This blog series begins here.
This post is about what I’ve learnt about how portfolio design is practiced. There may be grounds for approaching it in a completely different way, given what we know about climate change. In the words of Rupert Read and Samuel Alexander, ‘this civilisation is ended’. Our financial systems are delicate and climate change is a brutal force. How we choose to use, or turn on its head, knowledge of these existing practices will be a topic for another post. What’s certain is that we can’t insure against climate change. We can, however, choose to at least dial down our part in it.
A necessary element of pension fund management is portfolio design. IFAs assess your ‘attitude to risk’, along with your age, stage and other circumstances, and that has a bearing on the volatility of the portfolio they recommend. One way of increasing or decreasing the risk is to dial up or down the percentage of equities in the portfolio, i.e. shares. Other chunks of the portfolio may be held in bonds (fixed income loans), gilts (funds that invest primarily in government bonds), property etc. This is not to say that bonds and gilts are always low risk.
As well as considering volatility, other ways to mitigate risk when putting a portfolio design together might be to adjust geographical spread and/or sector spread.
Various companies, such as ii and Hargreaves Lansdown, have put together model portfolios that DIY investors can crib. These give insights into what balances portfolios tend to reflect. It’s possible to set up these portfolios virtually, and then analyse them. When you build up your own portfolio of investments, you can take inspiration from the balance of the model portfolios, tweaking as you choose to reflect your own circumstances and preferences. It’s all a bit of a black art, but there are some clues. This post is a hotchpotch of some of those clues, and no doubt misses important bits of received wisdom as I’m an amateur at this. Choosing individual investments within the portfolio is a subject for another post.
Where to Find Model Portfolios
Some places where you can find portfolio inspiration are:
- The ii Ethical Growth Portfolio (ii have other model portfolios too)
- Ready-made investment portfolios from Hargreaves Lansdown – this is more configurable for risk, but there is no ethical angle
- Castlefield B.E.S.T. Sustainable Portfolio Fund – this is a fund of funds, rather than a model portfolio. As there is a management charge for the fund, investing in it directly seems on the face of it to be an expensive option, but it’s possible to analyse it for balance and for fund inspiration.
- The ‘Sample Impact Fund Portfolio’ on the website for ‘thepath’ – this lists 12 funds, but not their proportions. (The Path are interesting – they talk about 80% alignment of investments with UN sustainable development goals. I plan to talk about IFAs in another post.)
How to Analyse Virtual Portfolios
I do this using a free account on Trustnet. As an example, to set up the ii Ethical Wealth Portfolio:
- Log in on trustnet.com
- Click the ‘Portfolio’ tab
- Click the black ‘Add a new portfolio’ button
- Add holdings – this always seems a bit tricksy:
- First, select ‘Investment Type’ – most come under ‘IA Unit Trusts and OEICs’, but three in this case come under ‘Investment Trust’ and one is an Exchange Traded Fund (ETF). You can find out which they are by clicking on them on the ii website.
- Select ‘Management Group’. To find this out, click on the investment in the portfolio list on the ii website, e.g. ‘Royal London Sustainable Leaders Acc’, then scroll down and click ‘View ‘Key Investor Information Document – KIID’ (PDF)‘. On the banner, it says: ‘Managed by RLUM Limited’. I’ve selected the closest match and hoped I’ve got it right – ‘RLUM (CIS) Ltd’.
- Now select the fund – again I’m winging it with the closest match, which looks to be: ‘Royal London Sustainable Leaders Trust C Acc’.
- Hope you’ve ended up with the right one
- Click ‘Go’
- Choose today as the date of purchase (you’ll still be able to see the history) and enter an amount. You might choose to go with the amounts suggested in the model portfolio, in this case £2K. (Note that if you go back to edit this, you need to clear the ‘Number of units’ box before you add a new value.)
- Click save.
- Once the holdings are added, check it adds up to the right sort of amount.
Exploring your Virtual Portfolio
Here are some things you can do:
- See how each of the funds has performed over any period, e.g. the last year. To do this, click on the ‘Analysis’ tab, choose e.g. ‘1y’ from the ‘Timescale’ drop-down, choose the ‘show both’ radio button and click ‘Update chart’. Some of the funds in this case are new, so you can only see a few months, but BMO seems to be the winner, with iShares trailing at the back. You can also see that Impact Healthcare took the biggest dip during the COVID crash (surprising on the face of it), while Trojan Ethical appeared to weather the storm with the least turbulance. The ‘My Portfolio’ line on the graph gives you an idea of the stability of the blend you’ve created.
- Check out the risk analysis. Go to the ‘Analyse risk exposure’ tab. Here you can see each fund plotted on the FE Fundinfo risk score, which has cash pegged at zero and the FTSE 100 at 100. There are three very high risk investments there, well above the 100 mark, and the overall portfolio risk is calculated at 69. I have noted that the risk score for a portfolio appears to be something other than just a weighted average – perhaps the calculation looks at e.g. diversification too.
