A well structured portfolio with 18 holdings

ANONYMOUS READER'S PORTFOLIO

Source: Investors Chronicle & *Yahoo Finance

Notes: Prices and value as at Wednesday 9 October. 1 USD = £0.63, 1 DKK = £0.11, 1 euro = £0.85.

Portfolio split: £100k Isas, £230k Sipp and £20k VCT/EIS

LAST THREE TRADES

Halfords (sell), IBM (buy), JEMI (buy)

WATCHLIST

Procter & Gamble, Heineken, RIT Capital Partners

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

You have sensible ideas about diversification. With a caveat that I'll come to, 15-20 holdings is a decent number of holdings of individual shares to have. It's sufficient to spread risk - especially with as broad a selection as you have - but not so much as to dilute individual returns so severely that you have merely a tracker fund.

I also like your attitude to funds, using them to do what you can't do yourself. I also like that you're holding an investment trust and an exchange traded fund (ETF), and so are mostly shunning higher-cost unit trusts.

You wouldn't expect me to like everything, though. I have some quibbles here. One is about your interest in emerging markets. You say the long-term economics are "attractive". Perhaps they are, perhaps not. But it doesn't matter. The cross-country evidence shows that there's no link between longish-term GDP growth and equity returns. This might be because investors anticipate growth, or because growth benefits new companies or overseas ones more than incumbents. Whatever the reason, you shouldn't hold emerging markets because of their growth potential.

I stress this because there might be a different reason for their good performance in recent years. It's that such markets benefit from loose global monetary policy. This poses the danger that when the Fed finally does start to tighten policy, emerging markets might suffer.

You say that "economic theory says that sustained outperformance isn't sustainable". It is - but only if you take above-average risks. I fear that emerging markets risk has paid off recently, but might not continue to do so.

Although your general stock-picking philosophy is a mainstream one, I'm sceptical about it on several grounds:

■ You can't really be a long-term investor and look for sustainable business models. This is because a major threat, in the long run, to even the mightiest companies is that technical change will hurt them. Nokia and Polaroid once looked as if they had Buffettian moats. But even the deepest moat can't protect a company if it is on the wrong side of Schumpeter's creative destruction. A portfolio that "looks after itself" can only be a tracker fund, not a few stocks.

■ Everyone's looking for high profits, good cash flow and rising dividends, so these will often come at a high price - and high prices mean low subsequent returns. The question to ask of any stock that you think looks like a bargain is: why are other investors avoiding this? 'Because they haven't done my research' is a poor answer. Better answers would be to find a cognitive bias which is causing them to underprice the stock (there are plenty of candidates) or to find a risk factor which causes them to avoid the stock, but which you are happy to expose yourself to. Remember - thousands of people have tried to replicate Warren Buffett's methods and most have failed. That tells us something.

■ Research shows that most fund managers have only half a dozen good stock ideas, and they fail to do well because they must dilute these good ideas with some poor ones. What makes you think you have more good ideas? Is there a case for concentrating your holdings, and using a tracker fund to diversify out of them?

That said, let's remember the big picture. If you can get 5 per cent annual real returns - which might be only slightly on the ambitious side - you will double your money in 15 years' time. On current annuity rates, this will buy you a joint life income of around £34,000, in today's prices. If annuity rates rise, as I and the market expect, you'll do even better.

Is this income too low? If it is, could you top it up by saving, or by reducing your likely future outgoings, or by using your home equity - say, by trading down when the kids have grown up? It's only if these alternatives are unavailable that you need to worry about beating the market over the long term. As you say, rule number one is: "don't lose money". And that means not being overly ambitious.

Helal Miah, investment research analyst at The Share Centre, says:

At the higher level, it's nice to know that you are making the most of Isas, Sipps and other tax-efficient wrappers. In the 20 or so years until your retirement, these wrappers will become ever more important as your portfolio grows.

You sound like an investor who has done his research. Financial theory and a number of studies have suggested that 20 or so stocks is generally enough to attain a satisfactory level of diversification with specific risk to almost be eliminated. Each additional stock added to the portfolio after this is only marginally beneficial in terms of diversification and as you say can lead to an unwieldy portfolio.

Given your age, you have a fairly long investment horizon and therefore the overall focus of the portfolio should be towards capital growth, and to a certain extent it is. You have the exposure to small-cap stocks, or more likely micro-caps, through the VCT and EIS schemes and certainly your emerging markets investments should be growth focused. However, some of your larger share holdings cannot be viewed in the same way. Tesco, your largest holding, is in a sector that we view as having limited opportunities. Competition for food and drug retailers is fierce and market share is being won through discounting, which is limiting margin expansion. However, this is a business that will deliver a steady dividend and has a strong online presence. Vodafone (VOD) is another example where growth may be limited. Following the announcement of the Verizon deal, we now question its increased reliance on Europe and whether the business going forward will be able to replace the strong cash flows that we have enjoyed through another acquisition.

However, I believe that every portfolio should have some core stocks that generate strong cash flows and provide a degree of stability and the two mentioned above along with Apple (AAPL: NSQ), HSBC (HSBA), IBM (IBM: NYQ) and Microsoft (MSFT:NYQ) are a nice fit. These companies are also brand leaders in their respective fields and will probably continue to be so for years if not decades to come, which is not a bad thing.

I would also agree with some of your value and recovery picks. Taking BP (BP.) for example, while the media still focuses on its past, investors should look forward to a leaner operation with good prospects from its Russian partnership. Aviva (AV.) is another business that has restructured, disposing of non-performing businesses in Europe and once again looking forward to improving earnings and cash flow to investors.

Your asset allocation, excluding the other assets you have outside of this portfolio such as property and cash, looks relatively good. However, your cash balance here may be a little large, earning you very little interest. You may want to consider beginning to bring in an element of bond or fixed-interest exposure with this cash and very gradually build this up over time. Yields here aren't great at the moment but should certainly beat cash. I would suggest investing in these through funds to begin with for the same reasons that you picked investing in emerging markets and Asian through funds over direct stocks.

With a UK exposure of 50 per cent, US at 17 per cent, Europe at 10 per cent and Asia and emerging markets at 9 per cent, along with an exposure to mid- and small-cap stocks, I think this allocation is reasonable for a UK-based investor. And, like you have already mentioned, most of the companies you have invested in are international in nature anyway.

In terms of sector allocation, there is a lot of focus on technology stocks and where I think the portfolio could be lacking a little is exposure to other cyclical sectors, such as the miners - a large diversified one such as BHP Billiton (BLT) - and engineers, or possibly even a general retailer.