March 15, 2013 6:23 pm

Small changes to cut risk levels

I’ve been watching the portfolio go up

Over the past month I have been watching the portfolio go up. The decision to go overweight in equities at the start of the year has paid off – so far, the equities are up by about 10 per cent from the original purchases. The property shares are up even more, averaging a 15 per cent gain to early March.

Investors are desperate to earn some more income. They have been willing in recent weeks to run some more risk to do so. Deposits yield very little. “Safe” bonds are on low yields, with the US, Japanese and UK authorities still buying up their own bonds to keep the yields artificially depressed. Just as the authorities intend, this forces more people into buying riskier assets.

I selected exchange traded funds tracking Asian, US and world real estate investment trusts (Reits) to provide real estate exposure. Good quality buildings in the main city centres of the world are performing much better now. The worst of the crash is behind us. There is stronger tenant demand, which will improve as the world economy grows.

Property values are rising from the low levels they reached in the US, and are reaching high levels in parts of Asia. In Europe, central London values are rising, with substantial foreign interest in both renting and buying buildings in the UK capital.

The Reits tend to own good portfolios of the better buildings in the main centres and are benefiting from rising values and stronger rents. Yields have now fallen a bit, but are still attractive compared to very low high-grade bond yields or the returns on cash.

In the equity part of portfolio, I decided to avoid the euro area. Although the German economy is one of the better ones worldwide, and although there are rallies from time to time when investors relax a bit about the euro troubles, I do not like the background of long-running recession in many parts of the eurozone.

Mario Draghi eased nerves when he said he would do “whatever it takes” to keep the euro alive. Countries in the south are making some progress in cutting their balance of payments deficits and their state deficits, but at the cost of big cuts in real incomes and output. Getting imports down makes the accounts better, but if it is only because people have so little spending power, it does not make for a healthy economy. The Italian election result reminded markets that there are still unresolved issues in the region. It gave the markets their worst shock of the year to date.

The Redwood Fund
Security Allocation % Gain %
iShares iBoxx £ Corporate Bond ex Financials 9.1 -0.89
iShares Markit iBoxx £ Corporate Bond 1-5 ETF 9.1 -0.28
iShares Barclays Emerging Market Local Govt Bond 9.5 3.69
iShares Global Index-Linked Fund 9.8 4.63
SPDR S&P UK Dividend Aristocrats ETF 5.2 12.5
Vanguard FTSE 100 ETF 5 8.29
Credit Suisse Nasdaq 100 2.6 9.07
HSBC S&P 500 ETF 2.7 13.2
Vanguard S&P 500 ETF 5.4 16
iShares Asia Pacific Select Dividend 5.2 11.4
iShares FTSE China 25 5.1 13.4
iShares MSCI Emerging Markets Minimum Volatility ETF 5 0.1
HSBC MSCI World ETF 5 11.4
iShares FTSE EPRA/NAREIT US Property 5.4 15.4
iShares FTSE EPRA/NAREIT Asia Property 5.3 16.3
HSBC FTSE EPRA/NAREIT Developed ETF 10.6 15.6
 Gains are since security was purchased;
 Source: John Redwood

Instead, I bought into the US, the UK, China and Asia Pacific. They have all done well for different reasons. It also serves to remind us just how often world markets these days move in step one with another, despite very different economic prospects. Late last year China led the way, this year so far the US has been a stronger performer. The fall of the pound against the dollar has helped to generate positive returns in sterling terms – I’ve deliberately gone for sterling share classes wherever possible, since that makes most sense for a UK-based investor.

One change I have made recently has been with the emerging market exposure. Following a good run in emerging market equities, I have switched to a lower volatility selection of emerging market shares using the iShares MSCI Emerging Market Minimum Volatility ETF, to reduce risk a little if we have a setback. Such “minimum volatility” products are a useful addition to the ETF universe for just this reason.

Another change has been to the bond portfolio. I have reduced the exposure to longer-dated sterling corporate bonds. Last year they did well, but this year there are more nerves about this asset class. Expecting a decline in sterling, I put 10 per cent of the total portfolio into an emerging markets sovereign bond fund instead.

This gives a higher yield, and the advantage of currency gains when sterling falls. I took another 10 per cent a bit shorter in date to reduce risk further – longer-dated bonds tend to be more volatile and more influenced by changes in interest-rate expectations. The portfolio already has 10 per cent in a global inflation linked bond fund, which has been the best performer of the bond funds so far.

The total fund is up 8.3 per cent since inception last November, which is a reasonable start in what have turned out to be good conditions for equity investors.

John Redwood is the chairman of Evercore Pan-Asset’s investment committee. The contents of this article are for general information only and do not constitute investment advice

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