Interactive Investor

Are these the only two funds DIY investors need to own?

A managing director at JP Morgan, who has 35 years of experience under his belt, says that in principle investors only need to hold two funds. Sam Benstead examines the pros and cons of this approach.

11th October 2023 12:18

by Sam Benstead from interactive investor

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What is the correct number of funds to hold in a portfolio? A typical fund of funds run by a professional typically holds between 10 and 20, but some can own even more.

To build a diversified portfolio, it makes sense to include a range of investment sectors, which may include emerging market equities, private equity, and growth and value shares. But the more funds you own and the more diversified you become, the harder it is to keep tabs on a portfolio.

But what if it was far simpler than that, and owning just two funds was enough for most investors?

This is the view of Jan Loeys, a managing director at JP Morgan who has a PhD in economics, more than 35 years experience at the bank, and who held previous roles at central banks and business schools.

He says that in principle, you do not really need more than two funds: an all-of-market global equity fund and a bond fund in your own currency, with weights adjusted for the risk and return needs of an investor.

“You are going to be fine just doing that. It gives you simplicity. It is easy to understand what you have, and it gives you liquidity as these are large markets you can easily move in [and] out of. It can be done in a passive form, which minimises costs.”

Moreover, he says that the bond fund does not have to be global as it adds foreign currency risk. For investors with particular market views, such as on the future of a theme such as technology, then they could simply add an exchange-traded fund (ETF) that tracks such a market, Loeys says.

For investors wanting to exclude certain sectors, such as oil companies, they can select a global fund that makes the relevant omissions, he adds.

“Overall, there is a lot of value in simply starting with two funds: a global equity one and a bond fund in your own currency,” he said.

Furthermore, Loeys says that due to sharing of financial information and research, there are unlikely to be any silver bullets for strong returns, such as by identifying value or growth shares.

Instead, he says that: “My experience is that the great majority of what used to be superior has by now been arbitraged away. There is not a lot of cheap structural alpha left, I am afraid. We are back to the hard work of having to take active views, short or long term, on the market.

Is it really that simple?

But is owning a global tracker fund alongside a local currency bond fund, really the best and most simple way of investing?

One passive global fund that has served investors well over the past decade has been the Super-60 rated iShares Core MSCI World ETF USD Acc GBP (LSE:SWDA), which is a market cap weighted index of around 1,500 stocks from developed markets.

It has risen 192% over the past 10 years, compared with 135% for the typical global equities fund. Fees are low at 0.2%.

However, looking under the bonnet of such a fund reveals that the strong performance can be attributed to its high weighting to US shares, currently at 70% of the portfolio. Therefore, due to the premium rating on US stocks, its price-to-earnings (p/e) ratio is currently an expensive 19 times – which may worry some investors. 

The clear pushback is that while the future may look like the recent past, with US shares leading global indices, there is no guarantee this will happen. Global indices now have such a high weighting to US shares that by owning a global tracker investors could be setting themselves up for volatility, and even a sustained period of poor returns, if US share p/e multiples fall back in line with global peers. 

Dan Brocklebank, of Orbis Investment Management, says that investors solely relying on this approach are taking more risk than they realise, as they are paying a lot for shares and profit margins are likely to revert back to normal levels.

His view is that while it may seem like today’s top stocks will keep their crown in a decade's time, history shows inflated valuations come before a change in market leadership.

Brocklebank says: “There is always the argument that the companies will stay the same, but competition will come in and disrupt the top firms. You don’t want to be saying that this time is different. You need to put the odds in your favour and owning market capped weighted US and global tracker funds does not put the odds in your favour.”

Funds to diversify a portfolio further

Instead, a more balanced passive approach to global equities could provide greater diversification and therefore help smooth out returns for investors. Adding index funds or ETFs that own UK, European and Japanese shares would bring down a portfolio’s overall valuation multiple, which could make it more resilient if we enter another period of rising interest rates, and also help it capture returns from other markets if US dominance fades.  

Super 60 investment ideas to consider include Fidelity Index UK, HSBC Japan Index and Vanguard FTSE Developed Europe ex UK ETF (LSE:VERX). This approach will keep costs low, but does require investors to manage their own geographic asset allocation and rebalance their portfolio if one market becomes too large an allocation. There is also a case to be made for holding a dedicated emerging markets tracker as well, such as Fidelity Index Emerging Markets.

Alternatively, if you want to have access to passive strategies at low cost and high convenience, with more balanced exposure to the US, you could consider something such as Vanguard LifeStrategy 100% Equity, which is made up of about 10 separate equity index funds covering the main markets, from the US and the UK to Japan and emerging markets. Vanguard LifeStrategy 60% and Vanguard LifeStrategy 80% Equity have allocations to bonds as well.

Another approach, according to Brocklebank, would be to include some funds that are “equal weighted”, meaning they own the same amount of every stock.

Examples include the Invesco S&P 500 Equal Weight Ucits ETF and Invesco NASDAQ-100 Equal Weight Ucits ETF.

In terms of bond funds in a portfolio, just relying on investment grade local currency corporate bonds as per Loeys suggestion, does restrict investors hungry for higher yields from their fixed-income allocation – but nonetheless is a good starting point from which an investor can then add more adventurous bond funds. 

Super 60-rated Rathbone Ethical Bond yields 5% and has a low ongoing charge of 0.66%. It’s a top-quartile performer relative to peers over the past five years, and could be considered a core bond allocation. 

For those seeking higher income – but at greater risk – the M&G Emerging Market Bond fund yields nearly 7%, in sterling, while high-yield bond fund Royal London Sterling Extra Yield yields just over 7%. Both are Super 60 investment ideas. 

Investors looking for a true one-stop shop bond fund may be better suited to a strategic bond fund, which can invest globally across different types of bonds. Two funds that invest in this manner are Super-60 rated M&G Global Macro Bond and Jupiter Strategic Bond. They currently yield around 5%.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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