A durable portfolio for recession

18th Aug '19 by William K

45 comments 3562 reads

In view of a possible recession and bear market, I’m currently trying to construct a portfolio that will hold up better than a 100% UK based equity portfolio. My horizon is 5 years. Some of my ideas have been borrowed from the Yale University Endowment Fund which has achieved spectacular results over the last 25 years.

The asset allocation I’ve decided on is:

Individual equities (mainly US and defensives) – 20%

Mutual funds & index trackers (US, Global & Emerging Markets) – 30%

Alternatives (private equity, infrastructure, anything with a beta <0.5) – 30%

Gold & precious metals (as an ETF like £SGLD) – 5%

Bonds (Investable corporate grade via ETFs or funds) – 10%

Cash 5%

Individual equities

These are mainly non-cyclicals. My focus is on large US stocks with a moat, such as Microsoft, McDonalds and Visa. I expect a nominal return of >60% over the next five years regardless of economic conditions.

Mutual Funds and index trackers

With these I’m looking for low management charges, a 5 year history of performance that beats the relevant benchmark and global diversification. I expect a nominal return >50% over the next five years.

Alternatives

For my purposes these are investment trusts dealing in infrastructure and private equity. I’m looking for a beta <0.5 and a NAV discount >5|%. (E.g. £HVPE). I expect a nominal return of >60% over five years.

Gold and precious metals

Whilst gold gives poor returns in good economic conditions, it provides a hedge against an economic downturn. It is popular with emerging nations and currently it is being bought heavily by Russia, China, Turkey and Poland. If we enter global recession, I expect a nominal return of 20% over five years.

Bonds

The returns on bonds are poor compared with equities in the long term, but in a market downturn they tend to hold their value and give a regular return. Corporate bonds via a mutual fund or ETF are probably the best buy.In the aftermath of a crash, bonds can be converted to cash and used to buy under-priced securities. I expect a nominal return of 20% over five years.

Cash

Cash has a beta of zero so provides some balance for…

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timarr

20th Aug '19

Like Lineker, Buffet & Munger's best days are sadly behind them.

It's the law of large numbers - basically the more money you manage the harder it becomes to generate excess returns. The same happened to Peter Lynch. It doesn't tell us anything directly about the underlying quality of the investment process.

As the only effective vehicle to use Buffett and Munger's services is via Berkshire Hathaway then it's probably true that you're unlikely to make excess returns. But if they were willing to take my pittance of a portfolio on individually then I'd happily entrust it to them.

Gary Lineker, on the other hand, is unlikely to see any of my money ...

Rusty2

Warren Buffet recommends buying a S&P 500 tracker. Interestingly I was just looking at Stockopedia performance figures for the USA and the best performing is the S&P500, the 90-100 rank has only made 10% in the last 5 years. Buffet's investing has changed, he now holds quite a few technology and airline shares. His largest holdings are insurance companies.
Capital Gearing Trust does look quite good, just bought some as have quite a bit of cash in my share ISA at the moment, may buy some more income shares such as Aviva (LON:AV.)

MarkOR

21st Aug '19

If you have a UK TV licence, regrettably most of that money DOES go to Gary Lineker. !

William K

Herbie47

Capital Gearing Trust does look quite good, just bought some as have quite a bit of cash in my share ISA at the moment, may buy some more income shares such as Aviva (LON:AV.)

Strangely enough I have just sold my Aviva shares and replaced them with Rio Tinto (LON:RIO) on the grounds that the dividends are nearly as good as Aviva (8.56% vs 9.02%) but the capital growth prospects are probably better. (Aviva's growth over the last five years is about -30% whilst Rio Tinto has grown 15% over the same period).

jwebster

Thanks for the David Swensen link.

Interesting sets of numbers on performance he calls out.

Also, he's figured out the gap between the best and worst quartile of managers in various asset classes and come to the view he needs to invest in areas such as private equity as there is greater dispersion between the best and the worst fund managers in these areas, hence his team can add value by finding the better managers. Which it seems, they have done so!

Whereas with picking stocks on the main market, he said this is too well researched and the narrow spread of performance between fund mangers (who pick stocks) is not worth the while, so might as well just buy a tracker.

Quite insightful and he's made it work.

As the Yale Investment Office report notes:

The Endowment’s long time horizon is well suited to exploit illiquid, less efficient markets such as real estate, natural resources, leveraged buyouts, and venture capital.

http://investments.yale.edu/reports

When your timeframe is essentially infinite you'll make different asset allocations to the average investor.

The updates are always worth reading, though.

I sold my Rio Tinto (LON:RIO) a few weeks ago, I did not like the problems they are having with their Mongolian copper mine but I may rebuy as have fallen about 20% now. Commodities are not good in a recession though, look at share prices in 2008. I think Aviva (LON:AV.) are more stable but they did also fall in last recession. Aviva (LON:AV.) does have quite a bit of cash. I quite like Unilever (LON:ULVR) think that is a good one for recession and also Diageo (LON:DGE). BP (LON:BP.) and Royal Dutch Shell (LON:RDSB) faired fairly well last recession and pay out around 6% dividend. GlaxoSmithKline (LON:GSK) is often mentioned regarding recession portfolio, dividend is 4.8%, I do hold all of the above and I may top up. Was looking at J Sainsbury (LON:SBRY) as well.

jonesj

I had a look at Yale allocations considering the reference in the opening post.

