This investor, who wishes to remain anonymous, is a 63-year-old divorcee living in rented accommodation. Aside from his salary of £54,000 he has income from his final salary pension of £17,000. When he retires next year he will receive an additional £7,000 from a second final salary pension. So, although he does not own a property, he will have a relatively comfortable guaranteed and inflation-protected base income in retirement of £24,000.
However, he wants to generate additional income during his retirement from his £362,000 investment portfolio. The portfolio is made up of pensions worth £279,000, individual savings accounts (Isas) worth £60,000 and a shares portfolio worth £23,000.
He is worried that his portfolio is too heavily weighted to UK equities. "My attitude to risk is middle of the road," he says. "I am prepared to have some more speculative investments balanced by 'safer' investments. My concern regarding my portfolio is the high investment in UK companies, via the shares portfolio (100 per cent), the self-invested personal pension (48 per cent) and the Hargreaves Lansdown Isa (58 per cent)."
Pensions and Isas
ANONYMOUS 63-YEAR-OLD'S PORTFOLIO
|Shares portfolio (no tax wrapper): £23,064||6|
|Allied Minds (ALM)||1,188||0|
|Amec Foster Wheeler (AMFW)||704||0|
|Advanced Medical Solutions (AMS)||707||0|
|Close Brothers Group (CBG)||1,610||0|
|Circassia Pharmaceuticals (CIR)||1,057||0|
|Galliford Try (GFRD)||1,380||0|
|Greencore Group (GNC)||1,205||0|
|KCOM Group (KCOM)||975||0|
|Pets At Home Group (PETS)||1,128||0|
|Quadrise Fuels International (QFI)||880||0|
|Renew Holdings (RNWH)||915||0|
|Smith DS (SMDS)||1,472||0|
|Severn Trent (SVT)||1,284||0|
|Vodafone Group (VOD)||1,176||0|
|Self-invested personal pension: £200,349||55|
|AXA Framlington Managed Balanced ZI Acc||23,383||6|
|CF Lindsell Train UK Equity Acc||10,133||3|
|CF Lindsell Train UK Equity D Acc||29,165||8|
|CF Woodford Equity Income Z Acc||45,699||13|
|Fidelity Moneybuilder Income Y Acc||6,848||2|
|First State Asia Pacific Leaders A Acc||7,172||2|
|First State Asia Pacific Leaders B Acc||7,482||2|
|GLG Japan CoreAlpha A Acc||7,173||2|
|Invesco Perpetual High Income F Acc||11,349||3|
|Morgan Stanley Sterling Corporate Bond F Acc||5,410||1|
|Newton Global Income W Acc||15,656||4|
|Newton Real Return W Acc||30,879||9|
|Zurich Cashbuilder Pension: £78,723||22|
|50/50 Global Equity Index||37,481||10|
|Corporate Bond 15+Yr Index||2,489||1|
|UK Equity Index||34,559||10|
|World ex UK Index||4,194||1|
|Individual savings account: £60,616||17|
|Scottish Widows Balanced Growth D Acc||6524||2|
|Scottish Widows Cautious Growth D Acc||6427||2|
|HSBC World Selection Balanced Portfolio A||7365||2|
|Baring Europe Select I Inc||2,566||1|
|CF Woodford Equity Income Z Acc||8,552||2|
|Marlborough Multi Cap Income P Inc||2,714||1|
|Newton Global Income W Acc||5,162||1|
|Newton Real Return W Acc||3,786||1|
|Old Mutual UK Smaller Companies R Acc||6,269||2|
|Schroder Managed Balanced I Acc||2,753||1|
|Threadneedle European Select Z Acc||2,490||1|
|Threadneedle UK Equity Alpha Income Z Inc||6,008||2|
Source: Investors Chronicle
YOUR UK EQUITY EXPOSURE
Chris Dillow, the Investors Chronicle's economist says:
You are right to ask if you are too heavily weighted towards UK equities - but not perhaps for the reason you might think.
It's possible that, by being under-invested in overseas shares, you will miss out on some returns. This would be especially the case if the US dollar rises or if global equities generally do well, because the UK market is relatively defensive.
For you, though, there's a bigger reason to invest overseas. It's that you don't own a house. This exposes you to inflation risk: if prices generally rise a lot, so too probably would rents and this would increase your costs of living more than it would for home-owners.
Personally, I don’t think this risk will materialise soon. I suspect house prices and rents (and inflation generally) aren't going to rise much, and there's a distinct possibility of house prices falling. But we shouldn't organise our affairs on the basis of an economic forecast. And the small chance of a big cost is one worth avoiding.
It's in this context that overseas equities might be useful. One way in which inflation could rise would be if sterling falls, thus raising import prices. Overseas shares protect you from this risk because they would become valuable in sterling terms if this happens. What's more, if UK inflation rises for any reason, UK equities might fall - there has for years been a correlation between inflation and dividend yields - and overseas shares would avoid this risk, insofar as the inflation is confined to the UK.
In these ways, greater exposure to overseas equities might help reduce your inflation risk. Of course, they don't do so as well as index-linked gilts would, but you must pay a very high price for those, in terms of foregone returns. You might, therefore, want to consider raising your overseas equity holdings. It's not often one gets to spread a risk without sacrificing much return.
