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Back the field rather than individual horses over the very long term

Our reader should diversify his daughter's portfolio by reducing the large holding in National Grid
December 14, 2017, Sophie Kilvert and Robert Ward

Rory has built up a portfolio comprising an individual savings account (Isa), Lifetime Isa (Lisa) and self-invested personal pension (Sipp) for his 18-year-old daughter.

Reader Portfolio
Rory Anderson's daughter 18
Description

Isa, Lisa and Sipp

Objectives

Fund retirement from the age of about 55 to 65

Portfolio type
Investing for growth

"The purpose of the portfolio is to fund my daughter's retirement from the age of about 55 to 65," explains Rory. "I intend to invest the maximum amount possible in Isas until she is 25, split between a stocks-and-shares Isa and a Lisa, and continue to contribute £2,880 a year to her Sipp.

"There is a large amount of cash in the stocks-and-shares Isa because a cash Isa has just been transferred into it and is yet to be deployed.

"In general, I'm interested in low-fee products with accumulation share classes that reduce the cost of reinvesting. I would particularly love to find a low-cost defensive equity exchange traded fund (ETF) that allows you to reinvest dividends, although as this is a very long-term savings pot I'm also happy to take on some risk.

"All the direct share holdings and funds are set to reinvest on the platform on which the portfolio is held, Hargreaves Lansdown."

 

Rory's daughter's portfolio

HoldingValue (£)% of portfolio
Isa  
Cash15,811.4112.74
BlackRock World Mining Trust (BRWM)7469.396.02
db x-trackers JPX-Nikkei 400 UCITS ETF (XDNG)4998.44.03
HSBC FTSE 100 UCITS ETF (HUKX)12115.259.76
Hutchinson China MediTech (HCM)47083.79
SSE (SSE)4457.63.59
UBS MSCI EMU UCITS ETF (hedged to GBP) (UB0F)5016.664.04
UK Commercial Prop Trust (UKCM)4993.544.02
Vanguard FTSE All-World UCITS ETF (VWRL)12449.2610.03
Vanguard FTSE Emerging Markets UCITS ETF (VFEM)4507.473.63
Lisa  
Cash104.750.08
Vanguard Global Value Factor UCITS ETF (VVAL)3865.363.11
Sipp  
Cash102.740.08
Henderson Smaller Companies Investment Trust (HSL)6530.045.26
iShares FTSE 100 UCITS ETF (CUKX)4591.593.7
Legal & General (LGEN)5078.924.09
National Grid (NG.)27335.9322.02
Total124,136.31 

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:

There's an important lesson that everyone planning to invest for the long term – as you are – should take note of. It's that you cannot hold individual stocks for decades. This is because in the long run there's a high chance that they will be devalued by market competition – creative destruction – or political change. For example, will your holdings in SSE (SSE) and National Grid (NG.) really survive the threat of nationalisation?

History demonstrates this. Only 28 of the FTSE 100 constituents in 1984 survive today. It's true that many have thrived after takeovers or splits. But many have not: Woolworths and MFI, to name but two, have collapsed. Today's blue-chips might be tomorrow's failures.

It's easy to understate this risk. Even if there's only a 1 per cent chance of a company failing in any one year, there's only a two-thirds chance of it surviving for 40 years.

The healthier and more dynamic the economy is, the greater the chances of companies failing in the long run because the forces of competition are so strong. And if you believe we are on the verge of another industrial revolution, the dangers of stockpicking for the long term are even greater. The companies that embody the artificial intelligence and robotics industries that might dominate the economy in your daughter's middle-age probably don't exist today. But they'll compete away the companies that do.

 

Sophie Kilvert, relationship manager at Seven Investment Management, says:

You have made an excellent start in building a portfolio for your daughter. You are making best use of the tax wrappers that are available to her, although when she does retire on this very good nest egg that you are building up for her, the retirement age could be higher than the 68 that's currently set for someone of her age.

Also bear in mind that as she starts working, the amount she or you can put into her pension and obtain tax relief on can go up to the limit of her annual earnings, capped at £40,000 gross. But if she has no earnings the maximum is £3,600 gross.

I would also ensure that you make clear to your daughter the process of investing, the benefits of compounding, and the relationship between risk and reward, so she can learn what impact taking more or less risk could have on her portfolio. Although she is not able to access any of the money in the pension at the moment, now that she has turned 18 the Isas are hers and she can do what she likes with them.

It is important that you both understand the purpose for which you intend for the Isas. You might want to consider taking a slightly different view with the Isas to the Sipp, as your daughter could use the Isas earlier for a house deposit or other expense. This would mean a shorter time horizon than for the pension fund, which will not be available to her for many years.

