Portfolio Dilemma: we tackle six investment problems

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In this episode, Kyle and Dave give their thoughts on a range of topics submitted by DIY investors, including whether there’s too much crossover when owning both US and global trackers, how to decide whether to cut your losses, what constitutes a reasonably sized position, and whether to invest a lump sum now or wait.

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to our latest On The Money podcast episodes, a weekly show that tackles investments and pension topics in a practical manner. 

Today, we’re going to be talking through questions that have been submitted for our editorial Portfolio Dilemma series in which we tackle topics that are front of mind for investors.

Joining me to provide his expert insights is Dave Baxter, senior fund content specialist at interactive investor. So, today we’re going to cover six questions. But before we get to them, most of the correspondence that we’ve had for the series has been from interactive investor customers on our social trading network, ii Community.

For those not familiar, could you provide an overview of what ii Community is, and why those listening to the podcast should get involved?

Dave Baxter, senior fund content specialist at interactive investor: So, it serves a handful of different functions. One is acting a bit like a forum, so people can talk on different pages for certain investments, for example, if you like an investment trust or a given share, you can post more generally and you can simply raise issues with other investors.

You can also do things like put updates of what you’ve recently bought or sold and your recent portfolio performance. I think it’s quite interesting because it can inspire some thoughts, but also it’s quite a useful way to learn, so you get a mix of quite veteran investors on there from what they’re saying, to my mind, and then you get some newer people, some budding investors, so you can pick up some interesting knowledge.

Kyle Caldwell: I absolutely love it. I mean, if I didn’t work for interactive investor, I would be using it. I think it’s great. Like you said, Dave, it’s a great way to speak and deepen your investment knowledge with other like-minded investors.

Dave Baxter: Yeah, and you get very different kinds of investors on there, don’t you? You get some more technical analysis people, and you get some more buy and hold, and ones with different preferences, and there’s a whole mix of stuff going on.

Kyle Caldwell: Yeah, there’s a real range of investors from beginners to, like you said, the more advanced investor who checks their portfolio every day, and is deeply engaged in the world of investing.

So, let’s move on to the six questions that have been submitted. However, before we do, if you have a question you’d like considered in future as part of our Portfolio Dilemma series, then the way to get in touch is by emailing us at editorial@ii.co.uk, or you can use the podcast email, which is: otm@ii.co.uk.

The first question that we’re going to cover asks whether there’s too much crossover in terms of holding both a US tracker fund and a global tracker fund. 

This is a question that a lot of people are considering at the moment given that stock markets are becoming increasingly concentrated. A small number of companies, the so-called Magnificent Seven, are a bigger influence for both US and global markets. 

Dave, what are your thoughts when you tackled this question?

Dave Baxter: I liked this question because it felt quite simple to me. I think they are asking about a global tracker fund and a US equity tracker fund.

To me, the answer is yes, and to flesh that out, at the time I was writing that article, I think if you looked at, say, an MSCI World tracker, the US accounted for 72% of that fund. If you looked at a so-called All World tracker, which includes emerging markets and is, to be fair, a bit more diversified, the US still made up about 62%. And then you talk about concentration in the US, the so-called Magnificent Seven shares are a big presence there, but they’re still nevertheless a big presence in a so-called global fund.

I thought that was important to bear in mind, and that leads on to two important points for you as an investor if you’re thinking about holding both those things together. 

One is that if you look at past performance, then performance has been very similar and that’s been fine in recent years when the US has powered ahead and done really well.

But the perhaps more important point is that a global fund is not really offering you the level of diversification that you think it is. 

So, I highlighted those issues and then I wanted to highlight a few potential solutions. One is simply maybe not to hold a US and global tracker together, and two is that you might want to take more nuanced approaches even if you’re simply using tracker funds.

One avenue I explored maybe a couple of months ago now in a column was the idea of, say, taking the five main equity regions, so the UK, US, Europe, Japan and Emerging Markets, and taking a dedicated ETF for each one and maybe just sticking 20% of your portfolio in each.

If we look through the past performance of that total portfolio, it’s actually held up all right against the MSCI World. Then, as we’ve discussed before, there are other more nuanced things, for example, people like the Vanguard LifeStrategy range that is a bit more UK and Europe-heavy, and less US-heavy.

Or you can do things like use the iShares MSCI World ex-USA ETF USD Acc GBP (LSE:XUSE) and then add a dedicated US fund. One of the things is, of course, that there are active funds, and they will have varied approaches.

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Kyle Caldwell: If you look at a performance line chart of, say, a US tracker fund following the up and down fortunes of the S&P 500 and also a global tracker fund, they have been pretty similar over three, five years. 

