Back in early spring, I wrote a couple of articles for members exploring the pros and cons of beaten-up infrastructure investment trusts like HICL (LSE: HICL).
All the listed infrastructure trusts sat on big premiums to net asset values (NAVs) before the 2022-2023 interest rate hikes.
Investors valued them for their chunky dividends in the depths of the near-zero rate era. They’d bid up the trust’s prices versus NAVs, which depressed the yields 1. But the yields on offer were still attractive to many, though not to me. (Not on a 20-30% premium to NAV!)
As interest rates rose, however, those premiums wilted.
Eventually the trusts were trading on 20-30% discounts. In most cases the dividend payments were at least held, so at least the income kept coming through.
Superficially all that had changed is investors wouldn’t pay a premium for income anymore. They wanted a discount, which boosted the yield for new money to 10% or more.
Canada comes calling
That situation unfolded over a couple of years. But my dives into infrastructure in early 2025 were prompted by something more immediate – an unexpected bid approach. One of the sector’s top trusts, BBGI, was taken out by a Canadian pension fund at very close to NAV.
Given that BBGI had swung from a 40% premium (!) to a 20% discount before the bid, the takeover price implied three things:
- An institutional-grade player saw BBGI’s quoted NAV of as accurate
- The NAVs of the remaining listed trusts might also be be pretty trustworthy
- Other bid approaches could unlock value for holders
It seemed a pretty good set-up. When I wrote my piece about it in early March, HICL, for instance was yielding 7.5%, just covered by income. So you were being paid to wait. Either for a recovery for the sector – probably with rate cuts – or for more takeover bids.
My post on HICL concluded:
While higher yields have increased discount rates and pressured asset prices, both HICL’s disposals and BBGI’s acquisition point to robust underlying valuations.
Adding to the case are the investment qualities of infrastructure that I discussed last time.
To which we might add that they aren’t big US tech shares trading on all-time frothy multiples!
I wouldn’t go crazy loading up on infrastructure, even in deaccumulation mode. But I do think a 5-10% allocation on today’s discounts makes sense, and I’m working towards the lower figure myself.
I’m not sure the trusts will beat the market over the next five years. But the high dividends will surely smooth the ride.
So far HICL has done okay. By summer the return after that Moguls piece was about 20% (including dividends) but it’s slipped back. I still hold, shuffling my position size up and down as I often do.
However I’m not here today to do a post-mortem on that infrastructure trust.
Rather I want to flag up the ones I deliberately avoided. The renewable trusts.
What’s wrong with renewable infrastructure?
In comments to my first article, readers asked about renewable trusts.
It would be hindsight to say I had a strongly bearish thesis about them. But I did note:
I agree with you about renewables in terms of the potential opportunity, but the risks are a lot greater too IMHO.
The truth was – and is – that renewable investment trusts give me the willies. While I have held them for brief periods, I’ve invariably soon gotten out again.
For what it’s worth, my gut instinct has been vindicated in 2025 by the share prices:
Source: Google Finance
These are year-to-date returns. Clearly you’d rather not have woken up on January 1 burning with a New Year’s Resolution to load up on infrastructure! (Except for BBGI…)
The returns would be less lousy with dividends, but the renewable trusts (Tickers: TRIG, BSIF, and UKW) would still be well underwater.
We can probably explain the overall weak returns with some handwaving about inflation and interest rates being higher for longer than expected, and perhaps greater political risk. I won’t rehash my member posts today.
But why the sharp divergence between infrastructure and renewables?
Renewable infrastructure trusts under the hammer
On the face of it, these infrastructure trusts all offer the same sort of thing. Upfront exposure to assets – which can be contracts to clean hospitals or fix nuclear reactors, not just physical stuff like wind turbines – in return for a stream of income over time.
Sometimes the income is linked to inflation, or to other pricing mechanisms. Also note that certain assets have a definitely fixed life (contracts, for instance) whereas others, with good care, could last indefinitely (say a bridge or port). All that affects how their NAVs are calculated.
Again, this post is just flagging up that stark divergence. I can’t get into analysing the many thousands of different assets and contracts held across all the trusts.
