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Reduce and diversify to achieve your objective

Reducing the number of holdings and broadening his asset allocation could help our reader meet his goals
August 18, 2016

Our reader is a retired GP aged 72. He has been investing for 34 years, initially in funds and direct equities and more recently in investment trusts. His 65-year old wife still works part time but they have sufficient pension to live on with cash for emergencies, and no outstanding mortgage. He says this means he can take a long-term view with his investments. He holds his portfolio via platforms such as Cavendish, Interactive Investor, X-O.co.uk, and Hargreaves Lansdown. Most of the investments are held within an individual savings account (Isa).

Reader Portfolio
Anonymous 72
Description

Isa and trading accounts

Objectives

Max total return possible with moderate volatility

"We live a simple life but do take holidays regularly," he says. "I manage this portfolio which includes my money and my wife's. It also includes investments for my two sons who are in their thirties and in full-time employment, and my two grandchildren aged five and seven.

"I would like some suggestions on how to improve my portfolio to achieve the maximum total return possible over five to 10 years, with moderate to high volatility. By that I mean that my portfolio shouldn't fall more than 20 per cent except in a catastrophic market collapse.

"I have been told that I have too many holdings. If that is the case, how should I correct it?

"I have some ordinary shares which are also held by some of my funds such as CF Woodford Equity Income (GB00BLRZQ620) CF Lindsell Train UK Equity (GB00B18B9X76) and Lindsell Train Global Equity (IE00BJSPMJ28), resulting in duplication. But I don't think I get sufficient exposure to these stocks by only accessing them via funds and investment trusts.

"The stocks in question are GlaxoSmithKline (GSK), Astrazeneca (AZN), British American Tobacco (BATS), Imperial Brands (IMB), Diageo (DGE), Reckitt Benckiser (RB:SWX), RELX (REL) and Unilever (ULVR).

"Am I right in believing that these bond proxies are likely to out perform over long periods with comparatively less volatility?

"Some of the funds and investment trusts also have the same holdings as each other, for example, those managed by Nick Train.

"And am I appropriately diversified? I do not have exposure to bonds, and little exposure to emerging and Asian markets, though I plan to increase my holding in Stewart Investors Asia Pacific Leaders (GB0033874768).

"I believe 15 to 30 stocks provide good exposure. But does one fund or investment trust count as one holding, or should I take its number of underlying holdings into account? Would say, just Fundsmith Equity (GB00B41YBW71) and CF Lindsell Train UK Equity be enough, and would any further satellite holdings create a tracker effect?

"And how can I diversify without knowing what all the underlying holdings of my funds and investment trusts are? Is there a way to work out what percentage of my overall portfolio each individual share accounts for, if the portfolio includes funds and investment trusts?

"I sold CF Miton UK Multi Cap Income (GB00B4M24M14) and MFM Slater Growth (GB00B7T0G907) ahead of the referendum on the European Union, but may reinvest. I intend to increase my holding in Castlefield CFP Sanford Deland UK Buffettology (GB00BKJ9C676) - would that be sufficient exposure to smaller companies?"

 

