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David:
This is MoneyTalk, the weekly investment podcast from the Motley Fool. I'm David Kuo, and if there is one thing that we learnt from the financial collapse of 2008 it is that you should only put all your eggs in one basket if you enjoy scrambled eggs, but if you're going to put all your eggs in one basket, just make sure you watch that basket very carefully, and here to explain everything we need to know about eggs and baskets, and how to cook them, is Trevor Greetham, Director of Asset Allocation at Fidelity. Welcome to the Motley Fool, Trevor.
Trevor:
Hi there.
David:
So today's podcast was inspired by one of our listeners called Colin Smith, who emailed me at moneytalk@fool.co.uk, and asked me if we could explore asset allocation. Before we launch into asset allocation, Trevor, can you tell me a little bit about Fidelity, for those of us who've never heard of Fidelity? – I can't think of anybody that's never heard of Fidelity, but if there is anybody out there, can you explain to them please?
Trevor:
OK, well Fidelity is a fund management company, we don't do anything else, all we do is manage investments for our clients, and we do that across equity funds, which I think we're pretty well known for, but also fixed income funds, and the area I'm involved in is multi-asset funds, so funds which are doing asset allocation, but also we have our experts picking what we think are the best stocks to invest in all the best bonds, the securities within each asset class.
David:
So you are a very well known person at Fidelity – there is somebody else who is also very well known at Fidelity called Anthony Bolton, so what is life like at Fidelity without Anthony Bolton being there?
Trevor:
I don't know, because he's still at Fidelity, he's moved to Hong Kong, he's in the process of moving to Hong Kong, as you know he's going to be running a China fund for us, but we're in pretty close contact with our research colleagues and our fund manager, our colleagues in Hong Kong and the rest of the world, so we don't feel we've lost Anthony at all, which is great.
David:
Well, it is great for everybody, because I think one of the worst pieces of news was to hear that he was going to be relinquishing his Fidelity Special Investment fund, and people were very disappointed at that, but he obviously was …
Trevor:
A special situation.
David:
A special situation, but he obviously sees opportunities in China now?
Trevor:
And his UK successor on that fund is doing very well as well, so Sanjeev Shah.
David:
Correct. So let's turn to asset allocation, which is why we actually got you in here today Trevor. What exactly is asset allocation?
Trevor:
Well it can generally mean one of two things, I mean you sort of talked about not putting all your eggs in one basket, that's a great analogy, so in one sense it's building a portfolio up with a range of different asset classes which have different risk return characteristics, and they do well at different stages of the economic cycle, so you spread your investments across stocks, bond, maybe some property – most of us have some property somewhere in our portfolios, even if it's just the place we live in, cash, maybe commodities. So asset allocation can mean the art of balancing your investments across these different types of asset class. It can also mean switching between them, so that tends to be called tactical asset allocation, deciding which one will do best at a particular point in time, and at Fidelity we're doing both of those things.
David:
So how does any individual decide what kind of asset allocation is correct for him or her?
Trevor:
Well, for each individual there'll be a different set of needs, so what people need to do is take advice or think about their own financial liability, so what do you need the money for, and when do you need it, and how certain do you need to be that you have a certain amount of money. So there's a big difference between someone who's say, setting out as a twenty year old investing, they're just investing a sort of nest egg for the future, in which case they might well take some risk, and put the money entirely into equities, than someone who's maybe a couple of years away from retirement, they'll want to have more security and more income when they retire. So it depends on individual circumstances, but those are the sorts of considerations that you should look at.
David:
Is it quite easy for somebody to do, to sort of decide whether or not he is somebody who is risk-averse, or somebody who is quite tolerant to risk?
Trevor:
I think if you're risk-averse, you learn that quite quickly, don't you, in the markets?
David:
You just put all your money under the mattress!
Trevor:
I think everyone, to a certain extent, in investment, learns from their mistakes, but I think it's always good to also learn from other people and stand on the shoulders of giants, if you like, and it's always a good idea to consider spreading your assets across more than one asset class, even if you only have a small amount outside of equity as an investor with a long time horizon. It's good to kind of get used to the idea that you should be doing this, and also revisiting it, because it's important to rebalance portfolios, so you might find that you've got a nice mix, you leave it for five years, and something's done or something's halved, it's good to go back and actually rebalance: sell one, buy the other, get the mix right again.
David:
Now the thing is, people out there sort of like formulas, they like things that they can see written down on a piece of paper to say, how much do I put here, how much do I put there. Now there was one man called Harry Malkovich who did his PhD on this, and he did his PhD on asset allocation, and he is generally regarded as a father of asset allocation. Now he reportedly has a book on his bookshelf by his statistics professor called Jimmy Savage, and the book, Foundations of Statistics, debates two proverbs. Now the first proverb is, “Look before you leap”, and the second proverb is, “Let's cross that bridge when we get to it”. Now which camp do you fall into, Trevor?
Trevor:
I am allowed to be in both?
David:
You can be in both, it's your privilege, yes.
Trevor:
For the strategic, long-term asset allocation, where you're getting the mix right, I think it's look before you leap – you need to kind of understand how these different asset classes behave in a long-term context, and get the balance right between them, rather than sort of putting it all into one and hoping that somebody will ring you up and say, now's the time to sell. It's good to get the balance right, over the long run. But in terms of tactical asset allocation, although we're looking at some things like market valuation, which can give you a bit of an idea of how attractive future returns might be, we're also looking very much at the way the world economy is developing. So the future hasn't been decided yet, you've got these different possible futures, you're trying to recognise which one you're moving along, which path you're moving along. So that's more of a kind of real time analysis, so that's more the kind of, cross the bridge when you see it.
David:
So people will be saying: ask Trevor, how easy is it to try and predict what is going to be happening next year, the year after, and ten years forward?
Trevor:
Well it's extremely difficult, and actually I try and set myself a slightly easier problem, which is also not necessarily that easy, which is what's happening now. The markets don't react to what will happen the year after next, because they don't know either what is going to happen in the future. Some people have this kind of almost mystical idea that stocks are reacting now to what will happen in 2011, but I don't believe it, so I think what you've got to do is you've got to focus on the trends, so growth and inflation are the two that we look at, and what's happening now with those trends are what determine our tactical asset allocation, so we use something we call the investment clock, and we may come back to in a minute.
David:
Now you touched on something called “tactical asset allocation”, in other words, switching from one to the other. Now how easy is it for people to try and switch from one to another, and then suddenly see the one that they sold is actually doing quite well and the one they switched into isn't doing quite well. It's my experience with investing, especially with shares, I come out of oil and I go into pharmaceuticals, and I suddenly find that the oil shares are doing very well and the pharmaceuticals aren't.
Trevor:
Well, I think that comes down to the sort of parameters you let yourself move within, so if you've decided there's a certain mix between different asset classes that makes sense for you, then it doesn't make a lot of sense to say, OK, forget all of that, I'm putting 100% into commodities today. So I think you've got to say, OK, well if I've got certain percentages in each asset class that makes sense for me, I'll allow myself to increase or decrease each asset class by maybe 10% of the portfolio, or 20% of the portfolio, and that's where I'll stop, so that means that you've always got some exposure to all of the asset classes, you're still diversified across the different asset classes. I think that makes some sense, otherwise you're betting a lot on your individual skill relative to this sort of long-term, don't put all your eggs in one basket theory.
David:
We're going back to the eggs in the basket theory – I told you we'd touch on eggs in baskets. Now the thing that we actually learnt from 2009, I guess, is that, when the market falls, everything falls at the same time. Now people will be saying, well, I had my money in shares because the Motley Fool tells us to buy shares all the time. So if I wanted to diversify my portfolio slightly, what should I be buying to correlate negatively to shares?
Trevor:
Well the first thing is, I would take the issue with the idea that everything fell together, I kept reading that time and time again, people saying, in a bear market, the only thing that rises is correlation, in other words meaning everything was falling.
David:
But for most people it did though, didn't it? – because the house prices fell, the shares fell, commercial property fell, so people are saying, what should I have put into my basket to try and correlate negatively to that?
Trevor:
Government bonds, or commodities. You've got to cast your mind back, the beginning of the bear market was decoupling, and it was a kind of stagflationary environment, where inflation was picking up; central banks weren't cutting rates, even though there was a financial crisis; oil got to $145, so the early part of the downturn, commodities made people very good money. From the middle of 2008 onwards, when commodities peaked, you had to get out pretty swiftly, government bonds took over, and people made 10, 15, 20% in government bonds. So you had ways of making money throughout the bear market, and the funds that I manage in the UK, which are called multi-asset strategic, that was down during the bear market by something like 10%, and now it's up from its pre-bear market level by more than 10%. We didn't lose a lot of money in the bear market, because we shifted our asset allocation quite aggressively towards government bonds and commodities when they were right. You do have to be a bit fleet of foot to get it right, but there are definitely things that do well in a bear market.
David:
So how do people know whether or not they've got their asset allocation correct? Is there a set of weighing scales that you can put your portfolio onto and go, now it feel right, it weighs OK?
Trevor:
Well, I think you can probably get a feel for whether you've got the spread of investments right, and you should always be thinking, when you look at your portfolio, is this the right sort of spread in terms of my time horizon, my risk tolerance, those sorts of things. But in terms of the tactical positioning, only time tells, and sometimes what turns out to be a very profitable investments feels awful at the time, and it's only later on that you sort of think, well actually that did pay off, but by that time you're worrying about your next investment.
David:
Well, exactly! Now the thing is, we have a broad spectrum of people who listen to this podcast, we have young people, middle-aged people and older people. So can you give people who are listening to this a rough idea as to what a young person's portfolio should really sort of look like?
Trevor:
We sort of try and address this with the multi-asset funds, so the multi-asset strategic funds are about 50% in the riskier assets, that should make you more money over the long run. So that's in stocks, property and commodities, and it's 50% in bonds and cash, which are more of a store of value. Now for the younger investors, we have another fund which is 75% in the long-term growth assets, so it's 75% equities primarily, and it can range between 65 and a hundred, and that's the right sort of mix, I think.
David:
You mean at some point you could go 100% into equities in that fund?
Trevor:
Yes, that's right.
David:
That's very aggressive?
Trevor:
Well it is and it isn't, because for most pension plans the default for a younger member would be 100% in equities, and you've got to bear in mind that a younger person, most of their portfolio consists of money they haven't invested yet. If you project their life forwards, they might start off with an investment of £100, later in their life they might be putting £100 a month in, so you've got to bear in mind that they can take risk in their early years in their portfolio because, compared to the sort of future income, which is quite a sort of stable asset, if you like, it's actually a tiny part of their final portfolio. I'm an actuary by training, so I'm sorry if I've lost everybody on that one.
David:
No you haven't lost anybody, I think people are completely gripped by this.
Trevor:
Obviously later on, yeah.
David:
So what you're saying is that a young person should in fact have more of their money in equities?
Trevor:
Yes, the point I guess I'm trying to make is …
David:
And just ignore the market, do you mean? – if the market falls, then just say, so be it?
Trevor:
Well, if they keep investing, and they're buying at those cheaper levels. The problem is, it's very tempting not to invest when the market's depressed, so a lot of people weren't investing, they cancelled their direct debits in sort of February/March last year, and that was actually the best time to be investing. So for a young investor, just keep investing in equities, and bear in mind if it feels volatile sometimes, bear in mind that your future investment portfolio, most of the money hasn't been put in yet, and so for a younger investor, a bear market is an opportunity, because you're still investing and you're buying at cheaper levels.
David:
So this young investor, as he or she starts to get a little bit older, what then should happen to their portfolio?
Trevor:
Well things change, so as you get nearer retirement, and perhaps nearer the end of your life of earning money and having money to invest, obviously your portfolio becomes far more important in your life than your future contributions, because you might be stopping your contributions quite soon.
David:
But generally those people are the ones that have the most amount of money though, aren't they? – because by the time you reach slightly older, you've paid off your house, your children have left home, you are then left with this pot of cash which you want to do something with. That is the time when you want to be aggressive, but you can't, you are saying?
Trevor:
No, it depends on individual circumstance, I come straight back to that, it depends on individuals, but what I'm saying is that, as you're approaching retirement, then you'll probably want to have a more stable portfolio than would have been appropriate when it was just the beginnings of a nest egg, 20, 30, 40 years earlier, but I wouldn't say it should all be in bonds and cash even then, because you're then vulnerable to bouts of future inflation, which is something we can't ignore at the moment as a possibility, and also your retirement might last 30 or 40 years these days, so life expectancy has extended dramatically, and so you can't really say that you don't want future return, so I still think you need a kind of mix with equities in there somewhere as you retire.
David:
So would they then be going for things like high yielding shares, things that look a little bit safer, the utilities, the telecoms?
Trevor:
Yes, or they'd have a mixture that includes corporate bonds and government bonds in a larger weighting, so just as we had that sort of fund with 75% in the growth assets, we have another one which is 25% in the growth assets, 75% in government and corporate bonds and cash. That's a much more stable kind of fund, but it hasn't given up on the idea of making money in these growth-related assets like stocks and commodities.
David:
So what you're saying is, even the older person needs some growth in the portfolio?
Trevor:
They do, yes, and those particular funds, we're also trying to time the markets with our tactical asset allocation. So if we think it's a great time to invest, then we'll increase that 25% to say 35; if we think it's a terrible time to be in risky assets, we can take it to zero. Those sorts of parameters, as an individual, that's what I would recommend people do, they keep a right sort of balance for their stage of life and their own needs, and allow themselves to deviate a bit either side of that, but it doesn't make a lot of sense if you're 25 years old to put everything into cash, and it doesn't make a lot of sense if you're 65 years old and about to retire to put everything into emerging market equities, say.
David:
So what you are saying, in fact, is yes, by all means, don't put your eggs into one basket, but even if you haven't put all your eggs in one basket, keep on watching those baskets very carefully, and just be very very cautious about what's going on?
Trevor:
That's right, or ask somebody else to do it for you.
David:
OK, that's fine. So I'm going to put you on the spot now Trevor – I want you to look into your crystal ball and tell me what you think is going to be happening in 2010 and beyond?
Trevor:
OK, the first thing to say, coming back to, I mentioned the investment clock, so I'm thinking about growth and inflation, and depending on what growth and inflation are doing, there'll be a different asset that fits that situation best. Now, starting with growth, I think we are in the middle of the strongest economic recovery in at least a generation. Now, most people look at me rather strangely when I say that, and I think that the data takes a long time to come out, but the leading indicators are as strong as they were in 1975, so basically after Lehman failed, companies panicked, they cut their capital spending plans, they fired people, they ran down their stockpiles, and what we've been seeing since March last year is a kind of reversal of that panic, so they're sort of panicking back in, if you like, to building up stockpiles, re-hiring, and retail sales is surprisingly positive, as we heard recently over Christmas in this country. So it's a very strong economic recovery, and it's got a fantastic tail wind, because the policy makers really panicked after Lehman failed, they all thought we were heading into the great depression, so we got these massive peacetime fiscal packages, we got zero interest rates, and these things have a really long fuse, so it takes at least a year, maybe even two years, before that policy has finally taken effect, and they haven't started tightening yet, so I think there's a big economic recovery coming through, and that favours the assets in the investment clock that are the more sort of economically-sensitive assets, so we're overweight stocks, we like the emerging markets in Asia, we like technology, resources, also some financials, and then other asset classes it favours are clearly commodities, I think there's a big demand for commodities coming through here. As for inflation, there's a lot of spare capacity in the world economy, a lot of empty factories still, a lot of unemployed people, and it's very hard to get inflation going in a meaningful way when you've got a lot of spare capacity, because somebody will come in and undercut you, and cut prices. So probably no serious inflation shock coming through, but in the near term, the inflation indicators are clearly pointing upwards, because commodity prices are rising, and I think this rebuilding of stockpiles is going to see a lot of demand for commodities. So at the moment we're also positioned in inflation hedges, so not just stocks, we're overweight commodities actually more than stocks at the moment in our portfolios.
