Michael Stevens is 62 and his wife 67. Both are retired and receive just over £3,000 a month in income from final-salary and state pensions and Michael’s part-time work. The couple own their own home, have one financially independent son and no grandchildren. The couple would like to spend around £7,000 a year on holidays and anticipate minimal large expenses in the medium term.
Isa and pensions invested in funds and investment trust
Grow portfolio to help supplement retirement income and allow one-off expenses.
“I want the portfolio to be able to provide 5 per cent growth a year to use as income,” Mr Stevens says. “Our pension income covers our monthly expenses and even leaves us with some room to pay for bigger-ticket items without dipping into the portfolio. However, I want to make sure we can dip, but that we also manage the reduction in our assets over the longer term.
“We don’t keep a huge amount of cash in the bank, but we do have easy-access and cash Isas to store protection and emergency funds. I also keep some of my portfolio in gold to provide protection.
“However, I think the portfolio could be unbalanced. I have high-risk equity funds matched with this significant amount in cash, gold and National Savings & Investment (NSI) bonds. I’m still wary about bond funds, especially given the mixed messages right now about whether they’re a good investment. If I do add bonds, I would do so via Jupiter Strategic Bond (GB00B544HM32).
“For returns I have focused on equities in the 15 years I’ve been investing. I used to try to find ‘the next best thing’ such as emerging markets, or specific funds or stocks, but results were mixed. Since then, I have focused on picking regions and finding funds and managers with good track records. I am particularly drawn towards managers such as Nick Train and James Anderson, who manages Scottish Mortgage Investment Trust (SMT).
“I think my attitude to risk is somewhere in the middle, and I would be prepared to lose 20 per cent of the equity holdings based on our ability to sit out a market rout and wait for markets to recover without our quality of life being affected too much.
“Recently I sold holdings in Fidelity China Special Situations (FCSS) and transferred it to Stewart Investors Asia Pacific Leaders (GB0033874768), and have boosted exposure to Baillie Gifford Japanese (GB0006011133) and Standard Life Smaller Companies (GB00BBX46183).”
Table 1: Michael Stevens' portfolio
|Holding||Value (£)||% of portfolio|
|Lindsell Train Global Equity (IE00BJSPMJ28)||26,450||14.34|
|Stewart Investors Asia Pacific Leaders (GB0033874768)||10,420||5.65|
|Standard Life UK Smaller Companies (GB00BBX46183)||10,291||5.58|
|Liontrust Special Situations (GB00BG0J2688)||8,051||4.36|
|Scottish Mortgage Investment Trust (SMT)||7,275||3.94|
|FP Crux European Special Situations (GB00BTJRQ064)||5,144||2.79|
|Jupiter European (GB00B5STJW84)||4,998||2.71|
|Baillie Gifford Japanese (GB0006011133)||3,832||2.08|
|Slater Growth (GB00B7T0G907)||3,002||1.63|
|Artemis Strategic Bond (GB00BJT0KV40)||2,930||1.59|
|Baring Europe Select (GB00B7NB1W76)||2,777||1.51|
|Legal and General US Index Trust (GB00BG0QPL51)||1,881||1.02|
|Legg Mason IF Japan Equity (GB00B8JYLC77)||1,355||0.73|
|Sylvania Platinum (SLP)||866||0.47|
|U and I Group (UAI)||754||0.41|
|Conygar Investment Company (CIC)||460||0.25|
|National Savings & Investments bonds||30,400||16.48|
|Cash (1-1.25 per cent Isa)||37,160||20.15|
|Cash (easy access Isa)||17,900||9.70|
NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THIS READER'S CIRCUMSTANCES.
THE BIG PICTURE
Chris Dillow, Investors Chronicle's economist, says:
The problem here is not that your portfolio is unbalanced. There’s nothing wrong with having low-return safe assets to balance out riskier equity investments. It’s just that you will not achieve your target of a 5 per cent annual return. This is simply because half of it is in assets such as gold, bonds and cash, which – for now at least – offer an expected return after inflation of pretty much nothing. Five per cent is a reasonable expectation for returns on your equity holdings. But these represent only half your portfolio. The question is: are you being overly cautious? But the answer isn’t clear.
