Asset Allocation

[minnow]

Hi all. Apologies for the slightly long-winded question but it may take a couple of paragraphs to set this one up.

As investors, we're deluged with information about how to select stocks and, to a lesser extent, bonds. We may go back and forth on the merits of active v passive, US v all-world indices, value v growth tilts, but I think it's fair to say that when most people think about "investing" they immediately think about a long equity portfolio, perhaps with a smallish allocation to govvies (or maybe even corp bonds for the adventurous).

As a thoroughly unexceptional investor, I started 2022 with a large allocation to stocks and relatively little in alternatives. I thought I'd done all the right things re. diversifying globally, but I'm starting to realise that diversifying within a single asset class really isn't going to help if equities as a whole go through a rough patch. After all, there, there have been plenty of times in history when a 60/40 went sideways for a decade or more (in real terms)

To try and correct this imbalance I have recently started nibbling at various commodity ETFs even though I know I'm quite late to the party. I'm also exploring concepts like risk parity portfolios, tail protection, alternative risk premia, etc. Basically anything to get away from the "long growth" bias that I've suffered from in the past. 2022 has been a fairly rough year for me in P&L terms, but on the plus side it has opened my eyes to a whole new way of thinking about investing.

I'm curious whether other commenters here have ventured beyond stocks and bonds, into other asset classes ?

[scrumpyjack]

The trouble with all the sort of things you list is that they are basically set up by managers in order to charge fees and in the longer term they will siphon off an awful lot of your assets in those fees. I therefore start from the position of avoiding all such financial 'products'.

[tjh290633]

I have stuck to equities for the last 60 years. Initially in a single fund, then more funds and inherited a few shares and some fixed interest stock. I soon got rid of the fixed interest and went in for several commodity oriented funds. One I still have has now become JP Morgan Natural Resources. First bought in 1970 as Ebor Commodity Fund, it has served me well over the years. My equities are fairly well diversified between sectors, and include miners, oils and property, all of which can be contrarian choices at times.

I have no intention of going for any form of fixed interest. Neither would I be interested in commodities as such or gold.

I have found that if I choose shares with yields at or above that of the market, and have an adequate spread of sectors, and within sectors, I have managed to be ahead of the market for most of the time. Very occasionally I will have a year or two when I lag the market, and my income is well ahead of the RPI. If you dig around this site, you will find plenty of posts of mine which illustrate what I have said above. Hope that helps.

TJH

[Gilgongo]

Coincidentally though, bonds are historically very, very low right now. So if you were to apply the logic that is often applied to stocks, and be greedy when others are fearful, then what's not to like about, say VAGP?

See also this thread:

viewtopic.php?p=489555#p489555

[minnow]

Thanks for the contributions so far, food for thought. I'm still mostly long global stocks, for now, with a tilt towards energy and miners, but I can't shake the growing feeling that we may be entering an environment that's radically different from the one we have been accustomed to since the early 80s. The slow, steady fall in base rates has been a terrific tailwind for stocks and bonds alike, no doubt about it. But I'm skeptical that we're going to see anything like the same level of real returns over the next decade or two (which sucks for me, as a recent retiree living off his portfolio). And if inflation proves stubborn and central banks are forced to hike faster than everyone expects - yikes, look out below !

Anyway, on that positive note thanks for the suggestions

[JohnW]

Maybe read some of this thread, starting with the post: ‘ Almost anything can be claimed to be a "diversifier." When this claim is made, it is commonly made because the asset has had low return.’
https://www.bogleheads.org/forum/viewto ... 8#p6716038
And note that because buying and selling commodities like oil, gas, minerals etc means having somewhere to store them and perhaps transport them at times, you’re often buying commodities’ futures when you invest in one of those funds. Futures and commodities are different.

[BT63]

I'm curious whether other commenters here have ventured beyond stocks and bonds, into other asset classes ?

Yes; gold.
I've held a varying proportion of my portfolio in gold since the dotcom era due to monetary policy being inappropriately loose for most of that time, currently gold makes up around a quarter of my portfolio.

[SteadyAim]

bonds are historically very, very low right now

Really? I wouldn't say that.

10 year gilts were paying ~6% or more in the dot com boom in 1999, never mind the levels from 10/20 years before that. What are they yielding now, 1.6% or something, even though inflation is way above that?

