How to build a core and satellite investment trust portfolio

Three investment experts suggest possible core and satellite portfolios for investors with different risk appetites.

It can be difficult for many private investors to make sense of an established portfolio, while new investors with a lump sum to invest often do not know where to start. One approach is to build a sensible core collection of trusts that focus on mainstream growth, total return or growing dividends that can be reinvested. A selection of satellite trusts can then be added, focusing on more specialist themes.

We ask three professional investors to build a core/satellite portfolio of investment trusts – the first for an investor with a cautious risk profile, the second for a balanced investor, and a final more adventurous one.

Cautious choices

For a cautious investor, Winterflood Securities research analyst Emma Bird suggests putting 75% in core holdings made up of nine investment trusts – typically well-diversified funds with decent yields – and the remaining 25% into five more specialist and typically higher-risk propositions.

“An emphasis on well-established trusts with experienced management teams is appropriate for cautious investors. While this portfolio is vulnerable to market falls, diversification in terms of geography, sectors and asset classes alleviates risk to a degree,” she says.

She puts 30% of the cautious allocation – 10% each – into three trusts designed to give core exposure to different areas: Bankers sits in the global equities sector; Troy Income & Growth in the UK equity income sector; and Personal Assets in the flexible investment sector.

Personal Assets has the objective to “protect and increase (in that order) the value of shareholders’ funds over the long-term” and its absolute return mandate enables it to provide some ballast to a cautious portfolio. “The fund’s significant exposure to government bonds and gold means it’s likely to lag equity market rallies, but it should continue to preserve capital in difficult markets,” says Bird.

She likes Bankers for its “well-managed, low-cost, core global equity exposure” and expects its considerable diversification – holdings number almost 200 – to result in less volatility than its global peers. Although the trust’s yield is a relatively modest 2.3%, its “impressive” record of 52 consecutive years’ dividend growth is a major part of its appeal for Bird.

Income and rising dividends feature in this portfolio. Troy Income & Growth yields 3.5%, while another 8% is in Perpetual Income & Growth, which yields 4.5%. “Sustainable dividend growth is likely to be a key attraction for cautious investors,” says Bird. “Investment trusts are well-suited to providing this dividend certainty, as they are able to build up revenue reserves to smooth payments in the event of underlying dividend cuts.’

Regional equity funds focusing on developed markets also command a slice of core assets – 8% goes into JPMorgan American and another 8% into Fidelity European Values. A further 7% in Mercantile gives exposure to UK medium-sized companies, while the remaining 14% of the core allocation is split equally between two fixed income funds – City Merchants High Yield, which invests predominantly in European high yield bonds and yields 5.6%, and TwentyFour Income, which invests in European asset-backed securities and yields 6.3%.

The satellite holdings have 5% in each of five punchier plays. JPMorgan Emerging Markets and Schroder Asian Total Return tap into the higher growth potential of emerging market equities, but still have an emphasis on investor protection due to the cautious nature of this portfolio. The JP Morgan trust focuses on high-quality growth companies, while the Schroder one uses put options and futures to hedge out unwanted risks.

Worldwide Healthcare offers broad exposure to healthcare, including 30% in the higher-risk biotechnology sector. TR Property and John Laing Environmental Assets give exposure to alternative assets – property equities and renewables infrastructure – while adding to the portfolio’s income-producing credentials. These trusts yield 3.2% and 6% respectively.

Cautious portfolio

UK equities: 29%
International equities: 44.2%
Fixed income: 19%
Cash: 1.3%
Other: 6.5%

Investment trust  (%)
Bankers 10
Troy Income & Growth 10
Personal Assets 10
Perpetual Income & Growth 8
JP Morgan America 8
Fidelity European Values 8
Mercantile 7
City Merchants High Yield 7
TwentyFour Income 7
Schroder Asian Total Return 5
JP Morgan Emerging Markets 5
Worldwide Healthcare 5
TR Property 5
John Laing Envtl Assets 5
Portfolio total 100


Balanced selections

For a balanced investor, Patrick Thomas, an investment manager at Canaccord Genuity Wealth Management, favours putting 75% in a “simple and low-cost” core and overlaying this with 25% in more concentrated structural themes.

