Building My Low Charge Investment Portfolio – Part 2 of 3

Portfolio construction starting point as previously described in Part 1

28% Bonds
72% Equities

Continuing to learn from Hale and Bernstein I then chose to add Property as a portfolio diversifier as it can be uncorrelated to Equities and Bonds. The more uncorrelated the assets theoretically the more likelihood that some assets will be low in price (and hence required to be bought by the author) while other assets are high in price (and hence required to be sold). To give 2 examples, Bernstein presents data from 1973 to 1998 suggesting a Property – (REIT - National Association of Real Estate Investment Trusts) to US Equities correlation of 0.56 while Hale presents data suggesting a UK Property to UK Equities correlation of 0.3. The property types I have chosen to buy into are predominantly Listed European Property Securities excluding the United Kingdom and a fund buying United Kingdom commercial property. I chose to allocate 10% to this sector. Portfolio is now:

23% Bonds
67% Equities
10% Property (Listed Euro Property and UK Commercial)

Next I chose to add some commodities exposure. Initially I went for exposure via a low cost ETC that gave exposure to energy, precious metals, industrial metals, livestock and agriculture via Futures contracts. In hindsight I think that what I did was a mistake and the reason you should always do your own research as I lost quite a lot of money here. Before anybody buys direct exposure to commodities I suggest you read about Contango / Backwardation , Counter-party risk. Additionally many ETC / ETF’s allow you to leverage your returns. Be sure to understand the affects of this also as they are typically rebalanced daily meaning performance will differ from what you expect. So what did I buy? In the end I settled on a simple vanilla ETF that buys physical gold and so tracks the gold spot price minus fees. Why gold? Using the Shiller dataset for the S&P 500 and the Austin Rare Coins dataset for Gold for the years 1968 to present day a relatively low correlation of 0.5 is achieved. What does 0.5 look like? Well rather than just show actual prices in history I present a chart showing real prices (ie after inflation) for both assets.


Additionally, it’s also worth looking at a chart showing the ratio of the S&P 500 to Gold (excluding inflation).


As always make up your own mind but I’ve settled for 5% to be allocated to Gold. As commodities can be highly volatile I’ve taken my Gold allocation from equities. Portfolio is now:
23% Bonds
62% Equities
10% Property (Listed Euro Property and UK Commercial)
5% Commodities (Gold)
Now to how I’ve allocated my equities. Hale suggests that traditional developed world equities have very high correlations of about 0.9 and so do not significantly diversify the portfolio. I guess this is because of globalisation. Emerging Markets on the other hand seem to have a much lower correlation of around 0.7. I’ve still chosen to spread widely through the world to remove country risk as much as possible and also to pick up some swings from exchange rates. I’ve settled on 21% Australian Equities, 21% UK Equities, 15% International Equities and 5% Emerging Market Equities. My Australian Equities are generally ASX 300 low cost trackers. My UK Equities are generally FTSE All Share low cost trackers. My International Equities are targeted to be 40% US, 40% Europe and 20% Japan. My 5% Emerging Markets simply track the MSCI Emerging Market TRN Index. Portfolio is now:
22% Bonds
21% Australian Equities (ASX 300)
21% United Kingdom Equities (FTSE All Share)
15% International Equities (40% US, 40% EU, 20% Japan)
5% Emerging Markets Equities (MSCI Emerging Market TRN Index)
10% Property (Listed Euro Property and UK Commercial)
5% Commodities (Gold)
Finally to my bond allocation. Within my bond allocation the first thing I do is hold 6 months worth of salary in cash. Just in case... Next within low tax wrappers I’m holding predominantly holding Index linked Gilts as I’m always concerned about returns after inflation. The final variation from a traditional bond allocation is that outside of the tax wrappers where instead of bonds I am holding what I consider to be a great little product from National Savings and Investments which are Index linked Savings Certificates. Portfolio is now:
22% Bonds (Cash, Index Linked Gilts, Index Linked Savings Certificates)
21% Australian Equities (ASX 300)
21% United Kingdom Equities (FTSE All Share)
15% International Equities (40% US, 40% EU, 20% Japan)
5% Emerging Markets Equities (MSCI Emerging Market TRN Index)
10% Property (Listed Euro Property and UK Commercial)
5% Commodities (Gold)

So that’s my portfolio based on what I think are basically traditional asset allocation strategies. The final portfolio weightings however are where I try and introduce allocations that vary based on what I think is a sensible method for determining asset values at any point in time. This I’ll cover in Part 3.