By Chris Dillow and Lee Robertson , 15 January 2013
- Name James Hunt
- Age 68
- Description Shares, offshore bonds and Isas
- Objectives Safeguard capital and provide income
Our reader nearing retirement needs to re-examine his bond holdings and diversify away from the UK stock market
James Hunt is 68 and has been investing for five years to safeguard his capital and provide an income for himself and his 62-year-old wife.
He sold his business in 2007 and had no previous investing experience. He has no need to take on risk to secure his future. "We live winters normally in the US where we own a home. We have been advised to invest offshore by an independent financial adviser (IFA) in the City. We draw between us £50,000 a year from bonds so secure a net income of around £85,000 a year."
He has a medium attitude to risk, while his wife's is low although he selects her shares. Their share portfolios are based mainly on a few inherited shares plus IC recommendations. "It is what we consider a mixture of steady companies and IC speculatives," he says.
|James Hunt's portfolio||His wife's portfolio|
|Name of share or fund||Name of share or fund|
|SHARES (value: £74,614)||SHARES (value: £88,855)|
|Anglo Asian Mining||Asian Citrus|
|BP Marsh & Partners||Banco Santander SA|
|Crystal Amber Fund||Medicx Fund|
|Hansard Global||Polo Resources|
|Picton Property Income||Sanderson|
|RSA Insurance||Smiths News|
|Randall and Quilter Investment||Standard Life|
|Standard Life||Telford Homes|
|Walker Greenbank||WH Ireland|
|OFFSHORE BOND (value: £529,071)||OFFSHORE BOND (value: £558,567)|
|Fidelity MoneyBuilder Income Net Inc||L&G Fixed Interest|
|Jupiter Corporate Bond Inc||Invesco Perp Corp Bond Acc|
|M&G Corporate Bond GBP X Acc||Cazenove UK Corp Bond B Inc|
|M&G Strategic Corporate Bond GBP A Acc||M&G Corporate Bond X Acc|
|Threadneedle UK Equity Alpha R||Cash|
|Liontrust Special Situations|
|Cazenove UK Smaller Companies B Acc|
|Isa (value: £10,798)||Isa (value: £11,358)|
|Threadneedle American Smaller Companies ACC||Invesco Perpetual Income Acc|
|TOTAL: £614,483||TOTAL: £658,780|
LAST THREE TRADES: Netcall, Anglo Asian Mining and Polo Resources (all IC recommendations).
SHARES OR FUNDS ON WATCHLIST: None. I usually 'bet' on Simon Thompson and others at IC if they make sense to me (I'm still learning) with mixed but generally beneficial results.
Chris Dillow, the Investors Chronicle's economist, says:
One feature of these portfolios is their big weighting in corporate bond funds. These are risky.
The risk that worries me - in the sense of its high probability - is that corporate bond prices might be dragged down if prices of government bonds fall. On a one- or two-year view, this would happen if an economic recovery reduces demand for safe assets.
How big a danger is this to your wealth? Two things should cushion the blow. One is that economic recovery should reduce credit spreads, helping to moderate the decline in corporate bond prices. The other is that the same economic recovery and increased appetite for risk that depresses bond prices should also raise share prices.
Net, the risk to your wealth is small. But it exists. Remember that bond funds carry price risk in a way that individual bonds, if held to maturity do not (they carry credit risk instead). You might want to consider shifting from the former to the latter.
There's another risk this portfolio carries - exchange rate risk. These assets are in sterling. But as you spend a lot of time in the US, your outgoings will be partly in US dollars. This exposes you to a danger that a rise in the US dollar against the pound would, in effect, raise your cost of living. The uncanny stability of sterling in recent months should not tempt you to disregard this danger. The dollar's volatility since 2000 is such that there is a one-in-six chance of it rising 10 per cent in the next 12 months. That would be a 10 per cent loss in your US buying power.
Luckily, there's a trivially straightforward solution here: to hold some of your cash in US dollars. Ordinarily, I'd advise retail investors against speculating in the foreign exchange market. But in your case, holding dollars isn't speculating, but merely ensuring that your assets match your liabilities.
There's a third issue here, which I'm afraid is rather unromantic (but then, there's no romance in economics): is this one portfolio or two?