Our reader's portfolio

HoldingValue (£)% of portfolio 
AXA Framlington Biotech (GB00B784NS11)13,470.002.25
Baillie Gifford Japanese Smaller Companies (GB0006014921)4,608.000.77
CF Lindsell Train UK Equity (GB00B18B9X76)19,499.003.25
CF Woodford Equity Income (GB00BLRZQ620)42,675.697.12
Castlefield CFP Sanford Deland UK Buffettology (GB00BKJ9C676)3,092.040.52
Fidelity American Special Situations (GB00B89ST706)3,048.360.51
Fidelity Index US (GB00BJS8SH10)30,165.995.03
Fundsmith Equity (GB00B41YBW71)92,086.0015.37
Lindsell Train Global Equity (IE00BJSPMJ28)22,098.713.69
Man GLG Continental European Growth (GB00B0119487)22,212.003.71
Old Mutual North American Equity (GB00B1XG9G04)8,479.001.42
Old Mutual UK Mid Cap (GB00B1XG9482)25,617.004.28
Stewart Investors Asia Pacific Leaders (GB0033874768)14,392.002.4
First State Global Listed Infrastruture (GB00B24HJL45)4,2640.71
AstraZeneca (AZN)10,076.001.68
Baillie Gifford Shin Nippon (BGS)14,608.002.44
Bellway (BWY)1,393.850.23
Berkeley Group (BKG)3,835.080.64
Berkshire Hathaway (BRK.B:NYQ)18,912.35*3.16
British American Tobacco (BATS)5,501.600.92
BT Group (BT.A)3,441.000.57
Centrica (CAN)1,761.040.29
Chelverton Growth Trust (CGW)5,297.900.88
Diageo (DGE)14,613.482.44
easyJet (EZJ)3,357.040.56
European Assets Trust (EAT)5,996.68*1
Fenner (FENR)197.470.03
Finsbury Growth & Income Trust (FGT)9,417.241.57
GlaxoSmithKline (GSK)11,581.141.93
Henderson Smaller Companies Investment Trust (HSL)3,383.000.56
Imperial Brands (IMB)11,865.311.98
International Biotechnology Trust (IBT)3,963.750.66
International Consolidated Airlines (IAG)1,602.000.27
JPMorgan Mid Cap Investment Trust (JMF)11,011.891.84
Jupiter European Opportunities Trust (JEO)11,518.131.92
M J Gleeson Group (GLE)2,836.300.47
National Grid (NG.)5,642.820.94
Newriver Retail (NRR)1,650.830.28
Nike (NKE:NYQ)2,110.20*0.35
Pacific Assets Trust (PAC)7,161.861.2
Polar Capital Technology Trust (PCT)1,886.520.31
Reckitt Benckiser (RB:SWX)6,228.47*1.04
Relx (REL)7,041.601.18
Royal Dutch Shell (RDSB)3,491.520.58
Scottish Mortgage Investment Trust (SMT)24,773.544.13
SSE (SSE)1,495.480.25
Telford Homes (TEF)2,343.940.39
The Biotech Growth Trust (BIOG)4,134.480.69
TR Property Investment Trust (TRY)5,604.250.94
Tritax Big Box REIT (BBOX)7,853.651.31
Unilever (ULVR)17,217.382.87
Walt Disney (DIS:NYQ)2,052.32*0.34
Whitbread (WTB)112.20.02
Woodford Patient Capital Trust (WPCT)5,979.951
Workspace Group (WKP)1,580.740.26
Worldwide Healthcare (WWH)3,948.480.66
Cash25,000.004.17
Total599,188.27

*Currency conversions as at 11 August 2016

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You ask whether its right to believe that bond type stocks will outperform. You are. This is exactly the world we've been living in for years. We have evidence from most developed countries for decades that defensive stocks do indeed beat the market on average.

Some readers might object that defensives have done well over the years because they have been under priced, as investors overlooked the virtues of companies with the sort of monopoly power that comes from high capital requirements or strong brand names. However, with many such stocks now on higher valuations investors might finally have wised-up to their errors, and so defensives won't do as well in future.

But there might be a more permanent reason for defensives to do well. Researchers at AQR Capital Management point out that high-beta shares are usually over-priced because bullish investors who cannot increase their gearing try to lever up returns by buying these. This causes them to be over-priced and means that low beta stocks are under-priced.

I suspect, therefore, that your holdings of defensive stocks such as Unilever and GlaxoSmithKline, and defensive funds such as CF Woodford Equity Income and Fundsmith which holds global defensives, are reasonable.

Such stocks will underperform if the market rises sharply and fall if the market drops - they are only relatively defensive. But on average, I reckon it's the right strategy.

 

James Baxter, partner at Tideway Wealth, says:

My first question would be around inter-generational tax and wrapper planning. Are all these investments in the right accounts, in the right people's names? There could be some big, zero risk, tax gains to be made if they are. For example, if £100,000 of the portfolio earmarked for your son is retained in your Isas, when it passes to him it could incur 40 per cent inheritance tax only leaving a £60,000 inheritance.

Alternatively, if your son is a 40 per cent tax payer and not fully funding his pensions, you might be able to turn the same £100,000 into £166,600, by gifting it to him into his pension account over the next few years.

 

Graham Spooner, investment analyst at The Share Centre, says:

Saying you are prepared for moderate to high volatility, but not for your portfolio to fall by more than 20 per cent, is slightly at odds. However, with the majority of your portfolio in funds, and your individual shares being large-caps with international earnings, then volatility is likely to be lower - barring a catastrophic collapse in markets.

It is very likely that your individual holdings are also held within some of your funds. If you are keen to gain greater exposure to specific individual companies, then to a certain extent you are creating your own fund, made up of shares that you believe will outperform over the long term. Only time will tell if that is a sensible approach, but it should focus your attention. It could even be more interesting, and enable you to benchmark your performance and stock picking against some well-known fund managers.

