Craig is 51 and has been investing for 20 years. He is single, doesn't have any debts and doesn't own property. As well as his investment portfolio, he has a teachers' pension. He was moved into a career average scheme in April, which won't pay out until normal retirement age, but 3/8ths of £37,000 from his former scheme will pay out in 2025, when he will also be entitled to a lump sum of three years' pension. He is considering moving to a country with better weather, such as Spain or Thailand, although probably wouldn't buy property in either.
Sipp, Isas and trading account
4-5 per cent income with protection against inflation
Craig holds all of his investment portfolio in individual savings accounts (Isas) and a self-invested personal pension (Sipp) worth about £70,000, with the exception of shares in Securities Trust of Scotland(STS) worth around £55,000.
"I'm looking to provide an income and preserve capital over the long run," says Craig. "I'm persuaded by the Barclays Equity Gilt Study, which advocates being in the right markets for as long as possible.
"I don't think in the long run I can receive more than about 5 per cent on average. I've never understood how volatility can be a proxy for risk, yet people say that when pricing options volatility is a plus. If we know that a graph of equity prices will always trend to the north-east then volatility is neither here nor there. So risk has to be the probability of an uninsurable and un-hedgeable loss.
"Bearing this in mind all I'm looking for is 4-5 per cent income with no real growth, but protection in the long run against inflation.
"I might take 25 per cent cash from my self-invested personal pension (Sipp) and run down the rest of it before I reach 60 as a tax-efficient measure. I could take £1,000 a month and get all of the cash before my pension starts, and avoid going too far over the personal allowance into basic-rate tax.
"I'm looking to diversify my portfolio across countries, sectors and currencies with relatively low costs and transparent legal structures, but I distrust exchange traded funds (ETFs).
"I don't trade - or very rarely - and I won't sell, so I don't really see volatility as a loss. I didn't enjoy seeing Murray International (MYI) fall to 760p after buying it at 840p, but the only time I sell is when investment trusts reach ridiculous premiums.
"I try to buy heavily when 'there's blood on the streets' and they're on discounts to net asset value (NAV). That said, I now don't have much cash left: buying during last year's volatility means I'm about 95 per cent in equities - for the first time ever.
"I don't try to beat the market and I think there's terrible madness in crowds, for example I couldn't believe the property bubble.
"I've been reinvesting dividends in Securities Trust of Scotland, which I sold at 158p having bought at 80p to 88p, and I'm now steadily buying it back at a discount. I made big investments last year in Murray International and Securities Trust of Scotland when the prices seemed attractive - £150,000 in total.
"I'd watched Murray International for a while, and I like the way its manager, Bruce Stout, thinks and speaks. I wasn't willing to buy it at 1,200p on a 10 per cent premium to NAV, but I jumped at it when it moved to a discount.
|Holding||Value (£)||% of portfolio|
|Dunedin Income Growth Investment Trust (DIG)||152,382||29.92|
|BlackRock Income Strategies Trust (BIST)||101,091||19.85|
|Securities Trust of Scotland (STS)||130,600||25.65|
|Murray International Trust (MYI)||125,164||24.58|
THE BIG PICTURE
Chris Dillow, Investors Chronicle's economist, says:
There are two things I like about your approach. One is that you don't try to beat the market. This saves you from incurring unnecessary dealing costs.
The other is your use of extreme discounts and premia on investment trusts as buy and sell signals. History suggests that these can be indicators of investor sentiment, with a wide discount relative to the trust's own history a sign that investors are unduly pessimistic, and a big premium a sign of undue optimism. Longer-term investors should bet against these mood swings, although be aware that irrational optimism and pessimism can both last a long time.
However, I suspect that many readers will raise an eyebrow at the fact that your portfolio comprises only four assets. Does this mean you are insufficiently diversified?
From one perspective, yes. These four trusts tend to rise and fall together: monthly price changes since 2005 shows correlation coefficients between them of more than 0.75. Losses on one, therefore, are highly likely to be accompanied by losses on others. This is simply because pretty much any reasonable collection of equities will tend to rise and fall with the global market, with the result that any two such collections will rise and fall together.
However, I'm not sure this is a fatal error. Your diversification is taking place within your funds, rather than across them. BlackRock Income Strategies, for example, mitigates equity risk by having a big position in bonds. And Dunedin Income Growth has a big holding in UK defensives. These have the twin virtues of being likely to hold up relatively well - and I stress relatively - in a market downturn, and to outperform over time on average: defensives have done so in the past.
Stephen Peters, investment analyst at Charles Stanley, says:
I agree with a lot of what you say, particularly with regard to long-term asset returns, your reluctance to trade, and the misplaced use of volatility as a proxy for risk.
However, looking at the portfolio, I wonder whether your stated goal of "4 to 5 per cent income with no real growth but protection in the long run against inflation" is consistent with its current make-up.