Colin Low, a chartered financial planner at Kingsfleet Wealth, says:
It wasn't that long ago when it was almost unheard of to be invested in anything other than a selection of UK equities or in a UK-based managed fund but now more individuals are aware of the income and growth opportunities that present themselves in other parts of the world. Holding some of these as assets within our investment portfolios is beneficial both in terms of diversification of risk and potential opportunities for improved returns.
Doug Millward, investment analyst at Lowes Financial Management says:
Your concern over your portfolio being too heavily weighted to the UK isn't really something to worry about. When viewed as a whole, you have approximately 57 per cent invested in the UK, with the balance spread fairly evenly across the rest of the globe. We feel that with the UK economy returning to growth, having around half of your portfolio in UK investments isn't a bad thing for a UK investor.
A few pension issues
Mr Dillow says:
You face a significant loss of income when you retire. Your Sipp, Isa, cashbuilder pension and share portfolio altogether might generate less than £20,000 a year, assuming a return of 5 per cent. Even with your £24,000 final salary pensions, this would imply that your pension income will be some £10,000 less than your current salary.
Granted, the state pension will plug some of this gap when you become eligible for it. And more of the gap can be plugged if you want to run down your capital. This is fine if you don’t want to leave a bequest. Otherwise, though, your income will drop. Are you sure you are ready for this?
Mr Millward says:
Following the recent pension changes, you should seek advice when you retire to ensure that your investment portfolio is structured to provide your income in the most tax-efficient way, but with flexibility should your circumstances change.
The Zurich pension is invested in a range of passive investments. While a low-cost way of investing, the outperformance of well selected, actively managed funds should negate the increased costs. As a employer-provided pension there may be little you can change at present, but we would suggest you seek advice on transferring it to your self-invested personal pension (Sipp) on retirement.
HOW TO IMPROVE THE PORTFOLIO
1. Cut your balanced funds
Mr Dillow says: Think about cutting the funds you are holding. Do you really need managed balanced funds? These simply combine equities, cash and bonds. But you can get such exposure anyway, often with lower fees.
2. Watch for overlap
Mr Dillow says: Some of your funds are correlated. For example, the biggest holdings of CF Woodford Equity Income, Invesco Perpetual High Income and Threadneedle UK Equity Alpha Income all include AstraZeneca (AZN) and Imperial Tobacco (IMT), and Woodford and Invesco’s funds also both have big holdings in BT Group (BT.A) and British American Tobacco (BATS).
There’s a strong case for holding such stocks. Over the long-run, high-yielding defensives have tended to do better than they should, and these might be a useful counterweight to some of the more speculative holdings you have in your share portfolio. But do you really need to do so over three different high-charging funds?
3. Add fixed interest and property
Mr Low says: I will take your definition of your attitude to risk as 'middle-of-the-road' to be what we would refer to as a 'balanced' investor and that you are not looking to access funds for home purchase in the near future.
Looking at the funds in which you are invested, I do not see many less volatile assets within your portfolio to balance out the possibly higher-risk assets which you seek to utilise. Naturally, any investment outside of the UK does add additional risk in the likely inclusion of currency volatility which also affects investment returns.
To balance out any non-UK assets which you hold, you may wish to consider perhaps 20-30 per cent of your holdings also being held in fixed interest or property assets. It may be that you utilise one of the more traditional pension arrangements as a means of holding this and consider including a fixed interest fund that offers maximum flexibility to the manager, such as a strategic bond fund.
4. Add global equity funds
Mr Low says: Our experience is that investing in broader based global equity funds rather than geographically-specific arrangements enables the managers to select a stock irrespective of where it is located but, rather, on its potential to provide potentially better returns. We do not believe that there is much to be gained from chasing investment returns in specific countries or geographic regions as this simply limits the managers’ options.
Global equity funds that we have recently recommended include: Invesco Perpetual Global Equity Income (GB00B3FD1Z66), Artemis Global Income (GB00BW9HLK22), Fundsmith Equity (GB00B41YBW71) and, for passive solutions, Vanguard FTSE Developed World ex UK Equity Index (GB00BPN5NX08).
Mr Low says: Ensure that you rebalance regularly. If you see yourself as being a 'balanced' investor, then it's important that you regularly bring your portfolio back into line to capture the growth that you have seen in the higher-risk arrangements and allow your lower-risk funds to be the store of that increased valuation.
6. Is your share portfolio a hobby or an investment?
Mr Millward says: Your share portfolio is well diversified, spread over a range of sectors and sizes, but with a sensible bias towards large and mid-cap stocks. It would have performed well of late, in fact outperforming a lot of UK Managed funds. Our concern is that as a portfolio containing 21 different companies it is relatively small in value. With most of the holdings around £1,000, dealing costs can start to have a significant effect on net returns. Also, at just 6 per cent of your total investments it will have limited impact on the total return.
You may enjoy managing this portfolio with it being as much a hobby as an investment, but if not it may be worth encashing this portfolio and using it to top up your Isas through a global equity fund such as Old Mutual World Equity (IE0031332939) which would then help reduce your UK exposure slightly.
7. Get the right defence
Mr Millward says:
We suggest you reconsider your holdings in the Newton Real Return (GB00B8GG4B61) and Scottish Widows Cautious Growth (GB00B4P1RR10) funds. Both are good, defensive funds, and can protect a portfolio if some of the other investments suffer a downturn, but funds like Standard Life’s Global Absolute Return Strategies (GB00B28S0218) and Invesco Perpetual’s Global Targeted Returns (GB00B8CHD050) have provided similar defensive qualities of late but with better returns.