Financial planning, Index trackers, Investment strategy

Riding the tide: Which Vanguard funds I’m adding to

Just 6 days have past, and my Vanguard funds (equities+bonds) have rebound from -17% to -9%. A slight silent relief (i.e. my equities are up £1.3k since 6 days ago), yet also a reminder for those waiting for a buying opportunity that the market waits for no one! And of course, we are in turbulent times – it’s likely to go down again, and very possibly further than before. We won’t know when it’s ‘bottomed out’ until after the fact.

Man surfing on sea waves during daytime | Pikrepo
Playing ftse to catch a wave?

So, I’m thinking now is as good a time as any around now to top up my slightly gaunt equity funds – in part to take the opportunity I have to offset my ‘current’ losses though with long-term investment in mind. I’m reminded: Do not invest in what you don’t understand. So rather than making fairly quick judgments on what funds to add to (as I did back in Feb, partly to avoid anxiety paralysis), I reminded myself of the facts and looked further into the 4 main Vanguard candidates (see table below).

I should add that none of this should be construed as financial advice but is a journal of my own financial thinking and personal views, Please do your own due diligence. New readers should note also that I have not drip-fed monthly contributions mainly because I only started investing around July 2019 (just before I started this blog) and so did a few lump sums to fill up my ISA allowance.

Before, I was considering to invest in UK all share and Pacific ex Japan in large part as both had fallen at least 25%. While there’s been some rebound, they have still fallen hardest. Global small caps have also dropped (for me: 18%); this and emerging markets may hold speculative opportunities as China is showing signs of ‘reopening’.

The 4 Vanguard contenders… Indices of different breeds

This post is about me taking you through my 3 main considerations when deciding which funds to top up…

Firstly, likely opportunity. I know in the FI world, the index fund is king and if you don’t cast aside thoughts about market timing, then you may find yourself banished out (slight exaggeration, but you get my point!). The fact is we DO know how much our funds have fallen AND that over the long-term, markets recover and grow. This may be an unprecedented crisis we are living through, but there are no real signs of an appetite to overthrow the capitalist system, yet anyway. So, by opportunity, I mainly mean: Which markets have fallen most? Do we think they will have a strong chance of recovery? Here, the largest companies in developed countries with arguably now undervalued stocks (relative to how they were performing before COVID-19) are what I would place my bets on.

From my contenders, this means the UK all share and Pacific ex Japan (fallen by 20% and 23% respectively compared to my purchases). While some large companies look likely to not survive this crisis (especially if they were struggling already), by investing in indices (rather than stock picking individual companies or specific sectors even), we spread the risk. In terms of Pacific ex Japan, it’s worth noting that Australia and NZ are currently relatively successful in ‘containing’ the coronavirus. Looking closely at the FTSE All Share index, while it may be a little frustrating it has risen from its under 3000s low in late March (before the new financial year, of course), the August 2019 version of me waxed lyrical on topping up this fund if it fell to 3500-3600! (It never did.) At close on Thursday, the index stood at 3233.

Also, I ask: who is ahead of (or managing to flatten) their curve? It may be tempting to invest in China on the reasoning that they may also be ahead of the curve in economic recovery (and may even gain from supplying PPE and tests to the rest of the world). China covers 36% of the emerging markets fund. While around 60% of this fund looks a pretty good opportunity (i.e. China, S Korea, Taiwan) as East Asia has learned from experiences of dealing with SARS (though not clear yet if their isolation exit strategy is working?), the remaining countries look like they may be heading into a nightmare (tragically), with India and Brazil’s densely populated slums being a major humanitarian challenge.

Secondly, likely risk. While it’s easy to get drawn into ‘buying opportunities’ mode as we FIers all love a ‘bargain’, I also remind myself of the risk involved especially as this is a volatile time for all world markets right now. It is also a challenging environment regarding job security and the economy for almost all sectors, and the great government ‘give-away’ to prop up the economy will give way eventually to higher taxes, which will almost certainly ‘hurt’ the economy for years to come. While I can divert a fair amount from my property investment deposit to top up my funds (which hadn’t been my original plan before recent events), I am wary keep diversified and keep cash too. Only invest what I can afford to lose.

