Fifty-three-year-old Richard McGregor-Cheers wants to build a fund of £350,000 in his Sipp by the time he expects to retire at the age of 68. He has decided to take a long-term view and invest in high-risk, volatile equity funds covering a wide selection of geographical locations and sectors. This includes emerging markets, UK smaller companies and gold and precious metals mining funds. He is making monthly contributions of £100 to this portfolio. He says: "I believe that my investment approach is extremely risky, but do have time on my side to ride out major fluctuations in the global equity markets in future years. I do, however, intend to reduce my exposure to high risk and highly volatile funds in the final two to four years before retiring by investing in low-risk funds."
High-risk Sipp
Long-term growth
| Name of share or fund | Number of shares/units held | Price per unit | Value £ |
| Aberdeen Emerging Markets A Acc | 1,740.20 | 499.67p | £8,695 |
| Baring Global Emerging Markets I GBP Acc | 2,685.43 | £19.59 | £52,607 |
| BlackRock Gold & General A Acc | 2,115.77 | 1,194p | £25,262 |
| Fidelity South East Asia | 261.748 | 655.3p | £1,715 |
| First State Global Emerging Markets Leaders A Acc | 5,131.01 | 359.41p | £18,441 |
| Invesco Perpetual Asian Acc | 1,554.29 | 355.12p | £5,519 |
| INVESCO Perp Latin American | 668.5787 | 158.42p | £1,059 |
| Jupiter India Acc | 3,893.30 | 56.66p | £2,205 |
| Marlborough Special Situations Acc | 3,031.15 | 655.53p | £19,870 |
| Threadneedle Latin American Retail Net GBP Acc | 943.4825 | 264.57p | £2,496 |
| TOTAL | £137,869 |
Price and value as at 11 May 2012
Chris Dillow, Investors Chronicle's economist says:
You say you want this fund to grow to around £350,000 over the next 15 years. This seems to me a reasonable expectation. It implies an annual nominal return of 6.4 per cent, ignoring the contributions you make, which is reasonable for a risky portfolio.
Instead, there are two problems. One is that you intend to reduce your risk exposure in the final years. This is wholly sensible. But it means that you need higher returns before then; to get to £350,000 in 11 years you need an average annual return of 8.8 per cent, which is optimistic.
My second problem is that I fear you misperceive the source of high returns in emerging markets. You say you expect "impressive" growth in Latin America and "amazing" growth in India. But this runs into a problem: strong economic growth does not mean high equity returns. Across countries, for various time periods, the correlation between growth and equity returns is, if anything, negative. One reason for this is that investors anticipate economic growth and so embed it into share prices in advance.
The reason to expect high returns on emerging markets has nothing to do with their likely economic growth. Instead, it is that such markets are risky, and high risk should mean high expected returns.
But, of course, there's a downside to high risk. It means that, even over long periods, there's a danger you'll do badly. For example, MSCI's index of emerging markets did not return to its January 1994 peak until mid-2005. That's 11 years of being under water.
We can, roughly, quantify this. The annualised standard deviation of sterling returns on emerging markets since 1987 has been just over 25 per cent. This implies that if we assume expected returns of 6.4 per cent a year then, over a 15-year period, there is a just over one-in-five chance of you falling £100,000 short of your £350,000 target.
I don't say this to say that you're wrong to take so much risk; that’s a matter of taste. I do so to suggest a way of checking whether your portfolio really matches your risk appetite. If you’re content with a one-in-five chance of falling £100,000 short, then fine. If not, then you should scale back your hopes and switch to less risky assets.
You are concerned that Aberdeen Emerging Markets fund has closed to new investment as optimal fund size has been reached. Yes, there is a risk of it not doing as well in future as it has recently, but this is largely because it’s done so well recently and history suggests that, over longish periods, good (risk-adjusted) fund performance does not persist.
Equally, though, the chance of significant underperformance is low, simply because funds’ tracking error (the volatility of relative performance) is not huge. For example, over the past three years the average emerging market fund has returned 50.1 per cent, but the tenth percentile fund (the one which 90 per cent of funds outperform) returned 34 per cent. That’s underperformance of only 16 percentage points. This is small, relative to the volatility of emerging market equities generally.
In this sense, you should worry more about the underlying asset allocation than the funds you are using.
Keith Bowman, equity research analyst at Hargreaves Lansdown, says:
While we complement you on your commencement of a pension plan, we would express our concern in relation to your current expectations. We calculate that in real inflation-adjusted terms, it will be very difficult reaching that figure of £350,000 in 15 years' time. Adjusting for inflation and assuming 7 per cent investment growth per annum, we would estimate a pension fund of around £247,000 in 15 years' time. This takes into account the current near-£138,000 established fund and ongoing £100 per month contribution.
Given this, you might want to consider increasing your contributions. Clearly if your chosen funds achieve a higher growth rate then our estimate, you will reach your target sooner. In order to achieve your target pension fund in actual monetary terms, not adjusting for inflation, we estimate that you will need to make a monthly contribution of well over £500 a month. You can use the pension calculator at http://www.investorschronicle.co.uk/your-money/tools-and-calculators to obtain a pension projection.
As for your current pension portfolio, it is clearly of a higher-risk nature. Except for the Marlborough Special Situations fund, most of the portfolio is pointing in the same direction - to emerging markets. Even the BlackRock Gold and General fund is linked in to the emerging markets. We would question this ultra-aggressive approach. It could prove to be a spectacular success, or it might significantly disappoint.
With regard to the actual funds held, we would generally highlight no major concerns. However, on a more standardised and lower-risk investor basis, the existing portfolio does lack balance. Room to inject what we would regard as more core holdings in the UK equity income arena such as the Invesco Perpetual Income fund or the PSigma Income fund clearly exists.
