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Every week, Kyle Caldwell and guests take a look at how the biggest stories and emerging trends could affect your investments, with practical tips and ideas to help you navigate your way through. Join the conversation, tell us what you want us to talk about or send us a question to OTM@ii.co.uk. Visit www.ii.co.uk for more investment insight and ideas.
Hello and welcome to the latest episode of On The Money, a weekly show that aims to help you make the most out of your savings and investments. The focus for this episode is on how to approach building a portfolio from scratch. And joining me to discuss this topic is Dave Baxter, who is senior fund content specialist at Interactive Investor. Dave, welcome back to the podcast.
Dave Baxter:Thanks for having me on.
Kyle Caldwell:So, Dave, you're gonna run through three hypothetical portfolios that you put together for three different risk levels. So low risk, medium risk, and high risk. Yeah. Before we delve into those, what would you say are the main considerations when starting to build a portfolio from scratch?
Dave Baxter:So I'm gonna make two, I guess, related points. One thing to consider is your time frame and your circumstances, which of course is related. So, you know, say you have ten or twenty or more years to, like, ride the ups and downs, then really you should be taking kind of maximum levels of risk because you can tolerate that volatility and you're going to maximise the growth that you can get. Whereas if you're, I don't know, retirement for example, or if you for some reason would need your money soon, you need to be a bit more cautious. And the other thing I would highlight which again is linked, is your appetite for risk and that's quite interesting because sometimes that can contrast a bit with your actual circumstances so you might have time to write out the ups and downs of markets.
Dave Baxter:But if you're particularly, you know, squeamish and freaked out about a big fall in your portfolio, then maybe just for your own kind of peace of mind, you might take off a bit of that risk.
Kyle Caldwell:I completely agree with everything you've just said. I think also when you're starting out, how much you've got to invest is a big factor, and that can help dictate how many funds or investments you choose. If you're just starting out with a thousand pounds, you could feasibly just buy one fund, a global index fund or a global ETF, for example, and that'll give you ready made diversification as those types of funds. They own thousands of shares across the globe, and it gives you lots of exposure to different areas, different countries, different sectors, different industries. Whereas as your portfolio hopefully grows over time or if you do have a larger initial investment amount, you can you can then consider holding more than one fund, holding several and spreads diversification out even wider.
Dave Baxter:I guess there's also the interesting, you know, how much how interested are you in your investing point? Because perhaps you kick off and, like you said, you're having a broad tracker and nothing else. And then over time, perhaps you're watching what it does and then perhaps you go down the rabbit hole of kind of, you know, studying a bit more about investing and then you can pick some of your more, like, individual kind of holdings.
Kyle Caldwell:And in terms of what to think about when constructing a portfolio, I do think the core and satellite approach is a really good rule of thumb for people to consider. So the theory is if you have around 80% in core holdings, such as a global fund, which you can, you know, build a portfolio around. And then the remains in 30 to 20% is in more satellite positions, potentially in more adventurous areas such as funds investing in smaller companies or funds investing in the emerging markets or Asia Pacific regions. And what a corn satellite approach does, it helps give you a a diversified portfolio and gives you plenty of balance.
Dave Baxter:Yeah. Definitely.
Kyle Caldwell:So let's go into the free hypothetical portfolios that you have assembled. Yeah. And we will put links to each article in the podcast episode description, which will contain the tables of the funds that you've selected for each of those hypothetical portfolios. But for those that are listening and watching on YouTube, we're also gonna show the tables during parts of this podcast recording. So let's firstly go into the lowest risk portfolio or the cautious portfolio.
Kyle Caldwell:So in terms of its asset allocation, talk us through how you decided in terms of how much percentage exposure to dedicate to shares, bonds, and you've also got some exposure to alternative investments in this one.
Dave Baxter:Yeah. So for argument's sake, I to be, yeah, to be frank, I've been very cautious, very conservative, and just put 20% in shares. And that's a very diversified exposure, I guess partly because so some people who are cautious investors would have more in equities because even if you're on retirement, you probably still wanna kind of keep growing your portfolio. But one thing I wanted to explore here is the dilemma you have with the defensive or the cautious side of a cautious portfolio. Because, you know, in the past you might simply have held a bit of equities and then loads and loads and loads of money in bonds because bonds in theory should gain in value when stock markets fall.