But that’s fine because the clear split in 2025 is between general infrastructure and renewable trusts. It suggests something broad strokes is going on.
Here are a few hypothesis (or guesses) which lean into those willies I’ve long had about the sector.
The renewable infrastructure trust business model is broken
There have always been questions about the long-term investment case for renewable energy trusts – and infrastructure more generally. About everything from fees, opacity, accountability, and business models to discount rates and technology risk.
The list goes on. But one oldie that has now come to a head is ongoing funding.
Long story short, renewable trusts used to issue shares at premiums to NAV to (in theory) invest in new assets and (less agreeably) to top-up or backstop their income.
Issuing shares at a big premium is in itself value-accretive. It can turn £1 of new money into, say, £1.20. Just by virtue of it moving on to a trust’s balance sheet!
Renewables needed to be able to issue shares like this long-term because they are not structured as finite life vehicles, and they are (or at least were) not priced as such.
But maybe they should have been. Because now that discounts are sky-high, nobody wants to buy newly-issued shares at NAV, let alone a premium.
We can debate about how long their assets – rusting windmills, ever less-efficient solar panels – will last. But even with build cost inflation, I don’t see anyone arguing that they are getting more valuable.
So NAVs are effectively in run-off mode.
Moreover some argue the trusts have not made proper provision for decommissioning. Absent the coming of nuclear fusion or the like, I’d presume an existing and permitted renewable installation is more likely to be maintained or replaced than decommissioned. But it’s a valid line of inquiry.
I was worried about funding for many years. (Monevator writer Finumus flagged the issue on his old site five years ago!) But it’s no longer merely a theoretical risk.
This month Bluefield Solar Income Fund (LSE: BFSIF) called it out as the reason it was putting itself up for sale, noting:
BSIF’s shares have traded at a persistent discount to NAV for over three years, limiting access to equity markets and constraining growth.
Earnings have been directed toward dividends rather than reinvestment, leaving the Company unable to fully benefit from its platform, proprietary pipeline and growth potential.
Without fresh capital, BSIF can’t grow without cutting its high dividends. And as income is the reason shareholders own this trust, that’s not an option.
BSIF has substantial assets. It trades on a 36% discount. You’d hope some institution will pay more than that to own them.
But the listed trust game is clearly up in today’s climate.
The renewable energy business model is in doubt
These funding issues are probably the main reason renewable trusts are languishing.
It’s a vicious loop. The worse the discounts get, the less likely they’ll ever trade even at par again. This makes them even less attractive, and prompts more selling and still-higher discounts.
By now I’d guess they are priced at the market’s best estimate of takeover value.
However this is a bit of a tautology. It doesn’t tell us why they cratered to deep discounts in the first place.
Besides all the wider drivers for infrastructure discounts that I listed above, could the investment case for renewable energy specifically be in doubt?
I think not… but also yes.
Some 97% of scientists agree that humans are warming the Earth by burning fossil fuels. This is causing climate change. So the push to emit less carbon via using more renewables is intact.
That’s true even as anti-scientific denialism in the White House has hamstrung the US.
The International Energy Agency just forecast that renewables will become the largest global electricity source by 2030, accounting for nearly 45% of production.
But the world hasn’t all gone full Greta Thunberg. It’s down to economics:
Source: Our World In Data
Unfortunately, we poor strivers must invest in vehicles that invest in renewable assets, not in the assets themselves. Let alone in spreadsheet maths! And this brings those high fees and so forth back into the picture – as well as issues like adverse selection due to the capital constraints and predictable income needs of renewable trusts compared to other players.
Moreover, the goalposts keep shifting.
Notice renewable trusts are struggling even as critics blame the UK’s ‘quixotic’ power-pricing mechanism – and the push to Net Zero – for our high electricity prices. If someone is making out like a bandit, it isn’t these trusts!
Nevertheless the government has announced it’s looking at the incentive regime – Renewable Obligation Certificates (ROCs) and Feed-in Tariffs (FiTs) – that was put in place to encourage more renewable installation.
Sticking with BSIF, the trust recently said the government’s proposals would cut the average annual household bill by £4 to £13, depending on exactly what changes are implemented.
However BSIF estimates the resultant hit to its NAV to range from 2% to a whopping 10%!