 

Robert Ward, chartered wealth manager at Walker Crips, says:

Optimising Isas, Lisas and pension allowances is an excellent way to invest tax efficiently. It's also good that all dividends are being reinvested, and within the tax-efficient wrappers, the benefits of which should not be underestimated. As Albert Einstein said, "the most powerful force in the universe is compound interest".

Your investment time horizon is also good, as the more that can be saved and invested towards retirement in the early stages of life, the easier things will be as time progresses. Keep on using the tax-efficient wrappers and making regular savings.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

A very long-term strategy should back the field rather than individual horses, which means holding tracker funds. And because we can't be at all confident about which economies will prosper the most over the next 40 years, they should be global trackers.

You can forget actively managed funds too. Even if you can find a great fund manager, you'll not find one that stays great for 40 years. Over such a time horizon active managers' fees also become monstrous. If a manager performs in line with the market before fees for 40 years but charges an extra percentage point in fees, he or she might well cost you over £2,000 for every £1,000 you invest, assuming a market return of 5 per cent a year.

Your therefore have the correct core holdings - low-cost ETFs. You are also right to look for defensive ETFs. We know that defensive stocks have beaten the market over the long run on average. And there might well be a hard-wired reason for this: investors who are prevented from borrowing express their bullishness by buying high-beta stocks, which leaves low-beta ones relatively underpriced.

There are a couple of ETFs with which you might be able to exploit this: PowerShares FTSE UK High Dividend Low Volatility UCITS ETF (UKHD) and Ossiam FTSE 100 Minimum Variance UCITS ETF (UKMV).

But there is another option. Many equity income funds and investment trusts have big holdings in defensive stocks, and many funds allow you to reinvest dividends automatically if you hold the accumulation share class.

But there is a danger here. It's quite possible that shares will not do well over the very long run: the fact that they've bounced back in the past does not prove that long-term investing will continue to be safe. Over a 40-year investment horizon we can't rule out the possibility that equities will be hurt by ongoing slow growth, political change or inflation. And even if capitalism thrives, it's quite possible that growth will come not so much from existing quoted companies as from unlisted ones. So equities are not a safe long-term bet.

 

Sophie Kilvert says:

You should invest the cash you have recently transferred over from the cash Isa. With current interest rates so low, the benefits of holding cash rather than stocks and shares are minimal. This is particularly the case given the investment risk that you can take due to the long time horizon, and since cash could be eroded in real terms due to the level of inflation.

You are using ETFs reasonably effectively to get coverage of a variety of assets and geographies. When choosing these, you should consider not just the cost, but also whether they replicate the index they track using physical or synthetic methods. The ETFs you currently hold look to replicate the returns of the indices they are tracking by physically owning shares. But if in future you opt for an ETF that replicates an index's returns by using derivatives you should consider the additional counterparty risk involved.

You also have quite a heavy overweight position in one individual share, National Grid, which represents over 20 per cent of the portfolio. This is a large position to have in one company when the rest of the portfolio seems to be quite balanced. National Grid has lost about 10 per cent of its value over the past five years, although it will have paid some decent dividends during this time. But I would question whether you should keep such a large position. It can be hard to cut losses, but when there are no tax implications in doing this, as National Grid is held within a pension, you might do better deploying the capital on a more diversified basis elsewhere.

Maybe put it into an investment trust which would offer you a well-managed diversified portfolio at a relatively low cost.

 

Robert Ward says:

In terms of the underlying holdings, you have something of a mixed strategy. You say that you require a defensive strategy, yet your daughter's time horizon is very long at over 30 years. When investing, you should stick to a very clear strategy for the portfolio – perhaps even write this down and refer back to it prior to making any amendments. Ensure there is a clear strategy and specific objectives, and that all investment decisions are aligned with these.

The portfolio is reasonably diversified, but holding lots of different companies doesn't always equal good diversification. For example, National Grid accounts for nearly a quarter of the portfolio, which is a very heavy weighting for a single stock. I would suggest that this position is reviewed and reduced to 10 per cent or less of the overall portfolio, with a view to making the portfolio more diverse.

Investors tend to have a 'home bias', preferring to invest in companies listed in their home country because they feel comfortable with these. Close to half of the portfolio is invested in UK equities, and although a large proportion of FTSE 100 earnings are derived from overseas, a partial switch out of National Grid would go a reasonable way towards diversifying the portfolio and reducing the home bias.

With a very long-term investment horizon it's worth considering strategies that could reap rewards over this period, while increasing exposure to countries and more particularly sectors that the portfolio doesn't currently have exposure to, such as technology. Although there are low-cost tracking options available, my preferred route for such an investment would be actively managed Polar Capital Technology Trust (PCT). This investment trust's managers have consistently outperformed their benchmarks over the long term so certainly justify their fees.

If you prefer a defensive route, there are low-cost passive options such as Vanguard Global Minimum Volatility UCITS ETF (VMVL). This provides exposure to global equities with low volatility for a very competitive 0.22 per cent ongoing charge.