.

“Jory relies on his own systems and alternative data, which is all very complicated but things like Google trends, which is then plugged into algorithms. That combined with the fundamental stuff is quite unique,” Spencer said.