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Temper your expectations, and get a strategy and process

Our reader wants a return of 10 per cent a year, but he needs to temper his expectations and reduce risk
March 2, 2017, James Norrington & Steve Wilson

Don Kingston is 33 and has recently got married. He works full time and owns one property, and describes himself as "relatively financially independent". He doesn't have any children.

Reader Portfolio
Don Kingston 33
Description

Sipp, Isa and trading account

Objectives

High capital growth

Portfolio type
Investing for growth

"I am aiming for capital growth until I retire at age 50," says Don. "I reinvest income and dividends, and am prepared to take risks with my capital for the next 10 years to achieve growth of 10 per cent a year plus. So I would like to increase the level of risk in my portfolio to increase return over the next 10 years. I am comfortable with leveraged products, and while I would be annoyed if I lost it all, I do have time to start again.

"I have played a little too safe with trackers and managed funds, so I would like to increase my exposure to technology and other industries of the future.

"My most recent trades were buying Hostelworld (HSW) and selling Telit Communications (TCM) and Renew (RNWH).

I am considering topping up Redde (REDD), and buying McCarthy & Stone (MCS), Rathbone Global Opportunities Fund (GB00B7FQLN12), lots of US technology shares and PureFunds ISE Cyber Security ETF (HACK:PCQ:USD).

 

Don's portfolio

 

HoldingValue (£)% of portfolio
BlackRock Continental European Equity Tracker (GB00BJL5BS14)5,686.952.90
CF Woodford Equity Income (GB00BLRZQC88)13,448.146.86
Greencore (GNC)7,103.783.63
Legal & General UK Index (GB00BG0QPJ30)10,983.745.61
Pets At Home (PETS)5,486.592.8
Aberdeen Global Indian Equity (LU0837977031)2,205.981.13
AO World (AO.)5,075.722.59
AXA Framlington Biotech (GB00B784NS11)1,749.370.89
AXA WF Framlington UK (LU1319654270)3,244.201.66
Fidelity America (LU0251120670)2,153.951.1
Fidelity Asia (GB00B6Y7NF43)3,788.621.93
Fidelity Emerging Asia (LU0528227852) 4,160.282.12
Fidelity Emerging Europe Middle East & Africa (GB00B87Z7808)10,137.695.17
Fidelity European Opportunities (GB00B8287518)5,572.822.84
Fidelity Global Financial Services (LU0116932376)6,909.993.53
Fidelity Global Technology (LU0116926998)4,292.992.19
Fidelity UK Smaller Companies (GB00B7VNMB18)9,784.944.99
Hostelworld (HSW)4,138.262.11
HSBC Japan Index (GB00B80QGN87)1,765.990.90
Lindsell Train Global Equity (IE00BJSPMJ28)9,090.744.64
M&G Property Portfolio PAIF (GB00B8FYD926)19.50.01
M&G Recovery Class (GB00B4X1L373)2,522.451.29
Marlborough Multi Cap Income (GB00B907VX32)1,616.130.82
Aberdeen New India Investment Trust (ANII)2,144.801.09
Old Mutual UK Alpha (GB00B8XY5K91)959.760.49
Rathbone Global Opportunities (GB00B7FQLN12)1,533.720.78
Rentokil Initial (RTO)3,268.501.67
Schroder Global Healthcare (GB00B76V7R15)4,331.112.21
Scottish Mortgage Investment Trust (SMT)4,618.652.36
Standard Life Investments Global Smaller Companies (GB00BBX46522)1,306.290.67
Stewart Investors Indian Subcontinent (GB00B1FXTG93)3,313.741.69
Woodford Patient Capital Trust (WPCT)8,317.024.25
Blancco Technology Group (BLTG)3,080.991.57
GVC (GVC)6,385.303.26
Redde (REDD)10,273.685.24
Watchstone (WTG)112.510.06
Seeing Machines (SEE)1,021.280.52
Telecom Plus (TEP)1,037.900.53
AXA Framlington UK Select Opportunities (GB00B703ZS07)5,772.512.95
Fundsmith Equity (GB00B4MR8G82)7,788.433.98
John Laing (JLG)3,952.662.02
Schroder Income Maximiser (GB00B5B0KM51)5,766.442.94
Total195,924.11 

 

 

 

None of the commentary here should be regarded as advice. It is general information based on a snapshot of the reader's circumstances.

 

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

Your ambitions for this portfolio are too high. Ten per growth a year is very unlikely. Figures from Credit Suisse show that, on average, global equities have returned 5 per cent a year since 1900. With market valuations around average - and higher in the US - there's no strong reason to suppose the next 10 years will see returns much above this long-run average.

Nor can we expect you to achieve your target by investing in "industries of the future". Quite the opposite. Investing in growth, on average, doesn't pay. Over the past 30 years the FTSE 350 Low Yield index - a measure of growth stocks - has given a total return of 2.5 percentage points a year less than the High Yield index. This warns us that investors, on average, pay too much for growth. They underestimate just how hard it is for companies to grow and overestimate their ability to predict growth - much of which is in fact random.

 

 

But there is a factor that pays off: momentum. You don't need to buy past winners to get exposure to this. Rather, you could follow a simple 10-month or 200-day moving average rule: buy when an asset's price is above its 200-day average, and sell when it is below.

Such a strategy, if applied to 'growth' stocks or markets such as tech or emerging markets, is in effect a way of riding bubbles. It gets you into bubbly stocks on the upside, but gets you out before the bubble fully deflates. It doesn't get you out at the precise top - but nothing other than luck will.

Such a rule, applied over the long run, would enhance returns mostly by preventing you from losing a lot in bear markets. If you must chase high returns, this is the way to go. Life might be easier, though, if you reduce your expectations.

