Picking the right funds for the core of a portfolio can be the difference between steady outperformance and a dud return - these are the building blocks on which the risk/return characteristics of a portfolio are generated. Cherry Reynard looks at how the core of a portfolio should be constructed and the best products on the market
Choosing which funds to use for the core of an investor's portfolio used to be an easy decision - for exposure to equities, bonds and perhaps a bit of commercial property, investors didn't have to look much further than with-profits funds. But now with-profits funds have been largely discredited, advisers have to be smarter about their core holdings. What are the best the market has on offer?
The first decision is whether to opt for a collection of single funds or a multi-manager solution. If investors go for the latter, advisers need to decide the extent to which they want exposure to alternative asset classes for diversification of risk within those multi-manager portfolios. They also need to decide whether they want some form of guarantee.
If selecting a number of single funds, advisers could do worse than look to the strategies used by the multi-managers. Marcus Brookes says: "With our core holdings, they have to be top quartile with more consistency and lower volatility. Above all, we need to be able to rely on them so that we can build spicier things round the outside. But they are not just fodder, they add consistency."
Gary Potter, joint head of multi-manager at Credit Suisse, says: "Our core funds tend to have certain characteristics. They are likely to be nearer to the index and what they do won't vary much over time. The biggest danger is that they are mediocre." He points out that what constitutes a core fund in Asia won't necessarily be what constitutes a core fund in the UK.
But how do they measure consistency? Potter looks at traditional measures such as standard deviation, but focuses more on how the manager's style fits into the overall portfolio than technical risk measures. He says: "I prefer funds that are neither deep value nor strong growth. But I want my core funds to be like a good midfielder. They can be defensive or rise up to attack, but they never lose sight of their position. I want something solid and long-term."
The funds currently fulfilling this role for Potter include the Rensburg Equity Income fund, Martin Currie UK Growth and M&G UK Select. He also trusts Andrew Green at GAM, and Legg Mason Value among US funds.
Brookes's core funds tend to be focused on the equity income sector. He says: "I like Artemis Income in this space. At heart it is so consistent and Adrian Frost's philosophy is rock hard. He takes a pragmatic approach based on cashflow yields."
In the fixed interest field he uses New Star Sterling Bond fund, which has produced long-term consistent performance from its basket of investment grade corporate bonds. He blends this with the Old Mutual Corporate bond fund run by Stephen Snowden. This is managed very differently, taking bigger, more aggressive positions. Brookes also believes that core funds have to be pragmatic in terms of style with no big style or market cap risk.
Neither Potter nor Brookes have longer holding periods for core funds, though both expect them to be long-term outperformers.
However, for those advisers not keen to select single manager funds, multi-manager can make the decision on core and satellite funds for them. Brookes says that the Gartmore range is structured to provide a core fund according to an investor's relative risk tolerance. The Fidelity multi-manager range takes this concept one step further with its Target return funds. These offer investors a one-stop shop throughout their lifetime with asset allocation adjusted through time to take account of decreasing risk tolerance with age.
With the advent of Nurs (non-Ucits retail schemes) portfolios, advisers have a new decision to make. Instead of vanilla multi-manager funds that just include equities, bonds and perhaps property, a new generation of products are emerging that offer exposure to, amongst other things, hedge funds, investment trusts, floating rate notes or credit derivatives. These funds are designed to have lower risk, more stable returns and better preservation of original capital.
This is a model of investment that has been open to high net worth investors for some time, but regulators have been twitchy about the risks presented to retail investors because of the use of derivatives. In unskilled hands there could be additional risks but, generally, the greater diversification offered by the use of these asset classes should reduce risk. Also, these alternative asset classes make up relatively small proportions of the portfolios. The groups offering this type of fund include New Star (Cautious Managed), Cazenove, Credit Suisse and Close Finsbury, with more in the pipeline.
A bad name
Advisers also have the option of selecting a guarantee. Guarantees got a bad name from their association with precipice bonds, where they were less of a guarantee and more of an 'if you're lucky'. But groups like the Hartford are now offering a more robust type of guarantee. John Enos, managing director of marketing at the Hartford, says: "Our SafetyNet mechanism catches the consumer who is still nervous about equity risk. They pay 0.5% additional annual fee and get a guarantee that they will get back their original investment. They can also lock in gains." Clearly these guarantees are worthless if the underlying investment is poor, but the Hartford offers a blend of good fund managers on its product range.
Trackers are often seen as a core investment, but with many still charging substantial upfront and annual management fees and high tracking error on some funds, investors are often guaranteeing underperformance of the market they are aiming to track. Exchange-traded funds like iShares offer a lower cost and more efficient alternative.
There is a wide range of choice available for the core of an investment portfolio now and retail investors are starting to get access to the sorts of investments that have previously only been available to high net worth investors. The investing world has democratised since the days of with-profits for the masses and Swiss private banking for the rich.
To promote 'long-term investment'
Switching 'hard and expensive'
Smaller funds still packing a punch
To drive progress