What's going to save your portfolio from a financial system reboot?
For many investors I suspect the answer is probably absolutely nothing. And that could turn out to be a dangerous shortcoming.
This is the final part of my mini-series on asset allocation. I want to show you why it's so important to allocate 25% of your portfolio to commodities. As well as industrial and agricultural commodities, I'm talking about precious metals, antiques, property... practically whatever you like!
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In brief: We've built up too much debt in the West. It needs to disappear so that our economies can start to grow again. In biblical times this was called a 'debt jubilee' debt forgiveness.
You can get there by decree, where the authorities re-set the monetary system, or it can come from hyperinflation, where the debt's real value gets inflated away. A deflationary depression could do it too: basically, businesses and individuals go bankrupt and debt disappears in a painful and protracted mess.
What's going to save you? Well, to my mind it's physical assets especially precious metals.
Ironically, gold could be your best bet whether we get the seemingly opposites of hyper-inflation or depressionary deflation.
Commodities generally include things such as industrial metals, agricultural staples and other foodstuffs. You'll see that these are tangible, rather than financial entities. You could expand the asset class to include anything from fine wines, art and collectibles to property. You could include anything that you're willing to sell to fund your retirement (or whatever you're saving for).
If you're investing in property, then that probably deserves its own asset class. But remember, this is property you're holding for re-sale.
Your asset allocation could look something like this:
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Cash
20%
Bonds
20%
Equities
20%
Commodities
10%
Property
30%
I make no bones about the fact that holding 25% of the portfolio in commodities (or tangible assets) is a reflection of the economic dangers we're facing. But it's not the only reason to hold a decent slug of commodities. The inexorable rise of the East is increasingly putting pressure on global resources. This is a theme that I expect to run and run until well after I hit retirement.
As with all our investments it's important to diversify within your commodities allocation.
Remember, we're insuring against the risk of several different outcomes here. A deflationary depression will massacre house prices there's a lot of mortgage debt to work through! Hyperinflation, on the other hand would suit house prices pretty well.
We can't divine the future, but we can prepare for it...
A diversified approach to commodities
Here's what I'm going for:
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Physical precious metals
8%
Gold & Silver ETFs
7%
Mining stocks
5%
Agri stocks
2%
CED2*
3%
Row 5 - Cell 0
25%
As I've said throughout this series on asset allocation, the final figure you come up with is and has to be uniquely up to you. What's most important is that you think long and hard about how your blend of assets works together to provide diversity to defend against different outcomes.
The king of the commodities is undoubtedly gold it's a key feature of my plan. It's been used for thousands of years for both transactions and storing wealth. Even today, world central banks use it to re-balance their ledgers. Those in trouble sell, while those with excess reserves buy.
Gold has historically been the ultimate security for the rich. And I guess if you think about it, you are rich! On a world-wide basis, you're right up there. Now you need to start thinking like a rich person.
Physical gold and silver coins safely tucked away are the ultimate insurance. But I can't put that in my SIPP or ISA, so ETFs give me a way to play 'financial gold'.
There are plenty of other ways to use the stock market for commodities exposure too. I recently I explained why I like mining stocks. Stocks such as Rio Tinto and Xstrata will get you a diversified exposure to industrial metals. The Association of Investment Companies (AITC) lists seven investment trusts that may be of interest too.
As far as agriculture and foodstuffs go, you can get exposure through various ETFs and other dedicated funds. But I'm not keen. Unlike metals and the like, an investment fund can't simply hold foodstuffs in a warehouse, or vault. Instead they use the futures markets to buy futures contracts.
Problem is, often these contracts cost money to roll over. Basically, when the contract comes close to maturity (ie physical delivery) the fund sells it and buys a 'long contract'. And more often than not, that long contract costs more than the expiring one they're selling. That makes the investment deeply unattractive over the long term they're often set up to lose.
I prefer agricultural stocks, or even agricultural equipment and fertilisers. There's a great article in MoneyWeek available to subscribers here.
I couldn't write a piece on commodities without mentioning my favourite commodities play. And that's the Close Brothers Enhanced Commodities trust (LSE: CED2). It's a play on crude oil, aluminium, copper, zinc, nickel, wheat, corn and sugar. I've shown it as the last entry in my diversified approach' table above.
The shares have suffered because of fears over the bank bonds (read the article to find out how it works) that back the trust. These fears look a little overdone to me, but in these markets the banks aren't given the benefit of the doubt (and rightly so!)
To my mind the stock still looks good value and gives a varied exposure to both industrial metals and agricultural commodities.
So there we are. That completes my mini-series on asset allocation. In case you missed the first three parts you can read them here:
Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
Managing Editor: Frank Hemsley. The Right Side is issued by MoneyWeek Ltd.
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Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.
He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.
Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.
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