Risk must be considered in terms of the funds, of course. While both the small caps and emerging markets funds incorporate impressively large baskets of funds that help mitigate risk, they are historically known to be high risk, but even more so in the context of Covid-19. Unfortunately, most small companies and developing markets are going to really struggle; we don’t yet know how long lockdowns will last across most of the globe. For example, this and this suggest just how much the developing economies, with their lack of health system and fragile currencies, will be devastated by COVID-19.

Further, small companies are duplicated in my portfolio, which currently leaves me pretty exposed: Global small cap index tracks small company stocks in developed markets including 56.5% in US and 7% UK. However, the FTSE All Share index itself (which Vanguard tracks) is made up of the FTSE 100, FTSE 250 and FTSE Small Cap Index, and the S&P index includes small company shares. (While I hold Europe and Japan funds also, small companies are not represented in them.)

One advantage of investing in the FTSE All Share for UK citizens is that it does not carry currency risk (or exchange rate risk), unlike when investing in foreign markets. That’s worth bearing in mind.

Thirdly, asset allocation is a consideration. How much do I want to really invest in that market? Given the disproportionate falls in different funds, do I need to rebalance? Indeed, what was my asset allocation? Here, I was originally informed by David Sawyer’s FI book, Reset. Overall, this is a very good read for a UK audience. For quick reference, see the table above for one of his target allocation recommendations for each index fund. While I largely like his thoughts on this, I’ve written previously that there may be too much UK exposure if I want my equities to represent world markets well, given that in the stats I’ve read, the UK accounts for 5.1% of world stock market share.

When I recalculated my distributions, I was surprised how spot on they were with David’s recommendation with the exception of my UK fund which as I had wanted was 18% rather than 23%. So, needing to re-balance isn’t a major driver right now. I wanted to keep my small caps, emerging markets and Pacific ex Japan small parts of my portfolio, and definitely wasn’t really looking to increase my share in global small caps (currently at 6%).

So, the verdict?

This time around, I’m going to go mostly with what I feel to be the best opportunity combined with lowest risk (relatively): the FTSE All Share index fund. While I’m not looking to have a quarter of my equities based on UK shares, I see this as a bit of an opportunity really, and will seek to rebalance in time. I will be investing knowing it may very well fall further (or may not!). I saw someone had predicted 2000s, but who knows?

I will also buy a little Pacific ex Japan. All the markets it invests in (Australia, Hong Kong, NZ and Singapore) are dealing with COVID-19 pretty well (so far) compared with us/Europe, and the fund looks potentially good value given my current 23% loss (unless over-valued previously, of course). Since these are still a fairly small market, I am again keen not to be over-exposed here, hence I’m looking at beefing this fund up by just a few hundred.

I won’t be investing in Emerging Markets for now, but perhaps next time around or the time after that. My view is that this is going to plunge, pulled down by the 40% or so invested outside of East Asia. There will be a buying opportunity at some point, so I’ll be watching.

I won’t be investing in Global Small Caps. This invests 88% in small companies in North America and Europe, places where COVID-19 is really affecting and hurting the economy. Further, 6% of my equities is probably already a high allocation given I’m already exposed to small companies in the UK and US.

I also won’t be selling any funds. I said this in my last post, but thought it’s worth reiterating.

Finally, I’m surprised by how much each of these markets is invested in the financial sector. I guess I shoudn’t be, but it is a bit concerning if we are heading for a world recession. Anyway, let’s sit tight and see what happens! We’re in for a ride.

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As usual, thanks for reading. What about you? Do you think now is a good time to buy or shall we stick it out a bit longer? Have you thought about this differently? What factors are you are considering?

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