Whatever the ultimate damage, it can only make renewable trusts less attractive.
Political risk
I’ve noted above that Donald Trump’s administration is defying the entire scientific consensus with its stance on global warming, and with the actions it has encouraged in response.
The results so far are mixed. Even some fossil fuel leaders are aghast (if only because of the policy uncertainty). But it does seem to have amped up new oil exploration at the margin and it has hit forecasts for US renewable installation:
Source: IEA
Meanwhile the man who brought us Brexit – you know, that great opportunity that’s costing us £100bn a year in lost GDP, that saw immigration of nearly a million arrivals in 2024, and that deleted your birthright to live in 27 other countries – has now turned his talents to decrying Net Zero and renewable energy.
Reform says it will scrap Net Zero targets and cut subsidies. It’s warned industry to stop working on new projects. All damaging stuff in the short and long-term. Yet Reform’s lead in the polls probably drove Labour’s mooted incentive changes.
It’s distasteful for me to even talk about this. It’s pure Barry Blimpism – literally tilting at windmills.
We probably should look soberly at the high cost of UK electricity, but not through this scaremongering and scapegoating. That’s populism for you.
Needless to say it doesn’t make investing in renewable trusts any more attractive. Unless maybe you think their assets will become more valuable if new investment dries up, reducing supply?
Dark, but I suppose possible given the economics. The market doesn’t see it though.
Weather risk
The UK wasn’t very windy in the first half of 2025. On the other hand it hasn’t been especially cloudy.
I’m inclined to dismiss this concern because while I certainly believe in climate change, I don’t think it’s changed sufficiently in a couple of years to hammer the case for these trusts versus prior assumptions.
Higher inflation
You might point to higher maintenance costs for installed renewable energy due to all the inflation we’ve seen since 2022.
But this shouldn’t have hit renewables much harder than wider infrastructure, so again I don’t see it.
The market just doesn’t care about listed infrastructure
With all this said maybe the divergence between vanilla and renewable infrastructure in 2025 is a red herring? Perhaps investors (/the market) remain very ambivalent about all these alternative assets?
The takeover for BGGI perked up demand for its direct peers, but that has mostly unwound. The enthusiasm we saw for the likes of HICL in the first-half of the year has gone.
As I type HICL is on a discount to NAV of c.24% again. INPP is on a 17% discount.
Smaller discounts than those of the renewables trusts, true, but still plenty big.
Into the too-hard pile
Of course the explanation is likely a combination of all these factors:
- Ongoing higher yields snuffed the recovery across the infrastructure sector.
- Growing political risk makes betting on any government-influenced income streams riskier.
- Persistent discounts imperil the business models of all the infrastructure trusts.
- Takeover hopes have dissipated.
On all of these counts, renewables fare worse.
Corporate activity has been more lacklustre – for example Downing Renewables was acquired at a 7.5% discount in June, versus BBGI going at par – and renewables look at far greater risk from a Farage-led backlash. Difficult-to-fathom and often unintuitive power contracts make them harder for analysts to value. And the bigger discounts that result from all this make the prospect of them ever raising new money seem remote.
Given my environmental concerns, I should be a natural investor in these trusts. But I avoided them when on premiums, and even with discounts I haven’t held bar a small position I had in early 2025. I’m in no rush to go back.
Things do change. It’s not impossible all the issues could be resolved to make the trusts a bargain.
But to me, the challenges look more structural than cyclical. Why take the bet? Plenty of established closed-end stuff in the UK – income trusts, private equity and VC, property – looks reasonably priced, without so much existential risk.
It’s raining in London as I type, but I’m confident sunny days will come again.
However I just can’t say the same about renewable infrastructure trusts.
I know some Monevator readers were keen on these trusts. Do you still hold them? I’d love to hear more in the comments below.
- Because yield is dividend/price.[↩]
What caught my eye this week.
We’re at the point now where about the only potential tax hike that hasn’t been run past the committee of public opinion is a revival of the 200-year old window tax.
Don’t laugh! It could be a real revenue spinner in our era of skyscrapers in the City and bifold doors in the suburbs.
In the meantime, a rise in income taxes in the upcoming Budget seems to finally be – maybe – on the agenda.
