Value could make your portfolio more resilient and well-rounded

“All our investments are held in tax-efficient wrappers – £600,000 in self-invested personal pensions (Sipps) and £220,000 in individual savings accounts (Isas),” says Jeffrey. “We want to draw about £20,000 a year from our Isas to fund holidays. When we respectively reach age 75 we plan to draw down 25 per cent of each pension and reinvest it in the Isas. We want to leave the remaining assets in the Sipps untouched for our daughter to inherit.

"We are prepared to see the value of our investments fall by up to 30 per cent or more in any given year. I have been investing for 30 years, mainly for growth, in investment trusts focused on equities. I hope that their geographic and sector spread provides enough diversification. We also have a large legacy holding in Lloyds Banking (LLOY) and a few other holdings that have grown tremendously over the years.

"I have avoided gilts (UK government bonds), gold, cash, and ethical and renewable energy funds.

Jeffrey and his wife's investment portfolio

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

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You should be able to meet your objectives as £20,000 a year is only 2.4 per cent of these investments, minus the properties. With average luck, over time you should be able to withdraw this amount while preserving the real value of your portfolio to pass on to your daughter.

It's also good that you're avoiding unnecessary expenses by making full use of tax shelters.

With no gilts or gold, and little cash, you are not very well diversified. However well you spread your equity holdings, you are still exposed to global market risk because almost all shares – and especially portfolios of them such as investment trusts – fall when global markets fall. This is a particular danger for your emerging markets and smaller companies trusts, which are likely to do especially badly in a recession.

Such an allocation is understandable. Gold and gilts offer insurance against many types of short-term stock market falls including the ones that have happened recently. But they offer it at the very high price of losses in real terms in average market conditions.

You could take short-term losses on the chin in the belief that equities will rise over the long run. But my concern is that long-term returns are not certain: western economies might be trapped in secular stagnation with the result that shares remain depressed or fall further. Such a prospect might seem slim, but it is unquantifiable so justifies holding some non-equity assets. You could do worse than cash.

Rob Morgan, pensions and investments analyst at Charles Stanley, says:

With no growth, your Isas at the value set out above plus 25 per cent from your Sipps would last nearly 20 years. So you could generate £20,000 per year without taking significant risk, although it is best to maximise return potential and counteract the effects of inflation. 

The most significant danger is the effect of market drawdowns on the value of your investments as recent events have highlighted – especially if you make any withdrawals at the wrong time. So set aside sections of the Isa portfolios to provide the necessary cash flow and consider lower volatility investments for these at the appropriate times.

I’ve nothing against residential property, but buy-to-lets tend to be relatively ‘hands on’ compared with other forms of investing, and this may become more of a burden later in life.

If you have not already made plans for this, also think about how to prepare to pass on your wealth in an effective manner to your daughter. It could be a good idea to seek professional financial advice on this.

Ben Yearsley, director at Shore Financial Planning, says:

I’m glad that you could tolerate the value of your investments falling up to 30 per cent in any given year, as the FTSE All-Share index is down 7 per cent as I write this. This is a good attitude to have with regard to risk and reward – in particular not panicking when markets fall. However, your portfolio includes many higher-risk holdings and you might want to slightly dial down the risk level in the next few years. 

You and your wife propose taking the 25 per cent tax-free entitlements from your pensions by the time you each are age 75, and to leave the rest of them for your daughter. If either or both of you die before age 75 the beneficiaries could draw on them tax-free. If you die after 75, the beneficiaries will be taxed on withdrawals from the pensions at their marginal rate of income tax. Depending on your daughter’s tax position at the time, some of this may fall into her annual tax-free personal allowance.

You assume that you will not need any income from the Sipps as your £50,000-a-year income after tax covers most of your expenses. You are going to reinvest your 25 per cent tax-free pension entitlements in your Isas, from which you will draw £20,000 a year to fund holidays.

But you will not be able to put the money you take out of your pensions – around £150,000 – into your Isas in one go. And the more you leave in the pensions, the better from an inheritance tax perspective. With a main residence worth about £450,000, two buy-to-let properties worth £320,000 and your Isas, your joint assets excluding the Sipps are worth about £1m.