Return-free risk.

SA

[SteadyAim]

[ replying to OP ]

Commodities (oil/gas, mining) and property shares are useful diversifiers. And if inflation continues for years rather than months that gives shares a tailwind. Watch the divis rather than the capital value.

The ftse 100 has held up pretty well in the recent downturn, partly because it was cheap to start with, and partly because it has some of those diversifying sectors, so that's one to consider.

If markets fall further you could consider shifting a bit more into shares at the cheaper prices, maybe go to 70% equities if markets fall another 10% from here and 80% if they fall 30% from here. (Choose your own levels obviously)

[minnow]

Thanks all. In response to earlier comments, I already have a healthy allocation to miners and energy (DEC and BHP two of my current faves). I'm also overweight FTSE100 because I love how widely disliked it is I agree that bonds don't look remotely attractive at their current (real) yields, and as for my small gold holding... well it hasn't exactly shot the lights out this year. I live in hope.

Back to the subject of commodities : I know that performance over the past couple of decades has been fairly shabby, as the bogleheads point out. But the 'inflation insurance' aspect is very appealing to me. AIUI, a broad basket of commodities is pretty much the only thing that does well when inflation really gets going - the trouble is, we haven't had that sort of environment for 50 years or so, and I wonder if people have become a bit too complacent ?

Personally I've had decent results this year with L&G's ENCG fund (broad basket of commodities accessed via futures) and coincidentally I added a bit more this morning. It could very well be that I'm buying at the top just when inflation expectations take a nose-dive, but I will sleep a bit sounder knowing that I own something that should thrive in a high-inflation environment.

Anyway, it was interesting to hear a cross section of views on this question. Thanks !

[BT63]

.....and as for my small gold holding... well it hasn't exactly shot the lights out this year. I live in hope.

31st December: £1351.
This evening: £1507.

+11.5% in just under six months.

[minnow]

+11.5% in just under six months.

Fair point, although a critic might point out that those gains are entirely due to a weakening pound (measured in USD, gold is slightly down over the same period). A profit's a profit, but you'd have got the same return holding USD in a your bank account. I've been disappointed with gold's performance over the period when many people were expecting it to fly. Maybe things just aren't apocalyptic enough yet.

[TUK020]

+11.5% in just under six months.

Fair point, although a critic might point out that those gains are entirely due to a weakening pound (measured in USD, gold is slightly down over the same period). A profit's a profit, but you'd have got the same return holding USD in a your bank account. I've been disappointed with gold's performance over the period when many people were expecting it to fly. Maybe things just aren't apocalyptic enough yet.

That could change very fast. All it takes is one tactical nuke in Ukraine. I view my smallish holding in Gold ETFs & Gold Producer ETFs (<5% of my portfolio) as an insurance policy.

[BT63]

+11.5% in just under six months.

Fair point, although a critic might point out that those gains are entirely due to a weakening pound (measured in USD, gold is slightly down over the same period). A profit's a profit, but you'd have got the same return holding USD in a your bank account.

How many people would have put a large chunk of their portfolio into cash USD, especially British investors? How many would consider that to be a long-term holding?

In US Dollars, gold declined 1% so for this year as of yesterday evening. The S&P declined 22%. So from an American point of view, cash Dollars were marginally better, but gold was a very close second and if we happened to have this conversation a few days ago, gold would have been slightly ahead and is slightly ahead again today.

[Kantwebefriends]

(i) Gold in the form of ETCs. I now view this as a form of FX, the foreign country in question being the 19th century. And conceivably the 22nd century. I hope gold will be a defence against a stock market crash and an insurance against future financial mayhem.

(ii) Silver: I view this as a commodity, one of the few where the ETC holds the commodity rather than holding futures. As a defence against unexpected inflation I'd also consider agricultural and mineral commodity funds. But is it too late or do you expect more "unexpected" inflation? That is, can you outguess the market about future inflation rates? Or even if you don't think you can would you like insurance against unexpected inflation?

(iii) Index-linked savings certificates from ns&i. Someday the government will forbid holders to roll these over but until then we are hanging on. If you don't already have any your only route to getting some is inheritance.

