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Portfolio in need of a drastic deep clean

Our experts tell this 76-year-old investor how to consolidate his eclectic mix of 57 investments.

Keith is 76 and has been investing for 60 years, accumulating a portfolio worth £186,000 spread across 57 holdings in direct company shares and investment funds.

He says: "To cover my living expenses, I do not need anything because I have a surplus of income over expenditure. However, the income to be generated from the portfolio is 5 per cent, which will include income generated from selling down growth."

"I never accept tips at face value because I believe public sentiment is an important aspect of a trading decision."

Keith has £43,000 in cash in his investment portfolio, plus £30,000 cash in individual savings accounts that he intends to invest.

Reader Portfolio
Keith 76
Description

Shares and funds

Objectives

5 per cent income

 

KEITH'S INVESTMENT PORTFOLIO

HoldingValue%
3i Group (III)£2,4421
Aberdeen Asian Income (AAIF)£2,1581
Alliance Trust (ATST)£2,6311
Aviva (AV.)£3,8722
BHP Billiton (BLT)£1,6571
BP (BP.)    £4,8843
BT Group (BT.A)£2,5481
Balfour Beatty (BBY)£2,3321
Barratt Developments (BDEV)£3,3972
BlackRock Commodities Income Investment Trust (BRCI)£1,4951
CQS New City High Yield (NCYF) £2,2711
Carillion (CLLN)£3,3742
Centrica (CNA)£1,8141
City Merchants High Yield (CHY)£2,7091
Dunedin Income Growth Investment Trust (DIG)£2,2961
Edinburgh Dragon Trust (EFM)£2,7772
F&C UK Real Estate Investments (FCRE)£4,5212
GlaxoSmithKline (GSK)£2,2601
Greencoat UK Wind (UKW)£2,5221
HSBC Holdings (HSBA)£2,2681
Henderson High Income (HHI)£3,6382
Interserve (IRV)£2,3321
Invesco Perpetual Enhanced Income (ILH)£1,7531
Invesco Perpetual Monthly Income Plus Y Acc (GB00BJ04JZ25) £3,2442
JPMorgan Indian Investment Trust (JII) £3,6552
JZ Capital Partners (JZCP)£1,2751
John Laing Infrastructure (JLIF) £3,1342
Lancashire Holdings (LRE)£1,9331
Land Securities Group (LAND)£2,4451
Lloyds Banking Group (LLOY)£2,3121
Marks and Spencer Group (MKS)£4,3412
Merchants Trust (MRCH)£2,6911
Morgan Sindall Group (MGNS)£3,4642
WM Morrison Supermarkets (MRW)£1,7861
National Grid (NG.) £4,3182
Pantheon International Participations (PIN)£2,9442
Phoenix Group Holdings (PHNX)£3,1262
Primary Health Properties (PHP)£3,0082
Royal Mail (RMG)£1,1661
Securities Trust of Scotland (STS)£2,4201
Shires Income (SHRS)£5,1623
DS Smith (SMDS)£2,8212
Standard Life Equity Income Trust (SLET)£2,7781
UBM (UBM)£7620
United Utilities Group (UU.)      £4,8533
Vodafone Group (VOD)£1,5741
William Hill (WMH)£2,8212
Woodford Patient Capital Trust (WPCT)£2,5571
Aviva 83/8% Cumulative Irrd Preference    GB0002114154 £2,8662
Newton Global Income I W Net Inc (GB00B8BQG486)£3,5852
Rathbone Global Opportunities IAcc (GB00B7FQLN12)£2,9022
Schroder Income Maximiser Z Acc (GB00B5B0KM51)£2,9712
Fidelity European Fund W Acc (GB00BFRT3504)£11,3506
Fidelity South East Asia Fund W Acc (GB00B6Y7NF43)£12,0246
Investec Emerging Markets Local Currency Debt Fund I Acc Net GBP (GB00B3TB1H89)  £3,0702
Neptune US Opportunities Fund C Acc (GB00B7K9LQ88) £14,9388
South32 (S32)£1130
TOTAL INVESTMENTS£186,360100

Source: Investors Chronicle

 

INVESTMENT VS ANNUITY

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

You say you want an income of 5 per cent per year from this portfolio, which could come partly from growth as well as yield. This is a reasonable expectation: since 1900 UK equities have given a real total annual return of 5.7 per cent on average, and lead indicators such as consumption-wealth ratios suggest we should see something close to 5 per cent in the next few years.

But you can do better. You could get an income of 5.6 per cent per year, rising in line with inflation, for certain.

I say this because 5.6 per cent, linked to RPI, is the annuity rate for someone of your age.

