One of the most common questions I’m asked is: How do you invest your money? It’s a difficult question to answer because it can be interpreted so broadly. Are we talking about how do I physically go about investing? Or, what asset allocations do I use? What strategic allocations do I use (UK equities vs US equities etc.)? Or what funds do I actually invest in?
Today, I’m going for the narrowest definition. I’m going to write about every fund I invest in. Along the way, I’ll show my asset allocations and such forth. But the focus, at least for today, will be on the specific funds I invest in and why.
Let’s start with my asset allocations
Overall, my target asset allocation is 90% invested in Equities and 10% in Bonds. I aim to hold 10% cash outside my investment portfolio.
Let’s start with what’s missing – commodities and property. There are strong arguments for holding these assets in an investment portfolio. I’ll avoid rehashing the arguments for and against. I don’t invest in commodities for three principal reasons:
- the thematic aim of my portfolio is towards investment growth – the evidence on commodities is mixed over the long-term for growth-based investment strategies
- the strongest argument for commodities is protection against inflation – again the evidence is mixed
- UK equities, particularly the FTSE100, are heavily tilted towards commodities-sensitive companies (think BP, Shell, Rio Tinto, Anglo American), investing in commodities as well could cause over-sensitivity to commodity prices
That said, there are diversification and crisis-protection benefits for having commodities in your investment portfolio.
Similar arguments can be levied against property allocations. In addition to the investment portfolio, I own a home with Mrs YFG which means we already have a significant amount of money invested in property outside my investment portfolio.
The 90/10 equity/bond split reflects my very long investment time-horizon and my relatively high-risk tolerance. Currently, I have no intention of encashing any of my investments. As such my holding period is relatively long. There is good evidence that on a risk-adjusted basis a more even split between bonds and equities is superior (in risk-adjusted returns). But, for now, I can comfortably stomach the volatility in my portfolio.
Overall, I’m almost 50% invested in Global Equities (more on what that specifically entails in a bit). I’m a firm believer in the global passive investment strategy that Lars Kroijer (and others) advocates. That said, you can see a strong tilt towards UK Equities. That’s because, whilst I think a global passive strategy is suitable for most people, we must not forget why we invest: to protect our future selves against inflation. To that end, I consider a tilt towards home markets advisable as they offer greater levels of specific protection against your personal inflation than a global portfolio can.
However, finding the right ’tilt’ is difficult. Whilst I could try and pretend that I’ve come up with some really smart mathematical model, I’ve gone for a rough rule-of-thumb of allocating 15-20% extra to UK equities than a Global Equities tracker. This means I’m roughly 30% invested in UK Equities. I’m very much open to any suggestions or tips if you have them!
[Note: I’ve set out the funds by their ‘ticker’, ‘SL Global’ is an amalgamation of various Standard Life pension funds invested in global equities]
Now before I go any further, a disclaimer: none of this post should be construed as a recommendation to invest in a particular investment or fund. This post is for information purposes only. Please do your own research, and speak to an FCA authorised investment adviser if necessary. I won’t take any liability for any decisions you make off the back of this post.
ETFs vs Mutual Funds
With that out of the way, let’s dive in. Overall, I’m heavily invested in ETFs over mutual funds. It’s my opinion that ETFs are a superior investment product to mutual funds for three main reasons:
- They are marked-to-market – there’s no discount or premium on trading, unlike closed-ended funds.
- They can be traded throughout the day – open-ended funds can only be settled at close.
- They generally have lower costs to hold, the ETF structure makes it cheaper to operate than an open-ended fund and platforms generally charge no holding fee for ETFs compared to mutual funds.
There are some downsides, however:
- There are bid-offer spreads – which can be substantial for smaller ETFs (i.e. smaller Assets Under Management, AUM).
- Some ETFs are “synthetic”, they don’t hold the specific securities they are tracking – opening the ETF up to counterparty risk.
- There is an active discussion on the liquidity of ETFs, with some prominent individuals arguing there is a major liquidity risk with ETFs (I think this argument is somewhat overblown, perhaps I can write about it another day).
