The annual review of our model portfolios charts their fortunes after a difficult year and reveals the fund changes in our biggest rejig since their inception in 2012.
Last year was a difficult one for investors. The UK stock market felt the heat of the Brexit burn as politicians failed to agree on a strategy to exit the European Union.
In the US, the runaway performance of technology stocks was finally checked and Donald Trump’s trade war rhetoric with China became tariff reality. The escalating tensions took their toll on global stock prices, in particular in emerging markets. Few markets delivered a positive return to UK investors during 2018, and those that did were helped by the weakness of the pound. This stands in stark contrast to 2017, when world stockmarkets reached new highs.
The road ahead looks fraught with danger too. The path to any type of Brexit and beyond is certain to be difficult, creating volatility for both sterling and UK equities. A series of gloomy trading updates from the UK high street and beyond in January did nothing to lighten the mood.
Despite the negative sentiment, it is a fool’s errand to bet on the direction of financial markets; they are prone to defying expectations. The appeal of putting long-term savings to work in the stockmarket remains, though investors concerned about immediate prospects should consider drip-feeding money into investments to take advantage of any market dips.
Why use model portfolios?
Constructing a diversified portfolio well-placed to weather storms and take advantage of future bright spots is no mean feat. That is where our 12 model portfolios come in. Each consists of seven funds chosen to take a specific level of risk and produce either growth or income.
With bonds proving weak alongside equities, the majority of our portfolios are showing mid to high single-digit losses over the year for the first time in their seven-year history, taking the shine off their longer-term performance records. Funds with an international flavour have provided the best returns, which is why our growth portfolios have held up a little better than our income ones – but none is in positive territory over the year.
While it is difficult to buck falling markets, we are unhappy to see that some of our portfolios lost more than 10% during the second half of 2018, so we have embarked on the biggest shakeup in their constituents to date.
A silver lining to starting a new year with a cloud hanging over the stockmarket is that equities are looking less overvalued – potentially providing rich pickings for stockpickers. Notably, we are getting rid of index trackers, to avoid blindly following the market lower, and putting our faith in active managers with good records for long-term outperformance.
Model portfolios performances over six timeframes
The Growth Portfolios
Profit-hunting over three timeframes
Our first six models are designed for those looking to grow their money – three for medium-risk and three for higher-risk investors.
The portfolio that is most appropriate for any particular investor depends on the investment timeframe. Our shorter-term portfolios are suitable for those looking five to nine years ahead; medium-term for 10-14 years; and longer-term for 15 years or more.
Those with shorter timeframes have a greater focus on capital preservation, as they have less time to recover in the aftermath of a big market correction. Conversely, those focused on returns 15 years down the line can take more risk for potentially greater rewards, albeit with considerable shorter-term risk.
The differences in portfolio performance during 2018 were as we would expect: the shorter the timeframe and lower the risk profile, the better the performance. Two portfolios beat the FTSE UK Private Investor Growth index in the process, and five out of six outperformed the FTSE All-Share.
Alpha underwent a reversal of fortunes in 2018. After being the weakest of our growth portfolios during 2017, it was the top performer last year, with no change in its value.
The largest contribution of 3% came from Capital Gearing Trust, which was introduced last year to provide a crucial element of capital preservation for this shorter-term portfolio. One of the few investment trusts that aims to produce an absolute return, it has been run since its launch in 1982 by Peter Spiller. He has become increasingly wary of the stockmarket and had just 12% in equities at the end of 2018. His largest allocation, of 35%, is to index-linked gilts.
Fundsmith Equity, run by financial industry stalwart Terry Smith, also made a notable contribution, up 2.3%. His approach – picking a small selection of high-quality, resilient global growth companies that are good value, and then sticking with them – has bucked the wider market gloom.
Despite a good show for Alpha, we think more explicit fixed-income exposure would be beneficial for this portfolio, so we are replacing the mixed-asset fund Artemis Monthly Distribution – Alpha’s worst performer over the past year – with Jupiter Strategic Bond. It is very risk-averse and all the recent return has come from its yield, but this bond fund is a good addition for a shorter-term growth portfolio.
For added diversification, we are putting 10% of assets into Mid Wynd International, a global equity trust that focuses on high-quality companies. That is funded by taking profits from core holdings Lindsell Train UK Equity and Fundsmith Equity, each down by 5%.
Rebalancing Bravo’s exposure to UK equities from 40% back to its original 25% stood it in good stead last year. It is the second-best performing portfolio over one year, having fallen by just 2.1%, and it has leapt into first place over three, five and seven years.