That’s because of the high overlap for the biggest companies in both those markets, globally and in the US. Personally, I think there’s too much overlap and I wouldn’t hold both. 

As you’ve outlined, Dave, there are lots of different ways of going about having different exposure.

For me, the key is that if you own a global tracker fund, and you hold something else alongside it that invests globally, it does need to be sufficiently different. Here, you could consider an actively managed fund that is investing very differently away from the global stock market.

Scottish Mortgage Ord (LSE:SMT), for example, holds around 30% of its assets at the moment in unlisted companies. It does have a big position in Space Exploration Technologies Corp Class A (NASDAQ:SPCX), of course, which at the time of this recording is around a quarter of its assets. So, that is something to bear in mind, but what you are getting with something like Scottish Mortgage is exposure that is very different from the global market.

Dave Baxter: Yeah, and there are also some global relatively US-light funds, and what’s been interesting in the last year or so is some global funds have actually been ditching the Magnificent Seven, or some of the Magnificent Seven, on the back of those concerns about AI capital expenditure. So, you do now get a bit of variety.

Kyle Caldwell: I think it’d be remiss of me not to mention that I do own shares in Scottish Mortgage, but there are lots of other global strategies that are very different from the global market. The likes of Blue Whale springs to mind, and Artemis Global Income I Acc (B5ZX1M7), and there are many others as well.

Dave Baxter: Yeah, and to give a different exposure to those, you have some of those dedicated value funds. Things like the old Jupiter Global Value Equity X Acc (BF5DRJ6), that kind of thing. They should have a very different take on markets.

Kyle Caldwell: Let’s move on to the second question, which is from an ii Community member. The question is about whether to give up on slow or losing investments. For me, it’s a lot easier to buy an investment than to sell an investment. Even if you’ve bought an investment that’s performing well, it’s very tempting to hold on to it and try and run it as a winner.

There’s still a fear of missing out if you sell too early. You think, with hindsight, that you could have made much more of a return if you’d run it as a winner. That’s a much better position to be in if your investments have performed well. It’s a harder decision if you’ve bought an investment that’s underperforming, or the returns have been quite sluggish over time.

For me, the important thing is to step back and remind yourself why you bought that investment in the first place and consider whether your investment thesis still stacks up.

I think we do stress the importance of investing for the long term on this podcast. If you’re buying a fund or an investment trust, you should have a five-year mindset when investing in any type of fund. 

However, while patience is often rewarded in investing, there are times when it can make more sense to move on. There’s the opportunity cost as well. If you hold on to an investment for too long, that money could have been put to better use elsewhere in another investment.

So, take a step back and consider why that fund or share is underperforming. Say it’s a value fund and the value style of investing is underperforming, then that’s a pretty obvious reason why it’s underperforming, and you might be more willing to hold on to the investment in the hope that the style will return to favour at some point. 

However, if, for example, you compare the performance of a fund against a similar fund, and there’s quite a big difference in terms of the performance, it could be that poor stock picking is the reason why that fund’s underperformed. And that might mean it’s time to give it greater attention and potentially move on.

I’d also think about management change as well. If the fund manager jumps ship to another fund management company, or if a founder leaves a company of an individual share that you own, it might be time to move on. I’d also consider succession planning as well, and whether that’s been smooth or otherwise.

Dave Baxter: Yeah. It’s interesting to note that perhaps with some stocks it’s a bit harder to make that call than with some funds because normally funds, as you said, should be quite a broad call in your portfolio. For example, it’s a value fund, it’s a fund covering x region, that kind of thing, and as long as you don’t have major changes to the strategy that should be fine.

It might be more of an interesting call with certain companies if, for example, you’ve spotted an out-of-favour name or you think things are going to turn around and then you have to keep assessing. But maybe it’s more of a speculative holding and it’s not going to be such a core part of your portfolio.

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Kyle Caldwell: As we’ve mentioned on the podcast previously, rebalancing, taking some profits from your winners, that helps you be disciplined as an investor. For example, if you bought a technology fund or investment trust five years ago, and you do rebalance, that means you take some profits, and you’re also reducing risk at the same time.

We’re now going to merge two questions as they cover similar territory. Both are from ii Community members. One asks, ‘What is a reasonably sized position? If you hold 50 different shares then, on average, each will be 2% of your portfolio. How small is too small?’ And the other question simply asks, ‘How many stocks should I hold?’ 

Dave, over to you for your thoughts.

Dave Baxter: I love the US and global trackers question because that, in my mind, is quite a simple one to answer. But for a lot of these questions, I think the answer unfortunately tends to be ‘it depends’ because it’s so reliant on your individual preferences and your individual circumstances.

