Company Pension Investment Choices

gm0

There has been a slight context switch in the thread between a more general active v passive topic for equities and the broader attempt to reduce correlation and volatility through diversification beyond equities + bonds into property, commodities, alternative trading strategies etc. The key comment - almost a throwaway in the very portfolio building reply which resonates the most is "the trick is finding them".

I am reading around the same issue. I would like to diversify more from equities.

As above the options I have been reviewing to do so are in an occupational scheme also of the "diversified growth fund" bundled variety with a % developed equities and then Black Rock or Schroeders or similar active diversified growth funds which are intrinsically fairly opaque.

If one is drawn to passive investing via desire for simplicity, logic of SPIVA findings, Krojier principles etc. then the opacity of these funds and the hanging question as to whether - come another crisis or a major equities revaluation - they actually will do what they say on the tin. But the throw away remark is key. What would you need to go and learn to access an alternative, more transparent and yet still effective diversification strategy.

If you haven't read about the permanent portfolio yet then I recommend you take a look. Not necessarily with a view to investing in that format (there's a lot of gold (preferably physical) in it - but from the perspective of the principles explored as to the role of different assets at different and extreme times to protect the overall.

bowlhead99

gm0 wrote: »

almost a throwaway in the very portfolio building reply which resonates the most is "the trick is finding them".

I am reading around the same issue. I would like to diversify more from equities. But the throw away remark is key. What would you need to go and learn to access an alternative, more transparent and yet still effective diversification strategy.

If you haven't read about the permanent portfolio yet then I recommend you take a look. Not necessarily with a view to investing in that format (there's a lot of gold (preferably physical) in it - but from the perspective of the principles explored as to the role of different assets at different and extreme times to protect the overall.

There is an almost bewildering amount of choice. But at the end of the day, an effective diversification strategy means having a bunch of assets that generally have some ability to grow in value and are not fully correlated with each other. If you were to look at the factsheet of the BG fund I linked earlier, you can see they summarise their current exposure to 15 different areas:

Listed Equities
Private Equity
Property
High Yield Credit
Investment Grade Bonds
Structured Finance
Commodities
Emerging Market Bonds
Infrastructure
Government Bonds
Absolute Return
Insurance Linked
Special Opportunities
Active Currency
Cash and Equivalents

That's not the only way to dissect the global investment markets it's just how BG chose to categorise their fund's investments for the purpose of this particular factsheet.

So, the first one of those areas - 'listed equities' - is what the OP would perhaps have covered through his UK/Developed ExUK equities and Emerging equities trackers, and which perhaps would account for 65-70% of his portfolio. The others are all valid areas in which to invest, but they are complicated and perhaps more difficult to access for the retail investor, especially one who is self-imposing the limitation that they will only want to use trackers and cheap funds .

The OP, no disrespect intended, is probably not going to have the first clue about which parts within which areas offer attractive risk/return characteristics at this point of the economic cycle and how to put together the 14 areas which are not 'listed equities' into the remaining 30% of his portfolio. Two potential solutions, one of which is more difficult than the other, are (a) do a lot of learning and then a lot of prudent investment followed by micro-management, or (b) pay one or more fund manager(s) to cover this part of your portfolio.

However, if he has skimmed a second hand synopsis of 'investing demystified' posted on the web, or some other simplistic introduction into passive investing, he will be put off both (a) and (b) due to fees and/or complexity. He may believe there is a third way: (c) all you need is a passive equity fund and a passive bond fund and periodically rebalance those two asset classes.

Way (c) requires you to forget the fact that there are 10+ niche classes of assets which are not equities, because the biggest sub-group of them can generically be referred to as 'bonds'; don't worry about the prospects for different types of bonds and what use they are in your portfolio - just allocate the money based on what value of different bond types exist in the global market. Then the credible-but-niche stuff will be ignored and you will just end up holding an amount of a particular bond type because it exists in large quantities rather than because you want it. To do this you simply accept that the market allocates capital efficiently and it is fine to hold whatever the massive institutional investors hold on average between them, even though you are not an averagely massive institutional investor yourself and might have different personal goals.

Also for property under approach (c), assume that property will often be correlated to equities and note that within your global equity trackers some of the underlying companies are property investment holding companies and so you have 2% property exposure anyway, which must be enough because that's how much exists on the public markets compared to equities of other company types; likewise some companies in your equity trackers will be exposed to changes in commodity pricing, so don't engage in holding any yourself; infrastructure projects are generally some combination of equity upside or downside and a bond-like yield, which sounds like an interesting low-volatility play but is perhaps just smoke and mirrors, don't worry about them because some part of your equities have 'equity upside' covered and some part of your bonds have 'low volatility yield' covered.

If you follow path (c), "stick it all in a bond index and you're done" for your non- 'listed equity' exposure, you are basically counting on oversimplification to justify going for a cheaper approach. Every one of ten, twenty or more different niche asset classes could be written off as, "well if it's only going to be a couple of percent of your portfolio, why bother..."

Personally I am not a fan of path (c) whereby I need to trust a single global bond index to cover all my non-equities needs, because I believe there's a bunch of different asset classes to consider and even if bonds was the largest group of assets I don't think the index of total value of all the bond types that exist is relevant for me as a UK individual with personal goals and risk preferences.

