61-year-old aims to preserve value of capital reserve

IAN'S PORTFOLIO

Source: Investors Chronicle. Price and values as at 4 June 2014

LAST THREE TRADES

Rathbone Income Fund (sell), Ashtead (sell), Trifast (buy)

WATCHLIST

Fastjet, Hunting, Keller, Henderson UK Equity Fund, JD Wetherspoon

Chris Dillow, Investors Chronicle's economist, says:

You haven't set yourself a high target for returns. This is sensible, as equity returns are mostly out of our control. And this portfolio should, on average, at least exceed your aim of beating inflation.

Here's how I think about equity returns. Let's assume shares are fairly valued, so their dividend yield won't change systematically over time but will fluctuate around current levels. And let's say dividends grow in line with profits, which grow in line with the economy. It then follows that share prices will rise at the same rate as the economy grows. If the future's anything like the past, this should give us real growth - that is, after inflation - of around 2 per cent a year. On top of this, we should get a yield of a little over 3 per cent. You should therefore, on average, beat inflation by around five percentage points per year. This means you should be able to take around 5 per cent out of this portfolio each year while leaving its real value intact. That should give you an income of around £150 a month.

However, you face a genuine risk: a risk year. Equity volatility has averaged 20 percentage points per year since 1900. This means there's a one-in-six chance that you will lose around 15 per cent or more (in real terms) over a 12-month period. Assuming you have 25 years of investing ahead of you, there is a 99 per cent chance that you will suffer at least one such year of loss. Could you cope with that? Is your cash on deposit sufficient to cover your expenses during such a bad time?

If the answers is 'yes', then there's no problem. If, however, you couldn't deal with just a loss then you should trim your equity exposure and put more into safer assets - of which cash is the easiest. Yes, its returns are low - but that's because there's high demand for safe assets.

Whether you do this or not is a matter of taste and of personal circumstances; I'm just reminding you of the costs and benefits of your current portfolio. There are, though, two aspects of your portfolio I'm less happy with.

One is that you're incurring unnecessary fees. You have almost 40 different assets here. This means, as a matter of brute maths, that you have something like a global index tracker fund; if global stock markets tumble, so will your portfolio. Now, there's nothing wrong with global tracker funds in themselves - and, in fact, plenty right. The problem is that you are paying too much to own one, due to the fees charged by actively managed funds. Many charge an annual fee of over 1 per cent, whereas Vanguard's global tracker fund, for example, charges only 0.3 per cent.

Over time, higher fees compound nastily. For example, over 25 years a difference in charges of 0.7 percentage points per year can add up to an additional cost of over £7,000 on a £13,000 portfolio. Such fees are worth paying if you get an extra 0.7 percentage points per year of returns from active managers. But are you really confident you'll get this? If not, look to switch into lower-cost tracker funds.

My second beef is your willingness to sell after short-term share price rises. Doing so means you lose out on one of investors' best friends - the momentum effect, the tendency (on average, over the long run) for recent winners to carry on rising. Remember that if you want to create an income from this portfolio, you can do so just as well by selling losers as winners - which also helps protect you from negative momentum.

Nick Sketch, a senior investment director at Investec Wealth & Investment, says:

This is an unusual portfolio in several respects, but it contains several equities that have done very well in recent years and some very well-run funds. As a result, areas that would justify review are probably most noticeable in terms of asset allocation rather than stock selection.

You are 61 and your pension only just meets your income requirements, with this portfolio as a key part of your capital reserve. Sticking to an all-equity and pro-risk portfolio was a good move following the crash seen in 2008, but stock markets have generally risen by 80 per cent or more since then (with mid caps and smaller companies generally outperforming strongly). It may well be time to consider moving to a more diversified shape to give a slightly smoother ride in the next few years, even though equity investments are likely to remain the majority of the portfolio.

Today, the portfolio has over 80 per cent in UK equity investments, split roughly evenly between FTSE 100, mid caps and smaller companies. Half of the remaining 19 per cent is in Asia (excluding Japan), with much smaller amounts in America, Europe and other emerging markets.

In an increasingly global investment world, it is worth remembering that the UK represents about 10 per cent of the world's stock market by value, and that FTSE 100 companies are over 80 per cent of the UK market by value. As a result, the very strong tilt to UK mid caps and small companies, though very successful in recent years, may well benefit from some profit-taking. More generally, it is hard to believe that 80 per cent of the world's best investment ideas are in the UK stock market, so rebalancing to increase the exposure to other mature markets is also worth considering. In this context, many European, American and Japanese investments are worth further investigation.

The portfolio also shows some strong themes in terms of sectors, with low weightings to the energy and consumer staples areas and high exposure to industrial cyclical, property shares and fund managers. Once again, this sector tilt will have helped past performance, but this may be a good time to bank profits and to increase the exposure to larger and more robust companies with strong long-term franchises. This could be done by buying individual equities in the UK or elsewhere, but given the portfolio size it may be more realistic to use well-managed funds to achieve this.

An aim of beating inflation probably means that the portfolio cannot have a high weighting in mainstream bonds or cash, given the ultra-low returns on offer at the moment. However, there are some attractive fixed-interest investments around and switching some cash to this area should make the overall value a little more stable during market wobbles (and we can be sure that there will be some more of those in the next five to 10 years). This would probably also boost the income yield from the portfolio, and this too may be useful, not least because dividends are often a more reliable form of return than capital gains.

Similar comments apply to other diversifying assets that can deliver a decent absolute return while not all rising and falling with stock market's gyrations. Property is a good example, but property shares tend to behave like equities (not buildings) when markets take a tumble. As a result, while they may be attractive as equity investments, they may not be the ideal choice in the long term. Even if funds of property shares are preferred, it may be worth looking beyond a purely UK focus, with TR Property Investment Trust (TRY) a perennial favourite in this area.

The portfolio has no exposure to infrastructure, commodities, hedge funds, structured products and other 'alternative' assets. These are all areas where we regard the average investment as probably being best avoided, but that does not mean that there are no investments in these areas that would benefit this portfolio - it is just that a bit more work to find the right holdings is needed.