Dave Baxter:But we've seen some challenges there, so in 2022 when we saw rate rises, you saw bonds falling in tandem with equities and we've had a weird kind of throwback to that with the conflicts in The Middle East. So again, you know, you'd be hoping that things like government bonds would be gaining in price while equity markets struggle, but they've also fallen because bonds hate the prospects of inflation and rate rises. So rather than going all in on bonds, we've kind of split it up, as you mentioned. So we've got 40% in bonds, some government bonds, some corporate bonds, and some inflation linked bonds. And then we've got some gold, we've got some commodities, we've got a bit of property, and also we've got a so called absolute return fund.
Kyle Caldwell:And the remains in 20%, is it, is in equities?
Dave Baxter:Yeah. It's 20% equities. So there we've gone for one really diversified fund. We've gone for the FNC Investment Trust, which kind of doesn't stray too far from the MSCI World Index and then interestingly, I thought to kind of highlight this interesting option, I've also gone for a MSCI World ex USA tracker, just because the F and C Trust is very heavily weighted to The US and, you know, as investors learned or remembered last year, there's a lot going on beyond The US and there are a lot of returns to be had beyond The US, so I just wanted to kind of give that spread.
Kyle Caldwell:And you've arrived at picking 10 different funds, and they've all got a 10% percentage waiting. And those listening in and watching the podcast on YouTube will now be able to see a table of your choices. You've already picked out FNC Investment Trust and run through that one. Are there any others that you would now pick out and talk through?
Dave Baxter:So a lot of these are actually ETFs. I think six of the funds are ETFs or passives of some form because we wanted some very straightforward exposure. So for gold, we simply wanted a physical gold ECC. With bonds, we've gone to some kind of broad bond trackers. But perhaps to touch on a couple more interesting options, you've got the Schroeder Real Estate Investment Trust, which is, you know, focused on physical property.
Dave Baxter:Property can be a diversifier against equities and property might hold up better if we did see that kind of inflationary environment that is going to threaten bond investors. And then one other one to highlight, this might be a controversial take, there's the Janus Henderson absolute return fund. So people a lot of people now probably pretty much hate absolute return funds because they haven't done that well in recent years. But this one has quite a good record of protecting your capital. It's a so called long short fund, so it does have some exposure to, you know, just buying equities, but it also does shorting, so betting on a price falling off a share.
Kyle Caldwell:I mean, personally, I'm not a big fan of absolute return funds. I think I think I think many of them are too risky. And I think if you see an absolute return funds in over a one year time period, it's delivered a return of 20% plus, then it's not really doing its job. It's you know, these these funds are supposed to provide steady returns in a range of different market conditions. I think if a if a fund can go up 20% in one year, it can also go down 20% in one year as well.
Kyle Caldwell:Now for each of these hypothetical portfolios, you've also come up with some more hands off options for people who, instead of building their own portfolio, might want to outsource the decision making for a cautious investor. You've mentioned the wealth preservation investment trusts are a potential good option. Could you explain why?
Dave Baxter:Yeah, so these are names like Rougher, Personal Assets and Capital Gearing. They do have some equity exposure, I can't remember the levels off the top of my head, but relatively kind of moderate. But they also use things like bonds, like kind of some derivative instruments, exposure to gold, that kind of thing, to try and protect you from when, you know, stock markets fall out a bit. So if you're a pretty cautious investor and yes, you want a bit of growth but you also want to protect what you've spent decades building up, then these trusts should hopefully do that job, give you a bit of a steady option. But it's really worth examining the different kind of levers that they use.
Dave Baxter:Some, like rougher, are actually a bit more complicated. They use more esoteric things. And the different funds have very different exposures to different sorts of bonds, to gold, and so on.
Kyle Caldwell:I think each of those free wealth preservation investment trust, they are potential really good options for a defensively minded investor. However, the thing to bear in mind is if you dedicate too much of a portfolio to that type of strategy, then you're potentially going to do that at the expense of long term capital growth.