I answered the ‘Is 2% too small’ question and that was interesting but very nuanced and idiosyncratic. So, yes, 2% can be a bit small because even if you do very well or do very badly, it’s not actually going to move the dial that much. For a so-called satellite position, where it’s not a major part of your portfolio and maybe it’s bit riskier, you maybe do want to start with 2% and maybe go up as much as, say, 5% or so, whereas a core position can be perhaps at least 10% and often it’s a lot more. If you hold some big multi-asset fund, if you hold a tracker that’s the backbone of your portfolio, that could even be 70%, and then you do more interesting things elsewhere.

But to avoid the risk of not answering the question at all, I wanted to outline what I described in my piece as the ‘three Rs’ to consider when you’re thinking about position sizing and you can expand this thinking to the idea of how many holdings you should have because the more holdings in theory the lower the position size. 

So, the first R is risk that you need to consider. As I said, 2% to 5% can’t do too much damage, while with 10%, if that does really badly, then it can. So, if you’re holding something more volatile like an individual share and perhaps an investment trust in a niche area like the beloved Seraphim Space Investment Trust Ord (LSE:SSIT), then those bigger positions can carry more risk and you just need to be aware of that and think how comfortable you are with those potential drops.

The other side of that coin is the second R which is reward. So, again, those small positions, even if your thesis works out perfectly, and even if a 2% position doubles, then it’s not going to make an enormous change to your overall portfolio. So, you might be the kind of investor, if you’ve got the stomach for it, where you want to put more conviction into your holdings and you then want to try and reap the rewards.

The third R is simply research because another consideration is just that it takes time to do your due diligence on these things and you only have so much time, brainpower, effort and so on to monitor different things. So, if you’re putting loads of time into researching individual companies, then maybe you do want to have fewer positions and bigger position sizes, if you can stomach the risk, just to make it more of an effectively run portfolio.

And then I couldn’t find an R for this, but another thing to think of - maybe it relates to risk - is stress and the keeping-you-up-at-night factor. So, if you’re going to worry a lot about your fund’s performance, then maybe you don’t want big positions in the riskier stuff. I mean, maybe you can do that in a broad portfolio, but maybe you want to have a more diversified approach.

Kyle Caldwell: The question of how many holdings you should have is a very common one. As you mentioned, Dave, the answer is that it depends. There’s no magic number, unfortunately. 

But I do think how much you have to invest is another factor to consider. If you’re starting out, and you, say, invest a £1,000 lump sum as your first investment, then probably that could just go into one fund, probably a multi-asset fund. You want to diversify your risk. 

You’ve already mentioned Vanguard LifeStrategy. There’s other fund ranges, the likes of BlackRock MyMap and Legal & General Multi-Index. At interactive investor, we have our own Managed Portfolios as well. Then over time, if you’re willing to be a hands-on investor, and your portfolio grows, that’s when you can introduce more positions.

One good tactic to consider is the so-called core and satellite approach, which is having 70% of your portfolio in core holdings and 30% in satellite holdings, which tend to be more adventurous. 

Next up is a question about market timing. The person who wrote in said that they are quite nervous at the moment about a potential stock market correction being on the cards, and they referenced fears of a potential artificial intelligence bubble. They asked whether they should wait for a better opportunity to invest a lump sum, or whether the price of staying on the sidelines would be more painful. 

My thoughts on this are that the reality is that it’s almost impossible to try and time market peaks and troughs.

It’s a little bit like when you first make a property purchase. Some people try and time the property market, and I think the same is true with investments. It’s notoriously difficult to do, and the key thing to bear in mind is that whenever you enter the market, there’s always some sort of items on the worry list that could create a market correction. But if there were no headwinds at all, that in itself would be concerning.

The key thing to bear in mind is that over the long run, history shows that if you invest, that does tend to yield better rewards than leaving your money in cash savings. And, yes, stock markets are more volatile. But for me, that’s the price that you pay for the fact that over the long run, investing does tend to yield greater rewards. You just need to think about the fact that there are certain things you can do to reduce risk.

They are things that we speak a lot about on this podcast. So, be diversified, think long term, and also consider drip feeding your money [into investments] on a monthly basis. So, if you invest regularly, this does away with the risk that you put all your money into the market at the wrong time, just before a nasty dip.

You could think about it like other household bills. If you commit an affordable amount that you’re going to put into the market each month, you can forget that you’re doing it in a way, by automating it. At interactive investor, regular investing is free.

Dave, any other further thoughts that I’ve not mentioned?

