How to build a World Cup-winning portfolio

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Football fever is sweeping the nation again after the men’s World Cup kicked off. There are parallels between the beautiful game and investing, particularly when it comes to team selection. 

In our latest On The Money podcast episode, host Kyle Caldwell and our head of markets, Richard Hunter, draw comparisons between investment types and positions on the pitch - goalkeepers, defenders, midfielders, and attackers. The duo also discuss the importance of having a ‘squad’ of investments that are ready to be brought on as substitutes when required.

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to the latest On The Money podcast, a weekly look at how to make the most out of your savings and investments. 

Football fever is sweeping the nation once again with the men’s World Cup taking place. Now, for investors, there are a number of parallels that can be drawn with the beautiful game, particularly when it comes to team selection. 

Joining me to discuss the types of investments that fit into each position on the pitch is someone who, despite supporting a different team in red than myself, shares a passion for both football and investing and that’s Richard Hunter, head of markets at interactive investor. Richard, thanks for coming on.

Richard Hunter, head of markets at interactive investor: No worries, Kyle, and people will have to guess from our accents who those teams might be.

Kyle Caldwell: Well, it’s fair to say we both won the league, but in the last two seasons. But I think it’s pretty obvious [which club teams we support] for most people listening.

So, Richard, before we run through the types of investments and attributes for different positions on the pitch, what would you say are the important considerations for when you’ve got a blank sheet of paper and you’re selecting your ‘team’ of investments?

Richard Hunter: Yeah, absolutely, and starting at the very beginning, you need to build your team depending on your attitude to risk. We’ll get to the analogy later, but if you’re going to go for all strikers, that’s going to be pretty punchy and high risk. If you’re going to go for a more defensive set-up then, obviously, that’s something where you cannot be exposed to those high-risk investments. And the chances are, as with selecting a team, you’ll take an element of mixture of all the positions.

Kyle Caldwell: Indeed. That’s the central thread to this podcast episode. In common with football, it’s important to have a mixture of different skillsets. In the investment world, doing so helps you achieve diversification, which is one of the golden rules of investing. It gives your portfolio balance, and it helps to reduce risk.

We’re going to go through the types of investments and attributes for each position on the pitch. You’ll start off on each occasion, and then I’ll chip in. So, let’s start with the goalkeeper. In the football world, having a good goalkeeper is the solid foundation of a team. You’re looking for a safe pair of hands. So, which types of investments fit into this position?

Richard Hunter: Yeah. I mean, the obvious things are the lowest risk on the scale that you can imagine, so that’s cash. Although there is a caveat there that over the long term cash on its own will be eroded by inflation. So, that’s just always something to bear in mind.

That being said, investors should have a rainy day fund, which will be cash, often described as, let’s say, being six months’ salary just in case the unexpected should happen.

The other thing is pretty straightforward and not necessarily equity-related things like life insurance products either for you or for your family in terms of something that is easily redeemable.

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Kyle Caldwell: I completely agree. Beyond the rainy day funds, in an investment portfolio, the lowest-risk type of funds, the goalkeeper, is money market funds. So, these funds invest in bonds that are considered very high quality and they have short lifespans.

The fund managers of money market funds are constantly investing in these bonds and recycling the bonds and generating a certain level of income for investors.

Typically, a money market fund will generate a level of income that is around the level of UK interest rates. So, at the moment, money market funds will typically yield around 3.75%.

But as you mentioned, Richard, it’s really important to have the right balance and not have too much of a portfolio in cash. Because, as you say, history shows us that cash returns tend to be eroded by inflation, which is the Achilles heel for cash.

Let’s now move on to the defensive part of a portfolio. So, like in football, you want your defenders to give your portfolio plenty of protection and limit losses as much as possible. Which types of investments fit into the defensive area?

Richard Hunter: Yeah. You’re absolutely right, strong and stable. I guess because we’re not really moving into the medium-term or medium-risk sort of profile at the moment, you’d probably put government bonds in there, UK government bonds or gilts.

Gilts are so called because they used to be gilt-edged certificates, and there’s never been an occasion of the UK government defaulting on its borrowing, unlike some other countries. So, that’s one of the things which gives your portfolio a solid foundation.

I think it’s fair to say these days that you’re probably talking about blue-chip equities as well as being low to maybe medium risk on occasion. But if you look at the blue chips within the FTSE 100, for example, there’s a lot of stable, established cash-generative companies in there.

