Today I am delighted to be able to share our updated "Fund Overview" document.
This version of the document is updated to include performance numbers and other charts and graphs to the 31st of December 2021. More important, however, we also explain some minor changes we have made to the composition of the fund with a view to reducing cost for our investors and comment on our positioning vis-a-vis Russia. In what follows, we have also taken the opportunity to restate our belief in the merits of the fund and take some criticisms head-on.
Evolution and cost reduction
In the last edition of this Fund Overview document, published in Q3 of 2021, we said of our ETF composition (i.e., the underlying Exchange Traded Funds we use to implement the strategy):
“Please note that these (ETFs) will change if we find better or cheaper alternatives ... as more such funds are launched in future. The target allocation may also change if deemed appropriate in the future. Any such changes will always be “evolution, not revolution” and would be entirely evidence based.”
In the second half of 2021, we conducted a review and optimisation exercise on the ETFs used to implement our strategy, in collaboration with Professors Thomas and Clare - our partners at the Bayes Business School. Our aim was to reduce the cost of the fund without impacting performance or liquidity. We made no change to the broad composition of the fund (this is shown in the pie chart on p. 27 of the document) but we have made the following minor changes within some of those asset class silos as a consequence of that exercise:
In Emerging Markets (EM) - we previously used 4 x 5% silos in each of “core” EM, Latin America, Asia and E. Europe and Russia. We have replaced this by using 2 x 10% “core” EM silos. This significantly reduces costs as the regional EM ETFs are expensive.
In Commodities - we previously used 4 x 2.5% silos in each of Agriculture, Energy, Industrial Metals and Gold. This has been replaced with using 2 x 5% silos in each of a wide-ranging General Commodities basket and Gold - again to reduce cost.
In Real Estate - we previously used 4 x 2.5% silos in each of US, UK, European and Asian real estate / property. We have simplified this to 2 x 5% in UK and US real estate.
The overall number of "silos" we now use as a result of these changes has reduced from 24 to 18.
Cost Reduced by 0.24%
We have also replaced a number of the ETFs we used previously with better value versions where we could find them, given how many more products are now available in the ETF market. Taken together, this exercise has reduced the Ongoing Charges Figure (OCF) of the fund from 1.48% to 1.24% as at year-end 2021.
Our backtesting has shown that these changes may also have a small (positive) impact on performance with negligible impact on volatility - hence our decision to make these small changes overall.
You can see the full list of ETFs that the fund now uses on page 44 of the document and compare the backtested performance numbers with the
new composition as against the old (on pages 35 and 46).
Russia
The other thing to note about these changes concerns any potential exposure to Russia. Given the current crisis in the Ukraine and the imposition of economic sanctions, several of our investors have wanted to know whether the fund has any exposure to Russia.
One of the changes we made as highlighted above, was to discontinue the use of an Eastern European and Russian Emerging Markets equity ETF. We did this at the beginning of December because it was an expensive product, not because of the situation brewing in the Ukraine. But this does mean we have had no direct equity exposure to Russia since then. This has clearly been a pleasing outcome both in terms of side-stepping a very significant potential fall in one of our positions and not having to worry about any direct exposure given the current situation.
The only other silo where there could be some very small Russian exposure is the JP Morgan EM Government bond. This may have some very minimal exposure to Russian debt - although I suspect they may be unwinding that given the sanctions rules. At present we do not own this silo, having sold out of it last November.
So, overall, we currently have zero exposure to Russian assets. Even if we bought back into the JP Morgan EM Government bond ETF, it seems likely that their team will have sold any Russian bond exposure by then and, even if they hadn't, our total exposure would be tiny.
More Generally / Bigger Picture...
We note that the fund is currently trading only a little above where it launched in September of 2017. Perhaps understandably, this has opened us up to a measure of criticism. I believe it is worth addressing that criticism head on. I hope that long-term followers of all that we do would agree that we are entirely transparent when it comes to such things.
It does what it is designed to do...
The first point to make is that, as is the case with any investment fund, our fund is designed to do a specific job, and is therefore only relevant and “appropriate” for people who want that job done.
As we explain in the Overview document, there are a number of reasons why avoiding a very significant fall in the value of your investments should be the number one consideration for many, if not most people when they consider investment, and particularly for people at or near retirement.
A strategy which avoids ever falling 30, 40 or even 50 or more per cent in years like 1999/2000 or 2007/2008, will more than likely be an investment “tortoise” that "wins the race" over many years of investment.
This is because roughly once a decade, when all those nicely performing “hares” fall 50%, or even more than that - and the "tortoise", perhaps only 5-10%, the hares then need to make 100% or more to catch back up - and this is actually pretty unlikely to happen - or, if it does, will take many years. The price our "tortoise” must pay to achieve this result can be really quite long periods of time where it goes nowhere - as has been the case since we launched.
But this doesn’t change the probability of the long-run result, considering the evidence of many decades, and how maths work at the most basic level (i.e. the fact that a 100% return is needed to recover 50% loss - sometimes referred to as the "break-even fallacy").
Below we show a graph of how £500,000 invested in the fund in January 2001 could have performed over the last twenty years or so and a table of the discrete annual performance over the same period immediately below that.
