Diversification across equities

ChilliBob

Albermarle said:

the mixed asset fund is your portfolio;

In this case I would have more than one , as all the main ones ( Vanguard, HSBC, Blackrock, Fidelity etc ) all construct their low cost multi asset funds in different ways , with mildly varying results . So makes sense to have two or three , as usually there is little extra cost involved , if any.

I experimented with this in my Son's JISA in a small proportion actually as I had read about the differences. I know this isn't supposed to provide a source of entertainment, but VLS80 and MyMap5 since around Jan haven't really done much (negative or positive that is), which I suppose in a way is a good thing when the rest of the JISA is quite a bit more volatile and active! I'm not overly bothered by volatility with a 15 year time horizon though on what's a tiny pot at the moment. I know it's 'naughty active' as Monevator would say but my favourite Multi Asset fund at the moment is probably BG Managed.

ChilliBob

Clearly coming from an active manager this is prone to be a bit biased towards actives, but it's an interesting read (oh and obviously it's a bit old): https://www.schroders.com/hu/sysglobalassets/digital/insights/pdfs/hidden-risk-of-going-passive-july-2014.pdf

underground99

ChilliBob said:

Linton said:

I aim for my Growth 100% equity portfolio to be as widely diversified as possible.  I do not adopt a core/satellite approach, instead using a set of specific geographical based funds, both large and small companies.  The problem with a core index is that you start off in the wrong place with say US at 60%, the top 10 companies all in the same very few sectors with 14% of the entire portfolio.  The satellites then have an impossible job to smooth out this concentration of assets. 

That makes sense, I guess no matter the size of your pot if you have 80% in a global equities tracker then no amount of very specific allocation will tip that balance by much. What's interesting about all of this is what you, @Linton @Thrugelmir and @underground99 are saying about the concentration risk. On the one hand this makes perfect sense when you consider the make up of the index and how much you'd end up holding in FAANGs alone vs everything else. There's plenty of research to support this from various sources On the other hand you have the likes of Lars K and others stating that doing anything besides investing in the widest possible index is you declaring you have an edge and know more than the market! - It's a view point quite a few people have and again comes from various sources. As a new investor this does represent a question as to which camp you feel makes the most sense, I began this investing malarky quite firmly in the second camp, with Lars, Monevator etc being my main points of reference. Over time though, and especially over the last few months I feel I'm coming round more towards the other viewpoint.

Yes, if you invest other than in line with the index, the fans of investing in the index will say you are taking more risk; the risk of not getting the same result as the index of all opportunities that exist. You might be happy to take that risk if it helps avoid certain outcomes (e.g. having 2% of your whole portfolio in Apple when Apple halves in value or goes bust due to some issue).

If you were trying to deploy $50 trillion across global markets or $3 trillion across UK markets you would have to follow market weight to deploy it all. It would be crazy to invest $25bn in Apple and $2 trillion in Tesco because you would blow away all the market consensus of what the companies are 'worth' and how much of your allocation they deserve. The market says that 80x as much money has been put into Apple as Tesco and if you're investing a trillion, doing it the other way around just isn't going to fit.  But you are not constrained by needing to spread all your money based on what will fit. You only need to spread it based on what fits your strategy. 

Tesco market cap is maybe 3x Sainsbury so if investing in UK supermarkets, the index allocates your £100 in a 75:25 manner.  Market would say the 75:25 is optimum as that's how the £25bn was allocated by all the investors.  But you know that the market result is just derived by people throwing £25bn at the companies and wanting to make sure that both were being valued at a fair multiple of assets or profits or prospects, which determined their market caps and their price. But you are not a price setter, just a price taker. If we believe the market, each company at current share prices is fairly valued on its prospects so you're not fundamentally an idiot it you give them both £50 to avoid being unduly exposed to Tesco's fortune.  However, if Tesco has more branches and real estate and profits, isn't it risky to put just as much money into the 'minnow'? That would be your nagging doubt.

You might find fund managers allocating among Tesco and Sainsbury in different ways. If one has more Tesco and the other has more Sainsbury, if you pay both managers for their expertise by holding both active funds, you are paying them for a bit of both. You might as well take the index and not pay them. But the index does give you quite extreme variations in how much goes into what. Within the FTSE350 we can understand why people would put a lot more into Shell and BP combined as they would put into relative tiddler Cairn Energy. And in S&P 500 you would expect more in Amazon than Gap Inc.  But it's not like 5:1 or 10:1 , those ratios are 200:1. 