Yes, those same higher income taxes that were ruled out ahead of the last election.
I have my doubts, but who knows. Perhaps Rachel Reeves and Keir Starmer believe the situation really is dire enough to warrant breaking the pledge? It’s already motived them to lift their silence on the £100bn hit to the economy – and the resulting black-hole-sized £40bn shortfall in state revenues – that Brexit has cost us.
Or maybe Labour thinks they might as well be hanged for a sheep as a lamb, considering the kicking they got anyway for dancing around taxes on ‘working people’ with the last budget?
Or maybe it’s just another ill-advised attempt to scare us with a worst-case scenario so that the real medicine doesn’t taste so bad.
We’ll find out on 26 November. But hell will hath no fury like the voting public if income tax rates rise by a bald 2p in the pound without a ‘sterilising’ 2p cut in National Insurance – which would undo much of the revenue-raising potential anyway.
And cutting national insurance won’t help the legions of vote-happy pensioners…
A stitch in time
I happen to believe that from a bunch of very unpalatable options, just hiking the basic rate of income tax and getting on with it wouldn’t be the worst.
But that would be partially on the grounds that it’s such a game-changer that it could have quashed the rumours and uncertainty caused by chipping away at absolutely everything else – from pensions, ISAs, dividends, and capital gains to property and the rest – to the sidelines.
However we’ve already had another three or four months of uncertainty. It’s made people save more, spend less, dither about moving house, and thrown yet more sand into the wheels of our lacklustre economy.
Worse, we’ve already had last year’s employer’s NI hike. Which had exactly the effect everyone predicted it would on youth employment, and on the health of the hospitality sector too.
If a bandaid was going to be ripped off then 2024 was surely the better time to go for it.
Rumour treadmill
Here’s a flavour of this week’s speculation:
- Chancellor refuses to rule out manifesto-breaking tax hikes – Sky
- NIESR: hike income tax by 2-10p in the pound – This Is Money
- How much would a 2p income tax rise cost you? – Which
- Reeves also reportedly considering a 20% exit tax on UK leavers – Guardian
- Stand down! Reeves said to cool on big cash ISA reforms – City AM
- A 5% VAT cut on electricity bills in Budget will backfire, experts say – Guardian
- How wealthy is ‘wealthy’, exactly? [Paywall] – FT
But that’s just a taste. I’ve run batches of budget speculation in these links for weeks, so thick and fast and indiscriminate have they come.
Of course what’s notably missing from most of the rumour-mongering is anything about spending cuts. I’ve probably read more about the two-child benefit cap being lifted – which will obviously cost yet more money – than on any mooted plans to curb spending.
It’s true the last round of so-called austerity under George Osborne didn’t do much for the UK. And perhaps it’s senseless to look to downsize government – or at least to stop it growing further – while the economy is only limping along.
But is this a different era? Rates are taking their time to fall, and we’ve borrowed much more money. There’s a growing feeling that we’re sleepwalking into a self-fulfilling prophecy.
I used to look forward to budgets. But I honestly just want this one to be over.
Have a great weekend!
Defensive asset allocation is trickier than the growth side of the equation. For the latter, you can just strap on a global equity tracker for portfolio propellant and be done with it. But there isn’t a universal ‘dark times’ asset class that reliably protects your wealth from economic misfortune.
A portfolio is exposed to multiple threat vectors: inflation, deflation, stagflation, recessions, and stock market bubbles. Fending that lot off requires a multi-layered defence. If the first line fails then perhaps the next will soften the blow.
Your choice is complicated by your personal risk exposure. For instance, inflation is typically a bigger threat to retirees than young people. The young are more exposed to recessions and periods of joblessness.
It makes sense therefore to strengthen where you’re personally most vulnerable – loading up on the assets most likely to counter your own financial arch-nemesis.
