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Don't try to time dips and diversify your portfolio

By Chris Dillow, Patrick Connolly & Andrew Rees , 11 May 2017

Reader portfolio

  • Name Jane Richardson
  • Age 53
  • Description Isa, shares portfolio, Junior Isa, CTF and cash
  • Objectives Save for children and retirement

Investing regularly might be a better strategy for our reader than trying to time the market

Jane is 53 and self employed. She is aiming to save at least £33,000 for each of her two children within the next five years to cover university costs or deposits to buy a home. Her long-term goal is to save for her own retirement, looking to substantially beat cash interest rates by investing selectively.

She has an income of around £39,000 a year, about half of which she puts into savings and investments. Her home is mortgage-free and she has no debt, and in addition to her portfolio she has pensions worth around £123,000.

"I intend to work until my late 60s, but my husband may retire in the next few years - if he can persuade me it's a good idea," says Jane. "I won't access my pensions and portfolio for the next 10 to 12 years, but when I retire I plan to buy a smaller house with large garden and orchard, and have a whale of a time indulging children and grandchildren as I grow old!

"I have been dabbling for 20 years, and been a keen investor for the past 10. I'm getting to that rather wonderful point where my month's capital gain on my portfolio and pension occasionally exceeds my income - over the past 10 months my portfolio is up by £8,214.

"I've got five years to hit my minimum £33,000 savings target for my second child, but I'm confident I'll achieve that easily. I may transfer my second child's child trust fund (CTF) into a junior individual savings account (Isa) soon, as the returns on the CTF are low.

"I would say that I am generally a contrarian investor, buying on dips in the market - I'll invest £7,000 or so at the next wobble. I'm a fan of [high profile investor and entrepeneur] Jim Mellon and he is probably my biggest single influence.

"My overall attitude to risk is medium. I would be prepared to lose up to 5 per cent a year, although with my children's portfolios it is rather lower as they have shorter timeframes

"I now tend to buy fewer shares and hold more funds, as I was spending at least an hour or two a day researching companies and watching for trends. I think my portfolio is due an overhaul, and that I should possibly reduce a few holdings that represent a large portion of it.

"I put £2,020 into each of Woodford Patient Capital Trust (WPCT) and Baillie Gifford Japanese Smaller Companies fund (GB0006014921) in February. I have also recently bought a further 300 shares in Stobart (STOB).

"I am considering investing in Just Eat (JE.), and putting more into the UK and developing economies in the next few years as I think European politics will get increasingly rocky."

 

Jane's portfolio

Holding Value (£) % of portfolio
British Land (BLND)6,0855.21
Carr's (CARR)3,8403.29
Condor (CNR)1840.16
KCom (KCOM)3660.31
Manx Financial (MFX)5400.46
McCarthy & Stone (MCS)2,9632.54
Polo Resources (POL)3880.33
Randall & Quilter (RQIH)1,4431.24
Saga (SAGA)7440.64
SalvaRx (SALV)5710.49
Stobart (STOB)1,1230.96
Woodford Patient Capital Trust (WPCT)2,0431.75
Old Mutual Global Equity (GB00B1XG9821)19,14316.39
Liontrust Sustainable Future Absolute Growth (GB0030029622) 2,5012.14
Baillie Gifford Japanese Smaller Companies (GB0006014921)2,0301.74
Fidelity Japan Smaller Companies (GB00B73VMD59)1,7771.52
Fidelity Multi Asset Allocator Strategic (GB00BC7GX947)9740.83
Fidelity UK Opportunities (GB00BH7HNY76)7,6936.59
Fidelity UK Smaller Companies (GB00B7VNMB18)14,49012.41
HSBC Japan Index (GB00B80QGN8)3,0152.58
Threadneedle UK Smaller Companies (GB00B8SWL553)3,6253.1
Aviva CF Woodford Equity Income (GB00BM4P6T59)13,14511.26
Premium bonds16,10013.79
Cash12,00010.28
Total 116,783