So with indexing you are going to get a lot of money in a few companies and very small amounts of money in a lot of companies.  When you look at the statistics on the factsheet, the index says you're broadly diversified across 5000 companies or whatever. But you are exposed to small amount of returns from lots of companies which are individually adding nothing to the return and could be dropped, while you are exposed to large returns from a few companies whose presence or absence would materially change the result for better or worse.  Lars K et al would say you are taking more risk if you underweight Apple and Amazon, and certainly you can see that your returns would have the potential to be very different if you didn't take them at market weight. 

The question is just, can you live with not getting a return heavily weighted to Apple and Amazon and Microsoft's fortunes, for better or worse, when all your friends and neighbours are going to get that return assuming they follow the index. In the future, you and your friends and neighbours will all be taking your pounds to the corner shop together to buy a nice loaf of bread. If there is only so much bread to go around, the price will be set through supply and demand, essentially an auction process. Do you want to risk having fewer pounds than your neighbours and not getting the bread? The upside is that if you did well, you could get more bread. 

An issue perhaps is that your comfort is about absolute comfort rather than relative to neighbours. If they all punt on Apple and it goes wrong and they lose money, it is not much fun losing money too and saying ah well I kept up with those Joneses losers. You might prefer to cast your net wider than the high concentrations of the index in an effort to not be as exposed to the actions of the herd. 

There is no 'right answer' as investing has a lot of opinion and outcomes are only available with hindsight. The fans of indexing will say their way has been proved by scientific papers, so anyone not following the index is the equivalent of a cultist / religious nutjob who shouldn't be respected because they're not following the science.  The people on the other side may say that it's the indexers who are the cultists and who won't take on board other reasonable arguments. What you can say is that you will get different results if you don't follow the rollercoaster of the index, and at some times you would do better and others worse. The reason to use the index is to keep it efficient so that at least you aren't losing money to fees.

If you have some other objective than absolute maximisation of return, fees and total return may not be the overriding factor. For example if you were trying to get lower volatility than the index you might not mind that your portfolio finished 10% lower on your deathbed if it had gone up smoothly in a straight line for a couple of decades rather than swinging up and down 40% each year along the way.  Of course, avoiding index concentrations does not necessarily improve volatility. A smallcap index can be more volatile than the FTSE100 even though it has more stocks in it and greater diversity of industries within it and a lower concentration to any one stock. If the biggest things in the index are boring oilers and banks and tobacco and healthcare and global consumer goods, it may be only modestly volatile. But then if something goes wrong with oil price or lending conditions or whatever, there can be a huge shock making it more volatile in the moment and more than making up for the previous observed stability.   So, one technique may work fine, until it doesn't.

Over time though, and especially over the last few months I feel I'm coming round more towards the other viewpoint.

Really, half the battle is recognising there are multiple viewpoints. Reading up on investments is like politics. If you only read one type of paper you will think you know all you need to know and it can be an eyeopener to suddenly find the other perspectives; whether or not you come around to whichever way of thinking, at least you are thinking broadly.

ChilliBob

Thanks, that's a really interesting and detailed response. To use your supermarket analogy, if you were going 'against' the market and putting more in Sainsbury's than Tesco that would be you essentially saying you feel you know better than the market though, which clearly as a retail individual you don't. I suppose your point is the way the market has allocated the money may not be 100% efficient (well, it won't be).

In terms of peers, I'm not too bothered when I see on say forum threads that perhaps one person's portfolio is up 35% year on year and someone else's is 20% etc. If mine is up 10% then yeah I'd be a bit peeved, but I think I'd just accept that this is the way of the world - and what's important is your own situation, not that of others.

I think I'd feel a bit of a muppet if I'd spent ages monitoring things, choosing active funds at a hefty price tag, to see my returns would have done better (net) if I'd just taken a global index! If returns were down on a global index I'd like to think I'd take the long term view that they'd pick up, and my cost incurred to get these returns (losses) were low. I suppose my thinking here is putting faith in an active manager, at a higher cost, would lead to more disappointment if they were below the returns of an index than if the index was doing crap.