Dave Baxter:Yes. Yeah. I guess that's the big risk that we kind of overlook with cautious investors that you are being too cautious and you're, like you say, you're giving up growth. And also, you just need to remember that inflation is a thing and you need to keep protecting your portfolio against those rising costs.
Kyle Caldwell:Let's now move on to the medium risk slash balanced hypothetical portfolio that you came up with. To start off, could you talk us through the asset allocation?
Dave Baxter:So often, you know, again, this is very subjective, but the idea of a balanced portfolio has in the past tended to land on this idea of, you know, sixty forty, which traditionally was 60% equities, 40% bonds. I've done a slightly different version of the sixtyforty, again because of those concerns we discussed earlier about bonds and, you know, their outlook. So we've got 60% in equities but we've got 20% in bonds and then we've got 20% split between a gold ETC and a commodity ETF. So hopefully, if bonds do have a rougher period, then those other assets will pick up some slack in terms of protecting investors from, you know, equity market volatility.
Kyle Caldwell:And with the medium risk portfolio, you went for 15 holdings, and you've dedicated 30% to the iShares core S and P 500 ETF. So talk us through your thought process.
Dave Baxter:So I still I guess, like everyone slightly fear and respects the world's biggest market, I don't wanna completely bet against The US, but I'm still, I guess, going sort of underweight The US with some exposure just because, as I mentioned before, you know, lots of markets have done really well beyond The US. There are still these questions about the outlook for The US now, and, obviously, current president is causing a lot of headaches for markets. So I've got that US exposure, I've got one other US funds to give a different form of exposure and then beyond that what I've done is I've taken exposures to the main equity markets, so we've got The UK, we've got Japan, we've got Asiaemerging markets, which are kind of bunched together, and we've also got Europe. And rather than just picking, say, a fund for The UK and a fund for Europe, I'm trying to be aware of the fact that investment styles can wax and wane. So, of course, as we know, value funds have done pretty well in recent years, but before that, so called quality and growth funds were doing really well.
Dave Baxter:So I've tried to mix or, I guess, pair a growth fund with a value fund.
Kyle Caldwell:And you've got a number of holdings that are 3% weighting. Yep. Do you think that's sufficiently high enough to to to do justice in terms of performance?
Dave Baxter:That's an interesting critique. Yeah. I mean, you could argue that you might wanna be, say, 5% or higher in order to kind of move the dial a bit better. I'm trying to I mean, what's interesting about these pieces is it just really highlights how difficult it can be to build your own portfolio because you're trying to, you know, juggle the different percentages. I didn't want to go too wildly underweight The US, but in my quest to do that and have diversification, that means you need to end up with some relatively small fund sizes.
Kyle Caldwell:I mean, for me, I think if you've got a holding that's less than 1%, it's gonna be very, very difficult for that to move the performance dial even it even if it has spectacular Yeah. Performance. But we we are gonna come back in a year's time to review how each of these portfolios fare both on the website, and we'll also do a podcast episode on the performances. So I suppose we will see in a year's time, you know, how how much of a difference those 3% weightings have made.
Dave Baxter:Yeah. Fingers crossed. 3% is the the magic number. So
Kyle Caldwell:for a hands off investor, what type of funds sort of fit into the category for a balanced investor? I mean, the one that springs to mind for me is something like the Vanguard Life Strategy 60% equity funds given that it has 60% in shares and 40% in bonds?
Dave Baxter:Yeah. That's the big beast, isn't it? And it's a nice kind of no stress option. It's very simple. They don't move those allocations around.
Dave Baxter:I guess, though given that I was talking about the question marks around the reliability of bonds, then a big criticism of that whole life strategy range is that their only diversifier is bonds. So there are rivals to life strategy, for example, BlackRock, Mind Map and a few others. They do delve a little bit into so called alternative assets, so try and diversify a bit differently beyond bonds. And, you know, there's a whole universe out there, but there are also kind of active multi asset funds which should try and kind of give you that that mix.
Kyle Caldwell:And, of course, at Interactive Investor, we also have our own managed ISA range. So let's now move on to the adventurous portfolio. So if you're investing in an adventurous manner, you could in theory have a 100% of your portfolio in shares. Is that what you've chosen to do?