 

First child's portfolio

Holding Value (£) % of portfolio
Old Mutual Global Equity (GB00B1XG9821)6,22117.63
Baillie Gifford Corporate Bond (GB0005947857)3,5139.95
Fidelity Asia (GB0003879185)2,8077.95
Fidelity Global High Yield (GB00B7K7SQ18)2,4366.9
Fidelity Moneybuilder Dividend (GB00B3LNGT95) 3,3549.5
Fidelity Moneybuilder Growth (GB00B6840Q15)5,55415.74
Fidelity UK Smaller Companies (GB00B7VNMB18)2,0395.78
NS&I Children's Bonds 4,39012.44
Cash4,98014.11
Total 35,294

 

Second child's portfolio

Holding Value (£) % of portfolio
NS&I Children's Bonds 2,10512.46
Child Trust Fund 14,55986.18
Cash2301.36
Total 16,894

 

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THIS READER'S CIRCUMSTANCES.

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

The problem with your strategy of buying on dips, is that we can never tell what is just a dip and what is the start of a deep bear market. Investors who bought on the 'dips' of early 2000 or late 2007 would have suffered big losses as the market fell further.

So rather than look for dips, you should look for genuine cheapness. One perhaps under-rated indicator here is investment trusts' discounts to net asset value (NAV): big discounts, relative to the trusts' own history, can be a sign that an asset class is unjustly out of favour.

In one sense, though, the composition of your portfolio doesn't matter much. Your relatively long time horizon and the fact that you save so much means that it represents only a small fraction of your likely future wealth: on current trends, you'll save three times as much as you have in this portfolio now.

A big question, therefore, is what to do with these savings. I'd consider making monthly direct debit contributions into an Isa, perhaps invested in a global tracker fund. Doing this is not only a useful discipline that protects you from errors of judgment, but also a form of structured buying on dips. Each £100 buys you more shares the lower the market is, so you buy more when the market is cheapest without needing to think about it.

 

Patrick Connolly, certified financial planner at Chase de Vere, says:

I agree with your approach of keeping separate cash savings, including Premium Bonds. Everybody should have accessible cash to cater for any short-term emergencies.

However, I think you are missing a trick by reviewing your Isa and shareholdings but not your pension, especially as this is worth more. You should treat pensions and Isas simply as tax-efficient wrappers, and look at an overall investment strategy combining both.

There is sense in buying on market dips as too many people jump into investments when markets are already riding high. However, an easier approach, which would negate the risks of market timing, would be to invest regular monthly premiums.

You appear to be on track with your plans for both children. Your first child has a good mix of investments, although you should review your second child's CTF investments.

Your own Isa and share portfolio is quite high risk, and this might be a concern as you are only prepared to lose 5 per cent in a year. This could be all right if you have a more diversified pension fund. However, if not, then you need to be aware that your holdings are likely to be highly correlated, so your portfolio could fall quite significantly if markets come down.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

This portfolio has quite a few speculative stocks. Of your direct holdings, only perhaps KCom (KCOM) is moderately defensive. British Land (BLND) has been, but I wonder whether it and other property companies will hold up if we see a serious downturn in traditional retailing of the sort the US is experiencing.

This poses the question: what are the counterweights to this risky stance?

One, of course, is diversification, and you are spreading some of your shares' idiosyncratic risks simply by holding eleven of them. This, however, means you are taking on market risk: it's a brute mathematical fact that diversification spreads stock-specific risk, but in doing so increases your exposure to the general market.

This exposure is magnified by your biggest holding, Old Mutual Global Equity Fund (GB00B1XG9821). What exactly does it offer that a global tracker fund doesn't? And it has a higher fee.

Also, by holding smaller companies funds you are taking on cyclical risk - an economic downturn would hurt these more than most. This risk might well be worth taking in the short run, as the outlook for the world economy looks okay. But this won't remain the case forever.