- Check out the broad asset allocation. First, go to the ‘Valuation’ tab and look at ‘Asset allocation at a glance’. We have 70% equity, 10% fixed interest, 5% property. The other 15% are a bit more obscure to me – 10% ‘mixed asset’ and 5% ‘Hedge’. There’s a rule of thumb that says that your percentage of equities should be 100 minus your age (more on this later), so without giving too much away, this portfolio is going to need some adjusting in our case.
- Check out the regional allocation. Do ‘Click here for a more detailed analysis’. Only 24% UK – that’s interesting. Note the warning down the bottom: ‘Portion of portfolio included in the scan: 75.07%’. That’s a very significant chunk missing!
- Check out the sectors. It looks to be well spread.
- Check out the top holdings. None make up more than 1.4% of the portfolio, so that’s good. Google the companies. The first two are healthcare. Then there’s ‘Nextera Energy’, which describes itself as a ‘clean energy company’. I googled ‘Nextera nuclear’ and sure enough, they operate ‘one of the largest nuclear power fleets in the United States’. That’s not for me, and nor is Tata; if I consider any of these funds I’ll need to work out what they’re invested in.
A Few Articles and Quotes about Asset Allocation
I’ll reproduce some of my Trustnet analysis below, but first, here are a few quotes and links about the black arts of portfolio creation.
Plain English Finance: ‘100 Minus Your Age’:
‘For some decades now, many financial advisers have used a basic rule of thumb that says that the percentage of your savings you hold in “risky” equities (shares) should be “100 minus your age”, with the rest being held in “low risk” bonds … Given what has happened to interest rates, life expectancy and retirement age, some financial advisers have advocated simply changing the rule to “110 – or even 120 minus your age” … My suggestion is that you might think about “aggressive” vs. “defensive” in your allocation, rather than the more simplistic original idea of “equities” vs. “bonds”.’
Motley Fool: How to Think About Asset Allocation:
‘Any money you don’t need for more than five to seven years is a candidate for the stock market’
The Motley Fool article has an ‘Intelligent Asset Allocator’, which suggests that if you can tolerate a loss of 10/15/20% of your portfolio, then you might allocate 30/40/50% to shares, respectively.
‘ETFs are tracker funds and offer fewer diversification benefits … property funds often look quite stable then experience severe corrections … just because I’m familiar with the UK market that doesn’t make it any less risky … my first goal is to meet the target risk level, and not to match the target asset allocation … maximum amount of diversification … This is based mostly on gut-feeling and some basic analysis’.
How Many Funds?
When I first put together a portfolio, I reasoned that there was no point in having a large number of funds because the funds themselves are each made up of numerous investments, and each has a fund manager looking after balance, mitigating risk, thinking about upcoming events etc. I thought it would keep things simple to just have a small number of 4 or 5 funds. But an IFA I spoke to said they would normally look at 12 to 18 funds. I have now come to agree – each fund does seem to have its own character and behaviour, and though they generally follow a similar broad trend in terms of ups and downs, increasing the number of funds does seem to mitigate risk.
If you decide to switch a fund, it also feels easier moving a relatively small pot of money. It takes days to switch money between funds, and in that time your money is out of the system – you can miss out on a big share price movement or fall foul of a change in the fortunes of the pound. (Though these things can work both ways of course!)
A Random Thought about Long Gilts
At one point we had a fund of ‘long gilts’ from a workplace pension. I noticed that it did a great job of evening things out whenever our equities took a hit. It seemed to almost mirror their behaviour. The fund was not in itself low risk, for reasons I barely understand, and in the end it got automatically rolled into a lower risk fund. After that, the portfolio overall felt more volatile. There’s an article describing this effect here (spoiler – it doesn’t always work): Monevator: How to Protect Your Portfolio in a Crisis
An Analysis of Model Portfolios
Below are some numbers from my model portfolio analysis. I’ve lost track at this point of whether this is useful or if I’ve just disappeared down a pointlessly obsessive rabbit hole. But hopefully when I put my portfolio together I can refer to this and gain some insight.
|Hargreaves Lansdown Cautious *||The Path Sample (assuming equal fund allocation)||ii Ethical Growth|
|% scanned in analysis||68.65||100?||75|
|FE fundinfo risk score||23||64||69|
|% Fixed Interest||26.64||32.10||10|
|% Mixed Asset||45.67||10|
|Commodity /Energy %||–||7.27||–|
|North America %||10.5|
|Money Market %||6.6||2.3||2.2|
|Europe ex UK %||6.9|
|Elsewhere / International |
/ Not Specified / Other %
|8.2 + 3.5 + 23.8||Other: 20.4||28.0|
|Health Care %||5.6||6.6|
|Consumer Staples %||3.8||5.3|
|Gov. Bonds %||4.1|
|Other Holdings %||72.8 (yikes!)||54.9 (still yikes!)||35.4|
* – Note: I modelled the Hargreaves Lansdown portfolio about a year ago, so it’s probably a bit different today
** – ‘The higher the Sharpe ratio the better … As the Sharpe ratio increases, so does the risk-adjusted performance’ – Trustnet webapp. See also Morningstar