Where this leaves me isn't entirely clear, for sure!... There's 100% a role for a Global Tracker in my portfolio, likewise there's 100% a role for quality active global funds (e.g. TRP, Rathbone, BG) some UK small caps, some more risky tech, and other stuff besides (infrastructure, gold etc). The (literally) million dollar question is the proportions of which (i.e. Asset Allocation) as opposed to how I source these. 

My goal isn't to smash the lights out with stonking returns, riding some hideous rollercoaster along the way, nor is it to just go for capital preservation and have it all sit there not moving much in the likes of Trojan/CGT/PNL etc. Some hybrid of the two is what I'm looking for - depending on pot. Perhaps, inadvertently I've just described a Global Tracker, although I sense forum consensus is that this is actually closer to the first scenario (considerably) than the second!

noclaf

I've been thinking about diversification too in regards to my investments allocations. Across pensions, Lisa and S&S ISA 89% is in Equities and the remainder global bonds and UK property. My S&S ISA represents around 3% of all my investments but planning to bulk this up soon. As the S&SISA is the most accessible of all 3 and therefore likely to be used as a 'bridge' before pension draw-down, if I wanted to reduce my equity exposure slightly does it make sense to use the S&SISA to do this? E.g: I could add a Bond fund alongside my global equities fund

I'm 39 for context. 
If on the other hand 90% equities is fine for my age as I try to grow my overall portfolio then I will probably leave it as is

strawb_shortcake

As a complete newbie to all of this, isn't it a bit like not looking back once you've booked a holiday, prices after you've committed are irrelevant, and in that respect tracking what you haven't but could have invested in isn't going to change your current position.
Admittedly there is a line between that and learning.

*disclaimer* I know my view point may not neccessarily add value to this topic but I don't have anyone else to share my ramblings and thoughts with, and it just came to mind reading some other replies

ChilliBob

I think it's too difficult to say if 90% equities is suitable for you or not - there's so many other factors to consider before knowing if this is right or not - so I don't think anyone on here would be able to give you a definitive answer. 

underground99

noclaf said:

My S&S ISA represents around 3% of all my investments but planning to bulk this up soon. As the S&SISA is the most accessible of all 3 and therefore likely to be used as a 'bridge' before pension draw-down, if I wanted to reduce my equity exposure slightly does it make sense to use the S&SISA to do this? 

There is perhaps an argument that as pension growth will ultimately be taxed in some way and LISA & S&S will not be, the highest returning assets could perhaps go in the ISA and LISA as they will never be taxed. That would particularly be the case if you were in danger of hitting the punitive 'lifetime allowance' on the pension, but this is not relevant for most.

However from a practical perspective if the S&S ISA will be the first pot to be accessed it may make sense for this to be the least volatile of your holdings as you would be less able to handle it falling in value and taking a while to recover.  Of course, there's a trade off between growing it more succesfully to a larger amount to serve you better, and not losing it in an untimely crash. If the S&S ISA is only 3% of the total you will not make a meaningful difference to your overall allocation if you convert a percent or two of it to bonds. 

I'm 39 for context. 
If on the other hand 90% equities is fine for my age as I try to grow my overall portfolio then I will probably leave it as is

It would be fine for some and too high for others. As Chillibob says, nobody can tell you it's 'fine for your age' as they don't really know your goals and your plans and your knowledge levels and how you will behave when the 90% of your worldly assets that are in equities fall in value by about a half over the course of a year or two and doesn't recover for a number of years.

ChilliBob

Interestingly that was by strategy I was intending to do - more risky active stuff like SMT, EWI, etc in the ISA and more steady stuff in the GIA.

It then dawned on me that this requires more research, and whilst this pot is smaller in size, it's still 100k of real money!

So, I toned it down a bit, thinking if I get say active global stuff that's not bonkers, I can always sell to buy more mental stuff. 

noclaf

The overall value of my investments is quite small compared to some of the figures I see thrown about on here! However the key one is my overall pensions value is a bit low for my age so starting from April I will be increasing my contributions via salary sacrifice. I also went slightly more aggressive by switching the fund for my current employer pension from the standard diversified fund to 100% equities. An older pension I is 60% equities so have some diversification there.
If there was a significant downwards market correction in the next few months (e.g: 30-40% or more) I would welcome it with open arms and 'fill my boots'...if it happens after I've just topped up my S&S ISA il likely be crying myself to sleep so trying to figure out a balance....and yes timing the market is futile I know
My S&SISA is a single fund (Vanguard FTSE Global All CAP) so keeping things nice n simple for now.