Of course, annuities have had a bad press lately. But there is a case for at least partially annuitising your portfolio. Doing so protects you from two big risks. One is longevity risk - the possibility that you'll live for a long time and so outlive your wealth. The other is investment risk - the danger of falling share prices. And this is considerable. If we assume as a central case that your portfolio will return 5 per cent a year with a standard deviation of 20 percentage points (your emerging market holdings increase volatility) then there is around a one-in-four chance that you'll lose money over the next five years.

Now, I appreciate that there are good reasons not to annuitise. But there are also bad ones. One is that annuity rates aren't as good as they once were. This, though, is mainly because gilt yields are low. And they are low in large part because investors anticipate weak economic growth and foresee big risks. This is not a climate in which to be confident of high and secure returns on equities. Low annuity rates are not therefore a case for preferring equities.

And, remember, for many investors the alternative to annuities is also a bad deal. If an actively managed fund charges 1 per cent more in fees than a tracker fund but performs (before charges) in line with the market, then it is likely to cost an investor around £600 over five years for every £10,000 invested. This is probably poor value for money compared with an annuity.

Instead, there are two better arguments against annuitising. One is that annuity rates might improve; not annuitising thus gives you a call option on future annuity rates. The other is that you want to leave a bequest. But are these arguments really so strong as to justify not annuitising at all?

 

HOW YOU ARE GETTING IT WRONG

Chris Dillow says:

My one criticism is that this portfolio suffers from a problem that is common with people who have been investing for a long time - that it contains some duplicated assets.

Look at the biggest holdings of Merchants Trust (MRCH). These include HSBC Holdings (HSBA), GlaxoSmithKline (GSK), British American Tobacco (BATS) and Royal Dutch Shell (RDSB). These are also among the biggest holdings of Shires Income (SHRS), Dunedin Income Growth (DIG) and Henderson High Income (HHI). And you have direct holdings in Glaxo and HSBC, too. In this sense, you might be overdiversified; you're holding assets that don't spread risk.

This problem arises because one tends to analyse stocks and funds in isolation. We ask: is this a good asset? And because there are hundreds of shares or funds which, in average times, might beat the market, it is easy to get an affirmative answer to this question and so buy. But we should instead ask: what would this asset contribute to my existing portfolio? This question provides a tougher hurdle. For example, does Shires really do something that Merchants doesn't (or vice versa)? Does Edinburgh's Dragon Trust add much to Fidelity's and Investec's funds? Do they, put together, do anything that Asian exchange-traded funds (ETFs) wouldn't do?

If you adopt this perspective, it might help to simplify this portfolio, without sacrificing performance.

 

James Baxter, a partner at Tideway Investment Partners, says:

Your portfolio is an interesting case study in portfolio construction and investment strategy. It mixes individual shares (c30), bond securities (1), investment trusts and open-ended funds (c30 combined). The investments span what might be loosely described as high-yield bonds, property, infrastructure, UK equity growth and income, and global equity growth.

The lack of any gilt or lower-risk corporate bonds will have served you well in 2015 to date, although I'm guessing the level of equity exposure generally and Asian and emerging market funds in particular will be providing some excitement of late. Probably bearable if you have been a three to five-year investor in the funds and stocks, less so if they have been acquired more recently.

If you want to own an eclectic mix of investments like this the only way is to do it yourself. That's not to say it's a bad list of investments, there are some great companies and fund managers listed and the logic for buying each one individually is no doubt sound. But as a collection it's hard to see the logic in the portfolio construction that might either control risk, meet specific objectives or provide a performance edge, and these are what professional portfolio managers are charged with doing.

 

To ask some tough questions:

■ As a one-man analyst team how well do you know the 30 individual companies?

■ What's your selection criteria for buying companies and selling them and how does this either control risk or generate outperformance?

■ How well do you know your 30 fund managers and how much overlap is there in holdings from one manager to the next?

■ What is the correlation in performance of these fund choices and do they reduce market-specific risks in any way?

■ What's the basis for your asset allocation and how does it vary over time?

■ What would be the likely downside risk in this portfolio if the S&P 500 sold off 20 per cent, or 40 per cent and are you happy with that given your investment timeframe and planned use of the funds?

The opportunity for DIY investors to hold an eclectic mix of investments, which would not be obtainable from a compliance-restrained professional portfolio manager is probably a more significant opportunity to generate premium risk-adjusted returns than the more obvious cost-cutting on fees. But, to exploit this requires significant regular effort on behalf of the individual combined with discipline and skill.

 

Jason Hollands, managing director, business development and communications at Tilney Bestinvest, says:

Diversification is an important principle when building and managing an investment portfolio, but it can also be taken too far. While there is no hard rule on the number of positions, for investors using pooled funds and investment companies, 20 positions is plenty to achieve risk diversification - beyond that a portfolio can be unwieldy and difficult to monitor properly.

