Interactive Investor

Why the 60/40 portfolio still makes sense

2nd November 2022 09:04

by Kyle Caldwell from interactive investor

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Jacob de Tusch-Lec, manager of the Artemis Monthly Distribution fund, explains why investing 60% in shares and 40% in bonds is still a good recipe for investment success, but how it doesn’t solve all investors’ problems. He also talks about his approach to investing at a time of high inflation, explains why he prefers value shares over growth shares, and names a stock he’s recently bought.

Artemis Monthly Distribution is a member of the interactive investor Super 60 list of investment ideas.

Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today I have with me Jacob de Tusch-Lec, fund manager of the Artemis Monthly Distribution fund. Jacob, thanks for coming in today.

Jacob de Tusch-Lec, fund manager of the Artemis Monthly Distribution fund:Thank you for having me.

Kyle Caldwell: With a backdrop of high inflation levels and interest rates going up, plenty of column inches have been written about the supposed ‘death’ of the 60/40 portfolio. What's your view on that?

Jacob de Tusch-Lec: The 60/40 portfolio has been incredibly popular because it has worked for many years. It has given investors some diversification. The two asset classes move opposite each other, but, of course, it has worked during a long period, decades of overall declining inflation, declining rates, and globalisation. So, we have sort of gone, basically since the late 1970s, through a period where both bonds and equities have been in a bull market. So, we've both had a bull market in bonds, in equities and in every asset class, really, every financial asset class. And you have had this diversification. So, it has worked. And there is a logical financial underpinning why it should work.

However, our concern is that what we're going into now is a world where inflation is here to stay, probably not at the levels we're seeing in the papers now, but it's going to stay higher than most of us thought a year ago and much higher than anybody thought three years ago. So, we have to kind of rewire ourselves that a world of 5% inflation is not impossible for a number of years to come.

We probably also have a world of more volatility, globalisation is being rolled back, that usually leads to volatility and currency movements as we're seeing now with sterling and probably could also see with other currencies in the coming 12 to 24 months.

So, in that environment a 60/40 portfolio still makes sense, but it probably doesn't solve all your problems. You need to have other things in the mix. One would be, for example, country selection. In a world where financial markets work seamlessly, where globalisation drives globalisation for companies as well, so an American company can produce in China and sell everywhere. When globalisation is being rolled back, country risk becomes a bigger part of it. We've seen that with Ukraine and Russia. We're seeing it with China and Taiwan and we're now seeing it as well with the UK, where you might have a great investment in the UK, but if you're losing 10% on the currency versus dollar, you might have been better off buying a mediocre investment in the US, but not losing the currency. So, currency and country risk are now something that you have to put into that 60/40 thinking rather than just say, I’ve got my asset allocation, I'm done.

Kyle Caldwell: And have you considered having some exposure to alternative assets, the likes of property and infrastructure, which have both been described by some commentators as good bond substitutes?

Jacob de Tusch-Lec: So, what we're trying to look for are asset classes or investments that have bond-like characteristics but have that inflation protection in there. Because a normal bond will not have inflation protection, the coupon is fixed, but if you can buy a toll road owner, or a REIT, or listed infrastructure, that all has this sort of inflation linkage, then the dividend should grow. At least in line with inflation. Examples could be telco infrastructure, 3G, 4G, 5G equipment on top of houses everywhere, creating telco and mobile telco infrastructure. We also have broadcast exposure, so basically masts all over beaming out TV signals. Those contracts are very often linked to inflation. So, there might be some pressure in the sense that electricity is more expensive and these companies their main cost is electricity, but they can pass that on to whoever wants the signals beamed out and ultimately that underpins the dividend and gives us scope for growth.

Kyle Caldwell: And has there been an increased focus on inflation as part of your strategy, or is it always underpinned how you invest?

Jacob de Tusch-Lec: The focus on inflation has always been there because let's not forget, inflation went away in developed markets, but in many emerging markets there's been inflation. So, it's not something that we have not talked about. And if we go to many economies in emerging markets, the rates are very high because they're used to inflation, they know they have to raise rates early and aggressively. So, inflation is always part of the discussion. What currency do we get the income in? What is the inflation? Are we getting a real return? But of course, when inflation is running at 8%, 10%, 12% and you sit with a management team and they say we can grow the dividend 5% a year, you might say, well that's not good enough for us anymore. The bar has been raised on that.

Kyle Caldwell: And given all the volatility that's been going on in both equities and bond markets, has it been a busier period, in terms of new holdings? I was wondering if you could name what's been the most recent new holding on the equity side.