Passive vs Active
You’ll also notice that I’m pretty much 100% invested in passive funds (I do hold a small active holding, more on that in a bit). The evidence is pretty overwhelming that active fund managers underperform their passive counterparts. Over the years, I have personally conducted analysis on the UK and South American investment markets. The evidence was that few investment managers outperform the market. Finding those managers is difficult, takes a lot of time and isn’t something I find interesting – so I stick to passive funds.
A long time ago, I used to invest in individual stocks. And with reasonable success to boot. I think it is entirely possible ‘to beat the market’. But it involves a significant amount of time to do the research required. I think it is also hard to beat the market unless you focus on a specialism – UK small cap, Euro special situations, UK dividend stocks. That means the ‘active component’ would only represent a small part of my diversified portfolio. With those two things in mind, it’s very much in my ‘too hard’ bucket.
For the eagle-eyed, you may also notice is that I’m heavily invested with Vanguard. Here are the breakdowns by manager:
- Vanguard – 69%
- Standard Life – 16%
- HSBC – 8%
- iShares – 6%
- Aberforth – 1%
I won’t hide it: I’m a big fan of Vanguard. I like their ethos: that fees are the most important determinant of investment performance and low fees mean superior performance. I also like their corporate structure (it’s set up as a mutual). There are also few alternatives to my largest single investment: VWRL, Vanguard FTSE-All World. I’m trying to reduce my dependence and diversify across more managers, but for now, it’s a slow process.
On to the specific investments. Details of each investment are (hopefully!) accurate at the time of writing: 20th June 2018, portfolio weights are in brackets.
a/k/a FTSE All-World UCITS ETF. With an ongoing charge factor (OCF) of 0.25%, it is the cheapest “true” all-world ETF tracker. It tracks the FTSE-All World index, which includes emerging markets. It’s invested in over 3,000 securities, offering instant equity diversification. It’s also got a long track record, going back to 2012. With a global passive strategy, this ETF is the bedrock of my portfolio. I’ve been looking for some alternatives, with limited success. Until one of Vanguard’s competitors gets their finger out, it’s the one to beat. Unfortunately, it’s 15 basis points more expensive than the US ETF equivalent which is quite disappointing!
Standard Life Global trackers (15%)
These are a mix of a number of funds across our mine and Mrs YFG’s occupational pensions. The OCFs are between 0.1% and 0.25% which make them, fee-wise, competitive with VWRL. To that end, they are staying put for as long as the fees stay reasonable.
a/k/a U.K. Gilt UCITS ETF. This is the ETF I use for investing in bonds and my sole bond fund. It’s a mixed-duration UK Gilt ETF. There’s a valid argument I should invest in corporate bonds, but the evidence on their efficacy is mixed at best – so I personally steer clear.
The argument is less borne out about investing in global government bonds. I’m principally concerned about UK inflation: so UK Gilts are much preferred over international bonds.
There are lots of UK Gilts in issue – currently 44 straight bonds (not including strips, there are also 28 index-linked Gilts in issue). The UK gilt market is also deep and liquid with strong market-processes in place to ensure orderly trading. For those reasons, I think the liquidity and suitability of a UK Government Bond ETF are fine. VGOV holds 43 securities and has an OCF of 0.12%. It used to be the cheapest UK Gilt ETF although it’s recently lost that title to Lxyor.
The index-linked market is more challenging, there are few ‘shorter’ issues (VGOV’s average duration is c.12 years vs INXG’s (iShares index-linked tracker) c.22 years), which means index-linked gilts are particularly volatile (the longer the time to maturity, the more volatile a bond’s return is to interest rates). For now, it’s straight UK Gilts only for me.
VMID (8%) and VUKE (3%)
VMID a/k/a FTSE 250 UCITS ETF. This my largest UK Equity holding. VMID holds the ‘mid-cap’ stocks of the FTSE 250. At an OCF of 0.10% it is the cheapest FTSE 250 tracker out there (by some distance).
VUKE a/k/a FTSE 100 UCITS ETF. VUKE holds the stocks of the FTSE 100. It has an OCF of 0.09%, a bit more than the cheapest ETFs at 0.07%.
