The six ETFs I'd pick if I was building a portfolio from scratch
David C Stevenson explains how to put together a simple, no-nonsense portfolio of ETFs from scratch.
This year is already shaping up to be grim for investors. The oil price and China's woes are likely to get worse over the next few weeks, while the profitability growth of big businesses has been stalling for months. But while that might suggest a recession, my gut (nothing more scientific) tells me that equity investors have just run ahead of themselves and pushed up valuations it doesn't feel like the start of a global slowdown (yet). However, I certainly wouldn't be 100% long (bullish) on equities developed-world equities definitely feel fragile, with little sign we're due a massive leap in profits.
If I had to build a portfolio of funds from scratch, using sensible "asset allocation" (diversifying across regions and themes), I'd mostly favour passive exchange-traded funds (ETFs listed funds that track an underlying index or asset class). Bar some key areas, I don't see how, in the main, active managers can do any better than the market. Sticking with a simple 60/40 equities/bonds split, I would go for the six funds in the table below. I'll explain why.
|60% equity bucket|
|Lyxor ETF SG Global Quality Income||LSE: SGQL||30%|
|State Street SPDR Euro Stoxx Low Volatility||LSE: LOWE||10%|
|Somerset Emerging Market Dividend Growth||www.somersetcm.com||10%|
|Source Technology S&P US Select Sector fund||LSE: XLKS||10%|
|40% bond bucket|
|iShares $ Treasury seven to ten year||LSE: CBU0||25%|
|TwentyFour Income||LSE: TFIF||15%|
In terms of regions, I think eurozone equities represent the best of a bad bunch in 2016. They're not incredibly cheap, but should see sustained earnings growth. But again, you need to stay defensive I've opted for the relatively new State Street SPDR Euro Stoxx Low Volatility ETF. It tracks big stocks, such as German titan MAN, as well as Munich Re, but has a filter that excludes highly volatile stocks. It's a cheap way to track big European defensives. I've also included one actively run fund the Somerset Capital EM Dividend Growth fund.
It has consistently beaten its passive peers in recent years, by focusing on developing-world businesses where both balance sheet and dividend growth prospects are strong. The fund still lost 6% in 2015, but if emerging markets do recover (not impossible), then it's a good way to play that defensively.
For my final equities component, I've abandoned the defensive focus. US tech stocks are in no way defensively priced many are ridiculously expensive. But this is one of the few sectors that could continue to see strong earnings growth. We are only midway through a prolonged technology capital expenditure cycle and I think that much of the savings from lower energy prices will end up being spent on tech, media and travel. The Source Technology S&P US Select Sector ETF, which tracks the biggest tech stocks in the S&P 500, is a cheap, easy way to buy into this late-cycle bull market.
As for the two bond funds, the big bet is on US Treasuries (government bonds) with maturities of seven to ten years. The suggested iShares ETF yields around 2.27% low by historic standards, but given today's environment, any yield of above 1.75% for a rock-solid fixed-income investment is decent. And if my cautious optimism is wrong, and we are about to enter recession, bond yields will fall again (so prices will rise).
Finally, there's the TwentyFour Income investment trust, with a running yield of about 5.3%. It holds a diversified portfolio of pan-European asset-backed securities mainly residential mortgage backed securities, and "mezzanine" debt tranches of collateralised loan obligations. These securities are backed by specific pools of assets and pay a floating interest income. According to Numis, the fund's strong structural protections should act as a buffer against defaults, which have been very low historically. The fund has no gearing and its currency exposure is hedged to sterling. It will be more volatile than rock-solid US Treasuries, but I think you'll be rewarded for the extra risk.