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Young investor has good core/satellite strategy

Our 24-year-old reader has made a strong start with a well-thought-out investment strategy. But he can do even better.

Steven is 24 and has been investing for one year. He says: "I aim to gradually build a portfolio over the long term that will allow me to enjoy a comfortable retirement with the ability to help children out with house deposits and university fees as and when required.

"I have created a core portfolio of funds, which are invested on a regular savings plan, around which I aim to buy individual companies as and when the opportunity arises. I am hopeful that this strategy will see my portfolio grow over the long term, with the power of compounding returns showing as time passes.

"As it is still early days, I am low on capital, and dealing charges are eating significantly into any returns on direct holdings in company shares. However, at this stage I am viewing the shares I hold as more of a learning experience, despite being hopeful that some will prove profitable in the long term.

"I am a fan of 'value investing' and, provided that the potential returns on offer justify the level of risk, I am willing to be fairly adventurous within my portfolio. Due to the long timescales I am working to, it should be relatively easy to see out any short-term volatility, reaping the long-term benefits down the line.

"I would be very interested to know what your experts consider the strengths and weaknesses of my portfolio, particularly in my core fund holdings, and if there are any ways I could improve my chances for long-term growth."

Reader Portfolio
Steven 24
Description

Funds and direct shares

Objectives

Comfortable retirement and help children

 

STEVEN'S PORTFOLIO

Name of share or fundNumber of shares/units heldPriceValue
'Core' fund portfolio 
Legal & General International Index Trust C Acc (GB00BG0QP604)481.85692.36p£445
BlackRock Emerging Markets Equity Tracker H GBP Acc (GB00BJL5BW59)355.261117.1p£416
BlackRock Japan Equity Tracker H GBP Acc (GB00BJL5BZ80)256.881118.7p£304
CF Lindsell Train UK Equity D Acc (GB00BJFLM156)249.825116.38p£290
Old Mutual UK Mid Cap R Acc (GB00B1XG9482)200.144196.37p£393
Baillie Gifford Corporate Bond B Acc (GB0005947857)141.712186.6p£264
Invesco Perpetual Tactical Bond X Acc (GB00BJ04K711)98.45208.14p£204
Threadneedle European Select Z Acc (GB00B8BC5H23)194.3059144.49p£280
Pictet Water I Inc (LU0448836600)1.39188£190.88£265
Individual Shares 
Henry Boot (BHY)141218.78p£308
HSBC Holdings (HSBA)48582.5p£279
Inland Homes (INL)85565.18p£557
Keller Group (KLR)411029.7p£422
Moss Bros Group (MOSB)307101p£310
Paragon Group of Companies (PAG)49423.2p£207
Tesco (TSCO)104241.9p£251
Pension 
Legal & General (PMC) UK Equity Index Fund 31475.2712479.2p*£36,574
TOTAL£41,769

Source: Investors Chronicle and *Trustnet as at 4 March 2015

 

THE BIG DECISIONS

Chris Dillow, Investors Chronicle's economist, says:

It is impossible to get all investment decisions right: the mere fact that the future is unknowable means that mistakes are inevitable. However, you have got the big decisions correct in three ways.

First, you've started investing young. This means the strongest force is with you - the power of compounding. It's difficult to grasp intuitively just how important this is, so here's a simple example. If you invest £1,000 a year for 30 years with a real return of 5 per cent per year (a reasonable assumption for equities) you'll have £66,439 after 30 years. If you invest for 25 years, however, you'll have just £47,727. That's a difference of £18,712 for an extra £5,000. In effect, your first £5,000 has earned you a return of 170 per cent.

Secondly, you're investing a lot in trackers. These minimise fees - which also compound over time. And history shows that they outperform most actively managed funds. The best thing a long-term investor can do is to hold tracker funds. Doing so, however, is boring. There is, therefore, a trade-off between good investing and interesting investing.

Thirdly, you're investing overseas. I think this is important for a young person. There's a risk that the UK, or western economies generally, will suffer secular stagnation - a long period of slow growth. If this happens, you'll not only see poor performance on western shares, but also suffer low wage growth or even periods of unemployment. Investing overseas helps diversify this risk away. Emerging markets are attractive not because they offer long-run growth, but because they might avoid the danger of stagnation in the west.

In big-picture terms, then, you're doing very well. But I suspect you can do even better.

 

Ben Yearsley, head of investment research at Charles Stanley Direct, says:

You have the right attitude towards investing, start early with what you can afford as the compounding effect over time can be huge. I also like your strategy - build a core and then add spicier and more specialist investments around the edge. One thing you don't mention is tax-efficiency; although it may not seem important now, it is imperative that you start off on the right footing and invest your capital in an individual savings account (Isa) (as well as the pension that you have) - up to £15,000 can be invested this tax year. As a reminder, Isas shelter any income from further tax and any gain is tax-free, too.

It is interesting that you have adopted a value contrarian stance, rather than an out- and-out growth one that many your age might consider. I am a big fan of being a contrarian, I like buying into out-of-favour companies and sectors. Contrarian and value investing has been a good long-term way of outperforming.

However, this approach means you have to be more active with your portfolio and the monitoring thereof. Once those value areas have come back into fashion you need to be looking for the next areas to invest in. Some of the best investors, such as Anthony Bolton, can be categorised as value/contrarian investors. One issue to consider with contrarian investing, especially if buying into individual companies, is getting caught in a 'value trap'; in other words a cheap company that just remains cheap.

