John Baron: Four trusts to diversify away from stocks

My last column ('The trusts I'm using to ride the stock market rally') explained why, having turned positive on stock markets early last year, I was still positive about the outlook. This remains the case. However, it is important to maintain investment discipline to ensure portfolio balance is retained, and diversification is adequate to remit.

This is particularly so when financial goals are nearing. Rising markets can be seductive and distract from the task at hand. The journey is better enjoyed if it can be afforded. This helps to explain recent changes in both portfolios. Of course, the assets that add diversification can, and should, be good investments.

Theory and practice

There is a minority view that diversification is second best to putting all of one’s eggs into the basket but knowing them very well. I tend to disagree. I have always considered diversification an important investment discipline, yet one which is often overlooked – particularly when markets are rising. Investors can underestimate just how just risk averse they are until a market correction takes place. Better then, as time passes, to increasingly diversify a portfolio away from equities toward other ‘alternatives’ – 'uncorrelated' assets which tend not to move in the same direction as equities, over the same period.

While few investments will escape a major market correction unscathed, adequate diversification helps reduce losses and protect past gains, while providing firepower for opportunities that usually avail themselves when markets are volatile. Assets used by the portfolios include bonds, infrastructure, renewable energy, commercial property, gold, commodities and capital preservation companies. Some of these also help portfolios achieve a high and growing income, which may become increasingly important to investors as time passes.

There are no fixed rules as to the pace and extent of diversification. An investor's income requirement, investment risk profile (influenced by portfolio size relative to other assets), financial objectives and proximity to goals, are key factors. The table on the ‘open’ Diversification page on the website www.johnbaronportfolios.co.uk quantifies the approach taken by the website’s live portfolios. Meanwhile, the table on the open Rationale page shows the growing yield of the five portfolios involved in the investment journey, courtesy at least in part of their increasing exposure to high-yielding alternative assets.

Four recent purchases

BH Macro (BHMG) is an unusual company – an investment trust providing direct exposure to the Brevan Howard Master Fund. This ‘macro-fund’ takes positions in relation to interest rates, currencies, and so on, which are strongly influenced by the company’s assessment of macroeconomic trends. The team has refined its proven approach since its IPO in 2007 and now has significant depth of investment resource. For the investor looking to improve portfolio diversification, a key attraction is the company’s strong record of performing well when markets turn down. In other words, it has an inverse correlation to global equities.

Indeed, recent figures suggest that since inception of the Brevan Howard Master Fund in 2003, it has produced positive returns in 17 of the worst 20 months for equities – including 2020 and 2021. It should be recognised, however, that the team’s approach is best suited to volatility. Between 2012 and 2017, a period characterised by low interest rates, flat yield curves and low growth, more mundane performance reflected fewer opportunities. The company has de-rated somewhat of late and stood on a 12 per cent discount when bought – it has regularly stood on double-digit premiums, particularly when markets were performing badly. Insurance is often only appreciated when it is needed.

CQS Natural Resources Growth & Income (CYN) seeks capital growth and a modicum of income courtesy of exposure to smaller mining and energy companies globally, and some bonds. The company has performed strongly relative to sector benchmarks and its peer group. This is in part because it can capitalise on the attractive valuations within its universe of stocks given exchange traded funds cannot easily duplicate benchmark holdings because of liquidity and crossholding issues. Keith Watson, the lead manager, believes there is no reason for this not to continue given its flexible mandate. The company traded on a 15 per cent discount and yielded 3 per cent when bought. An experienced management team adds to the investment case.

Schroder Real Estate Investment Trust (SREI) seeks an attractive level of income and capital growth from a diversified portfolio of good quality UK commercial properties situated mostly outside the South East. Relative to its MSCI benchmark, the company is overweight industrial assets, which we continue to favour, while being broadly in line with the index's office and retail weightings. Recent results confirmed the portfolio continues to outperform its benchmark by way of NAV return and rental growth, with 99 per cent of rent due collected. The dividend was raised by 3 per cent, is fully covered and equates to a yield of 7.6 per cent when bought, when standing on a 25 per cent discount – two recent disposals confirming the credibility of the NAV.

Importantly, the company’s debt has an attractive maturity profile of 10 years at an average interest cost of 3.5 per cent, with around 90 per cent either fixed or hedged. Indeed, most of the debt was refinanced in 2019 and is fixed for over 12 years at an average interest rate of 2.5 per cent. The balance is a revolving credit facility (RCF) which benefits from an interest rate collar, capped at 4.25 per cent. Meanwhile, SREI is rightly focusing on environmental sustainability. As the chair put it: “(this) will clearly differentiate the company and its strategy from peers, improving the defensive qualities of the portfolio and driving risk-adjusted returns for shareholders."

The Renewables Infrastructure Group (TRIG) seeks sustainable returns from a diversified portfolio of renewable infrastructure assets – mostly wind and solar energy in the UK and Europe, with battery storage assets currently representing roughly 5 per cent of assets. The portfolio is well diversified across proven technologies, weather patterns, regulatory regimes, and power markets. In line with many of its peers, TRIG has seen a significant derating in recent years and now stands on a circa 18 per cent discount to NAV. For much of the past 10 years, the company stood at a premium – often by as much as 10-15 per cent. The company continues to perform well, benefits from an experienced management team, and pursues a progressive dividend policy which equated to a yield of 7.5 per cent when bought.