Isa portfolio needs focus on allocation

ANONYMOUS STOCKS AND SHARES ISA PORTFOLIO

Source: Investors Chronicle, as at 3 September 2014

LAST THREE TRADES

Molins, Optos & Unilever

WATCHLIST

Fenner, Fastjet, DS Smith & Standard Life Smaller Companies Investment Trust

Chris Dillow, the Investors Chronicle's economist, says:

You have got one very big decision very right. In starting investing quite young, you stand to benefit from one of the greatest friends an investor can have - the power of compounding returns.

A simple sum shows how strong this force is. If you were to invest £1,000 a year at a real return of 5 per cent per year (which I reckon is a reasonable round number assumption for equities), you would have £50,113 after 25 years. After 30 years, however, you would have £69,760. Starting five years early therefore gives you an extra £19,647 for an additional £5,000 investment. That's a return of 193 per cent.

However, there's a problem here. Compounding is a powerful force in both directions. Yes, the compounding of returns makes us a fortune. But the compounding of fees can cost us a fortune.

Let's take a simple example, again based upon equity returns of 5 per cent a year over a 20-year period. If you invest £10,000 in a fund that charges 0.3 per cent a year - slightly more than a decent tracker - your money will grow to just over £25,000. If you put it into a fund that charges 1.5 per cent a year, it will grow to just under £19,900. The higher charging fund will thus cost you over £5,000 over the 20 years. That's more than half of your original investment. There's a reason why fund managers are rich.

And here's my problem. You are investing in some high-charging funds. Over the long run, this could be very expensive.

Of course, this is only the case if the pre-fee returns are equal. But this assumption is questionable. Many of your funds are riskier than ordinary shares. This is partly because they carry crash risk (your emerging markets and Russian funds), partly because they are high beta (gold shares), and partly because they are cyclical (higher income shares). Theory tells us that - over long periods and on average - such funds should outperform plain UK tracker funds.

However, these extra returns are only a reward for taking on extra risk. My fear is that many of the risk premia will end up in fund managers' pockets rather than yours. You're right to want to minimise trading costs. You should also try to minimise fees.

Luckily, there is a solution . Many of the exposures you have can be obtained at lower cost by using exchange traded funds. There are many emerging markets exchange traded funds (ETFs) to choose from, and a dividend plus ETF gives you exposure to higher-yielding stocks.

I would also suggest you buy a cheap tracker fund that tracks either the All-Share Index or general international market. The point is that we simply cannot tell how the investment environment will change over the next 20-25 years, and when faced with unquantifiable uncertainty we should back the field rather than any individual horse. This points to tracking the global market - although as the All-Share index is highly correlated with it, a UK tracker is a decent alternative.

I'd also advise you to try to make regular monthly investments even if these are small amounts, for two reasons. One is that doing so gets you into the habit of regular saving and so locks in the power of compounding returns. The other is that doing so means that you automatically buy on dips - because £100 buys you more units when prices are low - and so take advantage of temporary cheapness.

You've got the biggest decision - to invest in equities at a young age - right. Let's not spoil that by sub-standard implementation.

Adrian Lowcock, an independent investment adviser, says:

You have made a good start on your investment portfolio and have picked a very good time to review your investments. Your approach of following the recommendations of leading commentators will have kept close to your objectives and helped you pick some very good funds. However, this approach does need a bit of tweaking as it is unlikely you will developed a well-diversified portfolio as a result, and if it continues unchecked, you may over time end up with a lot of holdings, some of which are no longer recommended or suitable.

Given the portfolio size of around £32,000 this is a good time to put some structure into place around which you can build over time. By establishing an asset allocation model it will help you to avoid any duplication of investments, and you can consider commentators' suggestions within the context of your portfolio more easily.

Below is an example asset model for an adventurous investor.

• Equities, 70 per cent.

• Quality bonds, 10 per cent.

• High-yield bonds, 5 per cent.

• Hedge funds, 10 per cent.

• Cash, 5 per cent.

Within the equity element I would suggest holding around 28 per cent (of the whole portfolio) in UK equities, 13 per cent in US, 10 per cent in Europe and 7 per cent each in Asia and emerging markets, and the remainder 5 per cent in Japanese shares. Currently, you have around 55 per cent in the UK and nothing directly in US, Japan or Asia. Through your global funds you do have some exposure to the US and Europe, but very little to Asia and Japan.

I would suggest initially consolidating the global funds - CF JP FINN Global Opportunities and M&G Global Dividends into the Newton Global Higher Income Fund (GB00B5VNWP12) and creating a core holding which would account for around 20 per cent of the portfolio. This fund would also provide exposure to global equity income, which should help provide long-term growth without taking on unnecessary risk. With regards to the remainder of the portfolio, 55 per cent in the UK is a lot and we would look to reduce that exposure to provide further diversification through global equities, and keeping in line with your tolerance for a higher level of risk.

You have a few holdings in individual shares but these are relatively small. Given that individual shares can be volatile and the costs involved, I would suggest you should only consider buying shares when you have at least £2,000 to invest in each portfolio so they can make a meaningful contribution to the portfolio. At this time the money would be better used through a UK smaller companies fund or overseas equity fund.

The HL Multi-Manager Income & Growth Trust will have done a good job unto now but it is heavily focused on UK equities with a preference to equity income. I would suggest selling the fund to reduce UK equity exposure and use the proceeds from the sale to target specific areas, such as Asia and smaller companies.

With regards to your comments on Neptune Russia and Greater Russia, this is a case of where hindsight would be wonderful, but given the current political situation selling now feels a bit like closing the gate after the horse has bolted. Valuations are very cheap in Russia at present but they could get cheaper. However, given the size of the investment I would leave it be and ride out the volatile markets.

Your exposure to gold miners via BlackRock Gold & General, however, is a bit different. The gold miners have been through the grinder and new management have cut costs, reduced production and mothballed expensive mining projects. Gold also has a defensive element to the portfolio and I therefore would recommend you increase your exposure to 5 per cent, but no more.

My final bit of advice is to review your portfolio frequently - say once a year. This ensures that recommendations made by commentators are still relevant and up to date and you keep the number of funds in your portfolio down, to no more than 20.

My suggested portfolio is below. I have kept changes to a minimum and, as such, it will not exactly fit with the suggested asset allocation mentioned above but this should be used as a guideline to keep close to not exactly follow.

ADRIAN LOWCOCK'S SUGGESTED PORTFOLIO