Kyle Caldwell: In the world of funds, there’s lots of different types of bond funds. The ones that I see as being potential defenders are the ones that give you the most flexibility, so they can invest in any type of bonds. It is the fund manager’s job to invest in the best opportunities, but also they’re looking at trying to reduce downside risk as well. So, these funds are typically called strategic bond funds.

You might find that they’re called global bond funds as well. It’s the job of the fund managers to take a view on where interest rates are, and where inflation and interest rates are potentially heading, and then to invest the funds accordingly to manage the risk of both. Inflation and interest rates are both key for bond returns over different time periods.

Another thing that I’d also consider for the defensive area of a portfolio are wealth preservation investment trusts. So, three to bear to mind are Capital Gearing Ord (LSE:CGT), Personal Assets Ord (LSE:PNL), and Ruffer Investment Company (LSE:RICA).

The job of such portfolios is to manage downside risk. So, if we have a sudden and heavy sell-off in the global stock market, you’d expect these funds to limit losses as much as possible, and they will outperform potentially. Well, that’s what they’re hoping to achieve when markets fall.

Of course you’ll see on lots of marketing literature that historic returns do not necessarily mean that that’s going to be repeated in the future. But if you look back at how those funds have performed during risk-off periods, they have held up very well.

Each of those funds also has a decent chunk of exposure to bonds. So, you might think a wealth preservation trust will be an option for you instead of a bond fund because you are already getting a lot of bond exposure through those funds as well.

Let’s now move on to the ‘midfield’ part of a portfolio. I actually think this is the part of a portfolio that gives you the biggest team-selection headache. There’s lots of different options for investors.

Like any good midfielder, you want them to be the engine room of the portfolio, someone like Steven Gerrard, ideally. 

Richard Hunter: Or Declan Rice.

Kyle Caldwell: Or Declan Rice. Yeah, of course. We’re sticking to this World Cup. So, what would you say are the types of investments [investors could consider] for the midfield? 

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Richard Hunter: You’re absolutely right. This is where there really is a wide choice, and this is where things should be emanating from for the most part. 

Like any midfield, you’re probably going to have a holding player, and you’re going to have a creative player. And that means that the raft of options out there, as you say, are far and wide.

So, this is where you can start to think about things like ETFs, exchange-traded funds, where these days you can quite easily invest in a country, in a sector, in a theme. And we know that at interactive investor, a lot of our global strategic funds are very popular.

But also you can bring into that investment trusts which are also not having all their eggs in one basket. You’re going to probably want some exposure - although at the moment that comes with a slight caveat - to US growth. It’s obviously the world’s largest economy and indeed the world’s largest market. So, there are any number of [options, and] while staying slightly defensive, the holding midfielder, there’s also the creative midfielder who hopefully is going to make things happen.

Kyle Caldwell: I completely agree. A global index fund or an ETF, it’s going to give you exposure to lots of different countries, sectors, and industries, and they are potential core holdings for the long term. I’d also consider actively managed funds as well.

I think it’s very important particularly with a global actively managed fund, you want it to be invested sufficiently differently away from the global stock market, and [check that] you’re getting exposure to different types of companies because you want your investments to complement each other rather than there being too much crossover. Because if there’s too much crossover, then that could potentially dilute your returns rather than adding value and adding diversification for your portfolio.

Richard Hunter: ‘Diworsification’, they call it. 

Kyle Caldwell: Exactly. An obviously that also happens when you own too many types of similar funds in one particular region. 

For the midfield as well, you can also consider new regional funds such as funds that are invested in the UK and Europe, but I’d stick to developed markets for this area of the portfolio.

I also think it’s important to decide whether you’re more of a hands-off or hands-on investor. I think if you’re a hands-off investor, then you might want to consider a multi-asset fund that makes the decisions for you on your behalf. You might want to consider products such as Vanguard LifeStrategy, BlackRock MyMap, Legal & General Multi-Index Funds, and at interactive investor we have our own Managed ISA, which if you’re looking for a potential hands-off option or a core holding to build all the positions around, that’s a great option. It’s 10 funds with different risk levels, and they are very low cost as well.

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Let’s now move on to the attacking part of the pitch. So, this is where you can have more adventurous types of investments. Over the long term, you’re hoping that these investments are going to add the most value for you potentially.

Although one thing to bear in mind is that, like a striker, they can move in and out of form. So, Richard, which types of investments would you put at the top end of the pitch?