(iv) Owner-occupied housing - not only for the convenience, pleasure, and security but also because it is subject to a preposterously good tax deal.

(v) From time to time, but not at the moment, some of our "cash" has been in the form of Premium Bonds. Then again, at one time part of our savings was in Deutschmarks. I wonder whether it might be wise to hold some Swiss Francs or Singapore dollars?

(vi) From 1999 to 2006 we owned some convertible bonds. In fact they never were converted but behaved successfully as corporate bonds. I might repeat one day. To hold a bond to maturity seems more attractive to me than to hold a "fund" of bonds.

(vii) We've never owned BTL property and it looks to me to be a bad time to consider it. Farmland? Woodland? Never tried them. I did once consider buying some "lock-ups" for local people to rent to garage their cars in. But I didn't. I wonder if they might do well now if equipped with EV chargers? Could I turn a profit on the electricity too? But then they might burn down in a battery fire. Who knows how costly insurance against that sort of thing might become?

(viii) How about simply betting against the stock markets to effectively reduce your equity proportion without the nuisance of selling shares and forgoing dividends? I have no idea how to do it but I know it's called "shorting".

(ix) If some of your capital is in money-purchase pensions I'd keep an eye on the prospect of buying an index-linked annuity. Or perhaps a series of them as you get older. Someday they'll become attractive again. Anyone who bought one a year ago might already be pretty pleased.

(x) If you're not too old, take a job with an arm of government that brings a defined benefit pension with it.

[hiriskpaul]

My asset allocation is split between global equities (mostly passive funds/ETFs), direct FI securities (mostly high to very high yield at present) and what I call Opportunistic. Opportunistic can be anything, but is usually options and currently oil options. Most of the money here is on instant access deposit which may be required to cover variation margin. FI and equities have not done well so far this year, but Opportunistic is making up for it. The large cash holding on its own has outperformed my FI/equities.

For the last several months I have been selling puts on WTI futures. The return comes from implied volatility, which has been high to insanely high all year and significantly above actual volatility. The puts I sold yesterday expire on 15 July, strike was $80 and my premium was 0.202. I get to keep the premium provided the August WTI future is above $80 at expiry on 15 July. It is currently at $110 and was around $107 when I sold yesterday. Assuming the price cannot go below zero (invalid - it did once!) my return on an ungeared position will be 0.202/80 = 0.2525%, or a rate of return of about 3.7% over the 25 days to expiry. But I am about 4.5 times geared, such is my conviction that oil is not going anywhere near $80 in the next 3 weeks, so my rate of return is closer to 17%. In previous months my rate of return was even higher than that but implied volatility has come down from insane levels of over 100 to 63 at the $80 strike. This trade will eventually fizzle out if IV drops too far. Or it may go wrong and I will have to bail out at a loss if the price of oil collapses, but for the moment it seems to me to be the best short term opportunity around.

I may rebalance into FI/equities at the end of June as that coincides with ETF dividend payments and FI income. Commodities themselves, other than options, I would not want to touch. Too much cost to store and/or usually a lot of contango in commodity futures. Gold sovereigns, etc. I have some respect for provided they are well hidden, as there is no holding cost and they can be traded free of tax, but I don't hold any.

[minnow]

That's a really interesting response hiriskpaul, thanks. As I do more research, I'm increasingly coming to appreciate that successful long-term investing is about identifying and owning uncorrelated "risk premia", combined in the right proportions and rebalanced when necessary. It's quite a shift from the "long stocks" approach that I've had most of my investing life. Admittedly that approach has worked very well, but nothing lasts forever and I'm worried that the party may be nearly over.

One of the topics I've been reading about is the variance risk premium, which is exactly what you're describing with your oil trades. Sounds fascinating, although not something I'm comfortable to try without a lot more knowledge. But that's exactly the sort of "deep" diversification I was thinking of when I posed the question. Something that works even if financial markets take a dive !

I agree with your point about commodities (even though I have a small alloc). My understanding is that there's no significant risk premium, hence no expectation of a real return. Increasingly, roll yields are turning negative which means that long run returns for futures are even worse than spot. The only possible use for commods seems to be to protect against unexpected inflation surges, but I have almost certainly missed that boat. I'll probably hang on to my small holding for novelty value, if nothing else.

