A Sipp portfolio with principles to admire

DAVID GAYNOR'S SIPP PORTFOLIO

Source: David Gaynor

LAST THREE TRADES

Developed World Property ETF (Sell), Primary Health Care Properties (Sell), M&G High Income Investment Trust (Buy)

WATCHLIST

International Biotechnology Trust, Assura Group

Chris Dillow, the Investors Chronicle's economist, says:

There's so much to admire about this portfolio and the principles behind it. I like that you're well aware of the importance of minimising taxes and charges; not giving money away is a good way to protect your capital.

I like the decent weightings in tracker funds and in defensives (which include infrastructure funds); the latter, remember, tend to do better than they should over the long run.

I like, too, your awareness of the huge distinction between holding bonds and holding them to maturity; only the latter protects you from price risk, although it still exposes you to inflation and credit risk.

I also like the fact that you know you can create your own dividends simply by selling stocks; too many investors think they must buy income stocks if they want an income, oblivious to the fact that such stocks often offer a high yield only as compensation for poor growth prospects or high risk.

I like, too, the fact that, although you dislike cash for its negative return - don't we all - you have a decent holding in your Isas; there's always a case for some cash, as I'll come to.

Finally, I like that you review the portfolio annually. This avoids the dangers of rebalancing your portfolio too much, which not only incurs dealing costs but also the danger that your decisions will be distorted by short-term noise about the markets.

What's more, I see no great problems with your expectations. Returns of 3 per cent a year in real terms seem reasonable, as do your drawdown expectations, which are equivalent to just over 6 per cent of this portfolio's current value.

So, what can I quibble about? Two things.

First, I'd warn that the equity components of this portfolio might not be as well-diversified as they seem. This is not because of any failure on your part, or on the fund managers' part. It's simply because any reasonable basket of shares will tend to rise and fall with the global market. This means that if the general market does badly, you'll lose not just on your tracker funds but also on your investment trusts, your equity income funds and even on your commercial property trust; the latter has a high correlation of annual returns with some of your mainstream equity fund holdings, simply because property shares are shares.

Secondly, we should look more sceptically upon so-called wealth preservation funds. You note - rightly - that these offered no protection when the market fell in late May. There's a reason for this. Such funds comprise a mix of equities and fixed income; Standard Life's Gars has around two-fifths in shares and Trojan around a third. This mix has for years been reasonable, because bonds and equities have been negatively correlated so losses on one have often meant profits on the other. In May, however, this correlation broke down. Bonds and equities both did badly, because both suffered due to fears of the Fed reducing quantitative easing.

My concern is that this episode was not merely a one-off but perhaps the start of a period in which bonds and equities might be more correlated; this could be because of continued exposure to a normalisation of policy; or because of a return of duration risk; or because of the effects of the diminution of China's savings glut. If I'm right, then it's going to be harder to preserve wealth merely through a mix of bonds and equities, in which case absolute-return funds will find the going tougher. Given that you already have a good mix of bonds and shares, you might ask whether you need such funds.

But this poses the question: if bonds and equities do become more correlated, how can we preserve wealth in bad times? The answer's simple: cash. Your cash Isas might be more use than you think.

Patrick Connolly, a Certified Financial Planner with Chase de Vere, says:

You have taken a sensible approach to your finances and I agree with many of the decisions and assumptions you have made.

It seems reasonable to have around 50 per cent of your portfolio exposed to risk assets and 50 per cent in more defensive assets, assuming this meets your attitude to risk. As you are planning to remain invested, assuming you are in good health, there is no need for a wholesale move to safer investments.

I am a little wary of having too much exposure to individual corporate bonds, as there is no protection from the Financial Services Compensation Scheme (FSCS). You do have small amounts in most of these, which negates much of this risk. However, you have more than £50,000 in National Grid inflation-linked bonds. While National Grid should be a safe organisation, the same was thought previously about the UK's high-street banks and Lehman and Marconi for that matter, so there are no guarantees.

You have about £130,000 in exchange traded funds (ETFs). We are happy to use ETFs providing they adopt a full replication approach and aren't reliant on counterparty risks and are invested in liquid markets so there are no problems meeting redemptions. There are potential liquidity risks in fixed-interest markets, although your investment in short-duration bonds shouldn't, in theory, encounter any issue.

I also agree with you that there is a strong argument for using passive investments in efficient markets such as large-cap UK and US equities. In these regions, active managers often struggle to outperform and investors pay more for the privilege.

Infrastructure investments have proved very popular in recent years. A significant proportion of the returns come from income, which is attractive to many investors, especially if they are struggling to generate income from other assets.

However, while infrastructure is seen as a defensive play, it would be wrong to assume that investments are without risk. There can be risks related to the construction and operation of infrastructure assets and the potential of economic, regulatory or political risks, all of which could have an impact on returns. I agree with you that investment trusts are likely to be the most effective way to get exposure to infrastructure projects.

While I broadly agree with your approach, you do have 35 separate holdings and this could become unwieldy, especially if you don't have the time or inclination to continue giving your portfolio a great deal of attention.

I would question how you have divided your portfolio, with some investments split by asset class, such as corporate bonds or infrastructure, and others by investment wrapper such as ETFs and investment trusts. For example, the M&G High Income IT could arguably sit alongside your equity income Oeics or FTSE 100 ETF more than it does with Aberdeen Asia Smaller Companies or Biotech Growth Trust in the investment trust holdings.

I would also question your approach to rebalancing. While I advocate rebalancing, it works best when profits are taken from the assets that have performed best and reinvested in those that have performed worst, maintaining an overall asset allocation structure.

You say that International Biotechnology Trust is on your watchlist. This has already risen by 96 per cent in the past two years and so you'd have to question if now is the right time to buy and how this would work from a rebalancing perspective.

However, overall you are doing a good job. I'd suggest reducing the number of holdings, making sure they are grouped with similar assets and then rebalance regularly by asset class, taking profits and reinvesting into underperforming areas.