Know your enemy
Here’s a quick summary of portfolio pathogens paired with their most effective treatments:
| Threat vector | Best defensive asset | Worst defensive asset | Most exposed |
| Surging inflation, stagflation | Individual index-linked gilts, commodities, gold | Long bonds | Retirees |
| Deflation, recession, stock market drawdown | Nominal government bonds, cash, gold | Commodities | Mid-career, late-stage accumulators, aggressive equity investors |
| Currency debasement, sovereign debt crisis | Gold, assets priced in foreign currency | Domestic government bonds, cash | Investors heavily tilted towards domestic assets |
Handy though the table is, it’s missing nuance, and a generous sprinkle of ‘ifs’ and ‘buts’. Fear not: they’re coming next!
Gold, for example, looks like the ultimate wealth-preserver. I’ll have six sackfuls, please! But there are reasons to doubt it, too. (See the gold section below).
Also, just so we’re crystal clear:
- No asset class is risk-free or ‘safe’. Not even cash.
- No asset class is guaranteed to work on demand.
- Unexpected circumstances can nullify any defence.
- A defensive asset may come good but not immediately, nor for the entire duration of a crisis.
- Diversification is your best friend. Possibly your only friend in the capricious world of investing.
These negatives aren’t meant to crush morale before we get started. It’s just a bald statement of fact.
Hopefully things will go well for all of us. But it’s best to have the full picture in case they do not.
The historical record and inherent uncertainty about the future both point in the same direction: use every tool in the box.
The best defensive asset classes
Defensives are asset and sub-asset classes that can fortify your portfolio when equities go down. Each of the following can play a useful role:
Nominal high-grade domestic government bonds
(Also known as gilts in the UK)
Defends against: Demand-led slumps such as economic contractions, recessions, depressions, deflation, and stock market drawdowns.
Vulnerable to: Surging inflation and fast-rising interest rates.
Younger investors
Long maturities theoretically provide the best diversification for equity-heavy portfolios. Although it doesn’t always work out that way in practice.
Older investors
Favour shorter-dated bond maturities because longer-term government bonds are highly vulnerable to inflation and fast-rising interest rates. Such shorter-dated govies may be less effective in a downturn but offer a better overall balance of risks. They’re more resistant to spiralling inflation and interest rates.
Diversification options
Global government bonds hedged to the pound
Pros: Diversification across advanced economy government debt. Choose if you’re wary of having 100% exposure to the credit risk of the UK Government. Hedge them to offset the risk of adverse currency movements that swamp your bond returns.
Cons: Higher OCFs than gilt funds. Less crash protection due to lower durations. Indices tilt towards high-debt countries such as Japan, Italy, and the US.
Pros: Often outperform gilts in a crisis because dollar-denominated assets are viewed as a safer haven.
Cons: Currency risk means they can underperform at just the wrong time. Also US political risk.
High-grade corporate bonds
Pros: Offer higher yields than government bonds.
Cons: Corporates don’t perform as well as govies during most downturns. Essentially because countries can withstand economic peril better than companies.
Individual nominal gilts
Pros: Opportunity to target particularly useful bond issues. For example, investing in specific gilts can reduce your tax burden outside of tax shelters. Extremely long maturities may be especially potent equity diversifiers. No management or platform fees.
Cons: Require more hands-on management and a good understanding of bond mechanics. Not all brokers enable you to invest online.
Useful to know
High-grade (or high-quality) refers to bonds with a credit rating of AA- and above (or Aa3 in Moody’s system). Check out our bond terms post.
Bond maturity / duration: a brief guide to risk
The following table sketches out the three term-related bond risk categories:
| Bond maturities | Volatility | Suits | Yield / expected returns |
| Short (0-5 yrs) | Lower | Older investors, lower equity allocations, higher inflation concerns | Lower, cash-like at the shortest end of scale |
| Intermediate | Middle ground | Middle ground | Middle ground |
| Long (15+ yrs) | Higher | Younger investors, higher equity allocations, lower inflation concerns | Higher, but possibly not worth the extra risk |
Longer maturities imply longer durations, though other factors are in play as well.
Duration is the key metric when judging high-grade government bond risk. Your bond’s duration number 1 is an approximate guide to how big a gain or loss you can expect for every 1% move in its yield.
For example, if a bond’s duration number is 11, then it:
- Loses approximately 11% of its market value for every 1% rise in its yield. 2
- Gains approximately 11% for every 1% fall in its yield.
Read our piece on rising yields to understand how bonds respond when interest rates rise.
