Top themes of 2020, plus building a portfolio from scratch

Thomas McMahon, senior investment trust analyst at Kepler Trust Intelligence, talks themes influencing trust selection, trusts to own and how to put together a portfolio of trusts.

[Filmed on 6th December 2019)

Lee Wild, head of equity strategy at interactive investor:

So, Thomas, are there any themes that you believe will influence portfolio construction in 2020. How might investors tweak their portfolios to exploit any new trends?

Thomas McMahon, senior analyst at Kepler Trust Intelligence:    

I think the US-China trade confrontation is creating a bit of a quandary for investors, and I think it might be an interesting time to be looking at the other emerging market countries and regions.

It's very notable over the last few years how large a part of the emerging market index China has become, and even more if you include China, Hong Kong and Taiwan together, and conversely how small certain other parts have become. Latin America is 10 or 11% of the emerging markets index, Russia is 5 or 6%.

So, these tend to be very underrepresented areas in most investors' portfolios, and I think if you look at their correlation to China, in terms of stock market returns, it's been quite low. And so that could be an interesting place to increase your emerging market allocation, particularly as both countries, both regions, Russia and Latin America, have some very interesting reforms going on from a corporate governance perspective. 

Maybe on a similar theme, I think Japan is undergoing a once in a lifetime change in corporate governance, which has started to be reflected in the market, but many investors have been sceptical about, because, of course, Japan has been a basket case for many years.

And there have been all sorts of false dawns for that economy and market. But what we have is a government with a very strong position in the polls in parliament, which has been forcing a change in corporate culture to try and create a more efficient corporate sector, to try and pull the economy out of its slump.

And that's been felt in much more openness to investor engagement, massive increase in buy backs, doubling of buy backs on the last year in 2019, more dividends, offloading of cross-shareholdings, which are not really generating any returns for shareholders, but create a cosy environment for management. 

And the market has done well in 2019, and I think this is the beginning of a story that could do well for many years to come. Another theme I think we all need to be aware of is sustainability, so it's clearly something that is in the top of agendas politically around the world. 

And I think having managers who properly incorporate environmental, social, governance (ESG) risks within their investment process is an important thing to be doing at this point in time, because political change can happen very quickly. 

We've seen how volatile elections can be in the developed world as well as elsewhere. So, I think that's something that people should be looking to try and build into how they think about their portfolios more. 

Lee Wild:

It is certain that ethical investing is something that people read about far more, certainly in the past six months and it's a theme that's been building through 2019. Are there any investment trusts within that ethical ESG space that you would be looking at now?

Thomas McMahon:

I think the most interesting development is that, what was considered a sector, or a different way of doing investing, has just become incorporated into the mainstream. I think trusts like, for example, Alliance Trust (LSE:ATST), which is managed by Willis Towers Watson, they incorporate environmental, social and governance risk or sustainable investing risks into their investment process at every stage.

They view it as a part of risk management. They're not alone in that, it's a growing theme. But it's interesting to look at that one in particular because, of course, Willis Towers Watson have that strong institutional background, they run a lot of pension fund money, sovereign wealth fund money, so they're very up to speed with how the broader investment community is thinking about these risks.

And that determines corporate returns to a large extent because these are the people who are investing in global companies. So, I think that's an interesting trust to look for. I would say also it seems that Martin Currie have done a very good job of integrating ESG within their investment objectives and analysis, which is becoming a growing theme. 

I think one of the historical leaders in this regard has been Stewart Investors, and Pacific Assets (LSE:PAC) which invests in Asia Pacific equities. They have a very strong sustainable investing ethic. And they view it as very much a part of what makes a business prosper in the long run, that it has a sustainable attitude towards the society and environment it lives in, and it operates in.

This is an important criterion to be a successful investment in the long run, so I think that's another trust investors could look at if they want Asia exposure with that sort of sustainable investing tilt. 

Lee Wild: 

Investment trusts can be a great way to build a portfolio. If I were new to investing in 2020 though, could I build a well-diversified portfolio with just a handful of trusts, and, if you think yes, what trusts would be the building blocks of that portfolio?

Thomas McMahon:

I think if you're relatively new to investing, a good place to start is a portfolio that takes a fund of funds, or a manager of manager approach, and really tries to build a diversified portfolio itself for you. 

So, Alliance Trust is a great example of this. They have appointed various managers to pick their best ideas in different regions around the world. Witan (LSE:WTAN) is another trust which does a similar type of thing. 

JPMorgan Multi-Asset (LSE:MATE) is a multi-asset approach, not so much a manager of managers. They manage the different assets themselves. So there are a number of sort of core building blocks which you could start to invest in, and then maybe try to build your portfolio around the edges as you gain more confidence in where you want to be investing, making sure that you pay attention to perhaps position sizing.

Just be aware of what exposures you build up as you add to those core building blocks. I would also highlight that we have a series of rated funds that we have calculated to be particularly strong performers in recent years and awarded an income and growth rating too, which are good places to look for candidates, if you're very new to the investment trust space.

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But I think beginning by allowing somebody else to do the asset allocation and then adding to that as you develop, I think is a good way to go.