Conversely, while you say you have sufficient pension to live on and cash for an emergency, as you move into later life making financial decisions doesn't get easier, so leaving the majority of decisions to a fund manager is probably the more sensible option.

You ask how to find percentages of holdings within a portfolio. Gaining knowledge of some the individual constituents of funds is possible online, with the majority of fund managers producing monthly fact sheets that show the largest holdings in the fund and its sector breakdown, along with other useful information.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

You are over-diversified. This isn't the greatest error in the world, especially if you're not trading very much. But it does mean you are incurring unnecessary management charges, simply because you are paying fund fees for what is, in your portfolio as a whole, performance that is very similar to the market's.

I would address this by dumping high-charging open-ended funds, with the exception of those that give you exposure to defensives, and some of your smaller less defensive stocks. You could replace them with a global index tracker fund which would give your portfolio general equity exposure with a slant to defensives.

Doing this would also mean you are sufficiently exposed to Asian and emerging markets as a global tracker gives you the same weighting in areas as the average global investor has.

Right now, however, there might be a case for topping up such exposure. Emerging markets tend to be driven by sentiment. And sentiment feeds on itself: on average, a rising market leads to further rises and a falling one to further falls. For this reason, a policy of buying emerging markets when they have risen above their 200-day or ten month moving average has paid off, on average, over the years. I say this because emerging markets have recently broken through this average which might be a buy signal.

These might also diversify the risk of defensives under-performing. The circumstances in which this would happen would be if global stock markets do very well, a time when you'd win on emerging markets.

This isn't to say you should rush to get a big holding: we're at that time of year when emerging markets often do poorly. But it is to say that defensive stocks, a global tracker and perhaps emerging markets can fulfil your needs.

 

James Baxter says:

After tax planning comes the question of the investment mandate and broad asset class selection. This portfolio is virtually all in equity-based investments which will have a high level of correlation, and may not meet your 20 per cent capital loss limit in a market downturn.

High-yield bonds can match the returns of equities for very long periods and be less correlated, so that they do protect capital in a downturn. A good example of this is the returns from investing in Prudential's (PRU) ordinary equities versus its hybrid capital bonds. The hybrid bonds have generated both higher and more stable returns, whether with reinvestment of income or where investors are making regular withdrawals. And this is a company whose shares performed exceptionally well after the financial crisis.

Adding some high-yield bond funds into the portfolio could create some asset class diversification without lowering the long-term return outlook. This would be particularly effective in an exempt account like an Isa where there is no tax on the coupons earned.

As a basic guide, if you are going to create a core equity portfolio from individual shares, then a 5 per cent per stock limit or minimum of 20 holdings is a good benchmark to spread the specific risk of each company.

If you use collective funds as the core holdings, then allocation per fund can be much higher, and four or five well selected funds with differing portfolios would give ample manager and company specific diversification.

A more manageable solution would be a core-satellite approach of say, four to five funds each accounting for about 15 per cent to 20 per cent of the portfolio, plus four or five individual shares in which you have done your research and have strong conviction, each accounting for less than 5 per cent.

 

Graham Spooner says:

You have a good level of diversification. While there could be a case for saying you have too many holdings, you are running it for your sons and grandchildren as well, so I am not concerned. But with the difference in ages it would be normal for a lesser amount of risk to be taken with your part of the portfolio, and possibly an increased amount more positioned for growth for the younger members of the family.

And I would look over time to balance the amounts in each holding a little more. You could also have a spring clean of some of the smaller holdings such as Fenner (FENR), Whitbread (WTB) and Workspace (WKP), which would also address any concerns you have over the number.

Increasing your holding in Castlefield CFP Sanford Deland UK Buffettology (GB00BKJ9C676) may increase your exposure to smaller companies. However, this fund's management have specific criteria for selecting companies, including that they are comprehensible, generate high returns and have a strong balance sheet. Therefore holding this fund could mean that over time your portfolio has a bigger weight to large-caps than at present.

Regarding investments for your grandchildren, I would suggest funds whose managers have experience in developed and developing markets. You could increase Stewart Investors Asia Pacific Leaders, First State Global Listed Infrastructure (GB00B24HJL45) and Scottish Mortgage Investment Trust (SMT) as their managers have strong reputations.