May
2022
You say tomato…..
DIY Investor
4 May 2022
Do it yourself, or put it into a global fund and leave it to the experts – our analysts debate the merits of each approach….
Disclaimer
This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
William Heathcoat Amory
This year is the Platinum Jubilee. A moment to celebrate, not just for royalists, but for portfolio theorists too. For it is 70 years since Harry Markowitz published his seminal paper “Portfolio Selection”, which appeared in the Journal of Finance in March 1952.
Markowitz provided – for the first time – a quantitative framework to assess the benefits of diversification of a given portfolio, setting out the idea of a risk-return trade-off. Investors wishing to make higher returns must accept higher risks.
For the past decade, investors could be forgiven for having forgotten this simple premise. Because over this period, all that has really mattered for investors in terms of risk and return is that they have been invested in growth stocks and, ideally, the biggest companies in global equity markets.
Market leadership has at times been very narrowly focussed, with Apple, Amazon, and Microsoft having alone accounted for some 50% of the S&P 500’s total returns over 2020. Scottish Mortgage’s managers have an approach that in some ways turns Markowitz’s ideas on its head. They believe – and have delivered very strong returns to shareholders over the last decade on this premise – that what really matters is being able to benefit from the asymmetry of equity market investing.
They invest in a portfolio of high growth stocks, each of which has the potential to deliver radical change. The portfolio is highly concentrated, and whilst diversified itself, it represents a relatively pure exposure to ‘growth’. The short-term risks of this lack of ‘diversification’ are well illustrated by SMT’s underperformance this year and are why the managers continue to emphasise that investors should hold the trust as part of a wider portfolio.
Over the very long term (10 years or more), investors may be well placed to have SMT as part of their portfolio. However, over time there will likely be good times to buy the trust and less good depending on broader market dynamics. The graph below shows how the market has rotated between favouring growth stocks and then into value and back again over the past ten years.
For those investors without the confidence to decide when to add or when to trim, there may be better alternatives for a ‘core’ exposure. Other trusts offer much more diversified exposures, but each of these has the same – unquantifiable – risk that a manager or management team may just get it wrong. Investing is as much a behavioural and psychological challenge as much as it is an intellectual one. And as such, it often makes sense to diversify by management team too.
Past performance is not a reliable indicator of future results
Several trusts offer exposure to a diversified group of managers, which, when combined, provide a high level of underlying diversification and no key man risk. Witan (WTN) and Alliance Trust (ATST) both have similar approaches, each with its own nuances. However, both provide an elegant “fire and forget” approach to active management of global equities. Both employ a range of different underlying managers for proportions of the portfolio, with each manager’s performance under constant observation. Though ATST takes it one step further, allocating funds to their delegated managers is such a way as to diversify away any active risk (relative to the MSCI ACWI), preserving the benefits of active management without holding strong style biases relative to the index. One of the advantages of an investment trust over an open-ended fund is the presence of an independent board, which can change managers on shareholders’ behalf if they no longer cut the mustard. This is a huge advantage for long term investors looking to benefit from compounding returns. Unlike an open-ended fund where a manager is very unlikely to call time on themselves for underperformance (turkeys voting for Christmas), a trust’s board exists in part to hold the managers to account and can relatively easily switch horses if they fall short. Shareholders can therefore rest easy that their interests are being looked after by the board, and they can benefit from long term compounding without the need to crystallise a gain if the manager starts to lose their edge. With ATST and WTN, the theoretical barrier to changing managers is significantly lower because of both the multi-manager approach and also because the ‘brand’ of each trust is clearly not aligned with any one management company or team.
F&C Investment Trust (FCIT) has a slightly different approach to multi-manager solutions. While its lead manager Paul Niven utilises external fund managers in order to achieve diversified exposure to global equities, he also makes substantial use of the internal strategies at BMO, capitalising on their natural synergies to achieve what he believes is the best outcome for shareholders. Paul’s reach extends beyond listed equities however, as he also taps into private equity opportunities, utilising BMO’s networks to pick what he believes are some of the world’s best private equity managers. FCIT benefits not only from the active decisions of its delegated managers but also from Paul’s own proactive asset allocation decisions, as he weighs regions and styles in accordance with what he believes are most likely to outperform. This approach has been a recent boon to FCIT’s shareholders, outperforming the MSCI ACWI over the last 12 months and ranking as the third best performing global equity trust over the period.
