This article is part of Morningstar's Guide to Financial Education
Emma Wall: Hello, and welcome to the Morningstar series, 'Ask the Expert'. I'm Emma Wall and here with me today is Rosie Bullard, Portfolio Manager for James Hambro & Partners.
Hello, Rosie.
Rosie Bullard: Hello, Emma. Good morning.
Wall: So we're here today to talk about asset allocation as part of our Financial Education Week. I thought you might like to tell me exactly what role each asset can play in a portfolio, because I think it's sometimes quite tempting when led by headlines to think it's time to pour all your money into bonds, or at the moment, all your money into equities, but the blend is important, isn't it?
Bullard: It's always important for a client to look at what their long-term objectives are for the money that they're investing; the time horizon, when they need to make withdrawals and, therefore, take a balanced view as to which proportion of their assets they invest into; bonds, equities, alternatives, or keep in cash.
From our perspective, the way we build investment portfolios is for a medium to long-term view. We're looking at equities as being the core base of a portfolio and then complementing the equity component with different asset classes in order to be able to dampen volatility and perhaps provide exposure to other areas of growth within a portfolio.
Wall: As a broad generalisation, equities provide the best opportunity for growth over the long-term, but they are more volatile as an asset class, aren't they?
Bullard: That's right. And investors need to be prepared to take that additional risk and to ride through periods of volatility in order to be able to get the best out of the asset class itself.
We often take a view when markets are volatile of saying, ignore the headlines, ignore what the FTSE or whichever index you're looking at is doing and actually take a step back and look at what the underlying companies are doing. And whilst we might see capital values fluctuate, we might be getting quite a significant proportion of total return from income and, therefore, over time, your total return is positive, albeit at some points capital return might be positive or negative, but income should be a stable base for returns from equities.
Wall: Because of that option of reinvested dividends that you can do with equities?
Bullard: That's right. Exactly that. Or indeed, a lot of individuals, private individuals at the moment, like to choose equities because of the income that they can receive versus holding cash in the bank and indeed versus holding bonds in many cases as well, a fund that's across the market, a lot of equities are producing yields, much higher than their bond equivalence.
Wall: And bonds, quite unpopular at the moment because we've had this fantastic rally for the last sort of 15 years, but the tide is turning. That's not to say that you should completely ignore bonds in a portfolio, they still have a role to play?
Bullard: I think a lot of investors including ourselves have been surprised by the returns we've seen particularly from government debt this year, perhaps partly artificially stimulated by what's been going on in terms of increased monetary stimulus from the European Central Bank, for example.
But you're exactly right, in terms of bonds and where they are at the moment, we don't expect to see a crash in values, albeit there is capital downside risk as the interest rate path starts to normalize. But as with all of the economic recovery that we've seen since 2008 onwards, it's all been a very slow, gradual, unwinding and therefore, to expect to see bonds drop significantly overnight is quite unlikely. And therefore we say, yes, you can still continue to buy bonds, it wouldn't be our preferred asset class. We'd certainly have a larger proportion in equities over bonds and you have got to be conscious that there is a risk to capital downside over the long-term.
Wall: But it does play an important part in diversifying your portfolio and making sure that those unpredictable equity blips are balanced out by something a little bit more stable?
Bullard: You're exactly right. And so we can look away from equities to bonds, we can also look to alternatives as well. We've been particularly interested in certain parts of the commercial property market. One's got to be quite careful as to how one gains exposure to that asset class, be it through a unit trust, for example, that will perhaps have a significant proportion of the fund invested into listed equities rather than purely being in commercial property. But as long as investors know what they are holding within a portfolio, that can be another area to add value away from equities.
Wall: So predominantly, equities with this blend of supportive assets around the outside then?
Bullard: You're exactly right. Yeah.
Wall: Rosie, thank you very much.
Bullard: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
