The MoneyWeek exchange-traded fund (ETF) portfolio is very different to our investment trust portfolio. The investment trust portfolio consists of six trusts where we believe the managers will add considerable value through their decisions. The ETF portfolio is an asset-allocation strategy, which uses passive ETFs to build a cheap portfolio that’s diversified around the world and across different types of investment. It aims to strike a balance between risky, higher-return assets such as stocks and safer, lower-return ones such as bonds.
I use the strategy in my own portfolio as a standalone allocation for money that I want to invest (rather than have in cash savings), but might want to draw on more quickly than my mid-cap and emerging-market growth investments (which are very volatile) and sooner than my pension (which is invested to produce a long-term growing income stream). However, it’s designed to be flexible enough – and cheap enough to invest and divest – that it’s suitable for a number of scenarios where investors want steady long-term growth.
Falling behind in real terms
The past year has been another volatile one, but the portfolio has been unexceptional. It’s up slightly since our last update in May 2021 once you take dividends into account, but not by much. Exactly how much will be unusually sensitive to whether an investor rebalanced the portfolio back to target weights at that time or not, because the performance of different markets has been very variable.
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The S&P 500 ETF is up by 9% in sterling terms, but all other equity ETFs are down. FTSE 250 mid-caps are down 10%, having been the best performer last time with a 30% gain. Emerging markets has had a dreadful year, down 12%. Global real estate stocks are up 6% – that’s partly because they are quite heavily weighted to the US and partly because commercial real estate is rebounding after selling off in the pandemic. US inflation-linked bonds have done well, up 11%. UK nominal government bonds have not, down 7% on fears of higher inflation and interest rate rises. Our increased allocation to gold a couple of years ago – we doubled our holding from 5% to 10% precisely because of inflation concerns – has started to pay off, up 15% in sterling terms.
Inflation is the crucial point here. The consumer price index rose at 5.5% in the year to January; the older retail price index at 7.8%. Thus the portfolio has probably lost between 3% and 5% in real terms since our last update – better than stocks but not what we want. The Bank of England expects inflation to keep rising this spring and then start to subside – although given that central bankers failed to foresee this spike and continued to proclaim rising inflation was transitory, one should not read anything into this. The disruption to energy and commodity prices (including food) caused in part by Russia’s invasion of Ukraine is severe, and the outcome of these events is not at all predictable.
The balance of risks
A key principle of the ETF portfolio is that we do not try to make big bets on specific outcomes. We aim for a portfolio that should do okay in a wide range of plausible circumstances. So the question now is whether it should tilt more towards inflation risks.
We hold equities for growth: they do okay in moderate inflation, but badly in high inflation. However, they should retain their value in real terms over the long run, even if it takes a while for them to catch up after a 1970s-style inflation surge. We hold gold: we expect it to do well in severe inflation. We hold inflation-linked bonds: the yields on these are very poor in absolute terms, but we’d expect bond investors to flock to them even more if inflation takes hold. We still hold cash (although it means losing money in real terms) to take advantage of a major buying opportunity. We haven’t seen this since the portfolio was devised. Sustained high inflation and geopolitical tensions imply that we should expect volatile markets and a greater chance of a major crash such as 1973-1974, 1987, 2000-2003 or 2008-2009.
Then there’s conventional government bonds. They do well in a crisis (investors rush into safe assets) and they’d perform well if an inflationary surge turns into a deflationary bust. These have been the two reasons for retaining them, despite low yields. In any other scenario, they face near-certain losses in real terms. But it is increasingly difficult to see how we get back to a more deflationary scenario from here, so it seems the right time to finally ditch conventional UK bonds.
There are two obvious options. The logical one is to swap them for inflation-linked bonds. We favour US Treasury inflation-protected securities (Tips) over UK index-linked gilts in the portfolio for a number of reasons. The bolder option is to use the 1970s as a blueprint, treat inflation as the real risk and think about how to hedge that. We won’t use ETFs to track oil, metals or agricultural commodities directly here – returns on these are complex and depend on how very near-term prices move relative to those slightly further ahead. However, oil stocks remain cheap and unloved. They should do very well if oil prices remain high. If they do badly because oil falls back a long way, it’s probably good for our wider equity holdings, so the downside is balanced. So we’ll bring the SSGA SPDR MSCI World Energy ETF (LSE: WNRG) into the portfolio in the place of the Vanguard UK Gilt ETF. Investors who don’t want to go as far as swapping lower-risk bonds for equities should increase their investment in the iShares $ Tips ETF instead.
|Our all-weather ETF portfolio|
|Vanguard S&P 500 (LSE: VUSA)||10%|
|Vanguard FTSE Dev. Europe (LSE: VEUR)||10%|
|Vanguard FTSE 250 (LSE: VMID)||10%|
|Vanguard FTSE Japan (LSE: VJPN)||10%|
|iShares Core MSCI Em. Markets (LSE: EMIM)||10%|
|iShares Dev. Market Property Yield (LSE: IWDP)||10%|
|SSGA SPDR MSCI World Energy (LSE: WNRG)||10%|
|iShares $ TIPS (LSE: ITPS)||10%|
|iShares Physical Gold (LSE: SGLN)||10%|
Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
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