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Two ETF portfolios for income: Four months on

Our experts are happy with performance but want to make some changes.
June 2, 2015

In February we launched two model ETF portfolios for income in retirement, constructed by Alan Miller, founder of SCM Private and Paul Taylor, managing director of McCarthy Taylor. We checked in with Mr Miller and Mr Taylor this week to see how the portfolios were doing and ask if they are going to make any changes.

How have they performed?

Both portfolios have already started delivering capital growth as well as income, with the portfolios' total returns both coming in over 3 per cent. Mr Miller's portfolio delivered a total return of 4.4 per cent compared to 3.3 per cent for Mr Taylor's between 1 February 2015 and 26 May 2015

The portfolios have slightly different risk profiles. Mr Taylor says: "Am I miffed that Mr Miller's portfolio is doing better? Yes. Am I worried? No, because he's taking much more risk than me."

The best performing fund out of the two portfolios was one of Mr Miller's choices, Wisdomtree Europe Small Cap Dividend (DFE), which returned 14 per cent over that period. The fund pays out quarterly dividends and has a gross dividend yield of 3.2 per cent. It paid out its most recent dividend of €0.0474 per share in March.

WisdomTree Europe Small Cap Dividend selects the companies which comprise the bottom 25 per cent of the WisdomTree Europe Dividend Index based on market capitalisation, after taking out the largest 300 companies.

Europe small cap funds have been benefitting from the recovery there since the beginning of the year, with smaller, more domestic facing companies the most exposed to a bounce-back. European small cap indices have outperformed their larger counterparts by 3.29 per cent in the year to date.

iShares Core Japan IMI UCITS ETF (SJPA) delivered a total return of 9.4 per cent within the defined period, higher than most funds' total returns. The ETF is not currency hedged and currency hedged products have fared better in this region over the past two years due to the devaluation of the yen following the launch of Prime Minister Shinzo Abe's monetary stimulus plan in 2013. However, the equivalent hedged product, iShares MSCI Japan GBP Hedged UCITS ETF (IJPH) comes with a much higher price tag, having a 0.64 per cent ongoing charge. In recent months the rapid weakening of the currency has stalled so that in the early part of the year unhedged Japanese funds delivered better returns than their hedged counterparts.

The best performing ETF this year in Mr Taylor's portfolio is iShares UK Dividend UCITS ETF (IUKD), which tracks the performance of the FTSE UK Dividend+ Index. This index offers exposure to the 50 highest-yielding stocks in the FTSE 350 weighted by one-year forecast dividend yields, meaning it has a greater chance of homing in on the best income stocks in the UK market. This ETF's portfolio is concentrated making it slightly riskier but with Mr Taylor's portfolio remaining fairly low risk overall, it has been the main generator of returns this year. Top holdings include metals and mining company Vedanta Resources (VED) and major banks including HSBC Holdings (HSBA) and Standard Chartered (STAN). The ETF paid a dividend in March and is expected to pay another of £0.1196 in June.

Portfolio changes

Bond ETFs – stick or twist?

Bond ETFs were the worst performers in terms of total return, areas which Mr Taylor has considered amending. The iShares £ Index Linked Gilts (INXG) fell by 2.41 per cent between February and 26 May, iShares Global Inflation-Linked Government Bond (SGIL) dropped by 5.1 per cent and iShares Corporate Bond Ex Financials (ISXF) recorded a 4.6 per cent fall in total return.

Bond ETFs have had a tough few months following market nervousness around the timing of interest rate rises in the US and UK. iShares Global Inflation-Linked Government Bond is 43 per cent exposed to the US and a large chunk of its bonds have a long-dated maturity, meaning that it is reasonably susceptible to rate rises. Mr Taylor also suggests that the UK's dip into deflation in recent months has had an impact on the performance of index linked bonds.

Mr Taylor says: "Depending on the size of your portfolio, it may be cost-effective to consider a re-balance by taking profits on the UK Dividend ETF and adding to the Corporate Bond ETF position.