Its largest holding, Fundsmith Equity, is also its top equity-oriented performer, having returned 2.3% – an impressive showing given the wider stockmarket slide.
The best return was generated by the capital preservation-minded Capital Gearing Trust, up 3%. Significant contributions also came from Fidelity Global Dividend and CFP SDL UK Buffettology. The Fidelity fund is conservatively managed and provides diversified exposure to international stockmarkets, while Buffettology focuses on UK equities and follows the principle of legendary investor Warren Buffett, buying shares in good businesses for less than manager Keith Ashworth-Lord feels they are intrinsically worth.
Royal London Sustainable Diversified Trust was introduced last year, but we are removing this admittedly decent mixed-asset fund and allocating 10% to a pure bond fund. Bravo is already well-diversified in terms of its equities exposure – it incorporates everything from large, international businesses to small and medium UK companies – and the introduction of Jupiter Strategic Bond is a good fit for a medium-risk portfolio.
The remaining proceeds from selling the Royal London fund, of around 5%, are being invested in Artemis Global Growth. It was the worst-performing constituent of Bravo over the past year, having slid back by more than 7%, but it has a history of missing market inflection points and should bounce back when its value style is eventually reflected in stock valuations.
Charlie is our only growth portfolio that failed to beat the FTSE All-Share index during 2018, having lost 9.9% of its value.
LF Miton UK Value Opportunities has disappointed the most, having lost more than 17%. Mercantile Investment Trust suffered a slightly smaller loss. Their bias towards UK small and medium-sized companies has not been popular.
Baring Eastern Trust, a new addition to this portfolio in 2018, is also a significant loss-maker, down 16%. We have lost faith in this fund, but recognise the potential of Asia for longer-term investors. Generally speaking, it boasts more attractive valuations and better growth prospects than developed markets.
As this is a medium-risk portfolio, downside protection is important, so Schroder Asian Total Return Investment Trust is a solid replacement. Its managers, the veteran duo Robin Parbrook and King Fuei Lee, combine quality growth firms in Asia Pacific with a degree of capital preservation.
We are increasing exposure to wider emerging markets at the expense of the UK. The country is mired deep in Brexit, so this may not be the ideal moment to reduce UK equity exposure, but we deem 30% too high for medium-risk investors, so one of Charlie’s three UK holdings has to go.
As this is a longer-term portfolio, we are sticking with Mercantile, which is well-diversified with more than 100 holdings and has an excellent 10-year record. We are also persisting with Lindsell Train UK Equity, which has a concentrated large-company portfolio and finished 2018 down just 1%.
We are swapping the Miton fund for emerging markets exposure via Fidelity Emerging Markets, which we like because of its focus on larger companies and ‘best of breed’ approach.
Delta is our best-performing higher-risk growth portfolio over the past year, having lost just 5.4%. Having Fundsmith Equity as a core holding helped keep a lid on losses.
The biggest drags on performance were Rathbone Income, Witan Investment Trust, this portfolio’s second-best performer a year earlier (behind Fundsmith), and HSBC FTSE All Share Index, which simply tracked the market lower.
The portfolio has 40% in UK equities, an exposure we are reducing to around 33% as we aim to limit volatility for this portfolio. We are doing so by taking 5% out of Witan, taking the weighting of this mostly multi-manager investment trust down to around 16%; bringing in some ballast by way of an absolute return fund; and selling the HSBC tracker in favour of an actively managed fund.
We are using 5% from Witan and 5% from the sale of the tracker fund to introduce a 10% allocation to Capital Gearing Trust. It has a big slug of fixed interest and alternative investments designed to generate a positive return in any investment climate.
Given a significant weighting to UK large companies, adding something further down the size scale seems appropriate. Schroder Recovery is our choice to replace the rump of the HSBC tracker’s old weighting.
It invests in firms that have suffered a severe setback in either share price or profitability, and it has held up well in recent market weakness. Managers Kevin Murphy and Nick Kirrage have 75-80% in UK equities, with the remainder in overseas shares.
Echo has had the fewest investment trust holdings. It endured a difficult 2018, with performance weak over the second half of the year sending it into the red with a 7.6% loss. As a result, its five- and seven-year records are the worst among our growth portfolios.
LF Miton UK Value Opportunities was the biggest loser, but it still deserves its place in a higher-risk portfolio. Last year’s sell-off in small and medium-sized companies, where more than 70% of this fund is invested, hurt performance. However, the domestic names that are in bargain territory could bounce very hard in the event of an end to Brexit uncertainty. Manager Andrew Jackson has been buying banks and retailers (among them Lloyds Bank, Royal Bank of Scotland and Next) in the belief that they stand to profit handsomely.