On the one hand, no, you’re not. Rising US interest rates, a slowdown in China and a lack of momentum are all bad for emerging markets, and their troubles might weigh down developed markets in the near term. On the other hand, though, at least two lead indicators now point to decent returns on UK stocks: recent foreign selling of US equities; and the fact that the dividend yield on the FTSE All-share index is above its long-term average.
Your individual shareholdings are small. But there’s nothing wrong with this. You wonder how to spot the next Blue Prism or Fevertree Drinks. In truth, it is almost impossible to find genuine growth stocks and history warns us that investors often pay too much for them – perhaps because they overestimate their ability to predict growth, or perhaps because they are seduced by glamorous stories. What we can spot very easily, however, is momentum: Blue Prism and Fevertree Drinks are examples of momentum stocks that have done nicely.
Sadly, however, momentum has done terribly recently, which raises the danger that investors have wised up to this strategy too and so bid the profits away. I suspect, though, that there might be a case for paying attention to momentum in assessing growth stocks. The thing is that rapid growth is very difficult: companies often lose profits as they expand. Price momentum can be a sign that companies are overcoming the growing pains that so often hurt stocks, and might therefore be a sign that growth can continue. Pay attention to it.
Iain Barnes, head of portfolio management at Netwealth, says:
Your total portfolio is certainly not high risk, given that around 46 per cent is invested in cash or cash equivalents. Portfolios can be rated for risk in many ways, but a common method is the level of volatility relative to world equities. By this measure your portfolio is broadly invested in a ‘balanced’ manner, with around 47 per cent of the portfolio invested in globally diversified equity funds.
It is, however, worth noting that during 2008 global equities were down 40 per cent, so it may be wise to factor in losses of more than 20 per cent from this part of the portfolio, in a worst-case scenario. You also have considerable foreign currency exposure in your investments as you hold a large proportion of overseas equities. This has been very helpful in recent years as sterling has been weaker. However, currencies can be highly volatile and, as you mainly require sterling to meet your expenditures, you may wish to match up more of your assets to your spending requirements. You could do this by holding some of the overseas investments on a hedged basis.
Your final-salary pension income means that you shouldn’t be forced to draw from the portfolio at a time of market weakness. However, you should also ensure that you are comfortable with the level of fluctuation that might occur so that you can ride out any downturns and benefit from market returns in the long run.
Adrian Lowcock, head of personal investing at Willis Owen, says:
I always think that the investment portfolio should be looked at separately from the cash holdings, which would form part of a wider financial plan. So the first thing to address is the level of risk – your investment portfolio is riskier than you realise if you would only be willing to tolerate a 20 per cent fall in value.
Your overall portfolio is a barbell approach – a mix of very risky investments and very cautious cash savings, but the amount you have in cash is significant considering you are comfortably living off your pension income.
In the investment portfolio, you have about the right number of funds, so you are not overly diversified and indeed could cope with a couple more to broaden it out. It is very much growth orientated, which has been the right place to be in the past few years. There is also a bias towards smaller companies, which again adds to the growth bias of the portfolio. While I like smaller companies and indeed your funds, the portfolio needs some rebalancing to have a mixture of growth, income, value and defensive qualities. This would smooth out the performance of the portfolio and reduce short-term volatility and bring it more in line with what you expect.
HOW TO IMPROVE THE PORTFOLIO
Chris Dillow says:
I appreciate your scepticism about bonds: the case for these is that they are insurance against recession or a big sell-off in emerging markets, but this insurance is expensive now. You might, though, care to consider shifting a little from cash into a UK equity tracker fund.
Another issue is that some of your holdings are duplicated. Lindsell Train Global Equity (IE00BJSPMJ28) and Liontrust Special Situations (GB00BG0J2688) both invest in big defensive stocks with what Warren Buffett calls economic moats: both have big investments in Unilever (ULVR), Diageo (DGE) and Relx (REL), for example.
This means you are not as diversified as you might think. In holding both funds, you are taking on the same risk – the possibility that investors might have wised up to the value of economic moats and in doing so have bid up their prices too far.
Good manager track records are ambiguous. They might tell us the fund managers are genuinely good – although it takes very long records indeed to establish this with confidence. But they might also tell us something very different – that the assets the fund holds have become overpriced.
Iain Barnes says:
Despite expectations of a broadly rising interest rate environment, investing in bonds would significantly add to the diversification of the portfolio, and probably improve the portfolio’s risk-adjusted returns. This is because although we assume that equities will outperform bonds over the long term, it is very difficult to tell which asset class is going to be the strongest in any given year. If we again look back to 2008, government bonds were by far the best performing asset class, while emerging market equities were the worst. The following year, the opposite was the case.