"As the duration is likely to be over 20 years on the iShares £ Index-Linked Gilts it is likely to be more sensitive to increasing interest rates. While the timing of when rates will eventually rise is a matter of intense speculation it may be prudent to now consider reducing exposure."

Mr Taylor's portfolio changes

Both iShares £ Index Linked Gilts and iShares Global Inflation-Linked Government Bond have been downsized to make room for iShares MSCI World GBP Hedged UCITS ETF (IGWD). Mr Taylor says: "As currencies are so unpredictable and volatile, we are always conscious of currency risk. However, it is possible to negate currency risk and still obtain exposure to global equities by the use of hedged share classes."

"iShares MSCI World GBP hedged has a slight additional cost for being hedged (the ongoing charges figure is 0.55 per cent compared to 0.50 per cent for the unhedged version) but it is worth it in order to remove the risk that currencies move against you."

Despite the fall in total return of the bond ETFs in each portfolio, the yields on iShares £ Index Linked Gilts and iShares Corporate Bond Ex Financials are still positive, particularly the latter at 3.76 per cent. The ETF pays out two dividends per year in January and July, with the most recent dividend payment in January amounting to £2.2052.

Mr Taylor has also introduced the new iShares MSCI Target UK Real Estate UCITS ETF (UKRE), launched in March 2015 as a means of accessing the high-yielding real estate sector by tracking the return of the MSCI UK IMI Liquid Real Estate Index. The ETF invests in real estate investment trusts (Reits) rather than directly in real estate but is highly liquid. Mr Taylor says: "We have been considering the merits of this ETF as a complement to the actively managed Tritax Big Box Reit.

"iShares MSCI Target UK Real Estate UCITS ETF has a total expense ratio of 0.40 per cent and uses our preferred passive approach of physical replication by investing in the companies that comprise the index.

"With closed-end funds trading at high premiums to net asset value due to the appeal of the yields in the real estate sector, the use of an ETF is a useful means of diversifying a portfolio and capturing a good income."However, Mr Taylor says that as it is a new product, he will be keeping a close eye on performance.

Mr Miller's portfolio changes

Mr Miller has switched from db X-trackers FTSE All Share UCITS ETF (DR) 1D (XASX) to SPDR FTSE UK All Share UCITS ETF (FTAL), which charges 0.20 per cent instead of 0.40 per cent to track the same index.

The SPDR ETF has also delivered closer performance to the underlying index over the previous two years, returning 1.07 per cent in 2014 compared to 1.18 for the FTSE All Share and just 0.84 for the db X-trackers product.

In order to seek a higher yield from emerging markets bonds, he has moved out of iShares $ Emerging Market Corporate Bond (EMCR) into iShares JP Morgan $ Emerging Markets Bond UCITS ETF (IEMB). Mr Miller has based that decision in part on the higher yield to maturity on the latter of 5.47 per cent instead of 5 per cent for iShares $ Emerging Market Corporate Bond ETF. In bond ETFs, the yield to maturity is calculated as the average of the yield on the underlying bonds if held to maturity, adjusted for each bond's weight in the ETF. It is only an indicative measure, as many of the underlying bonds will not be held until maturity, but suggests a higher income from the underlying securities.

However the distribution yield is also much higher on iShares JP Morgan $ Emerging Markets Bond UCITS ETF than iShares $ Emerging Market Corporate Bond ETF, at 4.33 per cent compared to 2.13 per cent.

He has also replaced iShares Core Emerging Markets IMI UCITS ETF (EMIM) with SPDR MSCI Emerging Markets Small Cap UCITS ETF (EMSD), which he says "offers exposure to faster growing companies than the larger cap weighted MSCI Index." For that reason the ETF is higher up the risk scale and likely to deliver more volatile returns over the long term. SPDR MSCI Emerging Markets Small Cap UCITS ETF also has a slightly higher ongoing charge at 0.19 per cent compared to 0.14 per cent.