They hold more foreign equity than domestic (US) equity. Although, of course I do not know what is in some of the other categories. Going long on US large caps does not seem to be the way forward to clone Yale returns.

Also, the US market has high PE, high CAPE & high profit margins relative to history. Not the kind of characteristics I would want to buy into to have a durable portfolio for recession. A high CAPE is not good for expected returns according to Robert Shiller (Yale). The US may be due for some mean reversion.

As for timeframes (Timarr), this is a very good point. I like to think very long term, but when there is a 50% chance I will be dead in 30 years, investing has to be partly for lifestyle over the next 20 years and partly preservation of capital in case I survive way beyond the expectation.

Just looking at three shares mentioned above

Rio Tinto (LON:RIO) I think is a great share to hold, in the sense Iron Ore has long term demand and Rio is a low-cost provider, so unlikely to be dislocated by competition. Also, Rio currently has a great balance sheet, having paid down much of its debt. But the iron ore price is cyclical and is only just coming off a recent high from supply problems. I see the iron ore price hit lows in the 2016 China panic and the global 2009 recession. When I view Rio share price on a monthly chart since 1998 I see share price lows of £12 in 2009 and £17 in 2016, matching the commodities price cycle. Today Rio is £40 off the recent July high touching £50. Yes, if we were in a commodities downturn, Rio could be £20 again and we should mortgage the house and pile in. At today’s £40 price, hard call. Of course the market knows all this, hence the 9% yield. Nobody wants to pay too much for Rio late cycle.

Aviva (LON:AV.) Gone ex-growth and a new CEO. I can’t find a reason for the price weakness other than a combination of ex-growth, new CEO risk spending on vanity acquisition and de-rated with other large caps who have already cut dividends. Looking at the monthly price chart back to 1998 the low in 2009 was somewhere around £2.15 and in the 2016 China panic touched around £3.60 which is the same price as today. So actually, buying today might be ok as at least you are paying at the lower end of the price range, outside of a recession. I don’t have a view on their growth prospects.

Diageo (LON:DGE) This is a great company with growth franchises. Given world population growth is adding another billion people in Asia with consumer income going up, good macro level potential for premium spirits. Looking at the long-term price chart, in 2000 the low price was £4.60 and since then has steadily gone up to £34.60 today. The market knows this so the PER is 24x and dividend yield 2% not 9% ! It has an earnings yield of about 4% which compares favourably to bond yields, plus growth, which is why investors like it. Of course, any break in this steady growth story will ensure the price de-rates violently.

Personally, I prefer Rio and Diageo. With Rio I feel I have to be patient and wait for the usual China slowdown horror show to roll around, perhaps the situation in Hong Kong will nudge it. Diageo is a share you have to hold your value nose, buy it and wait ten years.

No easy decisions of course. These large caps are thoroughly researched by the big funds so you would expect it’s hard to find miss-pricing outside of a chaos event.

Appreciate others’ views !

Yes the 20% fall in Rio Tinto (LON:RIO) made them seem attractive again and has priced in the Mongolian issues. Also I hold Unilever (LON:ULVR) and Royal Dutch Shell (LON:RDSB) which are solid performers. Unilever I think with all its brands is a pretty good hedge against recession. J Sainsbury (LON:SBRY) at present doesn't tempt me. It seems to have lost its way. On the whole I'm moving to index trackers like VANGUARD S&P 500 UCITS ETF (LON:VUSA) and INVESCO EQQQ NASDAQ 100 UCITS ETF (LON:EQQQ) rather than buying individual equities.

I'm waiting for a correction before buying US index trackers, feel the US market is too high at the moment.

Howard Marx

"I'm moving to index trackers like VANGUARD S&P 500 UCITS ETF (LON:VUSA) and INVESCO EQQQ NASDAQ 100 UCITS ETF (LON:EQQQ) rather than buying individual equities."

Just my opinion, but I really think now is possibly the worst time to be maintaining or increasing an exposure to US Equities.

On the surface Global Equities have had a great run over the past ten years post the Great Financial crisis of 2008-09.

However, scratch below the surface & a different picture emerges.

Non-US Equities (as a group) HAVE GONE NOWHERE FOR THE PAST 8 YEARS. Only US Equities have been appreciating. This 'narrowness' does not represent a healthy market, not least when considering that the bulk of eps growth in the US has been a result of buybacks rather than earnings growth. US corporate debt as a consequence is at peak levels.

