Five Things You Won’t Find In My Portfolio

What you leave out of your portfolio is just as important as what you add in. You probably already spend a lot of time thinking about the assets you want to include in your portfolio. But you should spend just as much time thinking about what to exclude – especially if that means potentially missing out on some pretty gains. If you haven’t thought through what kind of investments you want to steer clear of, I’ve listed here the five I’m actively avoiding right now (and why), in case this helps your thought process…

1. Crypto

Bitcoin and other cryptocurrencies have made millionaires of others, but these assets are not for me. Well, at least not until I’m confident that I know how to value them, or until I at least have some certainty about the pillars of future crypto demand. Sure, you could argue that, like crypto, gold is notoriously hard to value – but that hasn’t stopped me from owning it. And that’s because, unlike cryptocurrencies, gold has thousands of years of history behind it and is a safe store of value. There is very little regulatory risk around it, and it’s generally seen as a safe (and scarce) asset because it is universally valued around the world. That gives me some security that I’m not going to wake up one day to find that owning or trading gold has been outlawed (although that actually did happen in the 1930s).

Crucially, there are more speculators than investors in crypto now. Having people who take a punt on the asset on the tiniest piece of news (real or fake – it doesn’t matter), also means that the volatility of the asset is a lot higher than you’d find with traditional asset classes, and far higher than I’m willing to accept in my portfolio. That’s not to say crypto will never have a place in my portfolio. It’s more like: I’m happy to sit out these early days and those heady returns until the market matures and there’s better visibility on the drivers of demand.

2. UK stocks

UK stocks are cheap, and that’s because the potent concoction of Brexit, political uncertainty, high inflation, and slow growth hasn’t been particularly enticing to investors. But that’s not the reason I’ve deliberately excluded them from my portfolio. I’m body-swerving these bad boys because my portfolio is already too concentrated in UK assets and I need more diversification. The bulk of my assets – my pensions and property – are all based in the UK. That means I’m very exposed to the vagaries of the UK economy and its currency. Plus, I currently work and live in the UK, so it could be tempting (but not wise) to put all my eggs in one big British basket.

There’s even a term for this: home-country bias. It’s when people choose to invest disproportionately heavily in the domestic market because it’s what they’re familiar with. To avoid this bias, take stock of your portfolio allocation (including your pensions and non-liquid assets) and compare it to the global stock market, and then shake things up if you need to.

3. Tobacco stocks

Investing isn’t just about generating the highest returns for me, it’s also about investing in line with my principles. Naturally, this makes investing a little more subjective, because each individual’s values can vary. Some may choose to completely divest from “sin” stocks, such as alcohol, gambling, adult entertainment, tobacco, and weapons, or to completely divest from fossil fuel assets. There are lots of ways you can invest according to your values and exclusionary screening – that is, deliberately avoiding a sector or a company – is only one of them.

Now, excluding these assets isn't easy, especially if you’re a passive investor. When you buy a market index ETF, you’re buying a share of all the companies listed on the index – including companies operating in “sin” industries. But if you buy an exclusionary index ETF instead, you’ll be buying the index minus those stocks. Such funds combine the benefits of sustainability considerations with the joys of index investing. The chart below shows the broad similarities between the performance benchmarks of the full index and the exclusionary index. Funds that fall into the exclusionary index include the Vanguard ESG U.S. Stock ETF (ticker: ESGV; expense ratio: 0.09%), the iShares MSCI World ESG Screened UCITS ETF (SAWD; 0.2%), or the iShares MSCI Europe ESG Screened UCITS ETF (SDUE; 0.12%).

Monthly returns of the FTSE US All Cap Choice Index and its non-ESG “parent” index (2016–21). Sources: Vanguard and Morningstar.

4. Actively managed mutual funds

I’m a big fan of passive investing. And that’s not difficult. There’s one investment that has stood out over the past three decades – the S&P 500 ETF – and you’d have done well investing in it. Since 1992, in fact, it’s outperformed 90% of actively managed funds. If the stark underperformance of active funds isn’t enough to convince you, consider the fact that active funds also cost more than passive funds.

There’s also another reason why I avoid these funds – active ETFs. They combine the benefits of both passive and active investing, at only a fraction of the cost of active mutual funds. Outside of my core positions, I can play out my views on the market through thematic ETFs, or make use of options-based ETFs to protect my downside and generate higher yields. The innovation in active ETFs means strategies that were once in the domain of institutional investors are now readily accessible to retail investors. What’s more, investment houses are now converting their star funds into ETFs, meaning that you can access these same funds through ETFs at a lower cost.

Distribution of active fund returns. Sources: S&P Dow Jones, CRSP, and Lipper.

5. High-yield bonds

As an asset class, bonds are generally less volatile than stocks. High-yield bonds, however, are the riskiest ones out there. These bonds, also called “junk bonds”, usually are below investment grade and issued by companies with low credit ratings. They offer you much higher yields to compensate for the risk that the firm might fail to repay you. However, in a rising rate environment, with slowing growth and a potential recession on the horizon, these assets can be particularly vulnerable to default.

With junk bonds averaging yields of 8%, better risk-adjusted returns abound. For example, I could lock in close to 75% of that yield in a low-risk, high interest rate savings account instead.

How to decide?

Investing isn’t static, so it’s safe to say that any of these five assets could once again feature in my portfolio – although it might take longer to persuade me on some of these. What you choose to include, and exclude, in your portfolio should be primarily driven by your investing aims – this includes your goals, risk appetite, investment horizon, and investing principles. It’s often understated, but knowing who you are as an investor is also important. Personally, I’m happy to miss out on the potential for quick gains if I don’t know enough about an asset or disagree with what’s driving the price higher. Investing is about knowing your limitations. As Warren Buffett has famously said: “Rule #1 is never lose money. And rule # 2 is to never forget rule No 1.”