Dave Baxter: No, I think that’s it. I would add, and I sound ancient here, but I’ve been writing about funds for 12 years and there obviously have been difficulties and you could argue that we’ve been in a very strange bull market, but people have made a lot of money while other people have worried about the world crashing.

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Kyle Caldwell: This question actually ties in nicely with our final Portfolio Dilemma. Someone wrote in and said that they were looking for ideas when it comes to bonds and absolute return funds to add some sort of resilience to their portfolio.

Dave, you tackled this one. What were your suggestions?

Dave Baxter: I thought this was a really difficult question because, at least in recent history, it’s been easy almost to make money, and it’s been really hard to find good diversifiers. So, diversifiers work and don’t work depending on the conditions. For example, bonds have worked well at points in the past, like in 2018 when equity markets fell, in the Covid sell-off in 2020, but they did terribly in 2022 and that was because equity markets were stressing about interest rates rising and bonds hate that. 

I will mention a couple of names but I just want to highlight that even those struggled because it was a difficult time for that asset class. So, one active fund that I’ve always found quite interesting is called MI TwentyFour AM Dynamic Bond I Acc (B5VRV67) and it holds some more esoteric bonds like asset-backed loans and things like that, and it has a good mix of stuff, but it did suffer in 2022. A passive option that holds a bit of a spread of defensive bonds is called the iShares Core Global Aggt Bd ETF GBPHDist (LSE:AGBP). 

But diversifying is tough, things don’t always work and touching on absolute return, again you do want to be careful. So, this for good reason is a pretty, I guess, derided sector. We had many of them proliferating on the back of the financial crash, and unfortunately, a lot of them have been very complicated. 

They do things that’s quite hard for a regular person to understand. For example, betting on a certain currency moving against a certain other currency and they don’t always work. Equally, some of them are actually very racy. They can make huge returns in one year and huge losses in the other year, so it’s not really what you want as a buffer against your equity exposure.

So, yeah, I’m not a big fan of the sector but one name I would highlight is Janus Henderson Absolute Return I Acc (B5KKCX1). That does kind of holding long equities and short equities, so betting on a price fall and it does have a good track record, so it’s tended to be dull but quite steady. It’s tended to eke out decent returns every year and it’s not suffered those massive drawdowns.

So, that is one option but I would just reiterate that finding buffers is not an easy thing. You should try and diversify among your buffers, so maybe hold different kinds of bonds. You can also hold things like property, infrastructure, defensive equities, and even some absolute return. 

But you do get conditions when most of these things struggle. So, again, 2022 was a terrible year for most investments, but bonds really struggled, equities really struggled, and then property and infrastructure actually can be quite linked to some of the things that bonds struggle with as well. So, they equally had a bad time.

Kyle Caldwell: You mentioned TwentyFour. That’s a fund firm that specialises in bond markets. When I’m researching funds for my own personal investments, I do like to see fund firms specialise in a particular area. 

This is one of the reasons why I like the three wealth preservation investment trusts, Capital Gearing Ord (LSE:CGT), Personal Assets Ord (LSE:PNL), and Ruffer Investment Company (LSE:RICA). Because the investment philosophies of those three firms is wealth preservation, and that’s what they do. 

I think as well, if you consider one of those options, because they have a sizable position in bonds, so you might not have to have bond exposure because you’re getting bond exposure through those vehicles.

Dave Baxter: Yeah. They do specialise in worry, fear, and bearishness, don’t they? They think about whether it’s inflation or AI exuberance or something that might topple markets. It’s worth checking out the different assets that they hold because they have very different levels of exposure to things like bonds and the kind of bonds they hold, gold and gold-related assets, and then other instruments.

Kyle Caldwell: Yeah, and I think when you’re researching them, the main differences I can see is the equity allocation in terms of what’s in that. Obviously, the percentage weightings do vary, but they all do have quite a low exposure to equities.

When it comes to bonds, at the moment, they’re all favouring US inflation bonds, called TIPS (Treasury Inflation-Protected Securities). But, yeah, the main difference is what’s inside the equity part of the portfolios.

Dave Baxter: Yeah, they hold some very different stocks.

Kyle Caldwell: So, Dave, we’ve run through each of the six questions, and that’s all we have time for today. Thank you very much for coming on.

Dave Baxter: Thanks for having me on.

Kyle Caldwell: Thank you for listening to this episode of On The Money. We’re now going to be taking a two-week summer break, and the podcast will return on Thursday 10 September. 

If you’re a regular listener, we’d really appreciate a rating or a review on your preferred podcast app. Those ratings and reviews play a crucial role in getting the podcast into more and more ears. 

In the meantime, until the podcast returns, you can find plenty of investing information on interactive investor’s website, which is ii.co.uk.

I’ll see you on 10 September.