Veritas Asian has also acted as a drag for Echo. Its underperformance over 2018 combined with charges that are higher than the median of its peer group, and a very high unit price means we are ejecting it from our model portfolios.
We are initiating a new position of nearly 12% in JPMorgan Emerging Markets Investment Trust, which is one of the largest global emerging market trusts and boasts highly competitive returns over three, five and 10 years, and putting the remaining 5% from the Veritas sale into Ardevora Global Equity, which has held up well.
We are exiting HSBC FTSE All Share Index, which simply tracks the UK market, in favour of CFP SDL UK Buffettology, a concentrated portfolio of UK growth companies. We are replacing Merian Global Equity with Monks Investment Trust, a far superior performer over three years.
International exposure saved Foxtrot from being the worst growth portfolio over the year (that was Charlie), but its higher-risk nature saw it slide by 9.2%, taking the gloss off longer-term performance.
A 22% allocation to Scottish Mortgage Investment Trust – among the strongest holdings across our models in 2018 – helped stem losses. An 18% allocation to Pantheon International, the private equity fund of funds, also contributed positively. A run for these funds has led us to bank profits and take 5% out of each.
We are also reducing exposure to UK equities by selling Miton UK MicroCap and Merian UK Mid Cap, collectively accounting for 28% of this portfolio, and re-investing 18% in Henderson Smaller Companies Investment Trust. It is a strong candidate for investors seeking exposure to a broad range of UK smaller companies.
With 20% left to play with, we are putting an extra 10% to work in Standard Life Global Smaller Companies and introducing a greater allocation to Japan, where we have just 1% – remiss for a higher-risk, longer-term growth portfolio.
The Asian powerhouse is being tipped as a strong growth market for the long term. Our pick in this space is Baillie Gifford Shin Nippon, which focuses on high-growth smaller companies under the stewardship of Baillie Gifford’s well-regarded Japanese equities desk.
Hermes Global Emerging Markets replaces the underperforming Baring Eastern Trust. The incoming fund has a wider emerging markets remit.
Portfolios undergo biggest shake-up so far
Our models are getting a major rejig for 2019. It’s arguably the biggest shake-up since their inception in January 2012.
We are ditching 16 constituent funds and trusts, with 11 of these leaving our models completely. Another five are being removed from certain portfolios, but they are retaining their places in others. We are introducing 20 new funds, of which 16 have not featured in our list of constituents during 2018. Another four have already featured, but we are increasing our exposure to them by adding them to more models.
Our switches conform with two big trends: the reduction of our allocation to UK equities, notably the domestic-focused small and medium-sized companies that have led the market lower; and the increasing of our allocations to bond funds, amid an uncertain outlook for equity markets.
Strategic bond funds are ‘go anywhere’ funds able to root out the best opportunities across the fixed-income spectrum. Jupiter Strategic Bond, being very risk-averse, is a good t for our medium-risk portfolios Bravo and Golf, while Sanlam Strategic Bond is suitable for investors prepared to take more risk and is being introduced to Hotel, Juliet and Kilo.
Royal London Global Bond Opportunities has a decent yield and is also being added to Juliet to boost its income-generating prowess. We are introducing an element of fixed-income exposure for the first time to Lima, our higher-risk growing income portfolio, through Baillie Gifford Strategic Bond, which is already in Golf, Hotel and Kilo.
The changes are also seeing us wave goodbye to our remaining exposure to index trackers. In a volatile market, the last thing we want to do is follow the market downwards.
Lastly, we are increasing diversification within four portfolios – namely Alpha, Delta, Golf and Juliet – by adding a seventh fund in common with our eight other models.
All of the model portfolio constituents are Money Observer Rated Funds for 2019.
Please click here to see larger version of table
The Income Portfolios
Choices to suit different income needs
Six models are designed for those looking for income – again, three for medium-risk and three for higher-risk investors. Two offer immediate income and make considerable use of bonds, property and derivatives. Our growing income portfolios prioritise capital growth to support future dividend increases, so they mainly rely on equity income funds and trusts, while our balanced income portfolios seek to strike a balance between current income and future capital growth.
A significant allocation to equities – particularly UK equities, which have struggled amid Brexit-related headwinds – has held back our income portfolios over the past year. They have all incurred losses in the mid to high single digits and underperformed the FTSE UK Private Investor Income index. However, this benchmark has 40% in bonds and 10% in cash, which is not reflected in any of our income portfolios. Five out of the six portfolios lost less than the FTSE All-Share index.
