Donald is 72 and lives in Singapore with his wife. Their home is worth around £7m and they also have a flat in London worth £2m, which they plan to spend more time in when visiting their children and grandchildren. Their equity and bond investments produce an income of £52,800 a year, and Donald also receives £3,400 a year from pensions. They do not have any debt.
UK and overseas shares, Singapore Reits, direct bonds, property and cash
5% growth, 2% income. Help children financially.
“We finance our living costs from the portfolio, supported by a healthy cash position,” says Donald. “Our children have grown up, but given the difficult situation for younger people these days due to the costs of education and housing in the UK, we need to assist them financially.
"This means we have an annual deficit of around £40,000, which I fund with my cash position. But the DBSSP 5.750% Perpetual Preference bond (SG7R06940349) has a call date on 15 June 2018 so will address any cash requirements for the foreseeable future.
“It would be unrealistic to expect a continuation of the past few years’ market performance. But once we have got through the correction I think that a reasonable return would be 5 per cent growth from my equity investments and 2 per cent from dividends.
“I have invested for about 40 years, initially in property and private equity deals, which did not turn out well. But I have been much more focused on equities over the past 10 years since retiring. I initially did a lot of trading, but have now built what I think is a reasonably diversified portfolio with exposure to the US, UK, Japan and China via Hong Kong shares, alongside some Singapore real-estate investment trusts (Reits).
“I try to buy and hold for the long term with occasional rebalancing.
“I used to have too much of an orientation towards risk, and as I didn’t plan properly that resulted in some poor investments.
“But now I am more aware of risk, although it cannot be eliminated. The most important thing is not to be a forced seller.
“I would hope that any correction wouldn’t incur a loss of more than £200,000, but if the market fell that much it would be foolish to get out at that point. I also appreciate that without taking risk there will be no reward.
"I am well positioned to take advantage of a correction and invest more in equities, because of my maturing bond and £153,000 cash. I would add to my existing shareholdings, and if GE (US:GE) experiences significantly more reduction in value I might buy it as a long-term recovery opportunity. I would also like to add Spectris (SXS), Salesforce.com (US:CRM) and National Grid (NG.) for the yield and Amazon (US:AMZN) if the shares became meaningfully cheaper.
“If there’s no meaningful correction I will sit on the cash. It is also important to try to assess the respective returns associated with the varying opportunities. For me this means having enough cash or lower-risk assets to see me through a downturn of, say, two years.
“I embrace risk where I think it could strengthen the portfolio. I spend a lot of time trying to understand the investment environment and how it might affect the stocks in my portfolio. I can take hits on individual holdings – the important thing is to have a balanced portfolio.
“I view my five Singapore Reit holdings as bond proxies because Singapore is a very stable property environment.
“I think market risk has reduced, however any correction in the US will have an effect on other markets. I realise that having more holdings would spread the portfolio’s risk further, however the more you go down that path, the more the reason to just buy the whole market via exchange traded funds (ETFs). But I am not going to do this as I enjoy the investing process, so prefer having an active portfolio – maybe with less market risk.”
|Holding||Value (£)||% of the portfolio|
|WH Group (288:HKG)||65,521||3.87|
|Shanghai Haohai Biological Technology (6826:HKG)||38,043||2.25|
|Standard Chartered (STAN)||28,944||1.71|
|Keppel-KBS US REIT (CMOU:SES)||21,741||1.28|
|Ascendas Reit (A17U:SES)||31,454||1.86|
|CapitaLand Commercial Trust (C61U:SES)||37,210||2.2|
|Frasers Centrepoint Trust (J69U:SES)||31,214||1.84|
|Viva Industrial Trust (T8B:SES)||32,055||1.89|
|DBSSP 5.750% Perpetual Pref (SGD) Capital Funding II (SG7R06940349)||275,367||16.27|
|Aviva 5.9021% FXD FKTG DCI (AV20)||213,355||12.61|
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:
I sympathise with your view that a significant market fall is possible in the next few years.
In large part, you’re prepared for it with your big holdings of cash and bonds – almost 40 per cent of your portfolio. Whether you want to hold even more of these depends in part on how much market risk you need to take. If you can fund your outgoings without the need for positive real returns, then you can afford a much bigger cash position and safer portfolio.
If that isn’t feasible, then consider what particular risks you are willing to take and which ones you aren’t prepared to take. There are four main risks to consider.
The most obvious one is market risk. In the event of a serious correction, almost all shares will fall to some extent – you cannot escape market risk by holding equities. While you hold a few defensives that should hold up relatively well, such as BP (BP.), AstraZeneca (AZN) and WH Group, your holdings in HSBC (HSBA) and Standard Chartered (STAN) add to market risk. Banks generally underperform in serious bear markets.
Then there’s liquidity risk. In serious downturns, property becomes harder to sell. It’s this risk that affects Reits and your housing investments. In theory, you could raise cash by downsizing. But it would be hard to do this quickly if there is a genuine global downturn.
Aside from your bank holdings and the fact that share prices in general do badly in recessions, you are not taking on much cyclical risk. You hold fewer construction stocks and industrials than many investors. In this sense, your portfolio is quite defensive.
There is, however, a fourth risk that might be underappreciated not just by you but by many investors – valuation risk. A big reason for the rise in share prices in recent years has been that investors have wised up to the importance of monopoly power as a source of sustained profit growth. This, I suspect, has fuelled the rising prices of Facebook (US:FB), Alibaba (US:BABA), Alphabet (US:GOOGL) and Tencent (700:HKG), among others.