Other ideas I have looked at, in case anyone's still reading : insurance (cat bonds), royalty streams and carbon futures. Haven't made any purchases yet but I'm considering these. They all offer the hope of returns that are uncorrelated with broader financial markets.

thanks for all the interesting ideas so far !

[minnow]

@Kantwebefriends -- I missed your response, thanks for your very comprehensive and creative list. vii is particularly interesting, I like the idea of earning a yield that isn't closely linked with the financial markets. You've started me thinking .. !

Re viii -- Funny you should say that. I'll probably regret doing this, but I opened a small short against the Nasdaq last week (the SQQQ ETF allows you to get 3x short exposure). I now own a bunch of cheap value-type stocks, plus a small short against growthy stuff. These things are impossible to predict, but I reckon QQQ might yet have further to fall. If nothing else, at least something will be green when the market takes another leg down ! Obv, it's important not to go crazy with these leverage ETFs but I really like their efficiency (just 10K invested gets the effect of 30K etc)

[hiriskpaul]

@Kantwebefriends -- I missed your response, thanks for your very comprehensive and creative list. vii is particularly interesting, I like the idea of earning a yield that isn't closely linked with the financial markets. You've started me thinking .. !

Re viii -- Funny you should say that. I'll probably regret doing this, but I opened a small short against the Nasdaq last week (the SQQQ ETF allows you to get 3x short exposure). I now own a bunch of cheap value-type stocks, plus a small short against growthy stuff. These things are impossible to predict, but I reckon QQQ might yet have further to fall. If nothing else, at least something will be green when the market takes another leg down ! Obv, it's important not to go crazy with these leverage ETFs but I really like their efficiency (just 10K invested gets the effect of 30K etc)

Inverse ETFs and especially 3X inverse ETFs can be dangerous and may not behave in the way you are expecting. Even if you are right on direction, you can still lose money due to volatility drag. eg invest £100 in a 3X inverse ETF, with market at 100. Market rises to 110, then falls to 95. Your ETF position will fall 30% then gain about 41% (3 times 15/110), so is now worth 100*0.7*1.41=£98.7. Even though you were right about the net direction of the underlying you still lost money!

Had the underlying fallen to 85 then risen to 95, you would have lost even more money. £100 up to £145 then down about 35% (3 times 10/85) to £93.80. In other words inverse ETFs suffer from volatilty drag and the outcome is path dependent. In addition, the expected loss increases with the length of time you hold so not only do you have to be right about the direction, you have to be right about the path and be right quickly!

You can make money out of inverse ETFs but the odds are stacked against you.

[Hariseldon58]

That's a really interesting response hiriskpaul, thanks. As I do more research, I'm increasingly coming to appreciate that successful long-term investing is about identifying and owning uncorrelated "risk premia", combined in the right proportions and rebalanced when necessary. It's quite a shift from the "long stocks" approach that I've had most of my investing life. Admittedly that approach has worked very well, but nothing lasts forever and I'm worried that the party may be nearly over.

One of the topics I've been reading about is the variance risk premium, which is exactly what you're describing with your oil trades. Sounds fascinating, although not something I'm comfortable to try without a lot more knowledge. But that's exactly the sort of "deep" diversification I was thinking of when I posed the question. Something that works even if financial markets take a dive !

I agree with your point about commodities (even though I have a small alloc). My understanding is that there's no significant risk premium, hence no expectation of a real return. Increasingly, roll yields are turning negative which means that long run returns for futures are even worse than spot. The only possible use for commods seems to be to protect against unexpected inflation surges, but I have almost certainly missed that boat. I'll probably hang on to my small holding for novelty value, if nothing else.

Other ideas I have looked at, in case anyone's still reading : insurance (cat bonds), royalty streams and carbon futures. Haven't made any purchases yet but I'm considering these. They all offer the hope of returns that are uncorrelated with broader financial markets.

thanks for all the interesting ideas so far !

With regard to further diversification, take a look at the annual reports of Capital Gearing Trust (CGT) , they hold some interesting investments apart from vanilla stocks and bonds.

I would have said be cautious with leveraged ETFs but Hiriskpaul has given a very comprehensive explanation of the potential pitfalls…