Among your equity holdings the main offset to these risks is Aviva CF Woodford Equity Income fund(GB00BM4P6T59). Many regard this as a bet on a star fund manager. I'd rather see it as a bundle of defensive stocks, and history tells us that these as opposed to more speculative plays have tended to outperform over the longer term.

Defensives, though, are only relatively defensive. They would fall if the general market falls - just not as much. You should ask therefore whether your cash holdings are significant enough to cushion you in the event of a big fall.

 

Patrick Connolly says:

I don't think you need to hold individual shares, of which you have 11 worth £18,000 in total, compared with 11 collective funds worth £70,000. This means you are likely to be spending a disproportionate amount of time on the shares, which only account for about 15 per cent of your portfolio.

You have Just Eat on your watchlist, but this share has risen around 170 per cent since August 2014 and 50 per cent in the past year, so you would be investing after impressive gains have already been made.

I've no problem with the funds in your portfolio, although these are predominantly focused on equities. You also have small amounts in some funds and a sizeable overall weighting in smaller companies funds. Smaller companies have the potential to outperform, but are also more volatile than larger companies.

You could sell your individual shares and use the proceeds to diversify your portfolio by investing in funds such as Jupiter Strategic Bond (GB00B4T6SD53), Rathbone Ethical Bond (GB00B77DQT14) and M&G Property Portfolio (GB00B8FYD926) within your Isa.

You could sell the Liontrust Sustainable Future Absolute Growth (GB0030029622), Fidelity Japan Smaller Companies (GB00B73VMD59) and Fidelity Multi Asset Allocator Strategic (GB00BC7GX947) funds, and get exposure to Asia and or emerging markets by reinvesting in Schroder Asian Alpha Plus (GB00BDD27J12) or JPM Emerging Markets (GB00B1YX4S73).

You have some exposure to Europe through Old Mutual Global Equity and shouldn't be put off adding more, as Europe boasts many excellent companies that earn a large proportion of their revenue outside of the eurozone.

 

Andrew Rees, investment manager at EQ Investors, says:

With an investment horizon of 10 to 12 years, having a high weighting to equities in your own portfolio makes sense, but I think you would benefit from having more diversification across asset classes. Your portfolio is heavily concentrated in equities, which offer very little downside protection, and are inconsistent with your annual capacity for loss of 5 per cent.

You could look to address this by switching around 20 per cent of your portfolio into alternative asset classes such as fixed income, which should help reduce sharp falls in its value if there is a market sell-off. For fixed income funds, TwentyFour Asset Management [which runs funds including MI TwentyFour AM Dynamic Bond (GB00B57TXN82)] is one of our preferred providers.

As you are a contrarian investor who likes to invest during market dips, perhaps look to buy investment trusts instead of open-ended funds. These can often trade at significant discounts to their NAV when their sector, style or region is out of favour.

If you wish to maintain your Alternative Investment Market (Aim) exposure then you may be interested in the recently launched Downing Strategic Micro-Cap Investment Trust (DSM). Its manager, Judith MacKenzie, uses private equity-style due diligence to select publicly listed UK smaller companies, and pro-actively engages with the managements of the companies she holds to add value and reduce risk.

Fees are a large detractor from returns and the average ongoing charge of your active funds is relatively high. As an alternative, consider building a core of tracker funds in efficient markets such as the UK and US - perhaps accounting for two-thirds of your portfolio - and then select a number of satellite specialist funds or managers that you have conviction in to complete your portfolio. Keeping an active mandate for regions where a fund manager can add real value, such as emerging markets, also makes sense.

The diversified asset allocation within your first child's investment portfolio is compatible with the shorter time horizon. However, the average cost of the funds in this portfolio is expensive. But using a core/satellite approach, as explained above, should ensure you are getting the most for your fees.

If you decide that this portfolio is to help with university costs, then I would recommend de-risking it further the closer you get to withdrawing from it. The last thing you want to do is have to sell down the portfolio when markets are volatile and at depressed values.

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