But one cause of the next market correction might be a reassessment of this. Maybe investors will come to believe that they are overpaying for monopoly power, either because valuations become stretched or because they doubt whether these companies really do have such strong "economic moats" as they thought. So far, these stocks have been winners from the process of creative destruction, but can we really be sure that this will remain the case?
Generally speaking, this portfolio is well diversified across countries and, more importantly, assets and types of risk exposure. You might, however, be taking on too much valuation risk.
Paul Derrien, investment director at Canaccord Genuity Wealth Management, says:
Overall, you have employed a good strategy so far. You have a significant enough number of equities and have kept a limit on the amount of your portfolio each accounts for. This keeps an appropriate balance with no excessive overweights, which is all very sensible.
There is also a good balance of assets – broadly 60 per cent risk assets and 40 per cent cash or fixed income. I feel that this is an ideal amount of risk assets as we enter a potentially more volatile period for equity markets, despite the fact the investments are a major source of your income. In an extreme period you also have substantial property reserves to fall back on if ever needed.
You are willing to accept a fall of about20 per cent in the value of your equities, and this level covers all but the most extreme market falls. Being willing to buy during these dips, no matter how severe, is an excellent strategy. Of course it could be different next time, but you have sufficient reserves to take advantage of downturns, even if it is just rebalancing to this 60:40 level.
Rory McPherson, head of investment strategy at Psigma Investment Management, says:
You don’t mention holding these investments in tax wrappers, so have a look at whether you could hold them in a more tax-efficient way. I would also urge you to speak to a financial planner to ensure that you take the capital you are receiving in the most tax-efficient way. For instance, both you and your spouse could hold these assets, so both of you could make full use of your UK personal allowances, which are £11,850 each, your capital gains allowances of £11,700 each and your dividend allowances of £2,000 each this tax year.
In the UK, you fall into the higher-rate tax band, which means that your dividend income will attract a rate of 32.5 per cent. This is as opposed to 7.5 per cent if you focused less on income and more on gains, bringing you into a lower tax band.
You have not said where you are tax resident, so it could be worth paying a one-off fee to an international financial planner who specialises in Singaporean expats, if that applies to you. It could also be worth seeking professional financial advice on ways to mitigate the inheritance tax liability of your residential properties.
HOW TO IMPROVE THE PORTFOLIO
Paul Derrien says
Your equity investments lack sector diversification. There are large exposures to technology and pharmaceuticals, which leave the portfolio exposed to any surprises in these sectors. You may be fully aware of and feel comfortable with this, but if you are nervous on equity markets I would suggest that now is an excellent opportunity to improve diversification.
You enjoy stockpicking, and invest time and effort into your strategy, so I would not change this approach. However, to address the lack of equity diversification in your portfolio, I would retain the individual equity positions you have, but reduce them to, say,2.5 per cent of the portfolio each.
The cash that this would raise could then be used to introduce some strategic diversification. This would be an adjustment rather than a wholesale change to your strategy. You could make specific country allocations if you felt strongly about a region or stick with something more global.
ETFs are a good low-cost way to do this. Or you could add funds you think will outperform and provide the necessary diversification. Options include Scottish Mortgage Investment Trust (SMT), Berkshire Hathaway (BRK.A:NYQ), Fundsmith Equity (GB00B41YBW71) or Murray International Trust (MYI). These would add some global diversification and reduce your stock-specific risk. But before adding such funds check that they do not have similar sector allocations to your portfolio.
Rory McPherson says:
You have put a lot of thought into your investments and have a mix of holdings that are likely to have done well over the past few years. But consider diversifying some of the risk going forwards and having more sterling exposure, as that is where the bulk of your liabilities are – your payments to your children.
This may seem counterintuitive given that you have around a quarter of your portfolio in UK-listed shares, but these are very large companies and roughly 70 per cent of their earnings are likely to be derived from overseas. I’d suggest investing in more domestically focused UK companies, and our preferred pick for accessing them is Royal London UK Equity Income Fund (GB00B3M9JJ78).
But given the nature of the UK equity market, it is very difficult to achieve 100 per cent sterling exposure. So you may want to add some bond funds such as Twenty Four Corporate Bond (IE00BSMTGF70), which has a 12-month yield of3.94 per cent.
Adding an allocation to fixed income would also help build some ballast into your portfolio. You do not want to suffer a loss greater than £200,000, but a 50 per cent drop in equities could equate to a capital hit of almost £450,000. We’re big fans of the bond teams at Twenty Four Asset Management in the UK [who run a number of other funds including MI TwentyFour Dynamic Bond (GB00B57TXN82)].
You have around half of your portfolio in 16 direct shareholdings, with roughly half of this in UK stocks, and the rest in US and Asian tech and consumer companies. Some of these tech companies have done fantastically well and it’s clearly a theme worth being exposed to, but I’d encourage you to consider letting an active fund manager make some of these decisions for you. You could add a global growth fund [see the IC Top 100 Funds for more suggestions on these].
With your healthcare and biotech allocation, it may be worth taking a ‘core/satellite’ approach, whereby some smaller stock positions are held alongside a core holding such as Polar Capital Healthcare Blue Chip Fund (IE00BPRBXV28).
You have residential property worth around £9m, so consider whether you want even more exposure via your large holdings in Reits, of which the underlying value is underpinned by property.