The reason I invest in the FTSE 250 over the FTSE 100 or All-Share is that the UK Equity market is heavily dominated by global companies which have global earnings – not necessarily great for protecting against UK inflation. As an aside, this is why the FTSE 100 surged post-brexit: sterling depreciated in value, so those foreign currency earnings became much more valuable in pounds, what the shares are priced in. The FTSE 100 is also heavily concentrated in a few sectors: (oil and gas: 17%, banks: 13%; tech makes up less than 1%) – (for more on this, have a look at a recent guest post on the subject over at The FIRE Starter).
Another reason is to capture some of the ‘size premium’ – the idea that smaller stocks outperform larger ones over the long-term. However, I’ll confess that, over time, I’ve seen more evidence to suggest the size premium is much weaker (if it exists at all) than first thought. As such, I’m no longer ‘actively’ investing for a size premium.
All-share tracker ETFs are, generally speaking, more expensive (0.2% OCF). Apparently, there’s a new Lxyor ETF on the block (with an OCF of 0.04%!) but has no track record – so we will have to see how it goes.
a/k/a HSBC MSCI World UCITS ETF. This is the cheapest MSCI World tracker at 0.15% (except for, you’ve guessed it, a new Lxyor ETF). This fund has been going for quite a while, since 2010.
It’s a recent addition to my portfolio as I’ve tried to wean myself away from VWRL. As it tracks the MSCI World index, it doesn’t include an allocation to emerging markets – this is a Developed World tracker. The allocations between Developed World and Emerging market are also different between MSCI and FTSE. The most notable difference between the two being MSCI thinks South Korea is developing, FTSE thinks it’s developed.
Unfortunately, the only MSCI ACWI (All Country World Index) ETFs are quite expensive (0.4%+ OCF) which, for me, means they are prohibitively expensive. For now, I’ll be using VWRL and HMWO + EMIM (see below).
a/k/a S&P 500 UCITS ETF. With an OCF of 0.07% this is one of the cheapest S&P500 trackers out there. This is in some ways, a legacy fund from the days before I started putting my investments into VWRL. Back then, I was replicating a global portfolio with a number of different funds in relevant proportions. I’ve now sold away most of my VUSA holdings, but this represents some of the holdings that still sit outside of my ISA with a big capital gain attached (see my post about what I do each new tax year) as well as the residual (“non-VWRL” allocation).
a/k/a FTSE Emerging Markets UCITS ETF. This is the ‘cheapest’ FTSE Emerging markets tracker at 0.25%. It’s more expensive than the MSCI equivalents (see EMIM below), but it follows the FTSE methodology on Emerging Markets.
I tilt towards Emerging Markets. Firstly, because they offer higher growth opportunities than Developed Markets (along with the associated higher risk). Secondly, as a proxy for the inability to invest in ‘Frontier Markets’. Those are the countries with small stock exchanges which are, for now, not really accessible to retail investors. By adding a tilt to Emerging Markets, I’m trying to slightly undo the underweighting those markets get from their exclusion in global indices.
As with my UK tilt above, there isn’t much maths to this, the aim is to hold an extra 5% to my portfolio.
Vanguard All-Share (5%)
a/k/a FTSE U.K. All Share Index Unit Trust. This is the only mutual fund in our portfolio (outside of our occupational pensions). It’s one of the cheapest All-share funds with an OCF of 0.08%. It’s held by Mrs YFG with iweb, which doesn’t charge holding fees for funds. So, for now, we are leaving it rather than swapping it out for ETF equivalents.
a/k/a iShares EURO STOXX Small UCITS ETF. This is an unusual fund, probably the most exotic in the portfolio. It tracks the EURO STOXX Small index, which is the smallest subset of stocks in the EURO STOXX index. Now by “small”, we are really talking about mid-cap type stocks such as Dassault Aviation, Christian Dior, Post Italiane, Pirelli. The idea behind this fund is to pair it with the Developed Europe Vanguard ETF (VEUR) to capture some ‘size premium’.
