No escape from the summer's China-induced tantrums - Model Portfolio Oct 15 update

It was a tough summer for investors. Concerns about Greece were soon followed by even greater fears about the impact of China's slowdown. Since being spooked in August by China's decision to change the way it pegged its currency to the dollar, global stock markets have struggled to recover.

Our model portfolios have reflected the fallout from these uncertainties and have all lost ground. We hope that investors are not surprised: all of the portfolios are heavily invested in shares, which means that when markets suffer a wholesale downturn there is little that even the best active investment managers can do to avoid losing ground.

One small consolation is that all but one of the portfolios have proved somewhat more resilient than the FTSE All-Share index over the quarter, which would not be the case for investors who had taken a purely passive approach.

It is important to remember that short-term fluctuations come with the territory when you are investing in the stock market, which is the reason it's so important to take a long-term approach to investment.

Fortunately, since the inception of the model portfolios nearly four years ago, all the portfolios have made gains and 10 of the 12 are ahead of the FTSE All-Share index. The same number are also ahead of the average performance of funds in the Investment Association's mixed investment sectors over the period.

We have not carried out any switches to the portfolios this quarter, despite disappointing performances from some of the holdings. The portfolios are subject to constant monitoring and switches can be made at any time, but it was never our intention that they should be actively traded.

Not only does this add to investors' costs, but switching to other funds that have recently been producing better returns - chasing performance - can be counterproductive, as it can mean you are investing at the top of a cycle.

Similarly, it is never easy to tell exactly when a certain asset class or region has bottomed out, so you could end up switching out just as it is on the brink of recovery. It is also the case that some investment strategies work better in certain environments than others, or that they need time to produce their optimum returns.

Nevertheless, at our next annual review in January (running in the February issue) we will be conducting a further in-depth assessment of all our holdings to establish whether they remain fit for purpose.

The income portfolios

Returns on the six income portfolios over the past quarter varied between -2.15% and -4.48%. At the two ends of the spectrum were different versions of the higher risk portfolios. Juliet the immediate income portfolio fell least, while Lima the growing income portfolio lost the most.

It was Juliet's exposure to non-equity assets, Henderson UK Property Income and Marlborough Global Bond, which made it the most resilient of our income portfolios during the quarter. Both funds actually achieved positive returns over the period, as investors sought out more secure assets.

However, their gains were more than offset by negative returns on the equity funds in the portfolio. Although Rathbone Income and Invesco Perpetual Income held up well, declining by only around 1%, Schroder Income Maximiser fell by 9%.

While it has continued to deliver an enhanced income, its capital value has been hit by poor market sentiment towards its long-term equity holdings, which include miner Anglo American and power generator Drax.

Our least resilient income portfolio was Lima, the higher-risk version of the growing income portfolio. All of its holdings lost ground, although there were no great surprises here.

Schroder Oriental Income has been hit by poor sentiment towards the region, while Scottish Mortgage, one of our previous star performers, is always likely to be more volatile than many in its peer group due to its managers' unconstrained approach to investing, which is exacerbated by its gearing - currently 12%.

Lima also contains one of our most disappointing income holdings, Temple Bar investment trust, which was down 9% over the quarter. This trust is held in three other income portfolios.

However, although its total returns have been disappointing, it is important to remember that the primary reason it has been included in these portfolios is to generate income.

In this respect it continues to deliver. It has increased its dividend over the past year as it has been doing for more than 30 years. Its current yield is 3.7% and it has recently started paying dividends quarterly.

One of the reasons we purchased this trust is because of the contrarian style of the manager, Alistair Mundy. He invests in undervalued, out-of-favour companies.

Unloved banks are currently an area where he is finding value, with exposure to financials accounting for nearly 30% of his portfolio. This approach means the trust does go through periods of underperformance.

But over the longer term we expect it will outperform as it has in the past. Since the inception of the portfolios it hasn't done so badly either. Over that period, Temple Bar has generated total returns of 39.2% compared to a 33.4% return from the FTSE All-Share index. It is currently one of Numis Securities' recommended UK equity income trusts.

It is worth pointing out that one of the funds held across all three of our medium-risk income portfolios, Threadneedle UK Equity Income, has lost a manager. Such changes can be a reason for switching to a different fund. However, in this case we are holding on because the new lead manager, Richard Colwell, is the fund's former co-manager.

He has been working with Leigh Harrison, the former manager, since 2010. Harrison needs time to pursue his other responsibilities at Columbia Threadneedle. Colwell has said he has no immediate plans to change the way the fund is run.

The growth portfolio

The variation in the performance of our model growth portfolios is wide, ranging from a decline of only 1.17% to a fall of 7.75%.

It was pleasing that Alpha, our short-term, medium-risk portfolio, showed the most resilience; our aim is to keep the short-term growth portfolios on as even a keel as possible, bearing in mind that they are designed for investors with a timescale of just five to nine years, which gives them less time to ride out stock market fluctuations.

Alpha's performance was supported by three of its funds that held their ground, led by Fundsmith Equity, which rose by 1.3%. Manager Terry Smith focuses on high-quality businesses with low borrowings, a strong competitive edge and good growth prospects.

He aims to be a long-term investor in his chosen stocks. These criteria tend to limit his choice, so his portfolio is concentrated into around 30 holdings; but his formula has clearly worked well recently.

The main detractor from the performance of Alpha was its holding in the HSBC FTSE All-Share index tracker which fell 6.6%. Such fluctuations are the key risk of holding tracker funds, but our aim is that the other, more defensive holdings in the portfolio will offset this effect, while still giving it a share of the action when UK share prices rise.

Our worst-performing portfolio over the quarter was Echo, the medium-term, higher-risk growth portfolio, which plunged by 7.75%. Although it is still showing a gain over the period since the inception of the model portfolios, it is our most disappointing portfolio over this period too, with a return of 26%.

Despite owning our best-performing fund over the quarter, CF Miton UK Value Opportunities, Echo has been dragged down by its large exposure to Asia and the emerging markets, as well as holding our worst-performing fund, BlackRock World Mining. The loss on the latter dwarfed the positive return achieved by the Miton fund.

BlackRock World Mining is also held in the Foxtrot growth portfolio. When this trust was added to these portfolios in January 2014, we felt that the bottom of the commodity cycle was rapidly approaching. We were premature. Prices have continued falling. However, selling now could mean we are making the classic mistake of losing our nerve just as share prices have bottomed out.

We still believe there will be a sharp recovery in commodity prices at some point - and in the long-term growth portfolio, with its timescale of 15 years or more, there is plenty of time for this to happen. We still expect the benefits of a recovery to be felt over the medium term (10-14 years) too.

Indeed, researchers at Morgan Stanley recently argued that better news flow from China is likely to improve investor sentiment towards emerging markets and commodities before the end of this year. Nevertheless, we will be reviewing our holdings in Echo in particular at the next annual review, to check whether this holding is appropriate.

Meanwhile, a new manager has been appointed for one of our growth holdings too. EdenTree UK Equity Growth saw the departure of its previous manager, Andrew Jackson, in May. We were quite happy to continue holding the fund at that point as it was left in the capable hands of two other EdenTree managers, Robin Hepworth and Sue Round.

Now Phil Harris has been appointed to run the fund. He was previously a director of RWC Partners and before that at Hermes where he was a fund manager on the Specialist UK Focus fund. Bearing in mind Harris's past experience, we intend to retain this fund for the time being but will be keeping it under review.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.