Index-linked government bonds (high-grade, domestic)
(Also known as ‘linkers’ in the UK)
Defends against: Inflation. Index-linked bonds also generally do okay in recessions but they aren’t as effective as nominal bonds.
Vulnerable to: Fast-rising interest rates (see below). Deflation – index-linked gilts lose nominal value when the RPI index falls as they lack a ‘deflation floor’. On the other hand, they won’t lose real value in this scenario, which is what counts most.
Snag: Index-linked bond funds can be real-terms losers in inflationary periods. That happens when steep interest rate hikes cause fund prices to drop. Sometimes the resultant capital loss is so severe that it drowns out the inflation-adjusted gains of the fund’s underlying bonds. The problem is solved by investing in individual index-linked gilts.
Individual linkers hedge inflation if held to maturity. Linkers still fall in price when interest rates rise but will make good the capital loss by their maturity date. Ignore that paper loss and each linker will ultimately return RPI plus the real yield on offer when you bought in.
In contrast, bond funds routinely sell their holdings before maturity. This causes losses in rising rate conditions (and gains when rates fall). The process doesn’t doom index-linked bond funds to lose against an equivalent portfolio of individual linkers over time. But it can make them a relatively poor inflation hedge.
Beware that if you buy individual linkers on negative yields – and hold to maturity – then you’re accepting an annual loss in exchange for broader inflation protection. In this scenario, the bond’s link to RPI means its value will rise to match inflation. However, the price you’d pay here for that inflation matching would be the negative real yield at the time of purchase.
Thankfully, real yields are now positive, so you’re covered against double-digit rises in inflation and you can make a small annual profit on top.
Younger investors
Can ignore index-linked gilts on the grounds that equities outperform inflation in the long run.
Older investors
Individual index-linked gilts held to maturity are the most reliable way to hedge inflation. If you use funds to hedge inflation then choose short-dated ones because long bonds are hit harder by soaring rates.
Useful to know: Don’t get hung up on index-linked gilts lacking a deflation floor. The UK hasn’t experienced annual deflation since 1933.
Diversification options
Short-term global index-linked funds hedged to the pound
Pros: Off-the-shelf convenience. Should outperform nominal bond equivalents during bouts of unexpected inflation.
Cons: Other countries’ inflation rates won’t perfectly match the UK’s. Interest rate risk interferes with inflation-hedging capability as described above. Currency risk issues if the fund isn’t hedged to GBP.
- For options, see the Global inflation-linked bonds hedged to £ section of our low-cost index funds page.
Index-linked gilt funds
Pros: May perform when interest rate rises aren’t a major factor. Aligned with UK inflation. No currency risk.
Cons: Almost all UK index-linked gilt funds have long average maturities / durations. An exception is iShares Up to 10 Years Index Linked Gilt Index Fund. Its lower duration places it on the outer rim of the short-term choices.
Individual index-linked gilts
Pros: Specifically designed to hedge UK inflation if held to maturity. No management or platform fees.
Cons: Require more effort to manage than bond funds. Not all brokers enable you to invest online.
Physical gold
Defends against: Stock market drawdowns, surging inflation, recessions, simultaneous falls in equities and bonds.
Vulnerable to: Volatility, small changes in demand, lack of fundamental value, myth-making.
Snag: Gold’s versatility looks incredible – like the everything burger of defensive assets. Yet there are reasons to be wary.
For one thing, gold’s track record as an investible asset is relatively short. That’s because it was subject to government control until 1975.
This means that unlike with bonds and cash, we can’t see how the precious metal performed during World Wars, depressions, and multiple inflationary episodes. There’s a danger that gold’s impressive history is flattered by a small sample bias. (Gold has only racked up 50 years as an investible asset class versus more than 150 years for other defensives.)
Moreover, beware being bedazzled by gold’s recent amazing run. Dig a little deeper and you’ll see that the yellow stuff fell 78% in real terms from 1980 to 1999.
Another concern is that physical gold returns aren’t linked to intrinsic value. Equities provide a claim on the future cash flows of productive businesses. Government bond interest is paid by tax revenues. Even commodity profits can be traced back to ‘roll return’ and interest on collateral.