This ETF is also unusual because it differs from most of my other holdings: it’s expensive (OCF of 0.4%); it’s not particularly well diversified (it holds only 96 stocks); and it uses an ‘optimised’ physical replication strategy (i.e. it doesn’t hold every stock in the index at their market weights). So why do I continue to hold it? Well, as with VUSA, it sits outside my ISA with a nice big capital gain. Over time I’ll defuse the gains and slowly replace this fund in my ISA.
On a tangential note, because of the types of companies in the index, the sector weighting is quite well placed towards consumer inflation (industrials, consumer goods, tech) which does make it interesting from that perspective.
a/k/a FTSE Developed Europe UCITS ETF. One of the cheapest broad Euro trackers with an OCF of 0.12%. Another Vanguard ETF, this also includes an allocation towards UK stocks (as it’s not an xUK fund).
SL UK trackers (1%)
These are Standard Life index funds that track UK markets. Again the OCFs are between 0.1% and 0.25%. As they make up such a small part of my portfolio I can’t be bothered to play around with them. So, for now, they sit there chalking up returns.
a/k/a iShares Core MSCI EM IMI UCITS ETF. As mentioned this a relatively new ETF for me, which I pair with HMWO. This ETF tracks the MSCI Emerging Markets Investable Market Index. What this means is that it is basically is a vehicle for investing in China, South Korea and Taiwan which dominate that index (29%, 15% and 12% respectively). It’s the cheapest emerging market ETF with an OCF of 0.18%. Very much a “let’s see how this plays out” investment.
The final and smallest holding is arguably the most interesting. It’s the Aberforth Smaller Companies Investment Trust. This is an actively managed(!) UK IT which invests in UK small caps. Every single other investment I have is passive, so why this sole active fund? Basically, because there are pretty much no UK passive small-cap trackers in the UK. I had looked around quite a bit, and good ol’ Mr Investor at Monevator had a feature on the fund. I liked what I read and I had a deeper look.
There are a few other small-cap funds. Of note is the Dimensional smaller companies fund. Unfortunately, you can only invest through an adviser and it’s really a pseudo-mid-cap fund, like quite a few others. Aberforth, invests in genuinely small-caps, with a value (rather than growth) tilt. Another distinguishing feature is that it has a relatively low OCF at 0.76% compared to its competitors (for example, Liontrust UK Smaller Companies has an OCF of 1.61%).
There are two final features which also set it apart from the other options. Firstly, the management house is focussed on small UK companies. From my experience, the more successful actively managed funds tend to be where the manager has a niche or specific investment philosophy compared to generalists. Secondly, the management team have been in place for almost 30 years, giving it a long track record. Now whilst there is an element of survivorship bias, the best funds tend to stick with their managers over the long-haul even when there is a period of underperformance (as with Aberforth).
As I’ve become more sceptical of the size-factor, I don’t think I’ll be adding to this holding. Although it’s nice to keep it as an experiment to see how it does. And with that, I’ve written about the most words about my smallest, most dormant holding…
Lots of words on picking funds and asset allocation, let’s get down to business – has it worked?
I’d argue that the answer is yes:
[Note: After posting, I’ve noticed there’s an issue with mutual fund data coming from google finance that was messing up my google sheet document. It means the chart and the return figures were slightly off. I ‘fixed it’ for now with hardcoded data. I think I’ve also been able to reproduce the benchmark returns using data from Vanguard. Please do let me know if you’ve come across this issue before!]
Since I started systematically recording my investment returns (August 2013), £10,000 in my portfolio has turned into
c.£19,000 c.18,000. With a 14% 13% money-weighted (IRR) return and a 12% 11% time-weighted return. For comparison, I benchmark against the Vanguard 80/20 LifeStrategy fund which has a 9.8% return (or the 100% fund with a return of 11.3%). Reassuringly, my portfolio and the LifeStrategy fund has a Rsqr of 0.98 (so I’m going well off base). On the other hand, I could just invest in the LifeStrategy fund and have a much quieter life…
All the best,
Young FI Guy
I’m incredibly thankful for the following websites/individual’s who have helped me out a great deal on my investment journey. They are, if you aren’t familiar with them already, excellent resources for the UK investor: