Brendan and I have discussed this subject many times so I decided to set myself a challenge:
To create a portfolio of less than 10 positions which is "appropriately" diversified but which gives up nothing in terms of the tax efficiency of a direct share portfolio that Brendan is looking for.
Important: The following is intended for educational purposes only and does not represent a recommendation for a particular portfolio of investments for any particular investor. To avoid the risk of anyone buying a potentially unsuitable portfolio without advice I have therefore left out the specifics of the underlying investments.
Note that although we have clients invested in portfolios substantially the same as described below the data described is "backtested" using a system from Morningstar, the actual results an investor might have achieved over the same time period could vary significantly due to transactions costs, fx costs, personal taxation and other factors.
However, the portfolio is comprised of just 9 positions and has the following characteristics:
Categorically subject to Income Tax and Capital Gains Tax - tick
Exposure to underlying positions in 1290 individual companies - tick
Market Cap weightings so 50% USA 20% Greater Asia etc - tick
Beta vs FTSE All World Index over 3,5 and 10 years 1.03, 1.02 and 0.99 so looks and feels like the index - tick
However, Alpha over the same periods vs the same index 1.68, 0.81 and 1.70 so you were getting about a percent a year over the market for the same risk - bonus
We can test that by looking at the sharpe ratios
3 years
portfolio 1.08 vs benchmark 0.97
5 years
portfolio 0.79 vs benchmark 0.75
10 years
portfolio 0.46 vs benchmark 0.37
Average annual returns to end of Sept 2015
1 year 8.95%
3 year 14.94%pa
5 year 12.91%pa
10 year 7.73%pa
These figures are total return numbers and include dividends
Valuation multiples
P/E
Portfolio 16.94
Benchmark 15.98
Price/Book
Portfolio 2.16
Benchmark 1.88
Geometric Avg Capitalization (Mil)
Portfolio 26,930.18
Benchmark 35,416.32
Source: All data and analysis source Morningstar
The performance data quoted represents past performance and does not guarantee
future results. The investment return and principal value of an investment will fluctuate
thus an investor's shares, when redeemed, may be worth more or less than their original
cost. Current performance may be lower or higher than return data quoted herein.
So, historically at least, we are getting more return for each unit of risk taken than the Index
For those of you worried about short term performance records, one of the investments in this portfolio launched in 1868.
So, my conclusion is that since it is possible to make just 9 trades and give up nothing in terms of the tax benefits of a more concentrated share portfolio and still retain all of the benefits of a more diversified portfolio then surely the rational thing to do would be to hold the more diversified portfolio?
Some caveats:
This portfolio is designed to have a beta of 1 against the FTSE All World benchmark index ( a globally diversified index of both developed and emerging markets) and it isn't therefore necessarily looking to outperform the index.
I have also created a value weighted and smaller companies portfolio which enables investors to tilt their portfolio away from the benchmark and towards a higher expected return.
To create a portfolio of less than 10 positions which is "appropriately" diversified but which gives up nothing in terms of the tax efficiency of a direct share portfolio that Brendan is looking for.
Important: The following is intended for educational purposes only and does not represent a recommendation for a particular portfolio of investments for any particular investor. To avoid the risk of anyone buying a potentially unsuitable portfolio without advice I have therefore left out the specifics of the underlying investments.
Note that although we have clients invested in portfolios substantially the same as described below the data described is "backtested" using a system from Morningstar, the actual results an investor might have achieved over the same time period could vary significantly due to transactions costs, fx costs, personal taxation and other factors.
However, the portfolio is comprised of just 9 positions and has the following characteristics:
Categorically subject to Income Tax and Capital Gains Tax - tick
Exposure to underlying positions in 1290 individual companies - tick
Market Cap weightings so 50% USA 20% Greater Asia etc - tick
Beta vs FTSE All World Index over 3,5 and 10 years 1.03, 1.02 and 0.99 so looks and feels like the index - tick
However, Alpha over the same periods vs the same index 1.68, 0.81 and 1.70 so you were getting about a percent a year over the market for the same risk - bonus
We can test that by looking at the sharpe ratios
3 years
portfolio 1.08 vs benchmark 0.97
5 years
portfolio 0.79 vs benchmark 0.75
10 years
portfolio 0.46 vs benchmark 0.37
Average annual returns to end of Sept 2015
1 year 8.95%
3 year 14.94%pa
5 year 12.91%pa
10 year 7.73%pa
These figures are total return numbers and include dividends
Valuation multiples
P/E
Portfolio 16.94
Benchmark 15.98
Price/Book
Portfolio 2.16
Benchmark 1.88
Geometric Avg Capitalization (Mil)
Portfolio 26,930.18
Benchmark 35,416.32
Source: All data and analysis source Morningstar
The performance data quoted represents past performance and does not guarantee
future results. The investment return and principal value of an investment will fluctuate
thus an investor's shares, when redeemed, may be worth more or less than their original
cost. Current performance may be lower or higher than return data quoted herein.
So, historically at least, we are getting more return for each unit of risk taken than the Index
For those of you worried about short term performance records, one of the investments in this portfolio launched in 1868.
So, my conclusion is that since it is possible to make just 9 trades and give up nothing in terms of the tax benefits of a more concentrated share portfolio and still retain all of the benefits of a more diversified portfolio then surely the rational thing to do would be to hold the more diversified portfolio?
Some caveats:
This portfolio is designed to have a beta of 1 against the FTSE All World benchmark index ( a globally diversified index of both developed and emerging markets) and it isn't therefore necessarily looking to outperform the index.
I have also created a value weighted and smaller companies portfolio which enables investors to tilt their portfolio away from the benchmark and towards a higher expected return.