David:
And how much of this is dependent on the Bank of England continuing to print money, continuing with its quantitative easing?
Trevor:
Well, it's not really dependent on that, as I say the policy has about a one year sort of fuse, so what they're doing now will affect 2011, but I think 2010 is already in strong recovery, that's how it looks at the moment. So at some point, central banks will start tightening, the Chinese are even starting to do that at the margins at the moment. So this year will be a year I think of strong growth, and people beginning to realise that interest rates will not stay this low.
David:
Your point about interest rates interest me, because over in Australia they've already started increasing interest rates, because they are so fearful about inflation. What happens when this starts to grip the whole world, when everybody is starting to increase interest rates?
Trevor:
Well, there's bound to be some volatility, I don't think we're in an asset bubble territory here at all at the moment, but there's bound to be some kind of wobbles in these markets when interest rates start to go up, because it's a negative, you can't paint it as a positive. So there will be volatility, but I think probably, certainly in recent years, it's the last rate hike you should really worry about and not the first, because it could take them a year or two years to rein growth in to the level they want it to be. So you shouldn't really worry about these early stages of tightening, unless you're holding government bonds, so government bonds here I think are at risk, because short term interest rates will rise, and that tends to push the longer term interest rates up as well, and if you've got a strong recovery with some inflation pressures, I think that's a negative, so I think the Bank of England will stop buying gilts, and the recovery will push yields higher, so when we're moving money in these multi-asset portfolios into things like stocks and commodities, the place I'm taking it out of is government bonds.
David:
Right. I'm glad to actually meet somebody who is more bullish about the market than me, because I thought I was the only one, but clearly you are almost as bullish as I am about the markets; people were ridiculing me because I was saying this was the first leg of a very long bull run, and clearly you're almost confirming that?
Trevor:
Well that's my view, yes.
David:
And stick to it, because I think it's the right view, because I think you're absolutely spot on, and I think increasingly more people will be joining this sort of camp that says we are beginning the longest bull run that we've actually seen for a long long time.
Trevor:
Well, it could well be, at the very least it feels to me like the 2003 fall, so you might have five, six, seven, you might have two or three years here of economic recovery with stocks going up, it's that sort of environment, and as the time goes on, you keep comparing it to your favourite example of the past, and a year ago if I'd come in I would have been talking about the Great Depression and something very gloomy.
David:
I'm glad you didn't come in a year ago.
Trevor:
You'd have to ask me why we were in government bonds and cash at the time, but that doesn't seem appropriate now, so it's more like the '03, '04 recovery that I think we're seeing.
David:
That's wonderful. Well thank you very much for coming in today Trevor. I end each podcast with a quote, by the way, and I found a quote that I think tries to sum up what we've actually been talking about, and today's quote comes from a maths professor called De McHale , who has this to say about statistics. He says, "The average human being has one breast and one testicle" – I think we know what he means by that.
Trevor:
Thank you.
David:
OK, you're welcome, but anyway, thanks for coming in today Trevor. This has been Money Talk, I have been David Kuo, and my guest has been Trevor Greetham, Director of Asset Allocation at Fidelity.
If you have a comment about today's show, you can post it on the Money Talk page, which you can find at www.fool.co.uk/podcast, and if you have a podcast which you'd like to suggest for the future, you can do so by emailing me at moneytalk@fool.co.uk. Everybody, have a great week.
