Building a portfolio with investment trusts

By Nick Britton, Head of Intermediary Communications, AIC

When the average investment trust has lost about a quarter of its value since the end of January, it may seem an odd time to be writing about building a portfolio with investment trusts. But it could actually be a very good time indeed.

No-one knows of course, and the market could plunge a lot further yet. But one thing that is fairly certain is that now is a better time to invest, on a long-term view, than it was a couple of months ago. Diversification, as ever, is key.

Building a portfolio

The first thing to ask yourself is what you are building a portfolio for. How long will it be before you need to touch the money? If it’s less than five years, then you should probably be in cash rather than investing. If it’s more than five years, do you need an income or growth from your investments – or a bit of both?

Once that’s decided, you’re ready to determine what’s called your ‘target asset allocation’. Imagine you have two buckets – one for risky assets like shares, and one for lower-risk ones such as bonds and cash. The more you put in the risky bucket versus the other, the more risk of losses but also the greater performance potential over the long term.

Let’s say you have a need for growth rather than income and can accept a fair amount of risk to try and get a good return. As I mentioned earlier, now is a better time to be buying the stock market than two months ago. So, you decide to allocate 75% of your portfolio to risky assets like shares and 25% to bonds. I am assuming you already have enough cash to meet your short- and medium-term needs and guard against any possible loss of income – three to six months of your salary in your emergency pot is usually recommended.

The equity portion

You’re then ready to select the investments. Investment trusts are a great way to get exposure to the stock market. They can gear (borrow money to invest) and many do so moderately to try and boost returns for their investors. This gearing does magnify losses as well as gains, but it’s one of the reasons investment trusts tend to outperform other types of fund over the long term.

There is also the chance of buying investment trusts at a discount to the value of their underlying assets, especially at the moment when the average investment trust discount is around 17%*. These discounts can widen as well as narrow, so it’s important to take a long-term view – but that average discount is already the widest it’s been since 2008.

Remember each investment trust offers a diversified portfolio of investments. If you have a smaller amount to invest (say, a four-figure sum) then it may be sufficient to just pick one investment trust for the “shares” part of your portfolio. If you go down this route, it’s best to make it a “global generalist” trust with a good spread of investments:

Read more about Elite Rated global generalist trusts such as Murray International and Scottish Mortgage Investment Trust

If you have a little more to invest, or want to make life more exciting, you could supplement your global generalist trust with a more specialist one. Possible choices to add spice include investment trusts that invest in smaller companies in the UK or globally, emerging markets trusts, and real estate investment trusts (REITs). Most of these are trading at discounts at the moment, which boosts your potential long-term returns, although there is no guarantee the discounts will narrow. Again, if you’re a beginner delving into more specialist trusts, maybe pick those that are more diversified and with a long, solid track record. (Yes, I know track records are no guarantee, but in a specialist area, I’d rather have one than not.)

Read more about Elite Rated specialist trusts such BMO Global Smaller Companies and TR Property Investment Trust

Those with larger sums could add more investment trusts to the mix, but don’t go crazy. I have eight investment trusts in my pension and I sometimes wonder if it’s too many. It’s important that you feel confident in the trusts you invest in – having too many different investments to monitor could add unnecessary complexity to your life. It is also more likely to lead to around-average performance, which isn’t the worst thing in the world, but if you’re investing in investment trusts you’re presumably aiming to achieve more than that.

The bond portion

Now for the bond part of the portfolio. There are a few excellent investment trusts that invest in bonds, but for the widest choice in this area, you need to be adding open-ended funds (OEICs or unit trusts) to the mix. Bonds have been very highly valued for a long time, but they have kept going up, until this latest panic has hit. Be aware that although bonds are supposed to be the lower-risk part of your portfolio, anything ‘high-yield’ (otherwise known as non-investment grade, or more rudely, as junk) could carry the risk of significant loss in the current climate. Even government bonds can suffer capital losses, though these are normally far less than the kind of market swings we regularly see in the stock market.

Search FundCalibre’s Elite Rated bond funds

Cultivating a Zen-like attitude

Once you have set up your portfolio, you need to monitor it regularly – but not too regularly, especially not in markets like these. If you feel you may be tempted to chop and change things, train yourself to look at it just once a quarter, or even twice a year. ‘Rebalancing’ to maintain your desired asset allocation (75% shares/25% bonds in our example) may be necessary from time to time, but don’t do it too often or you’ll rack up trading costs.

Remember that the most successful investors are sometimes those who look at their portfolio the least. One of my colleagues at the AIC bought a couple of investment trusts and then forgot about them for 20 years. I’ve never checked, but I have an uncomfortable feeling she might have outperformed those of us who chat about our holdings every day. Cultivate a Zen-like attitude to the markets and even a global pandemic won’t seem like the end of the world.

 

*Source: AIC, as at 24 March 2020

The views of the author and any people interviewed are their own and do not constitute financial advice. However the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Before you make any investment decision make sure you’re comfortable and fully understand the risks. If you invest in fund or trust make sure you know what specific risks they’re exposed to. Past performance is not a reliable guide to future returns. Remember all investments can fall in value as well as rise, so you could make a loss.