"By biasing a portfolio towards predictable revenue streams and removing the riskiest companies, we believe limited diversification can provide greater risk management for investors.”
This is a view echoed by Train, who takes the view that companies such as Unilever, in which he is invested, are, as multi-national companies, effectively providing asset allocation for shareholders, as they choose in which markets to invest globally.
On this basis, he feels owning a small number of stocks can provide a diverse exposure.
Proxy voters
Stocks such as Nestlé are often regarded as bond proxies – that is, stocks that do well when bond yields are low, as investors prize the predictability of the cash flows, even if the valuation is high. When bond yields rise, the relative attractiveness of those cash flows declines for many investors, explaining the relative underperformance of growth stocks for part of this year.
Giles Parkinson, a managing director and equity portfolio manager at Close Brothers Asset Management, says a mistake many equity managers make is to focus too much on finding what they believe to be “good companies”, and disregarding valuations.
He says this leaves an equity portfolio potentially over-exposed to certain types of stocks, which often trade at acutely high valuations, and so are not particularly diversified from each other.
But for Chris Miles, head of financial intermediaries at Capital Group, a portfolio starts with a core of good companies, which he defines as “steady compounders, subscription models, networks with annuity-like cash flows, smart industrials and drivers of sustainability”.
He says such companies can provide the building blocks for a portfolio for the long term.
If valuation is central to how advisers and their clients think about the question of asset allocation, Rupert Thompson, market strategist at Kingswood, a wealth management firm, says the UK equity market is presently trading at a 35 per cent discount to its long-term valuation average, and at a 40 per cent discount to US equities.
He says: “While markets generally look set to remain very volatile for a while yet, we continue to believe the UK should be one of the better-performing regions when equities eventually see a sustained rebound.”
Nathan Sweeney, deputy chief investment officer of multi-asset at Marlborough, says the portfolio construction element is “the most overlooked” source of returns.
He says it is possible and viable to identify which investment style is outperforming, and build, at the fund level, exposure to that style.
But he adds that the key is to understand why a particular equity investment style is doing well.
Sweeney says: “Today we are defensively positioned and have deliberately increased our exposure to income managers across several regions.”
Aymeric Forest, chief investment officer for multi-asset solutions at abrdn, says the issue with the above debate – value versus growth equities – is that while one can usually understand the economic and market conditions that make either of the above factors outperform, the challenge of moving between them to optimise returns is severe.