Looking at your portfolio, I see little wrong, barring the above quibbles. Similarly, there's not much wrong with your wife's. But if we combine the two, there is a problem of over-diversification.
I mean this in two senses. First, a portfolio of 29 different equities is one in which the contribution of many individual stocks is diluted away. You're likely to achieve much the same performance as you'd get with a tracker fund, but at higher cost.
Secondly, you're diversifying needlessly across corporate bond funds. My table shows that your six corporate bond funds have quite similar historical performance; all did poorly in 2008, recovered in 2009, did so-so in 2010 and 2011 and better last year. In diversifying across six different providers, you're spreading a risk that seems unlikely to materialise - that one fund will seriously underperform the sector - but carrying a more serious risk, that perhaps corporate bonds in general will do badly.
|Performance of corporate bond funds|
|Year to:||Jan 2013||Jan 2012||Jan 2011||Jan 2010||Jan 2009|
|Jupiter Corporate Bond||10.2||5.0||7.2||13.7||-6.4|
|M&G Corporate Bond||9.3||9.1||6.6||18.3||-1.1|
|M&G Strategic Corporate Bond||10.9||8.1||7.9||22.6||2.6|
|Invesco Perpetual Corporate Bond||19.3||-1.3||6.8||22.9||-8.8|
|Cazenove UK Corporate Bond||11.1||4.0||7.9||9.4||-4.9|
|L&G Fixed Interest||12.8||5.2||8.4||18.0||-12.1|
And this is where we get unromantic. Keeping separate portfolios is sensible if you are likely to get divorced, as it permits a cleaner break-up. But - tax considerations aside - it's less sensible if you stay together, as it can give you collectively an unnecessarily messy portfolio. (There's a parallel here with proposals to separate retailing and investment banking. The case for doing so isn't that it improves performance or reduces risk, but that it makes it easier to clean up the mess if there's a disaster.)
Naturally, I'm not going to give detailed advice on this point. Just be aware that what's sensible for two individuals need not always be sensible for both taken together.
Lee Robertson, chief executive officer and chartered wealth manager at Investment Quorum, says:
Looking at both of your portfolios, your fixed-interest exposure has delivered a very rewarding period, both from a capital and income stance. However, the best returns from government and UK corporate bonds are most likely now behind us.
Firstly, western core government bonds are now looking very expensive - inflation adjusted - and are most likely to deliver much less attractive returns over the longer term. Secondly, UK corporate bond yields have fallen dramatically over the past 12 months, as hungry income investors bought the asset class aggressively. Also consider the question surrounding possible liquidity issues on UK corporates - this was even flagged recently by the Financial Services Authority. While this might not be an immediate problem, it needs to be considered on a risk-adjusted basis. We would not wish to be alarmist here, but many institutional investors are revising their fixed-interest holdings towards equities at this time, and we would not like to see you caught on the wrong side of this trend.
Interest rates and global growth are likely set to remain at lower levels for longer, along with the possibility that a period of higher inflation might not be too far away. Inflation is always bad for bonds and, as you want to safeguard capital as well as generate an income, we feel it worth pointing out the potential dangers should inflation reappear. Governments have a poor track record of squeezing inflation out of the system and after all of the quantitative easing it will be even more difficult for them to do so.
While many of the UK companies you hold do have global exposure, and corporate earning power, you need some direct exposure to the global markets as many of these exciting regions around the world can deliver excellent capital returns, alongside a rising bond and dividend income stream. You might like to consider having a much wider strategic and tactical asset allocation towards the global equity and bond markets, rather than the current larger weighting in UK equities and bonds - particularly in light of you having an offshore bond, and a house in the US.
We would suggest that you tilt your portfolios carefully towards a more global growth and income orientated approach.
Taking all of your investment requirements into account, consider a global asset allocation split between high-yielding bond funds, UK and global equity income funds, and to a lesser degree global property funds and global index-linked bonds.
An asset allocation of around 60 per cent in strategic and high-yielding bonds, 30 per cent UK and global equities and 10 per cent into global property and linkers should give you a running yield of around 5 per cent. This should enable you to increase your capital values through a global approach over the longer term, and to achieve a degree of protection against any future inflationary pressures.