Are five funds enough to make a genuinely diversified portfolio? This is a question FE Trustnet has posed to a number of fund selectors over the past few months and typically the answer has been ‘No’.
There has always been something they would have liked to add if given more choices.
But Rob Morgan, pensions and investments analyst at Charles Stanley Direct, said that if done correctly investors can get a very good level of diversification with just five funds.
“If you are using eight or 10 then so much the better but you tend to get quite a lot of diversification through five, especially if you are using ones that are multi-asset in nature,” he said.
“Five is a good number because a lot of people don’t start off with a lot of capital to invest, hence they have the problem of diversification and people think you need to have 30 or 40 funds to do that but that’s definitely not the case.”
Below, he has chosen five funds which a first-time investor looking to make use of their ISA or SIPP might blend together.
“What I am trying to do is look at it from the point of view of gaining the expertise of several different managers that I would consider ‘truly active’ while blending different styles and areas together,” he said.
“As someone who looks into and tends to favour genuinely active management I found it an interesting exercise.”
Global equities
First up is the global sector, where Morgan has two selections. First up is the Scottish Mortgage Investment Trust managed by James Anderson and Tom Slater.
“If you are being adventurous and are looking at what else you hold to provide diversification then it’s fine to hold something as punchy as that,” he said.
The five FE Crown-rated trust has been the among the top three performers in the IT Global sector over one, three, five and 10 years.
It is also the main element within this portfolio for emerging market exposure, with the likes of Baidu and Tencent among other Chinese and Asian technology names the trust has exposure to.
Performance of fund and trust vs MSCI AC World over 5yrs
Source: FE Analytics
“If you are going to own the trust, which is growth-orientated, China/US orientated and extremely volatile, you need to dovetail with that with something that is behaving entirely differently,” he caveated.
The £7bn Scottish Mortgage Investment Trust is 9 per cent geared, according to data from the Association of Investment Companies (AIC). It is trading at a 3.2 per cent discount to net asset value (NAV) and has ongoing charges of 0.37 per cent.
To sit alongside the trust, Morgan recommended the £4.3bn Artemis Global Income fund run by Jacob de Tusch-Lec.
The fund has a shorter track record, having been launched in 2010, but has also been a top-quartile performer in the IA Global sector over five years.
“It is globally diversified to a greater extent and Europe tends to feature quite heavily because of the valuation discipline within the manager’s process,” Morgan said.
The portfolio is also well-rounded with exposure to undervalued, cyclical holdings as well as the more traditional consumer staples.
“Between the two of those it gives you a reasonably wide breadth of global equities and a diverse geographical exposure as well,” the Charles Stanley Direct pensions and investments analyst said.
“I am a fan of genuinely differentiated active funds and both fit into that camp. You have got a mix of styles, so you are not reliant on one or the other.”
Artemis Global Income has a yield of 3.03 per cent and a clean ongoing charges figure (OCF) of 0.8 per cent.
UK equities
With two overseas strategies, Morgan said that UK investors should also look to take some direct exposure to the domestic market.
He said: “If you are a UK investor you want a decent amount of exposure to your home market as having entirely overseas equities would tend to be quite an unusual step.
“In Scottish Mortgage and in Artemis there is very little UK exposure so I wanted a UK fund to capitalise on the best of the opportunities.”
Within the UK he has chosen FE Alpha Manager Henry Dixon and Jack Barrat’s four FE Crown-rated Man GLG Undervalued Assets fund.
“The UK is a much-maligned market, especially at the moment with what is hanging over us,” Morgan said, highlighting the faltering Brexit negotiations.
With an uncertain backdrop, the Charles Stanley Direct investment advisers said a value fund should work well in this market.
As well as this, the fund is a pragmatic, multi-cap portfolio, he said, which invests in smaller and medium-sized companies as well as large-caps.
“You are not just getting exposure to FTSE 100 heavyweights. It can express the full range of opportunities within the UK market from small to large,” he said.
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
Since its launch in 2013 the £1bn fund has returned 53.9 per cent, beating both the FTSE All Share benchmark and IA UK All Companies sector.
Man GLG Undervalued Assets has a yield of 2.51 per cent and an OCF of 0.9 per cent.
Flexible multi-asset portfolios
To complement the three funds above, Morgan has chosen two strategies that have an equity weighting but also offer investors access to other asset classes.
First up is the £3.1bn RIT Capital Partners investment trust, which is a diversified portfolio in its own right. The fund invests in direct equities as well as individual funds typically managed by third-party managers that UK investors don’t have access to, Morgan said.
There is also a private equity component within the fund, with almost a quarter dedicated to the alternative asset class.
“The objective of the trust chimes with a lot of investors in that it does prioritises capital preservation – it has that mentality,” Morgan (pictured) noted. 
“It is not just a growth investment trust, they are trying to give stock market-like returns but lower volatility and I think the managers there are well-placed to capitalise on the opportunities that they have got within selecting individual fund managers in certain areas.”
The fund has beaten both the MSCI AC World index and IT Flexible Investment sector over the past five years, although it lags the benchmark over the last decade.
“They have shown in the past that their asset allocation has been strong and with the various assets that they have got they have been able to add value,” Morgan said.
“It is a portfolio in its own right but I think it makes a really good diversifier within a portfolio as well as a core holding.”
The investment trust has a yield of 1.7 per cent and ongoing charges of 1.02 per cent. It is 6 per cent geared and is on an 8.1 per cent premium.
His other choice in this area is Investec Diversified Income, headed up by John Stopford, which sits in the IA Mixed Investment 0-35% Shares sector.
Morgan said: “The opportunities in the fixed income space are quite narrow – especially if you limit it down to UK corporate bonds. There is very little ability, I think, at the moment for an active manager to add value.
“If you go into strategic bond funds there is arguably a little bit more they can do in terms of managing the duration and perhaps investing larger amounts in overseas and using currencies and things like that.”
This fund, however, not only invests in bonds but can also take some exposure to equities, property and infrastructure where appropriate.
Since Stopford took charge in 2012, the fund has returned 33.28 per cent, beating the sector average peer by 7.42 percentage points.
Performance of fund vs sector & benchmark over manager tenure
Source: FE Analytics
“It can also invest in things like emerging market debt and if it wishes to property and infrastructure as well. It has got a bit more of an opportunity set and the level of income that it produces is pretty good,” he said.
“It should be a diversifier. Although fixed income is maligned at the moment for being overly expensive it will be a diversifier from equities in a lot of different market circumstances so it is important to have that part of your portfolio if you are looking to temper volatility overall.”
The fund has a yield of 4.2 per cent and an OCF of 0.75 per cent.