Important disclaimer: Past and simulated past performance is not a reliable indicator of future results.
The key point to make here is the very nature of the return profile. The strategy's number one focus is on capital preservation. We believe, however, that when there is a long, strong and durable trend - as can be seen from 2002 to 2007, through 2009 and 2010 and again in 2016 and 2017, the approach can also capture significant upside.
Taken together, we believe that in the (very) long run, the strategy may be able to achieve not far off stock market returns but with much lower than stock market risk. To do this, it must necessarily have a very different return profile to significantly more volatile assets.
We concede that this is a return profile which requires patience. Key to the story here are the five red lines in the top graphic. You can see that four times in the last twenty years, the strategy has gone sideways for a reasonably long period of time, just as it has in the time since launch (the fifth red line on the right hand side). But this has not detracted from the long-run result as can be seen.
People get in touch with me more or less frequently comparing our fund to the performance of the S&P, Nasdaq or even bitcoin. Our belief is that doing so very much misses the point of what the approach is seeking to deliver - and what we believe it can and does over time.
We fully concede that our approach looks pretty pedestrian in a world with US equity markets doing what they’re doing but that is the nature of the beast.
We don't think it is meaningful to compare an asset class like the Nasdaq, which might very well crash more than 60% at some point, to a strategy like ours. There will always be times where an investment hare like that is miles ahead of an investment tortoise like us - but that doesn’t mean this will always be the case.
If (when?!) stock markets have a proper crash, and especially a more "normal" one that takes two years to unfold as against the very unusual and rapid COVID crash of last year, our approach will have its time in the sun and our investors could have a great deal more capital from which to continue to build their wealth than all the folk currently benefitting from a once in a century run in stock markets.
For reasons of fundamental human psychology a return profile like our fund “should” also be better for long-run wealth preservation and growth than assets which can have very big up years but are then highly likely to fall a long way every decade or so: The evidence shows that you are far less likely to sell out of something which might have a maximum "drawdown" of 5-10% as against something which could fall more than 50% over a (very stressful) period of two years or more.
Mathematically - it only takes one big crash which unfolds over 2-3 years (as in 1999/2000 and 2007/2008 as I say) to erase many years of that great performance, for a fund like ours to then end up tens of percent ahead of those “better performing” assets and for those assets to quite possibly then never catch up (you can see this illustrated in figure 13 on page 37 of the linked document - copied below.
Compare the light blue and green lines to the red line over a period of twenty years).
The fact that this hasn’t yet happened since we launched the fund in no way changes this likelihood (in our view). As many of the world’s greatest investors have repeatedly pointed out: Time and patience are two of the most important factors in maximising your chances of long-run investment success.
At the time of writing, our fund has the 4th lowest risk score of 142 funds in the Investment Association's "flexible" category, yet we believe that it has a chance of achieving significant upside over the long-run, even if - as we fully concede - we have yet to prove that in the real world.
We also like to think that our investors could very well sleep better at night - particularly those who are at or near retirement, who have spent many decades working to build their wealth and for whom a very significant crash could be catastrophic.
We believe that our approach is an elegant, strategic way to build wealth over time with real peace of mind.
Only one tool in your investing tool-kit
Of course - we would also stress that our fund is only one possible component of how you might approach your finances.
If you have been following all things Plain English Finance for any length of time, you will hopefully be more than aware by now that our message is vastly bigger and broader than "you should own our multi-asset fund".
In particular, we have long advocated using the idea of “100 minus your age” to help people work out how to allocate between "defensive" and "aggressive" assets overall. My second book "Live on less, invest the rest", published in the summer of 2020, explained this approach in some detail.
Anyone following that approach will have had plenty of their money in other assets that we have covered in some detail, including the S&P or MSCI World, the biotech industry and smaller companies. We have also long advocated a meaningful exposure to gold and possibly silver.
We would like to think that anyone using that broad approach could very likely be more than happy with their overall "blended" return, notwithstanding the fact that our fund has "gone nowhere" for some time.
That having been said, we are also hopeful that our investors will be very glad of the exposure they do have in our fund when the time comes - and particularly those members of our audience and our online community who are at or near retirement.
If you own our fund (the VT PEF Global Multi-Asset Fund), I would hope that you will find this updated document particularly interesting and a restatement and reminder of what the strategy is and the evidence behind it as a long-run investment product.
If you do not own the fund, please do consider having a trot through this document nevertheless, mainly because there is a huge amount in here that is fundamental to investment overall, as well as to our fund specifically.
Including:
- What record low interest rates mean for us all as investors.
- Why human psychology is even more important than we realise.
- A reminder of something called "the break-even fallacy" (and why it is incredibly important for your ability to succeed as an investor).
- Sequence risk - something that could well make a six or even seven figure difference to your wealth over time which is seldom, if ever discussed in the financial press or by investment managers.
- The difference between accumulation (saving and investing) and decumulation (living on the money once you have enough to do that)...
We also revisit true diversification (i.e. across all main asset-classes and geographical regions) and look at the remarkable effect basic trend following can have on reducing risk and volatility over time.
Wherever you are on your investment journey we hope that, at the very least, you will find our new Fund Overview document interesting and another useful input into how you think about investment.