Jacob de Tusch-Lec: The increased volatility in markets, that sort of quite aggressive news flow that we've had over the last year, has to some extent created some changes in the portfolio. Primarily our focus on tangible assets. Both when it comes to things like soft commodities, because commodity prices have been going up, especially in the food space, wheat and corn and various types of oils, etc, have been going up in price. So, we have had sort of a bit of a wholesale move towards asset-backed companies where you have something tangible that has led to a fair amount of activity in the fund.

But fundamentally I would say we haven't changed our philosophy or our process. It's still about finding good stories where we think the income can grow. And where we think the risk/reward is good enough, i.e., where the amount of income that we can harvest is good enough for the amount of volatility we think we're going to get.

So, a stock that we bought this year, and which has become a big part of the fund, is an American company called Archer-Daniels (NYSE:ADM). That's the biggest, soft commodity processor in the world, and it covers a lot of things, but basically, they do everything that's above ground. So, getting wheat out of Brazil, Ukraine or wherever, moving it on to somewhere else, processing it and then selling it to a McDonald's or to a bakery. The way we look at Archer Daniels is that it's an incredibly important company that sits in the sort of food supply chain business, something that doesn't sound super-interesting, but at times like these, where we have got food inflation, where it's all about getting yields up in the agricultural sector and getting food from a field somewhere on to someone's table, that's a company that really has grown in importance. They've grown the dividend basically for the last two or three decades, more or less uninterrupted. So, a very strong underpinning, the dividend isn't super high, but in a way what they're doing is they're giving us a decent dividend, a couple of per cent, and then they're investing enough into their business so that the dividend can grow 5% to 10% year in year out. And especially with all the geopolitical uncertainty we're having right now, making sure that your supply chain works is now at the forefront of the minds, both of politicians and corporates. So, this is a company that we think really has proven its importance now after a number of years where everybody just kind of thought food miraculously appeared by itself on the table.

Kyle Caldwell: And in terms of investment style, you favour value shares over growth shares, could you explain why? And do you think that this recent market rotation, which has favoured value shares, has it got longer legs?

Jacob de Tusch-Lec: So, our preference for value shares over growth shares comes with the territory because growth shares don't tend to pay very high dividends. What we can do in the fund is that on the equity side we buy value shares. That means we don't have a lot of exposure to technology, for example, because technology companies rarely pay high dividends.

What we can then do is we can buy the bonds of technology companies and get a high income on that side in order to manage our sector exposure, we don't want to have a fund that has no exposure to technology at all. So that's one way we can use the capital allocation to make sure that we have exposure to a certain sector, but in the instrument that pays us the highest income.

On the equity side it's true, we have a very clear value bias, both because that's how we can harvest the highest dividend yields, but also because we find the valuations to be still very appealing in a lot of sectors. It's true that technology multiples have come down and those stocks have gotten cheaper than they were a year ago, but they're still much more expensive than many utilities, infrastructure, stocks, REITs, etc. There's still, in our opinion, a situation where tangible assets are too cheap and intangible assets are too expensive. So, the world we're in, utilities, real estate, infrastructure, to some extent food production, soft commodity supply chain, mining, and energy. That's where you have some real assets behind the business that ultimately produces the cash flows, and that's where we sit.

Kyle Caldwell: And that all underpins a long-term strategy for say, a five to 10-year view, those sectors that you're in?

Jacob de Tusch-Lec: We think that it does underpin a long-term strategy because these businesses are not going away, but they're also not growing very quickly. And that's why the fund has done well over the last 10 years, but obviously by not being invested in Apple, not being invested in Microsoft, not being invested in Netflix, these companies really don't pay a dividend, so for us we can't really invest in them.

But not being in that part of the market was at least a strong headwind over the last decade. I would think over the next five, maybe 10, but at least the next five years. And not being in that part of the market is, it might be a tailwind, but least it's not going to be a headwind. That would be the expectation from our side.

Kyle Caldwell: And finally, a question that we ask all fund managers that we interview. Do you personally invest in the Artemis Monthly Distribution Fund?

Jacob de Tusch-Lec: Yeah, I do. At Artemis, we're very keen to eat our own cooking. All our wealth is invested in Artemis funds. And that would mean my colleagues’ funds, but also in the monthly distribution fund.

Kyle Caldwell: Jacob, thank you for your time today.

Jacob de Tusch-Lec: Thank you.

Kyle Caldwell: That's all we have time for. You can check out the rest of our Insider interviews on our YouTubechannel where you can like and subscribe. Hopefully, see you next time.

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