Even full-time fund managers, backed by teams of analysts, might typically hold 50-75 individual stocks. So put bluntly, with 57 holdings, of which around 27 are diversified funds or trusts, your portfolio must be a nightmare to keep on top of and far too many small positions for what is, overall, a decent amount of money.

Yet despite this plethora of individual investments, the asset allocation approach is not great. I don't think any regulated investment adviser in the UK would recommend that a 76-year-old client seeking quite a high level of income in the current climate should be holding 88 per cent of their portfolio in equities or equity funds. And within this there are some notable holes, such as no meaningful exposure to Japan and only a very small position in Europe via Fidelity European (GB00BFRT3504), two of the most interesting developed markets at the moment, where stocks are reasonably valued and their respective central banks are engaged in vast stimulus programmes that should prove supportive to markets. In the case of Japan, the market is also being structurally supported by changes to the asset allocation model of the vast Japanese Government Pension Scheme, which is steering it to invest much more in domestic equities rather than low-yielding government bonds.

 

HOW TO IMPROVE YOUR PORTFOLIO

Jason Hollands says:

You have some decent holdings, including Aberdeen Asian Income (AAIF), Edinburgh Dragon (EFM), Fidelity South East Asia (GB00B6Y7NF43)), Invesco Perpetual Monthly Income Plus (GB00BJ04JZ25) and Schroder Income Maximiser (GB00B5B0KM51) and Standard Life Equity Income Trust (SLET). Greencoat UK Wind (UKW), John Laing Infrastructure (JLIF) and F&C UK Real Estate Investments (FCRE) are also sound investments, especially for income seekers, although each is trading at a premium to net asset value.

However, I would suggest you consider giving this portfolio a quite drastic deep clean with the goal of consolidating the overall number of holdings, in particular some of the small positions in individual stocks, which might in any case already be held in some of the investment companies and funds you hold.

You might consider redeploying some of this into European and Japanese equity funds. A strong performing European equity fund with an income tilt is Standard Life European Equity Income (GB00B3L7SB79) or for a core strategy, consider Threadneedle European Select (GB00B98WQ465), and while you are at this you might consider folding the Fidelity European position in to whatever fund you choose, as you can do better.

Japan has historically been a low-yielding market, but changes in corporate governance and earnings upgrades have seen strong growth in both dividend payouts and share buybacks, with Japan leading the way in developed market dividend rises last year. CF Morant Wright Nippon Yield (GB00B42MKS95) with a running yield of 2.1 per cent is worth looking at for a combination of income and growth from Japanese equities. Morant Wright isn't a household name but this boutique fund manager is exclusively focused on Japan.

We have a sell rating on Neptune US Opportunities (GB00B7K9LQ88), which has underperformed over one, three and five years. With the US equity market trading on an eye-popping 26 times valuation, based on cyclical adjusted price/earnings, this market looks expensive and increasingly vulnerable to a correction. The US market has powered ahead in recent years as quantitative easing and low interest rates have enabled companies to refinance their debt cheaply and buy back their own shares, but with US QE already ended and the US Federal Reserve expected to start raising rates again later this year, those heady days of loose money could be drawing to a close.

I would consider a US equity position with a greater focus on value and yield, as these stocks should prove more defensive if market complacency cracks. One such fund is the Aviva Investors US Equity Income II (GB00BCGD4Q00), which is managed by Kentucky-based River Road Asset Management. The recent performance doesn't look great, precisely because cautious, solid, dividend-generating stocks have been left behind by the racier companies during the boom - but investing is about the future not the past and that relative performance could quickly reverse in market sell-off. The yield on the fund might also be more useful to you as an income investor.

Other holdings I'm not convinced by are 3i Group (III), which is trading on a very large premium; BlackRock Commodities Income Investment Trust (BRCI), which is well managed but I am bearish on commodities as China's slowdown appears to be gathering pace; and Securities Trust of Scotland (STS) which has been a relatively dismal performer since changing to a global one in 2011. Alliance Trust (ATST) is worth hanging on to for now, but should be reviewed in a year's time, only because it has activist investor Elliott Advisors on its case, which has effectively given the board until the next AGM to demonstrate a turnaround in performance.

Finally, I note you have invested in the recently launched Woodford Patient Capital Trust (WPCT), a smaller company and venture capital focused investment company, from a manager whose long-term track record and reputation has been built around primarily investing in large FTSE 100 companies. This is meant to be a very, very long-term approach - hence why "patient" is in the name - but the 10.4 per cent premium looks unwarranted, so I'd be tempted to bank the profit given that the market environment could turn tougher and no one really knows whether Neil Woodford will turn out to be as successful at this end of the market as he has been investing in the likes of big tobacco companies.