“The core part of the portfolio is a geographically diverse group of trusts where managers generally have long tenure and simple processes and the long-term performance has been good,” he says. “The most important thing is that the individual funds are genuinely differentiated, so the portfolio is not susceptible to one theme or management style. This is straightforward diversification, but it works. The satellite portfolio is a smaller group of managers, more thematic in nature, where the performance profile is potentially more volatile.’

At the heart of the core allocation are two UK managers doing different things in different ways. Nick Train of Finsbury Growth & Income runs a concentrated portfolio of larger companies, many of them household names, with a focus on quality growth companies. Alex Wright of Fidelity Special Values offers the opposite – a more diversified portfolio of smaller companies with a focus on value stocks (those he believes are undervalued).

“Together they work well,” says Thomas, who suggests 16% in each. To these he adds three global trusts that bring something different to the table. He puts 9% in Monks, which invests in disruptive growth companies, particularly technology and healthcare stocks; 8% in Murray International, which has a preference for the Asia Pacific region and emerging markets plus an income focus (the trust yields 4.3%); and 8% in Smithson, a global smaller companies trust with an emphasis on corporate governance.

Thomas’s portfolio has no dedicated fixed income investments on the basis that he believes this asset class is better served by exchange-traded or open-ended funds that focus on government or investment-grade bonds.

“There are no investment trusts doing this,” he says. “[Trusts run by] CVC Partners and TwentyFour do not provide enough defensive ballast and we would recommend less credit-oriented strategies available in other vehicles.”

Protection in his investment trust portfolio is instead achieved through two defensive multi-asset funds. Personal Assets has historically taken big positions in gold and index-linked bonds, while RIT Capital Partners’ positions in unquoted investments, property and hedge funds bring diversification benefits. “If you look at volatile years for financial markets – 2008 for Personal Assets and 2018 for RIT are good examples – it’s clear to see the defensive qualities of these trusts,” he says.

The satellite holdings focus on the structural themes of the environment and social change. These are ideal for a balanced investor because they should persist regardless of what is happening in world markets and economies. “Environmental technology will become more and more important as the world moves towards a more circular ‘use and recycle’ economy,” says Thomas.

He advocates putting 9% in Pacific Assets, which invests in Asia Pacific companies that are committed to the sustainable development of the region. Another 8% is in Impax Environmental Markets, which backs small and medium-sized companies in the US, Europe and Asia that are devising cleaner or more efficient delivery of basic services such as energy, water and waste, and the remaining 8% in Civitas Social Housing, which offers a long-term, asset-backed income stream from social homes in England and Wales.

Balanced portfolio

International equities: 33%
UK equities: 32%
Absolute return:18%
Asian equities: 9%
Property: 8%

Investment trust (%)
Finsbury Growth & Income 16
Fidelity Special Values 16
Personal Assets 9
RIT Capital Partners 9
Monks 9
Murray International 8
Smithson 8
Pacific Assets 9
Impax Envtl Markets 8
Civitas Social Housing 8
Portfolio total 100


Adventurous picks

Chris Salih, a research analyst at FundCalibre, firmly believes that an adventurous portfolio should be invested entirely in equities. Within this, he suggests allocating 70% to core investments and 30% to riskier satellite holdings.

Starting with the core, 30% is invested in a “nice, steady UK equity compounder” – City of London. Run by manager Job Curtis since 1991, this UK equity income trust invests predominantly in the UK’s largest companies and benefits from thorough research and a conservative approach to stock selection. It is a ‘dividend hero’, having raised its dividend for 52 years running. It yields 4.4%.

Another 20% is in global growth heavyweight Scottish Mortgage. It invests in companies throughout the world that are united by their strong growth prospects and currently has around half of its assets in US equities.

“It can be quite adventurous in that 25% of the trust can be invested in unquoted companies [16% at present] and, as the managers aim to identify businesses that have the potential to disrupt their own industries, a relatively high allocation tends to be in technology companies,” says Salih.

Another 12% is allocated to Jupiter European Opportunities, which invests in medium and large-sized European companies, including the UK. “The manager, Alexander Darwall, has developed a real aptitude for recognising patterns of success in company business plans and management teams, looking for world-class companies that can grow irrespective of politics and market noise – companies that are in control of their own destiny,” he says.