Golf’s historic yield, at 5.3%, was the highest of all our income portfolios. However, a significant reduction in its UK equities holding from 50% to 36% did little to help its performance during 2018. The portfolio lost 5.2%, having suffered mostly at the hands of Premier Optimum Income.
It replaced Schroder Income Maximiser, but in hindsight this was a mistake and we have reversed the change this year while shaving the allocation by around 3%. Poor stockpicking has seen the Premier fund slide by 15%, while the Schroders fund has managed a modest loss of under 2%.
Both use options to give up some capital growth in exchange for extra income and both target income of 7% a year. The Premier fund is falling woefully short of this in its current financial year, whereas the Schroders fund has hit its income target every year since its launch in 2005.
The erratic performance of Invesco Monthly Income Plus means it has been shrinking as more compelling options come along, so we are replacing it this year with the cautiously positioned Jupiter Strategic Bond, albeit with a 5% lower allocation.
We are reducing the weighting to Picton Property Income Investment Trust by 8%, leaving 16%, in order to spread assets further and introduce a seventh holding in line with our other portfolios. Fidelity Multi Asset Income is our pick. It aims to generate a natural and sustainable income by investing in a broad range of assets to diversify risk and preserve investors’ capital. These changes now see the portfolio with a historic yield of 4.9%.
Hotel slid by 6.4% during 2018; this portfolio, which yielded 3.9%, now needs more ‘balance’, as its category suggests. Until recently, we have been happy with a heavy skew towards equities, but it is time to double the fixed-interest content from 16%.
We are removing Threadneedle UK Equity Income. Like City of London Investment Trust, its focus is on big blue-chips and there is some overlap in holdings. Hotel also holds Man GLG UK Income, which does not own many of the names typically owned by larger dividend-focused funds, so it is a good complement in this regard.
Sarasin Global Higher Dividend, the portfolio’s second-best performer during 2018, and Artemis Global Income, its worst, are also complementary – Sarasin focuses on global growth themes and Artemis on global value stocks.
We are taking 4% out of the Sarasin fund and redeploying this in the Baillie Gifford Strategic Bond, the best performer over a year.
Proceeds from the Threadneedle fund are going into new entrant Sanlam Strategic Bond. It has won a string of accolades in the past year and is truly strategic in its approach. Its management moved to Man GLG when Man acquired Sanlam’s strategic bond business in October 2018, but the portfolio managers moved as part of the deal and the strategy – focused on finding global value opportunities in corporate and government bonds – remains the same.
Managers Craig Veysey and Francois Kotze aim to produce a high monthly income and capital growth potential by unearthing attractively valued bonds, primarily within the investment-grade and higher credit-quality section of sub-investment-grade stock. These changes lift the portfolio’s historic yield to a little over 4%.
India is our second-best performing income portfolio, having lost 5.8%. This is testament to the strong stock selection of the managers of its seven constituent funds and a lower allocation to UK equities than some of our other models. The portfolio has almost 90% of its assets in equities, in line with its income growth mandate, of which around 27% is in the UK stockmarket.
Royal London Sterling Extra Yield Bond is the only constituent that produced a positive return during 2018. Henderson International Income Investment Trust also held up comparatively well, given that it excludes the UK.
India’s historic yield is a very respectable 3.6%. It requires much less of a revamp than some of our other models: the only change we are making is replacing the large £4 billion Threadneedle UK Equity Income fund, which has performed adequately, with Troy Income & Growth Investment Trust (TIGT), which has steadily outperformed its peer group over one, three, five and 10 years. It is a particularly good option for relatively cautious investors, because it takes capital protection as its main objective and offers a more defensive way of accessing the UK stockmarket.
Property and infrastructure form 10% of the trust. These holdings typically generate a stable flow of income underpinned by rents. Moreover, during a year of capricious markets, they have provided some resilience. Most of Troy’s outperformance during 2018 came in the fourth quarter when it shielded investors from losses incurred as ‘risk off’ sentiment gripped markets. We believe it is therefore well-placed to withstand a Brexit shock.
Juliet lost 7.6% during 2018 and ended the year with a yield of 4.5%. Given its remit to prioritise immediate income, we are making a few changes to boost the yield to at least 5%.
Marlborough Global Bond and Picton Property Income Investment Trust were the portfolio’s most resilient constituents during the year, but they have among the lowest yields of 3.2% and 4.2% respectively. Artemis Global Income is Juliet’s largest constituent, but it has the lowest yield of 2.9%.