Dealing costs

Although both experts have made changes to the portfolios both are reticent to make too many adjustments due to the dealing charges that come with trading ETFs. If you purchase an ETF portfolio you can incur hefty trading costs depending on how you buy the funds and this is something to bear in mind when considering making portfolio changes.

We will continue to monitor both portfolios and check in regularly to see how they are performing.

Alan Miller's original portfolio

Asset classFundsTotal return 1 Feb 2015- 26 May 2015 (%)Original allocation (%)Total return adjusted for allocation (%)
UK equitiesdb X-trackers FTSE All-Share ETF (XASX) 6.6352.3
Overseas equities iShares Core Japan IMI UCITS (SJPA) 9.4100.9
 iShares Core Emerging Markets IMI UCITS GBP (EMIM) 5.0100.5
 Powershares RAFI US 1000 ETF (PSRF)2.97.50.2
 Wisdomtree Europe Small Cap Dividend (DFE) 14.07.51
Bonds iShares £ Corporate Bond 1-5yr (IS15)0.050
 iShares USD Emerging Market Corporate Bond (EMCR) 1.850.1
 iShares £ Corporate Bond Ex Financials (ISXF) -4.615-0.7
 PIMCO Local currency emerging market bond (EMLP) -0.65-0.3
TOTAL PORTFOLIO RETURN 100 4.4

Alan Miller's adjusted portfolio

Asset classFundsAllocation (%)Ongoing charge (%)Yield if distributes income (%)
UK equities NEW: SPDR FTSE UK All Share UCITS ETF (FTAL) 350.2n/a
Overseas equities iShares Core Japan IMI UCITS (SJPA)100.2n/a
 NEW: SPDR MSCI Emerging Markets Small Cap UCITS ETF (EMSD) 100.55n/a
 Powershares RAFI US 1000 ETF (PSRF) 7.50.39n/a
 Wisdomtree Europe Small Cap Dividend (DFE) 7.50.383.2*
Bonds iShares £ Corporate Bond 1-5yr (IS15) 50.22.94
 NEW: iShares JP Morgan $ Emerging Markets Bond UCITS ETF (IEMB)50.454.32
 iShares £ Corporate Bond Ex Financials (ISXF) 150.23.76
 PIMCO Local currency emerging market bond (EMLP) 5 n/a

*Acc to Wisdomtree based on trailing 12 month dividend yields at March end

Paul Taylor's original portfolio

Asset classFunds Total return 1 Feb 2015- 26 May 2015 (%)Original allocation (%)Total return adjusted for allocation (%)
UK equity iShares UK Dividend UCITS (IUKD)8.650%4.295
Index-linked funds iShares £ Index linked gilts (INXG)-2.45%-0.1185
 iShares Global Inflation-Linked Government Bond (SGIL)-5.15%-0.253
Corporate bonds iShares Corporate Bond Ex Financials GBP (ISXF)  -4.630%-1.392
REITS Tritax Big Box REIT (BBOX)7.410%0.74
TOTAL PORTFOLIO RETURN 100 3.3

Paul Taylor's adjusted portfolio

Asset classFunds Allocation Ongoing charge (%)Yield if distributes income (%)
UK equity iShares UK Dividend UCITS (IUKD)500.403.00
Global equities NEW: iShares MSCI World GBP Hedged (IGWD)5 0.55n/a 
Index-linked funds iShares £ Index linked gilts (INXG)20.252.05
 iShares Global Inflation-Linked Government Bond (SGIL)3 0.25n/a
Corporate bonds iShares Corporate Bond Ex Financials GBP (ISXF)  300.203.76
REITS Tritax Big Box REIT (BBOX)5 1% AMC up to NAV of £500m*n/a
 NEW: iShares MSCI Target UK Real Estate UCITS ETF (UKRE) 50.40Too early for figure 

Source: Trustnet, Morningstar, as at 26 May 2015