Although cash will not lose value when equity markets drop, it will also not increase at any meaningful rate either. Depending on the exact instrument used, bonds are more volatile than cash, but they can also be inversely correlated with equities so that they provide positive returns while equities are falling.
It is still important to hold some cash for unexpected requirements, but adding an element of quality bonds to the portfolio may help to smooth the path of your portfolio returns over time.
Adrian Lowcock says:
Your concerns over bonds are understandable in a world of rising interest rates, however they will provide better protection should the market crash or a recession emerge – both will happen at some point.
First you should reduce your cash savings to a year's worth of income (£36,000) as this can be used in emergencies and for large one-off purchases. This can be done mainly through transferring your cash Isa into a stocks-and-shares Isa. I suggest moving around £50,000 of cash (from your Isa and NS&I holdings), which can be done within two years for you and your wife.
Your excess cash can be added to your investment portfolio to help boost its return, but also better help balance out the risks. As a starting point, you should have no more than 10 per cent in any one fund, even Lindsell Train Global Equity, which is a good fund.
I have designed a new portfolio (see Table 2), which address the main concerns I see. The new portfolio consolidates European equity funds into FP Crux European Special Situations (GB00BTJRQ064), but also adds equity income funds Threadneedle UK Equity Income (GB00B8169Q14) and Fidelity Global Dividend (GB00B7778087). Also, as I suggested, your bond exposure needs to increase, which is done via Kames Investment Grade Bond (GB00B142F707).
The Japanese funds you hold are both high-risk and high-return so I have removed them and added a more core Japan fund in Schroder Tokyo (GB00BGP6BR86). I also introduced some emerging markets exposure to gain access to all major equity sectors.
Spare cash or investments can be topped up from excess income from your pension and from any income received from your investments.
Table 2: Adrian Lowcock's suggested portfolio
|Holding||New portfolio value (£)||% of portfolio||Old portfolio value (£)||Change (£)|
|Lindsell Train Global Equity (IE00BJSPMJ28)||14,000||7.59||26,450||-12,450|
|Artemis Strategic Bond (GB00BJT0KV40)||14,000||7.59||2,930||11,070|
|NEW: Kames Investment Grade Bond (GB00B142F707)||14,000||7.59||0||14,000|
|Legal and General US Index Trust (GB00BG0QPL51)||14,000||7.59||1,881||12,119|
|NEW: Threadneedle UK Equity Income (GB00B8169Q14)||14,000||7.59||0||14,000|
|NEW: Fidelity Global Dividend (GB00B7778087)||12,591||6.83||0||12,591|
|FP Crux European Special Situations (GB00BTJRQ064)||12,000||6.51||5,144||6,856|
|Liontrust Special Situations (GB00BG0J2688)||10,000||5.42||8,051||1,949|
|Scottish Mortgage Investment Trust (SMT)||7,275||3.94||7,275||0|
|NEW: Schroder Tokyo (GB00BGP6BR86)||7,000||3.80||0||7,000|
|Standard Life UK Smaller Companies (GB00BBX46183)||7,000||3.80||10,291||-3,291|
|NEW: Lazard Emerging Markets (GB0008467101)||7,000||3.80||0||7,000|
|Stewart Investors Asia Pacific Leaders (GB0033874768)||5,000||2.71||10,420||-5,420|
|Sylvania Platinum (SLP)||866||0.47||866||0|
|U and I Group (UAI)||754||0.41||754||0|
|Conygar Investment Company (CIC)||460||0.25||460||0|
|National Savings & Investments bonds||18,100||9.81||30,400||-12,300|
|Cash (easy access Isa)||17,900||9.70||17,900||0|
Table 3: Removed holdings
|Holding||Old portfolio value (£)|
|Baillie Gifford Japanese (GB0006011133)||3,832|
|Legg Mason IF Japan Equity (GB00B8JYLC77)||1,355|
|Jupiter European (GB00B5STJW84)||4,998|
|Baring Europe Select (GB00B7NB1W76)||2,777|
|Slater Growth (GB00B7T0G907)||3,002|
|Cash (1-1.25 per cent Isa)||37,160|