‘I'm out of my depth – how do I revamp my £200,000 portfolio?’

An underperforming portfolio always creates a dilemma. Investors have to choose between waiting in the hope of recovering at least part of their losses and selling to reinvest in better holdings.

Alex, 48, is nursing significant losses in his £211,000 portfolio, which is split between two individual savings accounts (Isas), a lifetime Isa (Lisa), a personal pension and a general investment account, all made up of various investment trusts, funds and some individual stocks. Almost a quarter of his investments are in Scottish Mortgage (SMT), where Alex is sitting on a 21 per cent loss. And 13.4 per cent is invested in real estate investment trusts (Reits), which are also having a very difficult time due to higher interest rates.

“Over the past two years, I have felt well out of my depth,” says Alex. He has recently liquidated his “reasonably performing stocks” and entrusted this £340,000 pot to a wealth manager. Alex runs the poorly performing holdings himself but is wondering what to do with them.

“I appear to have bought all of the wrong types of stocks and at the top of the market,” he says. “I invested heavily in Reits, which made sense to me at the time but now looks like total madness. My main question is: are these stocks worth holding onto or should I look to cut my losses now?”

He is thinking about waiting until the holdings recover a little, then sell them, and put the money into Fundsmith Equity (GB00B41YBW71) or into a global blue-chip tracker. “I am hoping the stocks will recover some of their value; I am not expecting to get all, or even most, of my money back,” he notes.

Luckily, Alex has some time to ponder the best course of action. He lives with his civil partner David, 39, who is a carer for their nine-year-old daughter. Alex will go part-time with his teacher job in four years’ time, at which point he will start topping up his income using the £135,000 he holds in cash. Once he starts working part-time, Alex and his employer will be adding around £7,000 a year to his pension.

Alex plans to fully retire at 58; only then will he need to start drawing from his investments, which gives him an investment horizon of at least 10 years. Assuming 5 per cent annual investment growth, Alex’s pension should be worth about £55,000 at that point, and the rest of his self-managed portfolio about £342,000.

His defined-benefit workplace pension kicks in when he turns 60 and both Alex and David are on track to receive the full state pension, so their investments should only be needed to top up their income for a relatively short period of time.

Alex is happy to take risks “We would like to start accessing this money in nine to 10 years’ time, so there is no particular urgency to sell,” he says. “Despite my existing significant losses, I wouldn’t break a sweat over a decrease of up to 20 per cent in a year – although I would worry if there was a further significant decrease the following year.”

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

Darius McDermott, managing director at Chelsea Financial Services, says:

You have broken the first rule of investing: too many eggs in one basket. You have too much exposure to sectors negatively correlated to rising interest rates. Your asset allocation is too narrow and is focused on risky sectors such as technology, Reits and emerging markets. This can work for a while, but your failure to diversify has now impacted performance. 

Unfortunately, in the short term at least, you have suffered from the dramatic turn in rates. Stocks in growth or early-stage phases rely heavily on debt to finance their operations and growth. When interest rates are high, the cost of borrowing also increases, leading to higher interest costs. This impacts profit margins and cash flows, making it more challenging for them to service their debt and invest in growth. Higher rates also impact the value of future earnings calculated using a 'discount rate'.

The good news is that, if you take the long view, many of your positions will recover as sentiment eventually changes. Now is not the time to crystallise losses. Further, it does appear interest rates are not going much further up and may well go down in 2024. But you should only hold those investments if you are prepared for further losses in the short term, as nothing is certain.

You do need to broaden your asset class diversification. Taking a long-term view doesn’t just mean taking lots of risk. Investors need to build robust portfolios with parts that work in different investment environments and cycles. You should use any new money to diversify.

You have no bonds, which look more attractive now than they have in decades, with 2024 likely to be better than 2023 for the asset class. The Bank of England may put an end to the rate-hiking cycle, and even begin cutting if economic conditions worsen or we see a sustained decrease in inflation. Hence, we recommend holding more general, flexible bond funds that will contain a spread of short and longer-dated bonds such as the M&G Optimal Income Fund (GB00B1H05718).

We also like more diversified equity funds such as Rathbone Global Opportunities (GB00B7FQLN12), a global fund that buys major innovators but also companies that have flown under the radar. European equities also look attractive, and Janus Henderson European Selected Opportunities Fund (GB0032473653) is a good choice.

Elliott Frost, Investment Manager at Lumin Wealth Management, says:

Your portfolio’s two main exposures, Reits and growth stocks, have seen losses on the back of higher global interest rates. Sales of shares in Reits have been a consequence of rising rates and an opportunity to move towards safer asset classes with a higher yield. As rate cuts begin to be priced in throughout 2024, Reits and their consistent income yield are likely to become more appealing for investors.

You don’t expect to access your investments for the next decade and then plan to draw moderate amounts in retirement. That means you have an investment horizon beyond 10 years for most of your investable assets and can afford to take risk.

But this objective assessment needs to be combined with your risk tolerance. You seem uncomfortable with some of the large changes in values experienced, so you should consider rotating a proportion of the portfolio into bonds. They can protect capital and act as a diversifier to stocks, thereby smoothing out the natural ups and downs of investing.

For a low-cost option, try the iShares UK Gilts All Stocks Index Fund (GB00B83HGR24) with an average yield of 4.7 per cent, or the Vanguard UK Investment Grade Bond Index Fund (IE00B1S74Q32) with a yield of 6 per cent. The latter has a higher yield as it consists of company debt obligations, which come with more risk than government bonds. Bond funds offer a similar income to many Reits and possible capital upside if interest rates fall.

Although most of your portfolio is listed in the UK, the geographic diversification is greater than it initially seems. But your global assets are very correlated and have moved in tandem downwards. For example, Allianz Technology Trust (ATT), GAM Star Disruptive Growth (IE00B5VMHR51) and L&G Global 100 Index (GB00B0CNH056) all have the US big tech names such as Apple (US:AAPL), Nvidia (US:NVDA) and Microsoft (US:MSFT). 

You could consolidate your exposure in the lower-cost L&G 100 Index, or consider an alternative option such as the Fidelity Global Dividend Fund (GB00B7GJPN73). It invests in the largest global names, providing strong income generation. Income will account for a larger proportion of total return going forward, and the consistent income return aligns better with your risk appetite.

Scottish Mortgage and RIT Capital Partners (RCP) account for roughly 35 per cent of your portfolio. Both trusts have large private positions. To benefit from the illiquid nature of these holdings you must hold them for a long duration and be comfortable weathering short-term volatility.

A less concentrated portfolio may be appropriate. This is particularly true for single stocks, such as Impax Asset Management (IPX), which is being hit by investor outflows from environmental, social and governance funds.