19 Aug 2011 | Opinion

Diary of an Investor Part 2: Building a Portfolio 

In his second article, private investor Charles
White discusses building his investment portfolio.

In my previous article I explained how some 20 years ago I 'discovered' investment trusts as a vehicle for equity investment, initially starting with small monthly investment in two UK focussed trusts (Edinburgh Investment Trust and Graphite Enterprise Trust).   Within a few years I had begun to see growth in these investments and my appetite for careful equity investment increased, fortunately along with a willingness to divert some income from immediate gratification.

I extended my holdings into international trusts with a focus on Europe, Japan and Emerging Markets sectors, again using a monthly saving approach and low-costs provided by the trusts' savings schemes.  I chose established trusts with a proven track record and a good spread of companies in their investment portfolio – in this case Fidelity European Values, Fidelity Japanese Values and Templeton Emerging Markets.  In more recent years I have added trusts for equity income and smaller company exposure.  As with my two initial choices, I continue to invest monthly and they form the long term core of my portfolio.

Investment trusts offer a wide range of sectors and investment approaches.  I have steadily increased my portfolio since, having developed a further understanding of the workings of investment trusts, and some feeling for how to match them to my needs and extend into areas that I would not otherwise be able to invest in.   Aside from the well-known investment trusts in established equity sectors, there are increasingly more specialised trusts targetting for example technology, environmental and commodity based companies, and non-stock market assets such as commercial property, unquoted private equity, bonds.   Further, some trusts operate specific investment approaches.   One such example is Hansa Trust - it has a very focussed portfolio concentrated in a handful of companies, one of which represents over 35% of the portfolio value, reflecting particular strategic convictions of the investment manager (most trusts operate a less risky approach, and the trusts' articles often limit the amount of the portfolio that can be invested in any one company).   I have a small holding to offer diversification from more mainstream approaches.

When looking at more specialised situations it is important to remember an investment trust is a company too with its own risks according the way it is organised.   One feature of investment trusts, unlike unit trusts, is the ability to borrow additional funds for investment (like any other company may borrow to buy equipment for its business) – giving the trust 'gearing'.  Gearing magnifies performance for the trust shareholders assuming the strategy works, but needs good management if things move against the portfolio to avoid heavy losses.

While investment trusts as pooled funds reduce risks by investing in multiple underlying companies, the risks to consider are both the type of underlying assets (e.g. trusts in emerging markets or property would be considered more risky than trusts with UK FTSE companies), and trust’s approach to gearing and portfolio management –   high gearing or concentrated investment are potentially riskier regardless of underlying assets. Fortunately this information is readily available for comparison on various internet sites and of course trusts' own sites and annual reports.

In extending my portfolio I have adopted two different approaches to investing - monthly savings schemes for the core of trusts with a long term view, and a stockbroker internet trading account for shorter/medium term positions in riskier trusts.

The saving schemes approach is necessarily long term, as the timing and prices of purchases and sales is not under my immediate control, and you cannot respond to rapid market changes as sell instructions are typically pooled weekly.  My view here is for the holdings of a core set of trusts with a fairly ‘traditional’ approach, well-diversified portfolios - typically those that advertise to retail investors – to maintain long term exposure to major equity markets, with the benefit of active investment management that the trusts provide.   I have continued to invest regularly through market ups and downs, and the effect of “pound cost averaging” (you automatically purchase more shares when prices are low and fewer when they're high - a desirable behaviour given time!), low costs and dividend reinvestment have over the long term has still delivered good returns.  I review these investments annually and may sell a minority portion if for example the price seems to be peaking, or discounts are narrowing, to rebalance the portfolio and raise cash for future spending needs.

The stockbroker internet trading account gives control over price and especially the ability to sell quickly if needed.  I have used this approach for smaller investments in riskier sectors such as commodities or property related trusts.   Of course this also needs some more discipline for timing, and attention to individual trust situations. I have experienced some losses, and subsequent learnings (setting stop-loss orders in case of sudden movements), during the recent market fluctuations, reflecting the riskier nature of some of the investments (and with hindsight some poor judgement on my part).  On balance the successes outweigh the losses, and I continue to look for opportunities when funds and time for research permit.

As the size and mix of my portfolio has grown, applying risk management rules is important - so I keep enough cash to meet known needs - the “don't invest what you cannot afford to lose” adage holds true I believe (I have proven this for myself in hard cash), limited the proportion of money invested in the riskier choices, and spread across a number of different trusts if possible within a given sector if risky.

While this is not “get rich quick”, it is working for me as a balanced mix of approaches that is meeting my goals to build investment wealth over time and affords opportunities for the occasional more 'interesting' investment.

The views expressed in this article are those of the author and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.  They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

Trusts can borrow money to make further investments (sometimes known as “gearing”). The risk is that when this money is repaid by the trust, the value of the investments may not be enough to cover the borrowing and interest costs, and the trust will make a loss. If the trust's investments fall in value, any borrowings will increase the amount of this loss.

Author: Charles White
Charles White is a private investor.