Perfect fund and investment trust pairings

Like serving port with Stilton, blending the right funds can improve the overall flavour of a portfolio. Adding a companion fund can bring a calmer note to a high-octane fund, or add some spice to an otherwise dull core holding. In this article, we look at some of the most-popular funds on the interactive investor platform and find potential perfect pairings.

But why does a fund need a companion? Shouldn’t investors simply pick a fund they like and hope for the best? In a world of perfect information this would be a good strategy, but – from pandemics to inflation – there are always unknowns. Introducing balance into a portfolio can be an important way to minimise volatility and avoid the worst caprices of financial markets.

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​​​​Diversification is key

Nick Wood, head of fund research at Quilter Cheviot, says: “Diversification done correctly lowers the volatility of returns and enables investors to capture a wider range of opportunities. It requires investors to find funds which offer opportunity within different styles, such as ‘value’, ‘growth’ or ‘quality’ - market caps - large vs small - and asset classes to provide greater balance, lowering volatility, without reducing return, or perhaps even enhancing it.”

Achieving this equilibrium has become particularly important more recently. The abrupt rise in interest rates has changed the type of investments that have done well. The low interest rate environment flattered a certain type of growth company and the fund managers that focus on them. Many investors found their portfolios were pointing in a single direction, just as the market went the other way.

Daniel Lockyer, senior fund manager at Hawksmoor Fund Managers says: “Too many investors had a number of similar funds going into 2022 – Royal London Sustainable, Baillie Gifford Managed, Liontrust Sustainable – to name the top three in the multi-asset sector. All had large-cap, growth styles that were susceptible to rising interest rates and performed very similarly on the way up and on the way down.”

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Although the focus has been on the switch from growth to value, Lockyear says achieving proper diversification goes beyond growth versus value or active versus passive. He says: “We believe a perfect pair could be a passive fund alongside a highly active and alpha-generating fund. This could be in the US with a S&P tracker together with a US small-cap fund with a very different portfolio.”

For multi-asset funds, if a fund is exclusively invested in bonds and equity, such as the Vanguard LifeStrategy 60% Equity fund, he suggests mixing it with a fund with private assets exposure. “The two funds have got to be different, but not oppositely positioned so that one negates the other.” 

James Calder, chief investment officer at City Asset Management, says the Royal London Sustainable World Trust would be a good pair with the Vanguard LifeStrategy fund. He adds: “The Royal London fund invests predominantly (80%-plus) in equities with the balance in fixed-interest securities and cash. Mike Fox is the long-term lead fund manager and has an exceptional track record. He has significantly outperformed the peer group (and the Vanguard fund) over the past five years.”

US funds

The US is probably the area where achieving balance is most important. The consumer and technology giants of Apple (NASDAQ:AAPL), Microsoft Corp (NASDAQ:MSFT), Amazon (NASDAQ:AMZN), NVIDIA (NASDAQ:NVDA), Meta Platforms (NASDAQ:META), Alphabet (NASDAQ:GOOGL) and Tesla Inc (NASDAQ:TSLA) – the so-called Magnificent Seven – have led the market for so long that most people have done very well out of a S&P 500 tracker and have little inclination to change.

Wood says: “The US market has long been known as the graveyard of active management with many funds not able to outperform consistently. That has either been because they have too distinct a style in one direction or other, which at times is out of favour, or simply they have an inability to beat the market long term.

“Our pairing with the Vanguard US Equity Index fund is the JPMorgan American (LSE:JAM) investment trust. This is an investment which is balanced in terms of its style biases, somewhat concentrated, and with a long-term track record of consistent outperformance from the underlying team. The portfolio holds 40 stocks, 20 in the growth camp, 20 in the value camp, alongside a small allocation to a small-cap fund.”

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Calder suggests pairing a US equity tracker with the TwentyFour Income (LSE:TFIF) Limited, a listed fixed-income fund. He points out: “This provides the foil in terms of diversification. A simple pairing of US equities and an actively managed bond fund with a European bias. The basic theory is the equity risk is diversified with a bond holding.”

Global favourites

Then there are the perennial global fund favourites such as Fundsmith Equity, Alliance Trust (LSE:ATST) and Scottish Mortgage (LSE:SMT). These will often be used as core funds, although interactive investor’s research team classes Scottish Mortgage as an adventurous option that is more suited as a satellite holding.

Gavin Haynes, investment consultant at Fairview Investing, says: “Fundsmith Equity is a good core global equity holding with a clear style bias towards quality growth stocks. However, in an environment of higher inflation and interest rates there is a strong argument that the value approach should perform better than it did in the low interest rate environment.

“A global value fund such as Schroder Global Sustainble Value Equity could sit well alongside Fundsmith. Schroders have a well-resourced value team and this fund looks to find undervalued opportunities across global equity markets with a focus on sustainable businesses.”

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Alliance Trust is another favourite as a one-stop holding for many investors. Wood says: “People have to ask what they are missing. The obvious answer here is small-cap exposure. Small and mid-caps have done very poorly in recent years. As such, now is a good time to add to that exposure in an unloved asset class.”

He suggests Smithson Investment Trust (LSE:SSON), which gives a selection of higher-quality smaller companies primarily focused on the US and Europe. He adds: “The team follow the mantra coined by Terry Smith of ‘buy good companies, don't overpay and do nothing’. Today, industrials, technology and consumer stocks make up over three-quarters of the portfolio’s assets. The also trust stands on a wide discount that represents a potentially attractive entry point.”

Calder picks JLEN Environmental Assets Group (LSE:JLEN), which provides a diversified approach to green energy investing to complement Alliance Trust’s sustainable mandate.

Along with a number of funds in the Baillie Gifford stable, Scottish Mortgage has been hit hard by the shift in the interest rate environment. Haynes says: “This trust is likely to be favoured by investors looking for exciting growth opportunities and prepared to take a long-term approach. However, that doesn’t mean you should rely on one manager.” Two trusts that exclusively focus on technology shares are Polar Capital Technology (LSE:PCT) Trust and Allianz Technology Trust (LSE:ATT).

A touch of spice

There will also be times when investors need to mix things up a bit. While cash and money market funds have a place, they are not a solution for long-term growth or inflation protection. As such, Calder suggests Merchants Trust (LSE:MRCH) to balance low-risk funds such as the Royal London Short Term Money Market fund.

He says: “It provides access to UK large-cap equity investing through an active approach that has a yield target, balancing off the short-term nature of a money market fund. Merchants’ yield has stability and, through its revenue reserves, can augment weaker income years, while the money market fund will be driven purely by short-term rates.”

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It's been a bruising few years for investors in the UK. While the City of London (LSE:CTY) trust remains a popular choice for exposure to UK blue-chip dividend producing shares, it makes sense to look beyond the UK. Haynes says: “To diversify overseas I’d consider Guinness Global Equity Income. This fund has a total return focus, but all companies must pay a dividend. It has produced impressive long-term returns with low volatility and a strong record of outperforming in difficult markets.”

Finally, there should be a nod to some other popular funds. Greencoat UK Wind (LSE:UKW), for example, has been a popular choice for income, focused on green energy production through wind power. Calder pairs this with another investment trust, Fidelity Asian Values (LSE:FAS). He points out: “Focusing on small-cap value(ish) investment within the Asian region, the focus on capital growth provides the counter to Greencoat’s income bias.”

The idea behind every pairing is that each side should enhance the other and the whole should be better than the sum of its parts. The right balance can bring stability and improve performance over time.