Richard Hunter: Yeah. I mean, strikers are going to grab the headlines, aren’t they? And you do need that cutting edge in your portfolio. But in terms of numbers, it doesn’t want to be dwarfing what’s going on behind it, you know, defence and midfield. So, again, you’re looking at those towards the top of the risk spectrum.

In terms of shares, these can be shares that you still think [are] a good underlying story, but the price has been beaten down recently. Make sure that you know why it’s been beaten down because the market’s very good at uncovering reasons. Just as a side issue, there’s a number of companies which might have a high dividend yield, which looks very attractive, for example. But on the basis of how a dividend yield is calculated, a higher dividend yield could be because there’s a lower share price. So, again, that’s something that you need to basically keep an eye on.

So, that’s that’s. Another thing that points towards a higher level of risk is if you’re investing in specific stocks rather than funds, where you’re spreading your risk a bit. If you’re going for ABC and DEF, as separate individual direct equity holdings, then obviously that’s higher risk. But if you get the call right, then obviously you’ll get some decent returns, and that’s what you would hope for from your strikers.

Kyle Caldwell: And in terms of funds, those that are considered to be adventurous are funds, for example, that invest in emerging markets or the Asia-Pacific region. You’d also consider funds that invest in smaller companies. They are higher risk, but over the long term, if you look at the historical data, it does show that smaller companies have the edge over larger companies. One of the key reasons behind that is that due to their size, there’s greater capacity for them to grow.

Although if you’re individually shopping in that area, you’ve got to take a lot of care, you’ve got to do a lot of research…

Richard Hunter: And also be willing to make a substitution if necessary.

Kyle Caldwell: Exactly. I think we’ll come on to that in a moment, all the tactics that you can employ with your portfolio. But, yeah, that’s absolutely right. It’s important to consider chopping and changing if the story changes, for example, or your personal objectives change, then that might be time to put a substitution in place. But, we’ll come on to that in a moment. We’re going to talk about the importance of having a squad of investments and potential substitutes.

The last [point] for me on adventurous investments is that it they give you the opportunity to invest in particular themes, such as technology, for example, and, obviously, a growing area is artificial intelligence (AI) and that theme as well at the moment. That’s what you potentially have in the attacking area of the pitch.

So, just going back to the squad of players, I had an email from a listener who actually sent in [a list of] 23 investments, which forms his squad of investments. He actually came up with his own formation, and it wasn’t a classic 4-4-2. Not that many teams play that anymore. He actually had four up front, which is a bit more punchy than some teams having three up front at the moment, two wingers.

But there’s different ways you can go about this, and depending on where you are on your investment journey, and what you’re hoping to achieve, you can change up the tactics and you can become more attacking at certain points. But then, equally, there might be certain points where you’re happy to be more defensive as well.

Richard Hunter: Which could be age-related, of course. It’s an old adage that the younger you are, the more risk you can afford to take because obviously you’re in it for potentially 40 or 50 years. So, on that basis, you could go for what would used to be called a 4-2-4 formation that you just suggested. Or, if you really want to go back some years, the 2-3-5 that teams used to all use. I mean, we’re talking 60s and 70s now.

Kyle Caldwell: All right. It wasn’t too dissimilar to the one that was sent in by the listener. In terms of having a squad and potential substitute, for individual shares would you consider the substitutes to be shares in the same sector, for example?

Richard Hunter: Possibly. I’m not preferring any view but let’s just say for argument’s sake that you’ve got BT Group (LSE:BT.A) within your portfolio and the share price doubles. All of a sudden, you’re now overweight in BT, but you still like the telecom sector. So, one of the things you might want to consider is top slicing your holding in BT and putting some additional funds into Vodafone Group (LSE:VOD), for example.

Equally, if BT just aren’t doing it for you anymore, and they’ve strayed away from the reasons that you bought the share in the first place, then you just sell the entire holding and replace it with Vodafone, Deutsche Telekom AG (XETRA:DTE), whatever, and there’s your substitution.

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Kyle Caldwell: I think you can adopt a similar approach for funds as well. It’s just a case of doing your research and identifying which types of funds are quite similar, which funds have the same investment style and are investing in the same region. I think that’s key because there’s a danger with funds that you’re not comparing like for like performance. Like football, funds are in a sector, which is essentially like a league table.