 

James Norrington, specialist writer at Investors Chronicle, says:

Any portfolio like this, which is almost totally invested in equities alongside some property, cannot be said to be playing it safe. In the 2007-09 financial crisis the MSCI World Index of major blue-chip companies lost over half of its value, so there is considerable risk here already. With an aggressive investing strategy, it is especially important to keep aside enough cash savings to cover any emergency expenses; changes in your personal circumstances, for example if you and your spouse have children; or to meet mortgage payments if you were to suffer a period of unemployment.

With sensible contingency plans, provided your home and job are secure, then you are in a position to stay invested and reinvest dividends, riding out the inevitable bumps in equity markets and relying on compounding to give you the best chance of building a decent retirement pot.

Where you may struggle, however, is in achieving a 10 per cent annualised real return. True, there is a link between potential risk and return, but unless you are very lucky it will probably take far longer than the next 10 years for a high-risk strategy to pay off.

So you would be ill advised to add risk to this portfolio. The danger is that every time your portfolio suffers a severe drawdown in its value, your required rate of return to hit your target has to go up. If you try to achieve this by taking on ever more risk, then you may actually end up with very little capital and not enough time to rebuild - like a gambler at the tracks betting on ever longer odds each race to win back his losses.

 

Steve Wilson, director at Alan Steel Asset Management, says:

You have built up a decent sum in your individual savings account (Isa) at a fairly young age, and with the Isa allowance increasing to £20,000 from April you could use some of your annual capital gains tax exemption of £11,100 to move the holdings held outside tax wrappers into the Isa during the 2017-18 tax year.

You could also consider pension contributions as your pension fund is a bit light for someone your age. With higher-rate relief still available for pensions, that could be attractive, depending on your earnings, although you couldn't access the pension pot until at least age 55.

Although you are prepared to take more risk that doesn't always mean more return, so instead, a base of caution can be welcome at certain times in the cycle.

A 10 per cent-plus return, while not unachievable, is ambitious in the current low-growth environment.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

There's a further problem with your portfolio. It has too many high-charging actively managed funds. This is a big problem for a younger investor because fees compound over time. For every £10,000 you invest, one percentage point higher than necessary in fees will, on plausible assumptions, reduce your wealth by almost £1,500 over 10 years.

The first thing you should do, therefore, is ask of every fund you hold: can I get what this fund offers cheaper elsewhere? Unless you want to back a particular fund manager's ability, the answer is often: yes. Exchange traded funds (ETFs) and tracker funds can offer what some active funds offer, at lower cost.

You should also bet on factors that pay off over the long run, such as defensive stocks. These do better than they should over time. A reason for this is that many investors, like you, try to get geared returns on the market by investing in high-beta shares. This, however, means those stocks are overpriced on average, while lower-beta stocks are underpriced.

You have a little exposure to lower-beta stocks via CF Woodford Equity Income Fund (GB00BLRZQC88). You could get more. Some investment trusts, such as Finsbury Growth & Income (FGT) and City of London Investment Trust (CTY), for example, also have substantial exposure to defensives.

Defensives alone, though, won't make you 10 per cent per year: the defensive premium isn't that big.

 

James Norrington says:

Aim to improve the risk-efficiency of the portfolio, ie ensure that you have the best chance of being rewarded for the risks you are taking.

I would consider spreading risk with some more asset diversification. We are living in a strange world where many asset prices are high and, thanks to years of quantitative easing by central banks, yields on bonds are at historic lows. As well as considerable interest rate risk, this causes a major reinvestment headache for bond funds. Nevertheless, bonds could still react differently to equities in periods of market stress so it may be worth having, say, 20 per cent of the portfolio invested in quality corporate bonds and inflation-linked sovereign debt.

With your objective of growth, it is reasonable that the lion's share of capital remains in equities. You have bought into many funds and, for ease of management, I'd consider the themes and markets you want exposure to and prune down to a smaller number of holdings that offer this.

When investing in a number of global markets, it is worthwhile maintaining a mix of passive and active funds. In the case of themes such as technology stocks with growth potential, in which you express an interest, a managed fund will give you the benefit of a specialist investor's knowledge and is an easy way to access overseas markets, such as the US and Asia, which are strong in this sector.

Passive funds may be more appropriate for taking a broad position on a theme such as emerging market growth.

To chase higher overall returns, you might also consider passive ETFs, which offer a cheap way to invest in return factors such as value stocks. It is premature, however, to discard the expertise of active managers when looking at broad markets or regions, as they may have more contingency plans for future market falls.

 

Steve Wilson says:

There are too many funds in the portfolio and you have no real strategy. You have a combination of direct shares, tracker funds and active funds. I don't know what your buy process is, and whether you have a sell discipline, but I prefer funds to direct shares. A fund manager can have access to company balance sheets and company board meetings, so can gain real insight into details such as what a company's plans are and what the senior management are like.

Although tracker funds have delivered positive results over the past five years, as they do in rising markets, now more than ever we have entered an environment where a good active manager can outperform. This is because they can avoid certain sectors, unlike a tracker fund. Passive funds tracking UK markets, for example, are heavily influenced by the large oil stocks.

Your portfolio has too many specialist funds, such as those focused on healthcare, technology and biotechnology. I'd prefer a global fund manager who can switch in and out of those sectors when they think the time is right. You say that Rathbone Global Opportunities might be a potential purchase, and its manager, James Thomson, should be very adept at switching in and out of certain sectors at a good time.

Three India funds is too many: I'd suggest a broad Asian fund, which can balance between India, China and other regional markets.

You need to have a strategy and process in place, and perhaps get some guidance on tax.