Heading the right way for a 4 per cent return

David has a fixed-rate annuity of £9,100 a year, an annuity with guaranteed minimum pension of £6,200 a year, increasing at 3 per cent a year, and a state pension of £7,000 a year. He also has a cash Isa that he uses for small supplements to his income.

His wife has a total income of £9,240 from an annuity, state pension and dividends paid out by her funds.

David has been investing into his self-invested personal pension (Sipp) since October 2011, after transferring in funds and policies that matured when he turned 60. He has been investing into his stocks-and-shares individual savings account (Isa) since 2003. He does not make new contributions into them, although between July and October this year he is transferring £74,500 from maturing with-profits policies into his Sipp, and would like some suggestions on where to invest these.

Investors Chronicle last reviewed his portfolio in September 2013.

"Over the past few months I used the drawdown facility from my Sipp to take out £36,000, which I used to rebuild readily available capital in my Isas," says David. "In future, I may occasionally use this facility to supplement my income. I usually leave income to be reinvested, but may take the natural yield.

"My plan is to pass the Sipp to my wife, children and grandchildren to avoid inheritance tax, and the Isas to my wife.

"My secure income of £22,300 a year should cover most needs and the natural yield on my Sipp of over £10,000 a year will be sufficient extra in occasional years. The aim for the Sipp is to preserve capital and grow at a reasonable rate: I would be satisfied with a total return of inflation plus 3-4 per cent a year.

"I dislike cash and gilts as in real terms they lose value every year. I dislike bonds because of the risk of loss of capital as interest rates rise, although I hold a short-duration investment-grade bond exchange traded fund (ETF) and some direct holdings in bonds, one of which is inflation-linked.

"I also don't like highly volatile areas such as smaller companies and emerging markets, as well as Japan and southern Europe.

"I do like the US, Germany and more developed parts of Asia ex Japan, and I favour higher-yielding shares because the capital value is likely to be stable or improve. But I do not necessarily need the dividend because I can sell shares if I need income.

"I am mainly a buy-and-hold investor as I cannot get market timing right. I allocate at asset class and geographic level, then hold multiple funds in those areas to try to diversify within them.

"I prefer investment trusts as I think they can produce a better return and are appropriate for certain asset classes, for example physical property. Using them also avoids the extra 0.45 per cent a year charge my platform levies for holding open-ended funds. But I am wary of investment trusts trading at a premium to net asset value (NAV).

"My target asset allocation for the Sipp is roughly 50 per cent in cautious assets and 50 per cent in more adventurous assets. I review and rebalance it about once a year, and could use the income of over £10,000 a year it generates to add new assets to achieve this balance.

"Should I hold more commercial property, and small or mid-cap companies? And are there any specialist asset classes that I should consider adding? Also, should I keep £10,000-£20,000 in cash indefinitely, to counterbalance the risk of other correlated assets going down together, even though it will earn virtually nothing?

"I also wondered how to avoid the risks associated with infrastructure funds, and if I should add some wind and solar infrastructure funds?

"I am thinking of putting £5,000 each into Invesco Perpetual Global Target Return and Henderson UK Absolute Return, and adding £7,000 to Ruffer Investment Company (RICA)*.

"I am also thinking of adding £5,000 to each of F&C Commercial Property Trust (FCPT)*, Standard Life Investments Property Income Trust (SLI)* and Schroder Real Estate Investment Trust (SREI), which would take my allocation to commercial property to about 7 per cent.

"I am also considering investing £10,000 in iShares Core FTSE 100 UCITS ETF (ISF), £7,500 in MI Chelverton UK Equity Income (GB00B1FD6467)*, and £5,000 in each of MFM Slater Growth (GB00B7T0G907), Henderson Smaller Companies IT (HSL)* and Woodford Patient Capital Trust (WPCT).

"Or for UK equity allocation would CF Woodford Equity Income (GB00BLRZQB71)*, Edinburgh Investment Trust (EDIN) or Perpetual Income & Growth (PLI)* be better choices?"

David's portfolio

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

This is a well-diversified portfolio. Most of the time it should just about meet your target of a real return of 3-4 per cent per year, although you need to maintain a heavy equity weighting to achieve that. You shouldn't worry much about this, though, as your income from other sources meets your needs, suggesting you don't need to obsess about high growth.