- Most passive investors accept the need for them to to make some asset allocation decisions, such as to how to split their equity to bond allocation (60:40, 70:30, 80:20 etc). They don't let 'the market' do this allocation for them based on the total value of equities and bonds that exist, because it would give them significantly more bonds than equity, which is fine for 'the average investor in the world' but not suitable for growing their wealth for retirement.

- However, when it comes to whether their bond component should hold short term gilts or long term gilts or index linked gilts or international government bonds or investment grade corporate or high yield corporate or emerging market bonds or structured credit opportunities etc etc (which may each have some level of suitability for the portfolio), some passive investors will take a cop out at this point and say that they will let the market decide. Others say that they will shortcut to save more money by cutting out something like high yield bonds because they are somewhat correlated to equities so no need to hold them, and say that international bonds can be cut out because they are just like domestic bonds but with currency risk, and the equities part of the portfolio is already giving plenty of currency risk.

Generally I think passive investing does not solve well the question of what to do with the non-equities bit, due to a myriad of potential strategies being available among financial instruments with widely varying characteristics.

gm0

Keeping things as simple as possible and no simpler - which looks like it could include an element of these other asset categories if the reduction in volatility with adequate return can be illustrated across an interesting range of economic conditions. The short life of some funds and availability of data can be an issue. I struggle with the idea of more than 2 10% bets due to not knowing what's inside and suspicions that a number of categories smell of short term gambling or of arbitrary "mark to market" of the illiquid. But as you have said - most of us don't have access/skills to DIY this element.

When I did a CAGR analysis for my set of global equities options there was a delta but it was not very helpful to forward decision making in a period of benign+bullish conditions for equities. When you turn around the question from "which one makes the most" to "how do I make "enough to last 40 years at £x/SWR y%" - with the minimum required risk and size of volatility in the next drawdown. Then a different kind of analysis is needed. The open market choice is indeed huge. There seems to be a need to get properly to grips with Sharpe ratios and other measures (back testing - McClung book etc) risk and volatility to help become psychologically prepared for the behaviour of the equities component - at 20% or 50% or 60% down. Even last year's blip demonstrated an interesting psychology if you watched it (too often) going down (a little bit) as I did and then back.

Like the OP I have not found it easy to get comfortable with the DIY fund selection of the more complex categories - even within extremely restricted pallet of an occupational scheme.

Using a global equities approach and then building from there - all these options do broadly the same thing for the equities piece and show a CAGR from 2009 to an April 2019 date of between 10.4% and 12.1% based on unit prices. Naturally the cheaper passive ones don't provide any "diversification" component other than some blend in a mix of FX hedging/lack of hedging.

Passives

A) A tracker fund to FTSE4Good Developed (LGIM) - (Nothing alternative at all, unhedged, pure equities - ironically has done best of all in the period considered based on large cap and 50% US markets). Obscure tiny fund (and index arguably). Cheapest by some distance. Building block ?

A Global equity tracker made of:

( Sin stocks back in - half currency hedged to sterling, half not, little bit of EM)

45% MSCI World Adaptive Capped 2x Index
45% FTSE Developed World Index - GBP Hgd
10% FTSE Emerging Index

C) A geography weighted portfolio UK + Overseas mix made up of

Composite of 50% FTSE Developed (ex UK) Index and
50% FTSE Developed (ex UK) Index - GBP Hedged

Perhaps to be mixed with FTSE All Share Index tracker or a UK active option to push in some smaller capitalisation stocks. Another building block with hedging ?

But to move past these and include alternatives discussed then a switch or blend with a more sophisticated active option comes into play.

D) A global actively managed fund made up of:

BlackRock DC Diversified Growth
LGIM Global Equity Market Weights (30:70) Index Fund - 75% GBP Currency Hedged
Schroder Intermediated Diversified Growth

And then bonds if wanted separately

An index linked gilts fund mostly 2030-2050 75% UK
A fixed gilts and corporate bonds fund mostly (66%) UK gilts

The fund bond durations are medium/long. Interest rate outlook makes these a fairly unattractive buy - not going to do much - likely to lose out when interest rates crawl up (this based on not having any already due to riding the equities horse). The IL's might have a use as a short term cash alternative hedge against a UK inflationary period.

The logic chain being explored leads to the idea of creating an exposure to the Black Rock and Schroeder funds accepting the higher fee implied by that to hold some of the equities element that comes with it - and then a need to examine better the return, correlation/volatility impact that could be expected for the cost in a "normal" equities bear market (whatever that is). That can then be compared for drag with doing a similar thing in a retail SIPP with full options available thus revealing the implicit premium - be it positive or negative - of the retained occupational pension protection for the desired in retirement investment posture.

In my 20% bet example above that would imply:

~40% into the global actively managed fund and 60% in one of the cheaper global equities plays with 80% equities overall. First pass of course it still has 80% of the equities volatility unless there proves to be some healthy -ve correlation in the 20%. which is where I should probably look next as published data permits.

In my case the visible costs only go up by about 0.15% plus any difference in undeclared embedded trading costs to blend it in. However fact sheets seem to show it did worse than my global equities in 2018 and the long term return since launch (2011) is not great either - so it is protecting me from something we haven't seen these past ten years. Not enough useful data......