The portfolio is or can be consistent with this goal if the income from your pension assets are enough to cover the majority of your income needs, or your time horizon is long enough to withstand large falls in equity prices - both financially and psychologically. For that to be the case your time horizon needs to be at least five years.
Peter Savage, chartered financial planner at Fairstone Financial Management, says:
As you are single, inheritance planning might be less of a concern for you, so taking out the Sipp money tax-efficiently as you suggest would be beneficial, as less tax paid means more money in your pocket.
As you have £55,000 outside Isas and Sipps, continue to use your Isa allowance as this would provide further tax-efficient growth.
If you intend to move abroad, however, you may also consider the use of an offshore investment bond to hold this capital. An offshore bond will enable you to invest without any liability to UK taxes and there is no limit on the amount you can invest. However, as an investment bond is a non-income-producing tax wrapper, you would not be able to withdraw the natural yield from the investments but rather a fixed return.
HOW TO IMPROVE THE PORTFOLIO
Chris Dillow says:
I have two problems with your portfolio. One is that you are heavily weighted in equities and, I suspect, over-optimistic about future long-term returns. It's true that history tells us that shares have returned over 5 per cent a year after inflation. But we have no assurance that this will remain the case.
One reason for this is that volatility doesn't cancel out even over longish periods. The past distribution of equity returns warns us that even over a 10-year period there is around a one-in-six chance of shares suffering a loss in real terms, even if dividends are reinvested. An investor who'd bought in 1929, 1973 or 1999 would not have had a happy experience.
And we shouldn't rule out some nasty risks. If secular stagnation continues or intensifies, shares could fall as expectations of future dividends are cut. And populist backlashes against capitalism could see profits squeezed. Distribution risk has worked in investors' favour in the past, but it may not continue to do so.
My second problem is that your intention to move overseas exposes you to exchange rate risk: a further drop in sterling would raise your future cost of living and so, in effect, cut your real income.
These two problems might seem different. But they have a similar solution. If you were to hold foreign currency - probably euros if you intend to move to Spain, but dollars might also work - you'd be protected against falls in the pound. You would also have more insurance against stock market falls, given that sterling usually falls in the event of a financial crisis.
I suspect this small tweak to your portfolio would do a lot to reduce risk.
Stephen Peters says:
You need to think about whether you want a core of the portfolio to generate a high income, and to complement those holdings with tactical or discount ideas. For instance, multi-asset investment trust RIT Capital Partners (RCP)* pays a dividend below your 4 to 5 per cent target, but that dividend grows and this trust offers protection against market moves because it uses a diversified strategy.
BlackRock Income Strategies tries to achieve this, but its capital protection strategy is compromised by its gearing (debt) and high dividend, which requires it to have a high equity weighting. It is interesting that you see yourself as conservative and distrust ETFs, but buy potentially illiquid, expensive and complex investment trusts.
Consider whether you want or need greater diversification by investing style. For instance, the likes of Temple Bar Investment Trust (TMPL), JPMorgan Global Emerging Markets Income Trust (JEMI)* or one of the Asian equity income trusts would add some diversification.
There is not a great difference in performance between Dunedin Income Growth, which is run by Aberdeen, and open-ended Aberdeen UK Equity Income Fund (GB00B0XWNB45). This suggests that Dunedin's managers aren't necessarily using the advantages of the investment trust structure to the best advantage. This is not uncommon, but if this is important to you look at other trusts that do make use of gearing, and unlisted and smaller companies.
It would be tempting to suggest adding some higher-yielding alternative income trusts. However, they trade on what may seem like excessive premiums to NAV. Whether those NAVs are accurate is another question, but you may wish to weigh up your admirable long-term approach to investing with your income needs, and perhaps drip-feed money into such trusts when they cheapen. The renewable energy infrastructure sector looks the best value of these at the current time.
Peter Savage says:
If you are looking for yield, consider more exposure than you currently have to the US, as this offers a greater choice of equity yield stocks. And if you are looking for yield with diversification, then it might be worth considering a global equity index tracker, as this can provide diversification at a relatively low cost.
Overall your portfolio has little exposure to utilities and pharmaceuticals. These are defensive stocks that tend to pay good dividends especially in times of recession, so you could consider more of these types of stocks, especially for your UK exposure.
You are invested predominantly in equities. This means you have exposure around the globe but are still heavily exposed to the UK, with over 30 per cent of your portfolio in UK equities. So it may also be prudent to consider exposure to global high-yield bonds via a tracker fund. This will diversify your portfolio further while providing yield with growth potential.
In the past, when an investment trust traded at a discount it was an indication that there was something wrong with it, either at investment or board level. People would then sell and without the same number of buyers the price would fall.
However, nowadays, due to the nature of the investment trust market, a listed company with lower levels of selling can experience a share price fall, which means you can pick up some great bargains at a discount.
Notwithstanding this, don't always mistake a discount for great value. Murray International and Securities Trust of Scotland are still modestly priced and performing well, but Dunedin Income and BlackRock Income Strategies have underperformed for more than three years.