However, would this portfolio protect you from a UK economic downturn as much as you would like? You might think that because everyone expects such a downturn it is now priced in. But I'm not so sure: the earnings impact should be priced in, but history and theory warn us that the slowdown's effect on investor sentiment might not be so well anticipated.

In this context, you are perhaps wise to have little exposure to small-caps and commercial property, as these would be among the casualties of such an event. You are also wise to have exposure to overseas equities.

But one of your questions worries me - whether there are any specialist asset classes you are missing. This is the wrong thing to ask.

Assets aren't defined by names and what they do, but by risk and return. You should instead consider what sorts of risk you are willing to bear, for example volatility, liquidity or default risk, and whether there are any assets that will compensate you adequately for these risks. And I'm not sure there are.

And you are certain to miss out on lots of good investments simply because absolutely everyone does. Get rid of the fear of missing out. Focus instead on whether this portfolio fits your needs.

Colin Low, managing director of Kingsfleet Wealth, says:

Continuing to fund your Sipp while the option is available is sound from both an investment and estate planning perspective. But you could look at other ways to mitigate inheritance tax. Ways of keeping funds invested but making them more tax efficient from an estate planning perspective include enterprise investment schemes (EIS) and business property relief (BPR) funds.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Your heavy weighting in defensives is a good thing, and here your UK investment trusts help. Finsbury Growth & Income (FGT)*, Keystone (KIT) and Perpetual Income & Growth have decent exposure to defensives such as AstraZeneca (AZN), Unilever (ULVR) and tobacco stocks.

Such exposure is a good thing because in the long run and on average defensives do better than they should. However, they only partially protect you from any market downturn. In such an event defensives fall but less than shares generally: they have a low beta, but not a negative one.

Your holdings of corporate bonds might also suffer because default risk rises in downturns. Sure, you probably won't suffer an outright default. But the rise in perceived default risk from very low to merely low would hurt corporate bond prices.

So I think you should maintain a decent cash weighting. Real returns are negative, but rates are low precisely because the Bank of England is worried about economic growth. This isn't an environment in which we can be confident about equities. I prefer a certain return of minus 1 per cent to a fairly significant risk of a minus 20 per cent return. We probably live in a world of low returns on all assets, so low returns on cash should not be a prompt to adopt a high equity weighting.

Also remember that cash gives you a chance to go bargain-hunting. In the event of a downturn, deteriorating sentiment might open up some nice discounts on good investment trusts.

However, I'm ambivalent about infrastructure funds. These carry two different types of risk.

One is political as returns might be hit by changes to regulation. However, this risk shouldn't worry you too much because it is diversifiable, and can be diminished with a spread of infrastructure investments within a fund and also by your general equity holdings.

Other risks, however, are not diversifiable. Liquidity risk and refinancing risk - the likelihood that some projects will need to raise extra finance - are the sort of dangers that are more likely in bad times when share prices are falling. Such risks are not foreseeable and can arise very suddenly. For me, only having a small weighting in such funds.

Colin Low says:

You seem to have a very good understanding of the investment world, but say you see no value in fixed interest although this accounts for nearly a third of your Sipp.

Holding individual bonds incurs company-specific risk. But if your fixed-income exposure was obtained via a quality strategic bond fund, you would benefit from a manager who would look for opportunities that are generally less correlated with equities. A strategic bond fund manager might also look for value in markets that you are unlikely to be able to access directly, such as overseas fixed income.

You should be dispassionate about your choice of investment vehicles and not dismiss open-ended funds so readily in favour of investment trusts.

Regarding your questions, yes, do hold commercial property but follow the investment doctrines of the large US endowment funds and don't let your exposure to it exceed 10 per cent of your portfolio value. You should access this asset via investment trusts as some of these have moved to discounts to NAV. Options include TR Property (TRY)* and Standard Life Investments Property Income.

Having a good mix of companies with different market capitalisations is a further means of diversification. You could access these through multi-cap UK equity funds such as Liontrust Special Situations (GB00B57H4F11)* and Franklin Templeton UK Managers Focus (GB00BZ8FPB74).

The only genuine diversifying asset in your portfolio is cash, which if held strategically as part of a diversified portfolio, can be highly beneficial.

*IC Top 100 Fund