You have a good plan and strategy, I just think it needs a little refining to make the most of it; this is mainly in relation to your fund holdings and how a core-and-satellite approach works.

 

Graham Spooner, investment research analyst at The Share Centre, says:

You have started investing and planning for your future at a younger age than many of your peers. This will significantly increase your chances of achieving your goals in later life and you will potentially be far better placed regarding future decision-making on financial matters over the course of your life.

Your appreciation for higher risk is logical given the longer timeframe. You can afford to take more risk and building up a more diversified global portfolio may be advantageous.

Overall, this portfolio has a strong UK bias and you should be careful not to become significantly overweight in a certain company if you build an individual equity holding and it is also part of the portfolio of a UK fund.

Looking at funds globally gives investors a wider pool to search and more opportunities to reach your growth objective.

It is very encouraging to see that you describe your stock and fund picking approach as "very thorough" and that you are researching and looking at company accounts and coming to your own conclusions without being overly influenced by outside 'hype'.

 

PORTFOLIO IMPROVEMENTS

Core fund holdings

Mr Dillow says:

Do you really need two bond funds? These protect us from many types of short-term equity risks; bonds would probably do well if growth expectations or risk appetite fall. And they also protect us from that stagnation risk. But you're paying a high price for this insurance. Bonds are so highly priced now that their only chance of decent returns would be if stagnation actually materialises. Otherwise you might well lose - and you're paying fees for the privilege. Might not plain old cash be a better way of spreading equity risk?

Secondly, I doubt whether long-term investors should be holding actively managed funds. An additional annual charge of half a percentage point (relative to trackers) means an active fund has to grow by 15 percentage points more than a tracker over 30 years before making you money. But research by Vanguard Asset Management shows that only 18.8 per cent of the UK funds in the top quintile of performance in the five years to 2007 were in the top quintile in the following five years. That's less than you'd expect from chance.

 

Mr Yearsley says:

I'm not sure what your aim is with the fund portfolio. I'm a fan of active over passive management, if the time is taken to choose the managers in the first place and stick with them. You look as though you are using the trackers as a core of the portfolio - but, if that's the case, why double up and have an international tracker and then buy individual country/regional ones; why not either go international then buy active satellite funds or buy regional trackers with active satellites?

Looking at the non-passive funds, I don't see the point of a corporate bond fund at the age of 24 - it isn't a contrarian bet, either - but there is nothing wrong with the bong funds you have chosen.

Turning to equity funds, Old Mutual UK Mid Cap (GB00B1XG9482) is a good fund, as are the other active funds, Pictet Water (LU0448836600) and Threadneedle European Select (GB00B8BC5H23). I'm not sure Pictet Water is a value opportunity, though.

Europe fits into the contrarian play - I have personally been topping up Jupiter European (GB00B5STJW84) and Henderson European Focus (GB00B54J0L85) recently, which are two of my favoured European funds.

CF Lindsell Train UK Equity (GB00BJFLM156) is an excellent long-term core holding; it is focused, although the fund's manager Nick Train pays little attention to valuation. I would look to add a fund such as JO Hambro UK Dynamic (GB00BDZRJ101), which does like buying into out-of-favour companies.

 

Mr Spooner says:

You have diversified exposure in terms of asset class – including both equities and bonds, which reduce the risk and volatility across the portfolio. The use of trackers for overseas markets is a sound and logical approach whilst your knowledge is growing.

Exposure to the emerging markets via the tracker fund can be seen as being a contrarian investment, given the volatility in these markets. Given your longer term investment horizons, and demographic changes within many of the countries within these regions, such an investment should prove beneficial. The inclusion of the Pictet Water fund, brings an element of investment specialism to the overall portfolio which can be seen as adding a ‘satellite’ approach to the overall portfolio, albeit this does then bring an added element of risk given the sector specific risk.

 

Satellite

Mr Dillow says:

Be careful about your expectations for your individual shares. By all means regard these as shortish-term flutters, or as an interesting pastime: pitting your wits against 'Mr Market' can be fun and even if you lose you should learn something interesting about either yourself or the market. Do not, however, expect these to be long-term growth stocks which will last you 30 years.

I say this simply because long-term growth is largely unpredictable. Take for example, the original members of the FTSE 100 - those that were in the index when it was formed in 1984. Many of these no longer exist: have you heard of Exco, Sedgwick, or Harrisons and Crossfield?

If the next 30 years is anything like history, a lot of stock market growth will come from companies that don't yet exist.

And even the tiny minority of stocks that do grow over the next 30 years will probably have long periods of underperformance. Apple, for example, lost its investors two-thirds of their money in the mid-1990s.

 

Mr Yearsley says:

I like having a mix of shares and funds, however I do think you need to have about 20 shares to have a decent spread and a reasonable amount invested - as you have rightly pointed out, the costs are high when you deal in low amounts. Finally, you have clearly bought the individual shares on the basis of them having a tough time - just be aware of the value trap comment I made earlier. Has the share price plummeted for a reason?

 

Mr Spooner says:

As your stockpicking is a "learning experience", at this stage I wonder if a practice account may enable you to build up your knowledge and experience, without exposing yourself directly to the whims of the market and the charges involved in dealing. We certainly don't want to put you off buying individual shares, rather suggest that perhaps you concentrate on building up your fund holdings, while at the same time growing your knowledge.

IMPORTANT NOTE

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