So, at a glance, you can have an idea of how that fund is performing over different time periods. However, it doesn’t tell the full story because there’s different types of funds that are adopting different investment strategies, styles, and approaches.

So, the best thing to do is to get three or four other funds that invest in a similar way, and  compare performance. And if the performance looks out of kilter for that fund, then potentially consider making changes. Because if it’s out of kilter, the chances are it’ll be down to stock picking, not being successful over whatever time periods it is, where it’s underperformed other similar types of funds.

Richard Hunter: You mentioned diversification, and I think we’ve covered this off already, but it is worth saying as a standalone. In terms of the football analogy, what we are discussing is much more like a Premier League team. In as much as you are not restrained by picking people or investments of the same nationality, you can take a much broader approach. Obviously, if we were to stick just with the World Cup analogy, you’ve got your individual countries, and that is not the approach you would take to a balanced portfolio.

Kyle Caldwell: And, of course, there’s 48 countries in this World Cup. A record number of countries are participating and nowadays it’s never been easier to invest internationally as well. And if you do invest internationally, that gives you greater scope to have greater levels of diversification.

Because for instance, if you just stick with the UK market, you’re not going to get that much exposure to technology, for example.

Richard Hunter: Yeah. Absolutely right. Also, your circumstances might change, so you do need to be willing to tinker with your portfolio, not every six months, but you should be reviewing it at least six monthly. But there will come changes in your circumstances where the balance of your portfolio is starting to look slightly out of kilter with your objectives.

Kyle Caldwell: I think it’d be remiss of me not to give a mention of the fact that at interactive investor, you have access to 17 global exchanges, which is one of the widest choice of international investments on the market. Of the 48 countries that qualify for the World Cup, two major economies not competing are China and India. Are they two areas that you would consider having as part of your global portfolio?

Richard Hunter: Yeah, very much. [They are the] two biggest, in terms of population, countries in the world by far. They’ve both got an emerging middle class, which can have all sorts of ramifications, and by most projections, it’s likely that China, if not India as well in due course, but certainly China, is likely to overtake the US as the world’s largest economy within the next 10 years or so. So very much so, yes.

Kyle Caldwell: Also, at interactive investor, we have exposure to multi currencies as well, and we offer access to nine of the biggest global currencies that you can hold and invest in within your ii accounts.

So, I’ve got a list here, Richard, of all the football investment analogies we’re going to go through. I think we’ve covered most of them.

I just want to reiterate one of the points from the beginning that, just like in football, it’s important to have a diversified approach. You’ve mentioned potentially tinkering and bringing substitutions in and it’s also important to potentially maintain the shape of a portfolio. You can do that by rebalancing investments and reviewing your investments a couple of times a year.

I think we’ve already covered this point, but just to add a little bit more to it, it’s important to consider whether the investment on the pitch is delivering. Is it delivering to your expectations? If it doesn’t meet your expectations, as you said, you can bring in a substitute.

With funds, one of the main things to watch out for as well as performance is whether the same fund manager is still in place as when you first bought the funds. Because over time, fund managers can leave, and they quite often do actually leave.

So, you want to make sure that if one of the reasons why you bought the fund was because you liked the fund manager and the fund management team, you need to consider whether you follow them if they leave.

Richard Hunter: Yeah. Because you don’t want style drift.

Kyle Caldwell: Exactly. Because there’s no guarantees if a new fund manager comes in that they’re going to manage the funds in exactly the same way. They are going to want to put their own stamp on the fund, and  we’ve seen that with various football teams over the years.

Richard Hunter: It’s also worth mentioning at this point - just to get the last possible football analogy in there somewhere, and this is more, again, Premier League than international perhaps - but managers tend not to last a long time, and we’re talking about the football analogy.

But in terms of investment, it’s very much a long-term play, and you need patience. That’s not to say you don’t review your portfolio as you go along, but you start thinking about the tortoise rather than the hare.

Kyle Caldwell: Well, I think that’s a great point to end on, Richard, and thanks for coming on.

Richard Hunter: Pleasure.

Kyle Caldwell: That’s it for our latest episode of our On The Money podcast. We love to hear from listeners. If you’ve got a question you’d like one of us to tackle in future episodes, then please get in touch by emailing: OTM@ii.co.uk..

As ever, we have plenty of news analysis related to shares, funds, investment trusts, and ETFs on the interactive investor website, which is ii.co.uk. I’ll hopefully see you again next Thursday.