You could easily generate an income of 5 per cent a year from the Isas, especially with markets having fallen, which would cover half the annual £20,000 travel budget. Consider reallocating your Isas so that they have more of an income focus as this would also mean you could leave more of the Sipps untouched.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Keep an eye on investment trusts' discounts. A low discount, relative to a trust’s own history, can be a sign that sentiment towards it is too high and that its holdings are overpriced. Several of your funds have, until very recently, enjoyed great long-term returns. Although these vindicate your investments it might also be a sign that these have become overpriced. A few years ago, investors were underpricing monopoly-type stocks, which funds including Scottish Mortgage Investment Trust (SMT) and Finsbury Growth & Income Trust (FGT) hold. But investors might have overcorrected this error so such shares might be overpriced. In investing, nothing lasts forever.

However, I like that you have exposure to unquoted stocks via Pantheon International (PIN). It’s quite possible that a lot of future growth will come from younger, yet-to-be-listed companies.

It’s difficult to see why you have more than 8 per cent of your investments in just one stock, Lloyds Banking. Just because you’ve had it a long time doesn't mean that you should continue to hold it – future returns on an asset are unrelated to how long you’ve held it for. Your portfolio should not resemble my garage – full of stuff I haven’t got around to chucking out.

Your avoidance of ethical and renewable investments is reasonable. If markets are efficient, investors pay for the feeling that they are doing the right thing in the form of lower financial returns. But my concern is that markets are not efficient, so by avoiding these you might miss out on an area set to do well.

Rob Morgan says:

Your investments are highly growth-orientated, with lots of smaller company and private equity exposure. They include some good quality investment trusts and many of these holdings have done well over long periods. But you have heavy exposure to the technology sector, with a large weighting to Polar Capital Technology Trust (PCT) alongside Baillie Gifford-managed Monks Investment Trust (MNKS), Edinburgh Worldwide Investment Trust (EWI) and Scottish Mortgage Investment Trust. The latter three trusts' holdings overlap significantly in terms of style, so holding all three probably doesn't give you much benefit in terms of diversification. 

I don't know whether you are deliberately avoiding more value-orientated areas, but these could make the portfolio more resilient and well-rounded in terms of style. It’s been a terrible few years for most managers who run their funds according to a value investment style, but if you invest in good ones when the style is out of favour it could be beneficial over the longer term and mean that you are less reliant on growth investments outperforming.

Although your large holding in Lloyds Banking may be cherished, having quite so much in one individual company would make me uncomfortable. I don't know what Lloyds' share price is going to do, so it would seem wise not to be overly reliant on the fate of a single company. Consider diversifying.

Ben Yearsley says:

You have built a long-term growth-focused portfolio, but I would suggest making the Isas more income-focused. I'm not sure whether holdings such as Diverse Income Trust (DIVI) and HICL Infrastructure (HICL) are in the Isas or Sipps, but it would make sense to have them in the Isas to help generate income to cover the costs of your holidays.

Also switch some of the Isas' growth-focused holdings into more income-focused ones, and maybe add a global equity income fund such as Troy Trojan Global Income (GB00BD82KQ40). Or add some more infrastructure funds such as First State Global Listed Infrastructure (GB00B24HK556), which has a healthy yield and provides some inflation protection.

Some of your holdings have been hit hard in the current market correction, such as Lloyds Banking, although its dividend is still very attractive. However, the interest rate environment isn’t helpful in terms of Lloyds' share price improving.

I would allocate 25 per cent of the Sipps to more stable investments such as Personal Assets Trust (PNL), Architas Diversified Real Assets (GB00BRKD9W23) and RIT Capital Partners (RCP), which you already have. This is the 25 per cent that you plan to withdraw from your pensions within the next four to six years, so you still need it to grow in the meantime, but not at the same pace as holdings such as Polar Capital Technology Trust. 

I don’t have a problem with any one of your holdings and there are many good ones such as Montanaro UK Smaller Companies Investment Trust (MTU), Biotech Growth Trust (BIOG), Pantheon International and Scottish Mortgage Investment Trust.  But these and most of your other holdings have a growth investment style, so your investments are not well balanced. Funds that could give your portfolio more of a value tilt include Temple Bar Investment Trust (TMPL), Miton Global Opportunities (MIGO), JOHCM UK Dynamic (GB00BDZRJ101) and Schroder Global Recovery (GB00BYRJXP30).