The remaining 8% of the core is in Schroder Oriental Income, which Salih likes for its focus on income and total returns. “We like the relative stability that the income focus provides for this trust versus many others in the region, especially when paired with manager Matthew Dobbs’ total return mindset – his disciplined and detailed research process ensures the portfolio is well diversified. He also only uses gearing if he sees exceptional opportunities, which helps to reduce risk in these more volatile markets.”

The satellite allocation is split equally between four trusts: Baillie Gifford Shin Nippon, Fidelity China Special Situations, Polar Capital Global Healthcare and TR Property.

Shin Nippon means ‘new Japan’ and this trust invests in Japanese smaller companies in emerging or disruptive sectors, where the manager sees innovative growth opportunities. Salih is not alone in regarding Baillie Gifford as boasting one of the best Japanese equity teams around and says this trust is “ideally placed to make the most of the current resurgence in corporate Japan”.

The Fidelity trust invests predominantly in small and medium-sized companies listed both domestically in China and on the Hong Kong stock exchange. Manager Dale Nicholls is able to make use of Fidelity’s investment licences in China to get direct exposure to the long-term Chinese growth story.

Polar Capital Global Healthcare plays well to the long-term thematic trend of an ageing population and the need for better medicine at cheaper prices – the “Holy Grail most governments are currently seeking for their citizens”, according to Salih. This trust invests in healthcare stocks around the globe .

Finally, TR Property invests in the shares of property companies of all sizes, typically in Europe and the UK.

Adventurous portfolio

UK equities: 35.5%
European equities: 20%
Asian equities: 19%
US equities: 18%
Japanese equities: 7%
Property: 0.5%

Investment trust  (%)
City of London 30
Scottish Mortgage 20
Jupiter European Opps 12
Scottish Oriental Income 8
Baillie Gifford Shin Nippon 7.5
Fidelity China Special Situations 7.5
Polar Capital Global Healthcare 7.5
TR Property 7.5
Portfolio total 100


Changing the mix with age

As investors grow older and their appetite for risk diminishes, the asset allocation can be adjusted accordingly.

Generally speaking, exposure to more defensive assets and income should increase at the expense of equities. This is likely to entail steadily decreasing the satellite investments and reallocating them to core holdings.

Bird recommends increasing allocations to the fixed income and multi-asset trusts in the core part of her cautious portfolio – City Merchants High Yield, TwentyFour Income and Personal Assets – as well as the more diversified trusts Troy Income & Growth and Bankers.

Given the relatively concentrated nature of the balanced portfolio, Thomas suggests adding more income-led strategies. The introduction of City of London or Edinburgh Investment Trust would help to reduce manager concentration and increase income from UK equities, while European Assets and CC Japan Income & Growth would offer income and more geographical diversification within core holdings.

Thomas would also add specialist income funds to the satellite holdings, such as HICL Infrastructure (asset-backed PFI infrastructure), Secure Income REIT (specialised property assets) or Assura (medical premises), all of which offer attractive yields and lower volatility than the All-Share index.

An adventurous investor could keep their portfolio fully invested in equities even after they retire – after all, they might have a good 20 to 30 years to fund – but it would be prudent to dial down the risk within this asset class, says Salih.

He suggests reinvesting proceeds from the satellite investments in Lowland, a UK equity income trust, as a complement to City of London. He also recommends adding income from an alternative source.

“The only issue with investment trusts at the moment is that there’s very little choice outside of equities – unlike open-ended funds, there isn’t a wide selection of fixed income or low volatility absolute return funds from which to choose,” he says.

“If you are sticking to closed-ended funds, you may like to consider an infrastructure or a renewable energy trust. The former certainly is in a less volatile area of the market, and both offer good income diversification. The only caveat is both sectors trade on a premium, so investors need to make sure they’re not paying too much.”

Subscribe to Money Observer Magazine

Be the first to receive expert investment news and analysis of shares, funds, regions and strategies we expect to deliver top returns, plus free access to the digital issues on your desktop or via the Money Observer App.

Subscribe now

Add new comment