The Marlborough fund is being replaced by Sanlam Strategic Bond, also a newcomer to the Hotel and Kilo portfolios. It offers a bit more oomph from a portfolio of fixed-income securities, and pays a much higher yield.
We are reducing the weightings to the Picton and Artemis funds by 5% each to free up capital for redeployment in a fund with greater potential for those who want instant income. To this end we are allocating 10% to Royal London Global Bond Opportunities. It yields close to 6% from a mix of nearly 200 rated and unrated bonds.
The fund is run by Eric Holt and Rachid Semaoune, who have 30 and 18 years’ experience in credit markets respectively. Despite the 30-year bull market in bonds running out of steam, they believe the present pricing of corporate bonds is attractive over the medium term, while the level of income is appealing given the prospect of interest rates staying lower for longer.
As in the Golf portfolio, Schroder Income Maximiser has replaced the disappointing Premier Optimum Income.
Schroder Income is the standout performer for Kilo, surprisingly given that its value-driven approach has been truly out of favour. The fund lost 1% during 2018, but Kilo lost 9.7%, making it the worst performer of all of our income portfolios. The main reason for this was its near-50% weighting to UK equities and high exposure to UK smaller companies.
Typically domestically focused, these have fallen prey to Brexit uncertainty and are trading on discounts to the wider market not seen since the financial crisis. As a result, Chelverton UK Equity Income, the portfolio’s largest holding, accounting for 17% of assets, was among several constituent funds to notch up a double-digit loss last year.
Lowland Investment Trust is size-agnostic but also has a significant allocation to smaller firms. It has recovered strongly following previous setbacks, so it is our preference to keep it. In fact, we are taking 5% from the sale of the Chelverton fund to increase Lowland’s weighting to almost 16%. The remaining 12% from Chelverton is going into Sanlam Strategic Bond, which is also being introduced to Hotel and Juliet.
We added the income shares of JPMorgan European Investment Trust at the start of 2018, but are replacing these with Murray International Investment Trust shares. This is simply because we want to widen Kilo’s global exposure to complement its holding in Artemis Global Income. Both have had a difficult recent past, but we feel their focus on fundamental value and refusal to bend to being more benchmark-aware will serve the portfolio well now that momentum-driven strategies are less in the ascendant. Before these changes, the portfolio yielded 4%. The historic yield is now 4.1%.
Lima lost 8.5% in 2018 but remains the best-performing income portfolio over three, five and seven years. It yields 3.5%, despite the presence of Scottish Mortgage Investment Trust. The FTSE-100 listed investment company yields just 0.6%, so it is an unusual income choice.
It is, once again, this portfolio’s top performer – and, in fact, among the best-performing constituent across all our models last year. Its main purpose in this portfolio is to serve as a means for investors to withdraw capital, should income payments fall short elsewhere. We are replacing it in 2019 with Fundsmith Equity, which should be able to play a similar role but with less volatility.
Chelverton UK Equity Income is also leaving Lima, as it has too much smaller-companies exposure when combined with Lowland Investment Trust. We are attracted to Temple Bar Investment Trust as Chelverton’s replacement. It’s a contrarian fund that is quite conservatively managed, so it should thrive in the current environment.
Pure UK equity exposure is being pared back to 10% in Lowland (from 17%) and 10% in Temple Bar (down from 14% in Chelverton). The remainder is being split between existing allocations to JPMorgan European Income, Schroder Oriental Income and Utilico Emerging Markets.
Artemis Global Income, which accounted for around 13% of assets, is a third departure from Lima. We are making a straight swap into Baillie Gifford Strategic Bond as we introduce a small allocation to fixed income. The incoming fund seeks income and capital growth from a portfolio split 70/30 between investment-grade and high-yield bonds. The historic yield on the portfolio following these changes is 3.3%.
Note: We use three of the seven FTSE Private Investor multi-asset indices for measuring the comparative performance of our model portfolios. All are based on the performance of multi-asset benchmarks with various levels of historical volatility: Income is lower than average; Balanced is higher than average; and Growth has high historical volatility. The table shows how this is accounted for in asset allocation. Their performance is based on recognised indices for each of the asset classes. For example, global ex-UK equities is represented by the FTSE All-World ex UK index. Note that all these indices have an allocation to cash, which we don’t allocate to in our models. Most of our models also have a far lower allocation to bonds than is recommended in the benchmarks.
Picton Property Income Investment Trust
Note: We no longer have factsheet information for Picton Property Income Investment Trust. This is because the trust is now a REIT and on conversion ceased to be part of the Association of Investment Companies (AIC), which produces the factsheet information in conjunction with Morningstar.