In contrast, your gold gains are dependent on someone deigning to offer you a higher price than you bought in for.
Thus it’s worth asking if current gold prices are sustainable? Are they being driven by fundamental sources of demand? Or are waves of performance-chasers being suckered in by a succession of all-time highs? What happens when gold’s momentum falters?
The irresolvable nature of these questions underlies my caution about gold. For a (much) deeper discussion see the excellent Understanding Gold paper by Erb and Harvey.
Younger investors
Consider a 5-10% allocation for diversification purposes.
Older investors
Consider a 5-15% allocation for diversification purposes. Remain wary of overcommitting due to the question marks hanging over gold’s short track record and its high current valuation levels.
Diversification options
Gold miners: You’d have to be insane to think of miner stocks as a defensive asset class.
Gold future ETCs: WisdomTree Gold (Ticker: BULL) invests in gold future’s contracts and has seriously underperformed its physical counterparts since inception.
Silver: Appears to be a less powerful defensive diversifier because demand is more closely tied to economic activity.
Broad commodities
Defends against: Surging inflation.
Vulnerable to: Recessionary conditions.
Snag: Commodities are highly volatile and typically a liability during economic contractions when demand evaporates for raw materials. Diversification is key so choose broad commodity ETFs not single commodity funds.
Younger investors
Can ignore commodities on the grounds that equities outperform inflation over time.
Older investors
Potentially the best portfolio diversifier against inflation. Whereas index-linked gilts match inflation by design, commodities can massively outperform by nature. Commodities are especially potent when the cause of the price shock is global supply chain shortages – as occurred after each World War and post-Covid.
Diversification options
Single commodity ETCs
Pros: None – excessive idiosyncratic risk.
Cons: Studies show that a basket of diversified commodities significantly outperforms any single commodity over the long-term.
Commodity equities
Pros: None as a defensive portfolio diversifier.
Cons: Too correlated to the stock market.
Cash
Defends against: Demand-led slumps such as economic contractions, recessions, depressions, deflation, and stock market drawdowns.
Vulnerable to: Inflation, low interest rates.
Snag: Cash has delivered the lowest historical returns of any of the defensive diversifiers on our menu. Carrying too much cash will probably hold back your portfolio over time.
Younger investors
The flight-to-quality effect means longer-dated bonds are more likely to prop up an equity-dominated portfolio in a crisis.
Older investors
Cash is a useful complement to bonds. Cash won’t spike in value during a crisis but neither will it plummet when interest rates rocket. But beware the ‘money illusion’ effect when interest rates look good but are largely wiped out by inflation.
Diversification options
Money market funds (MMFs)
Pros: Highly responsive to interest rates. There’s no need to keep on top of Best Buy tables when interest rates are rising because MMFs automatically reinvest into higher-yielding securities. The opposite is true when rates are falling.
Cons: Riskier than cash. Money market funds can struggle to meet investors’ demands for their money back under extreme conditions. MMFs aren’t covered by the FSCS bank guarantee. (Your platform may be covered by the FSCS investor compensation scheme.) Management and platform fees.
Pros: Like money market funds they are highly responsive to interest rates. Backed by the UK Government so safer than MMFs.
Cons: Must be held to maturity – usually one, three, or six-monthly terms. Not covered by the FSCS bank guarantee. (Your platform may be covered instead.) Platform fees.
Defence in depth
If you’d like to see the multi-layered defence concept in action then check out our posts on:
- The All-Weather portfolio which has demonstrably dampened some of the world’s worst stock market crashes.
- The No Cat Food portfolio – it’s regularly tracked as part of our decumulation series.
Ultimately, a simple equity/bond portfolio was shown to be too simple by the events of 2022. Just swapping nominal bonds for cash is probably not ideal either. Money market funds have been soundly beaten by bonds in the long run.
What we know for sure is that all of the defensive asset classes we’ve covered above work some of the time. But none of them work all of the time.
They each have uses and flaws. As we never know what’s coming around the corner, the answer is surely diversification.
Take it steady,
The Accumulator
- Technically, modified duration.[↩]
- Yield to maturity or YTM. You can think of YTM like the interest rate you’ll get if you hold the bond to maturity.[↩]
