How can I improve my asset allocation to help preserve my wealth?

Andy is 61 and retired. He receives an index-linked public sector pension of £43,000 a year. His home is worth £950,000 and he has a second home worth £560,000, both of which are mortgage-free.

“When I start to receive the state pension of around £9,000 a year at age 66 I will have sufficient income to cover my expenses,” says Andy. “I plan to sell both my properties and buy one larger property. And I think that I have enough assets to cover most eventualities – my investments and cash are worth around £1.53m. 

“So my main aim is to protect my existing level of wealth in real terms. I reinvest all the income I receive. I will start to gift money to my nephews and nieces as I get older and have stated in my will that over 10 per cent of my assets should be left to charity.

“I fully use my annual individual savings account (Isa) allowance and hold investments worth £231,000 in this type of account. I also hold some in a self-invested personal pension (Sipp). But the value of my pensions has slightly breached the lifetime allowance and I think that I will have to pay a charge at age 75. So is there anything that I can do to mitigate this?

"I am a strong believer in passive tracker funds and do not feel the need, or have the interest, to research and monitor actively managed funds. I hold a mixture of regional and sectoral tracker funds, rather than one global equities tracker, because such funds have a higher allocation to the US than I want [see charts].

"My investments are all unlisted open-ended funds held on one investment platform. However, if I switched these into exchange traded funds (ETFs) my fund and platform charges would be lower. But would there be any disadvantages in doing this?

"I also wondered if it is a good idea to get exposure to government bonds via passive tracker funds or whether there are any significant advantages to investing in these via active funds?

"I also wondered if I should hold some of my cash in US dollars or other foreign currencies, rather than just sterling? And should I invest in gold?"

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THIS INVESTOR'S CIRCUMSTANCES.

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

I applaud your use of tracker funds. Being underweight US equities goes against the spirit of index tracking – taking the view that you don't know any more than the average investor so hold the same portfolio as them – but it is wholly understandable. The US has outperformed in recent years, largely because investors have attached increased value to big tech companies such as Apple (US:AAPL), Amazon (US:AMZN) and Microsoft (US:MSFT). It’s reasonable to doubt that this can continue, although if the US market falls it might well drag down shares elsewhere.

As for whether you should consider active bond funds, I’d suggest not. In the past 10 years, most active gilt funds have underperformed Vanguard UK Government Bond Index (IE00B1S75374). This isn’t very surprising, as the efficient market hypothesis applies more to gilts than equities. We have abundant evidence that stock markets are informationally inefficient in two respects: momentum and the ability of defensives to beat the market. There is much less evidence, however, of such big inefficiencies in the gilt market. So if you think that tracker funds are good enough for shares you should think they’re good enough for gilts too.

For an active fund to outperform in the gilt market, two things must happen. The shape of the yield curve must change notably so that short-dated gilts outperform longer-dated ones or vice versa. And the manager of the active gilt fund must anticipate these changes. But the conjunction of the two events has a low probability. One reason for this is that one of the main causes of changes in the yield curve is changes in the chances of recession. And as Prakash Loungani, assistant director in the independent evaluation office at the International Monetary Fund has pointed out, economists are terrible at forecasting these.

What is worth considering, though, is holding some cash in foreign currencies. Sterling is a riskier currency than dollars or euros so it falls in really bad times for the world economy, such as during the 2008 financial crisis and the start of the pandemic in 2020. This means that sterling-based holders of dollars and euros make a profit during such times, which can partly offset losses on equities. So foreign currency is a form of insurance. If wealth preservation is a priority, this is useful.

The same can be said for gold as this is priced in US dollars. This metal, however, is highly correlated with bonds so if their prices fall a lot it’s likely that gold will too. If you have a lot of exposure to bonds, therefore, you already in effect have some exposure to gold – but a small allocation to it might be a useful diversifier.

However, remember that government bonds have negative real yields, meaning that their holders face losses – and big ones over the longer term, unless yields fall even further resulting in a capital gain. Bonds' main virtue is that they insure portfolios against the recessions that are bad for equities. But this insurance comes at a high price.

Adrian Lowcock, independent investment analyst, says:

You are well-prepared financially and should be well set for retirement. With regard to the pensions lifetime allowance, there are two options. Either take the excess as a lump sum before age 75 and pay a one-off 55 per cent charge. Or keep it in the pension and pay a 25 per cent lifetime allowance charge. As pension income is taxable, 40 per cent higher-rate income tax plus the 25 per cent lifetime allowance charge is broadly similar to the 55 per cent lifetime allowance lump sum charge.

Given the size of your estate and pensions, it would make sense to get some professional financial advice to ensure that you are using all the opportunities available to you. 

As you say, it makes sense to have a focus on capital preservation with your investments. Your cash of nearly a quarter of a million pounds is substantial. This will easily meet any shortfall in your income until you reach state pension age, as you have around four to five years' living expenses in cash. But this is a lot – I typically suggest having one to three years' living expenses in cash.

Choosing between ETFs and unlisted open-ended tracker funds is a close call. The cost differences have narrowed significantly so the main advantage of ETFs now is daily pricing. Generally speaking, index funds are more suitable for long term investors while ETFs can be used tactically for short-term asset allocation investing. The issue here is platform fees, so consider the suitability of your platform.

Passive funds have some different risks to active funds, and their returns are dictated by the performance of the indices they track. This means that if an index is expensive then funds that track it will be as well. So if you invest passively, be aware of this given the valuations of some equity markets.

Also think about whether you should have exposure to government bonds. Although these are deemed to be lower-risk they are very sensitive to interest rate movements and, at the current yields, their prices could fall if interest rates start to rise. I would consider a broader, actively managed bond fund, as passive bond funds tend to invest in the largest borrowers, which is not necessarily a good thing. Funds such as M&G Global Macro Bond (GB00B78PGS53) or Artemis Strategic Bond (GB00B2PLJR10) would improve your portfolio's diversification.

Your portfolio has an asset manager bias due to significant exposure to Fidelity passive funds. Although the company is one of the leaders in the passive space it makes sense to diversify by asset manager to reduce exposure to any idiosyncrasies in their process and limit the risk, albeit unlikely, of there being an issue with Fidelity.

I also suggest looking at some defensive holdings such as absolute return funds, which aim to protect capital and should help to reduce your portfolio's volatility. Active defensive funds make sense because they need managers to react to circumstances. If you hold passive funds focused on defensive assets you yourself will need to be more active in managing your portfolio. Options include Troy Trojan (GB00BZ6CNS31) or BNY Mellon Real Return (GB00B8GG4B61).

That said, I also suggest holding about 5 per cent of your investments in a gold exchange traded commodity (ETC).