Over recent times – where the market has whipsawed between favouring extremes of growth or value – it is arguably unlikely that any of these broadly spread trusts will perform particularly well. However, over the longer term, enthusiasm for one sector or narrow range of stocks (remember the ‘meme stocks’…?) tends to wax and wane. WTN, ATST and FCIT enable investors to take a long-term view without backing a particular style, manager or theme.
A similar effect, although not a multimanager fund, can be seen in the performance characteristics of JPMorgan American (JAM). JAM offers a differentiated approach to other US investment trusts, being a blend of two highly active but distinct investment styles. Co-manager Timothy Parton manages JAM’s growth allocation with a highly concentrated portfolio of up to 20 of his highest conviction picks, whilst co-manager Jonathan Simon does the same with a value portfolio. As such, JAM offers investors a true ‘one-stop-shop’ for US equities, which has outperformed the S&P 500 since the managers took over in June 2019, which is no small task given the majority of ‘core’ managers have underperformed over this period, which seen market sentiment vacillate between growth and value.
Within the investment trust world, there are a wide variety of managers offering different exposures and styles, many of them using the structure to boost returns for shareholders. Occasionally, these trusts are available at a discount to NAV. There are several multi-manager trusts that aim to boost returns through discounts narrowing or trusts’ structural ability to hold very different assets. For example, Momentum Multi-Asset Value Trust (MAVT) invests in a broad range of assets, including UK and overseas equities, credit, and specialist alternative assets, using a value-based approach across its investments. As such, MAVT provides investors with an off-the-shelf multi-asset portfolio that can be used as a stand-alone holding for a value-orientated investor or to diversify a portfolio with exposures to global growth stocks. With many trusts exposed to growth, the diversification aspect of MAVT’s value exposure may appeal particularly to those seeking a real alternative.
MIGO Opportunities (MIGO) offers exposure to a diversified pool of closed-ended investment companies. These often operate in highly specialised areas and are trading on substantial discounts to their intrinsic value, at least in the view of MIGO’s managers – Nick Greenwood and Charlotte Cuthbertson . Nick and Charlotte’s approach often leads them to contrarian positions, seeking out unappreciated assets with intrinsic value that is unrecognised by the wider market – an experience Nick describes as ‘like waiting for a bus, at times’. Performance can come in fits and starts, but MIGO’s low demonstrated NAV correlation to both broader equity markets and a 60/40 equity/bond portfolio is a reflection of this contrarian approach and a reminder that diversification is not about the number of holdings, but about holding different assets which perform well in different environments.
BMO Managed Portfolio is managed by the highly experienced Peter Hewitt, who has been applying his distinctive style of building portfolios of investment trusts for several decades. Investors can buy two separate share classes with distinct portfolios and objectives to suit their needs. The Growth share class (BMPG) aims to maximise total returns, principally via capital growth. The objective of the Income share class (BMPI) is to provide a level of income exceeding that of the FTSE All-Share Index, along with the potential for growth. Peter seeks highly active trust managers with long term horizons running strategies that fit into his top-down views on investment themes, style tilts and macroeconomic and market trends. In recent years Peter has tilted the portfolio towards growth-orientated strategies, which has driven strong performance over the medium and long term. Peter diversifies across geographies, sectors, asset classes and investment styles when building portfolios, buying a wide range of trusts from sector specialists in biotechnology to alternative hedging strategies designed to protect capital during periods of market stress.
All of these trusts offer highly active, not to mention distinctive, underlying exposures to global equities. Investing in funds or trusts is all about accessing diversification. However, after a long run bull run for equities, which has arguably benefitted those least diversified, perhaps it is high time for regime change? Backing any of the trusts above is no guarantee of success, but it may allow the investor to take an enviably long-term view by backing active management rather than a particular manager to navigate markets till the Octogintennial Jubilee and beyond.
Neema Nabavian
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