Dave Baxter:I've done, I suppose, a 100% in so called risk assets, but it's not all shares. And, obviously, that's a very big bit of industry jargon, but it's 92%, I believe, in equities. And then I've chucked the remainder, so the remaining 8%, into kind of different forms of private asset exposure. So you know there's this argument that listed or public equity markets are shrinking and we're no longer seeing some of those great growth stories, you know, the most obvious example at the moment being SpaceX, they get a lot of their growth before they actually list onto the stock market. So I just wanted to spice things up a bit by giving some of that exposure and interestingly, again, is a dilemma because perhaps some people would argue that an adventurous portfolio now needs to have more in private assets and less than I've put into listed.
Kyle Caldwell:And with this adventurous hypothetical portfolio, you've once again opted for 15 holdings, and you've also once again selected iShares Core S and P five hundred ETF as the biggest weighting, and it accounts for 35% of this portfolio. Could you talk us through the rest of the lineup and how the adventurous portfolio differs from the medium risk portfolio?
Dave Baxter:Yeah. So I've tried to kind of have a a string of continuity between the three funds. So in this case, I've stuck with the whole S and P as a core and then having kind of paired with different or paired funds, sorry, with different styles for given regions. So to give an example, we have BlackRock European Dynamic which is flexible but can be quite quality growth y with Lightman European that's a value fund. So that's how it's similar to the balanced portfolio.
Dave Baxter:How it's different is I have put in a few, I suppose, punchy satellite funds. So we've got these aren't all the most obscure names, but we've got Scottish Mortgage, you know, the kind of future trends investment trust. We've got AVI Global, which is an interesting one because it's kind of a value fund but it also holds things like, you know, holding companies and has a lot in Japan. So it's offering you access to kind of growth opportunities that you're not really getting elsewhere. So that could have some potential.
Dave Baxter:And then we've gone for some private exposure, as I mentioned. So we have Harbourvest Global Private Equity, that's one of those big, sprawling PE trusts. It has exposure to so many different funds and hundreds, I think, of underlying companies. So that's a well diversified PE option. And then I've also gone for quite a fashionable fund at the minute, is Seraphim Space, so it's kind of catching that really exciting trend, again, predominantly in, like, private assets, also riding the kind of defense spending trend too.
Kyle Caldwell:And for a more hands off option, which types of funds would you say fall into the adventurous category?
Dave Baxter:So you've got your simple kind of global trackers, and you can have different kind of mixtures in terms of what exposure you have to The US. So life strategy has its own 100% fund and that is much more UK focused than say the MSCI World Index. But also don't forget, you know, the active fund because there are some global funds, I mentioned F and C before, which are quite diversified and they can try and act as a one stop shop. I would caution that perhaps with some of the really popular names like Scottish Mortgage, like Fundsmith Equity, they can actually be quite focused funds. So I don't know if you would necessarily put all of your money in those.
Dave Baxter:You probably wanna go for a wider spread.
Kyle Caldwell:Yes. Because in the case of something like f and c or Alliance Witten, they own hundreds of companies. That does give you greater levels of diversification, and they are a bit more steady eddy than, say, a Scottish mortgage or a funds with equity, which they have probably they do have more potential to outperform Yep. An f and c or an alliance wit, and, but at the same time, they are more likely to give you more of a volatile rise at certain points.
Dave Baxter:Yeah. I mean, it depends on your belief in those stock pickers, doesn't it, as well, and how much you how much risk you wanna take and how much of a bet you wanna take on, say, Terry Smith or the Bailey Gifford team.
Kyle Caldwell:Well, Dave, thank you for running through each of those three hypothetical portfolios. And as mentioned earlier on in the podcast, we'll put links to each of the articles and the tables in the episode description. And that's all we have time for for today. So thanks, Dave, for coming on.
Dave Baxter:Thanks for having me on.
Kyle Caldwell:And thank you for listening to this episode of On The Money. We love to hear from you, and the way to get in touch if you have an idea for a future episode or you have a question that you'd like one of the team to tackle is to email us on otm@ii.co.uk. In the meantime, you can find lots of analysis articles related to funds, investment trusts, and ETFs on the Interact Investor website, which is ii.co.uk, and I'll hopefully see you again next week.