10 year returns:

FTSE World ex-US +22% (yellow)
S&P-500 +193% (blue)
NASDAQ-100 +379% (red)

As Capital Gearing Trust (LON:CGT) wrote in a recent report "..the fund retains its low weighting to equities and an extremely low weighting to the US. "

22nd Aug '19

Thanks for the chart Howard. It certainly puts the US market in perspective. With regard to:

You may well be proved right, but market timing is notoriously difficult, even for professionals. I think the problem is best solved by 'dollar averaging' and buying at regular intervals although that may increase the dealing costs.

Yes, no question SPX has had a great run, which will come to an end, but when?

The 12 month forward PE ratio is currently 17.50 versus a 25 year average of 16.19 Not exceptionally high. Appreciate the CAPE on a ten year average is much higher at 29.

SPX is not cheap, but the signals of irrational exuberance are not present yet. SPX fund/EFT flows have been negative recently so money on the sidelines which will come back on FOMO. Also US employment stats are holding up which normally turn prior to recession.

The big news is we have seen a slight yield curve inversion on the 3 mth and 10 year bills. The New York Fed has a yield curve recession model, which as at July 2019 spits out 31.4866% as the magic number for the probability of a US recession in the next 12 months. This is a probability model not a forecast, but an important warning light on the dash board.

Otherwise, climbing the wall of worry.

Don't forget Trump needs a strong economy to get re-elected in Nov 2020. After then, who knows.

AnonymousUser192020

If you want confirmation of the absolute returns hype look no further......
"but said "potentially investors remain unconvinced that the funds in this sector can deliver what they promise (ie uncorrelated absolute returns)", particularly after the IA Targeted Absolute Return sector delivered disappointing results last year, with 86% of funds in the sector (100 out of 117 mandates with long-term track record) losing money for investors."
From https://www.investmentweek.co.uk/news/4004271/multi-managers-flee-alternative-funds-q2-2019

24th Aug '19

Duration of the last nine US Equity bear markets (months)

'Average' bear market overlaid onto S&P-500 (last 7 months):

mattomattor

29th Sep '19

Hi Wilkonz,

Firstly, fascinating thread so thanks for starting.

I wanted to know your view of buying into investment trusts with significant NAV premiums ahead of a potential recession. I see that you have bought into many of these situations (Lindsall Train, 3i Infrastructure, TRIG) all of which have significant premiums.

Are you looking to avoid this premium moving forward? Or are you betting that these trusts can maintain the premium?

That is a really important issue mattomattor. Thanks for raising it.

There is no correct answer, at least not one that I know. How important is the NAV? Should you buy at a premium or discount? Let's start with the Lindsell Train Investment Trust £LTI which currently trades at a premium to NAV of around 28% and has a bid-ask spread of 3%. A couple of months ago it was trading at premium to NAV of around 100% (yes, 100%). And then the price dropped from about £1800 to £1400 over a couple of days. Probably because investors decided that the 100% premium was bit too high. I think that the lesson from that is clear. Be wary of closed funds with huge premiums - even if they're run by the formidable Lindsell Train team. (Currently 20% of my portfolio is invested with the Lindsell Train Global Equity fund not the LTI which I see as far too expensive.)

But I'm happy to buy trust funds with a premium of under 10% if the metrics are otherwise sound. £TRIG has a current premium of 15% which is too much for me but I think it's a great organisation and if the premium falls I'll invest. £3IN (I hold) now has a premium of 25% but it was about half that when I bought it. Recently I bought £HVPE (discount to NAV 16%) because it looked excellent value.

As always it's a question of doing your own research and working out whether the premium to NAV is justified by past performance and the prospects for the sector that the trust fund specialises in. Perhaps one analogy is PE ratio. Sometimes a very low PE ratio means that a company is doomed whilst a high PE ratio means the company is perceived as a high flier. The only thing for certain is the trusts with high NAV premiums are more sensitive to bad news than trusts that sell at a discount, and therefore intrinsically more risky.

Once the investment is made, to come back to your specific question, if the NAV premium rises dramatically, it's probably wise to consider selling because you might be trapped in a bubble when the inevitable correction occurs.

(These are just my random thoughts on the subject and I claim no particular expertise.)

Mike888

Gold - "If we enter global recession, I expect a nominal return of 20% over five years."

I've never bought into the concept of small positions of Gold as a hedge, it just makes no sense to me. For example, in the above portfolio a 5% position, with a 20% growth over 5 years, triggered by a global recession, becomes nothing worth shouting about, most definitely not a sufficient hedge on the equity losses you may encounter. Even if it gained 100% over 5 years, it would still not be a sufficient hedge against losses.

However, Gold as a future source of cash does make more sense, to either tide you over the bad times, or to use when the markets are starting to show signs of life. In these scenarios, small positions do make more sense in my opinion.

30th Sep '19

New article suggesting the recent bubble in REITs and Utilities has been overdone
https://www.forbes.com/sites/johntobey/2019/09/30/the-stock-markets-safety-first-strategy-looks-overdone-so-its-time-to-sell-utilities-and-reits/#1fb98d282f82

A durable portfolio for recession

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William K

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