Building your own fund portfolio

Baseball player © iStock
Hitting home runs isn’t easy – but they’re the key to a great result

Investing doesn’t need to be left to the experts – with a little common sense most people can make their own decisions.

“Investment is simple, but it isn’t easy,” as Warren Buffett puts it. There is no shortage of advisers, salesmen and brokers urging individuals to entrust their investment decisions to “experts” – but there is no reason why any regular reader, armed with a little common sense, shouldn’t save some money and do it himself. Unfortunately, common sense is the least common of the senses, as the old adage goes – but that may be a greater problem for the professionals than for the amateur investor.

The first piece of common sense as we approach the end of the tax year is that the best time to invest your 2016/2017 Isa allowance was at the start of the tax year, not now. With interest rates negligible and investment returns high in the last year, those who invested early have seen considerable gains, while those who have waited have little to show for it. If you have the cash and intend to invest, go early.

The second lesson is to invest in equities rather than bonds or a multi-asset fund. As Nick Train, manager of Finsbury Income & Growth Trust, regularly points out, stockmarkets go up three years in four, so it’s right to be bullish for the long term. Setbacks and bear markets happen regularly, but they’re quickly recovered. Conversely, a 40-year bull market in bonds peaked in the middle of last year. Although the devastation wreaked on bond portfolios during the last bond bear market is unlikely to recur as severely, it is worth remembering Mark Twain’s observation that “history doesn’t repeat itself, but it rhymes”. Be prepared for disappointing bond returns in the years to come.

It is easy to be lulled by the siren voices of advisers, regulators and much of the media to “avoid risk”, perhaps by investing in “low-risk” multi-asset funds. However, what they mean by risk is volatility, not the permanent loss of capital. Professional investors who spend their days staring at screens are much more worried about volatility than private investors, who can take a longer-term view. “A desk is a dangerous place from which to view the world,” in the words of the author John le Carré.

A third piece of sound advice is to invest in closed-ended funds, including investment trusts, rather than open-ended ones. Closed-ended funds persistently outperform open-ended ones and have better corporate governance. This even applies where the same person or team manages side by side both open and closed-ended funds with the same investment remits. That is why there are many good closed-ended funds and relatively few duds, while for open-ended funds it is the other way around.

Investment is as much about avoiding mistakes as making good decisions. Common mistakes include having too much invested in the UK market, which represents under 10% of the global indices and underperformed the global average by 10% last year. Many private investors have unbalanced portfolios, heavily focused on, say, emerging markets rather than a good global spread. Some exposure to specialist funds can spice up a portfolio, but the core of a portfolio needs to be in mainstream, quality funds rather than highly specialised or single-country funds, even if the latter look cheap.

Everyone wants to be a contrarian, picking a successful investment that others shun, but the trouble with contrarians is that there are too many of them. Good contrarians buy stocks or funds that the consensus avoids but where the fundamentals have turned positive, yet are being ignored.

Cheap is not cheerful in investing: the US market has appeared expensive for at least five years but has continued to outperform the rest of the world. Markets, sectors or shares may be cheap for a very good reason. For most investments, it is better to seek the “reassuringly expensive”. This may involve choosing the “bleeding obvious” rather than hunting for “hidden gems”, of which very few are genuine.

However, following the crowd is as much a mistake as blind contrarianism. Many investors rushed to back Neil Woodford’s Patient Capital Trust at launch in 2015, but their patience is now being tested by its weak performance.

That said, it is as hard to find areas of the market today that are clearly overvalued as a result of excess investor enthusiasm as it is to identify areas that are clearly undervalued. Investing for income is notably popular, supported by long-term studies that suggest that funds focused on income outperform those focused on growth. But this only works if the income is reinvested – yet most investors, quite naturally, see income as being for spending. Expecting good capital growth while spending the income is the investment equivalent of having your cake and eating it.

A better way to think of investing for income is that a bird in the hand is worth two in the bush. Some investors will prefer £1 of income in cash to £2 of unrealised capital gain, but those who don’t need income should be patient. For income seekers, a modest but rising level of income will yield better returns than a high but flat income.

Knowing when to sell is the toughest challenge in investment. Everyone agrees that you should sell your mistakes or when the investment thesis changes; the trouble lies in putting that into practice. Investors are torn between wanting to be rid of a dud investment and the fear of selling at a low. Two years ago I came very close to selling out of BlackRock World Mining. Since then, the shares have more than doubled.

Many investors find it easier to believe that an investment that has halved in value can recover than that one that has doubled can double again. Hence they tend to take profits on winners rather than sell losers. “Nobody ever went bust taking a profit,” the saying goes. No – they went bust reinvesting in losers. I was taught long ago that baseball games are won in ones and twos, not in home runs, but I am not sure that is true. In baseball, as in investment, home runs make the difference between a reasonable result and a great result. The implication is we should take profits sparingly.

For those with an existing portfolio, topping it up with the annual Isa subscription is simply a choice between the temptation of a new holding and adding to an existing one. I plead guilty to having too many holdings, but still try to top up the smaller holdings to a reasonable size. Starting a new portfolio from scratch is more of a challenge. Low dealing costs for the self-invested on most dealing platforms mean that you don’t need to plough your whole Isa allowance into one investment.

My last word belongs to another old adage: “rules are for the guidance of the wise and the obedience of fools”. Different styles work for different people and the key to successful investing is finding what works for you before you have made too many expensive mistakes. The best advice for a novice is the words inscribed above the doorway of the temple of the Oracle at Delphi. “Know yourself.”

Two portfolios for income and growth

A diversified portfolio could comprise as few as six fund holdings, but I have included eight in the two illustrative portfolios below. All the holdings are London-listed closed-end funds, mostly investment trusts. The growth portfolio excludes any Europe-focused trusts – adding one of these would be the ninth choice. The selection of Mid Wynd instead of the highly regarded Scottish Mortgage is the result of including specialist healthcare and technology trusts, as these are two sectors in which Scottish Mortgage has high exposure.

The yield requirement for the income portfolio precludes exposure to these growth-orientated sectors and necessitates a higher UK exposure. For those who want to keep it very simple or are investing much less than the full Isa allowance and want to minimise the costs, there is nothing wrong with plumping for a single good, all-round fund, such as Witan, Foreign & Colonial or Finsbury Growth & Income.

Fund sector Growth fund % Income fund %
Global Mid Wynd International 30 Bankers 30
UK Perpetual Income & Growth 10
UK small cap BlackRock Smaller Comp’s 10 Invesco Perpetual UK Smaller Co’s 10
Technology Polar Capital Technology 10
Healthcare Worldwide Healthcare 10
Emerging markets Genesis 10 Utilico Emerging Markets 10
Japan Baillie Gifford Japan 10 CC Japan 10
Private equity Pantheon International 10 Apax Global 10
Property TR Property 10 F&C Commercial Property 10
Infrastructure HICL 10